CH 02

CHAPTER 2
Conceptual Framework Underlying Financial Accounting

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ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

Questions Brief Exercises Exercises Concepts for Analysis
Topics 1. 2. 3. !. 5. ". Conceptual framework general. Objectives of financial reporting. Qualitative c aracteristics of accounting. $lements of financial statements. (asic assumptions. (asic principles) a. *easurement. b. +evenue recognition. c. $,pense recognition. -. .ull -isclosure. /ccounting principles compre ensive. Constraints. Compre ensive assign0 ments on assumptions, principles, an- constraints.
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ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Lear i ! O"#ec$i%es 1. 2. 3. !. 5. ". %. &. =escribe t e usefulness of a conceptual framework. =escribe t e ./6(>s efforts to construct a conceptual framework. ;n-erstan- t e objectives of financial reporting. 7-entif1 t e ?ualitative c aracteristics of accounting information. =efine t e basic elements of financial statements. =escribe t e basic assumptions of accounting. $,plain t e application of t e basic principles of accounting. =escribe t e impact t at constraints ave on reporting accounting information.
Brie& E'ercises
E'ercises
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ASSIGNMENT CHARACTERISTICS TABLE
I$e( E2-1 E2-2 E2-3 E2-4 E2-5 E2-" E2-% E2-&
)escrip$io Qualitative characteristics. Qualitative characteristics. Elements of financial statements. ssumptions! principles! and constraints. ssumptions! principles! and constraints. .ull -isclosure principle. /ccounting principlescompre ensive. /ccounting principlescompre ensive.
Le%e* o& )i&&ic+*$,
Ti(e ((i +$es) 253# 1520 1520 1520 2025 2025 2025 2025
Moderate Simple Simple Simple Moderate #omple$ Moderate Moderate
# 2-1 # 2-2 # 2-3 # 2-4 # 2-5 # 2-" # 2-% # 2-& # 2-+ # 2-10 # 2-11 # 2-12
#onceptual frame'or()eneral. #onceptual frame'or()eneral. Objectives of financial reporting. Qualitative characteristics. *evenue and e$pense reco)nition principles. *evenue and e$pense reco)nition principles. E$pense reco)nition principle. E$pense reco)nition principle. E$pense reco)nition principle. Qualitative characteristics. E$pense reco)nition principle. #ost,-enefit.
Simple Simple Moderate Moderate #omple$ Moderate #omple$ Moderate Moderate Moderate Moderate Moderate
2025 2535 2535 3035 2530 3035 2025 2025 2030 2030 2025 3035
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SOLUTION TO CODIFICATION EXE CISES

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:a< @ e master glossar1 provi-es t ree -efinitions of fair value t at are foun- in A//B) .air CalueD@ e amount at w ic an asset :or Eiabilit1< coul- be boug t :or incurre-< or settle- in a current transaction between willing parties, t at is, ot er t an in a force- or li?ui-ation sale. .air CalueD@ e fair value of an investment is t e amount t at t e plan coul- reasonabl1 e,pect to receive for it in a current sale between a willing bu1er an- a willing seller, t at is, ot er t an in a force- or li?ui-ation sale. .air value s all be measure- b1 t e market price if t ere is an active market for t e investment. 7f t ere is no active market for t e investment but t ere is a market for similar investments, selling prices in t at market ma1 be elpful in estimating fair value. 7f a market price is not available, a forecast of e,pecte- cas flows, -iscounte- at a rate commensurate wit t e risk involve-, ma1 be use- to estimate fair value. @ e fair value of an investment s all be reporte- net of t e brokerage commissions anot er costs normall1 incurre- in a sale. .air Calue is t e price t at woul- be receive- to sell an asset or pai- to transfer a liabilit1 in an or-erl1 transaction between market participants at t e measurement -ate. :b< +evenueD+evenue earne- b1 an entit1 from its -irect -istribution, e,ploitation, or licensing of a film, before -e-uction for an1 of t e entit1>s -irect costs of -istribution. .or markets an- territories in w ic an entit1>s full1 or jointl10owne- films are -istribute- b1 t ir- parties, revenue is t e net amounts pa1able to t e entit1 b1 t ir- part1 -istributors. +evenue is re-uce- b1 appropriate allowances, estimate- returns, price concessions, or similar a-justments, as applicable. @ e glossar1 references a revenue -efinition for t e 6$C) :+evenue :6$C<<D6ee paragrap '!20235065''01, +egulation 60F +ule '0#5:c<:2<, for t e -efinition of revenue for purposes of +egulation 60F +ule '0#5. @ is -efinition relates to segment reporting re?uirements for public companies.
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Compre ensive 7ncome is -efine- as t e c ange in e?uit1 :net assets< of a business entit1 -uring a periofrom transactions anot er events an- circumstances from nonowner sources. 7t inclu-es all c anges in e?uit1 -uring a perio- e,cept t ose resulting from investments b1 owners an- -istributions to owners.
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@ e ./6( Co-ification>s organiGation is closel1 aligne- wit t e elements of financial statements, as articulatein t e Conceptual .ramework. @ is is apparent in t e la10out of t e H(rowseI section, w ic as primar1 links for /ssets, Eiabilities, $?uit1, +evenues, an- $,penses.
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@ e 7mportance of 7n-ustr1 Bractices is reflecte- in t e -esignation of several in-ustries as top level links in t e Co-ification organiGation. @ ere are separate links to sections for t e following in-ustries :section numbers prece-e eac name<) '#5 '#& '1# '12 '15 '2# '22 '2! '2" '2& '3# '32 '!# '!2 '!! '!" '!& '5# '52 '5! '5" '5& '"# '"2 '"5 '%# '%2 '%! '%" '%& '&# '&5 ''5 /griculture /irlines ContractorsDConstruction ContractorsD.e-eral Aovernment =evelopment 6tage entities $ntertainmentD(roa-casters $ntertainmentDCable @elevision $ntertainmentDCasinos $ntertainmentD.ilms $ntertainmentD*usic $,tractive /ctivitiesD*ining $,tractive /ctivitiesDOil an- Aas .inancial 6ervicesD(roker an- =ealers .inancial 6ervicesD=epositor1 an- Een-ing .inancial 6ervicesD7nsurance .inancial 6ervicesD7nvestment Companies .inancial 6ervicesD*ortgage (anking .inancial 6ervicesD@itle Blant .ranc isors Jealt Care $ntities Eimite- Eiabilit1 $ntities Kot0for0Brofit $ntities Blan /ccountingD=efine- (enefit Bension Blans Blan /ccountingD=efine- Contribution Bension Blans Blan /ccountingDJealt an- 4elfare (enefit Blans +eal $stateDAeneral +eal $stateDCommon 7nterest +ealt1 /ssociations +eal $stateD+eal $state 7nvestment @rusts +eal $stateD+etail Ean+eal $stateD@ime06 aring /ctivities +egulate- Operations 6oftware ;.6. 6teams ip $ntities
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ANS-ERS TO ./ESTIONS
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#% / conceptual framework is a co erent s1stem of interrelateobjectives an- fun-amentals t at can lea- to consistent stan-ar-s an- t at prescribes t e nature, function, an- limits of financial accounting anfinancial statements. / conceptual framework is necessar1 in financial accounting for t e following reasons) :1< 7t will enable t e ./6( to issue more useful an- consistent stan-ar-s in t e future. :2< Kew issues will be more ?uickl1 solvable b1 reference to an e,isting framework of basic t eor1. :3< 7t will increase financial statement users> un-erstan-ing of an- confi-ence in financial reporting. :!< 7t will en ance comparabilit1 among companies> financial statements. !% @ e primar1 objectives of financial reporting are as follows) :1< Brovi-e information useful in investment ancre-it -ecisions for in-ivi-uals w o ave a reasonable un-erstan-ing of business. :2< Brovi-e information useful in assessing future cas flows. :3< Brovi-e information about enterprise resources, claims to t ese resources, an- c anges in t em. $% HQualitative c aracteristics of accounting informationI are t ose c aracteristics w ic contribute to t e ?ualit1 or value of t e information. @ e overri-ing ?ualitative c aracteristic of accounting information is usefulness for -ecision making. &% +elevance an- reliabilit1 are t e two primar1 ?ualities of useful accounting information. .or informa0tion to be relevant, it s oul- ave pre-ictive value or fee-back value, an- it must be presente- on a timel1 basis. +elevant information as a bearing on a -ecision an- is capable of making a -ifference in t e -ecision. +elevant information elps users to make pre-ictions about t e outcomes of past, present, an- future events, or to confirm or correct prior e,pectations. +eliable information can be -epen-e- upon to represent t e con-itions an- events t at it is inten-e- to represent. +eliabilit1 stems from representational fait fulness, neutralit1, anverifiabilit1. '% 7n provi-ing information to users of financial statements, t e (oar- relies on general0purpose financial statements. @ e intent of suc statements is to provi-e t e most useful information possible at minimal cost to various user groups. ;n-erl1ing t ese objectives is t e notion t at users nee- reasonable knowle-ge of business anfinancial accounting matters to un-erstant e information containe- in financial statements. @ is point is important) it means t at in t e preparation of financial statements a level of reasonable competence can be assume-L t is as an impact on t e wa1 an- t e e,tent to w ic information is reporte-. (% Comparabilit1 facilitates comparisons between information about two -ifferent enterprises at a particular point in time. Consistenc1 facilitates comparisons between information about t e same enterprise at two -ifferent points in time. )% /t present, t e accounting literature contains man1 terms t at ave peculiar anspecific meanings. 6ome of t ese terms ave been in use for a long perio- of time, an- t eir meanings ave c ange- over time. 6ince t e elements of financial statements are t e buil-ing blocks wit w ic t e statements are constructe-, it is necessar1 to -evelop a basic -efinitional framework for t em. *% =istributions to owners -iffer from e,penses an- losses in t at t e1 represent transfers to owners, an- t e1 -o not arise from activities inten-e- to pro-uce income. $,penses -iffer from losses in t at t e1 arise from t e entit1>s ongoing major or central operations. Eosses arise from perip eral or inci-ental transactions.
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Questions C+apter ! :Continue-< ,% 7nvestments b1 owners -iffer from revenues an- gains in t at t e1 represent transfers b1 owners to t e entit1, an- t e1 -o not arise from activities inten-e- to pro-uce income. +evenues -iffer from gains in t at t e1 arise from t e entit1>s ongoing major or central operations. Aains arise from perip eral or inci-ental transactions. #-% @ e four basic assumptions t at un-erlie t e financial accounting structure are) :1< /n economic entit1 assumption. :2< / going concern assumption. :3< / monetar1 unit assumption. :!< / perio-icit1 assumption. ##% :a< 7n accounting it is generall1 agree- t at an1 measures of t e success of an enterprise for perio-s less t an its total life are at best provisional in nature an- subject to correction. *easurement of progress an- status for arbitrar1 time perio-s is a practical necessit1 to serve t ose w o must make -ecisions. 7t is not t e result of postulating specific time perio-s as measurable segments of total life. :b< @ e practice of perio-ic measurement as le- to man1 of t e most -ifficult accounting prob lems suc as inventor1 pricing, -epreciation of long0term assets, an- t e necessit1 for revenue recognition tests. @ e accrual s1stem calls for associating relate- revenues an- e,penses. @ is becomes ver1 -ifficult for an arbitrar1 time perio- wit incomplete transactions in process at bot t e beginning an- t e en- of t e perio-. / number of accounting practices suc as a-justing entries or t e reporting of corrections of prior perio-s result -irectl1 from efforts to make eac perio->s calculations as accurate as possible an1et recogniGing t at t e1 are onl1 provisional in nature. #!% @ e monetar1 unit assumption assumes t at t e unit of measure :t e -ollar< remains reasonabl1 stable so t at -ollars of -ifferent 1ears can be a--e- wit out an1 a-justment. 4 en t e value of t e -ollar fluctuates greatl1 over time, t e monetar1 unit assumption loses its vali-it1. @ e ./6( in Concept No% ' in-icate- t at it e,pects t e -ollar una-juste- for inflation or -eflation to be use- to measure items recogniGe- in financial statements. Onl1 if circumstances c ange -ramaticall1 will t e (oar- consi-er a more stable measurement unit. #$% 6ome of t e arguments w ic mig t be use- are outline- below) :1< Cost is -efinite an- reliableL ot er values woulave to be -etermine- somew at arbitraril1 an- t ere woul- be consi-erable -isagreement as to t e amounts to be use-. :2< /mounts -etermine- b1 ot er bases woulave to be revise- fre?uentl1. :3< Comparison wit ot er companies is ai-e- if cost is emplo1e-. :!< @ e costs of obtaining replacement values coul- outweig t e benefits -erive-. #&% Fair .alue is -efine- as Ht e price t at woul- be receive- to sell an asset or pai- to transfer a liabilit1 in an or-erl1 transaction between market participants at t e measurement -ate.I .air value is t erefore a market0 base- measure.
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#'% @ e fair value option gives companies t e option to use fair value :referre- to as t e fair value option as t e basis for measurement of financial assets anfinancial liabilities.< @ e (oar- believes t at fair value measurement for financial instruments provi-es more relevant an- un-erstan-able information t an istorical cost. 7t consi-ers fair value to be more relevant because it reflects t e current cas e?uivalent value of financial instruments. /s a result companies now ave t e option to recor- fair value in t eir accounts for most financial instruments, inclu-ing suc items as receivables, investments, an- -ebt securities.
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Questions C+apter ! :Continue-< #(% @ e fair value ierarc 1 provi-es insig t into t e priorit1 of valuation tec ni?ues t at are use- to -etermine fair value. @ e fair value ierarc 1 is -ivi-e- into t ree broa- levels. Fair /alue 0ierarc+y Le.el #1 Observable inputs t at reflect ?uote- prices for i-entical assets or liabilities in active markets. Le.el !1 7nputs ot er t an ?uote- prices inclu-e- in Eevel 1 t at are observable for t e asset or liabilit1 eit er -irectl1 or t roug corroboration wit observable -ata. Le.el $1 ;nobservable inputs :for e,ample, a compan1>s own -ata or assumptions<. Least elia3le 2ost elia3le
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/s in-icate-, Eevel 1 is t e most reliable because it is base- on ?uote- prices, like a closing stock price in t e Wall Street Journal. Eevel 2 is t e ne,t most reliable an- woul- rel1 on evaluating similar assets or liabilities in active markets. /t t e least0reliable level, Eevel 3, muc ju-gment is nee-e- base- on t e best information available to arrive at a relevant an- reliable fair value measurement. #)% +evenue is generall1 recogniGe- w en :1< realiGe- or realiGable, an- :2< earne-.
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@ e a-option of t e sale basis is t e accountant>s practical solution to t e e,tremel1 -ifficult problem of measuring revenue un-er con-itions of uncertaint1 as to t e future. @ e revenue is e?ual to t e amount of cas t at will be receive- -ue to t e operations of t e current accounting perio-, but t is amount will not be -efinitel1 known until suc cas is collecte-. @ e accountant, un-er t ese circumstances, insists on aving Hobjective evi-ence,I t at is, evi-ence e,ternal to t e firm itself, on w ic to base an estimate of t e amount of cas t at will be receive-. @ e sale is consi-ere- to be t e earliest point at w ic t is evi-ence is available in t e usual case. ;ntil t e sale is ma-e, an1 estimate of t e value of inventor1 is base- entirel1 on t e opinion of t e manage0ment of t e firm. 4 en t e sale is ma-e, owever, an outsi-er, t e bu1er, as corroborate- t e estimate of management an- a value can now be assigne- base- on t is transaction. @ e sale also lea-s to a vali- claim against t e bu1er an- gives t e seller t e full support of t e law in enforcing collection. 7n a ig l1 -evelope- econom1 w ere t e probabilit1 of collection is ig , t is gives a--itional weig t to t e sale in t e -etermination of t e amount to be collecte-. Or-inaril1 t ere is a transfer of control as well as title at t e sales point. @ is not onl1 serves as a--itional objective evi-ence but necessitates t e recognition of a c ange in t e nature of assets. @ e sale, t en, as been a-opte- because it provi-es t e accountant wit objective evi-ence as to t e amount of revenue t at will be collecte-, subject of course to t e ba- -ebts estimate- to -etermine ultimate collectibilit1. #*% +evenues s oulbe recogniGe- w en t e1 are realiGe- or realiGable an- earne-. @ e most common time at w ic t ese two con-itions are met is w en t e pro-uct or merc an-ise is -elivere- or services are ren-ereto customers. @ erefore, revenue for 6elane $ater1 s oulbe recogniGe- at t e time t e lunc eon is serve-. #,% +evenues are realiGe- w en pro-ucts :goo-s or services<, merc an-ise, or ot er assets are e,0c ange- for cas or claims to cas . +evenues are realiGable w en relate- assets receive- or el- are rea-il1 convertible to known amounts of cas or claims to cas . +ea-il1 convertible assets ave :1< interc angeable :fungible< units an- :2< ?uote- prices available in an active market t at can rapi-l1 absorb t e ?uantit1 el- b1 t e entit1 wit out significantl1 affecting t e price.
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Questions C+apter ! :Continue-< !-% $ac -eviation -epen-s on eit er t e e,istence of earlier objective evi-ence ot er t an t e sale or insufficient evi-ence of sale. Objective evi-ence is t e ke1. :a< 7n t e case of installment sales t e probabilit1 of uncollectibilit1 ma1 be great -ue to t e nature of t e collection terms. @ e sale itself, t erefore, -oes not give an accurate basis on w ic to estimate t e amount of cas t at will be collecte-. 7t is necessar1 to a-opt a basis w ic will give a reasonabl1 accurate estimate. @ e installment sales met o- is a mo-ifie- cas basisL income is recogniGe- as cas is collecte-. / cas basis is preferable w en no earlier estimate of revenue is sufficientl1 accurate. :b< @ e opposite is true in t e case of certain agricultural pro-ucts. 6ince t ere is a rea-1 bu1er an- a ?uote- price, a sale is not necessar1 to establis t e amount of revenue to be receive-. 7n fact, t e sale is an insignificant part of t e w ole operation. /s soon as it is arveste-, t e crop can be value- at its selling price less t e cost of transportation to t e market an- t is valuation gives an e,tremel1 accurate measure of t e amount of revenue for t e perio- wit out t e nee- of waiting until t e sale as been ma-e to measure it. 7n ot er wor-s, t e sale procee-s are rea-il1 realiGable an- earne-, so revenue recognition s oul- occur. :c< 7n t e case of long0term contracts, t e use of t e Hsales basisI woul- result in a -istortion of t e perio-ic income figures. / s ift to a Hpercentage of completion basisI is warrante- if objec0tive evi-ence of t e amount of revenue earne- in t e perio-s prior to completion is available. @ e accountant fin-s suc evi-ence in t e e,istence of a firm contract, from w ic t e ultimate realiGation can be -etermine-, an- estimates of total cost w ic can be compare- wit cost incurre- to estimate percentage0of0completion for revenue measurement purposes. 7n general, w en estimates of costs to complete an- e,tent of progress towar- completion of long0term contracts are reasonabl1 -epen-able, t e percentage0of0completion met o- is preferable to t e complete-0contract met o-. !#% @ e presi-ent means t at t e HgainI s oulbe recor-e- in t e books. @ is item s oulnot be entere- in t e accounts, owever, because it as not been realiGe-.
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!!% @ e cause aneffect relations ip can sel-om be conclusivel1 -emonstrate-, but man1 costs appear to be relate- to particular revenues an- recogniGing t em as e,penses accompanies recognition of t e revenue. $,amples of e,penses t at are recogniGe- b1 associating cause aneffect are sales commissions an- cost of pro-ucts sol- or services provi-e-. 61stematic anrational allocation means t at in t e absence of a -irect means of associating cause aneffect, an- w ere t e asset provi-es benefits for several perio-s, its cost s oulbe allocate- to t e perio-s in a s1stematic anrational manner. $,amples of e,penses t at are recogniGe- in a s1stematic anrational manner are -epreciation of plant assets, amortiGation of intangible assets, anallocation of rent aninsurance. 6ome costs are imme-iatel1 e,pense- because t e costs ave no -iscernible future benefits or t e allocation among several accounting perio-s is not consi-ere- to serve an1 useful purpose. $,amples inclu-e officers> salaries, most selling costs, amounts pai- to settle lawsuits, an- costs of resources use- in unsuccessful efforts. !$% @ e four c aracteristics are) :1< =efinitionsD@ e item meets t e -efinition of an element of financial statements. :2< *easurabilit1D7t as a relevant attribute measurable wit sufficient reliabilit1. :3< +elevanceD@ e information is capable of making a -ifference in user -ecisions. :!< +eliabilit1D@ e information is representationall1 fait ful, verifiable, an- neutral.
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Questions C+apter ! :Continue-< !&% :a< @o be recogniGe- in t e main bo-1 of financial statements, an item must meet t e -efinition of an element. 7n a--ition t e item must ave been measure-, recor-e- in t e books, an- passe- t roug t e -ouble0entr1 s1stem of accounting. :b< 7nformation provi-e- in t e notes to t e financial statements amplifies or e,plains t e items presentein t e main bo-1 of t e statements an- is essential to an un-erstan-ing of t e performance an- position of t e enterprise. 7nformation in t e notes -oes not ave to be ?uantifiable, nor -oes it nee- to ?ualif1 as an element. :c< 6upplementar1 information inclu-es information t at presents a -ifferent perspective from t at a-optein t e financial statements. 7t also inclu-es management>s e,planation of t e financial information an- a -iscussion of t e significance of t at information. !'% @ e general gui-e followe- wit regar- to t e full -isclosure principle is to -isclose in t e financial statements an1 facts of sufficient importance to influence t e ju-gment of an informe- rea-er. @ e fact t at t e amount of outstan-ing common stock -ouble- in 3anuar1 of t e subse?uent reporting perio- probabl1 s oulbe -isclose- because suc a situation is of importance to present stock ol-ers. $ven t oug t e event occurre- after =ecember 31, 2#1#, it s oulbe -isclose- on t e balance s eet as of =ecember 31, 2#1#, in or-er to make a-e?uate -isclosure. :@ e major point t at s oulbe emp asiGet roug out t e entire -iscussion on full -isclosure is t at t ere is normall1 no HblackI or Hw iteI but var1ing s a-es of gre1 an- it takes e,perience an- goo- ju-gment to arrive at an appropriate answer.< !(% /ccounting information is subject to two constraints) cost9benefit consi-erations, an- materialit1. 7nformation is not wort provi-ing unless t e benefits it provi-es e,cee- t e costs of preparing it. 7nformation t at is immaterial is irrelevant, an- conse?uentl1, not useful. 7f its inclusion or omission woulave no impact on a -ecision maker, t e information is immaterial. Jowever, if it is material, it s oulbe reporte-. !)% @ e costs of provi-ing accounting information are pai- primaril1 to ig l1 traine- accountants w o -esign an- implement information s1stems, retrieve an- anal1Ge large amounts of -ata, prepare financial statements in accor-ance wit aut oritative pronouncements, an- au-it t e information presente-. @ ese activities are time0consuming an- costl1. @ e benefits of provi-ing accounting information are e,perience- b1 societ1 in general, since informe- financial -ecisions elp allocate scarce resources to t e most effective enterprises. Occasionall1 new accounting stan-ar-s re?uire presentation of information t at is not rea-il1 assemble- b1 t e accounting s1stems of most companies. / -etermination s oulbe ma-e as to w et er t e incremental or a--itional costs of provi-ing t e propose- information e,cee- t e incremental benefits to be obtaine-. @ is -etermination re?uires careful ju-gment since t e benefits of t e propose- information ma1 not be rea-il1 apparent. !*% @ e concept of materialit1 refers to t e relative significance of an amount, activit1, or item to informative -isclosure an- a proper presentation of financial position an- t e results of operations. *aterialit1 as ?ualitative an- ?uantitative aspectsL bot t e nature of t e item an- its relative siGe enter into its evaluation. /n accounting misstatement is sai- to be material if knowle-ge of t e misstatement will affect t e -ecisions of t e average informe- rea-er of t e financial statements. .inancial statements are mislea-ing if t e1 omit a material fact or inclu-e so man1 immaterial matters as to be confusing. 7n t e e,amination, t e au-itor concentrates efforts in proportion to -egrees of materialit1 an- relative risk an- -isregar-s immaterial items. @ e relevant criteria for assessing materialit1 will -epen- upon t e circumstances an- t e nature of t e item an- will var1 greatl1 among companies. .or e,ample, an error in current assets or current liabilities will be more important for a compan1 wit a flow of fun-s problem t an for one wit a-e?uate working capital. Questions C+apter ! :Continue-<
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@ e effect upon net income :or earnings per s are< is t e most commonl1 use- measure of materialit1. @ is reflects t e prime importance attac e- to net income b1 investors anot er users of t e statements. @ e effects upon assets an- e?uities are also important as are misstatements of in-ivi-ual accounts an- subtotals
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inclu-e- in t e financial statements. @ e au-itor will note t e effects of misstatements on ke1 ratios suc as gross profit, t e current ratio, or t e -ebt9e?uit1 ratio an- will consi-er suc special circumstances as t e effects on -ebt agreement covenants an- t e legalit1 of -ivi-en- pa1ments.
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@ ere are no rigi- stan-ar-s or gui-elines for assessing materialit1. @ e lower boun- of materialit1 as been variousl1 estimate- at 5M to 2#M of net income, but t e -etermination will var1 base- upon t e in-ivi-ual case an- mig t not fall wit in t ese limits. Certain items, suc as a ?uestionable loan to a compan1 officer, ma1 be consi-ere- material even w en minor amounts are involve-. 7n contrast a large misclassification among e,pense accounts ma1 not be -eeme- material if t ere is no misstatement of net income. !,% :a< /cceptable if reasonabl1 accurate estimation is possible. @o t e e,tent t at warrant1 costs can be estimate- accuratel1, t e1 s oulbe matc e- against t e relate- sales revenue. :b< Kot acceptable. *ost accounts are collectible or t e compan1 will be out of business ver1 soon. Jence sales can be recor-e- w en ma-e. /lso, ot er companies recor- sales w en ma-e rat er t an w en collecte-, so if accounts for Ean-owska Co. are to be compare- wit ot er companies, t e1 must be kept on a comparable basis. Jowever, estimates for uncollectible accounts s oulbe recor-e- if t ere is a reasonabl1 accurate basis for estimating ba- -ebts. :c< Kot acceptable. / provision for t e possible loss can be ma-e t roug an appropriation of retaineearnings but until ju-gment as been ren-ere- on t e suit or it is ot erwise settle-, entr1 of t e loss usuall1 represents anticipation. +ecor-ing it earlier is probabl1 unwise legal strateg1 as well. .or t e loss to be recogniGe- at t is point, t e loss woulave to be probable an- reasonabl1 estimable. :6ee ./6( /6C !5#01#0#5 for a--itional -iscussion if -esire-.< Kote -isclosure is re?uire- if t e loss is not recor-e-. :-< /cceptable because lower of cost or market is in accor-ance wit generall1 accepte- accounting principles. $-% @ e 7/6( framework makes two assumptions. One assumption is t at financial statements are prepare- on an accrual basisL t e ot er is t at t e reporting entit1 is a going concern. @ e ./6( -iscuss accrual accounting e,tensivel1 but -oes not i-entif1 it as an assumption. @ e going concern concept is onl1 briefl1 -iscusse-. @ e going concern concept will un-oubte-l1 be -ebate- as to its place in t e conceptual framework. $#% 4 ile t ere is some agreement t at t e role of financial reporting is to assist users in -ecision0making, t e 7/6( framework as a- more of a focus on t e objective of provi-ing information on management>s performanceDoften referre- to as stewar-s ip. 7t is likel1 t at t ere will be muc -ebate regar-ing t e role of stewar-s ip in t e conceptual framework. $!% /s in-icate-, t e measurement project relates to bot initial measurement an- subse?uent measurement. @ us, t e continuing controvers1 relate- to istorical cost an- fair value accounting suggests t at t is issue will be controversial. @ e reporting entit1 project t at a--resses w ic entities s oulbe inclu-e- in consoli-ate- statements an- ow to implement suc consoli-ations will be a -ifficult project. Ot er -ifficult issues relate to t e tra-e off between ig l1 relevant information t at is -ifficult to verif1N Or ow -o we -efine control w en we are -eveloping a -efinition of an assetN Or is a liabilit1 t e future sacrifice itself or t e obligation to make t e sacrificeN
15
2#
25
3#
35
!#
2011
SOLUTIONS TO B IEF EXE CISES

B IEF EXE CISE !"#
5
4a5
1#
If t+e co6pany c+an7e8 its 6et+o8 for in.entory .aluation9 t+e consis"tency9 an8 t+erefore t+e co6para3ility9 of t+e financial state6ents +a.e 3een affecte8 3y a c+an7e in t+e 6et+o8 of applyin7 t+e accountin7 principles e6ploye8% T+e c+an7e :oul8 re;uire co66ent in t+e au8itor<s report in an explanatory para7rap+% If t+e co6pany 8ispose8 of one of its t:o su3si8iaries t+at +a8 3een inclu8e8 in its consoli8ate8 state6ents for prior years9 no co66ent as to consistency nee8s to 3e 6a8e in t+e C=A<s au8it report% T+e co6para3ility of t+e financial state6ents +as 3een affecte8 3y a 3usiness transaction9 3ut t+ere +as 3een no c+an7e in any accountin7 principle e6ploye8 or in t+e 6et+o8 of its application% 4T+e transaction :oul8 pro3a3ly re;uire infor6ati.e 8isclosure in t+e financial state6ents%5 If t+e co6pany re8uce8 t+e esti6ate8 re6ainin7 useful life of plant property 3ecause of o3solescence9 t+e co6para3ility of t+e financial state6ents +as 3een affecte8% T+e c+an7e is not a 6atter of consistency> it is a c+an7e in accountin7 esti6ate re;uire8 3y altere8 con8itions an8 in.ol.es no c+an7e in accountin7 principles e6ploye8 or in t+eir 6et+o8 of application% T+e c+an7e :oul8 pro3a3ly 3e 8isclose8 3y a note in t+e financial state6ents> if co66ente8 upon in t+e C=A<s report9 it :oul8 3e as a 6atter of 8isclosure rat+er t+an consistency% If t+e co6pany is usin7 a 8ifferent in.entory .aluation 6et+o8 fro6 all ot+er co6panies in its in8ustry9 no co66ent as to consistency nee8 3e 6a8e in t+e C=A<s au8it report% Consistency refers to a 7i.en co6pany follo:in7 consistent accountin7 principles fro6 one perio8 to anot+er> it 8oes not refer to a co6pany follo:in7 t+e sa6e accountin7 principles as ot+er co6panies in t+e sa6e in8ustry%
435
15
2#
4c5
25
485
3#
35
B IEF EXE CISE !"!

!#
4a5 435 4c5 485
/erifia3ility Co6para3ility Consistency Ti6eliness
2012Cop1rig
B IEF EXE CISE !"$ 4a5 435 4c5 485 4e5 4f5 475 4+5 4i5 4@5 E;uity e.enues E;uity Assets Expenses Losses Lia3ilities Distri3utions to o:ners ?ains In.est6ents 3y o:ners
1#
15
B IEF EXE CISE !"& 4a5 435 4c5 485 =erio8icity 2onetary unit ?oin7 concern Econo6ic entity
2#
B IEF EXE CISE !"'

25
4a5 e.enue reco7nition 435 Expense reco7nition 4c5 Full 8isclosure 485 0istorical cost B IEF EXE CISE !"( In.est6ent #ALe.el $ In.est6ent !ALe.el # In.est6ent $ALe.el ! B IEF EXE CISE !")
3#
35
!#
4a5 435 4c5 485
In8ustry practices Conser.atis6 Cost"3enefit relations+ip 2ateriality

2013
B IEF EXE CISE !"* Co6panies an8 t+eir au8itors for t+e 6ost part +a.e a8opte8 t+e 7eneral rule of t+u63 t+at anyt+in7 un8er 'B of net inco6e is consi8ere8 not 6aterial% ecently9 t+e SEC +as in8icate8 t+at it is oCay to use t+is percenta7e for t+e initial assess6ent of 6ateriality9 3ut ot+er factors 6ust 3e consi8ere8% For exa6ple9 co6panies can no lon7er fail to recor8 ite6s in or8er to 6eet consensus analyst<s earnin7s nu63ers> preser.e a positi.e earnin7s tren8> con.ert a loss to a profit or .ice .ersa> increase 6ana7e6ent co6pensation9 or +i8e an ille7al transaction liCe a 3ri3e% In ot+er :or8s9 3ot+ ;uantitati.e an8 ;ualitati.e factors 6ust 3e consi8ere8 in 8eter6inin7 :+en an ite6 is 6aterial% 4a5
15
1#
Because t+e c+an7e :as use8 to create a positi.e tren8 in earnin7s9 t+e c+an7e is consi8ere8 6aterial% Eac+ ite6 6ust 3e consi8ere8 separately an8 not nette8% T+erefore eac+ transaction is consi8ere8 6aterial% In 7eneral9 co6panies t+at follo: an Dexpense all capital ite6s 3elo: a certain a6ountE policy are not in .iolation of t+e 6ateriality concept% Because t+e sa6e practice +as 3een follo:e8 fro6 year to year9 Da6on<s actions are accepta3le%
435 4c5
2#
B IEF EXE CISE !",

25
4a5 435
3#
Net realiFa3le .alue% Goul8 not 3e 8isclose8% Lia3ilities :oul8 3e 8isclose8 in t+e or8er to 3e pai8% Goul8 not 3e 8isclose8% Depreciation :oul8 3e inappropriate if t+e 7oin7 concern assu6ption no lon7er applies% Net realiFa3le .alue% Net realiFa3le .alue 4i%e%9 re8ee6a3le .alue5%
4c5 485
35
4e5
201!Cop1rig
B IEF EXE CISE !"#4a5 435 4c5 485 Conser.atis6 Full 8isclosure Expense reco7nition principle 0istorical cost
B IEF EXE CISE !"##

1#
4a5 435
15
S+oul8 3e 8e3ite8 to t+e Lan8 account9 as it is a cost incurre8 in ac;uirin7 lan8% As an asset9 prefera3ly to a Lan8 I6pro.e6ents account% T+e 8ri.e:ay :ill last for 6any years9 an8 t+erefore it s+oul8 3e capitaliFe8 an8 8epreciate8% =ro3a3ly an asset9 as it :ill last for a nu63er of years an8 t+erefore :ill contri3ute to operations of t+ose years% If t+e fiscal year en8s Dece63er $#9 t+is :ill all 3e an expense of t+e current year t+at can 3e c+ar7e8 to an expense account% If state6ents are to 3e prepare8 on so6e 8ate 3efore Dece63er $#9 part of t+is cost :oul8 3e expense an8 part asset% Depen8in7 upon t+e circu6stances9 t+e ori7inal entry as :ell as t+e a8@ustin7 entry for state6ent purposes s+oul8 taCe t+e state6ent 8ate into account% S+oul8 3e 8e3ite8 to t+e Buil8in7 account9 as it is a part of t+e cost of t+at plant asset :+ic+ :ill contri3ute to operations for 6any years% As an expense9 as t+e ser.ice +as alrea8y 3een recei.e8> t+e contri3ution to operations occurre8 in t+is perio8%
4c5 485
2#
25
4e5 4f5
3#
2015
SOLUTIONS TO EXE CISES

EXE CISE !"# 4!-H$- 6inutes5
5
4a 5 43 5 4c5 48 5 4e5
Fee83acC /alue% CostIBenefit an8 2ateriality% Neutrality% Consistency% Neutrality%
4f5 475 4+5 4i5 4@5
ele.ance an8 elia3ility% Ti6eliness% ele.ance% Co6para3ility% /erifia3ility%
EXE CISE !"! 4#'H!- 6inutes5 4a 5 43 5 4c5 48 5 4e5

1#
Co6para3ility% Fee83acC /alue% Consistency% Neutrality% /erifia3ility%
4f5 475 4+5 4i5 4@5
ele.ance% Co6para3ility an8 Consistency% elia3ility% ele.ance an8 elia3ility% Ti6eliness%
EXE CISE !"$ 4#'H!- 6inutes5

15
4a5 435 4c5 485
2#
4e5 4f5 475 4+5 4i5 4@5
25
?ains9 losses% Lia3ilities% In.est6ents 3y o:ners9 co6pre+ensi.e inco6e% 4also possi3le :oul8 3e re.enues an8 7ains5% Distri3utions to o:ners% 4Note to instructor1 net effect is to re8uce e;uity an8 assets5% Co6pre+ensi.e inco6e% 4also possi3le :oul8 3e re.enues an8 7ains5% Assets% Co6pre+ensi.e inco6e% e.enues9 expenses% E;uity% e.enues%
201"Cop1rig
4C5 4l5
Distri3utions to o:ners% Co6pre+ensi.e inco6e%
201%
EXE CISE !"& 4#'H!- 6inutes5 4a5 )% 435 '% 4c5 *% 485 !% 4e5 #!% 4f5 #% 475 &% 4+5 ##% 4i5 #-% 4@5 $%
5
Expense reco7nition principle% 0istorical cost principle% Full 8isclosure principle% ?oin7 concern assu6ption% Conser.atis6% Econo6ic entity assu6ption% =erio8icity assu6ption% In8ustry practices% 2ateriality% 2onetary unit assu6ption%
EXE CISE !"' 4!-H!' 6inutes5 4a 5 43 5 4c5 48 5 4e5 4f5 47 5 4+ 5 4i5 4@5 0istorical cost principle% Conser.atis6% Full 8isclosure principle% Expense reco7nition principle% 2ateriality% In8ustry practices or fair .alue principle% Econo6ic entity assu6ption% Full 8isclosure principle% e.enue reco7nition principle% Full 8isclosure principle% 4C5 e.enue an8 expense reco7nition principles% 4l5 Econo6ic entity assu6ption% 465 =erio8icity assu6ption% 4n5 Expense reco7nition principle% 4o5 2ateriality% 4p5 0istorical cost principle% 4;5 Conser.atis6% 4r5 Expense reco7nition principle%
EXE CISE !"(

1#
4a5
It is :ell esta3lis+e8 in accountin7 t+at re.enues9 cost of 7oo8s sol8 an8 expenses 6ust 3e 8isclose8 in an inco6e state6ent% It 6i7+t 3e note8 to stu8ents t+at suc+ :as not al:ays t+e case% At one ti6e9 only net inco6e :as reporte8 3ut o.er ti6e :e +a.e e.ol.e8 to t+e present reportin7 for6at% T+e proper accountin7 for t+is situation is to report t+e e;uip6ent as an asset an8 t+e notes paya3le as a lia3ility on t+e 3alance s+eet% Offsettin7 is
15
435
201&Cop1rig
per6itte8 in only li6ite8 situations :+ere certain assets are contractually co66itte8 to pay off lia3ilities%
201'
EXE CISE !"( 4Continue85 4c5

5
Accor8in7 to ?AA=9 t+e 3asis upon :+ic+ in.entory a6ounts are state8 4lo:er of cost or 6arCet5 an8 t+e 6et+o8 use8 in 8eter6inin7 cost 4LIFO9 FIFO9 a.era7e cost9 etc%5 s+oul8 also 3e reporte8% T+e 8isclosure re;uire6ent relate8 to t+e 6et+o8 use8 in 8eter6inin7 cost s+oul8 3e e6p+asiFe89 in8icatin7 t+at :+ere possi3le alternati.es exist in financial reportin79 8isclosure in so6e for6at is re;uire8% Consistency re;uires t+at 8isclosure of c+an7es in accountin7 princi"ples 3e 6a8e in t+e financial state6ents% To 8o ot+er:ise :oul8 result in financial state6ents t+at are 6islea8in7% Financial state6ents are 6ore useful if t+ey can 3e co6pare8 :it+ si6ilar reports for prior years%
485
1#
15
EXE CISE !") 4a5 T+is entry .iolates t+e econo6ic entity assu6ption% T+is assu6ption in accountin7 in8icates t+at econo6ic acti.ity can 3e i8entifie8 :it+ a particular unit of accounta3ility% In t+is situation9 t+e co6pany erre8 3y c+ar7in7 t+is cost to t+e :ron7 econo6ic entity% T+e +istorical cost principle in8icates t+at assets an8 lia3ilities are accounte8 for on t+e 3asis of cost% If :e :ere to select sales .alue9 for exa6ple9 :e :oul8 +a.e an extre6ely 8ifficult ti6e in atte6ptin7 to esta3lis+ a sales .alue for a 7i.en ite6 :it+out sellin7 it% It s+oul8 furt+er 3e note8 t+at t+e re.enue reco7nition principle pro.i8es t+e ans:er to :+en re.enue s+oul8 3e reco7niFe8% e.enue s+oul8 3e reco7niFe8 :+en 4#5 realiFe8 or realiFa3le an8 4!5 earne8% In t+is situation9 an earnin7s process +as 8efinitely not taCen place% =ro3a3ly t+e co6pany is too conser.ati.e in its accountin7 for t+is transaction% T+e 6atc+in7 principle in8icates t+at expenses s+oul8 3e allocate8 to t+e appropriate perio8s in.ol.e8% In t+is case9 t+ere appears to 3e a +i7+ uncertainty t+at t+e co6pany :ill +a.e to pay% FASB State6ent No% ' re;uires t+at a loss s+oul8 3e accrue8 only 4#5 :+en it is pro3a3le t+at t+e co6pany :oul8 lose t+e suit an8 4!5 t+e a6ount of t+e loss can 3e reasona3ly esti6ate8% 4Note to instructor1 T+e stu8ent :ill pro3a3ly 3e unfa6iliar :it+ FASB State6ent No% '% T+e purpose of t+is ;uestion is to 8e.elop so6e 8ecision fra6e:orC :+en t+e pro3a3ility of a future e.ent 6ust 3e assu6e8%5
2#
435
25
3#
4c5
35
202#Cop1rig
EXE CISE !") 4Continue85 485

5
1#
At t+e present ti6e9 accountants 8o not reco7niFe price"le.el a8@ust"6ents in t+e accounts% 0ence9 it is 6islea8in7 to 8e.iate fro6 t+e cost principle 3ecause con@ecture or opinion can taCe place% It s+oul8 also 3e note8 t+at 8epreciation is not so 6uc+ a 6atter of .aluation as it is a 6eans of cost allocation% Assets are not 8epreciate8 on t+e 3asis of a 8ecline in t+eir fair 6arCet .alue9 3ut are 8epreciate8 on t+e 3asis of syste6atic c+ar7es of expire8 costs a7ainst re.enues% 4Note to instructor1 It 6i7+t 3e calle8 to t+e stu8ents< attention t+at t+e FASB 8oes encoura7e supple6ental 8isclosure of price"le.el infor6ation%5 2ost accountin7 6et+o8s are 3ase8 on t+e assu6ption t+at t+e 3usi"ness enterprise :ill +a.e a lon7 life% Acceptance of t+is assu6ption pro.i8es cre8i3ility to t+e +istorical cost principle9 :+ic+ :oul8 3e of li6ite8 usefulness if li;ui8ation :ere assu6e8% Only if :e assu6e so6e per6anence to t+e enterprise is t+e use of 8epreciation an8 a6ortiFation policies @ustifia3le an8 appropriate% T+erefore9 it is incorrect to assu6e li;ui8ation as ?onFales9 Inc% +as 8one in t+is situation% It s+oul8 3e note8 t+at only :+ere li;ui8ation appears i66inent is t+e 7oin7 concern assu6ption inapplica3le% T+e ans:er to t+is situation is t+e sa6e as 435%
4e5
15
2#
4f5
EXE CISE !"*

25
4a5
Depreciation is an allocation of cost9 not an atte6pt to .alue assets% As a conse;uence9 e.en if t+e .alue of t+e 3uil8in7 is increasin79 costs relate8 to t+is 3uil8in7 s+oul8 3e 6atc+e8 :it+ re.enues on t+e inco6e state6ent9 not as a c+ar7e a7ainst retaine8 earnin7s% A 7ain s+oul8 not 3e reco7niFe8 until t+e in.entory is sol8% Accoun"tants follo: t+e +istorical cost approac+ an8 :rite"ups of assets are not per6itte8% It s+oul8 also 3e note8 t+at t+e re.enue reco7nition principle states t+at re.enue s+oul8 not 3e reco7niFe8 until it is realiFe8 or realiFa3le an8 is earne8%
3#
435
35
2021
EXE CISE !"* 4Continue85 4c5

5
Assets s+oul8 3e recor8e8 at t+e fair 6arCet .alue of :+at is 7i.en up or t+e fair 6arCet .alue of :+at is recei.e89 :+ic+e.er is 6ore clearly e.i8ent% It s+oul8 3e e6p+asiFe8 t+at it is not a .iolation of t+e +istorical cost principle to use t+e fair 6arCet .alue of t+e stocC% ecor8in7 t+e asset at t+e par .alue of t+e stocC +as no conceptual .ali8ity% =ar .alue is 6erely an ar3itrary a6ount usually set at t+e 8ate of incorporation% T+e 7ain s+oul8 3e reco7niFe8 at t+e point of sale% Deferral of t+e 7ain s+oul8 not 3e per6itte89 as it is realiFe8 an8 is earne8% To explore t+is ;uestion at 7reater len7t+9 one 6i7+t asC :+at @ustification ot+er t+an t+e controller<s 6i7+t 3e use8 to @ustify t+e 8eferral of t+e 7ain% For exa6ple9 t+e rationale pro.i8e8 in ?AA=9 nonco6pletion of t+e earnin7s process9 6i7+t 3e 8iscusse8% It appears fro6 t+e infor6ation t+at t+e sale s+oul8 3e recor8e8 in !-## instea8 of !-#-% e7ar8less of :+et+er t+e ter6s are f%o%3% s+ippin7 point or f%o%3% 8estination9 t+e point is t+at t+e in.entory :as sol8 in !-##% It s+oul8 3e note8 t+at if t+e co6pany is e6ployin7 a perpetual in.entory syste6 in 8ollars an8 ;uantities9 a 8e3it to Cost of ?oo8s Sol8 an8 a cre8it to In.entory is also necessary in !-##%
1#
485
15
4e5
2#
2022Cop1rig
TI2E AND =U =OSE OF CONCE=TS FO ANALJSIS

5
CA !"# :@ime 2#25 minutes< BurposeDto provi-e t e stu-ent wit t e opportunit1 to comment on t e purpose of t e conceptual framework. 7n a--ition, a -iscussion of t e Concepts 6tatements issue- b1 t e ./6( is re?uire-. CA !"! :@ime 2535 minutes<
1#
BurposeDto provi-e t e stu-ent wit t e opportunit1 to i-entif1 an- -iscuss t e benefits of t e conceptual framework. 7n a--ition, t e most important ?ualit1 of information must be -iscusse-, as well as ot er ke1 c aracteristics of accounting information. CA !"$ :@ime 2535 minutes<
15
BurposeDto provi-e t e stu-ent wit some familiarit1 wit State6ent of Financial Accountin7 Concepts No% # . @ e stu-ent is aske- to in-icate t e broa- objectives of accounting, an- to -iscuss ow t is statement mig t elp to establis accounting stan-ar-s. CA !"& :@ime 3#35 minutes< BurposeDto provi-e t e stu-ent wit some familiarit1 wit State6ent of Financial Accountin7 Concepts No% ! . @ e stu-ent is aske- to -escribe various c aracteristics of useful accounting information an- to i-entif1 possible tra-e0offs among t ese c aracteristics. CA !"' :@ime 253# minutes<
2#
25
BurposeDto provi-e t e stu-ent wit t e opportunit1 to in-icate an- -iscuss -ifferent points at w ic revenues can be recogniGe-. @ e stu-ent is aske- to -iscuss t e Hcrucial eventI t at triggers revenue recognition. CA !"( :@ime 3#35 minutes< BurposeDto provi-e t e stu-ent wit familiarit1 wit an economic concept of income as oppose- to t e A//B approac . /lso, factors to be consi-ere- in -etermining w en net revenue s oulbe recogniGe- are emp asiGe-.
3#
CA !") :@ime 2#25 minutes< BurposeDto provi-e t e stu-ent wit an opportunit1 to assess -ifferent points to report costs as e,penses. =irect cause aneffect, in-irect cause aneffect, anrational an- s1stematic approac es are -evelope-.
35
CA !"* :@ime 2#25 minutes< BurposeDto provi-e t e stu-ent wit familiarit1 wit t e e,pense recognition principle in accounting. 6pecific items are t en presente- to in-icate ow t ese items mig t be reporte- using t e e,pense recognition principle. CA !", :@ime 2#3# minutes<
!#
BurposeDto provi-e t e stu-ent wit a realistic case involving association of costs wit revenues. @ e a-vantages of e,pensing costs as incurre- versus sprea-ing costs are e,amine-. 6pecific gui-ance is aske- on ow allocation over time s oulbe reporte-. CA !"#- :@ime 2#3# minutes<
!5
BurposeDto provi-e t e stu-ent wit t e opportunit1 to -iscuss t e relevance an- reliabilit1 of financial statement information. @ e stu-ent must write a letter on t is matter so t e case -oes provi-e a goo- writing e,ercise for t e stu-ents. CA !"## :@ime 2#25 minutes<
2023
BurposeDto provi-e t e stu-ent wit t e opportunit1 to -iscuss t e et ical issues relate- to e,pense recognition. CA !"#! :@ime 3#35 minutes< BurposeDto provi-e t e stu-ent wit t e opportunit1 to -iscuss t e cost9benefit constraint.
202!Cop1rig
SOLUTIONS TO CONCE=TS FO ANALJSIS

5
CA !"#
:a< / conceptual framework is like a constitution. 7ts objective is to provi-e a co erent s1stem of interrelateobjectives an- fun-amentals t at can lea- to consistent stan-ar-s an- t at prescribes t e nature, function, an- limits of financial accounting anfinancial statements. / conceptual framework is necessar1 so t at stan-ar- setting is useful, i.e., stan-ar- setting s oul- buil- on an- relate to an establis e- bo-1 of concepts an- objectives. / well0-evelope- conceptual framework s oulenable t e ./6( to issue more useful an- consistent stan-ar-s in t e future. 6pecific benefits t at ma1 arise are) :1< / co erent set of stan-ar-s an- rules s oul- result. :2< Kew an- emerging practical problems s oulbe more ?uickl1 soluble b1 reference to an e,isting framework. :3< 7t s oul- increase financial statement users> un-erstan-ing of an- confi-ence in financial reporting. :!< 7t s oul- en ance comparabilit1 among companies> financial statements. :5< 7t s oul- elp -etermine t e boun-s for ju-gment in preparing financial statements. :"< 7t s oul- provi-e gui-ance to t e bo-1 responsible for establis ing accounting stan-ar-s. :b< @ e ./6( as issue- si, 6tatements of .inancial /ccounting Concepts :6./C< t at relate to busi0ness enterprises. @ eir titles an- brief -escription of t e focus of eac 6tatement are as follows) :1< SFAC No% #9 HObjectives of .inancial +eporting b1 (usiness $nterprises,I presents t e goals anpurposes of accounting. :2< SFAC No% !9 HQualitative C aracteristics of /ccounting 7nformation,I e,amines t e c aracter0istics t at make accounting information useful. :3< SFAC No% $9 H$lements of .inancial 6tatements of (usiness $nterprises,I provi-es -efinitions of t e broa- classifications of items in financial statements. :!< SFAC No% '9 H+ecognition an- *easurement in .inancial 6tatements,I sets fort fun-amental recognition an- measurement criteria an- gui-ance on w at information s oulbe formall1 incorporate- into financial statements an- w en. :5< SFAC No% (9 H$lements of .inancial 6tatements,I replaces SFAC No% $9 H$lements of .inancial 6tatements of (usiness $nterprises,I an- e,pan-s its scope to inclu-e not0for0profit organiGations. :"< SFAC No% )9 H;sing Cas .low 7nformation an- Bresent Calue in /ccounting *easurements,I provi-es a framework for using e,pecte- future cas flows an- present values as a basis for measurement.
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:a< ./6(>s conceptual framework stu-1 s oul- provi-e benefits to t e accounting communit1 suc as) :1< gui-ing t e ./6( in establis ing accounting stan-ar-s on a consistent basis. :2< -etermining boun-s for ju-gment in preparing financial statements b1 prescribing t e nature, functions an- limits of financial accounting an- reporting. :3< increasing users> un-erstan-ing of an- confi-ence in financial reporting.
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:b< State6ent of Financial Accountin7 Concepts No% ! i-entifies t e most important ?ualit1 for accounting information as usefulness for -ecision making. +elevance an- reliabilit1 are t e primar1 ?ualities lea-ing to t is -ecision usefulness. ;sefulness is t e most important ?ualit1 because, wit out usefulness, t ere woul- be no benefits from information to set against its costs. :c< @ e number of ke1 c aracteristics or ?ualities t at make accounting information -esirable are -escribe- in t e State6ent of Financial Accountin7 Concepts No% !% @ e importance of t ree of t ese c aracteristics or ?ualities are -iscusse- below. :1< ;n-erstan-abilit1Dinformation provi-e- b1 financial reporting s oulbe compre ensible to t ose w o ave a reasonable un-erstan-ing of business an- economic activities an- are willing to stu-1 t e information wit reasonable -iligence. .inancial information is a tool an-, like most tools, cannot be of muc -irect elp to t ose w o are unable or unwilling to use it, or w o misuse it. :2< +elevanceDt e accounting information is capable of making a -ifference in a -ecision b1 elping users to form pre-ictions about t e outcomes of past, present, an- future events or to confirm or correct e,pectations. :3< +eliabilit1Dt e reliabilit1 of a measure rests on t e fait fulness wit w ic it represents w at it purports to represent, couple- wit an assurance for t e user, w ic comes t roug verification, t at it as representational ?ualit1.
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:Note to instructor1 Ot er ?ualities mig t be -iscusse- b1 t e stu-ent, suc as secon-ar1 ?ualities. /ll of t ese ?ualities are -efine- in t e te,tbook.<
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:a< @ e basic objectives in State6ent of Financial Accountin7 Concepts No% # are to) :1< provi-e information useful in investment ancre-it -ecisions for in-ivi-uals w o ave a reasonable un-erstan-ing of business. :2< provi-e information useful in assessing future cas flows. :3< provi-e information about economic resources, claims to t ose resources, an- c anges in t em.
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:b< @ e purpose of t is statement is to set fort fun-amentals on w ic financial accounting an- reporting stan-ar-s ma1 be base-. 4it out some basic set of objectives t at ever1one can agree to, inconsistent stan-ar-s will be -evelope-. .or e,ample, some believe t at accountabilit1 s oulbe t e primar1 objective of financial reporting. Ot ers argue t at pre-iction of future cas flows is more important. 7t follows t at in-ivi-uals w o believe t at accountabilit1 is t e primar1 objective ma1 arrive at -ifferent financial reporting stan-ar-s t an ot ers w o argue for pre-iction of cas flow. Onl1 b1 establis ing some consistent starting point can accounting ever ac ieve some un-erl1ing consistenc1 in establis ing accounting principles. 7t s oulbe emp asiGe- to t e stu-ents t at t e (oar- itself is likel1 to be t e major user an- t us t e most -irect beneficiar1 of t e gui-ance provi-e- b1 t is pronouncement. Jowever, knowle-ge of t e objectives an- concepts t e (oar- uses s oulenable all w o are affecte- b1 or intereste- in financial accounting stan-ar-s to better un-erstan- t e content an- limitations of information provi-e- b1 financial accounting an- reporting, t ereb1 furt ering t eir abilit1 to use t at informa0tion effectivel1 an- en ancing confi-ence in financial accounting an- reporting. @ at knowle-ge, if use- wit care, ma1 also provi-e gui-ance in resolving new or emerging problems of financial accounting an- reporting in t e absence of applicable aut oritative pronouncements.
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:1< +elevance is one of t e two primar1 -ecision0specific c aracteristics of useful accounting information. +elevant information is capable of making a -ifference in a -ecision. +elevant information elps users to make pre-ictions about t e outcomes of past, present, an- future events, or to confirm or correct prior e,pectations. 7nformation must also be timel1 in or-er to be consi-ere- relevant. :2< +eliabilit1 is one of t e two primar1 -ecision0specific c aracteristics of useful accounting infor0mation. +eliable information can be -epen-e- upon to represent t e con-itions an- events t at it is inten-e- to represent. +eliabilit1 stems from representational fait fulness an- verifiabilit1. +epresentational fait fulness is correspon-ence or agreement between accounting information an- t e economic p enomena it is inten-e- to represent. Cerifiabilit1 provi-es assurance t at t e information is free from bias.
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;n-erstan-abilit1 is a user0specific c aracteristic of information. 7nformation is un-erstan-able w en it permits reasonabl1 informe- users to perceive its significance. ;n-erstan-abilit1 is a link between users, w o var1 wi-el1 in t eir capacit1 to compre en- or utiliGe t e information, an- t e -ecision0specific ?ualities of information.
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:!< Comparabilit1 means t at information about enterprises as been prepare- an- presentein a similar manner. Comparabilit1 en ances comparisons between information about two -ifferent enterprises at a particular point in time. :5< Consistenc1 means t at unc anging policies an- proce-ures ave been use- b1 an enterprise from one perio- to anot er. Consistenc1 en ances comparisons between information about t e same enterprise at two -ifferent points in time.
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:b< :Note to instructor1 @ ere are a multitu-e of answers possible ere. @ e suggestions below are inten-e- to serve as e,amples.< :1< .orecasts of future operating results an- projections of future cas flows ma1 be ig l1 relevant to some -ecision makers. Jowever, t e1 woul- not be as reliable as istorical cost information about past transactions. :2< Bropose- new accounting met o-s ma1 be more relevant to man1 -ecision makers t an e,ist0ing met o-s. Jowever, if a-opte-, t e1 woul- impair consistenc1 an- make tren- comparisons of an enterprise>s results over time -ifficult or impossible. :3< @ ere presentl1 e,ists muc -iversit1 among acceptable accounting met o-s an- proce-ures. 7n or-er to facilitate comparabilit1 between enterprises, t e use of onl1 one accepte- account0ing met o- for a particular t1pe of transaction coul- be re?uire-. Jowever, consistenc1 woul- be impaire- for t ose firms c anging to t e new re?uire- met o-s. :!< Occasionall1, relevant information is e,cee-ingl1 comple,. 3u-gment is re?uire- in -etermining t e optimum tra-e0off between relevance an- un-erstan-abilit1. 7nformation about t e impact of general anspecific price c anges ma1 be ig l1 relevant but not un-erstan-able b1 all users.
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/lt oug tra-e0offs result in t e sacrifice of some -esirable ?ualit1 of information, t e overall result s oulbe information t at is more useful for -ecision making.
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:a< @ e various accepte- times of recogniGing revenue in t e accounts are as follows)
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:1< @ime of sale. @ is time is currentl1 acceptable w en t e costs an- e,penses relate- to t e particular transaction are reasonabl1 -eterminable at t e time of sale an- w en t e collection of t e sales price is reasonabl1 certain.
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:2< /t completion. @ is time is currentl1 acceptable in e,tractive in-ustries w ere t e salabilit1 of t e pro-uct at a ?uote- price is likel1 an- in t e agricultural in-ustr1 w ere t ere is a ?uote- price for t e pro-uct an- onl1 7ow a--itional costs of -eliver1 to t e market remain. :3< =uring pro-uction. @ is time is currentl1 acceptable w en t e revenue is known from t e contract antotal cost can be estimate- to -etermine percentage of completion. :!< /t collection. @ is time is currentl1 acceptable w en collections are receive- in installments, w en t ere are substantial Hafter costsI t at unless anticipate- woul- ave t e effect of overstating income on a sales basis in t e perio- of sale, an- w en collection risks are ig . :b< :1< @ e Hcrucial eventIt at is, t e most -ifficult task in t e c1cle of a complete transactionin t e process of earning revenue ma1 or ma1 not coinci-e wit t e ren-ering of service to t e subscriber. @ e new -irector suggests t at t e1 -o not coinci-e in t e magaGine business an- t at revenue from subscription sales an- a-vertising s oulbe recogniGe- in t e accounts w en t e -ifficult task of selling is accomplis e- an- not w en t e magaGines are publis e- to fill t e subscriptions or to carr1 t e a-vertising. @ e -irector>s view t at t ere is a single crucial event in t e process of earning revenue in t e magaGine business is ?uestionable even t oug t e amount of revenue is -eterminable w en t e subscription is sol-. /lt oug t e firm cannot prosper wit out goo- a-vertising contracts an- w ile a-vertising rates -epensubstantiall1 on magaGine sales, it also is true t at rea-ers will not renew t eir subscriptions unless t e content of t e magaGine pleases t em. ;nless subscrip0tions are obtaine- at prices t at provi-e for t e recover1 in t e first subscription perio- of all costs of selling an- filling t ose subscriptions, t e e-itorial anpublis ing activities are as crucial as t e sale in t e earning of t e revenue. $ven if t e subscription rate -oes provi-e for t e recover1 of all associate- costs wit in t e first perio-, owever, t e e-itorial anpublis ing activities still woul- be important since t e firm as an obligation :in t e amount of t e present value of t e costs e,pecte- to be incurre- in connection wit t e e-itorial an- publication activities< to pro-uce an- -eliver t e magaGine. Kot until t is obligation is fulfille- s oul- t e revenue associate- wit it be recogniGe- in t e accounts since t e revenue is t e result of accomplis ing two -ifficult economic tasks :selling an- filling subscriptions< an- not just t e first one. @ e -irector>s view also presumes t at t e cost of publis ing t e magaGines can be compute- accuratel1 at or close to t e time of t e subscription sale -espite uncertaint1 about possible c anges in t e prices of t e factors of pro-uction an- variations in efficienc1. Jence, onl1 a portionnot mostof t e revenue s oulbe recogniGe- in t e accounts at t e time t e subscription is sol-. :2< +ecogniGing in t e accounts all t e revenue in e?ual portions wit t e publication of t e magaGine ever1 mont is subject to some of t e same criticism from t e stan-point of t eor1 as t e suggestion t at all or most of t e revenue be recogniGe- in t e accounts at t e time t e subscription is sol-. /lt oug t e journalistic efforts of t e magaGine are important in t e pro0cess of earning revenue, t e firm coul- not prosper wit out magaGine sales an- t e a-vertising t at results from pai- circulation. Jence, some revenue s oulbe recogniGe- in t e accounts at t e time of t e subscription sale. @ is alternative, even t oug it -oes not recogniGe revenue in t e accounts ?uite as fast as it is earne-, is preferable to t e first alternative because a greater proportion of t e process of earning revenue is associate- wit t e mont l1 publication of t e magaGine t an wit t e subscription sale. .or t is reason, an- because t e task of estimating t e amount of revenue associate- wit t e subscription sale often as been consi-ere- subjective, recogniGing revenue in t e accounts wit t e mont l1 publication of t e magaGine as receive- support even t oug it -oes not meet t e tests of revenue recognition as well as t e ne,t alternative.
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:3< +ecogniGing in t e accounts a portion of t e revenue at t e time a cas subscription is obtaine- an- a portion eac time an issue is publis e- meets t e tests of revenue recognition better t an t e ot er two alternatives. / portion of t e net income is recogniGe- in t e accounts at t e time of eac major or crucial event. $ac crucial event is clearl1 -iscernible an- is a time of interaction between t e publis er an- subscriber. / legal sale is transacte- before an1 revenue is recogniGe- in t e accounts. Brior to t e time t e revenue is recogniGe- in t e accounts, it alrea-1 as been receive- in -istributable form. .inall1, t e total revenue is measurable wit more t an t e usual certaint1, an- t e revenue attributable to eac crucial event is -eterminable using reasonable :alt oug sometimes conceptuall1 unsatisfactor1< assumptions about t e relations ip between revenue an- costs w en t e costs are in-irect. :Note to instructor1 C/ 205 mig t also be assigne- in conjunction wit C apter 1&.<
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@ e economist views business income in terms of wealt of t e entit1 as a w ole resulting from an accretion attributable to t e w ole process of business activit1. @ e accountant must measure t e Hwealt I of t e entit1 in terms of its component parts, t at is, in-ivi-ual assets an- liabilities. @ e events must be i-entifiew ic cause c anges in financial con-ition of t e entit1 an- t e resulting c anges s oulbe assigne- to specific accounting perio-s. @o ac ieve t is i-entification of suc events, accountants emplo1 t e revenue recognition principle in t e measurement of perio-ic income.
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:b< +evenue recognition results from t e accomplis ment of economic activit1 involving t e transfer of goo-s an- services giving rise to a claim. @o warrant recognition t ere must be a c ange in assets t at is capable of being objectivel1 measure- an- t at involves an e,c ange transaction. @ is refers to t e presence of an arm>s0lengt transaction wit a part1 e,ternal to t e entit1. @ e e,istence an- terms of t e transaction ma1 be -efine- b1 operation of law, b1 establis e- tra-e practice, or ma1 be stipulate- in a contract. Kote t at an item s oul- meet four fun-amental recognition criteria to be recogniGe-. @ ose criteria are) :1< :2< :3< :!< =efinitionsD@ e item meets t e -efinition of an element of financial statements. *easurabilit1D7t as a relevant attribute measurable wit sufficient reliabilit1. +elevanceD@ e information is capable of making a -ifference in user -ecisions. +eliabilit1D@ e information is representationall1 fait ful, verifiable, an- neutral.
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7n t e conte,t of revenue recognition, recognition involves consi-eration of two factors, :a< being realiGe- or realiGable an- :b< being earne-, wit sometimes one an- sometimes t e ot er being t e more important consi-eration.
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$vents t at can give rise to recognition of revenue are) t e completion of a saleL t e performance of a serviceL t e pro-uction of a stan-ar- interc angeable goo- wit a guarantee- market, a -eterminable market value an- onl1 minor costs of marketing, suc as precious metals an- certain agricultural commo-itiesL ant e progress of a construction project, as in s ipbuil-ing. @ e passing of time ma1 be t e HeventI t at establis es t e recognition of revenue, as in t e case of interest revenue or rental income. /s a practical consi-eration, t ere must be a reasonable -egree of certaint1 in measuring t e amount of revenue recogniGe-. Broblems of measurement ma1 arise in estimating t e -egree of completion of a contract, t e net realiGable value of a receivable or t e value of a nonmonetar1 asset receive- in an e,c ange transaction. 7n some cases, w ile t e revenue ma1 be rea-il1 measure-, it ma1 be impossible to estimate reasonabl1 t e relate- e,penses. 7n suc instances revenue recognition must be -eferre- until proper perio-ic income measurement can be ac ieve- t roug t e matc ing process.
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:c< Ko. @ e factor apparentl1 relie- upon b1 EopeG /ssociates is t at revenue is recogniGe- as t e services giving rise to it are performe-. @ e firm as complete- t e construction of t e buil-ing, obtaine- financing for t e project, an- secure- tenants for most of t e space. *anagement of t e project is 1et to be ren-eret 2 2#1# 3o n 4ile1 5 6ons, 7nc.8ieso, Intermediate Accounting, 139e, 6olutions *anual:.or 7nstructor ;se Onl1<
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an- EopeG -i- not accrue revenue for t is service. Jowever, anot er factor must be consi-ere-. 6ince t e fee for EopeG>s services as as its source t e future profits of t e project, on *a1 31, 2#1#, t ere is no wa1 to measure objectivel1 t e amount of t e fee. 6etting t e amount at t e commercial value of t e services mig t be a reasonable approac were it not for t e contingent nature of t e source of t e fees. @ at an asset, contracts receivable, e,ists as a result of t is activit1 is outweig e- b1 t e inabilit1 to measure it objectivel1. +evenue recognition at t is time is unwarrante- because of t e contingent nature of t e revenue an- t e likeli oo- of overstating t e assets. @ us, revenue recognition at t is point woul- not be in accor-ance wit generall1 accepte- accounting principles. (ecause revenue cannot be recogniGe-, t e relate- e,penses s oulbe -eferre- so t at t e1 can be amortiGe- over t e respective perio-s of revenue recognition. 4it a reasonable e,pectation of future benefit, t e -eferre- costs conform to t e accounting concept of assets.
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6ome costs are recogniGe- as e,penses on t e basis of a presume- -irect association wit specific revenue. @ is presume- -irect association as been i-entifie- bot as Hassociating cause an- effectI an- as t e Hmatc ing concept.I =irect cause0an-0effect relations ips can sel-om be conclusivel1 -emonstrate-, but man1 costs appear to be relate- to particular revenue, an- recogniGing t em as e,penses accompanies recognition of t e revenue. Aenerall1, t e e,pense recognition principle re?uires t at t e revenue recogniGe- an- t e e,penses incurreto pro-uce t e revenue be given concurrent perio-ic recognition in t e accounting recor-s. Onl1 if effort is properl1 relate- to accomplis ment will t e results, calle- earnings, ave useful significance concerning t e efficient utiliGation of business resources. @ us, appl1ing t e e,pense recognition principle is a recognition of t e cause0an-0effect relations ip t at e,ists between e,pense an- revenue. $,amples of e,penses t at are usuall1 recogniGe- b1 associating cause aneffect are sales commissions, freig t0out on merc an-ise sol-, an- cost of goo-s sol- or services provi-e-.
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:b< 6ome costs are assigne- as e,penses to t e current accounting perio- because :1< t eir incurrence -uring t e perio- provi-es no -iscernible future benefitsL :2< t e1 are measures of assets recor-e- in previous perio-s from w ic no future benefits are e,pecte- or can be -iscerne-L :3< t e1 must be incurre- eac accounting 1ear, an- no buil-0up of e,pecte- future benefits occursL :!< b1 t eir nature t e1 relate to current revenues even t oug t e1 cannot be -irectl1 associate- wit an1 specific revenuesL :5< t e amount of cost to be -eferre- can be measure- onl1 in an arbitrar1 manner or great uncertaint1 e,ists regar-ing t e realiGation of future benefits, or bot L :"< an- uncertaint1 e,ists regar-ing w et er allocating t em to current an- future perio-s will serve an1 useful purpose. @ us, man1 costs are calle- Hperio- costsI an- are treate- as e,penses in t e perioincurre- because t e1 ave neit er a -irect relations ip wit revenue earne- nor can t eir occurrence be -irectl1 s own to give rise to an asset. @ e application of t is principle of e,pense recognition results in c arging man1 costs to e,pense in t e perio- in w ic t e1 are pai- or accrue- for pa1ment. $,amples of costs treate- as perio- e,penses woul- inclu-e officers> salaries, a-vertising, researc an- -evelopment, an- au-itors> fees.
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/ cost s oulbe capitaliGe-, t at is, treate- as a measure of an asset w en it is e,pecte- t at t e asset will pro-uce benefits in future perio-s. @ e important concept ere is t at t e incurrence of t e cost as resultein t e ac?uisition of an asset, a future service potential. 7f a cost is incurre- t at resultein t e ac?uisition of an asset from w ic benefits are not e,pecte- be1on- t e current perio-, t e cost ma1 be e,pense- as a measure of t e service potential t at e,pire- in pro-ucing t e current perio->s revenues. Kot onl1 s oul- t e incurrence of t e cost result in t e ac?uisition of an asset from w ic future benefits are e,pecte-, but also t e cost s oulbe measurable wit a reasonable -egree of objectivit1, an- t ere s oulbe reasonable groun-s for associating it wit t e asset ac?uire-. $,amples of costs t at s oulbe treate- as measures of assets are t e costs of merc an-ise on an- at t e en- of an accounting perio-, costs of insurance coverage relating to future perio-s, an- t e cost of self0constructe- plant or e?uipment.
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:-< 7n t e absence of a -irect basis for associating asset cost wit revenue an- if t e asset provi-es benefits for two or more accounting perio-s, its cost s oulbe allocate- to t ese perio-s :as an e,pense< in a s1stematic anrational manner. @ us, w en it is impractical, or impossible, to fin- a close cause0an-0effect relations ip between revenue an- cost, t is relations ip is often assume- to e,ist. @ erefore, t e asset cost is allocate- to t e accounting perio-s b1 some met o-. @ e allocation met o- use- s oul- appear reasonable to an unbiase- observer an- s oulbe followe- consistentl1 from perio- to perio-. $,amples of s1stematic anrational allocation of asset cost woul- inclu-e -epreciation of fi,e- assets, amortiGation of intangibles, anallocation of rent aninsurance. :e< / cost s oulbe treate- as a loss w en no revenue results. @ e matc ing of losses to specific revenue s oulnot be attempte- because, b1 -efinition, t e1 are e,pire- service potentials not relate- to revenue pro-uce-. @ at is, losses result from events t at are not anticipate- as necessar1 in t e process of pro-ucing revenue. @ ere is no simple wa1 of i-entif1ing a loss because ascertaining w et er a cost s oulbe a loss is often a matter of ju-gment. @ e accounting -istinction between an asset, e,pense, loss, an- prior perio- a-justment is not clear0cut. .or e,ample, an e,pense is usuall1 voluntar1, planne-, an- e,pecte- as necessar1 in t e generation of revenue. (ut a loss is a measure of t e service potential e,pire- t at is consi-ere- abnormal, unnecessar1, unanticipate-, an- possibl1 nonrecur0ring an- is usuall1 not taken into -irect consi-eration in planning t e siGe of t e revenue stream.
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:a< Costs s oulbe recogniGe- as e,piring in a given perio- if t e1 are not c argeable to a prior perio- an- are not applicable to future perio-s. +ecognition in t e current perio- is re?uire- w en an1 of t e following con-itions or criteria are present) :1< / -irect i-entification of association of c arges wit revenue of t e perio-, suc as goo-s s ippe- to customers. :2< /n in-irect association wit t e revenue of t e perio-, suc as fire insurance or rent. :3< / perio- c arge w ere no association wit revenue in t e future can be ma-e so t e e,pense is c arget is perio-, suc as officers> salaries. :!< / measurable e,piration of asset costs -uring t e perio-, even t oug not associate- wit t e pro-uction of revenue for t e current perio-, suc as a fire or casualt1 loss.
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:b< :1< /lt oug it is generall1 agree- t at inventor1 costs s oulinclu-e all costs attributable to placing t e goo-s in a salable state, receiving an- an-ling costs are often treate- as cost e,pirations in t e perioincurre- because t e1 are irregular or are not in uniform proportion to sales. @ e portion of t e receiving an- an-ling costs attributable to t e unsol- goo-s processe- -uring t e perio- s oulbe inventorie-. @ ese costs mig t be more rea-il1 apportione- if t e1 are assigne- b1 some -evice suc as an applie- rate. /bnormall1 ig receiving an- an-ling costs s oulbe c argeoff as a perio- cost. :2< @ e valuation of inventories at t e lower of cost or market as been wi-el1 a-opte- as a conservative met o- of valuing inventories. @ is met o- results in recor-ing losses but not gains prior to t e sale of t e inventor1. 4 ere t ere is not an atten-ant -rop in sales prices, costs an- revenues are mismatc e- to t e e,tent t at t e present perio->s reporte- net income is re-uce- an- t e ne,t perio->s reporte- net income is increase-. 6uc mismatc ing as been justifie- on t e groun-s t at t e ne,t perio- s oulreceive a Hfres startI an- its position be t e same as t oug t e inventor1 as been purc ase- at current market prices. @ is argument, it mig t be note-, is contrar1 to t e Hgoing concernI concept. 4 ere t e write-own is of a substantial amount, it as been suggeste- t at t e cost of goo-s sol- be reporte- in terms of original cost. @ e write-own woul- be e,clu-e- from t e cost of goo-s sol- section an- s own separatel1. 7n a--ition to matc ing costs wit revenues, t is proce-ure s ows normal an- abnormal operating results on t e income statement for comparative purposes. :3< Cas -iscounts on purc ases are treate- as Hot er revenuesI in some financial statements in violation of t e e,pense recognition principles :or matc ing<. +evenue is not recogniGe- w en goo-s are purc aseor cas -isburse-. .urt ermore, inventories value- at gross invoice price are recor-e- at an amount greater t an t eir cas outla1 resulting in misstatement of inventor1 cost in t e current perio- aninventor1 cost e,pirations in future perio-s. Close a- erence to t e e,pense recognition principle :or matc ing< re?uires t at cas -iscounts be recor-e- as a re-uction of t e cost of purc ases an- t at inventories be price- at net invoice prices. 4 ere inventories are price- at gross invoice prices for e,pe-ienc1, owever, t ere is a slig t -istortion of t e financial statements if t e beginning an- en-ing inventories var1 little in amount.
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:a< @ e preferable treatment of t e costs of t e sample -ispla1 ouses is e,pensing t em over more t an one perio-. @ ese sample -ispla1 ouses are assets because t e1 represent rig ts to future service potentials or economic benefits. /ccor-ing to t e e,pense recognition principle, t e costs of service potentials s oulbe amortiGe- as t e benefits are receive-. @ us, costs of t e sample -ispla1 ouses s oulbe matc e- wit t e revenue from t e sale of t e ouses w ic is receivable over a perio- of more t an one 1ear. /s t e sample ouses are left on -ispla1 for t ree to seven 1ears, =aniel (arenboim apparentl1 e,pects to benefit from t e -ispla1s for at least t at lengt of time.
!5
2033
CA !", 4Continue85
5
@ e alternative of e,pensing t e costs of sample -ispla1 ouses in t e perio- in w ic t e e,pen-iture is ma-e is base- primaril1 upon t e concept of conservatism. @ ese costs are of a promotional nature. Bromotional costs often are consi-ere- e,penses of t e perio- in w ic t e e,pen-itures occur -ue to t e uncertaint1 in -etermining t e time perio-s benefite-. 7t is likel1 t at no -ecision is ma-e concerning t e life of a sample -ispla1 ouse at t e time it is erecte-. Bast e,perience ma1 provi-e some gui-ance in -etermining t e probable life. / -ecision to tear -own or alter a ouse probabl1 is ma-e w en sales begin to lag or w en a new mo-el wit greater potential becomes available. @ ere is uncertaint1 not onl1 as to t e life of a sample -ispla1 ouse but also as to w et er a sample -ispla1 ouse will be torn -own or altere-. 7f it is altere- rat er t an torn -own, a portion of t e cost of t e original ouse ma1 be attributable to t e new mo-el. :b< 7f all of t e s ell ouses are to be sol- at t e same price, it ma1 be appropriate to allocate t e costs of t e -ispla1 ouses on t e basis of t e number of s ell ouses sol-. @ is allocation woul- be similar to t e units0 of0pro-uction met o- of -epreciation an- woul- result in a goo- matc ing of costs wit revenues. On t e ot er an-, if t e s ell ouses are to be sol- at -ifferent prices, it ma1 be preferable to allocate costs on t e basis of t e revenue contribution of t e s ell ouses sol-. @ ere is uncertaint1 regar-ing t e number of omes of a particular mo-el w ic will be solas a result of t e -ispla1 sample. @ e success of t is amortiGation met o- is -epen-ent upon accurate estimates of t e number an- selling price of s ell ouses to be sol-. @ e estimate of t e number of units of a particular mo-el w ic will be solas a result of a -ispla1 mo-el s oulinclu-e not onl1 units sol- w ile t e mo-el is on -ispla1 but also units sol- after t e -ispla1 ouse is torn -own or altere-. Cost amortiGation solel1 on t e basis of time ma1 be preferable w en t e life of t e mo-els can be estimatewit a great -eal more accurac1 t an can t e number of units w ic will be sol-. 7f unit sales an- selling prices are uniform over t e life of t e sample, a satisfactor1 matc ing of costs an- revenues ma1 be ac ieveif t e straig t0line amortiGation proce-ure is use-.
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CA !"#=ate
5
=ear ;ncle Carlos,
1# 7 receive- t e information on Keville Corp. an- appreciate 1our interest in s aring t is venture wit me. Jowever, 7
t ink t at basing an investment -ecision on t ese financial statements woul- be unwise because t e1 are neit er relevant nor reliable.
15
One of t e most important c aracteristics of accounting information is t at it is relevant, i.e., it will make a -ifference in m1 -ecision. @o be relevant, t is information must be timel1. (ecause Keville>s financial statements are a 1ear ol-, t e1 ave lost t eir abilit1 to influence m1 -ecision) a lot coul- ave c ange- in t at one 1ear.
/not er element of relevance is pre-ictive value. Once again, Keville>s accounting information proves irrelevant. 6 own wit out reference to ot er 1ears> profitabilit1, it cannot elp me pre-ict future profit0abilit1 because 7 2# cannot see an1 tren-s -eveloping. Closel1 relate- to pre-ictive value is fee-back value. @ ese financial statements -o not provi-e fee-back on an1 strategies w ic t e compan1 ma1 ave use- to increase profits. @ ese financial statements are also not reliable. 7n or-er to be reliable, t eir assertions must be verifiable b1 several in-epen-ent parties. (ecause no in-epen-ent au-itor as verifie- t ese amounts, t ere is no wa1 of knowing 25 w et er or not t e1 are represente- fait full1. .or instance, 7 woul- like to believe t at t is compan1 earneO2,!2!,2!#, an- t at it a- a ver1 favorable -ebt0to0e?uit1 ratio. Jowever, unau-ite- financial statements -o not give me an1 reasonable assurance about t ese claims.
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.inall1, t e fact t at *rs. Keville erself prepare- t ese statements in-icates a lack of neutralit1. (ecause s e is not a -isintereste- t ir- part1, 7 cannot be sure t at s e -i- not prepare t e financial statements in favor of er usban->s business.
7 -o appreciate t e trouble 1ou went t roug to get me t is information. ;n-er t e circumstances, owever, 7 -o not wis to invest in t e Keville bon-s an- woul- caution 1ou against -oing so. (efore 1ou make a -ecision in t is 35 matter, please call me. 6incerel1,
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Pour Kep ew
2035
CA !"##
:a< @ e stake ol-ers are investors, cre-itors, etc.L i.e., users of financial statements, current an- future.
:b< Jonest1 an- integrit1 of financial reporting, job protection, profit. :c< /ppl1ing t e e,pense recognition principle an- recor-ing e,pense -uring t e plant>s life, or not appl1ing it. @ at is, recor- t e mot ball costs in t e future.
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:-< @ e major ?uestion ma1 be w et er or not t e e,pense of mot balling can be estimate- properl1 so t at t e integrit1 of financial reporting is maintaine-. /ppl1ing t e e,pense recognition principle will result in lower profits an- possibl1 ig er rates for consumers. Coul- t is cost an1one is or er jobN 4ill investors ancre-itors ave more useful informationN On t e ot er an-, failure to appl1 t e matc ing principle means ig er profits, lower rates, an- greater potential job securit1. :e< 6tu-ents> recommen-ations will var1. Kote) Ot er stake ol-ers possibl1 affecte- are present an- future consumers of electric power. =ela1 in allocating t e e,pense will benefit to-a1>s consumers of electric power at t e e,pense of future consumers.
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25
1. 7nformation about competitors mig t be useful for benc marking t e compan1>s results but if management -oes not ave e,pertise in provi-ing t e information, it coul- lack reliabilit1. 7n a--ition, it is likel1 ver1 costl1 for management to gat er sufficientl1 reliable information of t is nature. 4 ile users of financial statements mig t benefit from receiving internal information, suc as compan1 plans an- bu-gets, competitors mig t also be able to use t is information to gain a competitive a-vantage relative to t e -isclosing compan1. 7n or-er to pro-uce forecaste- financial statements, management woulave to make numerous assumptions an- estimates, w ic woul- be costl1 in terms of time an- -ata collection. (ecause of t e subjectivit1 involve-, t e forecaste- statements woul- lack reliabilit1, t ereb1 -etracting from an1 potential benefits. 7n a--ition, w ile management>s forecasts of future profitabilit1 or balance s eet amounts coul- be of benefit, companies coul- be subject to s are ol-er lawsuits, if t e amounts in t e forecaste- statements are not realiGe-. 7t woul- be e,cessivel1 costl1 for companies to gat er an- report information t at is not use- in managing t e business. .le,ible reporting allows companies to Hfine0tuneI t eir financial reporting to meet t e information nee-s of its varie- users. 7n t is wa1, t e1 can avoi- t e cost of provi-ing information t at is not -eman-e- b1 its users. 6imilar to number 3, concerning forecaste- financial statements, if managers report forwar-0looking information, t e compan1 coul- be e,pose- to liabilit1 if investors un-ul1 rel1 on t e information in making investment -ecisions. @ us, if companies get protection from unwarrante- lawsuits :calle- a safe arbor<, t en t e1 mig t be willing to provi-e potentiall1 beneficial forwar-0looking information.
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FINANCIAL E=O TIN? = OBLE2

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5
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Fro6 Note #% e.enue eco7nitionASales are reco7niFe8 :+en re.enue is realiFe8 or realiFa3le an8 +as 3een earne8% 2ost re.enue transactions represent sales of in.entory9 an8 t+e re.enue recor8e8 inclu8es s+ippin7 an8 +an8lin7 costs9 :+ic+ 7enerally are inclu8e8 in t+e list price to t+e custo6er% T+e Co6pany<s policy is to reco7niFe re.enue :+en title to t+e pro8uct9 o:ners+ip an8 risC of loss transfer to t+e custo6er9 :+ic+ 7enerally is on t+e 8ate of s+ip6ent% A pro.ision for pay6ent 8iscounts an8 pro8uct return allo:ances is recor8e8 as a re8uction of sales in t+e sa6e perio8 t+at t+e re.enue is reco7niFe8% Tra8e pro6otions9 consistin7 pri6arily of custo6er pricin7 allo:ances9 6erc+an8isin7 fun8s an8 consu6er coupons9 are offere8 t+rou7+ .ari"ous pro7ra6s to custo6ers an8 consu6ers% Sales are recor8e8 net of tra8e pro6otion spen8in79 :+ic+ is reco7niFe8 as incurre89 7enerally at t+e ti6e of t+e sale% 2ost of t+ese arran7e6ents +a.e ter6s of approxi"6ately one year% Accruals for expecte8 payouts un8er t+ese pro7ra6s are inclu8e8 as accrue8 6arCetin7 an8 pro6otion in t+e accrue8 an8 ot+er current lia3ilities line in t+e Consoli8ate8 Balance S+eets%
15
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435
25
2ost of t+e infor6ation presente8 in =K?<s financial state6ents is reporte8 on an +istorical cost 3asis% Exa6ples are1 =roperty9 =lant9 an8 E;uip6ent9 In.entories 4:+ic+ is not in excess of 6arCet59 ?oo8":ill9 an8 Intan7i3le Assets% e7ar8in7 t+e use of fair .alue9 all of t+e co6pany<s 6arCeta3le in.est6ents are reporte8 at fair .alue 4;uote8 6arCet prices5% In a88ition9 t+e fair .alue of t+e co6pany<s financial instru6ents an8 t+e fair .alue of pension assets are 8isclose8% Exa6ination of t+e au8itor<s report9 :+ic+ :oul8 in8icate an accountin7 c+an7e% Also9 =K? in8icate8 t+at no ne: accountin7 pronounce6ents issue8 or effecti.e 8urin7 t+e fiscal year +a.e +a8 or are expecte8 to +a.e a 6aterial i6pact on t+e financial state6ents% Certain reclassifications of prior years< a6ounts +a.e 3een 6a8e to confor6 to t+e current year presentation% Sellin79 7eneral an8 a86inistrati.e expense pri6arily inclu8es 6arCe"tin7 expenses9 inclu8in7 t+e cost of 6e8ia9 advertising and related costs; sellin7 expenses> researc+ an8 8e.elop6ent costs> a86inist"rati.e an8 ot+er in8irect o.er+ea8 costs> an8 ot+er 6iscellaneous operatin7 ite6s%
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203%
CO2=A ATI/E ANALJSIS CASE

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Coca"Cola in8icates its 3usiness is nonalco+olic 3e.era7es9 principally soft 8rinCs9 3ut also a .ariety of noncar3onate8 3e.era7es% It notes t+at it is t+e :orl8<s lea8in7 6anufacturer9 6arCeter an8 8istri3utor of soft"8rinC 3e.era7e concentrates an8 syrups as :ell as t+e :orl8<s lar7est 6arCeter an8 8istri3utor of @uice an8 @uice"8rinC pro8ucts% In its se76ent supportin7 note to t+e financial state6ents9 +o:e.er9 it 8oes not pro.i8e a 3reaC8o:n of 3e.era7e 8rinCs into soft 8rinCs an8 noncar3onate8 3e.era7es% at+er se76ents are 8efine8 3ase8 on t+e follo:in7 7eo7rap+ic areas1 t+e Nort+ A6erican ?roup> t+e Africa ?roup> t+e European Union9 Eurasia ?roup9 t+e =acific ?roup> t+e Latin A6erica ?roup> an8 Corporate% =epsiCo .ie:s itself as a lea8in7 7lo3al snacC an8 3e.era7e co6pany% It 6anufactures9 6arCets9 an8 sells a .ariety of salty9 s:eet an8 7rain"3ase8 snacCs9 car3onate8 an8 noncar3onate8 3e.era7es an8 foo8s% It is or7aniFe8 in four 8i.isions1 Frito"Lay Nort+ A6erica9 =epsiCo Be.era7es Nort+ A6erica9 =epsiCo International9 an8 QuaCer Foo8s Nort+ A6erica% T+e Nort+ A6erican 8i.isions operate in t+e Unite8 States an8 Cana8a% T+e international 8i.isions operate in approxi6ately !-- countries9 :it+ t+e lar7est operations in 2exico an8 t+e Unite8 Lin78o6%
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Coca"Cola<s net operatin7 re.enues for !--) :as M!*9*') 6illion :+ic+ :as co6prise8 principally of 3e.era7e sales% =epsiCo reporte8 net sales of M$,9&)& 6illion of :+ic+ soft 8rinCs is an esti6ate8 M!(9-!* 4M#'9),* N #-9!$-5 6illion% T+e re6ain8er is relate8 to sales in t+e Frito"Lay an8 QuaCer Foo8s se76ents% Base8 on t+ese a6ounts9 Coca"Cola +as t+e 8o6inant position in 3e.era7e sales%
203&Cop1rig
CO2=A ATI/E ANALJSIS CASE 4Continue85 4c5

5
Coca"Cola .alues in.entory at t+e lo:er of cost or 6arCet% In 7eneral9 cost is 8eter6ine8 on t+e 3asis of a.era7e cost or first"in first"out 6et+o8s% =epsiCo also .alues its in.entory at t+e lo:er of cost or 6arCet% Approxi6ately #&B in !--) an8 #,B in !--( of t+e in.entory cost :as co6pute8 usin7 t+e LIFO 6et+o8% T+e 8ifferences 3et:een LIFO an8 FIFO 6et+o8s of .aluin7 t+ese in.entories are not 6aterial% Because =epsiCo uses LIFO for part of its in.entory9 if 6aterial9 it :oul8 3e necessary to a8@ust as 3est as possi3le to FIFO% An a88itional pro3le6 is t+at 3ot+ use t+e a.era7e cost for so6e of t+eir in.entory9 3ut infor6ation relate8 to its percenta7e use is not pro.i8e8%
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Bot+ =epsiCo an8 Coca"Cola :ere affecte8 3y t+e pro6ul7ation of ne: accountin7 stan8ar8s 3y t+e FASB in !--)% Description of t+ese stan8ar8 a8options is 8iscusse8 3elo:% Coca"Cola
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Recent Accounting Standards and Pronouncements

25
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In Dece63er !--)9 t+e FASB issue8 SFAS No% #&# 4re.ise8 !--)59 DBusiness Co63inations%E SFAS No% #&#4 5 a6en8s t+e principles an8 re;uire6ents for +o: an ac;uirer reco7niFes an8 6easures in its financial state6ents t+e i8entifia3le assets ac;uire89 t+e lia3ilities assu6e89 any noncontrollin7 interest in t+e ac;uiree an8 t+e 7oo8:ill ac;uire8% SFAS No% &#4 5 also esta3lis+es 8isclosure re;uire6ents to ena3le t+e e.aluation of t+e nature an8 financial effects of t+e 3usiness co63ination% SFAS No% &#4 5 is effecti.e for our Co6pany on Oanuary #9 !--,9 an8 t+e Co6pany :ill apply prospecti.ely to all 3usiness co63inations su3se;uent to t+e effecti.e 8ate% In Dece63er !--)9 t+e FASB issue8 SFAS No% #(-9 DNoncontrollin7 Interests in Consoli8ate8 Financial State6entsAan a6en86ent of Accountin7 esearc+ Bulletin No% '#%E SFAS No% #(- esta3lis+es accountin7 an8 reportin7 stan8ar8s for t+e noncontrollin7 interest in a su3si8iary an8 for t+e 8econsoli8ation of a su3si8iary%
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203'
CO2=A ATI/E ANALJSIS CASE 4Continue85 =epsiCo

5
Recent Accounting Pronouncements In Septe63er !--(9 t+e SEC issue8 SAB #-* to a88ress 8i.ersity in practice in ;uantifyin7 financial state6ent 6isstate6ents% SAB #-* re;uires t+at :e ;uantify 6isstate6ents 3ase8 on t+eir i6pact on eac+ of our financial state6ents an8 relate8 8isclosure% On Dece63er $-9 !--(9 :e a8opte8 SAB #-*% Our a8option of SAB #-* 8i8 not i6pact our financial state6ents% In Septe63er !--(9 t+e FASB issue8 SFAS #') :+ic+ 8efines fair .alue9 esta3lis+es a fra6e:orC for 6easurin7 fair .alue9 an8 expan8s 8isclosure a3out fair .alue 6easure6ents% T+e pro.isions of SFAS #') are effecti.e as of t+e 3e7innin7 of our !--* fiscal year% 0o:e.er9 t+e FASB +as 8eferre8 t+e effecti.e 8ate of SFAS #')9 until t+e 3e7innin7 of our !--, fiscal year9 as it relates to fair .alue 6easure6ent re;uire6ents for nonfinancial assets an8 lia3ilities t+at are not re6easure8 at fair .alue on a recurrin7 3asis% Ge are currently e.aluatin7 t+e i6pact of a8optin7 SFAS #') on our financial state6ents% Ge 8o not expect our a8option to +a.e a 6aterial i6pact on our financial state6ents% In Fe3ruary !--)9 t+e FASB issue8 SFAS #', :+ic+ per6its entities to c+oose to 6easure 6any financial instru6ents an8 certain ot+er ite6s at fair .alue% T+e pro.isions of SFAS #', are effecti.e as of t+e 3e7innin7 of our !--* fiscal year% Our a8option of SFAS #', :ill not i6pact our financial state6ents% In Dece63er !--)9 t+e FASB issue8 SFAS #&# an8 SFAS #(- to i6pro.e9 si6plify9 an8 con.er7e internationally t+e accountin7 for 3usiness co63inations an8 t+e reportin7 of noncontrollin7 interests in consoli8ate8 financial state6ents% T+e pro.isions of SFAS #&# an8 SFAS #(- are effecti.e as of t+e 3e7innin7 of our !--, fiscal year% Ge are currently e.aluatin7 t+e i6pact of a8optin7 SFAS #&# an8 SFAS #(- on our financial state6ents%
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FINANCIAL STATE2ENT ANALJSIS CASEAGAL"2A T

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4#5 In t+e year of t+e c+an7e9 Gal"2art :ill re.erse t+e re.enue reco7niFe8 in prior perio8s for laya:ay sales t+at are not co6plete% T+is :ill re8uce inco6e in t+e year of t+e c+an7e% 4!5 In su3se;uent years9 after t+e a8@ust6ent in t+e year of t+e c+an7e9 as lon7 as Gal"2art continues to 6aCe laya:ay sales at t+e sa6e le.els9 inco6e le.els s+oul8 return to prior le.els 4except for 7ro:t+5% T+at is9 t+e accountin7 c+an7e only c+an7es t+e ti6in7 of t+e reco7nition9 not t+e o.erall a6ount reco7niFe8%
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By reco7niFin7 t+e re.enue 3efore 8eli.ery9 Gal"2art :as reco7niFin7 re.enue 3efore t+e earnin7s process :as co6plete% In a88ition9 if cus"to6ers 8i8 not pay t+e re6ainin7 3alance o:e89 t+e realiFa3ility criterion is not 6et eit+er% G+ile Gal"2art liCely coul8 esti6ate expecte8 8eli.eries an8 pay6ents9 it is not apparent t+at t+is :as 8one% E.en if all retailers use8 t+e sa6e policy9 it still 6i7+t 3e 8ifficult to co6pare t+e results for laya:ay transactions% For exa6ple :+at if retailers +a.e 8ifferent policies as to +o: 6uc+ custo6ers +a.e to put 8o:n in or8er for t+e retailer to set asi8e t+e 6erc+an8ise% Note t+at t+e +i7+er 4lo:er5 t+e a6ount put 8o:n9 t+e 6ore 4less5 liCely t+e custo6er :ill co6plete t+e transaction% T+e concern un8er t+e prior rules is t+at retailers 6i7+t 7i.e .ery 7enerous laya:ay ter6s in or8er to accelerate re.enue reco7nition% In.estors :oul8 3e in for a surprise if custo6ers 8o not co6plete t+e transactions an8 t+e re.enue recor8e8 earlier 6ust 3e re.erse89 t+ere3y lo:erin7 reporte8 inco6e%
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INTE NATIONAL E=O TIN? CASE

T+e IASB an8 FASB fra6e:orCs are striCin7ly si6ilar% T+is is not surprisin79 7i.en t+at t+e IASB fra6e:orC :as a8opte8 after t+e FASB 8e.elope8 its fra6e:orC 4t+e IASB fra6e:orC :as appro.e8 in April #,*,5% In a88ition9 t+e IASC9 t+e pre8ecessor to t+e 5 IASB9 :as for6e8 to facilitate +ar6oniFation of accountin7 stan8ar8s across countries% T+is o3@ecti.e coul8 3e ai8e8 3y a8optin7 a si6ilar conceptual fra6e:orC% Specific si6ilarities inclu8e1
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=ri6ary Co6ponentsABot+ fra6e:orCs inclu8e ele6ents a88ressin7 o3@ecti.es9 assu6ptions9 ;ualitati.e c+aracteristics9 ele6ents of financial state6ents9 an8 constraints% T+e o3@ecti.es for 3ot+ fra6e:orCs focus on infor6ation a3out financial position9 perfor6ance an8 c+an7es in perfor6ance t+at is 8ecision"useful% ele.ance an8 relia3ility are i8entifie8 as Cey ;ualitati.e c+aracteris"tics of useful infor6ation% Bot+ fra6e:orCs a8opt si6ilar 8efinitions for assets an8 lia3ilities an8 8efine e;uity as t+e resi8ual of assets 6inus lia3ilities% Bot+ fra6e:orCs assu6e so6e le.el of un8erstan8a3ility 3y users of financial state6ents%
435
15
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485 4e5
25
So6e 8ifferences inclu8e1 4a5

3#
Ter6inolo7yAT+e IASB fra6e:orC contains so6e ter6s not foun8 in t+e FASB<s% For exa6ple9 pru8ence9 liste8 un8er relia3ility in t+e IASB fra6e:orC correspon8s to t+e notion of conser.atis6 in t+e FASB fra6e:orC% Assu6ptionsAT+e IASB 8oes not specifically a88ress assu6ptions a3out t+e 6onetary unit or econo6ic entity% Note t+at t+e accrual 3asis assu6ption9 in co63ination :it+ t+e ti6eliness constraint can 3e .ie:e8 as su3su6in7 t+e perio8icity assu6ption in t+e FASB fra6e:orC%
435
35
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INTE NATIONAL E=O TIN? CASE 4Continue85 4c5

5
Ele6entsAT+e IASB 8efines @ust fi.e ele6ents :it+out specific 8efini"tions for In.est6ents 3y an8 Distri3utions to O:ners or Co6pre+ensi.e Inco6e% T+ere is no 8istinction in t+e IASB fra6e:orC 3et:een 7ains an8 re.enues an8 losses an8 expenses% Note to InstructorsAT+ese 8ifferences 6ay 3e resol.e8 as t+e FASB an8 IASB :orC on t+eir perfor6ance reportin7 pro@ects%
1#
485
Qualitati.e C+aracteristicsAT+e IASB 8oes not 6aCe a 8istinction 3et:een pri6ary 4rele.ance an8 relia3ility5 an8 secon8ary ;ualitati.e factors 4co6para3ility59 alt+ou7+ 6any of t+e sa6e ;ualitati.e factors are apparent in eac+ fra6e:orC%
15
eco7nition an8 2easure6ent =rinciplesAT+e IASB Fra6e:orC9 as pre"sente8 in t+e O.er.ie: 8oes not a88ress 6easure6ent principles relate8 to 0istorical Cost9 e.enue eco7nition an8 Expense eco7nition% T+ese liCely are 8iscusse8 in t+e context of Accrual Basis an8 True an8 Fair =resentation%
2#
20!3
= OFESSIONAL ESEA C0
6earc 6trings) concept statement, Hmaterialit1I, HarticulationI
:a<
/ccor-ing to Concepts 6tatement 2 :COK 2<) Qualitative C aracteristics of /ccounting 7nfor0mation, HAlossar1I) H*aterialit1 is -efine- as t e magnitu-e of an omission or misstatement of accounting infor0mation t at, in t e lig t of surroun-ing circumstances, makes it probable t at t e ju-gment of a reasonable person rel1ing on t e information woulave been c ange- or influence- b1 t e omission or misstatement.I
1#
:b<
15
COK 2, /ppen-i, CD6ee @able 1Drefers to several 6$C cases w ic appl1 materialit1. 6tu-ents mig t also researc 6$C literature :e.g. 6taff /ccounting (ulletin Ko. ''<, alt oug 6$C literature is not in t e ./+6 -atabase. 6./C Ko. 2, 12&. provi-es t e following e,amples of screens t at mig t be use- to -etermine materialit1) H a. /n accounting c ange in circumstances t at puts an enterprise in -anger of being in breac of covenant regar-ing its financial con-ition ma1 justif1 a lower materialit1 t res ol- t an if its position were stronger. / failure to -isclose separatel1 a nonrecurrent item of revenue ma1 be material at a lower t res ol- t an woul- ot erwise be t e case if t e revenue turns a loss into a profit or reverses t e tren- of earnings from a -ownwar- to an upwar- tren-. / misclassification of assets t at woul- not be material in amount if it affecte- two cate0gories of plant or e?uipment mig t be material if it c ange- t e classification between a noncurrent an- a current asset categor1. /mounts too small to warrant -isclosure or correction in normal circumstances ma1 be consi-ere- material if t e1 arise from abnormal or unusual transactions or events.I
2#
b. c. -.
25
3#
Jowever, accor-ing to COK 2, Bars. 12', 131 t e ./6( notes t at more t an magnitu-e must be consi-ere- in evaluating materialit1) /lmost alwa1s, t e relative rat er t an t e absolute siGe of a ju-gment item -etermines w et er it s oulbe consi-ere- material in a given situation. Eosses from ba- -ebts or pilferage t at coul- be s rugge- off as routine b1 a large business ma1 t reaten t e continue- e,istence of a small one. /n error in inventor1 valuation ma1 be material in a small enterprise for w ic it cut earnings in alf but immaterial in an enterprise for w ic it mig t make a barel1 perceptible ripple in t e earnings. 6ome of t e empirical investigations referre- to in /ppen-i, C t row lig t on t e consi-erations t at enter into materialit1 ju-gments. 6./C Ko. 2, Bar. 131.6ome ol- t e view t at t e (oar- s oul- promulgate a set of ?uanti0tative materialit1 gui-es or criteria covering a wi-e variet1 of situations t at preparers coul- look to for aut oritative support. @ at appears to be a minorit1 view, owever, on t e basis of representations ma-e to t e (oar- in response to t e =iscussion *emoran-um, Criteria for =etermining *aterialit1. @ e pre-ominant view is t at materialit1 ju-gments can properl1 be ma-e onl1 b1 t ose w o ave all t e facts. @ e (oar->s present position is t at no general stan-ar-s of materialit1 coul- be formulate- to take into account all t e consi-erations t at enter into an e,perience- uman ju-gment.
35
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!5
20!!Cop1rig
= OFESSIONAL ESEA C0 4Continue85

:c< 6./C Ko. 3, Bar. 15.@ e two classes of elements are relate- in suc a wa1 t at :a< assets, liabilities, an- e?uit1 are c ange- b1 elements of t e ot er class an- at an1 time are t eir cumulative result an- :b< an increase :-ecrease< in an asset cannot occur wit out a correspon-0ing -ecrease :increase< in anot er asset or a correspon-ing increase :-ecrease< in a liabilit1 or e?uit1. @ ose relations ips are sometimes collectivel1 referre- to as Harticulation.I @ e1 result in financial statements t at are fun-amentall1 interrelate- so t at statements t at s ow elements of t e secon- class -epen- on statements t at s ow elements of t e first class an- vice versa.
1#
20!5
= OFESSIONAL SI2ULATION
Explanation
5
#%
1#
2ost accountin7 6et+o8s are 3ase8 on t+e assu6ption t+at t+e 3usiness enterprise :ill +a.e a lon7 life% Acceptance of t+is assu6ption pro".i8es cre8i3ility to t+e +istorical cost principle9 :+ic+ :oul8 3e of li6ite8 usefulness if li;ui8ation :ere assu6e8% Only if :e assu6e so6e per6anence to t+e enterprise is t+e use of 8epreciation an8 a6ortiFation policies @ustifia3le an8 appropriate% T+erefore9 it is incorrect to assu6e li;ui8ation as t+e co6pany +as 8one in t+is situation% It s+oul8 3e note8 t+at only :+ere li;ui8ation appears i66inent is t+e 7oin7 concern assu6ption inapplica3le% =ro3a3ly t+e co6pany is too conser.ati.e in its accountin7 for t+is transaction% T+e expense reco7nition principle in8icates t+at expenses s+oul8 3e allocate8 to t+e appropriate perio8s in.ol.e8% In t+is case9 t+ere appears to 3e a +i7+ uncertainty t+at t+e co6pany :ill +a.e to pay% FASB State6ent No% ' re;uires t+at a loss s+oul8 3e accrue8 only 4#5 :+en it is pro3a3le t+at t+e co6pany :oul8 lose t+e suit an8 4!5 t+e a6ount of t+e loss can 3e reasona3ly esti6ate8% 4Note to instructor1 T+e stu8ent :ill pro3a3ly 3e unfa6iliar :it+ FASB State6ent No% '% T+e purpose of t+is ;uestion is to 8e.elop so6e 8ecision fra6e:orC :+en t+e pro3a3ility of a future e.ent 6ust 3e assu6e8%5 T+is entry .iolates t+e econo6ic entity assu6ption% T+is assu6ption in accountin7 in8icates t+at econo6ic acti.ity can 3e i8entifie8 :it+ a particular unit of accounta3ility% In t+is situation9 t+e co6pany erre8 3y c+ar7in7 t+is cost to t+e :ron7 econo6ic entity%
!%
15
2#
$%
25
esearc+
3#
Accor8in7 to Concepts State6ent ! 4CON !51 Qualitati.e C+aracteristics of Accountin7 Infor6ation9 D?lossaryE1 D2ateriality is 8efine8 as t+e 6a7nitu8e of an o6ission or 6isstate6ent of accountin7 infor6ation t+at9 in t+e li7+t of surroun8in7 circu6"stances9 6aCes it pro3a3le t+at t+e @u876ent of a reasona3le person relyin7 on t+e infor6ation :oul8 +a.e 3een c+an7e8 or influence8 3y t+e o6ission or 6isstate6ent%E
35
20!"Cop1rig
= OFESSIONAL SI2ULATION 4Continue85 Accor8in7 to t+e DSU22A J OF = INCI=AL CONCLUSIONSE1

5
1#
15
D2ateriality is a per.asi.e concept t+at relates to t+e ;ualitati.e c+ar" acteristics9 especially rele.ance an8 relia3ility% 2ateriality an8 rele.ance are 3ot+ 8efine8 in ter6s of :+at influences or 6aCes a 8ifference to a 8ecision 6aCer9 3ut t+e t:o ter6s can 3e 8istin7uis+e8% A 8ecision not to 8isclose certain infor6ation 6ay 3e 6a8e9 say9 3ecause in.estors +a.e no nee8 for t+at Cin8 of infor6ation 4it is not rele.ant5 or 3ecause t+e a6ounts in.ol.e8 are too s6all to 6aCe a 8ifference 4t+ey are not 6aterial5% 2a7nitu8e 3y itself9 :it+out re7ar8 to t+e nature of t+e ite6 an8 t+e circu6stances in :+ic+ t+e @u876ent +as to 3e 6a8e9 :ill not 7enerally 3e a sufficient 3asis for a 6ateriality @u876ent% T+e Boar8<s present position is t+at no 7eneral stan8ar8s of 6ateriality can 3e for6ulate8 to taCe into account all t+e consi8erations t+at enter into an experience8 +u6an @u876ent% Quantitati.e 6ateriality criteria 6ay 3e 7i.en 3y t+e Boar8 in specific stan8ar8s in t+e future9 as in t+e past9 as appropriate%E Expan8e8 8iscussion of 6ateriality is foun8 at para7rap+s #!$H#$! an8 in Appen8ix C of CON !%
2#
20!%

CH 02

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CH 02

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CHAPTER 2

Conceptual Framework Underlying Financial Accounting

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

5, " 5, " 5, ", %, &, ', 11

ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)

1, 2 3, 11 !, &, ', 1# 5, ", ', 1# %, &, 1#

ASSIGNMENT CHARACTERISTICS TABLE

I$e( E2-1 E2-2 E2-3 E2-4 E2-5 E2-" E2-% E2-&

Le%e* o& )i&&ic+*$,

Moderate Simple Simple Simple Moderate #omple$ Moderate Moderate

SOLUTION TO CODIFICATION EXE CISES

SOLUTIONS TO B IEF EXE CISES

B IEF EXE CISE !"!

4a5 435 4c5 485

/erifia3ility Co6para3ility Consistency Ti6eliness

B IEF EXE CISE !"'

4a5 435 4c5 485

In8ustry practices Conser.atis6 Cost"3enefit relations+ip 2ateriality

B IEF EXE CISE !",

B IEF EXE CISE !"##

SOLUTIONS TO EXE CISES

Fee83acC /alue% CostIBenefit an8 2ateriality% Neutrality% Consistency% Neutrality%

4f5 475 4+5 4i5 4@5

ele.ance an8 elia3ility% Ti6eliness% ele.ance% Co6para3ility% /erifia3ility%

EXE CISE !"! 4#'H!- 6inutes5 4a 5 43 5 4c5 48 5 4e5

Co6para3ility% Fee83acC /alue% Consistency% Neutrality% /erifia3ility%

4f5 475 4+5 4i5 4@5

ele.ance% Co6para3ility an8 Consistency% elia3ility% ele.ance an8 elia3ility% Ti6eliness%

EXE CISE !"$ 4#'H!- 6inutes5

4a5 435 4c5 485

4e5 4f5 475 4+5 4i5 4@5

Distri3utions to o:ners% Co6pre+ensi.e inco6e%

EXE CISE !"(

EXE CISE !"( 4Continue85 4c5

EXE CISE !") 4Continue85 485

EXE CISE !"*

EXE CISE !"* 4Continue85 4c5

TI2E AND =U =OSE OF CONCE=TS FO ANALJSIS

SOLUTIONS TO CONCE=TS FO ANALJSIS

FINANCIAL E=O TIN? = OBLE2

CO2=A ATI/E ANALJSIS CASE

CO2=A ATI/E ANALJSIS CASE 4Continue85 4c5

Recent Accounting Standards and Pronouncements

CO2=A ATI/E ANALJSIS CASE 4Continue85 =epsiCo

FINANCIAL STATE2ENT ANALJSIS CASEAGAL"2A T

INTE NATIONAL E=O TIN? CASE

So6e 8ifferences inclu8e1 4a5

INTE NATIONAL E=O TIN? CASE 4Continue85 4c5

= OFESSIONAL ESEA C0 4Continue85

= OFESSIONAL SI2ULATION 4Continue85 Accor8in7 to t+e DSU22A J OF = INCI=AL CONCLUSIONSE1

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