CHAPTER 2 CONCEPTUAL FRAMEWORK UNDERLYING FINANCIAL REPORTING SUMMARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY

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1 CAPTER 2 CONCEPTUAL FRAEWORK UNDERLYING FINANCIAL REPORTING SUARY OF QUESTION TYPES BY LEARNING OBJECTIVE AND LEVEL OF DIFFICULTY LO ,3, Note: E = Easy LOD E E E E = eium LO LOD LO LOD ultiple Choie Coneptual 3 E 27. E 3 E E E 39. erises LO LOD *7. *8. *9. *50. *51. * E = ar *This topi is ealt with in an Appenix to the hapter.

2 2-2 Test Bank for Intermeiate Aounting, Tenth Canaian Eition SUARY OF LEARNING OBJECTIVES BY QUESTION TYPE Type Type 1. C 2. C 3.. C C C C C C C C C C C C C C C C C C 1. C 2. C. C 5. C *7. C *8. C Note: C = ultiple Choie Type Type Learning Ojetive Learning Ojetive 2 7. C 9. C 8. C 10. C Learning Ojetive C 20. C 19. C 5. Learning Ojetive 31. C 36. C 32. C 37. C 33. C 38. C 3. C 39. C 35. C 0. C Learning Ojetive 5 3. C 62. Learning Ojetive 6 6. C Learning Ojetive 7 *9. C *50. C Type Type C C C *51. C *52. C = erise *This topi is ealt with in an Appenix to the hapter.

3 Coneptual Framework Unerlying Finanial Reporting 2-3 CAPTER STUDY OBJECTIVES 1. Iniate the usefulness an esrie the main omponents of a oneptual framework for finanial reporting. A oneptual framework is neee to (1) reate stanars that uil on an estalishe oy of onepts an ojetives, (2) provie a framework for solving new an emerging pratial prolems, (3) inrease finanial statement users unerstaning of an onfiene in finanial reporting, an () enhane omparaility among ifferent ompanies finanial statements. The first level eals with the ojetive of finanial reporting. The seon level inlues the qualitative harateristis of useful information an elements of finanial statements. The thir level inlues founational priniples an onventions. 2. Ientify the qualitative harateristis of aounting information. The overriing riterion y whih aounting hoies an e juge is eision usefulness; that is, the goal is to provie the information that is the most useful for eision-making. Funamental harateristis inlue relevane an faithful representation. These two harateristis must e present. Enhaning harateristis inlue omparaility, verifiaility, timeliness, an unerstanaility. There may e trae-offs. 3. Define the asi elements of finanial statements. The asi elements of finanial statements are (1) assets, (2) liailities, (3) equity, () revenues, (5) expenses, (6) gains, an (7) losses.. Desrie the founational priniples of aounting. (1) Eonomi entity: the assumption that the ativity of a usiness enterprise an e kept separate an istint from its owners an any other usiness unit. (2) Control: the entity has the power to make eisions an reap the enefits or e expose to the losses (whih are variale). (3) Revenue reognition: revenue is generally reognize when it is (a) earne, () measurale, an () olletile (realizale). () athing assists in the measurement of inome y ensuring that osts (relating to long-live assets) inurre in earning revenues are ooke in the same perio as the revenues earne. (5) Perioiity: the assumption that an enterprise s eonomi ativities an e ivie into artifiial time perios to failitate timely reporting. (6) onetary unit: the assumption that money is the ommon enominator y whih eonomi ativity is onute, an that the monetary unit gives an appropriate asis for measurement an analysis. (7) Going onern: the assumption that the usiness enterprise will have a long life. (8) istorial ost priniple: existing GAAP requires that many assets an liailities e aounte for an reporte ase on their aquisition prie. any assets are later revalue. (9) Fair value priniple: assets an liailities are value at fair value that is, an exit prie an viewe from a market partiipant perspetive. (10) Full islosure priniple: aountants follow the general pratie of proviing information that is important enough to influene an informe user s jugement an eisions. 5. plain the fators that ontriute to hoie an/or ias in finanial reporting eisions. Choie is the result of many things, inluing priniples-ase stanars, measurement unertainty, an inreasingly omplex usiness transations. The oneptual framework is the founation that GAAP is uilt on. If there is no primary soure of GAAP for a speifi eision, then professional jugement must e use, making sure that the aounting poliies hosen are onsistent with the primary soures of GAAP an the oneptual framework.

4 2- Test Bank for Intermeiate Aounting, Tenth Canaian Eition Finanial engineering is the proess of legally struturing a usiness arrangement or transation so that it meets the ompany s finanial reporting ojetive. This is a angerous pratie sine it often results in iase information. Frauulent finanial reporting often results from pressures on iniviuals or the ompany. These pressures may ome from various soures, inluing worsening ompany, inustry, or eonomi onitions; unrealisti internal ugets; an finanial statement foal points relate to ontratual, regulatory, or apital market expetations. Weak internal ontrols an governane also ontriute to frauulent finanial reporting. 6. Disuss urrent trens in stanar setting for the oneptual framework. The IASB an FASB will ontinue to work towar a ommon oneptual framework. The projet on ojetives an qualitative harateristis is omplete. The oars are fousing on efining elements an the reognition/measurement frameworks.

5 Coneptual Framework Unerlying Finanial Reporting 2-5 ULTIPLE COICE Coneptual Answer No. Desription 1.Coneptual framework 2.Ojetives of finanial reporting 3.Funamental qualitative harateristis.relevane 5.Relevane 6.Representational faithfulness a 7.Criterion for aounting information 8.Enhaning qualitative harateristis 9.Comparaility a 10.Timeliness a 11.Comparaility 12.Timeliness 13.Costs of proviing useful information 1.Common harateristi of assets an liailities 15.Equitale oligations a 16.s inlue in equity uner IFRS 17.Definition of gains 18.Other omprehensive inome 19.Statements prepare using ASPE 20.Components of omprehensive inome 21.Eonomi entity assumption 22.Timing of revenue reognition a 23.ample of full islosure 2.Eonomi entity assumption 25.Reognition an measurement 26.Perioiity assumption 27.Going onern assumption 28.istorial ost priniple 29.athing priniple a 30.Use of allowane for outful aounts 31.istorial ost priniple a 32.Eonomi entity assumption 33.athing priniple 3Reoring of epreiation 35.Fair value of an asset 36.Full islosure priniple 37.easurement unertainty 38.Full islosure priniple 39.anagement Disussion an Analysis a 0.s inlue in D&A 1.Priniples-ase GAAP 2.Finanial engineering 3.Frauulent finanial reporting.propose new efinition of asset 5.Propose new examples of assets 6.Propose new examples of liailities

6 Test Bank for Intermeiate Aounting, Tenth Canaian Eition 2-6 a *7.Input levels for estimating fair value *8.Definition of the ost moel *9.Definition of the inome moel *50.Definition of the market moel *51.Use of isounte ash flow moel *52.Remeasuring a liaility at fair value *This topi is ealt with in an Appenix to the hapter. EXERCISES Desription Coneptual framework Aounting terminology fill in the lanks Equitale oligations Founational priniples Ientifiation of founational aounting priniples Ientifiation of founational aounting priniples an qualitative harateristis Founational aounting priniples an qualitative harateristis mathing Fair value measurement athing onept Priniples vs. rules ase GAAP Finanial engineering Frauulent finanial reporting

7 Coneptual Framework Unerlying Finanial Reporting 2-7 ULTIPLE COICE Coneptual 1. Whih of the following is NOT part of the oneptual framework for finanial reporting? a) Elements of finanial statements ) Qualitative harateristis of aounting information ) Notes to finanial statements ) Founational priniples 2. Whih of the following is NOT an ojetive of finanial reporting? a) To provie information aout an entity s eonomi resoures, oligations an equity/net assets ) To provie information that is useful to investors an reitors an other users in making resoure alloation eisions an/or assessing management stewarship ) To provie information that is useful in assessing the eonomi performane of the entity ) To provie the most useful information possile even if the osts exee the enefits 3. Funamental qualitative harateristis inlue a) relevane an omparaility. ) representational faithfulness an timeliness. ) relevane an representational faithfulness. ) verifiaility an relevane.. Whih of the following oes NOT relate to the onept of relevane? a) The information must e apale of making a ifferene in a eision. ) Both material an immaterial information is important. ) The information has preitive value. ) The information has feeak/onfirmatory value. 5. Aounting information is onsiere to e relevant when it a) an e epene on to represent the eonomi onitions an events that it is intene to represent. ) is apale of making a ifferene in a eision. ) is unerstanale y reasonaly informe users of aounting information. ) is verifiale an neutral. 6. Representational faithfulness inlues a) ompleteness, neutrality an omparaility. ) neutrality, ompleteness, an unerstanaility. ) relevane, ompleteness an freeom from material error. ) neutrality, ompleteness an freeom from material error. 7. The overriing riterion y whih aounting information an e juge is that of a) usefulness for eision making.

8 2-8 Test Bank for Intermeiate Aounting, Tenth Canaian Eition ) freeom from ias. ) timeliness. ) omparaility. 8. Whih statement is orret regaring enhaning qualitative harateristis? a) Full isussion of the information presente is a sustitute for omparale information. ) Numers that are easily verifiale with a reasonale egree of auray are alle soft numers. ) Information must e availale efore it loses its aility to influene users eisions. ) Finanial information must e of suffiient quality an larity that even uninforme reaers an unerstan it. 9. Comparaility allows any finanial statement user to a) make timely eisions. ) unerstan all the information presente. ) verify all the ata provie. ) ientify the real similarities an ifferenes in eonomi phenomena. 10. Timeliness is inrease y a) quarterly reporting. ) omparative finanial statements. ) representational faithfulness. ) annual reporting. 11. Sunury Lt. operates in oth Canaa an the Unite States. The ompany wants to improve the qualitative harateristis of its finanial statements. Whih of the following woul OST likely improve the omparaility of Sunury s finanial statements? a) The restatement of its finanial statements from Canaian GAAP to US GAAP for its Amerian investors. ) The preparation of monthly finanial statements. ) The introution of a poliy that speifies how Sunury's apital assets shoul e epreiate. ) The use of U.S.-traine aountants. 12. You want to improve the qualitative harateristis of your firm's finanial statements. Whih of the following options woul OST likely improve the timeliness of your ompany's finanial statements? a) inreasing the numer of islosures ) hanging the timing of when revenues are reognize ) inreasing the frequeny of statements from annually to quarterly ) ereasing the useful life of property, plant an equipment from ten years to five 13. The osts of proviing useful information o NOT inlue a) olleting, proessing an istriuting information. ) auiting finanial statements.

9 Coneptual Framework Unerlying Finanial Reporting 2-9 ) islosure to ompetitors. ) users alloation of resoures. 1. The ommon harateristi of oth assets an liailities is that they BOT a) provie an eonomi enefit. ) result from a past transation or event. ) represent a present responsiility. ) represent ontratual or other rights. 15. Equitale oligations arise ue to a) statutory requirements. ) ontratual oligations. ) moral or ethial onsierations. ) union agreements. 16. Uner IFRS, equity oes NOT inlue a) long term leases. ) ommon an/or preferre shares. ) aumulate other omprehensive inome. ) retaine earnings. 17. Gains are efine as a) inreases in eonomi resoures resulting from an entity s orinary ativities. ) ereases in eonomi resoures resulting from an entity s orinary ativities. ) the resiual interest remaining after liailities are eute from assets. ) inreases in equity resulting from an entity s peripheral or iniental transations. 18. Uner IFRS, other omprehensive inome oes NOT inlue a) unrealize holing gains an losses on ertain seurities. ) gains an losses on isposal of property, plant an equipment. ) gains an losses relate to ertain types of heges. ) ertain gains an losses relate to foreign exhange transations. 19. Finanial statements prepare uner ASPE inlue a a) statement of omprehensive inome. ) statement of ash flows an a statement of hanges in shareholers equity. ) alane sheet an a statement of retaine earnings. ) statement of retaine earnings an a statement of omprehensive inome. 20. Whih of the following elements of finanial statements is NOT a omponent of omprehensive inome? a) Revenues

10 2-10 Test Bank for Intermeiate Aounting, Tenth Canaian Eition ) Distriutions to owners ) Losses ) penses 21. A loal usinessman owns several ifferent ompanies. is aountant prepares separate finanial statements for eah of these usinesses. This is an appliation of the a) full islosure priniple. ) perioiity assumption. ) going onern assumption. ) eonomi entity assumption. 22. Generally, revenue from sales shoul e reognize at a point when a) management eies it is appropriate to o so. ) the prout is availale for sale. ) an exhange has taken plae an the earnings proess is sustantially omplete. ) the entire amount reeivale has een ollete from the ustomer an there remains no further warranty liaility. 23. During a major renovation projet of its hea offie, a worker was seriously injure. While the ompany elieves that it was not at fault, it oes inlue the inient in the notes to its finanial statements. This is onsistent with the a) full islosure priniple. ) perioiity assumption. ) going onern assumption. ) eonomi entity assumption. 2. The eonomi entity assumption a) is inappliale to uninorporate usinesses. ) reognizes the legal aspets of usiness organizations. ) requires perioi inome measurement. ) is appliale to all forms of usiness organizations. 25. When eiing whether to reognize a finanial statement element (or not), an how to measure it, the aountant shoul a) always use estimates. ) reor har numers an ignore soft numers. ) etermine an aeptale level of unertainty. ) reognize a finanial statement element even if it annot e measure. 26. During the lifetime of an entity, aountants proue finanial statements at aritrary points in time in aorane with the a) full islosure priniple. ) perioiity assumption.

11 Coneptual Framework Unerlying Finanial Reporting 2-11 ) going onern assumption. ) eonomi entity assumption. 27. The assumption that a usiness enterprise will NOT e sol or liquiate in the near future is known as the a) eonomi entity assumption. ) monetary unit assumption. ) fair value priniple. ) going onern assumption. 28. Valuing assets at their liquiation values rather than their ost is inonsistent with the a) perioiity assumption. ) historial ost priniple. ) mathing priniple. ) eonomi entity assumption. 29. Whih of the following is NOT a goo example of the mathing priniple? a) A mahine that proues ertain goos is epreiate over its useful life. The epreiation expense is mathe with the proees from the sale of those goos. ) The entire amount of a two-year insurane premium is expense in the first year. ) An unolletile reeivale is written off in the year that the sale was mae. ) Reognition of revenue for whih assoiate expenses annot yet e etermine is elaye until suh etermination an e mae. 30. Use of an allowane for outful aounts is an appliation of the a) mathing priniple. ) revenue reognition priniple. ) historial ost priniple. ) full islosure priniple. 31. Whih of the following statements oes NOT apply to the historial ost priniple? a) istorial ost represents a value at a point in time. ) The priniple oes not apply to finanial instruments. ) istorial ost results from a reiproal or two-way exhange. ) Over time, historial ost eomes irrelevant in terms of preitive value. 32. Preparation of onsoliate finanial statements when a parent-susiiary relationship exists is an example of a) the eonomi entity assumption. ) the mathing priniple. ) omparaility. ) reliaility.

12 2-12 Test Bank for Intermeiate Aounting, Tenth Canaian Eition 33. The mathing priniple is est emonstrate y a) not reognizing any expense unless some revenue is realize. ) assoiating effort (expense) with aomplishment (revenue). ) reognizing prepai rent reeive as revenue. ) measuring expenses orretly. 3. Whih of the following serves as the justifiation for the perioi reoring of epreiation expense? a) assoiation of efforts (expense) with aomplishments (revenue) ) minimization of inome tax liaility ) immeiate reognition of an expense ) systemati an rational alloation of ost over the perios enefite 35. Fair value (of an asset) is a) an entry prie. ) an entity-speifi measure. ) an exit prie. ) not use when following IFRS. 36. Appliation of the full islosure priniple a) is theoretially esirale ut not pratial eause the osts of omplete islosure exee the enefits. ) is violate when important finanial information is urie in the notes to the finanial statements. ) is emonstrate y the inlusion of information suh as information aout ontingenies. ) requires that the finanial statements e onsistent an omparale. 37. Where there is a signifiant unertainty with respet to the measurement of an item, a) o not reor anything in the finanial statements. ) reognize the item in the finanial statements an islose the measurement unertainty in the notes to the finanial statements. ) o not reor anything in the finanial statements ut islose the measurement unertainty in the notes to the finanial statements. ) reor the maximum amount in the finanial statements. 38. The operations of a resoure ompany's oil sans operations results in environmental amage. While the extent of the amage annot e etermine at this time, the situation is islose in its finanial statements. This BEST emonstrates a) the appliation of professional jugement. ) the full islosure priniple. ) representational faithfulness. ) goo management stewarship.

13 Coneptual Framework Unerlying Finanial Reporting anagement Disussion an Analysis (D&A) is a) notes on meetings etween management an auitors. ) internal ouments not release to shareholers. ) supplementary information inlue in the annual report. ) supplementary information inlue in the notes to the finanial statements. 0. anagement Disussion an Analysis (D&A) oes NOT inlue a) notes to the finanial statements. ) key performane rivers. ) the ompany s vision an strategy. ) the ompany s apailities (apital an other resoures). 1. Priniples-ase GAAP is sometimes ritiize for eing a) too inflexile. ) too flexile. ) too inonsistent. ) too iffiult for the reaer to unerstan. 2. Whih of the following situations oes NOT emonstrate an attempt at finanial engineering? a) reating omplex legal arrangements an finanial instruments ) struturing et finaning so that it meets the GAAP efinition of equity rather than et ) aounting for ona fie usiness transations in a transparent manner ) aggressively interpreting GAAP so that the impat on ritial ratios is minimize 3. Frauulent finanial reporting is a usiness reality. While it annot e eliminate, the risk of frauulent reporting an e erease. Whih of the following onsierations is LEAST likely to lessen that risk? a) an inepenent auit ommittee ) an internal auit funtion ) vigilant management ) an inrease fous on tying onuses to short-term ompany performane. The IASB an FASB are urrently working on a joint projet to omplete a ommon oneptual framework. Whih of the following statements est esries the propose (new) efinition of an asset? a) The asset must involve future eonomi resoures an the entity has a right or aess to the resoures, while others o not. ) The asset must involve future eonomi resoures an the resoure must e freely availale to all. ) The asset must involve present eonomi resoures an the entity has a right or aess to the resoures, while others o not. ) The asset must involve present eonomi resoures an the resoure must e freely availale to all.

14 2-1 Test Bank for Intermeiate Aounting, Tenth Canaian Eition 5. The IASB an FASB are urrently working on a joint projet to omplete a ommon oneptual framework. Aoring to the propose (new) efinition, whih of the following woul e onsiere assets? a) aounts reeivale, aounts payale, an patents ) insurane ontrats an aounts reeivale ) lan, aounts reeivale an unearne revenue ) property, plant an equipment an onstrutive oligations 6. The IASB an FASB are urrently working on a joint projet to omplete a ommon oneptual framework. Aoring to the propose (new) efinition, whih of the following woul e onsiere liailities? a) aounts reeivale an aounts payale ) onstrutive oligations, long term leases an insurane ontrats ) aounts payale, unearne revenue, an opyrights ) lawsuits oth settle an in progress *7. Whih of the following statements is orret regaring the levels of inputs require for estimating fair value of finanial statement elements? a) Level 3 inputs are the highest quality inputs. ) The lower the level of input, the greater the require islosures. ) Level 2 inputs are generally not oservale an hene more sujetive. ) Level 1 inputs are the lowest quality inputs. *8. Valuation moels may e ategorize into three groups. Cost moels a) attempt to reflet the amount that woul e require to replae the asset s servie apaity. ) onvert future amounts to urrent amounts, using, for example, isounte ash flows or options priing moels. ) use pries an other information generate from market transations involving iential or similar transations. ) use either isounte ash flows methos, or pries an other information generate from market transations involving iential or similar transations. *9. Valuation moels may e ategorize into three groups. Inome moels a) attempt to reflet the amount that woul e require to replae the asset s servie apaity. ) onvert future amounts to urrent amounts, using, for example, isounte ash flows or options priing moels. ) use pries an other information generate from market transations involving iential or similar transations. ) use either isounte ash flows methos or pries an other information generate from market transations involving iential or similar transations. *50. Valuation moels may e ategorize into three groups. arket moels a) attempt to reflet the amount that woul e require to replae the asset s servie apaity.

15 Coneptual Framework Unerlying Finanial Reporting 2-15 ) onvert future amounts to urrent amounts, using, for example, isounte ash flows or options priing moels. ) use pries an other information generate from market transations involving iential or similar transations. ) use either isounte ash flows methos or pries an other information generate from market transations involving iential or similar transations. *51. Fair value estimates arrive at y using isounte ash flow moels woul NOT use a) estimates of ash flows. ) time value of money. ) unertainty (risk). ) original ost of an asset. *52. A formerly profitale ompany is urrently experiening losses an, as a result, is ash-squeeze. Thus, it may not e ale to repay its ank et aoring to the loan s terms. If fair value is eing use to measure this liaility, then a) the ompany s reit risk has erease. ) the eit to equity ratio will inrease. ) the present value of the liaility will erease, resulting in a gain ooke through other omprehensive inome. ) the present value of the liaility will erease, resulting in a gain ooke through profit an loss.

16 2-16 Test Bank for Intermeiate Aounting, Tenth Canaian Eition ULTIPLE COICE ANSWERS CONCEPTUAL Ans. a Ans. a a a Ans. a Ans. a a Ans. Ans. Ans. a *7. *8. a *9. *50. *51. *52.

17 Coneptual Framework Unerlying Finanial Reporting 2-17 EXERCISES Coneptual framework Briefly esrie the ojetives of a sounly evelope oneptual framework. Solution 2-53 A sounly evelope oneptual framework shoul 1. inrease finanial statement users' unerstaning of an onfiene in finanial reporting, 2. enhane omparaility among ompanies' finanial statements, 3. allow new an emerging pratial prolems to e solve more quikly Aounting terminology - fill in the lanks Fill in the lanks elow with the aounting term(s) that est ompletes eah sentene. 1. A sounly evelope oneptual framework is a set of stanars an rules. an are the funamental qualitative harateristis that make aounting information useful for eision-making. 2. Enhaning qualitative harateristis are,, an. 3. Liailities have three essential harateristis: 1. They represent a, 2. the entity has a, an 3... While onsoliate finanial statements are prepare from the perspetive of the, taxes are pai from the perspetive of the. 5. Colletaility is one of the three onitions of the revenue reognition priniple. Assuming the other two onitions are met, revenue shoul only e reognize if olletaility is. 6. The stipulates that anything that is relevant to eisions shoul e inlue in the finanial statements. 7. A ompany s anagement Disussion an Analysis (D&A) is an example of. 8. A - ase approah, as use in Canaian GAAP an IFRS, is sometimes ritiize for eing too. 9. Uner the priniple, inurre uring a partiular perio are mathe with earne uring that same perio. 10. The is ase on the assumption that a usiness enterprise will ontinue to operate for the foreseeale future.

18 2-18 Test Bank for Intermeiate Aounting, Tenth Canaian Eition 11. One of the assumptions of the is valuation at a partiular point in time. 12. is efine as the prie that woul e reeive to sell an asset or pai to transfer a liaility in an orerly transation etween market partiipants at the measurement ate. 13. Stanar setters have given ompanies the option to use instea of historial osts. Solution oherent, relevane, representational faithfulness 2. omparaility, verifiaility, timeliness, unerstanaility 3. present uty or oligation, present enforeale oligation, the liaility results from a past transation or event. eonomi entity, legal entity 5. reasonaly assure 6. full islosure priniple 7. supplementary information 8. priniples, flexile 9. mathing, expenses, revenues 10. going onern assumption 11. historial ost priniple 12. Fair value 13. fair value Equitale oligations Due to the urrent poor eonomi onitions, Latimer Corp, a meium size manufaturer in Burnay, is ownsizing its Shipping Dept, an has to let go two of the employees, Jiner an Tang. Both are exellent workers an have een with the ompany for several years. The Shipping Dept supervisor, Jane Kowalski, goes to the ompany CEO to see if there is another alternative for these employees (other than termination of their employment). Jane suggests that Jiner oul e retraine to learn how to operate a forklift an Tang woul like to learn how to e a first ai attenant. Sine Latimer always nees employees with these skills, the CEO agrees to try this. Latimer s work fore is not

19 Coneptual Framework Unerlying Finanial Reporting 2-19 unionize. What type of oligation is this? Disuss. Solution 2-55 This woul e an equitale oligation, whih oes not arise from a ontratual oligation, ut rather from moral or ethial onsierations. Theoretially (sine there is no union ontrat with attenant language regaring layoffs an terminations), the ompany has no oligation to Jiner an Tang an oul let them go without any further ao. owever, it appears that oth s Kowalski an the CEO feel a moral oligation to help the employees y retraining them. This will have future enefits for Latimer. For example, the ompany will not lose goo workers; it will enefit from their new skills; an it will improve morale among other workers who may feel threatene y potential future jo losses Founational priniples Briefly explain the founational priniples of reognition, measurement, presentation an islosure that unerlie finanial aounting. Solution 2-56 These onepts help explain whih, when, an how finanial elements an events shoul e islose. Reognition fouses on whether something shoul e inlue in a ompany's finanial statements. It inlues the eonomi entity assumption, ontrol, revenue reognition an mathing priniples. easurement relates to the "onversion" of information into numers. It inlues the perioiity, monetary unit an going onern assumptions, an the historial ost an fair value priniples. Presentation/islosure relates to how (an how muh) information is onveye to the user. It inlues the general pratie of proviing information that is important enough to influene an informe user's jugement an eisions Ientifiation of founational aounting priniples State the aounting priniple or assumption that is most appliale in the following situations: 1. A ompany prepares onsoliate finanial statements for a susiiary that it owns. 2. The eision to remove an asset from the alane sheet 3. A large sale on aount is not reognize as revenue eause olletaility is an issue.. Dislosure of the liaility from a lawsuit in the finanial statements 5. Preparation of monthly finanial statements 6. Using the Canaian ollar in finanial statements 7. An energy ompany inlues etaile information aout its reserves in its notes to the finanial statements. Solution Control or eonomi entity assumption 2. Dereognition 3. Revenue reognition priniple

20 2-20. Test Bank for Intermeiate Aounting, Tenth Canaian Eition Full islosure priniple 5. Perioiity assumption 6. onetary unit assumption 7. Full islosure priniple Ientifiation of founational aounting priniples an qualitative harateristis Presente elow are a numer of aounting proeures an praties followe y January Corp. For eah of these items, list the assumption, priniple, or qualitative harateristi that is NOT eing followe. 1. Beause the ompany's inome is low this year, January swithe from aelerate epreiation to straight-line epreiation. 2. The presient of January elieves it is foolish to report finanial information on a yearly asis. She elieves that finanial information shoul e islose only when signifiant new information is availale relate to the ompany's operations. 3. January eies to estalish a large loss an relate liaility this year eause of the possiility that it may lose a pening lawsuit. The possiility of loss is onsiere remote y the orporation s lawyers.. One of the orporation s exeutives purhase a new home omputer for personal use with ompany money, harging isellaneous pense. 5. The orporation has not estalishe an Allowane for Doutful aounts, even though there are a signifiant numer of their aounts that are either slow paying or may not pay their ets in full. Solution Representational Faithfulness/ Neutrality 2. Perioiity assumption 3. athing priniple. Eonomi entity assumption 5. athing priniple Founational aounting priniples an qualitative harateristis - mathing Liste elow are several founational aounting priniples an qualitative harateristis. ath the letter of eah with the appropriate phrase esriing its appliation. Note that eah item may e use more than one or not at all. a. Eonomi entity assumption g. athing priniple. Going onern assumption h. Full islosure priniple. onetary unit assumption i. Relevane. Perioiity assumption j. Reliaility e. istorial ost priniple k. Comparaility

21 Coneptual Framework Unerlying Finanial Reporting f. Revenue reognition priniple l Representational faithfulness Using the Canaian ollar in the finanial statements The earning proess is omplete an realize or realizale. Aounting information reflets the eonomi sustane of the event or transation. Quarterly finanial reports The use of aruals an eferrals in ajusting the aounts Useful stanar measuring unit for usiness transations Inluing explanatory notes as part of the finanial statements The affairs of the usiness are istinguishe from those of its owners. A usiness enterprise is assume to have a long life. Valuing assets at amounts originally pai for them Appliation of the same aounting priniples as in the preeing year Presentation of timely information with preitive an feeak value Solution f 3. l. 5. g h 8. a e 11. k 12. i Fair value measurement The ongoing tren towar using fair value has oth its supporters an its ritis. Briefly explain arguments in favour of an against the use of fair value. Solution 2-60 Arguments in favour: Fair values are urrent an therefore more relevant. The ost at whih an asset is arrie (using the

22 2-22 Test Bank for Intermeiate Aounting, Tenth Canaian Eition ost at whih it was aquire, say, twenty years ago) may ear little resemlane to its urrent replaement ost. Arguments against: Fair values may e iffiult to asertain, espeially when markets for the unerlying assets o not exist. Fair values may sujet finanial statements to a signifiant egree of variaility in volatile markets athing onept A onept is a group of relate ieas. athing oul e onsiere a onept eause it inlues ieas relate to oth revenue reognition an expense reognition. Briefly explain the theory ehin a) revenue reognition an ) expense reognition. Solution 2-61 a) The asis of revenue reognition inlues the following: 1. Revenues are inflows of net assets from elivering or prouing goos or servies or other earning ativities that are the major operations of an enterprise uring a perio. 2. Reognition is reoring an reporting in the finanial statements. 3. Revenues are realize when goos or servies are exhange for ash or laims to ash.. Revenues are earne when the earnings proess is omplete or virtually omplete. The revenue reognition priniple says that revenue is reognize when performane is ahieve (earne) an measuraility an olletaility are reasonaly assure (realize/realizale). ) The asis of expense reognition inlues "expense" an "mathing": 1. penses are outflows of net assets uring a perio from elivering or prouing goos or servies or other ativities that are the major operations of the entity. 2. penses are reognize when the goos or servies (efforts) make their ontriution to revenue. The mathing priniple says that expenses are mathe with revenues. penses are mathe three ways: 1. When there is an assoiation with revenue, expenses are mathe with revenues in the perio the revenues are reognize. 2. When no assoiation with revenue is evient, expenses are alloate on some systemati an rational asis. 3. When no assoiation with revenue is evient an no future enefits are expete, expenses are reognize immeiately Priniples vs. rules ase GAAP There has een muh isussion aout priniples-ase stanars versus rules-ase stanars. Disuss the avantages an isavantages of a priniples-ase approah. Solution 2-62 Avantages of a priniples ase approah: 1. Deisions are ase on the oneptual framework so they shoul e onsistent.

23 Coneptual Framework Unerlying Finanial Reporting Flexiility allows for making eisions aout new or unusual transations ase on priniples. Allows aountants to use their professional expertise an professional jugement. Disavantages of a priniples ase approah: 1. Flexiility may result in reue omparaility etween ifferent firms. 2. Flexiility may e ause an ias may reep into eisions Finanial engineering plain the pratie of finanial engineering an how it relates to frauulent finanial reporting. Solution 2-63 Finanial engineering is a proess wherey a usiness arrangement or transation is struture legally suh that it meets the ompany s finanial reporting ojetive within GAAP. This is often one y using omplex legal arrangements an finanial instruments. This proues a transation or item that may have the form of one kin of transation or item when the sustane is something ifferent. Enron was involve in many transations of this type. Sine the sustane of these arrangements is to osure the real nature of the transations or items involve, they are potentially frauulent Frauulent finanial reporting Ientify several fators that ontriute to frauulent finanial reporting. Solution Unrealisti internal ugets an finanial statement foal points arising from ontratual, regulatory, or apital market expetations 2. Weak internal ontrol an governane 3. Worsening eonomi onitions or inustry

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