Constraints and Present Value

Question 1

What is an Accounting Constraint?

Answer 1

They provide exceptions to GAAP. They refer to a condition for which the normal measurement and recognition rules are modified.

Question 2

What are the 2 accounting constraints?

Answer 2

1. ) Cost Materiality

2. ) Cost effectiveness

Question 3

What is the cost effectiveness constraint?

Answer 3

This limits recognition and disclosure if the cost of providing the information exceeds its benefit. Firms may not omit disclosures if they are material and mandated by GAAP.

Question 4

What is the conservastism constraint?

Answer 4

This is no longer a constraint. This is the reporting of less optimistic amounts under conditions of uncertainty where GAAP provides a choice. This sometimes is preferred so that expectations are not inflated for investors.

Question 5

What Financial Statements should be included in a “Full Set”?

Answer 5

1. ) Financial Position at year-end (Balance Sheet)
2. ) Earnings for Year (Income Statement)
3. ) Statement of Comprehensive Income
4. ) Statement of Cash Flows
5. ) Statement of Owner’s Equity

Question 6

What Criteria must be met in relation to measurement and recognition of items in a Financial Report?

Answer 6

1. ) Definition - Must meet definition
2. ) Measurability - There is an attribute to be measured
3. ) Relevance - Information capable of influencing decisions, is timely, has predictive ability, provides feedback value.
4. ) Reliability - Is faithful, verifiable, and neutral.

Question 7

What are the 10 elements that appear in a financial report?

Answer 7

1. ) Assets - Resources that have probable future benefits.
2. ) Liabilities - Future sacrifices of economic benefits
3. ) Equity - Residual interest in the firm’s assets
4. ) Investments by Owners - Capital Contributed
5. ) Distribution to Owners - Decrease of assets to owners
6. ) Comprehensive Income - Changes in equity other than investment by owner and distribution
7. ) Revenue - Increases in assets or settlements of liab.
8. ) Expenses - Decreases in assets or incurrence of liab.
9. ) Gains - Increase in equity from peripheral trans.
10. ) Losses - Decrease in equity from peripheral trans.

Question 8

What are the 3 Aspects that define an “Asset”?

Answer 8

1. ) Resources that have probable future benefits
2. ) Controlled by Management
3. ) Resulting from Past Transactions

Question 9

What does a Fresh Start measurement do?

Answer 9

Establishes a new carrying value after an initial recognition and is unrelated to previous amounts.

Question 10

List the elements which a present value measurement should include that fully captures economic differences?

Answer 10

1. ) An estimate of future cash flows
2. ) Expectations about variations in amount or timing of those cash flows
3. ) Time value of money as measured by the risk-free rate of interest
4. ) The price for bearing the uncertainty inherent in the asset or liability
5. ) Any other relevant factors

Question 11

What are the two approaches to computing present value using cash flows?

Answer 11

1. ) The traditional approach

2. ) The expected cash flow approach

Question 12

What is the Traditional Approach to computing present value?

Answer 12

Uses a single most likely cash flow in the computation. It uses the interest rate to capture all the uncertainties and risks inherent in a cash flow measurement. This is the approach that continues to be applied in some present value applications

Question 13

What is the Expected Cash Flow Approach to computing present value?

Answer 13

Uses expectations about all possible cash flows instead of the single most likely cash flow. Both uncertainty as to the timing and amount can be incorporated into the calculation. The board believes this gives a better estimate than the single cash flow value because it directly incorporates the uncertainty in estimated future cash flows.