Chapter 2: Investing and Financing Decisions and The Accounting System Flashcards
What is the conceptual framework in accounting?
The conceptual framework in accounting is a theoretical framework that defines key accounting terms and concepts, providing a foundation for financial reporting.
What is the purpose of the IASB Conceptual Framework for Financial Reporting?
The IASB Conceptual Framework serves to identify the objective, concepts, and limitations of correctly preparing and reporting financial statements.
It also provides guidance to accounting standard setters.
Why is understanding accounting concepts important in studying accounting?
Understanding accounting concepts is vital in studying accounting because it helps students comprehend the rationale behind the accounting process, making it easier to learn and apply.
It also forms the foundation for grasping more complex business activities in later chapters.
What is the objective of financial reporting to external users according to the Conceptual Framework?
The objective of financial reporting to external users is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.
What are the fundamental qualitative characteristics of useful accounting information?
The fundamental qualitative characteristics are relevance and faithful representation.
Name the enhancing characteristics of useful accounting information
The enhancing characteristics include comparability (including consistency), verifiability, timeliness, and understandability.
What are the elements that should be measured and reported in financial reporting?
The elements to be measured and reported include:
assets,
liabilities,
shareholders’ equity,
investments by owners,
distribution to owners,
revenues,
expenses,
gains,
losses,
and comprehensive income.
List some of the concepts used for measuring and reporting financial information.
Concepts for measuring and reporting financial information include assumptions like
separate entity,
stable monetary unit,
continuity (going concern),
periodicity,
principles such as mixed-attribute measurement (including historical cost) and revenue recognition,
and constraints like cost.
What does financial reporting need to enable decision makers to do according to the text?
Financial reporting needs to enable decision makers not only to assess the amounts, timing, and uncertainty of future cash inflows and outflows but also to understand the financial value of both the assets owned and claims against those assets (liabilities and equity).
Why are creditors interested in financial information about an entity according to the text?
Creditors are interested in financial information to assess an entity’s ability to pay interest on a loan over time and to repay the initial amount borrowed (principal).
Who are some of the decision makers mentioned in the text who use financial reports?
Decision makers who use financial reports include average investors, creditors, and experts who provide financial advice.
Decision makers are expected to have a reasonable understanding of accounting concepts and procedures.
What do investors want to evaluate when assessing an entity’s financial information?
Investors want to evaluate the entity’s ability to pay dividends in the future and assess how successful the company might be in the future, which can impact the share price.
What are the two fundamental qualitative characteristics of accounting information?
What are the two fundamental and four enhancing qualitative characteristics of accounting information?
relevance and faithful representation
comparability, verifiability, timeliness, and understandability.
The quality of accounting information for external decision makers is determined by the balance of the six characteristics
What is the purpose of the conceptual framework in relation to accounting standards and guidance?
The conceptual framework serves as the exclusive, authoritative source of standards and guidance for providing useful accounting information.
What is the constraint mentioned in the text regarding accounting measurement?
The text mentions a constraint on accounting measurement, but it doesn’t provide the specific constraint. The constraint is often referred to as “cost constraint,” which implies that the benefits of providing certain information should outweigh the costs of obtaining and presenting it.
Qualitative Characteristics of Accounting Information
Definition of Relevant information in this textbook
RELEVANT INFORMATION
Information that can influence a decision; it has predictive and/or confirmatory value.
What is relevance in financial reporting?
Relevance in financial reporting means that information disclosed in financial statements can influence users’ decisions by helping them assess the economic effect of past activities and/or predict future events.
How does information in a statement of earnings exhibit predictive value?
Information in a statement of earnings has predictive value if it helps users predict future levels of net earnings or its components, such as earnings from operations.
How can the predictive value of a statement of earnings be enhanced?
The predictive value of a statement of earnings can be enhanced by presenting non-recurring items separately on a multiple-step statement of earnings, as these items are transient in nature.
What does it mean when information on a statement of earnings has confirmatory value?
Information on a statement of earnings has confirmatory value if it confirms or changes prior expectations based on previous evaluations.
Why is the comparison of predicted results with actual results important in financial reporting?
Comparing predicted results with actual results is important in financial reporting because it helps improve the quality of the prediction process, ensuring that users can make more informed decisions.
What is meant by “faithful representation” in financial reporting?
Faithful representation in financial reporting means that the information provided in financial statements must accurately reflect the economic phenomena it represents, reflecting the substance of the underlying transactions.
It must be complete, neutral, and free from error.
How does recognizing cash collected in advance prematurely as revenue affect faithful representation?
Recognizing cash collected in advance prematurely as revenue can lead to a lack of faithful representation because it overstates the amount of revenue reported, which does not accurately represent the current-period revenues.
What is neutrality in the context of accounting information?
Neutrality means that accounting information should be free from bias in its measurement and presentation, ensuring that it does not favor one group of users over others.
How is neutrality related to the measurement and reporting of liabilities, as mentioned in the text?
Neutrality is related to the measurement and reporting of liabilities in the sense that these should not be consistently understated on the statement of financial position, as it could favor owners over creditors and influence investment and credit decisions of financial statement users.
How does the concept of prudence support neutrality in financial reporting?
The concept of prudence supports neutrality by requiring special care to avoid overstatement of assets and revenues and understatement of liabilities and expenses.
This ensures that potential sources of trouble for the company are adequately disclosed, satisfying the needs of users, particularly creditors.
Definition of prudence in terms of accounting
PRUDENCE
Taking care not to overstate assets and revenues or understate liabilities and expenses.
How does prudence relate to the lower-of-cost-and-market guideline?
Prudence relates to the lower-of-cost-and-market guideline by attempting to offset managers’ natural optimism about their business operations, ensuring that asset values are reduced when current values are significantly lower.
This guideline helps maintain neutrality in financial reporting.
What is the significance of reflecting the economic substance of transactions rather than their legal form in financial reporting?
Reflecting the economic substance of transactions rather than their legal form ensures that financial statements accurately portray how transactions affect the economic condition of the company.
Regardless of the legal form, if the underlying substance reflects a purchase transaction, accountants must classify it as such, ensuring faithful representation.
What is comparability in accounting information?
Comparability in accounting information refers to the ability to compare financial information across businesses or within the same company over time.
How is comparability across businesses enhanced?
Comparability across businesses is enhanced when similar accounting methods have been applied, enabling users to identify similarities and discrepancies between the financial reports of different companies.
Why is comparability important when comparing information provided by the same company over time?
Comparability is important when comparing information from the same company over time because it helps users assess trends and changes in the company’s financial performance and position.
What enhances the comparability of financial reports over time?
The comparability of financial reports over time is enhanced when consistent information is made available by using the same accounting methods consistently.
How do changes in accounting methods impact the comparability of financial information?
Changes in accounting methods reduce the comparability of financial information.
When such changes occur, it is necessary to disclose the effects of the change to maintain comparability.
What is verifiability in financial statements?
Verifiability in financial statements means that independent accountants can agree on the nature and amount of a transaction or item presented in the financial statements.
What makes the historical cost of an asset, like a piece of land, highly verifiable?
The historical cost of an asset, such as a piece of land, is highly verifiable because it is based on the purchase price and related costs resulting from actual exchanges with external parties.
Why is the appraised value of an asset considered less verifiable?
The appraised value of an asset is considered less verifiable because it is a subjective estimate based on the appraiser’s past experience and not on an actual exchange transaction.
