Ch 5 Conceptual Framework

Question 1

True or false?

The overarching objective of IFRS accounting is to provide decision-useful information, in particular, for investors.

Answer 1

True

Question 2

To be decision-useful, information must be relevant, i.e., capable of
making a difference to the decision maker.

Answer 2

True

Question 3

True or False
Decision-usefulness can only be defined with reference to a specific user of financial statements. However, different users may have different information needs.

Answer 3

True

Question 4

The going-concern assumption assumes that the entity will be
liquidated within the next period and not continue its operations.

Answer 4

False
(it’s the exact opposite)

Question 5

The IFRS framework defines equity simply as the residual interest in
the assets of the entity after deducting all its liabilities.

Answer 5

True (Equity = Assets - Liabilities)

Question 6

Other comprehensive income (OCI) are gains and losses from
changes in current values of assets and liabilities that are not reported
in the statement of profit or loss.

Answer 6

True.

Example: For a company with international subsidiaries, changes in the value of assets or liabilities due to exchange rate fluctuations are recorded in OCI. These gains or losses from currency translation do not impact profit or loss until the assets are realized (= sold, disposed of, or settled)

Question 7

Historical cost information is often very relevant to financial statement
users, but in comparison to current value information (e.g., fair value) historical cost information is typically less reliable.

Answer 7

False.

Historical cost is often considered more reliable than current value (e.g., fair value), because it is based on actual transactions that have occurred and are verifiable

Question 8

Indicate whether an asset exists:

company has entered a 9-month lease agreement to rent a business
office

Answer 8

Yes

Under IFRS 16, even short-term leases can be recognized as a right-of-use asset unless the company chooses to apply the short-term lease exemption

Question 9

Indicate whether an asset exists:

costs of a high-level executive development course for the company’s
top management

Answer 9

No

This is an expense, not an asset, because it provides no future economic benefit that can be reliably measured or controlled.

Question 10

Indicate whether an asset exists:

company has acquired the right to use a well-known brand name

Answer 10

Yes

This is an intangible asset because the right to use the brand name provides future economic benefits and is controlled by the company.

Question 11

Indicate whether an asset exists:

expenditure on a promising research project

Answer 11

Yes

If the expenditure meets the criteria for capitalization under development phase accounting rules (e.g., the project is feasible, and future economic benefits are probable (>50%!)), it can be recognized as an intangible asset.

Question 12

Indicate whether an asset exists:

building bequeathed to a company

Answer 12

Yes

The company now controls the building, which has probable future economic benefits, making it an asset.

Question 13

Indicate whether an asset exists:

unsigned, documented contractual agreement to build specialised
equipment for a client

Answer 13

No

Without a signed contract, there is no enforceable right, so this does not meet the definition of an asset.

Question 14

Indicate whether an asset exists:

exploration project to find oil in the arctic sea
(10% chance of finding oil that can be exploited commercially)

Answer 14

Yes

The exploration costs might be recognized as an asset under successful efforts accounting if future economic benefits are probable. Even with a low probability, if the project is capitalized as exploration and evaluation assets under IFRS 6, it can be considered an asset.

Question 15

Indicate whether an asset exists:

the company holds a 5-year option to acquire property which was
purchased by the company a year ago

Answer 15

Yes

The option to acquire property is an asset because it provides a future economic benefit and is under the company’s control.

Question 16

Does a liability exist?

the company is being sued for injuries sustained by an employee who
claims that the workplace steps he fell down were unsafe

Answer 16

Yes

A potential liability exists due to the lawsuit, which could result in an obligation if the company is found liable.

Question 17

Does a liability exist?

The company has placed an order for raw materials with one of its regular suppliers (the material has not been delivered yet)

Answer 17

No

No liability exists until the materials are delivered and the company is obligated to pay.

Question 18

Does a liability exist?

Our company signs a contract to build a customized machine for a customer in the U.S.; the customer will pay after the machine has been installed

Answer 18

Yes.

A liability exists because the company has an contractual obligation

Question 19

Does a liability exist?

The company has unsecured notes (= a promise to pay/deliver which is not covered by collateral - ex.: medical bills) of $1,000,000 outstanding

Answer 19

Yes

The outstanding notes represent a financial obligation, making it a liability.

Question 20

Does a liability exist?

The company prepares its financial statements at the year-end; the company has a loan of $1,000,000 outstanding on which interest is payable annually, on the 15th of December

Answer 20

Yes

The company has an obligation to pay the interest, making it a liability.

Question 20

Does a liability exist?

The company has a loan of $1,000,000 outstanding which is secured by a mortgage on the company headquarters

Answer 20

Yes

This loan is a liability since the company is obligated to repay the loan.

Question 21

Does a liability exist?

At the end of the financial year, the company’s employees are still entitled to 2,475 vacation days related to the past year

Answer 21

Yes

The accumulated vacation days represent a liability, as the company is obligated to compensate employees for this time.

Question 22

Identify the best possible answer to the following question!

What is the objective of general purpose financial statements in accordance
with the IFRS Conceptual Framework for Financial Reporting?

(for WHOM, and for WHAT)

A) … providing the management of the company with information about the
financial position and performance of the company.

B) … providing information about the company that is useful to present and
future investors, lenders and other creditors in making decisions about
providing resources to the company.

C) … providing a starting point for determining payouts to shareholders.

D) … providing a starting point for determining tax payments of the company

Answer 22

B) is correct

WHO: present and
future investors, lenders and other creditors

WHAT: purpose is to give information useful to providing resources to the company

Question 23

What is the main purpose of the IFRS Conceptual Framework for
Financial Reporting?

A) The Conceptual Framework provides answers to accounting issues, which companies encounter in practice and which are not covered
in IFRS standards or interpretations.

B) … the Conceptual Framework provides rules for the recognition and
measurement of income and expenses in the Statement of Income.

C) Whereas IFRS standards present rules for the recognition and measurement
of assets, liabilities, income and expenses, the Conceptual Framework
provides detailed rules for disclosures in the Notes.

D) The Conceptual Framework outlines the objectives of financial reporting and
defines the elements of financial statements (assets, liabilities, income,
expenses). The purpose is mainly to guide the IASB itself in the development
of new IFRS standards.

Answer 23

D) is correct.

The framework provides general principles and guidance for financial reporting, not specific and detailed rules.

Question 24

Which qualitative characteristics are fundamental to general purpose
financial statements according to IFRS Conceptual Framework for Financial
Reporting?

A) relevance and comparability

B) relevance and verifiability

C) relevance and faithful representation

D) faithful representation and understandability

Answer 24

C) relevance ( -> capable of making a difference in the decisions made by users) and faithful representation ( = complete, neutral, and free from material error)

Question 25

Which set of characteristics best describes the qualitative characteristic
“faithful representation” according to The IFRS Conceptual Framework for
Financial Reporting?

A) completeness and neutrality

B) neutrality, freedom from error and verifiability

C) completeness, neutrality and freedom from error

D) neutrality, verifiability and understandability

Answer 25

C) Be complete: All necessary information must be provided.

Be neutral: It must be free from bias.

Be free from material error: The information should be accurate and not misleading.

Question 26

How is an asset defined according to the IFRS Conceptual Framework for
Financial Reporting?

A) An asset is a present economic ressource owned by the entity as a result of
past events

B) An asset is a present economic ressource controlled by the entity as a result
of past events.

C) An asset is a benefit controlled by a company as a result of past transactions
and events.

D) An asset is a past economic resource controlled by the entity as a result of
current events.

Answer 26

B) is correct.
According to the IFRS Conceptual Framework, an asset is defined as:

Present: It exists currently.
Economic resource: It is capable of generating future economic benefits.

Controlled by the entity: The entity has the right to use or direct the asset.

Result of past events: The control and ownership arose from past transactions or actions.

Question 27

The accrual assumption of accounting …

A) ensures that accounting records and statements are based on the most
reliable data available.

B) holds that the entity will remain in operation for the foreseeable future.

C) ensures that transactions and events are recognized when they are
economically caused.

D) enables accountants to ignore the effect of inflation in the accounting records

Answer 27

C) is correct

The accrual assumption in accounting means that revenues and expenses are recorded when they are earned or incurred, not when cash is exchanged

A) is the concept of reliability

B) is going-concern

D) is the historical cost convention

Question 28

Which of the following best describes a liability?

A) Liabilities are a form of paid-in capital.

B) Liabilities are future economic benefits to which a company is entitled.

C) Liabilities are debts payable to outsiders called creditors.

D) Liabilities are current economic obligations to owners to be paid at some
future date by the corporation.

Answer 28

C) is correct

A) paid-in capital refers to the equity or funds provided by shareholders

B) asset

D) liabilities are obligations to creditors, not to owners

Question 29

Expenses are …

A) Expenses are increases in liabilities resulting from purchasing assets.

B) Expenses are increases in assets resulting from operations.

C) Expenses are decrease in liabilities earnings resulting from operations.

D) Expenses are decreases in equity resulting from operations

Answer 29

D)

A) this is not the definition of an expense. Expenses reduce equity, not increase liabilities directly.

B) expenses do not result in an increase in assets. Expenses are the opposite; they reduce equity by consuming resources or incurring costs as part of operations

C) expenses do not decrease liabilities. Expenses result in a decrease in equity, not liabilities

Question 30

When should the following be recognised as assets or liabilities?
(date of purchase/ sale

A) increase in accounts payable

B) purchase of put options

C) purchase of raw materials inventory

D) sale of a product for which there is a warranty commitment

Answer 30

A) Accounts payable are recognized as a liability when the obligation to pay arises, typically at the time of purchase.

B) Put options, a type of derivative, are recognized as an asset when the entity gains control of the option, which is typically at the date of transaction.

C) Raw materials are recognized as an asset when the company purchases and gains control over them.

D) Warranty commitments are recognized as a liability at the point of sale because the company now has an obligation to provide warranty services in the future.

Question 31

A company buys a rental property for $10M, depreciated over 50 years, reducing it to $9.8M after year one. The appraised fair value is $15M (±10%).

Q: What should the company consider when measuring the building in its financial statements?

Answer 31

A: The company should consider:

• Relevance: Is the fair value of $15M relevant to investors’ decisions? Is it material to the company’s financial health?
• Faithful representation: Is the $15M valuation accurate and unbiased despite the uncertainty (±10%)? Does it faithfully represent the building’s value?

Question 32

A company buys a rental property for $10M, depreciated over 50 years, reducing it to $9.8M after year one. The appraised fair value is $15M (±10%).

Q: Should the company report the property at $15M or $9.8M in the financial statements?

Answer 32

A: The IFRS Conceptual Framework does not specify which basis to use. The decision should balance relevance and faithful representation based on investor needs and the accuracy of the valuation.

Question 33

Q: What is the trade-off between relevance and faithful representation in measuring property values?

Answer 33

A: Relevance ensures information influences decisions, while faithful representation ensures accuracy.

Sometimes, relevant information may involve estimates, and judgment is needed to balance these characteristics.

Question 34

Q: What are the advantages of measuring assets at historical cost?

Answer 34

• Reliable and objective
• Verifiable and prudent
• Conservative for lending decisions
• Less subject to manipulation
• Not dependent on active markets

Question 35

What are the disadvantages of measuring assets at historical cost?

Answer 35

• Outdated information (sunk costs)
• No reflection of changing price levels
• May misrepresent current economic situation in rising price environments

Question 36

What are the advantages of measuring assets at fair value?

Answer 36

• Relevant, up-to-date information
• Reflects economic reality
• Useful for investors concerned with value
• Unbiased and consistent when using active market prices

Question 37

What are the disadvantages of measuring assets at fair value?

Answer 37

• Subjective assumptions and estimates
• More manipulation potential
• Market dependency and volatility
• Unrealized gains lead to earnings volatility

Question 38

Why do principles-based standards require a conceptual framework?

Answer 38

Principles-based standards rely on agreed-upon principles to provide consistency and reduce the need to debate definitions or methods for each new standard.

Question 39

How does a conceptual framework help develop principles-based standards?

Answer 39

The framework offers underlying principles, like measurement approaches, that can be applied in different standards, making the standard-setting process faster and more consistent.

Question 40

How are principles-based standards more flexible than rule-based standards?

Answer 40

They provide guidance, allowing companies to interpret and apply principles in a way that fits their business, leading to more useful information for decision-making.

Question 41

What are rule-based standards, and how do they differ from principles-based standards?

Answer 41

Rule-based standards provide detailed, specific directions, often including thresholds like “greater than 50%.” They are more rigid but easier to follow and enforce.

Question 42

What is a major drawback of rule-based standards?

Answer 42

Rule-based standards can be “worked around” to comply with the form of the rule while ignoring its substance, leading to results that don’t meet the objective of the standard.

Question 43

Give an example of how rule-based standards can be manipulated.

Answer 43

1: Leases that are essentially finance leases can be structured to meet operating lease criteria, allowing companies to report them as operating leases instead of finance leases.

2:

Question 44

How can revenue recognition be manipulated under rule-based standards?

Answer 44

Companies might time the recognition of revenue based on meeting specific rule thresholds (like shipping goods early to recognize revenue), even if it doesn’t reflect the actual economic reality of the transaction.

Question 45

How can inventory valuation be manipulated under rule-based standards?

Answer 45

Companies might selectively apply inventory accounting methods (like FIFO or LIFO) to manipulate reported earnings or the value of inventory, even if it doesn’t reflect the real cost flow of goods.

Question 46

How can goodwill impairments be manipulated under rule-based standards?

Answer 46

Companies can delay recognizing impairments to goodwill until a more convenient time, even though the value has declined earlier, thereby keeping their financial statements artificially inflated for longer.