Conceptual Framework, Standard-Setting and Financial Reporting MCQ's Flashcards
Which of the following will best protect investors against fraudulent financial reporting by corporations?
- Criminal statutes
- Requirement that F/S be audited
- The fact that all firms must report in the same way
- The integrity of management
Correct: Requirement that F/S be audited
Incorrect: The fact that all firms must report in the same way, because: GAAP is reasonably uniform, but many accounting standards allow a choice across more than one method. Even if standards were completely uniform, that would not guarantee that all firms would report truthfully. GAAP are rules and all rules can be broken.
In reference to proposed accounting standards, the term “negative economic consequences” includes:
- The cost of complying with GAAP
- The inability to raise capital
- The cost of government intervention when not in compliance with GAAP
- The failure of internal control systems.
Correct: The inability to raise capital
A proposed standard may cause firm earnings to fall, for example when it is adopted. Firms will be concerned that lower earnings may make it more difficult to sell stock or to secure loans.
As a result, negative economic consequences become a focal point for arguments against the proposed standard.
Each of the following statements is correct regarding the Financial Accounting Standards Board except
- It develops principles and attributes that allow organizations to understand the necessary elements to ensure a robust system of internal control.
- It is recognized as authoritative by the United States Securities and Exchange Commission and the American Institute of Certified Public Accountants.
- It establishes accounting concepts and standards for financial accounting and reporting and provides guidance on implementation of standards.
- It provides a conceptual framework that helps to increase understanding of, and confidence in, financial information on the part of users of financial reports.
Correct: It develops principles and attributes that allow organizations to understand the necessary elements to ensure a robust system of internal control.
*The FASB does not develop guidance for elements of internal control. The FASB sets accounting standards for U.S. GAAP.
Dannon Co. reported its expenses of $35,200 on the cash basis. Corporate records revealed the following information:
Beginning prepaid expense $1,300
Beginning accrued expense 1,650
Ending prepaid expense 1,800
Ending accrued expense 1,200
What amount of expense should Dannon report on its books under the accrual basis?
Cash to Accrual Basis
Change in Equity = Change in Assets - Change in Liabilities
Beginning prepaid expense $1,300
Less: Ending prepaid expense $1,800
= -$500
Beginning accrued expense $1,650
Less: Ending accrued expense $1,200
= $450
Change in Equity = -500 - 450 = -950
Expenses of $35,200 - $950 = $34,250
U Co. had cash payments on account during the current year totaling $455,000. U’s beginning and ending accounts payable balances for the year were $64,000 and $50,000, respectively. What amount represents U’s accrual-basis purchases for the year?
A/R = $455,000
Beginning A/P $64,000
Less: Ending A/P $50,000
= $14,000
Cash to Accrual Basis:
Change in Equity = Change in Assets - Change in Liabilities
$455,000 - $14,000 = $441,000
Young & Jamison’s modified cash-basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual-basis operating expenses, what would be the amount of operating expenses?
Cash to Accrual Basis:
Change in Equity = Change in Assets - Change in Liabilities
Operating Expense of $150,000
Beginning Prepaid $10,000
Less: Ending Prepaid $15,000
= - $5,000
Beginning Accrued Liab $5,000
Less: Ending Accrued Liab $25,000
= -$20,000
Change in Equity = -$5000 + $20,000
$150,000 + $15,000 = $165,000
At December 31, 20X0, Ashe Co. had a $990,000 balance in its advertising expense account before any year-end adjustments relating to the following:
1) Radio advertising spots broadcast during December 20X0 were billed to Ashe on January 4, 20X1. The invoice cost of $50,000 was paid on January 15, 20X1.
2) Included in the $990,000 is $60,000 for newspaper advertising for a January 20X1 sales promotional campaign.
Ashe’s advertising expense for the year ended December 31, 20X0, should be:
Beginning Adv. Expense of $990,000
+ $50,000 in Expense (recognize in same year services rendered)
- $60,000
= $980,000
Zeta Co. reported sales revenue of $4,600,000 in its Income Statement for the year ended December 31, 20X1. Additional information is as follows:
12/31/X0 12/31/X1 Accounts receivable $1,000,000 $1,300,000 Allowance for uncollectible accounts (60,000) (110,000)
Zeta wrote off uncollectible accounts totaling $20,000 during 20X1. Under the cash basis of accounting, Zeta would have reported 20X1 sales of:
$4,600,000 Sales Revenue for 20X1
*Allowance for uncollectible accounts ignore - cash basis = collections
AR T Account:
$1,000,000 Beg
$4,600,000 in sales
$20,000 in write-offs
$XX in collections
$1,300,000 End
Solving for $XX = $1,000,000 + $4,600,000 - $20,000 - $1,300,000
$XX = $4,280,000
U.S. GAAP includes a very large set of accounting guidance. Choose the correct statement.
- The FASB Accounting Standards Codification includes guidance about items that are not under the purview of the Generally Accepted Accounting Principles, such as the income tax basis of accounting.
- Authoritative guidance from FASB Statements adopted before the FASB Accounting Standards Codification does not appear in the Codification.
- There is an implied hierarchy within the FASB Accounting Standards Codification, with FASB Statements assuming the top level.
- International accounting standards are not included in the FASB Accounting Standards Codification.
International accounting standards are not included in the FASB Accounting Standards Codification.
During the period when an enterprise is under the direction of a particular management, its financial statements will directly provide information about:
- Both enterprise performance and management performance.
- Management performance but does not directly provide information about enterprise performance.
- Enterprise performance but not directly provide information about management performance.
- Neither enterprise performance nor management performance.
Enterprise performance but not directly provide information about management performance.
The financial statements provide a wealth of information about the performance and financial position of the enterprise, but they do not directly allow an evaluation of management. There are too many factors that affect the firm’s performance to be able to single out management’s contribution (or lack of it). Many factors interact to determine the performance of the enterprise, one of them being management’s performance. Also, for example, current enterprise performance is affected by the past actions of managers that may no longer be with the enterprise.
A company owns a financial asset that has no principal market. The financial asset is actively traded in four markets and the company has the ability to transact in all four of these markets. The following are the quoted prices for the financial asset in each of the four markets:
Market A $20,000
Market B $25,000
Market C $30,000
Market D $35,000
What is the fair value of the financial asset?
Market D $35,000
REMEMBER: In the absence of a principal market, the entity would use the most ADVANTAGEOUS market to determine the FV for an asset or liability.
Which one of the following is not a purpose of the fair value framework as set forth in ASC 820, “Fair Value Measurement”?
- Provide a uniform definition of “fair value” for GAAP purposes.
- Provide a framework for determining fair value for GAAP purposes.
- Establish new measurement requirements for financial instruments
- Establish expanded disclosures about fair value when it is used.
Establish new measurement requirements for financial instruments
In determining the fair value of an asset in the most advantageous market, the market-based exit price should be adjusted for:
1) Transaction Cost - Yes or No
2) Transportation Cost - Yes or No
1) Transaction Cost - No
2) Transportation Cost - Yes
Crossroads Co. chooses to report a financial asset at its fair value. The asset trades in two different markets; however, neither market is the principal market for the financial asset. In the first market, sales proceeds are $76, which is net of transaction costs of $6. In the second market, sales proceeds are $80, which is net of transaction costs of $1. What amount should Crossroads report as the fair value of the asset?
$81
REMEMBER: In the absence of a principal market, the entity would use the most ADVANTAGEOUS market to determine the FV for an asset or liability.
Which of the following statements concerning inputs used in ascertaining fair value is/are correct?
I. Only observable inputs can be used.
II. Inputs that incorporate the entity’s assumptions may be used.
Only II
Which of the following items would best enable Driver Co. to determine whether the fair value of its investment in Favre Corp. is properly stated in the balance sheet?
- Discounted CF’s of Favre’s ops
- Quoted market prices available from a business broker for a similar asset
- Quoted market prices on a stock exchange for an identical asset
- Historical performance & return on Driver’s Investment in Favre
-Quoted market prices on a stock exchange for an identical asset (level 1)
Each of the following would be considered a Level 2 observable input that could be used to determine an asset or liability’s fair value, except
- Quoted prices for identical assets/liab. in markets that are not active
- Quoted prices for similar assets/liab. in markets that are active
- Internally generated CF projections for a related asset/liab
- Interest rates that are observable at commonly quoted intervals
-Internally generated CF projections for a related asset/liab
For a firm that elects to measure certain of its financial assets and financial liabilities at fair value, required financial statement disclosures are intended to facilitate which of the following comparisons?
I. Comparisons between entities that use different measurement methods for similar assets and liabilities.
II. Comparisons between assets and liabilities of a single entity that uses different measurement methods for similar assets and liabilities.
Both I and II
The intended purpose of F/S Disclosures required of a firm that elects to use FV measurement are to facilitate comparisons both across firms and differently measured financial assets and liabilities of a single firm
For a firm that elects to use fair value to measure eligible financial assets and financial liabilities, specific disclosures are required for which of the following financial statements?
1) Balance Sheet (Yes or No)
2) Income Statement (Yes or No)
Both the B/S and the I/S
When an entity uses the fair value option for eligible financial assets and liabilities, which one of the following is not an expected outcome of the disclosures required of that entity?
- Users being able to understand management’s reasons for using the fair value option
- Users being able to understand how changes in fair value affect net income
- Replace the kind and amount of information that would have been provided if the fair value option had not been used with information related to fair value
- Users being able to understand the difference between fair value and cash flows
Replace the kind and amount of information that would have been provided if the fair value option had not been used with information related to fair value
Winn Co. sells subscriptions to a specialized directory that is published semiannually and shipped to subscribers on April 15 and October 15. Subscriptions received after the March 31 and September 30 cutoff dates are held for the next publication. Cash from subscribers is received evenly during the year and is credited to deferred subscription revenue. Data relating to year 2 are as follows:
Deferred subscription revenue, 1/1/Y2 - $750,000
Cash receipts from subscribers - $3,600,000
In its December 31, year 2 balance sheet, Winn should report deferred subscription revenue of:
$900,000
The 12/31/Y1 deferred revenue of $750k would have been earned on 4/15
The cash collected through the 9/30 cutoff date is
= 9/12 * $3.6M = $2.7M - would also have been earned when the 4/15 and 10/15 directories were mailed as cash is received evenly throughout the year
However, cash collected after 9/30 = 3/12 * $3.6M = $900k will not be earned until Y3
Which of the following is not an objective of using PV in accounting measurements?
- To capture the value of an asset or liability in the context of a particular entity
- To estimate FV
- To capture the economic difference between sets of future cash flows
- To capture the elements that taken together would comprise a market price if one existed
To capture the value of an asset or a liability in the context of a particular entity.
According to SFAC 7, the objective of using present value in an accounting measurement is to capture, to the extent possible, the economic difference between sets of future cash flows. The objective of present value, when used in accounting measurements at initial recognition and fresh-start measurements, is to estimate fair value. Stated differently, present value should attempt to capture the elements that taken together would comprise a market price, if one existed, that is fair value. Value-in-use and entity-specific measurements attempt to capture the value of an asset or liability in the context of a particular entity. An entity-specific measurement substitutes the entity’s assumptions for those that marketplace participants would make.
According to SFAC 7, Using Cash Flow Information and Present Value in Accounting Measurements, the most relevant measurement of an entity’s liabilities at initial recognition and fresh-start measurements should always reflect
- The expectations of the entity’s management
- Historical cost
- The credit standing of the entity
- The single most likely minimum or maximum possible amount
-The credit standing of the entity
Those who hold the entity’s obligations as assets incorporate the entity’s credit standing in determining the prices they are willing to pay.
Compared to the accrual basis of accounting, the cash basis of accounting understates income by the net decrease during the accounting period of
*Read carefully
A/R
Accrued Expenses
Accrued Expenses
A decrease in A/R means that cash was collected. In accordance with the cash basis of accounting when cash is received it is recorded as revenue (Dr. Cash, Cr. Revenue), whereas under the accrual basis the revenue would have been recorded when the receivable was recorded (Dr. AR, Cr. Revenue). Thus, a decreased accounts receivable balance would result in increased revenue/income (vs. understated). Therefore, the answer for this account is No.
A decrease in the accrued expenses means cash was paid on some expenses. Under the cash basis, when the cash is paid the expense is recorded (Dr. Expense, Cr. Cash), whereas under the accrual basis the expense would have been recorded when the accrued expense was recorded (Dr. Expense, Cr. Accrued Expense). Thus, a decreased accrued expenses account would result in increased expenses/lower income for the cash basis. Thus, the answer for this account is Yes.
Wright Company sells for cash major household appliance service contracts agreeing to service customers’ appliances for a 1-year, 2-year, or 3-year period. Cash receipts from contracts are credited to unearned service contract revenues and this account had a balance of $1,440,000 at December 31, year 1, before year-end adjustment. Service contract costs are charged to service contract expense as incurred and this account had a balance of $360,000 at December 31, year 1. Outstanding service contracts at December 31, year 1, expire as follows:
During year 2 - 300,000
During year 3 - 450,000
During year 4 - 200,000
What amount should Wright report as unearned service contract revenues at December 31, year 1?
$950,000
The amount in this liability account should be the total amount of outstanding service contracts or (300k+450k+200k).
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 currently reported NI and Comprehensive income
*While financial capital is applied to comprehensive income, physical capital is not applied to currently reported net income.
Roro, Inc. paid $7,200 to renew its only insurance policy for three years on March 1, Year 5, the effective date of the policy. At March 31, Year 5, Roro’s unadjusted trial balance showed a balance of $300 for prepaid insurance and $7,200 for insurance expense.
What amounts should be reported for prepaid insurance and insurance expense in Roro’s financial statements for the three months ended March 31, Year 5?
$7,000 Prepaid, $500 Expense
$300 balance in prepaid transferred to expense as it related to the PY policy that ended.
Also, one month (March) under the new policy needs to be captured as expense - $200
So, your prepaid insurance account should be: ($300) Beg \+$7,200 Policy Paid -$200 month of March =$7,000
Your Insurance Expense account will be:
$300 last month of PY Policy
+$200 month of March
= $500
In analyzing a company’s financial statements, which financial statement would a potential investor use primarily to assess the company’s liquidity and financial flexibility?
Balance Sheet
Discloses the assets and liabilities, usually classified by proximity to realization (assets) or payment (liabilities). The balance shows the relative magnitude of assets and liabilities and, therefore, the ability to pay obligations in the near and longer term. It also shows the degree of leverage and ability to adapt to changing financial conditions as well as the ability to manage future cash flows when conditions change. Much of the potential of the firm is disclosed in the Balance Sheet. It is a statement of the wealth position of the firm and allows an assessment of the relative risk of the enterprise.
The fair value for an asset or liability is measured as
- The appraised value of the asset or liability.
- The price that would be paid to acquire the asset or received to assume the liability in an orderly transaction between market participants
- The price that would be received when selling an asset or paid when transferring a liability in an orderly transaction between market participants.
- The cost of the asset less any accumulated depreciation or the carrying value of the liability on the date of the sale.
REMEMBER FV BASED ON EXIT PRICE WHICH IS
The price that would be received when selling an asset or paid when transferring a liability in an orderly transaction between market participants.
Marco has an investment that is traded in two different markets, Front market and Side market. Marco has equal access to each market. In order to determine the fair value of its investment, Marco has obtained the selling price and the transaction cost per share for the securities as of the close of business December 31, the end of its fiscal year:
Front Market $52/sh $6/sh
Side Market $50/sh $1/sh
If neither Front market nor Side market is a principal market for the security for Marco, using the market approach which one of the following would be the per share amount used for measuring the investment at fair value?
SINCE NEITHER MARKET IS THE PRINCIPAL MARKET, MUST DETERMINE MOST ADVANTAGEOUS MARKET, THE MARKET THAT MAKES YOU THE MOST MONEY
Front Market makes you $46/sh
Side Market makes you $49/sh
Side Market is MOST ADVANTAGEOUS
Note, FV would be determined in that market as the selling price
ANSWER = $50
Investment in Walker Holdings LP (10%) (Fair Value elected)
for Gala Inc.
Information given is the Balance Sheet of Walker Holdings that has Partners’ Capital Accounts at BV and FV - Gala is $646,813
Information is not public -communicated to Investor only
In this situation, management is using the NAV obtained from the balance sheet related to its 10% investment. NAV is determined by looking at the investor’s capital account at fair value. For Gala Inc. NAV of its investment is $646,813 ((Assets minus liabilities) × 10 %.)
Since, NAV is communicated to the investor, but is not publicly available, NAV is being used as a practical expedient for fair value and is excluded from the fair value hierarchy. In this situation, management is using the NAV obtained from the balance sheet, which is not publicly available. Therefore, management is using NAV as a practical expedient and the investment will not be classified into the fair value hierarchy; however, disclosures about the use of NAV are required.
What hierarchy level are the following inputs:
1) The lowest level of inputs specified in the input hierarchy.
2) The highest level of inputs specified in the input hierarchy.
1) Level 3, lowest, least desirable level of inputs - not based on observable, external, market-based inputs, but rather are inputs based on an entity’s internal assumptions/estimates
2) Level 1 - the opposite
What is realization vs. recognition?
Realization - Revenues and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash.
Recognition - is the process of formally recording or incorporating an item into the financial statements of an entity as an asset, liability, revenue, expense, or the like.” SFAC 5 continues the recognition concept by stating, “An item and information about it should meet four fundamental recognition criteria to be recognized and should be recognized when the criteria are met, subject to a cost-benefit constraint and a materiality threshold.”
What is Comprehensive Income vs. Revenue vs. Earnings?
Comprehensive income is a broad measure of the effects of transactions and other events on an entity, comprising all recognized changes in equity (net assets) of the entity during a period from transactions and other events and circumstances except those resulting from investments by owners and distributions to owners.
Revenues - inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations
Earnings - is a measure of performance during a period that is concerned primarily with the extent to which asset inflows associated with cash-to-cash cycles substantially completed (or completed) during the period exceed (or are less than) asset outflows associated, directly or indirectly, with the same cycles
What is Current Market Value?
The amount of cash, or its equivalent, that could be obtained by selling an asset in orderly liquidation.
In Dart Co.’s year two single-step Income Statement, as prepared by Dart’s controller, the section titled “Revenues” consisted of the following:
Sales. $250,000
Purchase discounts $3,000
Recovery of accounts written off $10,000
Total revenues $263,000
In its year two single-step Income Statement, what amount should Dart report as total revenues?
Revenues are inflows of economic resources. The purchase discounts would be netted against purchases, not sales. The recovery of accounts written off is not revenue, it is an adjustment to the allowance for uncollectible accounts. Therefore the total revenue reported should be $250,000.
Which of the following would be reported as an investing activity in a company’s statement of cash flows?
- Collection of proceeds from a note payable.
- Collection of a note receivable from a related party.
- Collection of an overdue account receivable from a customer.
- Collection of a tax refund from the government.
Collection on a note receivable from a related party is an investing activity. The company is lending money to the related party and lending is not a primary business activity – the fact that the loan is in the form of a note implies that it is interest bearing.
