EXERCISES
E2-1 (L01,2) (Usefulness, Objective of Financial Reporting) Indicate whether the following statements about the conceptual framework are true or false. If false, provide a brief explanation supporting your position.
(a) Accounting rule-making that relies on a body of concepts will result in useful and consistent pronouncements.
(b) General-purpose financial reports are most useful to company insiders in making strategic business decisions.
(c) Accounting standards based on individual conceptual frameworks generally will result in consistent and comparable accounting reports.
(d) Capital providers are the only users who benefit from general-purpose financial reporting.
(e) Accounting reports should be developed so that users without knowledge of economics and business can become informed about the financial results of a company.
(f) The objective of financial reporting is the foundation from which the other aspects of the framework logically result.
E2-2 (L01,2,3) (Usefulness, Objective of Financial Reporting, Qualitative Characteristics) Indicate whether the following statements about the conceptual framework are true or false. If false, provide a brief explanation supporting your position.
(a) The fundamental qualitative characteristics that make accounting information useful are relevance and verifiability.
(b) Relevant information only has predictive value, confirmatory value, or both.
(c) Information that is a faithful representation is characterized as having predictive or confirmatory value.
(d) Comparability pertains only to the reporting of information in a similar manner for different companies.
(e) Verifiability is solely an enhancing characteristic for faithful representation.
(f) In preparing financial reports, it is assumed that users of the reports have reasonable knowledge of business and economic activities.
E2-3 (L03,7) GROUPWORK (Qualitative Characteristics) SFAC No. 8 identifies the qualitative characteristics that make accounting information useful. Presented below are a number of questions related to these qualitative characteristics and underlying constraint.
(a) What is the quality of information that enables users to confirm or correct prior expectations?
(b) Identify the pervasive constraint developed in the conceptual framework.
(c) The chairman of the SEC at one time noted, “If it becomes accepted or expected that accounting principles are determined or modified in order to secure purposes other than economic measurement, we assume a grave risk that confidence in the credibility of our financial information system will be undermined.” Which qualitative characteristic of accounting information should ensure that such a situation will not occur? (Do not use faithful representation.)
(d) Muruyama Corp. switches from FIFO to average-cost to FIFO over a 2-year period. Which qualitative characteristic of accounting information is not followed?
(e) Assume that the profession permits the savings and loan industry to defer losses on investments it sells because immediate recognition of the loss may have adverse economic consequences on the industry. Which qualitative characteristic of accounting information is not followed? (Do not use relevance or faithful representation.)
(f) What are the two fundamental qualities that make accounting information useful for decision-making?
(g) Watteau Inc. does not issue its first-quarter report until after the second quarter’s results are reported. Which qualitative characteristic of accounting is not followed? (Do not use relevance.)
(h) Predictive value is an ingredient of which of the two fundamental qualities that make accounting information useful for decision-making purposes?
(i) Duggan, Inc. is the only company in its industry to depreciate its plant assets on a straight-line basis. Which qualitative characteristic of accounting information may not be followed?
(j) Roddick Company has attempted to determine the replacement cost of its inventory. Three different appraisers arrive at substantially different amounts for this value. The president, nevertheless, decides to report the middle value for external reporting purposes. Which qualitative characteristic of information is lacking in these data? (Do not use relevance or faithful representation.)
E2-4 (L03) (Qualitative Characteristics) The qualitative characteristics that make accounting information useful for decision- making purposes are as follows.
Relevance Neutrality Verifiability
Faithful representation Completeness Understandability
Predictive value Timeliness Comparability
Confirmatory value Materiality Free from error
Instructions
Identify the appropriate qualitative characteristic(s) to be used given the information provided below.
(a) Qualitative characteristic being employed when companies in the same industry are using the same accounting principles.
(b) Quality of information that confirms users’ earlier expectations.
(c) Imperative for providing comparisons of a company from period to period.
(d) Ignores the economic consequences of a standard or rule.
(e) Requires a high degree of consensus among individuals on a given measurement.
(f) Predictive value is an ingredient of this fundamental quality of information.
(g) Four qualitative characteristics that are related to both relevance and faithful representation.
(h) An item is not recorded because its effect on income would not change a decision.
(i) Neutrality is an ingredient of this fundamental quality of accounting information.
(j) Two fundamental qualities that make accounting information useful for decision-making purposes.
(k) Issuance of interim reports is an example of what enhancing quality of relevance?
E2-5 (L04) (Elements of Financial Statements) Ten interrelated elements that are most directly related to measuring the performance and financial status of an enterprise are provided below.
Assets Distributions to owners Expenses
Liabilities Comprehensive income Gains
Equity Revenues Losses
Investments by owners
Instructions
Identify the element or elements associated with the 12 items below.
(a) Arises from peripheral or incidental transactions.
(b) Obligation to transfer resources arising from a past transaction.
(c) Increases ownership interest.
(d) Declares and pays cash dividends to owners.
(e) Increases in net assets in a period from nonowner sources.
(f) Items characterized by service potential or future economic benefit.
(g) Equals increase in assets less liabilities during the year, after adding distributions to owners and subtracting investments by owners.
(h) Arises from income statement activities that constitute the entity’s ongoing major or central operations.
(i) Residual interest in the assets of the enterprise after deducting its liabilities.
(j) Increases assets during a period through sale of product.
(k) Decreases assets during the period by purchasing the company’s own stock.
(l) Includes all changes in equity during the period, except those resulting from investments by owners and distributions to owners.
Instructions
Identify by number the accounting assumption, principle, or constraint that describes each situation below. Do not use a number more than once.
(a) Allocates expenses to revenues in the proper period.
(b) Indicates that fair value changes subsequent to purchase are not recorded in the accounts. (Do not use revenue recognition principle.)
(c) Ensures that all relevant financial information is reported.
(d) Rationale why plant assets are not reported at liquidation value. (Do not use historical cost principle.)
(e) Indicates that personal and business record keeping should be separately maintained.
(f) Separates financial information into time periods for reporting purposes.
(g) Assumes that the dollar is the “measuring stick” used to report on financial performance.
E2-7 (L05,6) (Assumptions, Principles, and Constraint) Presented below are a number of operational guidelines and practices that have developed over time.
Instructions
Select the assumption, principle, or constraint that most appropriately justifies these procedures and practices. (Do not use qualitative characteristics.)
(a) Fair value changes are not recognized in the accounting records.
(b) Financial information is presented so that investors will not be misled.
(c) Intangible assets are amortized over periods benefited.
(d) Agricultural companies use fair value for purposes of valuing crops.
(e) Each enterprise is kept as a unit distinct from its owner or owners.
(f) All significant post-balance-sheet events are disclosed.
(g) Revenue is recorded when the product is delivered.
(h) All important aspects of bond indentures are presented in financial statements.
(i) Rationale for accrual accounting.
(j) The use of consolidated statements is justified.
(k) Reporting must be done at defined time intervals.
(l) An allowance for doubtful accounts is established.
(m) Goodwill is recorded only at time of purchase.
(n) A company charges its sales commission costs to expense.
E2-8 (L06) (Full Disclosure Principle) Presented below are a number of facts related to Weller, Inc. Assume that no mention of these facts was made in the financial statements and the related notes.
Instructions
Assume that you are the auditor of Weller, Inc. and that you have been asked to explain the appropriate accounting and related disclosure necessary for each of these items.
(a) The company decided that, for the sake of conciseness, only net income should be reported on the income statement.
Details as to revenues, cost of goods sold, and expenses were omitted.
(b) Equipment purchases of $170,000 were partly financed during the year through the issuance of a $110,000 notes payable.
The company offset the equipment against the notes payable and reported plant assets at $60,000.
(c) Weller has reported its ending inventory at $2,100,000 in the financial statements. No other information related to inventories is presented in the financial statements and related notes.
(d) The company changed its method of valuing inventories from weighted-average to FIFO. No mention of this change was made in the financial statements.
1. Economic entity assumption
2. Going concern assumption
3. Monetary unit assumption
4. Periodicity assumption
5. Measurement principle (historical cost)
6. Measurement principle (fair value)
7. Expense recognition principle
8. Full disclosure principle
9. Cost constraint
10. Revenue recognition principle E2-6 (L05,6) (Assumptions, Principles, and Constraint) Presented below are the assumptions, principles, and constraint used in this chapter.
E2-9 (L06) GROUPWORK (Accounting Principles and Assumptions—Comprehensive) Presented below are a number of business transactions that occurred during the current year for Gonzales, Inc.
Instructions
In each of the situations, discuss the appropriateness of the journal entries in terms of generally accepted accounting principles.
(a) The president of Gonzales, Inc. used his expense account to purchase a new Suburban solely for personal use. The following journal entry was made.
Miscellaneous Expense 29,000
Cash 29,000
(b) Merchandise inventory that cost $620,000 is reported on the balance sheet at $690,000, the expected selling price less estimated selling costs. The following entry was made to record this increase in value.
Inventory 70,000
Sales Revenue 70,000
(c) The company is being sued for $500,000 by a customer who claims damages for personal injury apparently caused by a defective product. Company attorneys feel extremely confident that the company will have no liability for damages resulting from the situation. Nevertheless, the company decides to make the following entry.
Loss from Lawsuit 500,000
Liability for Lawsuit 500,000
(d) Because the general level of prices increased during the current year, Gonzales, Inc. determined that there was a $16,000 understatement of depreciation expense on its equipment and decided to record it in its accounts. The following entry was made.
Depreciation Expense 16,000
Accumulated Depreciation—Equipment 16,000
(e) Gonzales, Inc. has been concerned about whether intangible assets could generate cash in case of liquidation. As a consequence, goodwill arising from a purchase transaction during the current year and recorded at $800,000 was written off as follows.
Retained Earnings 800,000
Goodwill 800,000
(f) Because of a “fire sale,” equipment obviously worth $200,000 was acquired at a cost of $155,000. The following entry was made.
Equipment 200,000
Cash 155,000
Sales Revenue 45,000
E2-10 (L06) GROUPWORK (Accounting Principles—Comprehensive) Presented below is information related to Cramer, Inc.
Instructions
Comment on the appropriateness of the accounting procedures followed by Cramer, Inc.
(a) Depreciation expense on the building for the year was $60,000. Because the building was increasing in value during the year, the controller decided to charge the depreciation expense to retained earnings instead of to net income. The following entry is recorded.
Retained Earnings 60,000
Accumulated Depreciation—Buildings 60,000
(b) Materials were purchased on January 1, 2017, for $120,000 and this amount was entered in the Materials account. On
December 31, 2017, the materials would have cost $141,000, so the following entry is made.
Inventory 21,000
Gain on Inventories 21,000
(c) During the year, the company purchased equipment through the issuance of common stock. The stock had a par value of $135,000 and a fair value of $450,000. The fair value of the equipment was not easily determinable. The company recorded this transaction as follows.
Equipment 135,000
Common Stock 135,000
(d) During the year, the company sold certain equipment for $285,000, recognizing a gain of $69,000. Because the controller believed that new equipment would be needed in the near future, she decided to defer the gain and amortize it over the life of any new equipment purchased.
(e) An order for $61,500 has been received from a customer for products on hand. This order was shipped on January 9, 2018. The company made the following entry in 2017.
Accounts Receivable 61,500
Sales Revenue 61,500
