Intermediate Accounting: IFRS Edition, 3rd Edition Solution Manual

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CHAPTER 1Financial Reporting and Accounting StandardsASSIGNMENT CLASSIFICATION TABLETopicsQuestionsConcepts forAnalysis1.Global marketsand financial reporting.1, 2, 3, 442.Objective of financial reporting.5, 6, 7, 8, 9, 102, 33.Standard-setting organizations.11, 12, 13, 14,15, 16, 17, 181,2,3,5,6, 8, 9,114.Financial reporting challenges.19, 20, 21, 22,23, 24, 253, 7,8, 10, 11, 12

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ASSIGNMENT CHARACTERISTICS TABLEItemDescriptionLevel ofDifficultyTime(minutes)CA1.1IFRS and standard-setting.Simple5–10CA1.2IFRS and standard-setting.Simple5–10CA1.3Financial reporting and accounting standards.Simple15–20CA1.4Financial accounting.Simple15–20CA1.5Need for IASB.Simple15–20CA1.6IASB role in standard-setting.Simple15–20CA1.7Accounting numbers and the environment.Simple10–15CA1.8Politicalization of IFRS.Complex15–20CA1.9Models for setting IFRS.Simple10–15CA1.10Economic consequences.Moderate10–15CA1.11Rule-making Issues.Complex20–25CA1.12Financial reporting pressures.Moderate25–35

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ANSWERS TO QUESTIONS1.World markets are becoming increasingly intertwined. The tremendous variety and volume of bothexported and imported goods indicates the extensive involvement in international trade. As aresult, the move towards adoption of international financial reporting standards has and will continuein the future.LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication2.Financial accounting measures, classifies, and summarizes in report form those activities and thatinformation which relate to the enterprise as a whole for use by parties both internal and externalto a business enterprise. Managerial accounting also measures, classifies, and summarizes in reportform enterprise activities, but the communication is for the use of internal, managerial parties, andrelates more to subsystems of the entity. Managerial accounting is management decision orientedand directed more toward product line, division, and profit center reporting.LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication3.Financial statements generally refer to the four basic financial statements: statement of financialposition, statementof comprehensiveincome, statement of cash flows, and statement of changes inequity. Financial reporting is a broader concept; it includes the basic financial statements and anyother means of communicating financial and economic data to interested external parties.LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication4.If a company’s financial performance is measured accurately, fairly, and on a timely basis, the rightmanagers and companies are able to attract investment capital. To provide unreliable and irrelevantinformation leads to poor capital allocation which adversely affects the securities market.LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication5.A single set of high quality accounting standards ensures adequate comparability. Investors areable to make better investment decisions if they receive financial information from a U.S. companythat is comparable to an international competitor.LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication6.The objective ofgeneral-purpose financial reporting is to provide financial information about thereporting entity that is useful to present and potential equity investors, lenders, and other creditorsin making decisions inabout providing resources to the entity.LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication7.General-purpose financial statements provide financial reporting information to a wide variety ofusers. To be cost effective in providing this information,general-purpose financial statementsprovideat the least cost the most useful information possible.LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication8.Shareholders, creditors, suppliers, employees, and regulators all usegeneral-purpose financialstatements. The primary user group iscapital providers (shareholders and creditors).LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication9.The proprietary perspective is not considered appropriate because this perspective generally doesnot reflect a realistic view of the financial reporting environment. Instead the entity perspectiveis adopted which is consistent with the present business environment where most companiesengaged in financial reporting have substanceseparate anddistinct from theirowners.LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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Questions Chapter 1(Continued)10.This statement is not correct.The objective of financial reporting is primarily to provide informationto investors interested in assessing the company’s ability to generate net cash inflows andmanagement’sabilitytoprotectandenhancethecapitalproviders’investments.Financialreporting should help investors assess the amounts, timing and uncertainty of prospective cashinflows.LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication11.The two organizations involved in international standard-setting are IOSCO (International Organi-zation of Securities Commissions) and the IASB (International Accounting Standards Board.) TheIOSCO does not set accounting standards, but ensures that the global markets can operate in anefficient and effective manner. Conversely, the IASB’s mission is to develop a single set of highquality,enforceable and globalfinancial reporting standards (IFRSs) forgeneral-purpose financialstatements.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication12.IOSCO is an association of organizations that regulate theworld’s securities markets.Membersare generally the main financialregulatorsfora given country. IOSCO does not set accountingstandards.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication13.The mission of the IASB is to develop, in the public interest, a single set of high quality,enforceableglobalinternational financial reporting standards (IFRSs) forgeneral-purpose financialstatements.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication14.The purpose of theMonitoringBoard is to establish alinkbetween accountingstandard-settersand thosepublicauthorities (such as IOSCO)that generally oversee accountingstandard-setters.Thisboardalso providespoliticallegitimacyto the overall organization.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication15.The IASB preliminary views are based on research and analysis conducted by the IASB staff.IASB exposure drafts are issued after the Board evaluates research and public response topreliminary views. IASB standards are issued after the Board evaluates responses to the exposuredraft.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication16.IASBInternationalFinancialReportingStandardsare financial accounting standards issued by theIASBand are referred to as InternationalFinancial Reporting Standards (IFRS).TheIFRSConceptualFramework forFinancial Reportingsets forth fundamental objectives and conceptsthat the Board uses in developing future standards of financial reporting. The intent of theConceptualFramework is to form a cohesive set of interrelated concepts that will serve as tools forsolving existing and emerging problems in a consistent manner.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication17.International Financial Reporting Standards are the most authoritative, followed by InternationalFinancial ReportingStandardInterpretations then theConceptualFramework.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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Questions Chapter 1(Continued)18.The International Financial ReportingStandardsInterpretations Committee (IFRIC) applies aprinciples-based approach in providing interpretative guidance. The IFRIC issues interpretationsthat cover newly identified financial reporting issues not specifically dealt with in IFRS, and issueswhere conflicting interpretations have developed, or seem likely to develop in the absence ofauthoritative guidance.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication19.Some major challenges facing the accounting profession relate to the following items:Nonfinancial measurement—how to report significant key performance measurements such ascustomer satisfaction indexes, backlog information and reject rates on goods purchased.Forward-looking information—how to report more future oriented information.Soft assets—how to report on intangible assets, such as market know-how, market dominance,and well-trained employees.Timeliness—how to report more real-time information.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication20.The sources of pressure are innumerable, but the most intense and continuous pressure to changeor influence the development of IFRS come from individual companies, industry associations,governmental agencies, practicing accountants, academicians, professional accounting organizations,and investing public.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication21.Economic consequences means the impact of accounting reports on the wealth positions of issuersand users of financial information and the decision-making behavior resulting from that impact. Inother words, accounting information impacts various users in many different ways which leads towealth transfers among these various groups.If politics plays an important role in the development of accounting rules, the rules will be subjectto manipulation for the purpose of furthering whatever policy prevails at the moment. No matterhow well intentioned the rule maker may be, if information is designed to indicate that investing ina particular enterprise involves less risk than it actually does, or is designed to encourage invest-ment in a particular segment of the economy, financial reporting will suffer an irreplaceable loss ofcredibility.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication22.No one particular proposal is expected in answer to this question. The students’proposals, however,should be defensible relative to the following criteria:(1)The method must be efficient, responsive, and expeditious.(2)The method must be free of bias and be above or insulated from pressure groups.(3)The method must command widespread support if it does not have legislative authority.(4)The method must produce sound yet practical accounting principles or standards.The students’ proposals might take the form of alterations of the existing methodology, an accoun-ting court (as proposed by Leonard Spacek), or governmental device.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication23.Concern exists about fraudulent financial reporting because it can undermine the entire financialreporting process. Failure to provide information to users that is accurate can lead to inappropriateallocations of resources in our economy. In addition, failure to detect massive fraud can lead toadditional governmental oversight of the accounting profession.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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Questions Chapter 1(Continued)24.The“expectations gap”is the difference between what people think accountants should be doing andwhat accountants think they can do. It is a difficult gap to close. The accounting profession recognizesit must play an important role in narrowing this gap. To meet the needs of society, the profession iscontinuing its efforts in developing accounting standards, such as numerous pronouncements issuedby the IASB, to serve as guidelines for recording and processing business transactions in thechanging economic environment.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication25.Accountants must perceive the moral dimensions of some situations because IFRS does notdefine or cover all specific features that are to be reported in financial statements. In theseinstances,accountants must choose among alternatives. These accounting choices influencewhether particular stakeholders may be harmed or benefited. Moral decision-making involvesawareness of potential harm or benefit and taking responsibility for the choices.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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TIME AND PURPOSE OF CONCEPTS FOR ANALYSISCA1.1(Time 5–10 minutes)Purpose—to provide the student with an opportunity to answer questions about IFRS andstandard-setting.CA1.2(Time 5–10 minutes)Purpose—to provide the student with an opportunity to answer questions about IFRS andstandard-setting.CA1.3(Time 15–20 minutes)Purpose—to provide the student with an opportunity to answer questions aboutfinancial reportingandstandard-setting.CA1.4(Time 15–20 minutes)Purpose—to provide the student with an opportunity to distinguish between financial accounting andmanagerial accounting, identify major financial statements, and differentiate financial statements andfinancial reporting.CA1.5(Time 15–20 minutes)Purpose—to provide the student with an opportunity to evaluate the viewpoint of removing mandatoryaccounting rules and allowing each company to voluntarily disclose the information it desired.CA1.6(Time 15–20 minutes)Purpose—to provide the student with an opportunity to identify the sponsoring organization of the IASB,the method by which the IASB arrives at a decision, and the types and the purposes of documentsissued by the IASB.CA1.7(Time 10–15 minutes)Purpose—to provide the student with an opportunity to describe how reported accounting numbersmight affect an individual’s perceptions and actions.CA1.8(Time 15–20 minutes)Purpose—to provide the student with an opportunity to focus on the types of organizations involved inthe rule making process, what impact accounting has on the environment, and the environment’sinfluence on accounting.CA1.9(Time 10–15 minutes)Purpose—to provide the student with an opportunity to focus on what type of rule-making environmentexists. In addition, this CA explores why user groups are interested in the nature of IFRS and why somegroups wish to issue their own rules.CA1.10(Time10–15minutes)Purpose—to provide the student with the opportunity to discuss the role of government officials inaccounting rule-making.CA1.11(Time 20–25 minutes)Purpose—to provide the student with an opportunity to consider the ethical dimensions of implementationof a new accounting pronouncement.CA1.12(Time 25–35 minutes)Purpose—to provide the student with a writing assignment concerning the ethical issues related tomeeting earnings targets.

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SOLUTIONS TO CONCEPTS FOR ANALYSISCA1.11.True.2.False. Any company claiming compliance with IFRS must comply with all standards and inter-pretations, including disclosure requirements.3.False. TheIFRSadvisorycouncil provides advice andcouncilto the IASB on major policies andtechnical issues. It is not a governmental body4.True.5.False. The IASB has no government mandate and does follow a due process in issuing IFRS.LO:3, Bloom:K, Difficulty: Simple, Time:5-10, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationCA1.21.False. The objective emphasizes an entity perspective.2.False. The objective of financial reporting is to provide financial information about the reportingentity that is useful to present and potential equity investors, lenders, and other creditors in makingdecisions in their capacity as capital providers.3.False. International Accounting Standards were issued by the International Accounting StandardsCommittee while International Financial Reporting Standards are issued by the IASB.Both haveauthoritativesupport.4.True.LO:2,3,Bloom:K, Difficulty: Simple, Time: 5-10, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationCA1.31. (c); 2. (d); 3. (c); 4. (d); 5. (b); 6. (a); 7. (a); 8. (b); 9. (d); 10. (b).LO:2,3,Bloom: K, Difficulty: Simple, Time:15-20, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationCA1.4(a)Financial accounting is the process that culminates in the preparation of financial reports relative tothe enterprise as a whole for use by parties both internal and external to the enterprise. In contrast,managerial accounting is the process of identification, measurement, accumulation, analysis, prepa-ration, interpretation, and communication of financial information used by the management to plan,evaluate, and control within an organization and to assure appropriate use of, and accountability for,its resources.(b)The financial statements most frequently provided are the statement of financial position, thestatement of comprehensiveincome, the statement of cash flows, and the statement of changes inequity.

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CA1.4 (Continued)(c)Financial statements are the principal means through which financial information is communicated tothose outside an enterprise. As indicated in (b), there are four major financial statements. However,some financial information is better provided, or can be provided only, by means of financialreporting other than formal financial statements. Financial reporting (other than financial statementsand related notes) may take various forms. Examples include the company president’s letter orsupplementary schedules in the corporate annual reports, prospectuses, reports filed with govern-ment agencies, news releases, management’s forecasts, and descriptions of an enterprise’s socialor environmental impact.LO: 1, Bloom: K, Difficulty: Simple, Time:15-20, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationCA1.5It is not appropriate to abandon mandatory accounting rules and allow each company to voluntarilydisclose the type of information it considered important. Without a coherent body of accounting theoryand standards, each accountant or enterprise would have to develop its own theory structure and set ofpractices, and readers of financial statements would have to familiarize themselves with every company’speculiar accounting and reporting practices. As a result, it would be almost impossible to prepare state-ments that could be compared.In addition, voluntary disclosure may not be an efficient way of disseminating information. A company islikely to disclose less information if it has the discretion to do so. Thus, the company can reduce its costof assembling and disseminating information. However, an investor wishing additional information hasto pay to receive additional information desired. Different investors may be interested in different typesof information. Since the company may not be equipped to provide the requested information, it wouldhave to spend additional resources to fulfill such needs; or the company may refuse to furnish suchinformation if it’s too costly to do so. As a result, investors may not get the desired information or theymay have to pay a significant amount of money for it. Furthermore, redundancy in gathering anddistributing information occurs when different investors ask for the same information at different pointsin time. To the society as a whole, this would not be an efficient way of utilizing resources.LO:3, Bloom:AP, Difficulty: Simple, Time:15-20, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationCA1.6(a)The InternationalFinancial ReportingStandards Committee Foundation (The Foundation) is thesponsoring organization of the IASB. TheFoundationselects the members of the IASB and theAdvisory Council, funds their activities, and generally oversees the IASB’s activities.The IASB follows a due process in establishing a typical International Financial Reporting Standard.The following steps are usually taken: (1) A topic or project is identified and placed on the Board’sagenda. (2) Research and analysis are conducted by the IASB and a preliminary views document isdrafted and released. (3) A public hearing is often held. (4) The Board analyzes and evaluates thepublic response and issues an exposure draft. (5) The Board studies the exposure draft in relation tothe public responses, revises the draft if necessary, gives the revised draft final consideration andvotes on issuance of an IFRS. The passage of a new accounting standard in the form of an IASBStandard requires the support ofsix of the elevenBoard members.(b)The IASB issues three major types of pronouncements: International financial reporting standards,conceptualframeworkforfinancialreporting,andInternationalfinancialreportingstandardsinterpretations. Financialreportingstandards issued by the IASB are referred to as InternationalFinancial Reporting Standards (IFRS).

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CA1.6 (Continued)TheInternationalAccountingStandardsCommittee(IASBpredecessor)issuedadocumententitled “Framework for the Preparation and Presentation of Financial Statements.” This frameworksets forth fundamental objectives and concepts that the Board uses in developing future standardsof financial reporting. The intent of the document is to form a cohesive set of interrelated concepts,a conceptual framework, that will serve as tools for solving existing and emerging problems in aconsistent manner.Interpretations issued by the International Financial ReportingStandardsInterpretations Committee(The Interpretations Committee) are also considered authoritative and cover (1) newly identifiedfinancial reporting issues not specifically dealt with in IFRS, and (2) issues where unsatisfactory orconflicting interpretations have developed, or seem likely to develop in the absence of authoritativeguidance.The Interpretations Committeecan address controversial accounting problems as they arise. Itdetermines whether it can quickly resolve them, or whether to involve the IASB in solving them. TheIASB will hopefully work on more pervasive long-term problems, while theInterpretations Committeedeals with short-term emerging issues.LO:3, Bloom: K, Difficulty: Simple, Time:15-20, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationCA1.7Accounting numbers affect investing decisions. Investors, for example, use the financial statements ofdifferent companies to enhance their understanding of each company’s financial strength and operatingresults. Because these statements follow international accounting standards, investors can makemeaningful comparisons of different financial statements to assist their investment decisions.Accounting numbers also influence creditors’ decisions. A commercial bank usually looks into a company’sfinancial statements and past credit history before deciding whether to grant a loan and in what amount.The financial statements provide a fair picture of the company’s financial strength (for example, short-term liquidity and long-term solvency) and operating performance for the current period and over aperiod of time. The information is essential for the bank to ensure that the loan is safe and sound.LO:4, Bloom: K, Difficulty: Simple, Time:10-15, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationCA1.8(a)Arguments for politicalization of the accounting standard-setting process:1.Accounting depends in large part on public confidence for its success. Consequently, thecritical issues are not solely technical, so all those having a bona fide interest in the output ofaccounting should have some influence on that output.2.There are numerous conflicts between the various interest groups. In the face of this, compro-mise is necessary, particularly since the critical issues in accounting are value judgments, notthe type which are solvable, as we have traditionally assumed, using deterministic models. Onlyin this way (reasonable compromise) will the financial community have confidence in the fairnessand objectivity of accounting standard-setting.3.Over the years, accountants have been unable to establish, on the basis of technical accoun-ting elements, standards which would bring about the desired uniformity and acceptability. Thisinability itself indicates standard-setting is primarily consensual in nature.

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CA1.8 (Continued)4.The public accounting profession made rules which business enterprises and individuals “had” to follow. Formany years, these businesses and individuals had little say as to what the standards would be, in spite ofthe fact that their economic well-being was influenced to a substantial degree by those standards. It is onlynatural that they would try to influence or control the factors that determine their economic well-being.(b)Arguments against the politicalization of the accounting standard-setting process:1.Many accountants feel that accounting is primarily technical in nature. Consequently, they feelthat substantive, basic research by objective, independent and fair-minded researchers ultimatelywill result in the best solutions to critical issues, such as the concepts of income and capital,even if it is accepted that there isn’t necessarily a single “right” solution.2.Even if it is accepted that there are no “absolute truths” as far as critical issues are concerned,many feel that professional accountants, taking into account the diverse interests of the variousgroups using accounting information, are in the best position, because of their independence,education, training, and objectivity, to decide what international financial reporting standardsought to be.3.The complex situations that arise in the business world require that trained accountants developthe appropriatereporting standards.4.The use of consensus to developreporting standardswould decrease the professional statusof the accountant.5.This approach would lead to “lobbying” by various parties to influence the establishment ofreporting standards.LO:3, Bloom: K, Difficulty:Complex, Time:15-20, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationCA1.9(a)Most believe the IASB process is a public private mixed approach.In many respects, the IASB is aquasi-governmentalagencyinthatitspronouncementsarerequiredtobefollowedinsomejurisdictions. For example, all public European companies are required to use IASB standards whenpreparing financial statements. In fact, both the FASB and the IASB believe that IFRS has the bestpotential to provide a common platform on which companies can report and investors can comparefinancial information.The purely political approach is used in France and West Germany. The private,professionalapproach is employed in Australia, Canada, and the United Kingdom.(b)Publicly reported accounting numbers influence the distribution of scarce resources. Resources arechanneled where needed at returns commensurate with perceived risk. Thus, reported accountingnumbers have economic effects in that resources are transferred among entities and individuals as aconsequence of these numbers. It is not surprising then that individuals affected by these numberswill be extremely interested in any proposed changes in the financial reporting environment.LO:3, Bloom: K, Difficulty: Simple, Time:10-15, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationCA1.10President Sarkozyputpressure on the IASB to craft fair value standards that favor banks. However,byintroducingpoliticsintothestandard-settingprocesswilllikelyleadtothefollowingconsequences:1.Too many alternatives.2.Lack of clarity that will lead to inconsistent application.3.Lack of disclosure that reduces transparency.4.Not comprehensive in scope.

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CA1.10 (Continued)When the resulting standards have these attributes, they will be of lower quality and the credibilityof the standard-setting process will be questioned. At the extreme, market participants will haveless confidence in accounting information and capital markets will be less liquid—cost of capitalwill be higher. Another indication of the problem of government intervention is shown in theaccounting standards used by some countries around the world. Completeness and transparencyof information needed by investors and creditors is not available in order to meet or achieve otherobjectives. In the fair value case, the IASB did respond by accelerating its process to develop anew standard, which provided some exceptions to the fair value accounting that benefited somebanks and insurance companies.LO:4, Bloom:AP, Difficulty:Moderate, Time:10-15, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationCA1.11(a)Inclusion or omission of information that materially affects net income harms particular stakeholders.Accountants must recognize that their decision to implement (or delay) reporting requirements willhave immediate consequences for some stakeholders.(b)Yes. Because the IASB rule results in a fairer representation, it should be implemented as soon aspossible—regardless of its impact on net income.(c)Thecontroller’s responsibility is to provide financial statements that present fairly the financialcondition of the company. By advocating early implementation, Weller fulfills this task.(d)Potentiallendersandinvestors,whoreadthefinancialstatementsandrelyontheirfairrepresentationofthefinancialconditionofthecompany,havethemosttogainbyearlyimplementation—they would be most directly harmed by deferral of implementation. At the sametime, ashareholderwho is considering the sale of shares may be harmed by early implementationthat lowers net income (and may lower the value of the shares). If employee bonuses are basedonthereportedincomenumber,theemployeescouldreceivelowerbonuseswithearlyimplementation.LO:3, Bloom:AP, Difficulty:Complex, Time:20-25, AACSB:Ethics, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication, LegalCA1.12(a)The ethical issue in this case relates to making questionable entries to meet expected earningsforecasts. As indicated in this chapter, businesses’ concentration on “maximizing the bottom line,”“facing the challenges of competition,” and “stressing short-term results” places accountants in anenvironment of conflict and pressure.(b)Given that Normand has pleaded guilty, he certainly acted improperly. Doing the right thing, makingthe right decision, is not always easy. Right is not always obvious, and the pressures to “bend therules,” “to play the game,” “to just ignore it” can be considerable.(c)No doubt, Normand was in a difficult position. I am sure that he was concerned that if he failed togo along, it would affect his job performance negatively or that he might be terminated. These jobpressures, time pressures, peer pressures often lead individuals astray. Can it happen to you?One individual noted that at a seminar on ethics sponsored by the CMA Society of SouthernCalifornia, attendees were asked if they had ever been pressured to make questionable entries.This individual noted that to the best of his recollection, everybody raised a hand, and more thanone had eventually chosen to resign.(d)Major stakeholders are: (1) Troy Normand, (2) present and potentialshareholdersand creditors ofWorldCom,(3)employees, and (4) family.Recognize that WorldComisoneofthelargestbankruptciesin United States history, so many individuals are affected.

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LO:4, Bloom:AP, Difficulty:Moderate, Time:25-35, AACSB:Ethics, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication, Legal

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FINANCIAL REPORTING PROBLEM(a)Thetwoorganizationsinvolvedininternationalstandard-settingareInternational Organization of Securities Commissions (IOSCO) and theInternational Accounting Standards Board (IASB).(b)Differentauthoritativeliteraturepertainingtomethodsofrecordingaccounting transactions exists today. Some authoritative literature hasreceived more support from the profession than other literature. Theliterature that has substantial authoritative support is the one mostsupported by the profession and should be followed when recordingaccounting transactions. These standards and procedures are calledInternationalFinancialReportingStandards (IFRS).LO:3, Bloom: K, Difficulty: Simple, Time:10-15, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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FINANCIALREPORTING CASE(a)The International Accounting Standards Board is an independent, pri-vately funded accounting standards-setter based in London, UK. TheBoard is committed to developing, in the public interest, a single set ofhigh quality, enforceableandglobal accounting standardsthat requiretransparentandcomparableinformationingeneral-purposefinancialstatements. In addition, the Board cooperates with national accountingstandards setters to achieve convergence in accounting standardsaround the world.(b)In summary, the following groups might benefit from the use of Inter-national Accounting Standards:•Investors, investment analysts and stockbrokers: to facilitate inter-national comparisons for investment decisions.•Credit grantors: for similar reasons to bullet point above.•Multinational companies: as preparers, investors, appraisers of pro-ducts or staff, and as movers of staff around the globe; also, as raisersof finance on international markets (this also applies to some comp-anies that are not multinationals).•Governments: as tax collectors and hosts of multinationals; also inter-ested are securities markets regulators and governmental and non-governmental rule makers.(c)The fundamental argument against convergence is that, to the extentthatinternational differences in accounting practices result from under-lying economic, legal, social, and other environmental factors, convergencemay not be justified. Different accounting has grown up to serve thedifferent needs of different users; this might suggest that the existingac-counting practice is “correct” for a given nation and should not be changedmerely to simplify the work of multinational companies or auditors.There does seem to be strength in this point particularly for smaller com-panies with no significant multinational activities or connections. To foistupon a small private family company in Luxembourg lavish disclosurerequirements and the need to report a “true and fair” view may be anexpensive and unnecessary piece of convergence.

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FINANCIAL REPORTING CASE(Continued)The most obvious obstacle to convergence is the sheer size anddeeprootednessof the differences in accounting. These differences havegrown up over the previous century because of differences in users,legal systems, and so on. Thus, the differences are structural ratherthan cosmetic, and require revolutionary action to remove them.LO: 1,2,3,4,Bloom: K, Difficulty:Moderate, Time:20-25, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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ACCOUNTING, ANALYSIS AND PRINCIPLESACCOUNTING(a)The requirements will depend on the jurisdiction in which they intendto sell the securities. The International Accounting Standards Board(IASB) issuesInternationalFinancialReportingStandards (IFRS) whichare used on most foreign exchanges.The IASBstandards requirecompanies to prepare a full set of financial statements and relateddisclosures so investors can evaluate and compare investments.(b)The two entities that are primarily responsible for establishing IFRS areIOSCO (International Organization of Securities Commissions) and theIASB (International Accounting Standards Board).The IOSCO does not set accounting standards, but ensures that theglobalmarketscanoperateinanefficientandeffectivemanner.Conversely, the IASB’s mission is to develop a single set of highquality,enforceableandglobalInternationalFinancialReportingStandards (IFRSs) forgeneral-purpose financial statements.ANALYSIS(a)Decision-usefulness involves providing investors interested in financialreporting information that is useful for making decisions.(b)The financial statements provide information on company performance(statementofcomprehensiveincome),financialposition–assetsowned and liabilities incurred (statement of financial position) andcash flows (statement of cash flows)and statement of changesinequity. Investors and creditors use this information to form their ownexpectationsaboutacompany’sfuturecashflows.Theseassessments are the basis of the decision about an investment in thecompany.

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ACCOUNTING, ANALYSIS AND PRINCIPLES (Continued)PRINCIPLESThe hierarchy of IFRS to determine what recognition, valuation, and disclosurerequirements should be used are:1.International Financial Reporting Standards;2.International Accounting Standards; and3.InterpretationsfromtheInternationalFinancialReportingStandardsInterpretationsCommitteeAny company indicating that it is preparing its financial statements inconformity with IFRS must use these standards and interpretations, asappropriate.LO: 1,2,3,4,Bloom: K, Difficulty:Moderate, Time:20-25, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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RESEARCHCASEThe following responses are drawn fromthe IFRS ConceptualFramework(a)As indicated in theConceptualFrameworkfor Financial Reporting,“Theobjectiveoffinancialstatementsistoprovidefinancialinformation about the reporting entity that is useful to existing andpotential investors, lenders, and other creditors in making decisionsabout providing resources to the entity.(b)According to paragraph 21 of theConceptualFramework, notes andsupplementary schedules serve in this role. For example, they maycontain additional information that is relevant to the needs of users abouttheitemsinthestatementoffinancialpositionandstatementofcomprehensiveincome(incomestatement.)Theymayincludedisclosures about the risks and uncertainties affecting the entity and anyresources and obligations not recognised in the statement of financialposition (such as mineral reserves). Information about geographical andindustry segments and the effect on the entity of changing prices mayalso be provided in the form of supplementary information.(c)As indicated in paragraphs 13 and 14, financial statements prepared tomeet the objective of financial reporting meet the common needs of mostusers. However, financial statements do not provide all the informationthat users may need to make economic decisions since they largelyportraythe financial effects of past events and do not necessarily providenon-financial information. In addition, financial statements also show theresults of the stewardship of management,orthe accountability ofmanagement for the resources entrusted to it. Those users who wish toassess the stewardship or accountability of management do so in orderthat they may make economic decisions; these decisions may include,for example, whether to hold or sell their investment in the entity orwhether to reappoint or replace the management.LO:2,4, Bloom: K, Difficulty:Complex, Time:25-30, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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GAAP CONCEPTS and APPLICATIONGAAP1.1Generallyacceptedaccountingprinciples(GAAP)forU.S.companiesaredevelopedbytheFinancialAccountingStandards Board (FASB). The FASB is a private organization.TheU.S.SecuritiesandExchangeCommission(SEC)exercises oversight over the actions of the FASB.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: CommunicationGAAP1.2DifferencesbetweenU.S.GAAPandIFRSshouldnotbesurprising because standard-setters havedeveloped standardsin response to different user needs. In some countries, theprimary users offinancial statements are private investors. Inothers,theprimaryusersaretaxauthoritiesorcentralgovernmentplanners.IntheUnitedStates,investorsandcreditors have driven accountingstandardformulation.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB:None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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CHAPTER 2Conceptual Framework for Financial ReportingASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)TopicsQuestionsBriefExercisesExercisesConceptsfor Analysis1.Conceptual framework–general.11, 22.Objective of financialreporting.2,7131, 233.Qualitative characteristicsof accounting.3, 4,5,6,81, 2, 3, 4,11, 132, 3, 44,84.Elements of financialstatements.9,10,245, 655.Basic assumptions.11, 12, 137, 8,126, 76.Basic principles:a. Measurement.b. Revenue recognition.c. Expense recognition.d. Full disclosure.14, 15, 16, 1718, 19,20, 21, 222324, 25, 269, 10,1299,129,126, 7, 9, 107, 9, 106, 7, 9, 106, 7, 8, 9, 10555, 6, 7,97.Constraint.27, 2812, 133, 6, 7108.Comprehensive assignmentson assumptions, principles,and constraints.136, 7, 9, 10

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ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)Learning ObjectivesBrief ExercisesExercisesConceptsforAnalysis1.Describe the usefulness of a conceptualframeworkand explainthe objective offinancial reporting.131, 21, 2,32.Identify the qualitative characteristics ofaccounting informationandthe basicelements of financial statements1, 2, 3, 4,5,6,11, 132, 3, 4,58, 43.Reviewthe basic assumptions of accounting.7, 8, 126, 74.Explain the application of the basic principlesof accounting.9, 10,11,12,133,6, 7, 8,9,105, 6, 7, 9,10

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ASSIGNMENT CHARACTERISTICS TABLEItemDescriptionLevel ofDifficultyTime(minutes)E2.1Usefulness, objective of financial reporting.Moderate10–15E2.2Usefulness, objective of financial reporting, qualitativecharacteristics.Moderate10–15E2.3Qualitative characteristics.Moderate15–20E2.4Qualitative characteristics.Simple15–20E2.5Elements of financial statements.Simple10–15E2.6Assumptions, principles, and constraint.Simple15–20E2.7Assumptions, principles, and constraint.Moderate20–25E2.8Full disclosure principle.Complex20–25E2.9Accounting principles–comprehensive.Moderate20–25E2.10Accounting principles–comprehensive.Moderate20–25CA2.1Conceptual framework–general.Simple20–25CA2.2Conceptual framework–general.Simple25–35CA2.3Objective of financial reporting.Moderate25–35CA2.4Qualitative characteristics.Moderate30–35CA2.5Revenue recognition principle.Complex25–30CA2.6Expense recognition principle.Complex20–25CA2.7Expense recognition principle.Moderate20–30CA2.8Qualitative characteristics.Moderate20–30CA2.9Expense recognition principle.Moderate20–25CA2.10Cost-constraint.Moderate30–35

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ANSWERS TO QUESTIONS1.A conceptual framework is a coherent system of concepts that flow from an objective. Theobjective 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, andcircumstances to be represented, (3) how they should be recognized and measured, and (4) howthey should be summarized and reported. A conceptual framework is necessary in financialaccounting for the following reasons:(1)It will enable the IASB to issue more useful and consistent standards in the future.(2)New issues will be more quickly solvable by reference to an existing framework of basic theory.(3)It will increase financial statement users’ understanding of and confidence in financial reporting.(4)It will enhance comparability among companies’ financial statements.LO:1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication2.The primary objective of financial reporting is as follows:The objective of general purpose financial reporting is to provide financial information about thereporting entity that isuseful to present and potential equity investors, lenders, and othercreditors in making decisionsabout providing resources to theentity.Information that isdecisionuseful to capital providers may also be useful to other users of financial reporting who arenot capital providers.LO:1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication3.The IASB identified the qualitative characteristics of accounting information that distinguish better(more useful) information from inferior (less useful) information for decision-making purposes.They involve determining which alternative provides the most useful information for decision-makingpurposes(decision-usefulness).Thefundamentalqualitativecharacteristicsarerelevance and faithful representation.LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication4.Relevance and faithful representation are the two fundamental qualities that make accountinginformation useful for decision-making. To berelevant,accounting information must be capable ofmaking a difference in a decision. Information with no bearing on a decision is irrelevant. Financialinformation is capable of making a difference when it has predictive value, confirmatory value, orboth.Faithful representationmeans that the item is representative of the real-world phenomenonthat it purports to represent. Faithful representation is a necessity because most users haveneither the time nor the expertise to evaluate the factual content of the information. In other words,faithful representation means that the numbers and descriptions match what really existed orhappened. To be a faithful representation, information must be complete, neutral, and free ofmaterial error.LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication5.Materiality refers to the relative significance of an amount, activity, or item to informative disclosureand a proper presentation of financial position and the results of operations. Materiality hasqualitative and quantitative aspects; both the nature of the item and its relative size enter into itsevaluation.

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Questions Chapter 2(Continued)Materiality is a company-specific aspect of relevance. Information is material if omitting it ormisstating it could influence decisions that users make on the basis of the reported financialinformation. An individual company determines whether information is material because both thenature and/or magnitude of the item(s) to which the information relates must be considered in thecontext of an individual company’s financial report. Information is immaterial, and thereforeirrelevant, if it would have no impact on a decision-maker. In short, it must make a difference or acompany need not disclose it. Assessing materiality is one of the more challenging aspects ofaccounting because it requires evaluating both the relative size and importance of an item.However, it is difficult to provide firm guidelines in judging when a given item is or is not material.Materiality varies both with relative amount and with relative importance.One should consider the importance of the relative size of an item in determining its materiality.Itis generally not feasible to specify uniform quantitative thresholds at which an item becomesmaterial. Rather, materiality judgments should be made in the context of the nature and theamount of an item. Materiality factors into a great many internal accounting decisions. Only by theexercise of good judgment and professional expertise can reasonable and appropriate answers befound, which is the materiality concept sensibly applied.LO:2, Bloom:C, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication6.The enhancing qualitative characteristics are comparability, verifiability, timeliness, and understandability.These characteristics enhance the decision usefulness of financial reporting information that isrelevant and faithfully represented. Enhancing qualitative characteristics are complementary to thefundamental qualitative characteristics. Enhancing qualitative characteristics distinguish more-useful information from less-useful information.LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication7.Decision-makers vary widely in the types of decisions they make, how they make decisions, theinformation they already possess or can obtain from other sources, and their ability to process theinformation. For information to be useful, there must be a connection (linkage) between theseusers and the decisions they make. This link, understandability, is the quality of information thatletsreasonablyinformedusersseeitssignificance.Understandabilityisenhancedwheninformation is classified, characterized, and presented clearly and concisely.Usersoffinancialreportsareassumedtohaveareasonableknowledgeofbusinessandeconomic activities. In making decisions, users also should review and analyze the informationwith reasonable diligence. Information that is relevant and faithfully represented should not beexcluded from financial reports solely because it is too complex or difficult for some users tounderstand without assistance.LO: 1, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication8.Informationthatismeasuredandreportedinasimilarmannerfordifferentcompaniesisconsideredcomparable.Comparabilityenablesuserstoidentifytherealsimilaritiesanddifferences in economic events between companies.Another type of comparability, consistency,is present when a company applies the same accounting treatment to similar events, from periodto period. Through such application, the company shows consistent use of accounting standards.LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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Questions Chapter 2(Continued)9.An important aspect of developing any theoretical structure is the body of basic elements ordefinitions 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 isasset. Is it merely something we own? Or is an asset something we have the right to use, as in thecase of leased equipment? Or is it anything of value used by a company to generate revenues—inwhich case, should we also consider the managers of a company as an asset?LO:2, Bloom:C, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication10.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 amomentintime.Thesecondgroupoftwoelementsdescribestransactions,events,andcircumstances that affect a company during a period of time. The first class, affected by elementsof the second class, provides at any time the cumulative result of all changes. This interaction isreferred to as “articulation.” That is, key figures in one financial statement correspond to balancesin another.LO:2, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication11.The five basic assumptions that underlie the financial accounting structure are:(1)An economic entity assumption.(2)A going concern assumption.(3)A monetary unit assumption.(4)A periodicity assumption.(5)Accrual-basis assumption.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication12.a)Users need to know a company’s performance and economic status on a timely basis so thattheycanevaluateandcomparecompanies,andtakeappropriateactions.Therefore,companies must report information periodically. The periodicity (or time period) assumptionimplies that a company can divide its economic activities into artificial time periods. Thesetime periods vary, but the most common are monthly, quarterly, and yearly. The shorter thetime period, the more difficult it is to determine the proper net income for the period. Amonth’s results usually prove less reliable than a quarter’s results, and a quarter’s results arelikely to be less reliable than a year’s results. Investors desire and demand that a companyquicklyprocessanddisseminateinformation. Yetthequickeracompanyreleasestheinformation, the more likely the information will include errors. This phenomenon provides aninteresting example of the trade-off between relevance and faithful representation in preparingfinancial data. The problem of defining the time period becomes more serious as productcyclesshortenandproductsbecomeobsoletemorequickly.Manybelievethat,giventechnology advances, companies need to provide more online, real-time financial informationto ensure the availability of relevant information.b)Companies prepare financial statements using the accrual basis of accounting. Accrual-basisaccountingmeansthattransactionsthatchangeacompany’sfinancialstatementsarerecorded in the periods in which the events occur.For example, using the accrual basismeans that companies recognize revenues when it satisfies a performance obligation (therevenue recognition principle). This is in contrast to recognition based on receipt of cash.Likewise,undertheaccrualbasis,companiesrecognizeexpenseswhenincurred(theexpense recognition principle) rather than when paid.Financial statements prepared on theaccrual basis inform users not only of past transactions involving the payment and receipt ofcash but also of obligations to pay cash in the future and of resources that represent cash tobe received in the future. Hence, they provide the type of information about past transactionsand other events that is most useful in making economic decisions.LO:3, Bloom:C, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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Questions Chapter 2(Continued)13.The monetary unit assumption assumes that the unit of measure remains reasonably stable sothat Euros, Yen, or dollars of different years can be added without any adjustment. When the valueof the currency fluctuates greatly over time, the monetary unit assumption loses its validity.The IASB indicated that it expects the currency unadjusted for inflation or deflation to be used tomeasure items recognized in financial statements. Only if circumstances change dramatically willthe Board consider a more stable measurement unit.LO:3, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication14.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 arbitrarilyand there would be considerable disagreement as to the amounts to be used.(2)Amounts determined by other bases would have to be revised frequently.(3)Comparison with other companies is aided if cost is employed.(4)The costs of obtaining fair values could outweigh the benefits derived.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication15.Fair valueis defined as “the price that would be received to sell an asset or paid to transfer aliability in an orderly transaction between market participants at the measurementdate.” Fair valueis therefore a market-based measure.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication16.The fair value option gives companies the option to use fair value as the basis formeasurement offinancial assets and financial liabilities. The Board believes that fair value measurement for financialassets and financial liabilities provides more relevant and understandable information than historicalcost. It considers fair value to be more relevant because it reflects the current cash equivalentvalue of financialassets and financial liabilities. As a result companies now have the option torecord fair value in their accounts for most financialassets and financial liabilities, including suchitems as receivables, investments, and debt securities.LO:4, Bloom:C, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication17.The fair value hierarchy provides insight into the priority of valuation techniques that are used todetermine fair value. The fair value hierarchy is divided into three broad levels.Fair Value HierarchyLevel 1:Observable inputs that reflect quoted prices forLeast Subjectiveidentical assets or liabilities in active markets.Level 2:Inputs other than quoted prices included in Level 1 thatare observable for the asset or liability either directly orthrough corroboration with observable data.Level 3:Unobservable inputs (for example, a company’s owndata or assumptions).Most SubjectiveAs indicated, Level 1 is the most reliable because it is based on quoted prices, like a closing stockprice in theWall Street Journal. Level 2 is the next most reliable and would rely on evaluating similarassets or liabilities in active markets. At the least-reliable level, Level 3, much judgment is neededbased on the best information available to arrive at a relevant and reliable fair value measurement.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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Questions Chapter 2(Continued)18.The revenue recognition principle requires that companies recognize revenue in the accountingperiod in which the performance obligation is satisfied. In the case of services, revenue is recognizedwhen theservices are performed.In the caseofselling a product, the performance obligation is metwhentheproductisdelivered.Companiesfollowafive-stepprocesstoanalyzerevenuearrangements to determine when revenue should be recognized: (1)Identify the contract(s) with thecustomer; (2) Identify the separate performance obligations in the contract; (3) Determine thetransaction price;(4)Allocatethetransaction pricetoseparate performance obligations; and(5) Recognize revenue when each performance obligation is satisfied.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication19.A performance obligation is a promise to deliver a product or provide a service to a customer.Therevenue recognition principle requires that companies recognize revenue in the accounting period inwhich the performance obligation is satisfied. In the case of services, revenue is recognized whenthe services are performed.In the case of selling a product, the performance obligation is met whenthe product is delivered.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication20.The five steps in the revenue recognition process are:Step 1.Identify the contract(s) with the customer.A contract is an agreement between twoparties that creates enforceable rights or obligations.Step 2.Identifytheseparateperformanceobligationsinthecontract.Aperformanceobligation is ether a promise to provide a service or deliver a product, or both.Step 3.Determine the transaction price.Transaction price is the amount of consideration thata company expects to receive from a customer in exchange for transferring a good orservice.Step 4.Allocate the transaction price to separate performance obligations.This is usuallydone by estimating the value of consideration attributable to each product or service.Step 5.Recognize revenue when each performance obligation is satisfied. This occurswhen the service is provided or the product is delivered.Note that many revenue transactions pose few problems because the transaction is initiated andcompleted at the same time.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication21.Revenues are recognized when a performance obligation is met. The most commontime at whichthese two conditions are met is when the product or merchandise is delivered or services arerendered to customers. Therefore, revenue for Selane Eatery should be recognized at the time theluncheon is served.LO:4, Bloom:C, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication22.The president means that the “gain” should be recorded in the books. This item should not beenteredintheaccounts,however,becauseareliablemeasurementoftherevenueisquestionable.LO:4, Bloom:C, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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Questions Chapter 2(Continued)23.The cause and effect relationship can seldom be conclusively demonstrated, but many costsappear to be related to particular revenues and recognizing them as expenses accompaniesrecognition of the revenue. Examples of expenses that are recognized by associating cause andeffect are sales commissions and cost of products sold or services provided.Systematic and rational allocation means that in the absence of a direct means of associatingcause and effect, and where the asset provides benefits for several periods, its cost should beallocated to the periods in a systematic and rational manner. Examples of expenses that arerecognized in a systematic and rational manner are depreciation of plant assets, amortization ofintangible assets, and allocation of rent and insurance.Some costs are immediately expensed because the costs have no discernible future benefits orthe allocation among several accounting periods is not considered to serve any useful purpose.Examples include officers’ salaries, most selling costs, amounts paid to settle lawsuits, and costsof resources used in unsuccessful efforts.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication24.An item that meets the definition of an element should be recognized if: (a) it is probable that anyfuture economic benefit associated with the item will flow to or from the entity; and (b) the item hasa cost or value that can be measured with reliability.LO:2,4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication25.(a)To be recognized in the main body of financial statements, an item must meet the definition ofan element. In addition,the item must have been measured, recorded in the books, and passedthrough the double-entry system of accounting.(b)Information provided in the notes to the financial statements amplifies or explains the itemspresented in the main body of the statements and is essential to an understanding of the per-formance and position of the enterprise. Information in the notes does not have to be quanti-fiable, nor does it need to qualify as an element.(c)Supplementary information includes information that presents a different perspective from thatadopted in the financial statements. It also includes management’s explanation of the financialinformation and a discussion of the significance of that information.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication26.The general guide followed with regard to the full disclosure principle is to disclose in the financialstatements 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 subsequentreporting period probably should be disclosed because such a situation is of importance to presentshareholders. Even though the event occurred after December 31,2019, it should be disclosed onin the notes to the financial statements as of December 31,2019, in order to make adequatedisclosure. (The major point that should be emphasized throughout the entire discussion on fulldisclosure is that there isnormally no “black” or “white” but varying shades of grey and it takesexperience and good judgmentto arrive at an appropriate answer.)LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication27.Accounting information is subject tothe costconstraint.Information is not worth providing unlessthe benefits it provides exceed the costs of preparing it.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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Questions Chapter 2(Continued)28.The costs of providing accounting information are paid primarily to highly trained accountants whodesign and implement information systems, retrieve and analyze large amounts of data, preparefinancial statements in accordance with authoritative pronouncements, and audit the informationpresented. These activities are time-consuming and costly. The benefits of providing accountinginformation are experienced by society in general, since informed financial decisions help allocatescarce resources to the most effective enterprises. Occasionally new accounting standards requirepresentation of information that is not readily assembled by the accounting systems of mostcompanies. A determination should be made as to whether the incremental or additional costs ofproviding the proposed information exceed the incremental benefits to be obtained. This deter-mination requires careful judgment since the benefits of the proposed information may not bereadily apparent.LO:4, Bloom: K, Difficulty: Simple, Time: 3-5, AACSB: None, AICPA BB: None, AICPA FC: Reporting, AICPA PC: Communication

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