- The postulates and principles approach was concerned with user objectives.
ANSWER: F
- Several important committee reports gave rise to objectives and standards in place of the postulates and principles approach.
ANSWER: T
- “A Statement of Basic Accounting Theory” (ASOBAT) assumed that the evaluative framework of standards and guidelines was dependent upon the objectives of accounting.
ANSWER: F
- The purpose of ASOBAT was to refine the objectives of financial statements as a part of a metatheoretical structure.
ANSWER: F
- Moonitz felt that APB Statement 4 should have been issued as an opinion rather than as a statement because departures from GAAP made in a statement did not have to be disclosed.
ANSWER: T
- APB Statement No. 4 acknowledges a conflict between the relevance and reliability objectives.
ANSWER: T
- Relevance is considered the most important of the qualitative objectives of APB Statement 4.
ANSWER: F
- APB Statement 4 adopted a very strong emphasis on the diversity of users.
ANSWER: T
- APB Statement 4 was in agreement with ASOBAT that financial statements should be oriented toward a limited group of users.
ANSWER: F
- According to APB Statement 4, basic accounting terminology is defined by whatever is being done in practice.
ANSWER: T
- Large parts of APB Statement 4 are restatements of the conventional wisdom of the time.
ANSWER: T
- The Trueblood report noted that, during the short run, cash flows are a better predictor of cash-generating power than are earnings.
ANSWER: F
- In the Trueblood Committee Report, the meaning of the word accountability is limited to the functions of safekeeping of assets and ensuring that they are used in accordance with investors’ purposes.
ANSWER: F
- According to the Trueblood Committee Report, current values should be reported when they differ significantly from historical costs.
ANSWER: T
- The purpose of SATTA was to provide a survey of the current financial accounting literature and a statement of where the profession stood relative to accounting theory.
ANSWER: T
- The decision usefulness approach is one of the classical approaches to accounting theory mentioned in SATTA.
ANSWER: F
- The overriding message of SATTA is that current cost should be accepted as the dominate valuation system.
ANSWER: F
- A problem brought up by SATTA is the diversity of users in terms of their decisions and their possible different information needs.
ANSWER: T
- Accounting information is determined by supply and demand.
ANSWER: F
- Empirical research has proven that user needs are heterogeneous.
ANSWER: F
- Accountability refers to the responsibility of management to report on achieving goals for the effective and efficient utilization of enterprise resources.
ANSWER: T
- Measurements based on the accountability objective would include earnings per share but not return on investment.
ANSWER: F
- The main problem standing in the way of newer information approaches is the perceived competitive disadvantage of making public matters that management would prefer to keep secret.
ANSWER: T
- The first statement to address the issue of user objectives extensively was ASOBAT.
ANSWER: F
- SATTA expressed the opinion that choice among accounting theories could not be made at the time because of the diversity of users and their presumably different objectives and information needs.
ANSWER: T
- The Chartered Financial Analysts’ business reporting model for equity investors shows a preference for relevance over reliability.
ANSWER: T
MULTIPLE CHOICE
- Which of the following bodies did not publish one of the important committee reports and documents that lead to accounting objectives and standards?
ANSWER: D
- Which of the following organizations published “Objectives of Financial Statements” (Trueblood Committee Report)?
ANSWER: B
- Which of the following organizations published “A Statement of Basic Accounting Theory” (ASOBAT)?
ANSWER: A
- Which of the following documents stated fundamental concepts of financial reporting that would serve as a foundation for the opinions of the APB?
| a. | “Objectives of Financial Statements” (Trueblood Committee Report) |
| b. | “Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises” (APB Statement 4) |
| c. | “A Statement of Basic Accounting Theory” (ASOBAT) |
| d. | “Statement of Accounting Theory and Theory Acceptance” (SATTA) |
ANSWER: B
- Which of the following documents contained a definition of accounting that fortified the perception of the accountant as a learned professional whose presentation must be accepted by those who do not have his qualifications and credentials?
| a. | “Statement of Accounting Theory and Theory Acceptance” (SATTA) |
| b. | “A Statement of Basic Accounting Theory” (ASOBAT) |
| c. | “Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises” (APB Statement 4) |
| d. | “Accounting Terminology Bulletin No. 1” |
ANSWER: D
- Which of the following documents defined accounting as a service activity whose function is “to provide quantitative information… that is intended to be useful in making economic decisions”?
| a. | “Objectives of Financial Statements” (Trueblood Committee Report) |
| b. | “Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises” (APB Statement 4) |
| c. | “A Statement of Basic Accounting Theory” (ASOBAT) |
| d. | “Statement of Accounting Theory and Theory Acceptance” (SATTA) |
ANSWER: B
- Which of the following documents first stated that users of financial statements should be knowledgeable and should understand the characteristics and limitations of financial statements?
| a. | “Objectives of Financial Statements” (Trueblood Committee Report) |
| b. | “Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises” (APB Statement 4) |
| c. | “A Statement of Basic Accounting Theory” (ASOBAT) |
| d. | “Statement of Accounting Theory and Theory Acceptance” (SATTA) |
ANSWER: B
- ASOBAT emphasized which of the following in its definition of accounting?
| a. | The creative ability of the accountant |
| b. | The work and skill of the accountant |
| c. | The needs of the users of accounting information |
| d. | Recording transactions |
ANSWER: C
- Which of the following was not a goal of ASOBAT?
| a. | To identify the field of accounting so that useful generalizations about it could be made and a theory developed |
| b. | To establish standards by which accounting information might be judged |
| c. | To point out possible improvements in accounting practice |
| d. | To emphasize the creative skill and ability of the accountant, whose presentation should be accepted by those who do not have his or her qualifications and credentials |
ANSWER: D
- Which of the following is not one of the four objectives of accounting given by ASOBAT?
| a. | To make decisions concerning the use of limited resources (including the identification of crucial decision areas) and to determine objectives and goals |
| b. | To direct and control an organization’s human and material resources effectively |
| c. | To relate the evaluative framework of standards and guidelines to the objectives themselves |
| d. | To facilitate social functions and controls |
ANSWER: C
- Which of the following set of standards is at the heart ASOBAT?
| a. | Relevance, Verifiability, Objectivity, Usefulness |
| b. | Relevance, Verifiability, Freedom from Bias, Quantifiability |
| c. | Reliability, Verifiability, Freedom from Bias, Quantifiability |
| d. | Relevance, Usefulness, Freedom from Bias, Objectivity |
ANSWER: B
- Which of the following is not a problem of APB Statement 4 mentioned in the text?
| a. | It is questionable whether the objectives can be implemented by means of the various principles derived from the existing body of accounting. |
| b. | It contains a loosely worded set of definitions. |
| c. | It attempts to be all things to all people. |
| d. | It does not state important evolutionary changes that had begun to occur. |
ANSWER: D
- Which of the following standards is related to measurement theory?
| a. | Quantifiability |
| b. | Freedom from bias |
| c. | Usefulness |
| d. | Objectivity |
ANSWER: A
- Which of the following standards is related to the qualitative characteristic of neutrality?
| a. | Quantifiability |
| b. | Freedom from bias |
| c. | Usefulness |
| d. | Objectivity |
ANSWER: B
- Which of the following statements is not true regarding the Trueblood Committee?
| a. | It was formed at a time when the APB was under heavy criticism. |
| b. | It was formed when very little progress was being made in terms of reformulating the structure of accounting theory. |
| c. | It was charged with using APB Statement 4 as a vehicle for refining the objective of financial statements. |
| d. | It enumerated a total of twelve objectives of financial accounting. |
ANSWER: B
- According to Sorter and Gans, which of the following describes the intent of the Trueblood Committee Report’s second financial statement objective?
| a. | Financial statements should serve those with limited ability. |
| b. | Financial statements should serve special needs of specific users. |
| c. | Financial statements should serve the general needs of users. |
| d. | Financial statement should serve only those users who are very knowledgeable about financial statements and information. |
ANSWER: C
- According to the text, “limited ability” in the Trueblood Committee Report’s second financial statement objective may refer to:
| a. | full disclosure. |
| b. | financial statements designed to meet the special needs of specific users. |
| c. | serving users with specific limitations. |
| d. | both a and b. |
ANSWER: A
- Which of the following statements is true regarding the Trueblood Committee Report?
| a. | It expresses the belief that different valuation bases are appropriate for different assets and liabilities. |
| b. | It is concerned with guaranteeing additivity of asset and liability amounts. |
| c. | It expresses the belief that the same valuation base should be used for all assets and all liabilities. |
| d. | Both b and c. |
ANSWER: A
- Which of the following statements is not true regarding the Trueblood Committee Report?
| a. | It emphasizes the importance of cash flows to users. |
| b. | It emphasizes the relation of earning-power measurements to the generation of future cash flows. |
| c. | Its earning-power orientation to income is grounded in the notion that in computing economic income, future cash flows should not be discounted to present value. |
| d. | Its objectives represented an important step taken toward establishing a meaningful conceptual framework of objectives. |
ANSWER: C
- Which of the following is not true regarding SATTA?
| a. | It attempted to develop metatheoretical guidelines for the evaluation of accounting information and valuation systems. |
| b. | It took into account the many valuation systems of accounting as well as other theoretical considerations. |
| c. | It enumerated the reasons why it was impossible to develop criteria that would enable the profession to unequivocally accept a single valuation system for accounting. |
| d. | It was commissioned by the AAA. |
ANSWER: A
- What was the purpose of SATTA?
| a. | To develop standards for accounting |
| b. | To determine an appropriate valuation system for financial statements |
| c. | To provide a survey of the current financial accounting literature and a statement of where the profession stood relative to accounting theory |
| d. | To develop metatheoretical guidelines for the evaluation of accounting information and valuation systems |
ANSWER: C
- For which of the following areas is broad information applicable to many user groups?
| a. | Predictive ability |
| b. | Accountability |
| c. | Both a and b |
| d. | None of the above |
ANSWER: C
- Which of the following is true regarding the predictive ability of accounting data?
| a. | The predictive ability objective is validated by market efficiency. |
| b. | Previous studies have indicated that historical cost income is not as good a predictor of itself as general price-level-adjusted income or current value income. |
| c. | Studies have found that income measurement methods that have the greatest predictive ability are also best in terms of most other objectives. |
| d. | Predictive ability is the same as the quantifiability standard of ASOBAT. |
ANSWER: A
- Which of the following statements is true regarding accountability?
| a. | Accountability refers to a narrower concept than does stewardship. |
| b. | Measurements based on the accountability objective include earnings per share but not return on investment. |
| c. | The question of which valuation system provides the best input for accountability-oriented measurement is unimportant. |
| d. | Accountability refers to the responsibility of management to report on achieving goals for the effective and efficient utilization of enterprise resources. |
ANSWER: D
- What is the most common thread running through various documents, reports, and monographs discussed in the text?
| a. | The historical cost method of income measurement is as good a predictor of itself as other methods. |
| b. | Financial statements should be relevant to users for decision-making purposes. |
| c. | Earning-power measurements are essential to the prediction of future cash flows. |
| d. | The same valuation base should be used for all assets and all liabilities. |
ANSWER: B
- Which of the following documents was the first to be based on an orientation toward user relevance?
| a. | “Objectives of Financial Statements” (Trueblood Committee Report) |
| b. | “Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises” (APB Statement 4) |
| c. | “A Statement of Basic Accounting Theory” (ASOBAT) |
| d. | “Statement of Accounting Theory and Theory Acceptance” (SATTA) |
ANSWER: C
- Which of the following documents was the first to address the issue of user objectives extensively?
| a. | “Objectives of Financial Statements” (Trueblood Committee Report) |
| b. | “Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises” (APB Statement 4) |
| c. | “A Statement of Basic Accounting Theory” (ASOBAT) |
| d. | “Statement of Accounting Theory and Theory Acceptance” (SATTA) |
ANSWER: A
- Which of the following documents expressed the opinion that a choice among accounting valuation systems could not be made because of the diversity of users?
| a. | “Objectives of Financial Statements” (Trueblood Committee Report) |
| b. | “Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises” (APB Statement 4) |
| c. | “A Statement of Basic Accounting Theory” (ASOBAT) |
| d. | “Statement of Accounting Theory and Theory Acceptance” (SATTA) |
ANSWER: D
- The major objectives of financial statements are:
| a. | capital maintenance measurement and adaptability. |
| b. | accountability and adaptability. |
| c. | predictive ability and accountability. |
| d. | capital maintenance and predictive ability. |
ANSWER: C
- The secondary objectives of financial statements are:
| a. | capital maintenance measurement and adaptability. |
| b. | accountability and adaptability. |
| c. | predictive ability and accountability. |
| d. | capital maintenance and predictive ability. |
ANSWER: A
ESSAY
- How did the definition of accounting change from the period before ASOBAT to the issuance of SATTA in 1977?
ANSWER:
Prior to ASOBAT, the most widely disseminated definition of accounting was used in 1953 in Accounting Terminology Bulletin No. 1, which emphasized the work and skill of the accountant. This definition fortified the perception of the accountant as a learned professional whose presentation must be accepted by those who do not have his qualifications and credentials. Virtually, no mention was made of the user of accounting information.
ASOBAT’s definition of accounting represented a fundamental departure from the past by addressing the users of accounting information and their needs. It defined accounting as “… the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information.”
APB Statement 4 started by defining accounting along the newer, user-oriented track that ASOBAT took. APB 4 then went further than ASOBAT by stating that users of financial statements should be knowledgeable and should understand the characteristics and limitations of financial statements.
Both ASOBAT and APB Statement 4 recognized the fact that many user groups require information for decision-making purposes. One of ASOBAT’s reactions to this problem was to call for multiple measures. The Trueblood Report, on the other hand, established the premise that while there are different user groups, they make similar decisions and have similar information needs. SATTA was more pessimistic than the Trueblood Report and concluded that while there is a large degree of user homogeneity among high users, there is much less homogeneity among other users.
- List and define the four standards for evaluating accounting that are at the heart of ASOBAT.
ANSWER:
The four standards at the heart of ASOBAT are:
| (1) | Relevance pertains to usefulness in making the decision at hand. |
| (2) | Verifiability is synonymous with objectivity and refers to the degree of statistical consensus among measurers. |
| (3) | Freedom from bias refers to neutrality in the preparation of financial statements. |
| (4) | Quantifiability refers to the ability to be measured. |
- Identify the major contributions of APB Statement 4.
ANSWER:
The major contributions of APB Statement 4 are:
| (1) | It defined accounting along the user-oriented track taken by ASOBAT. |
| |
| (2) | It adopted ASOBAT’s very strong emphasis on the diversity of users, but went further by stating the users of financial statements should be knowledgeable and should understand the characteristics and limitations of financial statements. |
| |
| (3) | It viewed financial statements as being general purpose in nature as opposed to oriented toward a limited group of users. |
| |
| (4) | It noted that accounting is a measurement discipline. |
| |
| (5) | The qualitative objectives identified consist of relevance, understandability, verifiability, neutrality, timeliness, comparability, and completeness. These would later appear as qualitative characteristics in the conceptual framework. The statement concurs with ASOBAT on possible conflict among objectives. |
| |
| (6) | It concentrated on developing the user-oriented approach. |
| |
| (7) | The pervasive principles and modifying conventions in the section on generally accepted accounting principles consist of those concepts that constitute the heart of the system of historical costing. |
- Respond to the following:
| a. | What is the decision usefulness approach to accounting theory? |
| b. | What are the characteristics and limitations of the decision-model approach? |
| c. | What are the characteristics of the decision-maker approach? |
ANSWER:
| a. | The decision usefulness approach is a contemporary approach to accounting theory that has concentrated on users of accounting reports, their decisions, information needs, and information-processing abilities. This approach has been further dichotomized into decision models and decision-makers. |
| |
| b. | The characteristics of the decision-model approach are: |
| (1) | They are normative and deductive. |
| (2) | Some form of relevance for particular decisions by a particular user group or groups is stressed. |
| (3) | The relevance criterion is instrumental in measuring the selected attributes of assets, liabilities, and income transactions. |
| Since decision-model approaches are deemed appropriate for communicating extremely relevant information for decision-making, an argument can be made that users must be educated to understand the method. |
| |
| c. | The decision-maker approach is descriptive and inductive. It attempts to find out what information is actually used or desired, the assumption being that the information that is desired should be supplied. |
- Identify and explain the two primary objectives of financial statements and the two secondary objectives of financial statements.
ANSWER:
The two primary objectives of financial statements are predictive ability and accountability. Predictive ability refers to the usefulness of accounting data as an aid to predicting future variables. Accountability refers to the responsibility of management to report on achieving goals for the effective and efficient utilization of enterprise resources.
The two secondary objectives of financial statements are capital maintenance and adaptability. A measure of capital maintenance gives information about the amount of dividends that can be paid during a period without returning capital to the stockholders. Adaptability is concerned with measuring total liquidity available to the firm. This is determined by measuring the exit value of the firm’s assets minus its liabilities.
- Respond to the following:
| a. | List some of the possible groups of financial statement users. |
| b. | What is meant by “user diversity,” and does user diversity create a potential problem? |
ANSWER:
Possible user groups include:
| (1) | Shareholders (actual and potential) |
| (2) | Creditors |
| (3) | Financial analysts and advisers |
| (4) | Employees |
| (5) | Labor unions |
| (6) | Customers |
| (7) | Suppliers |
| (8) | Industry trade associations. |
| (9) | Governmental agencies |
| (10) | Public-interest groups |
| (11) | Researchers and standard setters |
User diversity refers to the fact that different users have different types of objectives. For example, actual shareholders probably desire information that would maximize security values, whereas potential shareholders would prefer information that would minimize security values. This creates a potential problem because it is not clear whether the information needs of the various types of objectives can be satisfied by general-purpose financial statements. However, despite the heterogeneity of groups of users as well as within groups, empirical research has not proven that the groups have strongly differentiated information needs.
CHAPTER 7
TRUE/FALSE
- The conceptual framework is an attempt to provide a metatheoretical structure for financial accounting.
ANSWER: T
- The most important new issue brought up in the discussion memorandum that preceded the conceptual framework was predictive ability.
ANSWER: F
- The discussion memorandum that preceded the conceptual framework was perhaps the most extensive ever published by the FASB.
ANSWER: T
- The eight (8) statements making up the conceptual framework establish generally accepted accounting principles.
ANSWER: F
- SFAC No. 1 maintains that financial statements should be geared toward specific needs of particular user groups.
ANSWER: F
- The conceptual framework maintains that accounting reports should become the only relevant source of information about enterprises.
ANSWER: F
- SFAC No. 1 takes the position that users of financial statements must be assumed to be knowledgeable about financial information and reporting.
ANSWER: T
- With regard to users, SFAC No. 1 established that financial statements should be aimed at a common core of similar information users.
ANSWER: T
- The quality of understandability is a characteristic influenced by both users and preparers of accounting information.
ANSWER: T
- The benefits of accounting information pertain to how useful the accounting information is relative to the capital maintenance and accountability objectives.
ANSWER: F
- Competitive disadvantage is an indirect cost of published information.
ANSWER: T
- The indirect costs of information pertain to gathering, preparation, and dissemination of information.
ANSWER: F
- There is a conflict between timeliness and the other aspects of relevance.
ANSWER: 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.
ANSWER: 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.
ANSWER: F
- SFAC No. 5 appears to deny one of the main tenets of the efficient markets hypothesis.
ANSWER: 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.
ANSWER: T
- Comprehensive income as defined by SFAC No. 6 includes all changes in equity during a period.
ANSWER: F
- Relevance and reliability are the primary characteristics that standard setters should be concerned with.
ANSWER: T
- Timeliness and predictive value are the two main aspect of relevance.
ANSWER: F
- “Economic consequences” is not part of the conceptual framework.
ANSWER: T
- SFAC No. 8 included the true and fair view in the qualitative characteristics of accounting.
ANSWER: F
- Timeliness is an enhancing qualitative characteristic of information about economic phenomenon.
ANSWER: T
- Codification is a justification of the standard-setting process itself rather than of the individual standards that result from that process.
ANSWER: T
- The jurisprudential view of the FASB is concerned with the theory embodied in the conceptual framework.
ANSWER: F
- Opinion is virtually unanimous that SFAC No. 5 on recognition and measurement is the low point of the conceptual framework.
ANSWER: T
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. |
| d. | It includes seven statements of financial accounting concepts. |
ANSWER: C
- 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. |
| 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. |
ANSWER: A
- Which statement in the conceptual framework deals with qualitative characteristics of accounting information? Note that SFAC No. 8 replaces this older SFAC.
| a. | SFAC No. 1 |
| b. | SFAC No. 2 |
| c. | SFAC No. 3 |
| d. | SFAC No. 5 |
ANSWER: B
- Which statement in the conceptual framework is concerned with the objectives of business financial reporting? Note that SFAC 8 replaces this SFAC.
| a. | SFAC No. 1 |
| b. | SFAC No. 2 |
| c. | SFAC No. 3 |
| d. | SFAC No. 5 |
ANSWER: A
- 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 |
ANSWER: D
- The objectives of business financial reporting 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 |
ANSWER: A
- 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. |
| d. | Users of accounting information have limited ability regarding financial information and reporting. |
ANSWER: C
- The qualitative characteristics of accounting on which the conceptual framework is centered come under the general heading of:
| a. | relevance. |
| b. | materiality. |
| c. | representational faithfulness. |
| d. | decision usefulness. |
ANSWER: D
- Which of the following is a pervasive constraint under the “original” qualitative characteristics of accounting, pre-SFAC No. 8? It is an entity-specific constraint post SFAC No. 8.
| a. | Decision usefulness |
| b. | Understandability |
| c. | Materiality |
| d. | Neutrality |
ANSWER: C
- Under SFAC No. 8, which of the following are aspects of relevance?
| a. | Comparability and understandability |
| b. | Timeliness and comparability |
| c. | Representational faithfulness and decision usefulness |
| d. | Predictive value and confirmatory value |
ANSWER: D
- Which component of the conceptual framework is perhaps the most difficult to apply in practice?
| a. | Confirmatory value |
| b. | Understandability |
| c. | Benefits greater than costs |
| d. | Faithful representation |
ANSWER: C
- 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. |
| c. | representational faithfulness. |
| d. | understandability. |
ANSWER: B
- The degree of consensus among measurers is referred to in the conceptual framework as:
| a. | reliability. |
| b. | relevance. |
| c. | representational faithfulness. |
| d. | understandability. |
ANSWER: A
- 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. | faithful representation. |
| d. | understandability. |
ANSWER: C
- 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. |
ANSWER: D
- Pre-SFAC No. 8, the three components of reliability are:
| a. | predictive value, feedback value, timeliness. |
| b. | verifiability, neutrality, representational faithfulness. |
| c. | verifiability, predictive value, feedback value. |
| d. | relevance, comparability, materiality. |
ANSWER: B
- 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 |
ANSWER: D
- Which of the following is not part of the conceptual framework?
| a. | Conservatism |
| b. | Economic consequences |
| c. | Consistency |
| d. | None of the above are in the conceptual framework |
ANSWER: B
- 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 |
| b. | Earnings |
| c. | Revenue |
| d. | Profits |
ANSWER: A
- 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. |
| 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. |
ANSWER: B
- Which of the following is a true statement?
| a. | The eight 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. |
| d. | The key document in the series of SFACs that comprise the conceptual framework is SFAC No. 1. |
ANSWER: C
- Which of the following concepts was referred to as a convention in SFAC No. 2?
| a. | Consistency |
| b. | Materiality |
| c. | Comparability |
| d. | Conservatism |
ANSWER: D
- 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. |
ANSWER: D
- 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. |
| 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. |
ANSWER: A
- Which of the following is not true regarding SFAC No. 7?
| a. | SFAC No. 7 requires that estimated future cash flows be used for asset measurement in certain circumstances. |
| b. | SFAC No. 7 concerns specific measurement issues rather than conceptual-type issues. |
| c. | SFAC No. 7 applies only to initial recognition and not subsequent revaluations. |
| d. | SFAC No. 7 is divided into two parts: asset measurement and income measurement. |
ANSWER: D
ESSAY
- 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 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.
- Respond to the following:
| 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. |
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| 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 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 increases in equity from peripheral or incidental transactions of an entity and form all other transactions and other event and circumstance 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 transaction and other events and circumstance affecting the entity except those that result from expenses or distribution to owners.
- Discuss the criticisms that of 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 characteristics 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.
- Explain the main key points regarding asset and liability measurement made in SFAC No. 7.
ANSWER:
The most important point about asset measurement is that present value measurements are intended to simulate fair value rather than the particular present value of the asset to the firm itself. If a firm does not know the specific market value of a particular asset, it should strive for that discount rate which would lead as closely as possible to estimated fair value. Discount rates should also include risk and uncertainty which would reflect the assessment of the market toward the asset’s value. If a particular asset has several possible cash flows within specific years, the expected cash flows should be determined (the individual cash flows should be multiplied by their expected probabilities) rather than using the single most likely cash flow.
The key point about liability measurement is that the discount rate must be tied to the credit standing of the firm. This means that if the firm’s credit standing worsens, the valuation of the liability decreases (because a poorer credit standing means that the applicable interest (discount) rate would rise). Hence any firm acquiring the liability from the original creditor would pay less to acquire the liability due to the debtor’s worsening credit standing.
