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QUESTIONS
1. What is a conceptual framework? Why is a conceptual framework necessary in financial accounting?
2. What is the primary objective of financial reporting?
3. What is meant by the term “qualitative characteristics of accounting information”?
4. Briefly describe the two fundamental qualities of useful accounting information.
5. How is materiality (or immateriality) related to the proper presentation of financial statements? What factors and measures should be considered in assessing the materiality of a misstatement in the presentation of a financial statement?
6. What are the enhancing qualities of the qualitative characteristics?
What is the role of enhancing qualities in the conceptual framework?
7. According to the FASB conceptual framework, the objective of financial reporting for business enterprises is based on the needs of the users of financial statements. Explain the level of sophistication that the Board assumes about the users of financial statements.
8. What is the distinction between comparability and consistency?
9. Why is it necessary to develop a definitional framework for the basic elements of accounting?
10. Expenses, losses, and distributions to owners are all decreases in net assets. What are the distinctions among them?
11. Revenues, gains, and investments by owners are all increases in net assets. What are the distinctions among them?
12. What are the four basic assumptions that underlie the financial accounting structure?
13. The life of a business is divided into specific time periods, usually a year, to measure results of operations for each such time period and to portray financial conditions at the end of each period.
(a) This practice is based on the accounting assumption that the life of the business consists of a series of time periods and that it is possible to measure accurately the results of operations for each period. Comment on the validity and necessity of this assumption.
(b) What has been the effect of this practice on accounting? What is its relation to the accrual system? What influence has it had on accounting entries and methodology?
14. What is the basic accounting problem created by the monetary unit assumption when there is significant inflation? What appears to be the FASB position on a stable monetary unit?
15. The chairman of the board of directors of the company for which you are chief accountant has told you that he has little use for accounting figures based on historical cost.
He believes that replacement values are of far more significance to the board of directors than “out-of-date costs.” Present some arguments to convince him that accounting data should still be based on historical cost.
16. What is the definition of fair value?
17. What is the fair value option? Explain how use of the fair value option reflects application of the fair value principle.
18. Briefly describe the fair value hierarchy.
19. Explain the revenue recognition principle.
20. What is a performance obligation, and how is it used to determine when revenue should be recognized?
21. What are the five steps used to determine the proper time to recognize revenue?
22. Selane Eatery operates a catering service specializing in business luncheons for large corporations. Selane requires customers to place their orders 2 weeks in advance of the scheduled events. Selane bills its customers on the tenth day of the month following the date of service and requires that payment be made within 30 days of the billing date. Conceptually, when should Selane recognize revenue related to its catering service?
23. Mogilny Company paid $135,000 for a machine. The Accumulated Depreciation—Equipment account has a balance of $46,500 at the present time. The company could sell the machine today for $150,000. The company president believes that the company has a “right to this gain.”
What does the president mean by this statement? Do you agree?
24. Three expense recognition methods (associating cause and effect, systematic and rational allocation, and immediate recognition) were discussed in the text under the expense recognition principle. Indicate the basic nature of each of these expense recognition methods and give two examples of each.
25. Statement of Financial Accounting Concepts No. 5 identifies four characteristics that an item must have before it is recognized in the financial statements. What are these four characteristics?
26. Briefly describe the types of information concerning financial position, income, and cash flows that might be provided (a) within the main body of the financial statements,
(b) in the notes to the financial statements, or (c) as supplementary information.
27. In January 2018, Janeway Inc. doubled the amount of its outstanding stock by selling on the market an additional 10,000 shares to finance an expansion of the business. You propose that this information be shown by a footnote on the balance sheet as of December 31, 2017. The president objects, claiming that this sale took place after December 31, 2017, and therefore should not be shown. Explain your position.
28. Describe the major constraint inherent in the presentation of accounting information.
29. What are some of the costs of providing accounting information?
What are some of the benefits of accounting information? Describe the cost-benefit factors that should be considered when new accounting standards are being proposed.
30. The treasurer of Landowska Co. has heard that conservatism is a doctrine that is followed in accounting and, therefore, proposes that several policies be followed that are conservative in nature. State your opinion with respect to each of the policies listed.
(a) The company gives a 2-year warranty to its customers on all products sold. The estimated warranty costs incurred from this year’s sales should be entered as an expense this year instead of an expense in the period in the future when the warranty is made good.
(b) When sales are made on account, there is always uncertainty about whether the accounts are collectible.
Therefore, the treasurer recommends recording the sale when the cash is received from the customers.
(c) A personal liability lawsuit is pending against the company. The treasurer believes there is an even chance that the company will lose the suit and have to pay damages of $200,000 to $300,000. The treasurer recommends that a loss be recorded and a liability created in the amount of $300,000.
BRIEF EXERCISES
BE2-1 (L03) Match the qualitative characteristics below with the following statements.
1. Relevance 5. Comparability
2. Faithful representation 6. Completeness
3. Predictive value 7. Neutrality
4. Confirmatory value 8. Timeliness
(a) Quality of information that permits users to identify similarities in and differences between two sets of economic phenomena.
(b) Having information available to users before it loses its capacity to influence decisions.
(c) Information about an economic phenomenon that has value as an input to the processes used by capital providers to form their own expectations about the future.
(d) Information that is capable of making a difference in the decisions of users in their capacity as capital providers.
(e) Absence of bias intended to attain a predetermined result or to induce a particular behavior.
BE2-2 (L03) Match the qualitative characteristics below with the following statements.
1. Timeliness 5. Faithful representation
2. Completeness 6. Relevance
3. Free from error 7. Neutrality
4. Understandability 8. Confirmatory value
(a) Quality of information that assures users that information represents the economic phenomena that it purports to represent.
(b) Information about an economic phenomenon that corrects past or present expectations based on previous evaluations.
(c) The extent to which information is accurate in representing the economic substance of a transaction.
(d) Includes all the information that is necessary for a faithful representation of the economic phenomena that it purports to represent.
(e) Quality of information that allows users to comprehend its meaning.
BE2-3 (L03) Discuss whether the changes described in each of the cases below require recognition in the CPA’s audit report as to consistency. (Assume that the amounts are material.)
(a) The company changed its inventory method to FIFO from weighted-average, which had been used in prior years.
(b) The company disposed of one of the two subsidiaries that had been included in its consolidated statements for prior years.
(c) The estimated remaining useful life of plant property was reduced because of obsolescence.
BE2-4 (L03) Identify which qualitative characteristic of accounting information is best described in each item below. (Do not use relevance and faithful representation.)
(a) The annual reports of Best Buy Co. are audited by certified public accountants.
(b) Black & Decker and Cannondale Corporation both use the FIFO cost flow assumption.
(c) Starbucks Corporation has used straight-line depreciation since it began operations.
(d) Motorola issues its quarterly reports immediately after each quarter ends.
BE2-5 (L03) Presented below are three different transactions related to materiality. Explain whether you would classify these transactions as material.
(a) Blair Co. has reported a positive trend in earnings over the last 3 years. In the current year, it reduces its bad debt allowance to ensure another positive earnings year. The impact of this adjustment is equal to 3% of net income.
(b) Hindi Co. has an unusual gain of $3.1 million on the sale of plant assets and a $3.3 million loss on the sale of investments.
It decides to net the gain and loss because the net effect is considered immaterial. Hindi Co.’s income for the current year was $10 million.
(c) Damon Co. expenses all capital equipment under $25,000 on the basis that it is immaterial. The company has followed this practice for a number of years.
BE2-6 (L04) For each item below, indicate to which category of elements of financial statements it belongs.
(a) Retained earnings (e) Depreciation (h) Dividends
(b) Sales (f) Loss on sale of equipment (i) Gain on sale of investment
(c) Additional paid-in capital (g) Interest payable (j) Issuance of common stock
(d) Inventory
BE2-7 (L04) Explain how you would decide whether to record each of the following expenditures as an asset or an expense.
Assume all items are material.
(a) Legal fees paid in connection with the purchase of land are $1,500.
(b) Eduardo, Inc. paves the driveway leading to the office building at a cost of $21,000.
(c) A meat market purchases a meat-grinding machine at a cost of $3,500.
(d) On June 30, Monroe and Meno, medical doctors, pay 6 months’ office rent to cover the month of July and the next 5 months.
(e) Smith’s Hardware Company pays $9,000 in wages to laborers for construction on a building to be used in the business.
(f) Alvarez’s Florists pays wages of $2,100 for the month to an employee who serves as driver of their delivery truck.
BE2-8 (L05) Identify which basic assumption of accounting is best described in each item below.
(a) The economic activities of FedEx Corporation are divided into 12-month periods for the purpose of issuing annual reports.
(b) Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation.
(c) Walgreen Co. reports current and noncurrent classifications in its balance sheet.
(d) The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes.
BE2-9 (L05) If the going concern assumption is not made in accounting, discuss the differences in the amounts shown in the financial statements for the following items.
(a) Land. (d) Inventory.
(b) Unamortized bond premium. (e) Prepaid insurance.
(c) Depreciation expense on equipment.
BE2-10 (L06) Identify which basic principle of accounting is best described in each item below.
(a) Norfolk Southern Corporation reports revenue in its income statement when the performance obligation is satisfied instead of when the cash is collected.
(b) Yahoo! recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue.
(c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements.
(d) Gap, Inc. reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair value is greater.
BE2-11 (L06) Vande Velde Company made three investments during 2017. (1) It purchased 1,000 shares of Sastre Company, a start-up company. Vande Velde made the investment based on valuation estimates from an internally developed model. (2) It purchased 2,000 shares of GE stock, which trades on the NYSE. (3) It invested $10,000 in local development authority bonds.
Although these bonds do not trade on an active market, their value closely tracks movements in U.S. Treasury bonds. Where will Vande Velde report these investments in the fair value hierarchy?
BE2-12 (L06) What accounting assumption, principle, or constraint would Target Corporation use in each of the situations below?
(a) Target was involved in litigation over the last year. This litigation is disclosed in the financial statements.
(b) Target allocates the cost of its depreciable assets over the life it expects to receive revenue from these assets.
(c) Target records the purchase of a new Dell PC at its cash equivalent price.
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