TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 2-1 (Time 20–25 minutes)
CA 2-2 (Time 25–35 minutes)
CA 2-3 (Time 25–35 minutes)
Purpose—to provide the student with some familiarity with the Conceptual Framework. The student is
asked to indicate the broad objective of accounting, and to discuss how this statement might help to
establish accounting standards.
CA 2-4 (Time 30–35 minutes)
CA 2-5 (Time 25–30 minutes)
CA 2-6 (Time 20–25 minutes)
CA 2-7 (Time 20–25 minutes)
CA 2-8 (Time 20–30 minutes)
Purpose—to provide the student with a realistic case involving association of costs with revenues. The
advantages of expensing costs as incurred versus spreading costs are examined. Specific guidance is
asked on how allocation over time should be reported.
CA 2-9 (Time 20–30 minutes)
CA 2-10 (Time 20–25 minutes)
CA 2-11 (Time 30–35 minutes)
SOLUTIONS TO CONCEPTS FOR ANALYSIS
CA 2-1
(a) A conceptual framework is like a constitution. Its objective is to provide a coherent system of
interrelated objectives and fundamentals that can lead to consistent standards and that prescribes
the nature, function, and limits of financial accounting and financial statements.
A conceptual framework is necessary so that standard setting is useful, i.e., standard setting
should build on and relate to an established body of concepts and objectives. A well-developed
conceptual framework should enable the FASB to issue more useful and consistent standards in
the future.
Specific benefits that may arise are:
(1) A coherent set of standards and rules should result.
(2) New and emerging practical problems should be more quickly soluble by reference to an
(b) The FASB has issued eight Statements of Financial Accounting Concepts (SFAC) that relate to
business enterprises. Their titles and brief description of the focus of each Statement are as follows:
(1) SFAC No. 1, “Objectives of Financial Reporting by Business Enterprises,” presents the goals
and purposes of accounting.
(2) SFAC No. 2, “Qualitative Characteristics of Accounting Information,” examines the character–
istics that make accounting information useful.
CA 2-2
(a) FASB’s Conceptual Framework should provide benefits to the accounting community such as:
(1) guiding the FASB in establishing accounting standards on a consistent basis.
CA 2-2 (Continued)
(b) The most important quality for accounting information is usefulness for decision making. Relevance
and faithful representation are the primary qualities leading to this decision usefulness. Usefulness is
the most important quality because, without usefulness, there would be no benefits from information
to set against its costs.
(c) There are a number of key characteristics or qualities that make accounting information desirable.
The importance of three of these characteristics or qualities is discussed below.
(1) Understandability—information provided by financial reporting should be comprehensible to
those who have a reasonable understanding of business and economic activities and are
(Note to instructor: Other qualities might be discussed by the student, such as enhancing qualities. All
of these qualities are defined in the textbook).
CA 2-3
(a) The basic objective is to provide financial information about the reporting entity that is useful to
present and potential equity investors, lenders, and other creditors in making decisions about
providing resources to the entity.
(b) The purpose of this statement is to set forth fundamentals on which financial accounting and
reporting standards may be based. Without some basic set of objectives that everyone can agree
CA 2-4
(a) (1) Relevance is one of the two primary decision-specific characteristics of useful accounting
(2) Faithful representation is one of the two primary decision-specific characteristics of useful
accounting information. Reliable information can be depended upon to represent the conditions
(3) Understandability is a user-specific characteristic of information. Information is understandable
(4) Comparability means that information about enterprises has been prepared and presented in a
similar manner. Comparability enhances comparisons between information about two different
enterprises at a particular point in time.
(5) Consistency means that unchanging policies and procedures have been used by an enterprise
from one period to another. Consistency enhances comparisons between information about the
same enterprise at two different points in time.
(b) (Note to instructor: There are a multitude of answers possible here. The suggestions below are
intended to serve as examples).
(1) Forecasts of future operating results and projections of future cash flows may be highly relevant
to some decision makers. However, they would not be as free from error as historical cost
information about past transactions.
(c) Although trade-offs result in the sacrifice of some desirable quality of information, the overall result
should be information that is more useful for decision making.
CA 2-5
(a) The “crucial event” in determining when revenue is recognized is when a performance obligation
is satisfied. In the case of subscriptions, the performance obligation is met when the magazines
are delivered (including ads contained therein). The new director suggests that this principle does
not apply in the magazine business and that revenue from subscription sales and advertising
should be recognized in the accounts when the difficult task of selling is accomplished and not
when the magazines are published and delivered to fill the subscriptions or to carry the
advertising.
The director’s view that there is a single crucial event in the process of earning revenue in the
magazine business is questionable even though the amount of revenue is determinable when the
(b) Recognizing in the accounts all the revenue in equal portions with the publication of the magazine
every month is subject to some of the same criticism from the standpoint of theory as the
suggestion that all or most of the revenue be recognized in the accounts at the time the
subscription is sold. Although the journalistic efforts of the magazine are important in the process
of earning revenue, the firm could not prosper without magazine sales and the advertising that
(c) Recognizing in the accounts a portion of the revenue at the time a cash subscription is obtained
and a portion each time an issue is published meets the tests of revenue recognition better than
the other two alternatives. A portion of the net income is recognized in the accounts at the time of
each major or crucial event – that is, when a performance obligation has been met. Each crucial
event is clearly discernible and is a time of interaction between the publisher and subscriber. A
CA 2-6
(a) Some costs are recognized as expenses on the basis of a presumed direct association with
specific revenue. This presumed direct association has been identified both as “associating cause
and effect” and as “matching (expense recognition principle).”
Direct cause-and-effect relationships can seldom be conclusively demonstrated, but many costs
appear to be related to particular revenue, and recognizing them as expenses accompanies
(b) Some costs are assigned as expenses to the current accounting period because
(1) their incurrence during the period provides no discernible future benefits;
(2) they are measures of assets recorded in previous periods from which no future benefits are
Thus, many costs are called “period costs” and are treated as expenses in the period incurred
because they have neither a direct relationship with revenue earned nor can their occurrence be
directly shown to give rise to an asset. The application of this principle of expense recognition results
in charging many costs to expense in the period in which they are paid or accrued for payment.
Examples of costs treated as period expenses would include officers’ salaries, advertising, research
and development, and auditors’ fees.
(c) A cost should be capitalized, that is, treated as a measure of an asset when it is expected that the
asset will produce benefits in future periods. The important concept here is that the incurrence of
CA 2-6 (Continued)
(d) In the absence of a direct basis for associating asset cost with revenue and if the asset provides
benefits for two or more accounting periods, its cost should be allocated to these periods (as an
(e) A cost should be treated as a loss when no revenue results. The matching of losses to specific
revenue should not be attempted because, by definition, they are expired service potentials not
related to revenue produced. That is, losses result from events that are not anticipated as
CA 2-7
(a) Costs should be recognized as expiring in a given period if they are not chargeable to a prior
period and are not applicable to future periods. Recognition in the current period is required when
any of the following conditions or criteria are present:
(1) A direct identification of association of charges with revenue of the period, such as goods
(b) (1) Although it is generally agreed that inventory costs should include all costs attributable to placing
the goods in a salable state, receiving and handling costs are often treated as cost expirations in
the period incurred because they are irregular or are not in uniform proportion to sales.
(2) Cash discounts on purchases are treated as “other revenues” in some financial statements in
violation of the expense recognition principles (or matching). Revenue is not recognized when
goods are purchased or cash disbursed. Furthermore, inventories valued at gross invoice price
CA 2-8
(a) The preferable treatment of the costs of the sample display houses is expensing them over more
than one period. These sample display houses are assets because they represent rights to future
service potentials or economic benefits.
According to the expense recognition principle, the costs of service potentials should be amortized
as the benefits are received. Thus, costs of the sample display houses should be matched with the
revenue from the sale of the houses which is receivable over a period of more than one year. As
the sample houses are left on display for three to seven years, Daniel Barenboim apparently
expects to benefit from the displays for at least that length of time.
(b) If all of the shell houses are to be sold at the same price, it may be appropriate to allocate the
costs of the display houses on the basis of the number of shell houses sold. This allocation would
be similar to the units-of-production method of depreciation and would result in a good matching of
costs with revenues. On the other hand, if the shell houses are to be sold at different prices, it may
be preferable to allocate costs on the basis of the revenue contribution of the shell houses sold.
CA 2-9
Date
Dear Uncle Carlos,
I received the information on Neville Corp. and appreciate your interest in sharing this venture with me.
However, I think that basing an investment decision on these financial statements would be unwise
because they are neither relevant nor representationally faithful.
These financial statements are also not representationally faithful. In order to be representationally
faithful, their assertions must be verifiable by several independent parties. Because no independent
auditor has verified these amounts, there is no way of knowing whether or not they are represented
faithfully. For instance, I would like to believe that this company earned $2,424,240, and that it had a
very favorable debt-to-equity ratio. However, unaudited financial statements do not give me any
reasonable assurance about these claims.
Your Nephew/Niece
CA 2-10
(a) The stakeholders are investors, creditors, etc.; i.e., users of financial statements, current and future.
CA 2-10 (Continued)
(d) The major question may be whether or not the expense of mothballing can be estimated properly
so that the integrity of financial reporting is maintained. Applying the expense recognition principle
will result in lower profits and possibly higher rates for consumers. Could this cost anyone his or
CA 2-11
1. Information about competitors might be useful for benchmarking the company’s results but if
2. While users of financial statements might benefit from receiving internal information, such as
company plans and budgets, competitors might also be able to use this information to gain a
competitive advantage relative to the disclosing company.
3. In order to produce forecasted financial statements, management would have to make numerous
assumptions and estimates, which would be costly in terms of time and data collection. Because of
4. It would be excessively costly for companies to gather and report information that is not used in
managing the business.
5. Flexible reporting allows companies to “fine–tune” their financial reporting to meet the information
6. Similar to number 3, concerning forecasted financial statements, if managers report forward–
looking information, the company could be exposed to liability if investors unduly rely on the
FINANCIAL REPORTING PROBLEM
From note 1:
(a) Revenue Recognition
Sales are recognized when revenue is realized or realizable and has
been earned. Most revenue transactions represent sales of inventory.
The revenue recorded is presented net of sales and other taxes we
Trade promotions, consisting primarily of customer pricing
allowances, merchandising funds and consumer coupons, are offered
(b)
Historical Cost
Buildings, Machinery and equipment.
Fair Value
On July 1, 2009, we adopted the provisions of the fair value
measurement accounting and disclosure guidance related to non–
financial assets and liabilities recognized or disclosed at fair value on
FINANCIAL REPORTING PROBLEM (Continued)
(c) P&G has the following sub-section:
(d) Accounting Policy Related to Advertising
COMPARATIVE ANALYSIS CASE
(a) Primary Lines of Business
Coke
Description of Business
The Coca-Cola Company is the world’s largest beverage company. We
Operating Segments
The business of our Company is nonalcoholic beverages. Our
PepsiCo
Our Divisions
We manufacture or use contract manufacturers, market and sell a
COMPARATIVE ANALYSIS CASE (Continued)
Our Operations
We are organized into four business units, as follows:
1) PepsiCo Americas Foods (PAF), which includes Frito– Lay North
Our four business units are comprised of six reportable segments
(referred to as divisions), as follows: FLNA, QFNA; LAF; PAB; Europe;
AMEA.
(b) Dominant Position – Beverage Sales: Coke or Pepsi
Coca-Cola: Net operating revenues for 2011 were $46,542 million,
(c) Inventories, cost allocation method, affect on comparability
Coke
Inventories
Inventories consist primarily of raw materials and packaging (which