Conceptual Framework of Financial Reporting by Business Enterprises Flashcards
What are the Primary Qualitative Characteristics of Financial Information?
Faithful representation and Relevance (FARR).
What are the ingredients of Relevance?
Predictive value, Confirmatory value, Materiality.
What is Predictive Value?
To be relevant, accounting information should assist financial statement users in making predictions about future events.
What is Confirmatory Value?
To be relevant, accounting information should assist decision makers in confirming past predictions.
What are the ingredients of Faithful representation?
Completeness, Free from material error, Neutrality.
What is completeness?
Information is complete if it includes all data necessary to be faithfully representative.
What does it mean to be free from error?
Information is free from error if it is truthful.
What is Neutrality?
To be neutral, accounting information must be free of bias.
List the enhancing qualitative characteristics of financial information.
Comparability;
Verifiability;
Timeliness;
Understandability.
What is Comparability?
The quality of information that enables users to identify similarities and differences between sets of information.
What is Verifiability?
Information is verifiable if different knowledgeable and independent observers can reach similar conclusions.
What is Timeliness?
To be relevant, accounting information must be received in time to make a difference to the decision maker.
What is Understandability?
Information is understandable if the user comprehends it with reasonable effort and diligence.
What are Objectives of Financial Reporting?
To provide information about the entity to current and future users of the financial statements who are making credit and investment decisions.
Who is the Target Audience of Financial Statements?
Decision makers; mainly potential investors, creditors, and regulators.
Relevance has three components. T/F
TRUE
When the reported measure of an economic condition or situation aligns with the economic condition or situation, then it is representationally faithful. T/F
TRUE
GAAP assumes that most financial statement users are experts such as stock analysts. T/F
FALSE
Is the primary focus of financial accounting information on assisting the evaluation of past performance rather than on assisting users to assess the future prospects of a firm?
NO
GAAP pertains primarily to general purpose financial statements rather than reports tailored to specific needs. T/F
TRUE
Neutrality means valid. T/F
FALSE
What is the entity assumption?
We assume there is a separate accounting entity for each business organization.
What is the going concern assumption?
In the absence of information to the contrary, a business is assumed to have an indefinite life, that is, it will continue to be a going concern.
What is the unit of measurement assumption?
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 is operated.
What is the concept of capital maintenance?
Capital is said to be maintained when the firm has positive earnings for the year, assuming no changes in price levels.
What is the time period assumption?
The indefinite life of a business is broken into smaller time frames, typically a year, for evaluation purposes and reporting purposes.
What does the historical cost accounting principle state?
Assets and liabilities are recorded at historical cost, that is, their cash equivalent amount at time of origination. This value is the market value of the item on the date of acquisition.
What are revenues?
Revenues are increases in assets or extinguishment of liabilities stemming from delivery of goods or from providing services – the main activities of the firm.
When should a company recognize revenues?
Revenues are recognized when they are earned and collectability is reasonably assured.
When does realization occur in the accounting period?
(1) Goods or services have been provided, (2) Collectability of cash is assured, (3) Expenses of providing goods and services can be determined.
How do we measure a revenue?
Revenues are measured as the cash equivalent amount of the good or service provided.
What is the matching principle?
Recognize expenses only when expenditures help to produce revenues.
What is the full disclosure principle?
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.
A firm has income of exactly zero for a year during which both specific and general prices (inflation) have increased. The firm maintained its capital under the financial concept of capital maintenance. T/F
TRUE
Are most assets subsequently adjusted for changes in market value under the historical cost principle?
NO
The accounting assumption of separate entity supports the inclusion of prepaid insurance in total assets. T/F
FALSE
Matching is not an accounting assumption. T/F
TRUE
If the going concern assumption were not met, adherence to the historical cost principle would continue to be appropriate. T/F
FALSE
A manager uses a company car for both business and personal use. Therefore, the car should not be included among the firm’s assets. T/F
FALSE
Can all expenses be directly matched with revenue?
NO
A firm has negative income for a period. Has the firm experienced a return on capital?
NO
Under the historical cost principle, are most assets recorded at market value on the purchase date?
YES
Define cost effectiveness.
This constraint on Generally Accepted Accounting Principles (GAAP) limits recognition and disclosure if the cost of providing the information exceeds its benefit.
What is the constraints to setting accounting standards?
Cost effectiveness (or cost-benefit).
What is Cost Effectiveness?
This constraint on Generally Accepted Accounting Principles (GAAP) limits recognition and disclosure if the cost of providing the information exceeds its benefit.
What is Conservatism?
Conservatism (also called prudence) is the reporting of less optimistic amounts (lower income, net assets) under conditions of uncertainty or when Generally Accepted Accounting Principles (GAAP) provides a choice from among recognition or measurement methods.
List the elements included in a full set of financial statements.
(1) Balance sheet, (2) Income statement, (3) Statement of comprehensive income, (4) Statement of cash flows, (5) Statement of owner’s equity.
What are the four criteria that must be met to be recognized and measured in a financial report?
Definition,
Measurability,
Relevance,
Reliability.
What does a fresh start measurement do?
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).
List the elements which a present value measurement that fully captures economic differences should include.
(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.
In order for revenues to be recognized, the seller must be substantially finished with its work, and cash collection must be reasonably assured.
TRUE
A new Accounting Standards Update is not adopted based on the view that, although users would benefit from the information, reporting firms would be unduly burdened by the proposed requirement. This is an example of conservatism.
FALSE
Are the materiality and cost-benefit constraints essentially the same?
NO
General Motors rounds its balance sheet amounts to the nearest million dollars. This is an example of materiality.
TRUE
A firm has reported a 20% increase in earnings for the past three years. To dampen investor expectations, it has decided to understate revenues and overstate expenses. Is this an appropriate application of the conservatism constraint?
NO
For completeness, footnotes must accompany the financial statements. This is an example of full disclosure.
TRUE
A firm did not disclose a relatively small payment to a foreign government that is in conflict with the Foreign Corrupt Practices Act. This is a violation of full-disclosure.
TRUE
During periods of deflation, the use of FIFO rather than LIFO is an example of liberal accounting.
FALSE
