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CHAPTER 2
Conceptual Framework for Financial Reporting
ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)
Topics
Questions
Brief
Exercises
Exercises
Concepts
for Analysis
1.
Conceptual framework–
general.
1
1, 2
5.
Basic assumptions.
11, 12, 13
7, 8, 12
6, 7
6.
Basic principles:
a. Measurement.
b. Revenue recognition.
14, 15, 16, 17
18, 19, 20, 21, 22
9, 10, 12
9
6, 7, 9, 10
7, 9, 10
5
5
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Brief Exercises
Exercises
Concepts
for
Analysis
1. Describe the usefulness of a conceptual
framework and explain the objective of
financial reporting.
13
1, 2
1, 2,3
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
Level of
Difficulty
Time
(minutes)
E2.1
Usefulness, objective of financial reporting.
Moderate
10–15
E2.2
Usefulness, objective of financial reporting, qualitative
characteristics.
Moderate
10–15
E2.3
Qualitative characteristics.
Moderate
15–20
CA2.1
Conceptual framework–general.
Simple
20–25
CA2.2
Conceptual framework–general.
Simple
25–35
CA2.3
Objective of financial reporting.
Moderate
25–35
ANSWERS TO QUESTIONS
1. A conceptual framework is a coherent system of concepts that flow from an objective. The
objective identifies the purpose of financial reporting. The other concepts provide guidance on
(1) identifying the boundaries of financial reporting, (2) selecting the transactions, other events, and
circumstances to be represented, (3) how they should be recognized and measured, and (4) how
they should be summarized and reported. A conceptual framework is necessary in financial
accounting for the following reasons:
2. The primary objective of financial reporting is as follows:
3. The IASB identified the qualitative characteristics of accounting information that distinguish better
(more useful) information from inferior (less useful) information for decision-making purposes.
4. Relevance and faithful representation are the two fundamental qualities that make accounting
information useful for decision-making. To be relevant, accounting information must be capable of
making a difference in a decision. Information with no bearing on a decision is irrelevant. Financial
5. Materiality refers to the relative significance of an amount, activity, or item to informative disclosure
Questions Chapter 2 (Continued)
Materiality is a company-specific aspect of relevance. Information is material if omitting it or
misstating it could influence decisions that users make on the basis of the reported financial
information. An individual company determines whether information is material because both the
6. The enhancing qualitative characteristics are comparability, verifiability, timeliness, and understandability.
These characteristics enhance the decision usefulness of financial reporting information that is
7. Decision-makers vary widely in the types of decisions they make, how they make decisions, the
information they already possess or can obtain from other sources, and their ability to process the
information. For information to be useful, there must be a connection (linkage) between these
8. Information that is measured and reported in a similar manner for different companies is
considered comparable. Comparability enables users to identify the real similarities and
Questions Chapter 2 (Continued)
9. An important aspect of developing any theoretical structure is the body of basic elements or
definitions to be included in it. Accounting uses many terms with distinctive and specific meanings.
These terms constitute the language of business or the jargon of accounting. One such term is
asset. Is it merely something we own? Or is an asset something we have the right to use, as in the
case of leased equipment? Or is it anything of value used by a company to generate revenues—in
which case, should we also consider the managers of a company as an asset?
10. The IASB classifies the elements into two distinct groups. [5] The first group of three elements—
assets, liabilities, and equity—describes amounts of resources and claims to resources at a
11. The five basic assumptions that underlie the financial accounting structure are:
(1) An economic entity assumption.
12. a) Users need to know a company’s performance and economic status on a timely basis so that
they can evaluate and compare companies, and take appropriate actions. Therefore,
companies must report information periodically. The periodicity (or time period) assumption
implies that a company can divide its economic activities into artificial time periods. These
time periods vary, but the most common are monthly, quarterly, and yearly. The shorter the
Questions Chapter 2 (Continued)
13. The monetary unit assumption assumes that the unit of measure remains reasonably stable so
that Euros, Yen, or dollars of different years can be added without any adjustment. When the value
14. Some of the arguments which might be used are outlined below:
(1) Cost is definite and reliable; other values would have to be determined somewhat arbitrarily
15. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a
16. The fair value option gives companies the option to use fair value as the basis for measurement of
financial assets and financial liabilities. The Board believes that fair value measurement for financial
17. The fair value hierarchy provides insight into the priority of valuation techniques that are used to
determine fair value. The fair value hierarchy is divided into three broad levels.
Fair Value Hierarchy
Level 1: Observable inputs that reflect quoted prices for
Least Subjective
identical assets or liabilities in active markets.
Questions Chapter 2 (Continued)
18. The revenue recognition principle requires that companies recognize revenue in the accounting
period in which the performance obligation is satisfied. In the case of services, revenue is recognized
19. A performance obligation is a promise to deliver a product or provide a service to a customer. The
revenue recognition principle requires that companies recognize revenue in the accounting period in
20. The five steps in the revenue recognition process are:
Step 1. Identify the contract(s) with the customer. A contract is an agreement between two
parties that creates enforceable rights or obligations.
21. Revenues are recognized when a performance obligation is met. The most common time at which
these two conditions are met is when the product or merchandise is delivered or services are
22. The president means that the “gain” should be recorded in the books. This item should not be
Questions Chapter 2 (Continued)
23. The cause and effect relationship can seldom be conclusively demonstrated, but many costs
appear to be related to particular revenues and recognizing them as expenses accompanies
recognition of the revenue. Examples of expenses that are recognized by associating cause and
effect are sales commissions and cost of products sold or services provided.
24. An item that meets the definition of an element should be recognized if: (a) it is probable that any
25. (a) To be recognized in the main body of financial statements, an item must meet the definition of
an element. In addition, the item must have been measured, recorded in the books, and passed
through the double-entry system of accounting.
26. The general guide followed with regard to the full disclosure principle is to disclose in the financial
statements any facts of sufficient importance to influence the judgment of an informed reader.
The fact that the amount of outstanding common shares doubled in January of the subsequent
27. Accounting information is subject to the cost constraint. Information is not worth providing unless
Questions Chapter 2 (Continued)
28. The costs of providing accounting information are paid primarily to highly trained accountants who
design and implement information systems, retrieve and analyze large amounts of data, prepare
financial statements in accordance with authoritative pronouncements, and audit the information
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 2.1
(a) Comparability
BRIEF EXERCISE 2.2
(a) Faithful representation
BRIEF EXERCISE 2.3
(a) If the company changed its method for inventory valuation, the consis-
tency, and therefore the comparability, of the financial statements have
been affected by a change in the method of applying the accounting
BRIEF EXERCISE 2.3 (Continued)
(c) If the company reduced the estimated remaining useful life of plant
property because of obsolescence, the comparability of the financial
BRIEF EXERCISE 2.4
(a) Verifiability
BRIEF EXERCISE 2.5
(a) Should be debited to the Land account, as it is a cost incurred in
BRIEF EXERCISE 2.5 (Continued)
(d) If the fiscal year ends December 31, this will all be an expense of the
current year that can be charged to an expense account. If statements
BRIEF EXERCISE 2.6
(a) Equity
(b) Income
BRIEF EXERCISE 2.7
(a) Fair value, or net realizable value, if the land was sold.
(b) Would not be disclosed. Depreciation would be inappropriate if the
BRIEF EXERCISE 2.7 (Continued)
Note: In each of these cases, historical cost or fair value valuation might be
BRIEF EXERCISE 2.8
(a) Periodicity
BRIEF EXERCISE 2.9
(a) Revenue recognition
BRIEF EXERCISE 2.10
Investment 1—Least verifiable.
BRIEF EXERCISE 2.11
(a) Material; although amount is small the change affects the trend.
BRIEF EXERCISE 2.12
(a) Accrual basis (Expense recognition principle)
BRIEF EXERCISE 2.13
1. Costs; costs
SOLUTIONS TO EXERCISES
EXERCISE 2.1 (10–15 minutes)
(a) True.
(b) False. General purpose financial reporting helps users who lack the
(c) False. Accounting standards based on individual conceptual frameworks
generally will not result in consistent and comparable accounting
reports. Rather, standard-setting that is based on personal conceptual
frameworks will lead to different conclusions about identical or similar
issues than it did previously. As a result, standards will not be con-
sistent with one another and past decisions may not be indicative of
future ones.
EXERCISE 2.2 (10–15 minutes)
(a) False. The fundamental qualitative characteristics that make accounting
information useful are relevance and faithful representation.
(d) False. To be a faithful representation, information must be complete,
neutral, and free of material error.
(e) False. While comparability does pertain to the reporting of information in
a similar manner for different companies, it also refers to the consistency
of information, which is present when a company applies the same
EXERCISE 2.3 (15–20 minutes)
(a)
Confirmatory Value.
(e)
Neutrality.
EXERCISE 2.4 (15–20 minutes)
(a)
(b)
Comparability.
Confirmatory Value.
(g)
Comparability (Consistency),
Verifiability, Timeliness, and
EXERCISE 2.5 (10–15 minutes)
(a) Liabilities.
(b) Equity.
EXERCISE 2.6 (15–20 minutes)
(a)
8.
Expense recognition principle.
(b)
6.
Historical cost principle.
EXERCISE 2.7 (20–25 minutes)
(a)
(b)
Historical cost principle.
Accrual-basis assumption.
(j)
Revenue and expense recogni-
tion principles.
EXERCISE 2.8
(a) It is well established in accounting that revenues, cost of goods sold
and expenses must be disclosed in an income statement. It might be
EXERCISE 2.8 (Continued)
(c) The basis upon which inventory amounts are stated (net realizable value)
and the method used in determining cost (Weighted Average, FIFO, etc.)
EXERCISE 2.9
(a) This entry violates the economic entity assumption. This assumption
in accounting indicates that economic activity can be identified with a
particular unit of accountability. In this situation, the company erred
by charging this cost to the wrong economic entity.
(b) The historical cost principle indicates that assets and liabilities are
(c) The company should not record this loss. The expense recognition
principle indicates that expenses should be allocated to the
