FINANCIAL REPORTING CONCEPTS

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CHAPTER 11

FINANCIAL REPORTING CONCEPTS

CHAPTER STUDY OBJECTIVES

1.Explain the importance of having a conceptual framework of accounting, and list the key components. The conceptual framework ensures that there is a consistent and coherent set of accounting standards. Key components of the conceptual framework are the: (1) objective of financial reporting; (2) elements of the financial statements; (3) qualitative characteristics; (4) recognition and measurement concepts; and (5) foundational concepts, assumptions, and constraints.

2.Explain the objective of financial reporting, and define the elements of the financial statements.The objective of financial reporting is to provide useful information for investors and creditors in making decisions in their capacity as capital providers. The elements are assets, liabilities, equity, revenue, and expense. Each element has a specific definition. The definitions provide important guidance on when an element should be recognized.

3.Apply the fundamental and enhancing qualitative characteristics of the conceptual framework to financial reporting situations. The fundamental qualitative characteristics are relevance and faithful representation. Financial information has relevance if it makes a difference in a decision. Materiality is an important component of relevance. An item is material when it is likely to influence the decision of a reasonably careful investor or creditor. Information is faithfully represented when it shows the economic reality and is complete, neutral, and free from material error.The enhancing qualitative characteristics are comparability, verifiability, timeliness, and understandability. Comparability enables users to identify the similarities and differences between companies. The consistent use of accounting policies from year to year is part of the comparability characteristic. Information is verifiable if two knowledgeable and independent people would generally agree that it faithfully represents the economic reality. Timeliness means that financial information is provided when it is still highly useful for decision-making. Understandability enables reasonably informed users to interpret and comprehend the meaning of the information provided in the financial statements.

4.Apply the recognition and measurement criteria of the conceptual framework to financial reporting situations. General recognition criteria require that elements be recognized in the financial statements when it is probable that any economic benefit associated with the item will flow to or from the business and the item has a cost or value that can be measured or estimated with a reasonable amount of reliability. There are two approaches to revenue recognition: (1) contract-based and (2) earnings. The contract-based approach requires that revenue be recognized when promised goods or services are transferred and the amount reflects the consideration the business expects to receive.The earnings approach requires that revenue be recognized when the earnings process is complete, Accounting Principles 8th Canadian Edition (Volume 2) Jerry Weygandt, Donald Kieso, Paul Kimmel, Barbara Trenholm, Valerie Warren, Lori Novak (Test Bank All Chapters, 100% Original Verified, A+ Grade) (Chapter 11-18) Answers At The End Of Each Chapter 1 / 4

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the risks and rewards of ownership have been transferred, and the amount can be reliably measured.Expenses are recognized when there is a decrease in an asset or increase in a liability, excluding transactions with owners, which result in a decrease in owners’ equity. Four measurements used in accounting are (1) historical cost, (2) current cost, (3) realizable value, and (4) present value. Incorrect application of the basic recognition and measurement concepts can lead to material misstatements in the financial statements. Incorrect application can be due to error or intentional misstatement.

• Apply the foundational concepts, assumptions, and constraints of the conceptual framework to

financial reporting situations. The foundational concepts, assumptions, and constraints form the bedrock of accounting and are used to achieve the objective of financial reporting. The reporting entity concept requires that accounting for a reporting entity’s activities be kept separate and distinct from the accounting for the activities of its owner and all other reporting entities. The going concern assumption assumes that the company will continue operating for the foreseeable future. The monetary unit concept means that money is the common denominator of economic activity. The periodicity concept guides businesses in dividing up their economic activities into distinct time periods. The cost constraint is a pervasive constraint that ensures the value of the information provided is greater than the cost of providing it. The full disclosure concept requires companies to fully disclose circumstances and events that make a difference to financial statement users.

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EXERCISES

Exercise 1

The conceptual framework for accounting discusses the following:

Code:

A Objective of Financial Reporting B Qualitative Characteristics of Accounting Information C Elements of Financial Statements

Instructions For each item below, indicate the area of the conceptual framework that pertains to that item by selecting the appropriate code.

Example:

C Asset (An asset is an element of financial statements.) ____ 1. Information that is helpful in assessing management’s performance ____ 2. Owners' equity ____ 3. Timeliness ____ 4. Neutral ____ 5. Expense ____ 6. Confirmatory value ____ 7 Faithful representation ____ 8 Comparability-consistency ____ 9. Information that is useful in making resource allocation decisions ____ 10 Full disclosure principle

Solution 1 (5 min.)

• A

• C

• B

• B

• C

• B

• B

• B
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• A

• B

Bloomcode: Analysis

Difficulty: Medium

Learning Objective: Explain the importance of having a conceptual framework of accounting, and list the key components.

Section Reference: The Conceptual Framework of Accounting

Learning Objective: Explain the objective of financial reporting, and define the elements of the financial statements.

Section Reference: The Objective of Financial Reporting

Learning Objective: Apply the fundamental and enhancing qualitative characteristics of the conceptual framework to financial reporting situations.

Section Reference: Qualitative Characteristics of Useful Financial Information

Learning Objective: Apply the foundational concepts, assumptions, and constraints of the conceptual framework to financial reporting situations.

Section Reference: Foundational Concepts, Assumptions, and Constraints

CPA: Financial Reporting

AACSB: Analytic

Exercise 2 For each item below, indicate whether the item is a(an) (1) Fundamental Qualitative Characteristic, (2) Enhancing Qualitative Characteristic, (3) Element of the Financial Statements, (4) Concept, or (5) Constraint.

Example:

(3)_ Asset (An asset is an element of financial statements.) ____ a) Relevance ____ b) Comparability ____ c) Cost-Benefit ____ d) Timeliness ____ e) Revenue ____ f) Owner’s equity ____ g) Faithful representation ____ h) Going concern ____ i) Reporting entity ____ j) Monetary unit

Solution 2 (5 min.)

• (1)

• (2)
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