Qs And As conceptual framework
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bestravila on January 30, 2012
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chapter 2 questions
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Terms | Definitions |
|---|---|
 conceptual framework | A conceptual framework is a coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial account-ing and financial statements. A conceptual framework is necessary in financial accounting for the following reasons: (1) It will enable the FASB to issue more useful and consistent standards in the future. (2) New issues will be more quickly solvable by reference to an existing framework of basic theory. (3) It will increase financial statement users' understanding of and confidence in financial reporting. (4) It will enhance comparability among companies' financial statements. |
| financial reporting objective | The basic objective is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in making decisions about providing resources to the entity. |
| Qualitative characteristics | "Qualitative characteristics of accounting information" are those characteristics which contribute to the quality or value of the information. The overriding qualitative characteristic of accounting infor-mation is usefulness for decision making. |
| fundamental qualities of useful accounting information | Relevance and faithful representation are the two primary qualities For information to be relevant, it should should be capable of making a difference in a decision by helping users to form predictions about the outcomes of past, present, and future events or to confirm or correct expectations. Faithful representation of a measure rests on whether the numbers and descriptions matched what really existed or happened |
| Materiality | material items are considered based on the size and nature of the item. It is material if it affects the decisions of the average informed reader. The most commonly way to measure materiality is to see the effect it has on net income or earnings per share. No standards or guidelines it has usually been between 5-20 percent, but each case should be individually assessed. |
| Enhancing qualities | Enhancing qualities are qualitative characteristics that are complementary to the fundamental qualitative characteristics. These characteristics distinguish more-useful information from less-useful information. Enhancing characteristics are comparability, verifiability, timeliness, and understandability. |
| level of sophistication assumed by the board | In providing information to users of financial statements, the Board relies on general-purpose financial statements. The intent of such statements is to provide the most useful information possible at minimal cost to various user groups. Underlying these objectives is the notion that users need reasonable knowledge of business and financial accounting matters to understand the information contained in financial statements. This point is important; it means that in the preparation of financial statements a level of reasonable competence can be assumed; this has an impact on the way and the extent to which information is reported. |
| comparability and consistency | Comparability facilitates comparisons between information about two different enterprises at a particular point in time. Consistency, a type of comparability, facilitates comparisons between information about the same enterprise at two different points in time. |
| definitional framework | At present, the accounting literature contains many terms that have peculiar and specific meanings. Some of these terms have been in use for a long period of time, and their meanings have changed over time. Since the elements of financial statements are the building blocks with which the statements are constructed, it is necessary to develop a basic definitional framework for them |
| expenses, losses, and distribution to owners | Distributions to owners differ from expenses and losses in that they represent transfers to owners, and they do not arise from activities intended to produce income. Expenses differ from losses in that they arise from the entity's ongoing major or central operations. Losses arise from peripheral or incidental transactions. |
| revenues, gains, and investments by owners | Investments by owners differ from revenues and gains in that they represent transfers by owners to the entity, and they do not arise from activities intended to produce income. Revenues differ from gains in that they arise from the entity's ongoing major or central operations. Gains arise from peripheral or incidental transactions. |
| four basic assumptions | The four basic assumptions that underlie the financial accounting structure are: (1) An economic entity assumption. (2) A going concern assumption. (3) A monetary unit assumption. (4) A periodicity assumption. |
| measurement of periods | (a) In accounting it is generally agreed that any measures of the success of an enterprise for periods less than its total life are at best provisional in nature and subject to correction. Measurement of progress and status for arbitrary time periods is a practical necessity to serve those who must make decisions. It is not the result of postulating specific time periods as measurable segments of total life. (b) The practice of periodic measurement has led to many of the most difficult accounting prob-lems such as inventory pricing, depreciation of long-term assets, and the necessity for revenue recognition tests. The accrual system calls for associating related revenues and expenses. This becomes very difficult for an arbitrary time period with incomplete transactions in process at both the beginning and the end of the period. A number of accounting practices such as adjusting entries or the reporting of corrections of prior periods result directly from efforts to make each period's calculations as accurate as possible and yet recognizing that they are only provisional in nature. |
| monetary unit assumption | The monetary unit assumption assumes that the unit of measure (the dollar) remains reasonably stable so that dollars of different years can be added without any adjustment. When the value of the dollar fluctuates greatly over time, the monetary unit assumption loses its validity. The FASB in Concept No. 5 indicated that it expects the dollar unadjusted for inflation or deflation to be used to measure items recognized in financial statements. Only if circumstances change dramatically will the Board consider a more stable measurement unit. |
| cost | Some of the arguments which might be used are outlined below: (1) Cost is definite and reliable; other values would have to be determined somewhat arbitrarily and there would be considerable disagreement as to the amounts to be used. (2) Amounts determined by other bases would have to be revised frequently. (3) Comparison with other companies is aided if cost is employed. (4) The costs of obtaining replacement values could outweigh the benefits derived. |
| fair value | Fair value is defined as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." Fair value is therefore a market-based measure. |
| fair value option | The fair value option gives companies the option to use fair value (referred to as the fair value option as the basis for measurement of financial assets and financial liabilities.) The Board believes that fair value measurement for financial instruments provides more relevant and understandable information than historical cost. It considers fair value to be more relevant because it reflects the current cash equivalent value of financial instruments. As a result companies now have the option to record fair value in their accounts for most financial instruments, including such items as receivables, investments, and debt securities. |
| fair value hierarchy | The fair value hierarchy provides insight into the priority of valuation techniques that are used to determine fair value. The fair value hierarchy is divided into three broad levels. Fair Value Hierarchy Level 1: Observable inputs that reflect quoted prices for Least Subjective identical assets or liabilities in active markets. Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability either directly or through corroboration with observable data. Level 3: Unobservable inputs (for example, a company's own data or assumptions). Most Subjective As indicated, Level 1 is the most reliable because it is based on quoted prices, like a closing stock price in the Wall Street Journal. Level 2 is the next most reliable and would rely on evaluating similar assets or liabilities in active markets. At the least-reliable level, Level 3, much judgment is needed based on the best information available to arrive at a relevant and reliable fair value measurement. |
| revenue recognition | Revenue is generally recognized when (1) realized or realizable, and (2) earned. The adoption of the sale basis is the accountant's practical solution to the extremely difficult problem of measuring revenue under conditions of uncertainty as to the future. The revenue is equal to the amount of cash that will be received due to the operations of the current accounting period, but this amount will not be definitely known until such cash is collected. The accountant, under these circumstances, insists on having "objective evidence," that is, evidence external to the firm itself, on which to base an estimate of the amount of cash that will be received. The sale is considered to be the earliest point at which this evidence is available in the usual case. Until the sale is made, any estimate of the value of inventory is based entirely on the opinion of the management of the firm. When the sale is made, however, an outsider, the buyer, has corroborated the estimate of management and a value can now be assigned based on this transaction. The sale also leads to a valid claim against the buyer and gives the seller the full support of the law in enforcing collection. In a highly developed economy where the probability of collection is high, this gives additional weight to the sale in the determination of the amount to be collected. Ordinarily there is a transfer of control as well as title at the sales point. This not only serves as additional objective evidence but necessitates the recognition of a change in the nature of assets. The sale, then, has been adopted because it provides the accountant with objective evidence as to the amount of revenue that will be collected, subject of course to the bad debts estimated to determine ultimate collectibility. |
| billing and recognizing revenue | Revenues should be recognized when they are realized or realizable and earned. The most common time at which these two conditions are met is when the product or merchandise is delivered or services are rendered to customers. Therefore, revenue for Selane Eatery should be recognized at the time the luncheon is served. |
| realized and realizable | Revenues are realized when products (goods or services), merchandise, or other assets are ex-changed for cash or claims to cash. Revenues are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. Readily convertible assets have (1) interchangeable (fungible) units and (2) quoted prices available in an active market that can rapidly absorb the quantity held by the entity without significantly affecting the price. Realizable is illustrated when sales revenue is recorded upon receipt of an actively traded security in exchange for inventory. |
| recognizing revenues at time of sale | Each deviation depends on either the existence of earlier objective evidence other than the sale or insufficient evidence of sale. Objective evidence is the key. (a) In the case of installment sales the probability of uncollectibility may be great due to the nature of the collection terms. The sale itself, therefore, does not give an accurate basis on which to estimate the amount of cash that will be collected. It is necessary to adopt a basis which will give a reasonably accurate estimate. The installment sales method is a modified cash basis; income is recognized as cash is collected. A cash basis is preferable when no earlier estimate of revenue is sufficiently accurate. (b) The opposite is true in the case of certain agricultural products. Since there is a ready buyer and a quoted price, a sale is not necessary to establish the amount of revenue to be received. In fact, the sale is an insignificant part of the whole operation. As soon as it is harvested, the crop can be valued at its selling price less the cost of transportation to the market and this valuation gives an extremely accurate measure of the amount of revenue for the period without the need of waiting until the sale has been made to measure it. In other words, the sale proceeds are readily realizable and earned, so revenue recognition should occur. (c) In the case of long-term contracts, the use of the "sales basis" would result in a distortion of the periodic income figures. A shift to a "percentage of completion basis" is warranted if objec-tive evidence of the amount of revenue earned in the periods prior to completion is available. The accountant finds such evidence in the existence of a firm contract, from which the ultimate realization can be determined, and estimates of total cost which can be compared with cost incurred to estimate percentage-of-completion for revenue measurement purposes. In general, when estimates of costs to complete and extent of progress toward completion of long-term contracts are reasonably dependable, the percentage-of-completion method is preferable to the completed-contract method. |
| right to gain | The president means that the "gain" should be recorded in the books. This item should not be entered in the accounts, however, because it has not been realized. |
| expense recognition principle | The cause and effect relationship can seldom be conclusively demonstrated, but many costs appear to be related to particular revenues and recognizing them as expenses accompanies recognition of the revenue. Examples of expenses that are recognized by associating cause and effect are sales commissions and cost of products sold or services provided. Systematic and rational allocation means that in the absence of a direct means of associating cause and effect, and where the asset provides benefits for several periods, its cost should be allocated to the periods in a systematic and rational manner. Examples of expenses that are recognized in a systematic and rational manner are depreciation of plant assets, amortization of intangible assets, and allocation of rent and insurance. Some costs are immediately expensed because the costs have no discernible future benefits or the allocation among several accounting periods is not considered to serve any useful purpose. Examples include officers' salaries, most selling costs, amounts paid to settle lawsuits, and costs of resources used in unsuccessful efforts. |
| four characteristics of items in financial statements | The four characteristics are: (1) Definitions—The item meets the definition of an element of financial statements. (2) Measurability—It has a relevant attribute measurable with sufficient reliability. (3) Relevance—The information is capable of making a difference in user decisions. (4) Reliability—The information is representationally faithful, verifiable, and neutral. |
| financial position, income, cash flows | (a) To be recognized in the main body of financial statements, an item must meet the definition of an element. In addition the item must have been measured, recorded in the books, and passed through the double-entry system of accounting. (b) Information provided in the notes to the financial statements amplifies or explains the items presented in the main body of the statements and is essential to an understanding of the per-formance and position of the enterprise. Information in the notes does not have to be quanti-fiable, nor does it need to qualify as an element. (c) Supplementary information includes information that presents a different perspective from that adopted in the financial statements. It also includes management's explanation of the financial information and a discussion of the significance of that information. |
| selling shares | The general guide followed with regard to the full disclosure principle is to disclose in the financial statements any facts of sufficient importance to influence the judgment of an informed reader. The fact that the amount of outstanding common stock doubled in January of the subsequent reporting period probably should be disclosed because such a situation is of importance to present stockholders. Even though the event occurred after December 31, 2012, it should be disclosed on the balance sheet as of December 31, 2012, in order to make adequate disclosure. (The major point that should be emphasized throughout the entire discussion on full disclosure is that there is normally no "black" or "white" but varying shades of grey and it takes experience and good judgment to arrive at an appropriate answer). |
| presentation of accounting information | Accounting information is subject to the cost constraint. Information is not worth providing unless the benefits exceed the costs of preparing it. |
| costs | The costs of providing accounting information are paid primarily to highly trained accountants who design and implement information systems, retrieve and analyze large amounts of data, prepare financial statements in accordance with authoritative pronouncements, and audit the information presented. These activities are time-consuming and costly. The benefits of providing accounting information are experienced by society in general, since informed financial decisions help allocate scarce resources to the most effective enterprises. Occasionally new accounting standards require presentation of information that is not readily assembled by the accounting systems of most companies. A determination should be made as to whether the incremental or additional costs of providing the proposed information exceed the incremental benefits to be obtained. This deter¬mination requires careful judgment since the benefits of the proposed information may not be readily apparent. |
| conservative | (a) Acceptable if reasonably accurate estimation is possible. To the extent that warranty costs can be estimated accurately, they should be matched against the related sales revenue. (b) Not acceptable. Most accounts are collectible or the company will be out of business very soon. Hence sales can be recorded when made. Also, other companies record sales when made rather than when collected, so if accounts for Landowska Co. are to be compared with other companies, they must be kept on a comparable basis. However, estimates for uncollectible accounts should be recorded if there is a reasonably accurate basis for estimating bad debts. (c) Not acceptable. A provision for the possible loss can be made through an appropriation of retained earnings but until judgment has been rendered on the suit or it is otherwise settled, entry of the loss usually represents anticipation. Recording it earlier is probably unwise legal strategy as well. For the loss to be recognized at this point, the loss would have to be probable and reasonably estimable. (See FASB ASC 450-10-05 for additional discussion if desired.) Note disclosure is required if the loss is not recorded; however, conservatism is not part of the conceptual framework. (d) Acceptable because lower of cost or market is in accordance with generally accepted account¬ing principles. |
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