Chapter 2: The Conceptual Framework

Question 1

Objective of the conceptual framework

Answer 1

To lessen the different circumstances that lead to the use of various definitions and recognition criteria which are used for the preparation of financial statements.

Question 2

Objective of general purpose financial reporting

Answer 2

To provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors (primary users) in making decisions about providing resources to the entity.

Question 3

Qualitative characteristics of useful financial information

Answer 3

Features that make information in financial statements useful for the users.

Question 4

Name two fundamental qualitative characteristics

Answer 4

• Relevance

- Faithful representation

Question 5

Relevance

Answer 5

• Predictive value (can be used to make one’s own predictions)
• Confirming value (provides feedback on previous evaluations)

Question 6

Faithful representation

Answer 6

• Completeness
• Neutrality
• Free from error

Question 7

4 enhancing qualitative characterisitics

Answer 7

• Comparability
• Verifiability
• Timeliness
• Understandability

Question 8

Comparability

Answer 8

Users want comparable information to judge tendencies over time and between similar entities to evaluate their own relative financial position.

Question 9

Verifiability

Answer 9

Verifiability helps assure users that information faithfully represents the economic events it purports to represent.

Question 10

Timeliness

Answer 10

Information must be available on a timely basis for users to influence their decisions.

Question 11

Understandability

Answer 11

Information must be reasonably understandable to users.

Question 12

Underlying assumptions to the preparation of financial assumptions.

Answer 12

• Accrual basis

- Going concern

Question 13

Accrual basis

Answer 13

Transactions and other events are accounted for when they occur and not as late as the date on which cash is received or paid.

Question 14

Going concern

Answer 14

Financial statements are prepared with the assumption that the entity will continue to be in business in the foreseeable future.

Question 15

Five elements of financial statements

Answer 15

• Assets
• Liabilities
• Equity
• Income
• Expenses

Question 16

Asset

Answer 16

A resource that is controlled by the entity as a result of events in the past and from which future economic benefits will flow to the entity.

Question 17

Two broad groups of assets

Answer 17

• Non-current assets (property, vehicles etc.)

- Current assets (cash, inventory, etc.)

Question 18

Liability

Answer 18

A present obligation of an entity arising from past events, the settlement of which is expected to result in an outflow of resources from the entity.

Question 19

Two broad groups of liabilities

Answer 19

• Non-current liabilities (long-term loans)

- Current liabilities (creditors, bank overdrafts, provisions).

Question 20

Equity

Answer 20

The residual interest in the assets of the entity after deducting all its liabilities.

Question 21

Two subdivisions of equity

Answer 21

• Capital (Contributions minus withdrawals

- Profit/loss

Question 22

Income

Answer 22

Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets, or decreases in liabilities that result in increase in equity, other than those relating to contributions by equity participants.

Question 23

Revenue

Answer 23

Income that arises in the course of ordinary activities of an entity (sales, fees, interest, dividends, royalties, rent).

Question 24

Gains

Answer 24

Income that doesn’t necessarily arise from the ordinary activities of an entity.
(profit on sales of assets, etc.)

Question 25

Recognition

Answer 25

The process of including an item in the balance sheet or income statement.
The item complies with the definition of an element that satisfies the criteria for recognition.

Question 26

Recognisable item

Answer 26

• it is probable that future economic benefits, closely related to the item, will flow to or from the entity
• the item has a cost or value which could be measured reliably

Question 27

Fair value

Answer 27

The amount for which an asset could be exchanged, or a liability settled, between two knowledgeable, willing parties in an arm’s length transactions.

Question 28

Conditions for recognising revenue from the sale of goods:

Answer 28

• The entity has transferred to the buyer the significant risks and rewards of ownership of the goods.
• The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold.
• The amount of revenue can be measured reliably
• It is probable that economic benefits associated with the transaction will flow to the entity
• The costs incurred or to be incurred in respect of the transaction can be measured reliably

Question 29

Conditions for the reliable estimation for the outcome of a transaction:

Answer 29

• The amount of revenue can be measured reliably.
• It is probable that the economic benefits associated with the transaction will flow to the entity.
• The stage of completion of the transaction can be measured reliably.
• The costs incurred for the transaction and the costs to complete the transaction can be measured reliably.

Question 30

Measurement

Answer 30

The process of determining the amount at which the elements of the financial statements are recognised and reflected in the balance sheet and the income statement.

Question 31

Measurement bases used in financial statements

Answer 31

• Historical cost
• Current cost
• Realisable value
• Present value

Question 32

Historical cost of assets

Answer 32

Cash/cash equivalents paid to acquire the asset.

Question 33

Historical cost of liabilities

Answer 33

Settlement amount

Question 34

Current cost of an asset

Answer 34

Cash/cash equivalents to acquire the same asset currently

Question 35

Current cost of a liability

Answer 35

Undiscounted cash/cash equivalents needed to settle the obligation currently.

Question 36

Realisable value of an asset

Answer 36

Cash/cash equivalents that could currently be obtained by selling the asset in an orderly disposal.

Question 37

Realisable value of a liability

Answer 37

Cash/cash equivalents expected to be paid to settle the liability in the ordinary course of business.

Question 38

Present value of assets

Answer 38

Present discounted value of the future net cash inflows expected to be generated in the normal course of business.

Question 39

Present value of liabilities

Answer 39

Present discounted value of the future net cash outflows required to settle the liabilities in the normal course of business.

Question 40

The entity concept

Answer 40

The fundamental concept in accounting:
The difference between the enterprise/entity and its owners/shareholders.
A separate set of financial records and financial statements are required for each entity as well as for the owners of the entity.