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, 7
1, 2
2.
Objective of financial
2
1, 2
3
3.
Qualitative characteristics
of accounting.
3, 4, 5, 6, 8
1, 2, 3, 4
2, 3, 4
4, 9
4.
Elements of financial
statements.
9, 10, 11
6, 10, 12
5
Basic assumptions.
12, 13, 14
5, 7
6, 7
7.
Accounting principles–
comprehensive.
9, 10
Cost constraint.
28, 29, 30
3, 6, 7
9.
Assumptions, principles,
and constraints.
6, 7
ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)
Learning Objectives
Questions
Brief
Exercises
Exercises
Concepts for
Analysis
1. Describe the usefulness of a
conceptual framework.
1
1, 2
CA2-1
2. Describe the FASB’s efforts to
construct a conceptual framework.
CA2-1, CA2-
3. Understand the objectives of
financial reporting.
2
1, 2
CA2-2, CA2-
4. Identify the qualitative
characteristics of accounting
information.
3, 4, 5, 6, 8
1, 2, 3, 4, 5
2, 3, 4
CA2-4, CA2-
5
5. Define the basic elements of
financial statements.
7, 10, 11,
6, 12
5
6. Describe the basic assumptions of
accounting.
9, 12, 13,
7, 10, 11
6, 7
7. Explain the application of the basic
principles of accounting.
24, 26, 27,
9, CA2-10,
accounting information.
28, 29, 30
CA2–11
15, 16, 17,
18, 19, 20,
21, 22, 23,
8, 9, 11
6, 7, 8, 9,
10
CA2-5, CA2-
6, CA2-7,
CA2-8, CA2-
ASSIGNMENT CHARACTERISTICS TABLE
Item
Description
Level of
Difficulty
Time
(minutes)
E2-1
Usefulness, objective of financial reporting.
Simple
15–20
E2-2
Usefulness, objective of financial reporting, qualitative
characteristics.
Simple
15–20
E2-3
Qualitative characteristics.
Moderate
25–30
E2-4
Qualitative characteristics.
Simple
15–20
E2-5
Elements of financial statements.
Simple
15–20
E2-6
Assumptions, principles, and constraint.
Simple
15–20
E2-7
Assumptions, principles, and constraint.
Moderate
20–25
E2-8
Full disclosure principle.
Complex
20–25
E2-9
Accounting principles–comprehensive.
Moderate
20–25
E2–10
Accounting principles–comprehensive.
Moderate
20–25
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
CA2-4
Qualitative characteristics.
Moderate
30–35
CA2-5
Revenue recognition principle.
Complex
25–30
CA2-6
Expense recognition principle.
Complex
20–25
CA2-7
Expense recognition principle.
Moderate
20–25
CA2-8
Expense recognition principle.
Moderate
20–30
CA2-9
Qualitative characteristics.
Moderate
20–30
CA2–10
Expense recognition principle.
Moderate
20–25
CA2–11
Cost Constraint.
Moderate
30–35
SOLUTION TO CODIFICATION EXERCISES
CE2-1
(a) The master glossary provides three definitions of fair value that are found in GAAP:
Fair Value—The amount at which an asset (or liability) could be bought (or incurred) or settled in a
current transaction between willing parties, that is, other than in a forced or liquidation sale.
(b) Revenue—Revenue earned by an entity from its direct distribution, exploitation, or licensing of a
film, before deduction for any of the entity’s direct costs of distribution. For markets and territories
(c) Comprehensive Income is defined as the change in equity (net assets) of a business entity during
CE2-2
The FASB Codification’s organization is closely aligned with the elements of financial statements, as
ANSWERS TO QUESTIONS
1. A conceptual framework is a coherent system of interrelated objectives and fundamentals that can
lead to consistent standards and that prescribes the nature, function, and limits of financial account-
ing and financial statements. A conceptual framework is necessary in financial accounting for the
following reasons:
2. 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.
3. “Qualitative characteristics of accounting information” are those characteristics which contribute to
4. Relevance and faithful representation are the two primary qualities of useful accounting information.
For information to be relevant, it should should be capable of making a difference in a decision by
5. The concept of materiality refers to the relative significance of an amount, activity, or item to
informative disclosure, proper presentation of financial position, and the results of operations.
Materiality has qualitative and quantitative aspects; both the nature of the item and its relative size
enter into its evaluation.
An accounting misstatement is said to be material if knowledge of the misstatement will affect the
Questions Chapter 2 (Continued)
6. Enhancing qualities are qualitative characteristics that are complementary to the fundamental
7. In providing information to users of financial statements, the Board relies on general-purpose
financial statements. The intent of such statements is to provide the most useful information
8. Comparability facilitates comparisons between information about two different enterprises at a
particular point in time. Consistency, a type of comparability, facilitates comparisons between
information about the same enterprise at two different points in time.
9. At present, the accounting literature contains many terms that have peculiar and specific meanings.
10. Distributions to owners differ from expenses and losses in that they represent transfers to owners,
and they do not arise from activities intended to produce income. Expenses differ from losses in
that they arise from the entity’s ongoing major or central operations. Losses arise from peripheral
or incidental transactions.
11. Investments by owners differ from revenues and gains in that they represent transfers by owners
12. The four basic assumptions that underlie the financial accounting structure are:
(1) An economic entity assumption.
13. (a) In accounting it is generally agreed that any measures of the success of an enterprise for
periods less than its total life are at best provisional in nature and subject to correction.
Questions Chapter 2 (Continued)
(b) The practice of periodic measurement has led to many of the most difficult accounting prob–
lems such as inventory pricing, depreciation of long-term assets, and the necessity for
14. The monetary unit assumption assumes that the unit of measure (the dollar) remains reasonably
stable so that dollars of different years can be added without any adjustment. When the value of
15. Some of the arguments which might be used are outlined below:
16. Fair value is defined as “the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the measurement date.” Fair value
is therefore a market-based measure.
17. The fair value option gives companies the option to use fair value (referred to as the fair value
option as the basis for measurement of financial assets and financial liabilities.) The Board believes
18. 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)
19. 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
20. 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
21. 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.
Step 2 Identify the separate performance obligations in the contract. A performance
obligation is ether a promise to provide a service or deliver a product, or both.
22. Revenues are recognized when a performance obligation is met. The most common time at which
23. The president means that the “gain” should be recorded in the books. This item should not be
entered in the accounts, however, because it has not been realized.
24. The cause and effect relationship can seldom be conclusively demonstrated, but many costs
Questions Chapter 2 (Continued)
Systematic and rational allocation means that in the absence of a direct means of associating
cause and effect, and where the asset provides benefits for several periods, its cost should be
25. The four characteristics are:
26. (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.
27. The general guide followed with regard to the full disclosure principle is to disclose in the financial
statements any facts of sufficient importance to influence the judgment of an informed reader.
The fact that the amount of outstanding common stock doubled in January of the subsequent
28. Accounting information is subject to the cost constraint. Information is not worth providing unless
the benefits exceed the costs of preparing it.
29. 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
Questions Chapter 2 (Continued)
30. In general, conservatism should not be the basis for determining the accounting for transactions.
(a) Acceptable if reasonably accurate estimation is possible. To the extent that warranty costs can
be estimated accurately, they should be matched against the related sales revenue.
(b) Not acceptable. Most accounts are collectible or the company will be out of business very soon.
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 2-1
(a) 5. Comparability
BRIEF EXERCISE 2-2
(a) 5. Faithful representation
BRIEF EXERCISE 2-3
(a) If the company changed its method for inventory valuation, the consis-
(b) If the company disposed of one of its two subsidiaries that had been
included in its consolidated statements for prior years, no comment as
BRIEF EXERCISE 2-3 (continued)
(c) If the company reduced the estimated remaining useful life of plant
BRIEF EXERCISE 2-4
(a) Verifiability
BRIEF EXERCISE 2-5
Companies and their auditors for the most part have adopted the general
rule of thumb that anything under 5% of net income is considered not material.
Recently, the SEC has indicated that it is okay to use this percentage for
(a) Because the change was used to create a positive trend in earnings,
the change is considered material.
BRIEF EXERCISE 2-6
(a) Equity
(b) Revenues
BRIEF EXERCISE 2-7
(a) Periodicity
BRIEF EXERCISE 2-8
(a) Revenue recognition
BRIEF EXERCISE 2-9
BRIEF EXERCISE 2-10
(a) Net realizable value.
BRIEF EXERCISE 2-10 (continued)
BRIEF EXERCISE 2-11
BRIEF EXERCISE 2-12
(a) Should be debited to the Land account, as it is a cost incurred in acquir-
ing land.
(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
are to be prepared on some date before December 31, part of this cost
SOLUTIONS TO EXERCISES
EXERCISE 2-1 (15–20 minutes)
(a) True.
(b) False – General-purpose financial reports helps users who lack the
ability to demand all the financial information they need from an entity
EXERCISE 2-2 (15–20 minutes)
(a) False – The fundamental qualitative characteristics that make account–
ing information useful are relevance and faithful representation.
EXERCISE 2-3 (20–30 minutes)
(a)
Confirmatory Value.
(g)
Timeliness.
EXERCISE 2-4 (15–20 minutes)
(a)
(b)
Comparability.
Confirmatory Value.
(h)
(i)
Materiality.
Relevance and Faithful
EXERCISE 2-5 (15–20 minutes)
(a) Gains, losses.
(b) Liabilities.
(c) Investments by owners, comprehensive income.
EXERCISE 2-6 (15–20 minutes)
(a)
7.
Expense recognition principle.
EXERCISE 2-7 (20–25 minutes)
(a)
Measurement (historical cost)
principle.
(i)
(j)
Full disclosure principle.
Expense recognition and
(e)
Measurement (fair value)
principle.
(m)
Measurement (fair value)
principle.
(g)
Economic entity assumption.
Full disclosure principle.
(n)
Measurement (historical cost)
principle.
EXERCISE 2-8
(a) It is well established in accounting that revenues and cost of goods
(b) The proper accounting for this situation is to report the equipment as
EXERCISE 2-8 (Continued)
(c) According to GAAP, the basis upon which inventory amounts are
stated (lower of cost or market) and the method used in determining
EXERCISE 2-9
(a) This entry violates the economic entity assumption. This assumption
in accounting indicates that economic activity can be identified with a
(b) The historical cost principle indicates that assets and liabilities are
accounted for on the basis of cost. If we were to select sales value,
(c) The expense recognition principle indicates that expenses should be
allocated to the appropriate periods involved. In this case, there
appears to be a high uncertainty that the company will have to pay.
EXERCISE 2-9 (Continued)
(d) At the present time, accountants do not recognize price-level adjust-
ments in the accounts. Hence, it is misleading to deviate from the
measurement principle (historical cost) principle because conjecture
(e) Most accounting methods are based on the assumption that the busi-
ness enterprise will have a long life. Acceptance of this assumption
EXERCISE 2-10
(a) Depreciation is an allocation of cost, not an attempt to value assets.
As a consequence, even if the value of the building is increasing,
costs related to this building should be matched with revenues on the
income statement, not as a charge against retained earnings.
(b) A gain should not be recognized until the inventory is sold. Accoun–
EXERCISE 2-10 (Continued)
(c) Assets should be recorded at the fair value of what is given up or the
(d) The gain should be recognized at the point of sale. Deferral of the gain
(e) It appears from the information that the sale should be recorded in
2015 instead of 2014. Regardless of whether the terms are f.o.b.