Study Unit 1: Conceptual Framework

Question 1

What is the going concern assumption?

Answer 1

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.

Question 2

What is the unit of measurement assumption?

Answer 2

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.

Question 3

What is the concept of capital maintenance?

Answer 3

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

Question 4

What are revenues?

Answer 4

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 5

How do we measure a revenue?

Answer 5

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

Question 6

What does the full disclosure principle state?

Answer 6

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 7

What is the Full Disclosure Principle sometimes referred as?

Answer 7

This principle is sometimes referred to as the adequate disclosure principle.

Question 8

What is the entity assumption?

Answer 8

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

Question 9

What does the matching principle state?

Answer 9

Recognize expenses only when expenditures help to produce revenues.

Question 10

What does the historical cost accounting principle state?

Answer 10

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.

Question 11

When should a company recognize revenues?

Answer 11

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

Question 12

What is the time period assumption?

Answer 12

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

Question 13

When does realization occur in the accounting period?

Hint: 3 things should occur

Answer 13

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

Question 14

What should be included in the auditor’s report when reporting on compliance with contractual agreements related to audited financial statements?

Hint: it’s 3 key things

Answer 14

1) Affirm that the financial statements were audited;
2) Identify the specific covenants and provide negative assurance about compliance; and
3) Restrict the distribution of the report to the parties to the agreement.

Question 15

What changes should be made in an auditor’s report when reporting on financial statements prepared under another comprehensive basis of accounting (OCBOA)?

Answer 15

Add an explanatory paragraph before the opinion paragraph describing the basis used and refer to the footnote to the financial statements that describes the basis used; and

in the opinion paragraph refer to that same footnote

also reference the financial statements that describes the basis of presentation used, since it differs from GAAP.

Question 16

Describe special-purpose financial presentations that may be consistent or inconsistent with GAAP.

Answer 16

Financial statements presented on a prescribed basis resulting in an incomplete presentation, but otherwise consistent with GAAP; or

Financial statements prepared on a basis of accounting prescribed in an agreement, not in conformity with GAAP or other comprehensive basis of accounting.

Question 17

List some examples of an “other comprehensive basis of accounting” (OCBOA).

Answer 17

1) Financial statements prepared using the cash-basis of accounting;
2) Financial statements prepared using income-tax principles;
3) Financial statements prepared using regulatory accounting principles;
4) Financial statements prepared using any other basis having “substantial support.”

Question 18

Under what circumstances can an auditor report on a specified element of the financial statements that is derived from net income, such as “profit participation.”

Answer 18

The auditor can report on a specified element of the financial statement that is derived from net income when he/she has audited the entire set of financial statements.

Question 19

How should a significant interest in a separate business be shown in a personal statement of financial condition?

Answer 19

As a single line item at the estimated current fair value of the net assets, separate from other assets.

Question 20

Describe the basis for measuring assets for a personal statement of financial condition.

Answer 20

Assets in a personal statement of financial condition should be measured at estimated current (fair) value in an arms-length transaction, net of disposal costs, if any.

Question 21

In what order should assets be shown in a personal statement of financial condition?

Answer 21

In the order of liquidity, with no distinction as to current/non-current classifications.

Question 22

At the time a financial instrument first becomes eligible for the fair value option, how is any difference between the then-current carrying value of the instrument and its fair value treated?

Answer 22

Any difference between the carrying value of a financial instrument and its fair value when the fair value option is first elected for the financial instrument is recognized as a gain or loss in the income of the period of election.

Question 23

Subsequent to the election to use the fair value option for financial instruments, how are gains and losses that result from changes in fair value treated?

Answer 23

Gains and losses on financial instruments for which the fair value option has been elected are recognized in current income of the period in which fair value changes.