Ch07 FASB Conceptual Framework.docx

Chapter 7 The FASB’s Conceptual Framework TRUE/FALSE The conceptual framework is an attempt to provide a methatheoretical structure for financial accounting ANS: T The most important new issue brought up in the discussion memorandum that preceded the conceptual framework was predictive ability. ANS: F The discussion memorandum that preceded the conceptual framework was perhaps the most extensive ever published by the FASB. ANS: T The six statements making up the conceptual framework establish generally accepted accounting principles. ANS: F SFAC No. 1 maintains that financial statements should be geared toward specific needs of particular user groups. ANS: F The conceptual framework maintains that accounting reports should become the only relevant source of information about enterprises. ANS: F SFAC No. 1 takes the position that users of financial statements must be assumed to be knowledgeable about financial information and reporting. ANS: T With regard to users, SFAC No. 1 established that financial statements should be aimed at a common core of similar information users. ANS: T The quality of understandability is a characteristic influenced by both users and preparers of accounting information. ANS: T The benefits of accounting information pertain to how useful the accounting information is relative to the capital maintenance and accountability objectives. ANS: F Competitive disadvantage is an indirect cost of published information. ANS: T The indirect costs of information pertain to gathering, preparation, and dissemination of information. ANS: F There is a conflict between timeliness and the other aspects of relevance. ANS: T According to SFAC No. 4, “earnings” is the indicator of a non-business organization’s performance that is comparable to “income” in the profit sector. ANS: F SFAC No. 5 makes clear that the concepts discussed in the conceptual framework apply to other means of disclosure in addition to financial statements. ANS: F SFAC No. 5 appears to deny one of the main tenets of the efficient-markets hypothesis. ANS: T The definitions of SFAC No. 6 are virtually identical to those in SFAC No. 3 except that they are extended to non-business organizations. ANS: T Comprehensive income as defined by SFAC No. 6 includes all changes in equity during a period. ANS: F Relevance and reliability are the primary characteristics that standard setters should be concerned with. ANS: T Timeliness and predictive value are the two main aspects of relevance. ANS: F “Economic consequences” is not part of the conceptual framework. ANS: T The concept of consistency was referred to as a convention in SFAC No. 2. ANS: F Timeliness is a constraint on both of the other aspects of relevance. ANS: T Codification is a justification of the standard-setting process itself rather than of the individual standards that result from that process. ANS: T The jurisprudential view of the FASB is concerned with the theory embodied in the conceptual framework. ANS: F MULTIPLE CHOICE Which of the following is not true regarding the FASB’s conceptual framework? a. It is supposed to embody a system of interrelated objectives. b. It is an attempt to provide a metatheoretical structure for financial accounting. c. It establishes generally accepted accounting principles. XXXXX d. It includes six statements of financial accounting concepts. Which of the following is not true regarding the discussion memorandum that preceded the conceptual framework? a. It represented the end product of the FASB’s deliberations related to the conceptual framework project. XXXXX b. The most important new issue brought up in the document was capital maintenance. c. It brought up three views of financial accounting and financial statements. d. It presented various definitions for basic accounting terms. Which statement in the conceptual framework deals with qualitative characteristics of accounting information? a. SFAC No. 1 b. SFAC No. 2 XXXXX c. SFAC No 3 d. SFAC No. 5 Which statement in the conceptual framework is concerned with the objectives of business financial reporting? a. SFAC No. 1 XXXXX b. SFAC No. 2 c. SFAC No. 3 d. SFAC No. 5 The qualitative characteristics of accounting information detailed in the conceptual framework proceeded directly from which of the following documents? a. The Trueblood Report b. SATTA c. APB Statement 4 d. ASOBAT XXXXX The objectives of business financial reporting detailed in the conceptual framework proceeded directly from which of the following documents? a. The Trueblood Report XXXXX b. SATTA c. APB Statement 4 d. ASOBAT Which of the following is a value judgment found in SFAC No. 1? a. Accounting reports should become the only relevant source of information about enterprises. b. Cash basis accounting is extremely useful in assessing and predicting earning power and cash flows of an enterprise. c. Information is not costless to provide, so benefits of usage should exceed costs of production. XXXXX d. Users of accounting information have limited ability regarding financial information and reporting. The qualitative characteristics of accounting that the conceptual framework has centered on come under the general heading of: a. Relevance b. Materiality c. Representational faithfulness d. Decision usefulness XXXXX Which of the following is a pervasive constraint of the qualitative characteristic of accounting? a. Decision usefulness b. Understandability c. Materiality XXXXX d. Neutrality Which of the following are aspects of relevance? a. Comparability and neutrality b. Timeliness and verifiability c. Representational faithfulness and decision usefulness d. Predictive value and feedback value XXXXX Which component of the conceptual framework is perhaps the most difficult to apply in practice? a. Materiality b. Timeliness c. Benefits greater than costs XXXXX d. Neutrality The quality of being capable of “making a difference in a decision by helping users to form predictions about the outcomes of past, present, and future events or to confirm or correct expectations” is referred to in the conceptual framework as: a. Reliability b. Relevance XXXXX c. Representational faithfulness d. Understandability The degree of consensus among measurers is referred to in the conceptual framework as: a. Reliability XXXXX b. Relevance c. Representational faithfulness d. Understandability The idea that a measurement should correspond with the phenomenon it is attempting to measure is referred to in the conceptual framework as: a. Reliability b. Relevance c. Representational faithfulness XXXXX d. Understandability Which of the following is a true statement regarding feedback value. a. It concerns confirming or correcting decision makers’ earlier expectations. b. It refers to assessing where the firm presently stands. c. It is closely related to accountability. d. All of the above XXXXX The three components of reliability are: a. Predictive value, feedback value, timeliness b. Verifiability, neutrality, representational faithfulness XXXXX c. Verifiability, predictive value, feedback value d. Relevance, comparability, materiality Which qualitative characteristic pertains wholly to the attitude of board members as opposed to being more directly concerned with specific aspects of information contained in the financial statements? a. Representational faithfulness b. Verifiability c. Consistency d. Neutrality XXXXX Which of the following is not part of the conceptual framework? a. Conservatism b. Economic consequences XXXXX c. Consistency d. None of the above are in the conceptual framework SFAC designated which of the following as the term to indicate the comprehensive or total change in net assets occurring during the period as a result of operations? a. Income XXXXX b. Earnings c. Revenue d. Profits Which of the following is a true statement? a. SFAC No. 5 makes clear that the concepts discussed in the conceptual framework apply to other means of disclosure in addition to financial statements. b. SFAC No. 5 appears to deny one of the main tenets of the efficient- markets hypothesis, that disclosure outside of the body of financial statements is as effective as disclosure within statements themselves. XXXXX c. SFAC No. 5 made a clear attempt to resolve the issues of recognition and measurement. d. SFAC No. 5 was successful because it addressed measurement prior to discussing recognition. Which of the following is not a true statement? a. Codification is a justification of the standard-setting process itself rather than of the individual standards that result from that process. b. The codificational approach results in a selection of the best possible accounting standards. XXXXX c. The conceptual framework is said to embody aspects of both a constitution and a theory. d. The codificational approach requires good reasons for the choice of accounting standards. Which of the following is a true statement? a. The six SFACs that comprise the conceptual framework were not evolutionary because they were derived from previous documents such as the Trueblood Report and ASOBAT. b. The definitions of SFAC No. 6 were basically a restatement of the definitions of APB Statement 4. c. The Achilles’ heel of the document is SFAC No. 5, which reaffirmed historical cost as the basic measurement system. XXXXX d. The key document in the series of SFACs that comprise the conceptual framework is SFAC No. 1. Which of the following concepts was referred to as a convention in SFAC No. 2? a. Consistency b. Materiality c. Comparability d. Conservatism XXXXX Which of the following is not a true statement? a. SFAC No. 3 defines 10 elements of financial statements. b. SFAC No. 3 is a resolution of the definitions presented in the discussion memorandum for the conceptual framework project. c. SFAC No. 3 was amended by SFAC No. 6 d. SFAC No. 3 discusses in detail the three views of financial accounting mentioned in the discussion memorandum. XXXXX Which of the following is a true statement? a. Predictive value refers to usefulness of inputs for predictions rather than being an actual prediction itself. XXXXX b. Timeliness complements rather than conflicts with the other aspects of relevance because information is more complete and accurate if it is timely. c. The conceptual framework stressed predictive value rather than the importance of decision-making by outside users. d. Timeliness and predictive value are the two main aspects of relevance. ESSAY QUESTIONS Do the SFACs that constitute the conceptual framework establish generally accepted accounting principles? What are the benefits and limitations of this approach? ANSWER: The SFACs that constitute the conceptual framework do not establish generally accepted accounting principles. This avoids the possibility of a crisis arising from a failure to comply with the statements. Also, the process of arriving at a workable and utilitarian metatheoretical-type structure must be acknowledged as a slow, evolutionary process. The tentative nature of the statements may make it easier to change components as the need arises. On the other hand, the possibility also exists that the statements will have a purely cosmetic effect. Why might SFAC No. 5 be considered a “failure?” ANSWER: SFAC No. 5 did not deal extensively with the issues of recognition and measurement. It backed away from considering possible criteria for change, which suggests a continued use of present measurement attributes and reliance on an evolutionary approach. It dealt with recognition ahead of measurement, but the issue of when to recognize an element cannot be discussed until we know the measurement characteristics that are to be recognized. In addition, the move toward the asset-liability viewpoint in the first three SFACs was a shift toward current valuation and away from matching. The counterreformation of SFAC No. 5, particularly its statement to the effect that change should occur in a gradual and evolutionary manner, effectively stymied this reform. a. How is net income different from earnings in SFAC No. 5? b. What is comprehensive income? ANSWER: a. One of the principal concerns of SFAC No. 5 was the format and presentation of changes in owners’ equity that do not arise from transactions with owners. “Earnings” would replace net income and would differ from the latter by excluding the cumulative effect on prior years of a change in accounting principle. Earnings would thus be a better indicator of current operating performance than net income. b. Comprehensive income includes all changes in owner’s equity during the period except for transactions with owners. A cumulative effect of a change in accounting principle would be included in comprehensive income as would such items as the income effect of recognized gains and losses of marketable securities that are not classified as current assets, foreign currency translation adjustments, and prior period adjustments. Explain the hierarchy of accounting qualities identified in SFAC No. 2. ANSWER: Decision-makers are at the top of the hierarchy. The specific qualitative characteristics of accounting come under the general heading of decision usefulness, continuing the emphasis on decision-makers and their needs. The two primary, decision-specific qualities are relevance and reliability. Comparability is a secondary qualitative characteristic. Relevance is defined as being capable of making a difference in a decision by helping users to form predictions about the outcomes of past, present, and future events or to confirm or correct expectations. Relevance has two main aspects – predictive value and feedback value – and one minor one, timeliness. Predictive value refers to usefulness of inputs for predictions while feedback value concerns confirming or correcting the expectations of decision-makers. Timeliness is really a constraint on both of the other aspects of relevance. To be relevant, information must be timely, which means that it must be “available to decision makers before it loses its capacity to influence decisions.” Reliability is composed of three components: verifiability, representational faithfulness, and neutrality. Verifiability refers to the degree of consensus among measurers. Representational faithfulness refers to the idea that the measurement itself should correspond with the phenomenon it is attempting to measure. Neutrality refers to the belief that the policy-setting process should be primarily concerned with relevance and reliability rather than the effect a standard or rule might have on a specific user group or the enterprise itself. These qualities are applied within the constraints of benefits greater than cost and materiality. Materiality addresses whether an item is large enough to influence users’ decisions. Define the elements of financial statements identified in SFAC No. 3 and SFAC No. 6. ANSWER: Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. Equity (or net assets) is the residual interest in the assets of an entity that remains after deducting its liabilities. Investments by owners are increases in equity resulting from transfers to it from other entities of something valuable to obtain or increase ownership interests (equity) in it. Distributions to owners are decreases in equity resulting from transferring assets, rendering services, or incurring liabilities by the enterprise to owners. Comprehensive income is the change in equity during a period from transactions and other events and circumstance from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Revenues are inflows or other enhancements of assets or settlements of its liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. Expenses are outflows or other depletion of assets or incurrences of liabilities from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations. Gains are increase in equity from peripheral or incidental transactions of an entity and form all other transactions and other events and circumstances affecting the entity except those that result from revenues or investment by owners. Losses are decreases in equity from peripheral or incidental transactions of an entity and from all other transactions and other events and circumstance affecting the entity except those that result from expenses or distribution to owners. Discuss the criticisms that have been aimed at SFAC No. 6. ANSWER: The definitions of the elements of financial statements have been criticized on the grounds that the various criteria for each of the categories is necessary but not sufficient to determine whether a general type of accounting event falls into a particular definitional category. However, it would be impossible to completely specify all characteristic of elements. The lack of completeness must be complemented by the professional judgment capabilities of the accountant and auditor. It has also been argued that the FASB definition of assets that emphasized future economic benefits is grounded in future revenue and income measurement. Consequently, the matching concept is the primary focus of the definition. It has been argued that the asset definition should concentrate on property rights that are concerned with wealth, which provides a true balance sheet orientation. This would result in certain deferred charges being expensed immediately even though their incurrence may bring about future economic benefits. Another argument related to the definitions of SFAC No. 6 concerns how broadly the term “past transactions” can be interpreted under the asset and liability definitions.