Chapter 1: Financial Reporting Environment

Question 1

Explain the concept of materiality based on SFAC 8.

Answer 1

Materiality is entity-specific. Information is material if it is probable that an omission or misstatement of an item in a financial report will affect the judgement of a reasonable person who relied on this information. There is no specific quantitative threshold for materiality.

Question 2

What is the objective of general purpose financial reporting?

Answer 2

To provide information about the reporting entity that is useful to the primary users in making decisions about (1) providing resource to the entity and (2) assessing the entity’s ability to generate future net cash inflows.

Question 3

Who are the primary users of financial information?

Answer 3

The primary users are current or potential investors and creditors. Management is not a primary user.

Question 4

What are the fundamental qualitative characteristics of useful financial information?

Answer 4

• Relevance
• Faithful representation

Question 5

When is information relevant?

Answer 5

If it can make a difference is user decisions. That is, when the information is material and has
- Predictive value and/or
- Confirmatory value

Question 6

When does information have predictive value?

Answer 6

Information has predictive value when it can be used to generate predictions as an input in predictive process.

Question 7

When does information have confirmatory value?

Answer 7

When it provides feedback that confirms or corrects prior evaluations.

Question 8

When is representation of financial information faithful?

Answer 8

• Complete (containing what is needed for user understanding)
• Neutral (unbiased in its selection and presentation)
• Free from error

Question 9

What are the qualitative characteristics that enhance the usefulness of relevant and faithfully represented information?

Answer 9

• Comparability.
• Understandability
• Timeliness, and
• Verifiability

Question 10

Based on SFAC 8, describe the meaning of comparability

Answer 10

Information should be comparable with similar information for
- Other entities, and
- The same entity for another period of time.

Question 11

Based on SFAC 8, describe the meaning of understandability

Answer 11

Information should be clearly and concisely classified, characterized, and presented such that it is readily understandable by diligent users who have reasonable knowledge of business and economic activities.

Question 12

Based on SFAC 8, describe the meaning of timeliness

Answer 12

Information is timely when it is available in time to influence decisions.

Question 13

Based on SFAC 8, describe the meaning of verifiability

Answer 13

Information is verifiable if knowledgeable and independent observers can reach a consensus (not necessarily unanimity) that a phenomenon is faithfully represented.

Question 14

What is the cost constraint of financial reporting?

Answer 14

The benefits of reporting specific information must justify the costs incurred to provide and use that information.

Question 15

What are the elements of a statement of financial position (balance sheet)?

Answer 15

• Assets
• Liabilities
• Equity
• Investments by owners
• Distributions by owners

Question 16

Define assets

Answer 16

Assets are probable future economic benefits obtained or controlled by an entity as a result of a past transactions or events

Question 17

Define liabilities

Answer 17

Probable future sacrifices of economic benefits. Existing obligations of a specific entity to transfer assets or provide services to other entities as a result of previous transactions or events.

Question 18

As the discount rate increase, the present value

Answer 18

Decreases

Question 19

As the discounted period increases, the present value

Answer 19

Decreases

Question 20

Define the valuation allowance accounts and assets and liabilities

Answer 20

A part of the carrying amount of the related assets or liabilities. Examples include: Asset valuation allowance: Accumulated depreciation, credit losses, premiums and discounts on bonds receivable.
Liability valuation allowance: Discounts and premiums on bonds payable

Question 21

Define equity

Answer 21

The residual interest in the assets of an entity after subtracting liabilities

Question 22

What is the purpose of notes to the financial statements?

Answer 22

Supplement or further explain information in the financial statement

Question 23

What is the purpose of supplementary information in relation to the financial statements?

Answer 23

Provides information in addition to information in the financial statements and notes to financial statements. - Such as Management’s Discussion and Analysis

Question 24

What are the elements of statement of earning and comprehensive income?

Answer 24

• Revenues
• Gains
• Expenses
• Losses
• Comprehensive income

Question 25

Define comprehensive income

Answer 25

Includes all changes in equity during a period except those resulting from investments by owners and distributions to owners (owner sources).

Question 26

What are the assumptions of financial accounting?

Answer 26

• Economic-entity assumption
• Going-corner assumption
• Monetary-unit assumption
• Periodicity assumption

Question 27

Explain the economic entity assumption

Answer 27

The reporting (accounting) entity is separately identified for the purpose of economic and financial accountability.

Question 28

Explain the going-concern assumption

Answer 28

Unless evidence indicates otherwise, every business is assumed to be a going concern that operates for the foreseeable future

Question 29

Explain the monetary-unit assumption

Answer 29

Accounting records are stated in units of money. The changing purchasing power of the monetary unit (inflation) is assumed not to be material.

Question 30

Explain the periodicity assumption

Answer 30

Economic activity can be divided into distinct time periods. The assumption requires reporting estimates in the financial statements.

Question 31

What are the four fundamental criteria for recognizing items in the financial statements?

Answer 31

• The item must meet the definition of an element of financial statements,
• The item must have a relevant attribute measurable with sufficient reliability
• The information must be relevant, and
• The information must be reliable

Question 32

When are transactions and other events recognized under accrual accounting?

Answer 32

Recognizes transactions and events when they occur, not necessarily when the direct cash flows occur

Question 33

When should revenue be recognized?

Answer 33

When an entity satisfies a performance obligation by transferring a promised good or service (an asset) to a customers (ie. the customer obtains control of the asset)

Question 34

What are the factors considered in a present value measurement?

Answer 34

• Estimates of future cash flows
• Expected variability of their amount and timing
• The time value of money based on the risk-free interest rate
• The price of uncertainty inherent in an asset of liability
• Other factors such as lack of liquidity or market imperfections

Question 35

What periodic financial statements does Regulation S-X apply to?

Answer 35

Applies to the reporting of interim and annual financial statement,s including notes and schedules.

Question 36

Give examples of information discussed in management’s discussion and analysis (MD&A)

Answer 36

The information includes the entity’s outlook and significant effects of known trends, events, and uncertainties. It addresses such matters as
- Liquidity
- Capital resources
- Results of operations
- Effects of changing prices

Question 37

What is the SEC’s Form 10-K?

Answer 37

The annual report, it must be audited by an independent public accountant

Question 38

What’s the SEC’s Form 10-Q?

Answer 38

The quarterly report, it must be reviewed (not audited) by and independent accountant.

Question 39

What is the SEC’s Form 8-K?

Answer 39

A current report to disclose material events. It must be filed within 4 business days after the material event (e.g., change in control, bankruptcy, or resignation of director).

Question 40

What is XBRL?

Answer 40

XBRL (eXtensible Business Reporting Language) is the format is which the SEC requires companies provide their financial statements (e.g., Form 10-K) XBRL, derived from XML (eXtensible Markup Language), is a standard for transmitting business information by using a uniform format to tag each piece of financial data being transmitted.

Question 41

Notes to Financial Statements

Answer 41

Information disclosed in notes or parenthetically on the face of financial statements amplifies or explains information recognized in the financial statements.

Question 42

Revenues of an entity are usually measured by the exchange values of the assets of liabilities involved. Recognition of revenue does not occur until

Answer 42

A performance obligation is satisfied by transfer of control of an asset.
Revenues should be recognized when an entity satisfies a performance obligation by transferring a promised good or service to a customer. An asset is transferred when the customer obtains control of the asset.