According to the fasb conceptual framework, predictive value is an ingredient of:

Exercise 1-1

Aspects of the FASB’s Conceptual Framework

Determine whether the following statements are true or false. If a statement is false, explain why.

1. Comprehensive income includes changes in equity resulting from distributions to owners.

2. Confirmatory value and predictive value are both characteristics of relevant information.

3. The tendency to recognize favorable events early is an example of conservatism.

4. The conceptual framework focuses primarily on the needs of internal users of financial information.

5. The eight Statements of Financial Accounting Concepts are considered part of generally accepted accounting principles.

6. The overriding objective of financial reporting is to provide information for making economic decisions.

7. The term recognition is synonymous with the term disclosure.

8. Once an accounting method is adopted, it should never be changed.

Exercise 2-2

Conceptual Framework Terminology

Match the numbered statements below with the lettered terms. An answer (letter) may be used more than once, and some terms require more than one answer (letter).

1. Key ingredients in quality of relevance

2. Traditional assumptions that influence the FASB’s conceptual framework

3. The idea that information should represent what it purports to represent

4. An important constraint relating to costs and benefits

5. An example of conservatism

6. The availability of information when it is needed

7. Recording an item in the accounting records

8. Determines the threshold for recognition

9. Implies consensus

10. Transactions between independent parties

    1. Cost effectiveness

    2. Faithful representation

    3. Recognition

    4. Verifiability

    5. Time periods

    6. Unrealized

    7. Completeness

    1. Timeliness

    2. Materiality

    3. Predictive value

    4. Economic entity

    5. Lower-of-cost-or-market rule

    6. Phrenology

    7. Arm’s-length transactions

Exercise 1-3

Objectives of Financial Reporting

For each of the following independent situations, identify the relevant objective(s) of financial reporting that the company could be overlooking. Discuss each of these objectives.

1. The president of Daughters, Inc. believes that the financial statements should be prepared for use by management only, because they are the primary decision makers.

2. Sparkling Tile Co. believes that financial statements should reflect only the present financial standing and cash position of the firm and should not provide any future-oriented data.

3. The vice president of Greed Enterprises, Inc. believes that the financial statements are to present only current-year revenues and expenses, not to disclose assets, liabilities, and owners’ equity.

4. Lohan Co. has a policy of providing disclosures of only its assets, liabilities, and owners’ equity.

5. Bob Building, Inc. always discloses the assets, liabilities, and owners’ equity of the firm along with the revenues and expenses. Bob’s management believes that these items provide all of the information relevant to investing decisions.

Exercise 1-4

Applications of Accounting Characteristics and Concepts

For each situation listed, indicate by letter the appropriate qualitative characteristic(s) or accounting concept(s) applied. A letter may be used more than once, and more than one characteristic or concept may apply to a particular situation.

1. Goodwill is recorded in the accounts only when it arises from the purchase of another entity at a price higher than the fair value of the purchased entity’s identifiable assets.

2. Land is valued at cost.

3. All payments out of petty cash are debited to Miscellaneous Expense.

4. Plant assets are classified separately as land or buildings, with an accumulated depreciation account for buildings.

5. Periodic payments of $2,300 per month for services of R. Robertson, who is the sole proprietor of the company, are reported as withdrawals.

6. Small tools used by a large manufacturing firm are recorded as expenses when purchased.

7. Investments in equity securities are initially recorded at cost.

8. A retail store estimates inventory rather than taking a complete physical count for purposes of preparing monthly financial statements.

9. A note describing the company’s possible liability in a lawsuit is included with the financial statements even though no formal liability exists at the balance sheet date.

10. Depreciation on plant assets is consistently computed each year by the straight-line method.

    1. Understandability

    2. Verifiability

    3. Timeliness

    4. Faithful representation

    5. Neutrality

    6. Relevance

    1. Going concern

    2. Economic entity

    3. Historical cost

    4. Measurability

    5. Materiality

    6. Comparability

Exercise 1-5

Trade-Off between Qualitative Characteristics

In each of the following independent situations, an example is given requiring a trade-off between the qualitative characteristics discussed in the text. For each situation, identify the relevant characteristics and briefly discuss how satisfying one characteristic may involve not satisfying another.

1. The book value of an office building is approaching its originally estimated salvage value of $100,000. However, its fair value has been estimated at $10 million. The company’s management would like to disclose to financial statement users the current value of the building on the balance sheet.

2. JCB Industries has used the FIFO inventory method for the past 20 years. However, all other major competitors use the LIFO method of accounting for inventories. JCB is contemplating a switch from FIFO to LIFO.

3. Hobson, Inc. is negotiating with a major bank for a significant loan. The bank has asked that a set of financial statements be provided as quickly after the year-end as possible. Because invoices from many of the company’s suppliers are mailed several weeks after inventory is received, Hobson, Inc. is considering estimating the amounts associated with those liabilities to be able to prepare its financial statements more quickly.

4. Starship, Inc. produces and sells satellites to government and private industries. The company provides a warranty guaranteeing the performance of the satellites. A recent space launch placed one of its satellites in orbit, and several malfunctions have occurred. At year-end, Starship, Inc.’s auditors would like the company to disclose the potential liability in the notes to the financial statements. Officers of Starship, Inc. believe that the satellite can be repaired in orbit and that disclosure of a contingency such as this would unnecessarily bias the financial statements.

Exercise 1-6

Elements of Financial Reporting

For each of the following items, identify the financial statement element being discussed.

1. Changes in equity during a period except those resulting from investments by owners and distributions to owners

2. The net assets of an entity

3. The result of a transaction requiring the future transfer of assets to other entities

4. An increase in assets from the delivery of goods that constitutes the entity’s ongoing central operations

5. An increase in an entity’s net assets from incidental transactions

6. An increase in net assets through the issuance of stock

7. Decreases in net assets from peripheral transactions of an enterprise

8. The payment of a dividend

9. Outflows of assets from the delivery of goods or services

10. Items offering future value to an entity

Exercise 1-7

Assumptions of Financial Reporting

In each of the following independent situations, an example is given involving one of the five traditional assumptions of the accounting model. For each situation, identify the assumption involved (briefly explain your answer).

1. A subsidiary of Parent, Inc. was exhibiting poor earnings performance for the year. In an effort to increase the subsidiary’s reported earnings, Parent, Inc. purchased products from the subsidiary at twice the normal markup.

2. When preparing the financial statements for MacNeil & Sons, the accountant included certain personal assets of MacNeil and his sons.

3. The operations of Uintah Savings & Loan are being evaluated by the federal government. During their investigations, government officials have determined that numerous loans made by top management were unwise and have seriously endangered the future existence of the savings and loan.

4. Pine Valley Ski Resort has experienced a drastic reduction in revenues because of light snowfall for the year. Rather than produce financial statements at the end of the fiscal year, as is traditionally done, management has elected to wait until next year and present results for a two-year period.

5. Colobri, Inc. has equipment that was purchased in 2001 at a cost of $150,000. Because of inflation, that same equipment, if purchased today, would cost $225,000. Management would like to report the asset on the balance sheet at its current value.

Exercise 1-8

Measurement Attributes and Going Concern Problems

One of the underlying assumptions of the accounting model is the going concern assumption. When this assumption is questionable, valuation methods used for assets and liabilities may differ from those used when the assumption is viable. For each of the following situations, identify the measurement attribute that would most likely be used if the company is not likely to remain a going concern.

1. Plant and equipment are carried at an amortized cost on a straight-line basis of $2,100,000.

2. Bonds with a maturity price of $1,500,000 and interest in arrears of $400,000 are reported as a noncurrent liability.

3. Accounts receivable are carried at $600,000, the gross amount charged for sales. No allowance for doubtful accounts is reported.

4. The reported LIFO cost of inventory is $250,000.

5. Investments in a subsidiary company are recorded at initial cost plus undistributed profits.

Exercise 1-9

Sample CPA Exam Questions

1. One of the elements on a financial statement is comprehensive income. Comprehensive income excludes changes in equity resulting from which of the following?

1. Loss from discontinued operations

2. Unrealized loss from foreign currency translation

3. Dividends paid to stockholders

4. Unrealized loss on investments in noncurrent marketable equity securities

2. According to the FASB conceptual framework, the objectives of financial reporting for business enterprises are based on

1. generally accepted accounting principles.

2. reporting on management’s stewardship.

3. the need for conservatism.

4. the needs of users of the information.

3. Statements of Financial Accounting Concepts are intended to establish

1. generally accepted accounting principles in financial reporting by business enterprises.

2. the meaning of “Present fairly in accordance with generally accepted accounting principles.”

3. the objectives and concepts for use in developing standards of financial accounting and reporting.

4. the hierarchy of sources of generally accepted accounting principles.

4. According to Statements of Financial Accounting Concepts, neutrality is an ingredient of faithful representation? Of relevance?

1. Yes; Yes

2. Yes; No

3. No; Yes

4. No; No

5. According to the FASB conceptual framework, which of the following statements conforms to the realization concept?

1. Equipment depreciation was assigned to a production department and then to product unit costs.

2. Depreciated equipment was sold in exchange for a note receivable.

3. Cash was collected on accounts receivable.

4. Product unit costs were assigned to cost of goods sold when the units were sold.

What is FASB conceptual framework?

What are the ingredients of relevance?

What are the three components of conceptual framework?

What are the four key elements of the conceptual framework?