BASICS OF ACCOUNTING THEORY Flashcards
1
Q
- What are the Statements of Financial Accounting Concepts intended to establish?
a. Generally accepted accounting principles in financial reporting by business enterprises.
b. The meaning of “Present fairly in accordance with generally accepted accounting principles.”
c. The objectives and concepts for use in developing standards of financial accounting and reporting.
d. The hierarchy of sources of generally accepted accounting principles.
A
- (c) The Statements of Financial Accounting Concepts (SFAC) were issued to establish a framework from which financial accounting and reporting standards could be developed. The SFAC provide the theory behind accounting and reporting and provide guidance when no GAAP exists. The SFAC are not included as GAAP.
2
Q
- According to the FASB conceptual framework, the objectives of financial reporting for business enterprises are based on
a. Generally accepted accounting principles.
b. Reporting for regulators.
c. The need for conservatism.
d. The needs of the users of the information.
A
- (d) Per SFAC 8, the objectives of financial reporting focus on providing present and potential investors and creditors with information useful in making investment decisions. Financial statement users do not have the authority to prescribe the data they desire. Therefore, they must rely on external financial reporting to satisfy their information needs, and the objectives must be based on the needs of those users.
3
Q
- According to the FASB conceptual framework, the relevance of providing information in financial statements is subject to the constraint of
a. Comparability.
b. Cost-benefit.
c. Reliability.
d. Faithful representation.
A
- (b) The FASB conceptual framework has identified the cost
4
Q
- The enhancing qualitative characteristics of financial reporting are
a. Relevance, reliability, and faithful representation.
b. Cost-benefit and materiality.
c. Comparability, verifiability, timeliness, and understandability.
d. Completeness, neutrality, and freedom from error.
A
- (c) The enhancing qualitative characteristics of financial reporting are comparability (including consistency), verifiability, timeliness, and understandability. Answer (a) is incorrect be cause relevance and faithful representation are fundamental qualitative characteristics of financial information. Reliability is no longer listed as a fundamental quality. Answer (b) is incorrect because cost-benefit is a constraint, and materiality is a threshold for reporting useful information. Answer (d) is incorrect because completeness, neutrality, and freedom from error are characteristics of faithful representation, a fundamental qualitative characteristic.
5
Q
- According to Statements of Financial Accounting Concepts, neutrality is an ingredient of Faithful representation a. Yes b. Yes c. No d. No Relevance Yes No Yes No
A
- (b) SFAC 8 defines neutrality as the quality of information which requires freedom from bias toward a predetermined result. Unbiased information would always be more faithfully represented than biased information. Other components of faithful representation include information to be verifiable and free from error. Neutrality is not an ingredient of relevance because relevance requires information to have predictive value and confirmatory value, or both.
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6
Q
- According to the FASB conceptual framework, which of the following is an enhancing quality that relates to both relevance and faithful representation?
a. Comparability.
b. Confirmatory value.
c. Predictive value.
d. Freedom from error.
A
- (a) Per SFAC 8, comparability is an enhancing quality of financial reporting which relates to both relevance and faithful representation. Confirmatory value and predictive value only relate to relevance. Freedom from error only relates to faithful representation.
7
Q
- According to the FASB conceptual framework, the process of reporting an item in the financial statements of an entity is
a. Allocation. b
. Matching.
c. Realization.
d. Recognition.
A
- (d) Per SFAC 5, recognition is the process of formally recording or incorporating an item into the financial statements as an asset, liability, revenue, expense, or the like. According to SFAC 6, allocation is the process of assigning or distributing an amount according to a plan or formula, matching is the simultaneous recognition of revenues with expenses that are related directly or jointly to the same transactions or events, and realiza tion is the process of converting noncash resources and rights into money.
8
Q
- Under FASB Statement of Financial Accounting Concepts 5, which of the following items would cause earnings to differ from comprehensive income for an enterprise in an industry not having specialized accounting principles?
a. Unrealized loss on investments classified as available for-sale securities.
b. Unrealized loss on investments classified as trading securities.
c. Loss on exchange of similar assets.
d. Loss on exchange of dissimilar assets.
A
- (a) Per SFAC 5, earnings and comprehensive income have the same broad components— revenues, expenses, gains, and losses— but are not the same because certain classes of gains and losses are excluded from earnings. Changes in market values of investments in marketable equity securities classified as available-for-sale securities are included in comprehensive in come, but are excluded from earnings until realized. Answers (b), (c), and (d) are incorrect because they would be included in both earnings and comprehensive income. Note that unrealized gains and losses on marketable equity securities classified as trading securities are included in earnings. This treat ment is in accordance with SFAS 115.
9
Q
- Under FASB Statement of Financial Accounting Concepts 5, comprehensive income excludes changes in equity resulting from which of the following? a. Loss from discontinued operations. b. Prior period error correction. c. Dividends paid to stockholders. d. Unrealized loss on securities classified as availablefor-sale.
A
- (c) Per SFAC 6, comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Dividends paid to stockholders is a change in equity resulting from a distri bution to owners, so it is excluded from comprehensive income. Answers (a), (b), and (d) are all included in comprehensive in come because they are changes in equity, but are not invest ments by, or distributions to, owners.
10
Q
- The fundamental qualitative characteristic of faithful repre sentation has the components of a. Predictive value and confirmatory value. b. Comparability, consistency, and confirmatory value. c. Understandability, predictive value, and reliability. d. Completeness, neutrality, and freedom from error.
A
- (d) The fundamental qualitative characteristic of faithful representation has the components of completeness, neutrality, and freedom from error. Answer (a) is incorrect because predictive value and confirmatory value are the components of relevance. Answer (b) is incorrect because comparability and consistency are enhancing characteristics, and confirmatory value is a component of relevance. Answer (c) is incorrect, because understandability is an enhancing characteristic, predictive value is a component of relevance, and reliability is no longer a characteristic in the concept statements.
11
Q
- According to the FASB conceptual framework, which of the following statements conforms to the realization concept? a. Equipment depreciat was assigned to a production department and then to product unit costs. b. Depreciated equipment was sold in exchange for a note receivable. c. Cash was collected on accounts receivable. d. Product unit costs were assigned to cost of goods sold when the units were sold.
A
- (b) According to SFAC 6, realization is the process of converting noncash resources and rights into money through the sale of assets for cash or claims to cash. When equipment is sold for a note receivable, money is realized since a note qualifies as a claim to cash. Answers (a) and (d) relate to cost allocation. Answer (c) is incorrect because accounts receivable represents a claim to cash. Realization occurs at the time of sale rather than when cash is collected.
12
Q
- What is the underlying concept that supports estimating a fixed asset impairment charge? a. Substance over form. b. Consistency. c. Matching. d. Faithful representation.
A
- (d) An estimate of an impairment charge to a fixed asset can only be a faithful representation if the entity has applied impairment rules properly, disclosed the process of arriving at the impairment estimate and disclosed any uncertainties that affect the impairment estimate. Assuming the above is true, and no other estimate is better than the derived estimate, then the esti mate is comprised of the best available information. Therefore, it is a faithful representation.
13
Q
- What is the concept that supports the issuance of interim reports? a. Relevance. b. Materiality. c. Consistency. d. Faithful representation.
A
- (a) Relevant financial information is capable of making a difference if it has predictive value, confirmatory, value, or both. Predictive value requires information to be used to predict future outcomes. Confirmatory value requires that information either confirm or change prior expectations. An interim report provides both predictive value and confirmatory value because it provides a basis to forecast future earnings and it provides feed back about prior performance expectations. Therefore, interim reporting is relevant.
14
Q
- FASB’s conceptual framework explains both financial and physical capital maintenance concepts. Which capital maintenance concept is applied to currently reported net income, and which is applied to comprehensive income? Currently reported net income
a. Financial capital
b. Physical capital
c. Financial capital
d. Physical capital Comprehensive income Physical capital Physical capital Financial capital Financial capital
A
- (c) Per SFAC 6, the major difference between financial and physical capital maintenance is related to the effects of price changes on assets held and liabilities owed during a period. The financial capital concept is applied in current GAAP. Under this concept, the effects of the price changes described above are considered “holding gains and losses,” and are included in com puting return on capital. Comprehensive income, which is de scribed in SFAC 5, is “the change in equity of a business enter prise during a period from transactions and other events and circumstances from nonowner sources.” It is also a measure of return on financial capital. The concept of physical capital maintenance seeks to measure the effects of price changes that are not currently captured under GAAP (e.g., replacement costs of nonmonetary assets). Under this concept, holding gains and losses are considered “capital maintenance adjustments” which would be included directly in equity and excluded from return on capital.
15
Q
- According to the FASB conceptual framework, an entity’s revenue may result from
a. A decrease in an asset from primary operations.
b. An increase in an asset from incidental transactions.
c. An increase in a liability from incidental transactions.
d. A decrease in a liability from primary operations.
A
- (d) Per SFAC 6, revenues are inflows of assets or settlements of liabilities, or both, during a period as a result of an en tity’s major or primary operations. Two essential characteristics of revenues are that revenues (1) arise from a company’s primary earnings activities and (2) are recurring or continuing in nature. Therefore, answer (d) is correct because it meets the above crite ria. Answers (b) and (c) are incorrect because they result from incidental transactions. Answer (a) is incorrect because a de crease of an asset is not a revenue.
