Acct 351 Chapter 02

Question 1

assets

Answer 1

Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

Question 2

basic elements

Answer 2

These are definitions that are to be included in any theoretical structure, for instance terms that constitute the language of accounting and business, e.g. assets, liabilities, equity

Question 3

comparability

Answer 3

Where information that has been measured and reported in a similar manner for different enterprises is considered comparable. This enables users to identify the real similarities and differences in economic phenomena because they have not been obscured by incomparable accounting methods

Question 4

completeness

Answer 4

The quality of accounting information that makes it reliable by including all information necessary to provide an accurate portrayal of events and transactions.

Question 5

comprehensive income

Answer 5

An income measure that includes net income and all other changes in equity exclusive of owners’ investments and distributions.

Question 6

conceptual framework

Answer 6

A coherent system of interrelated objectives and fundamentals that can lead to consistent standards and that prescribes the nature, function, and limits of financial accounting and financial statements

Question 7

conservatism

Answer 7

A constraint of financial reporting that means: when in doubt choose the solution that will least likely overstate assets and income.

Question 8

consistency

Answer 8

When an entity applies the same accounting treatment to similar events from period to period, the entity is considered to be consistent in its use of accounting standards

Question 9

constructive obligation

Answer 9

A type of performance obligation not stated in a contract that is created through a past practice or by signalling something to potential customers, such as a “100% satisfaction guaranteed” policy.

Question 10

control

Answer 10

Definitions vary. Under PE GAAP, control is the continuing power to determine the strategic operating, financing, and investing policies of another entity without the cooperation of others. A new definition under IFRS refers to control as the power to direct the activities of another entity to generate returns, either positive or negative, for the investor

Question 11

cost-benefit relationship

Answer 11

A constraint of financial reporting meaning that the costs of obtaining and providing information should not be higher than the benefits that are gained by providing it

Question 12

debt covenants

Answer 12

These are requirements to adhere to certain liquidity and solvency ratios such as current and debt-to-equity ratios that many creditors include in lending agreements

Question 13

decision usefulness

Answer 13

The amount and types of information to be disclosed and the format in which information should be presented involves determining which alternate provides the most useful information for decision-making purposes.

Question 14

derecognition

Answer 14

The process of removing an item from an entity’s balance sheet or income statement

Question 15

discounted cash flow model

Answer 15

A model for measuring fair value that deals with uncertainty and the time value of money. It has two approaches: the traditional approach, and the expected cash flow approach

Question 16

economic entity assumption

Answer 16

An assumption that a company’s business activity can be kept separate and distinct from its owners and any other business units. Economic activity can therefore be identified with a particular degree of accountability

Question 17

economic substance

Answer 17

The underlying economic reality reported on a representationally faithful document (see transparency).

Question 18

elements of financial statements

Answer 18

Definitions of basic terms in accounting

Question 19

equity/net assets

Answer 19

The residual interest in the assets of an entity that remains after deducting its liabilities.

Question 20

exit price

Answer 20

Debt may be issued with a detachable warrant (option to buy common shares of the company). The warrants give the holder the right to buy common shares at a fixed price for a specified period of time.

Question 21

expected cash flow approach

Answer 21

An approach to the discounted cash flow model where a risk-free discount rate is used to discount cash flows that have been adjusted for uncertainty. The discount rate is the risk-free rate and the cash flow uncertainty is dealt with by using probabilities.

Question 22

expenses

Answer 22

These are decreases in economic resources, either by outflows or reductions of assets or incurrence of liabilities resulting from an entity’s ordinary revenue-generating activities.

Question 23

fair value option

Answer 23

The option given to companies allowing them to use fair value for most financial instruments where certain conditions are met

Question 24

fair value principle

Answer 24

The principle which requires assets and liabilities to be valued at a market-based fair value

Question 25

feedback/confirmatory value

Answer 25

The notion that relevant information helps users confirm or correct prior expectations

Question 26

financial engineering

Answer 26

This is a process whereby a business arrangement or transaction is structured legally such that it meets the company’s financial reporting objective (e.g., to maximize earnings, minimize a debt-to-equity ratio or other).

Question 27

first principles

Answer 27

These are foundational principles from which decisions stem (all decisions should theoretically be consistent if they stem from the same foundational reasoning). (Synonym: CICA Handbook Section 1000 principles plus concepts underlying all Handbook standards)

Question 28

freedom from material error/bias

Answer 28

A measure of the reliability of reported information, meaning that the relevant information is accurate and unaffected by the opinions of stakeholders.

Question 29

full disclosure principle

Answer 29

Financial reporting of any financial facts significant enough to influence the judgement of an informed reader.

Question 30

gains

Answer 30

Increases in equity (net assets) from an entity’s peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the entity during a period, except those that result from revenues or investments by owners

Question 31

general-purpose financial statements

Answer 31

These are basic GAAP financial statements that provide information that meets the needs of external users (normally investors and creditors)

Question 32

going concern assumption

Answer 32

The assumption of most accounting methods that the business will have a long life

Question 33

highest and best use

Answer 33

A concept for valuing assets that assumes the highest value that the market would place on the asset considering uses that are possible, legally permissible, and financially feasible.

Question 34

historical cost principle

Answer 34

An accounting principle required by GAAP that requires most assets and liabilities to be accounted for and reported on the basis of acquisition price.

Question 35

information overload

Answer 35

Too much information may result in a situation where the user is unable to digest or process the information

Question 36

laid-down costs

Answer 36

Any cost incurred to get the asset in place and ready for use (whether it is for sale or to generate income through use). (Synonym: out-of-pocket costs)

Question 37

liabilities

Answer 37

Described in the CICA Handbook as “obligations of an enterprise arising from past transactions or events, the settlement of which may result in the transfer of assets, provisions of services or other yielding of economic benefits in the future”.

Question 38

losses

Answer 38

Decreases in equity (net assets) from an entity’s peripheral or incidental transactions and from all other transactions and other events and circumstances affecting the entity during a period, except those that result from expenses or distributions to owners.

Question 39

management best estimate

Answer 39

Assumptions made by management in light of their knowledge and familiarity with the company, the industry and the economy.

Question 40

matching

Answer 40

The accounting principle that dictates that efforts (expenses) be matched with accomplishments (revenues) whenever reasonable and practicable

Question 41

materiality

Answer 41

The constraint that relates to an item’s impact on a firm’s overall financial operations. An item is material if its inclusion or omission would influence or change the judgement of a reasonable person

Question 42

measurement uncertainty

Answer 42

This is when there is a variance between the recognized amount and other reasonably possible amount

Question 43

monetary unit assumption

Answer 43

The assumption that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis

Question 44

most advantageous market

Answer 44

A concept for valuing assets that considers the value based on the market that would pay the most for the asset

Question 45

neutrality

Answer 45

The quality of accounting information that makes it reliable by being reasonably free of error and bias.

Question 46

non-monetary or barter transactions

Answer 46

A type of transaction where no cash or monetary consideration is exchanged, making it hard to determine cost or fair value.

Question 47

non-monetary, non-reciprocal transactions

Answer 47

A type of transaction where there is no exchange (e.g., donations), making it hard to determine cost or fair value.

Question 48

notes to financial statements

Answer 48

Information that is linked to the financial statements that generally amplifies or explains the items presented in the main body of the statements in order to complete the picture of an enterprise’s performance and position.

Question 49

objective of financial reporting

Answer 49

As laid out in the CICA Handbook: “to communicate information that is useful to investors, member, contributors, creditors, and other users in making their resource allocation decisions and/or assessing management stewardship

Question 50

other comprehensive income

Answer 50

This is the balance of all past charges and credits to other comprehensive income to the balance sheet date

Question 51

performance obligations

Answer 51

An obligation that arises when an entity promises to deliver something or provide a service in the future

Question 52

periodicity assumption

Answer 52

The accounting assumption that implies that an enterprise’s economic activities can be divided into artificial time periods

Question 53

predictive value

Answer 53

A characteristic of accounting information that helps users make predictions about the ultimate outcome of past, present, and future events

Question 54

present economic resources

Answer 54

Resources owned by an entity that have economic value and can be sold or used right away.

Question 55

qualitative characteristics

Answer 55

The characteristics defined by the conceptual framework that distinguish more useful information from less useful information for decision-making purposes.

Question 56

realizable (revenue)

Answer 56

Revenue from assets received or sold can be readily converted into cash or claims to cash.

Question 57

realized (revenue)

Answer 57

Revenue from assets received or sold that are exchanged for cash or claims to cash

Question 58

reciprocal exchange

Answer 58

A two-way exchange

Question 59

recognition

Answer 59

The process of recording a transaction in an entity’s balance sheet or income statement

Question 60

related party transactions

Answer 60

When a business engages in transaction in which one of the transacting parties has the ability to significantly influence the policies of the other, or in which a nontransacting party has the ability to influence the policies of the two transacting parties

Question 61

relevance

Answer 61

A qualitative characteristic of accounting information that indicates that it must make a difference in a decision

Question 62

representational faithfulness

Answer 62

A qualitative characteristic of accounting information that represents economic reality. It must be transparent, complete, neutral, and free from material error/bias.

Question 63

revenue recognition principle

Answer 63

The accounting principle that sets guidelines as to when revenue should be reported

Question 64

revenues

Answer 64

Increases in economic resources, either by inflows or other enhancements of an entity’s assets or settlement of its liabilities resulting from an entity’s ordinary activities

Question 65

stand-ready obligations

Answer 65

A type of liability that is unconditional whereby the obligor stands prepared to fulfill the terms of the contract when required, such as an insurance contract or warranty.

Question 66

supplementary information

Answer 66

Information that may include details or amounts, which presents a different perspective from that adopted in the financial statements

Question 67

timeliness

Answer 67

A characteristic of relevance that states that information must be available for decision-makers before it loses its capacity to influence their decisions

Question 68

traditional approach

Answer 68

An approach to the discounted cash flow model where the discount rate reflects all risks in the cash flows but the cash flows are assumed to be certain. The stream of contracted cash flows is discounted, and the discount rate is adjusted to accommodate their riskiness

Question 69

transparency

Answer 69

Is a goal of financial reporting such that the information provided reflects the underlying transactions and events and their effects on a company. (Synonym: representational faithfulness)

Question 70

understandability

Answer 70

The quality of information that permits reasonably informed users to perceive its significance

Question 71

verifiability

Answer 71

The quality of information that demonstrates that independent measurers, using the same measurement methods, obtain similar results

Question 72

Describe the usefulness of a conceptual framework

Answer 72

Describe the usefulness of a conceptual framework.
A conceptual framework is needed to (1) create standards that build on an established body of concepts and objectives, (2) provide a framework for solving new and emerging practical problems, (3) increase financial statement users’ understanding of and confidence in financial reporting, and (4) enhance comparability among different companies’ financial statements

Question 73

Describe the main components of a conceptual framework for financial r

Answer 73

The first level deals with the objective of financial reporting. The second level includes the qualitative characteristics of useful information and elements of financial statements. The third level includes foundational principles and conventions

Question 74

Understand the objective of financial reporting

Answer 74

The objective of financial reporting is to provide information that is useful to individuals making investment and credit decisions

Question 75

Identify the qualitative characteristics of accounting information

Answer 75

The overriding criterion by which accounting choices can be judged is decision usefulness; that is, the goal is to provide the information that is the most useful for decision-making. Fundamental characteristics include relevance and faithful representation. These two characteristics must be present. Enhancing characteristics include comparability, verifiability, timeliness, and understandability. There may be trade-offs.

Question 76

Define the basic elements of financial statements

Answer 76

The basic elements of financial statements are (1) assets, (2) liabilities, (3) equity, (4) revenues, (5) expenses, (6) gains, and (7) losses

Question 77

Describe the foundational principles of accounting

Answer 77

(1) Economic entity: the assumption that the activity of a business enterprise can be kept separate and distinct from its owners and any other business unit. (2) Control: the entity has the power to make decisions and reap the benefits. (3) Revenue recognition: revenue is generally recognized when it is (a) earned, (b) measurable, and (c) collectible (realizable). (4) Matching assists in the measurement of income by ensuring that costs (relating to long-lived assets) incurred in earning revenues are booked in the same period as the revenues earned. (5) Periodicity: the assumption that an enterprise’s economic activities can be divided into artificial time periods to facilitate timely reporting. (6) Monetary unit: the assumption that money is the common denominator by which economic activity is conducted, and that the monetary unit gives an appropriate basis for measurement and analysis. (7) Going concern: the assumption that the business enterprise will have a long life. (8) Historical cost principle: existing GAAP requires that many assets and liabilities be accounted for and reported based on their acquisition price. Many assets are later revalued. (9) Fair value principle: assets and liabilities are valued at fair value, that is, an exit price and viewed from a market participant perspective. (10) Full disclosure principle: accountants follow the general practice of providing information that is important enough to influence an informed user’s judgement and decisions

Question 78

Explain the factors that contribute to choice and/or bias in financial reporting decisions

Answer 78

Choice is the result of many things, including GAAP’s basis of principles, measurement uncertainty, and increasingly complex business transactions. The conceptual framework is the foundation that GAAP is built on. If there is no primary source of GAAP for a specific decision, then professional judgement must be used, making sure that the accounting policies chosen are consistent with the primary sources of GAAP and the conceptual framework.

Financial engineering is the process of legally structuring a business arrangement or transaction so that it meets the company’s financial reporting objective. This is a dangerous practice since it often results in biased information.
Fraudulent financial reporting often results from pressures on individuals or the company. These pressures may come from various sources, including worsening company, industry, or economic conditions; unrealistic internal budgets; and financial statement focal points related to contractual, regulatory, or capital market expectations. Weak internal controls and governance also contribute to fraudulent financial reporting

Question 79

Discuss current trends in standard setting for the conceptual framework

Answer 79

The IASB and FASB will continue to work toward a common conceptual framework. The project on objectives and qualitative characteristics is essentially complete. The Boards are focusing on defining elements and the recognition/measurement frame-works.

Question 80

Understand in greater detail how fair value is measured

Answer 80

Fair value measurement is a market-based approach which incorporates the specific attributes of the asset/liability being measured, the valuation premise (how the asset/liability is to be used), the most advantageous market, and the availability of data. Since market prices are not always available, valuation models are used to measure the value. Inputs to these models are either observable in the market or not. Observable inputs are most useful since they are more objective. The fair value hierarchy establishes three levels of inputs, with level one being the highest/best type of input (based on market prices which are observable). Because level three inputs are more subjective, additional disclosures are required. Valuation models include discounted cash flow and options pricing models.