CH2 Conceptual Framework for Financial Reporting

Question 1

Conceptual Framework

Answer 1

a coherent system of interrelated objectives and fundamentals that can lead to consistent standards.

Question 2

Basic Objective

Answer 2

the foundation of the conceptual framework and requires that general-purpose financial reporting provide information about the reporting entity that is useful to present and potential investors in making investment and credit-granting decisions.

Question 3

Fundamental Qualities of Accounting

Answer 3

Relevance, information that is capable of making a difference in a decision, and Faithful Representation, numbers and descriptions match what really happened or existed.

Question 4

Parts of Relevance

Answer 4

• Predictive Value: the information can help users form expectations about the future
• Confirmatory Value: the information validates or refutes expectations based on previous evaluations
• Materiality: information is material if omitting or misstating it could influence decisions that users make on the basis of the reported financial information.

Question 5

Parts of Faithful Representation

Answer 5

• Completeness: all necessary information is provided
• Neutrality: the information is unbiased
• Free from error: the information is accurate

Question 6

Enhancing Qualities of Accounting

Answer 6

-compatibility: companies record and report information in a similar manner (consistency: use the same accounting methods from period to period)

• verifiability: independent people use the same methods to arrive at similar conclusions
• timeliness: information available before it loses relevance

-understandability: reasonably informed users should be able to comprehend the information that is classified and presented

Question 7

Basic Elements of Accounting

Answer 7

• assets: probable future economic benefits obtained or controlled by a particular entity as a result of past transactions/events
• liabilities: probable future sacrifices of economic benefits that arise from the present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions
• equity (ownership interest): residual interest in the assets of an entity that remains after deducting its liabilities
• investments by owners: increase in net assets of a particular enterprise resulting from transfers to it from other entities of something of value to obtain or increase ownership interests (or equity) in it. assets are most commonly received as investments by owners, but that which is received may include services or satisfaction or conversion of liabilities of the enterprise
• distributions to owners: decreases in net assets of a particular enterprise that result from transferring assets, performing services, or incurring liabilities by the enterprise to owners. distributions to owners decrease ownership interests (or equity) in an enterprise.

Question 8

Basic Elements of Accounting (cont.)

Answer 8

• comprehensive income: change in equity (net assets) of an entity during a period from transactions and other events and circumstances from nonowner sources. it includes all changes in equity during a period, except those resulting from investments by owners and distributions owners.
• revenues: inflows or other enhancements of assets of an entity or settlement of its liabilities (or a combination of both) during a period from delivering or producing goods, performing services, or other activities that constitute that entity’s ongoing major or central operations.
• expenses: outflows or other using up of assets or incurrence of liabilities (or a combination of both) during a period from delivering or producing goods, performing services, or other activities that constitute that entity’s ongoing major or central operations.
• gains: increases in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses or distributions to owners.
• losses: decrease in equity (net assets) from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstances affecting the entity during a period except those that result from expenses or distributions to owners.

Question 9

Basic Assumptions of Accounting

Answer 9

• economic entity assumption: the economic activities of an entity can be accumulated and reported in a manner that assumes the entity is separate and distinct from its owners or other business units.
• going concern assumption: in the absence of contrary information, a business entity is assumed to have a long life. the current relevance of the historical cost principle is dependent on the going-concern assumption.
• monetary unit assumption: money is the common denominator of economic activity and provides an appropriate basis for accounting measurements and analysis. the monetary unit is assumed to remain relatively stable over the years in terms of purchasing power. in essence, this assumption disregards any inflation or deflation in the economy in which the entity operates.
• periodicity assumption: the life of an economic entity can be divided into artificial time periods for the purpose of providing periodic reports on the economic activities of the entity.

Question 10

Basic Principles of Accounting

Answer 10

• measurement principle: the historical cost principle requires that companies account for and report many assets and liabilities on the basis of the acquisition price.
• fair value: information may be more useful for certain types of assets and liabilities and in certain industries
• revenue recognition principle: revenue is recognized when a company satisfies its performance obligations. recognition at the time of sale provides a uniform and reasonable test. (certain long-term construction contracts, end-of-production recognition, and recognition upon receipts)
• expense recognition principle: using the matching principle accountants attempt to match expenses incurred while earning revenues with related revenues. use of accrual accounting procedures assists the accountant in allocating revenues and expenses properly among the fiscal periods that compose the life of a business enterprise.
• full disclosure principle: in the preparation of financial statements, the accountant should include sufficient information to permit the knowledgeable reader to make an informed judgment about the financial condition of the enterprise in question.

Question 11

Cost Constraint

Answer 11

the cost constraint (or cost-benefit relationship) relates to the notion that the benefits to be derived from certain accounting information should exceed the costs of providing that information (cost and benefits are not always evident or measurable)