Conceptual Framework Flashcards
What is the underlying concept that supports estimating a fixed asset impairment charge?
a. Substance over form. b. Consistency. c. Matching. d. Faithful representation.
d. Faithful representation.
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 estimate is comprised of the best available information. Therefore, it is a faithful representation.
According to the FASB Conceptual Framework, which of the following relates to both relevance and faithful representation?
Consistency Verifiability
a. Yes ---- Yes b. Yes ---- No c. No ---- No d. No ---- Yes
A
Verifiability and consistency (a component of comparability) are both enhancing qualitative characteristics relating to both relevance and faithful representation.
When a parent-subsidiary relationship exists, consolidated financial statements are prepared in recognition of the accounting concept of:
a. Reliability. b. Materiality. c. Legal entity. d. Economic entity.
Economic Entity.
Consolidated financial statements are an example of trying to account for the economic entity that comprises more than one legal entity.
On December 31, 20X2, Brooks Co. decided to end operations and dispose of its assets within three months. At December 31, 20X2, the net realizable value of the equipment was below historical cost.
What is the appropriate measurement basis for equipment included in Brooks’ December 31, 20X2, Balance Sheet?
a. Historical cost. b. Current reproduction cost. c. Net realizable value. d. Current replacement cost.
NRV.
When a firm is in liquidation, historical cost and entry values (replacement cost) are no longer relevant.
The going concern assumption supports the historical cost principle. The firm is no longer a going concern. The only amounts relevant are the amounts to be received on sale of the assets. Net realizable value is the net value to be received, after the costs of getting the asset ready for sale are deducted.
According to the FASB conceptual framework, certain assets are reported in financial statements at the amount of cash or its equivalent that would have to be paid if the same or equivalent assets were acquired currently. What is the name of the reporting concept?
a. Replacement cost. b. Current market value. c. Historical cost. d. Net realizable value.
Replacement Cost.
Replacement cost is the amount to be paid for an item at the current time. This concept is used in the lower-of-cost-or-market inventory valuation procedure. Replacement cost is an example of an entry price-the amount required to be paid currently to obtain an asset already held.
Which of the following is an application of the principle of systematic and rational allocation?
a. Amortization of intangible assets. b. Sales commissions. c. Research and development costs. d. Officers’ salaries.
Amortization of intangible assets.
According to SFAC 5, amortization of intangible assets is an item that is recognized in a systematic and rational manner. Systematic and rational allocation is one of the three pervasive expense recognition principles.
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 decrease in a liability from primary operations.
Per SFAC 6, revenues are inflows of assets or settlements of liabilities, or both, during a period as a result of an entity’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.
Recognizing depletion expense is an example of the accounting process of
Allocation Amortization
a. No No
b. No Yes
c. Yes Yes
d. Yes No
Yes and Yes.
SFAC 6 defines allocation as the process of assigning or distributing an amount according to a plan or formula and amortization as an allocation process for accounting for prepayments and deferrals. Allocation is broader in scope and thus includes amortization. Specific examples of amortization include recognizing expenses for depletion, depreciation, and insurance, and recognizing earned subscription revenues.
According to the FASB conceptual framework, earnings
a. Are the same as comprehensive income. b. Exclude certain gains and losses that are included in comprehensive income. c. Include certain gains and losses that are excluded from comprehensive income. d. Include certain losses that are excluded from comprehensive income.
Exclude certain gains and losses that are included in comprehensive income.
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 included in comprehensive income but are excluded from earnings.
Gains and losses may be classified as
a. Operating
b. Non Operating
c. Both
Both.
Per SFAC 6, gains and losses may be described or classified as “operating” or “nonoperating,” depending on their relation to an entity’s major ongoing or central operations.
A patent, purchased in year 1 and being amortized over a 10-year life, was determined to be worthless in year 5. The write-off of the asset in year 5 is an example of which of the following principles?
a. Associating cause and effect. b. Immediate recognition. c. Systematic and rational allocation. d. Objectivity.
Immediate recognition.
Per SFAC 5, the principle of immediate recognition requires that items carried as assets in prior periods that are discovered to be impaired in value be charged to expense (e.g., a patent that is determined to be worthless).
Which of the following is an example of the expense recognition principle of associating cause and effect?
a. Allocation of insurance cost. b. Sales commissions. c. Depreciation of fixed assets. d. Officers’ salaries.
Sales commissions.
Sales commissions are recognized as an expense on the basis of a presumed direct association with the related sales revenue (SFAC 5).
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?
Financial capital is applied to both NI and CI.
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 computing return on capital. Comprehensive income, which is described in SFAC 5, is “the change in equity of a business enterprise 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.
What is the underlying concept governing the Generally Accepted Accounting Principles pertaining to recording gain contingencies?
a. Conservatism. b. Relevance. c. Consistency. d. Faithful representation.
Conservatism.
Gain contingencies are not recognized, but loss contingencies that are probable and estimable are recognized. This is a classic example of conservatism, which suppresses positive information under conditions of uncertainty but requires the reporting of negative information when the negative outcome is likely.
In calculating present value in a situation with a range of possible outcomes all discounted using the same interest rate, the expected present value would be
a. The most-likely outcome. b. The maximum outcome. c. The minimum outcome. d. The sum of probability-weighted present values.
The sum of probability-weighted present values.
The expected cash flow approach uses all expectations about possible cash flows in developing a measurement, rather than just the single most-likely cash flow. By incorporating a range of possible outcomes (with their respective timing differences), the expected cash flow approach accommodates the use of present value techniques when the timing of cash flows is uncertain. Thus, the expected cash flow is likely to provide a better estimate of fair value than the minimum, most-likely, or maximum taken alone. According to SFAC 7, expected present value refers to the sum of probability-weighted present values in a range of estimated cash flows, all discounted using the same interest rate convention.
