Conceptual Framework of Financial Reporting

Question 1

List the enhancing qualitative characteristics of financial information.

Answer 1

(1) Comparability
(2) Verifiability
(3) Timeliness
(4) Understandability

Question 2

What is verifiability?

Answer 2

Information is verifiable if different knowledgeable and independent observers can reach similar conclusions.

Question 3

What does it mean to be free from material error?

Answer 3

Information is free from material error if it is accurate and truthful.

Question 4

What is Neutrality?

Answer 4

To be neutral, accounting information must be free of bias.

Question 5

What is completeness?

Answer 5

Information is complete if it includes all data necessary to be faithfully representative.

Question 6

What are the Ingredients of Relevance?

Answer 6

Predictive value, Confirmatory value.

Question 7

Who is the target audience of financial statements?

Answer 7

Decision makers; mainly investors, creditors and regulators.

Question 8

What are the objectives of financial reporting?

Answer 8

To provide information about the entity to current and future users of the financial statements who are making credit and investment decisions.

Question 9

What is Timeliness?

Answer 9

To be relevant, accounting information must be received in time to make a difference to the decision maker.

Question 10

What is Comparability?

Answer 10

The quality of information that enables users to identify similarities and differences between sets of information.

Question 11

What is Understandability?

Answer 11

Information is understandable if the user comprehends it with reasonable effort and diligence.

Question 12

What are the ingredients of Faithful Representation?

Answer 12

Completeness.
Free from material error.
Neutrality.

Question 13

What is Confirmatory Value?

Answer 13

To be relevant, accounting information should assist decision makers in confirming past predictions.

Question 14

What is Predictive Value?

Answer 14

To be relevant, accounting information should assist financial statement users in making predictions about future events.

Question 15

What are the Primary Qualitative Characteristics of Financial Information?

Answer 15

Relevance

Faithful representation

Question 16

What does the historical cost accounting principle state?

Answer 16

Assets and liabilities are recorded at historical cost, that is, their cash equivalent amount at time of origination. The value is the market value of the item on the date of acquisition.

Question 17

What does the matching principle state?

Answer 17

Recognize expenses only when expenditures help to produce revenues.

Question 18

When does realization occur in the accounting period?

Answer 18

(1) Goods or services have been provided
(2) Collectability of cash is assured
(3) Expenses of providing goods and services can be determined

Question 19

What is the concept of capital maintenance?

Answer 19

Capital is said to be maintained when the firm has positive earnings for the year, assuming no changes in price levels.

Question 20

When should a company recognize revenues?

Answer 20

Revenues are recognized when they are earned and collectability is reasonably assured.

Question 21

What is the entity assumption?

Answer 21

We assume there is a separate accounting entity for each business organization.

Question 22

What does the full disclosure principle state?

Answer 22

Financial statements should present all information needed by an informed reader to make an economic decision. This principle is sometimes referred to as the adequate disclosure principle.

Question 23

What are revenues?

Answer 23

Revenues are increases in assets or extinguishment of liabilities stemming from delivery of goods or from providing services – the main activities of the firm.

Question 24

What is the going concern assumption?

Answer 24

In the absence of information to the contrary, a business is assumed to have an identifiable life, that is, it will continue to be a going concern.

Question 25

How do we measure a revenue?

Answer 25

Revenues are measured as the cash equivalent amount of the good or service provided.

Question 26

What is the unit of measurement assumption?

Answer 26

Assets, liabilities, equities, revenues, expenses, gains, losses, and cash flows are measured in terms of the monetary unit of the country in which the business in operated.

Question 27

What is the time period assumption?

Answer 27

The indefinite life of a business is broken into smaller time frames, typically a year, for evaluation purposes and reporting purposes.

Question 28

What does a fresh start measurement do?

Answer 28

Establishes a new carrying value after an initial recognition and is unrelated to previous amounts (e.g., mark-to-market accounting and recognition of asset impairments).

Question 29

List the elements included in a full set of financial statements.

Answer 29

(1) Balance Sheet
(2) Income Statement
(3) Statement of Comprehensive Income
(4) Statement of Cash Flows
(5) Statement of Owner’s Equity

Question 30

What are the two accounting constraints?

Answer 30

Materiality and cost effectiveness (or cost-benefit).

Question 31

What is cost effectiveness?

Answer 31

This constraint on GAAP limits recognition and disclosure if the cost of providing the information exceeds its benefit.

Question 32

What are the four criteria that must be met to be recognized and measured in a financial report?

Answer 32

(1) Definition
(2) Measurability
(3) Relevance
(4) Reliability

Question 33

What is Conservatism?

Answer 33

Conservatism (also called prudence) is the reporting of less optimistic amounts (lower income, net assets) under conditions of uncertainty or when GAAP provides a choice from among recognition or measurement methods.

Question 34

List the elements which a present value measurement that fully captures economic differences should include.

Answer 34

(1) An estimate of future cash flows
(2) Expectations about variations in amount or timing of those cash flows
(3) Time value of money as measured by the risk-free rate of interest
(4) The price for bearing the uncertainty inherent in the asset or liability
(5) Any other relevant factors

Question 35

To what conditions do accounting constraints refer?

Answer 35

These constraints refer to a condition for which the normal measurement and recognition rules are modified.