Solution manual intermediate accounting 9e by nicolai

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CHAPTER 1

THE ENVIRONMENT OF FINANCIAL REPORTING

CONTENT ANALYSIS OF CASES

Number

Content

Time Range
(minutes)

C1-1

Pronouncements. Matching a list of descriptive statements
with a list of pronouncements establishing or related to
generally accepted accounting principles.

C1-2

Accounting Organizations. Matching of a list of descriptive
statements with a list of abbreviations of accounting
organizations. Identify complete name of each organization.

10-15

C1-3

History of Establishment of GAAP. Discuss CAP, APB, FASB, and
related pronouncements.

15-30

C1-4

(AICPA adapted). Accounting Principles. Define accounting
principles. Discuss sources of GAAP.

10-20

C1-5

(CMA adapted). Standard Setting. Describe why there is
political action and social involvement in the standard setting
process.

10-20

C1-6

Organization of the FASB. Summarize the structure of the FASB,
its documents (GAAP pronouncements), and its operating
procedures.

10-20

C1-7

GAAP and the AICPA. Summarize the GAAP-related
documents published by the AICPA.

C1-8

Code of Professional Conduct. Identify, briefly discuss, and
provide examples to illustrate the first five principles of CPC.

10-20

C1-9

GAAP Hierarchy. Define GAAP, indicate where to find GAAP,
and identify which GAAP are more important (hierarchy).

10-20

C1-10

Lobbying the FASB. Discuss pros and cons of lobbying FASB by
interested parties.

5-15

C1-11

Ethical Dilemma. Discuss steps to take in an ethical dilemma
("misplaced" book in library).

10-20

C1-12

Ethical Responsibilities. Discuss steps to take in an ethical
dilemma (cheating by friend on exam).

10-20

1-1

5-10

5-10


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ANSWERS TO QUESTIONS
Q1-1

Primary markets are those capital markets where the exchanges of stocks and bonds
are directly between a corporation and investors. Secondary markets are those
where the exchanges are among the investors themselves.

Q1-2

The decision makers, or the users of financial information, can be divided into two
major categories: external users and internal users. These two groups have
somewhat different decision making information needs because of their differing

relationships with the company providing economic information. External users need
information for three basic decisions--whether to buy, to hold, or to sell (or in the case
of creditors, whether to extend credit, maintain the credit relationship, or not extend
credit). These users rely mainly on financial statements in their decision processes.
Internal users (i.e., a company's management) need information to make operating
decisions and may request any type of information they need which the accounting
system is capable of providing.

Q1-3

Financial accounting is the information accumulation, processing, and
communication system designed to satisfy the investment and credit decisionmaking information needs of external users of accounting information. Financial
accounting information is communicated through published financial statements,
and is constrained by the pronouncements of several policy-making groups.
Managerial accounting is the information accumulation, processing, and
communication system designed to meet the decision-making information needs of
internal users. Managerial accounting information is communicated via internal
company reports and is not subject to the policy standards that apply to externally
communicated information. It is constrained by the usefulness of the information
provided for a specific decision and the cost of providing that information.

Q1-4

Financial reporting is the process of communicating financial accounting information
about a company to external users. The primary way a company's financial
accounting information is reported is in its annual report.

Q1-5

The three major financial statements of a company and what they summarize are:

(1) the balance sheet (or statement of financial position) which summarizes the
company's financial position at a given date, (2) the income statement which
summarizes the results of the company's income-producing activities for a period of
time, and (3) the statement of cash flows which summarizes the cash inflows and
cash outflows for a period of time. Many companies also present the statement of
changes in stockholders' equity, which summarizes the changes in each item of
stockholders' equity for a period of time, as a fourth major financial statement.

Q1-6

Generally accepted accounting principles (GAAP) are the guidelines, procedures,
and practices that a company is required to use in recording and reporting the
accounting information in its audited financial statements. The four accounting
bodies that have established generally accepted accounting principles are the
Financial Accounting Standards Board (FASB), Accounting Principles Board (APB),
American Institute of Certified Public Accountants (AICPA), and Securities and
Exchange Commission (SEC).

1-2


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Q1-7

There are five categories of GAAP in the hierarchy of generally accepted
accounting principles. The pronouncements included in Category A are FASB
Statements of Financial Accounting Standards and Interpretations, APB Opinions,
and AICPA Accounting Research Bulletins (as well as SEC Regulation S-X and
Financial Reporting Releases for companies that file with the SEC).

Q1-8

The CAP was the Committee on Accounting Procedure. This group was given the
authority to issue pronouncements on accounting procedures and practice. These
pronouncements were published as Accounting Research Bulletins. The CAP was
replaced by the APB in 1959.
The APB was the Accounting Principles Board. It was formed as an attempt to create
a policy-making body whose rules would be binding rather than optional. The
pronouncements of the APB were termed Opinions of the Accounting Principles
Board. The APB was phased out and replaced in 1973 by the FASB.
The FASB is the Financial Accounting Standards Board. This Board was formed upon
the recommendations of the Wheat Committee. The FASB issues four types of
documents which constitute generally accepted accounting principles: Statements
of Financial Accounting Standards, Interpretations, Technical Bulletins, and
Statements of Financial Accounting Concepts.

Q1-9

Before issuing a Statement of Concepts or Standards, the FASB generally completes a
multistage process as follows:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)

(10)

identifies topic
appoints task force
conducts research
issues Discussion Memorandum or Invitation to Comment
holds public hearings
deliberates on findings
issues Exposure Draft
holds public hearings
modifies Exposure Draft
votes

After a 4-3 positive majority vote is attained, the Statement is issued.
Q1-10

The FASB issues four types of pronouncements:
1.

Statements of Financial Accounting Standards. These pronouncements are
releases indicating the methods and procedures required on specific
accounting issues.

2.

Interpretations. These pronouncements provide clarifications of conflicting or
unclear issues relating to previously issued FASB Statements, APB Opinions, or
Accounting Research Bulletins.

3.

Technical Bulletins. These pronouncements are issued by the staff of the FASB
to provide guidance on accounting and reporting problems related to
Statements of Standards or Interpretations.

1-3


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Q1-10

(continued)
4.

Statements of Financial Accounting Concepts. These pronouncements are a
series establishing a theoretical foundation upon which to base financial
accounting and reporting standards. They are the output of the FASB's
"conceptual framework" project.

Q1-11

The organizations other than the FASB that have had an impact on the
development of generally accepted accounting principles are the: (1) Securities'
and Exchange Commission, (2) American Institute of Certified Public Accountants,
(3) FASB Emerging Issues Task Force, (4) Cost Accounting Standards Board,
(5) Internal Revenue Service, (6) American Accounting Association, (7) International
Accounting Standards Committee, (8) Governmental Accounting Standards Board,
and (9) G4 + 1.

Q1-12

The IASB is the International Accounting Standards Board. The IASB has 12 full-time
members (and 2 part-time members) from various countries. It issues International
Accounting Standards. To do so, its operating procedures include study of the topic,
issuance of an Exposure Draft, evaluation of comments, and consideration of a
revised draft. If approved by at least 8 members of the IASB, the International
Accounting Standard is issued.

Q1-13

The professional organizations that play an important role in the accounting
standard-setting process include the: (1) Financial Executives Institute, (2) Institute of
Management Accountants, and (3) Association for Investment Management and
Research.

Q1-14

The Code of Professional Conduct is a document published by the AICPA to help
guide members in public practice, industry, government, and education in
performing their responsibilities in an ethical and professional manner. The six areas
covered by the Principles include: (1) responsibilities, (2) public interest, (3) integrity,
(4) objectivity and independence, (5) due care, and (6) scope and nature of
services.

Q1-15

The steps a person should follow to determine whether an action is ethical include:
(1) gathering the facts (e.g., who are the "stakeholders," what are my
responsibilities); (2) asking whether the action is acceptable according to three

ethical criteria, (a) utility: does the action optimize the satisfactions of all
stakeholders? (b) rights: does the action respect the rights of all individuals, and (c)
justice: is the action fair and just?; (3) considering whether there are any
"overwhelming factors" such as conflicts between criteria that may justify
disregarding one or more of the ethical criteria; and (4) deciding whether the
action is ethical based on an evaluation of the applicable ethical criteria.

Q1-16

Creative thinking is the process of finding new relationships or ideas among items of
information that potentially can be used to solve a problem. It involves using
imagination and insight in order to view issues in a different light.
A creative thinker may be described as being insightful, intuitive, imaginative,
sensitive, flexible, original, adaptable, and tolerant of ambiguity.

1-4


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Q1-17

Critical thinking is the process of testing new relationships or ideas in order to
determine how well they will work. It involves the use of inductive or deductive
reasoning to analyze an issue in a logical manner.
A critical thinker may be described as being objective, independent, analytical,
logical, rational, able to synthesize, consistent, and organized.

ANSWERS TO CASES
C1-1

E
C

1.
2.

C
G
A
D
J
H
I
F
B
E
K
L

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.

12.

B
D

3.
4.

F
A

5.
6.

C1-2
Committee on Accounting Procedure (CAP)
Cost Accounting Standards Board (CASB)
Internal Revenue Service (IRS)
International Accounting Standards Board (IASB)
Governmental Accounting Standards Board (GASB)
Financial Accounting Standards Board (FASB)
American Accounting Association (AAA)
Financial Accounting Standards Advisory Council (FASAC)
Accounting Principles Board (APB)
Securities and Exchange Commission (SEC)
American Institute of Certified Public Accountants (AICPA)
Emerging Issues Task Force (EITF)

C1-3
Three organizations primarily have been responsible for the establishment of generally

accepted accounting principles in the private sector. These organizations are the
Committee on Accounting Procedure (CAP), the Accounting Principles Board (APB), and
the Financial Accounting Standards Board (FASB).
In 1938, the AICPA formed the CAP. This group was responsible for issuing pronouncements
to narrow the differences in accounting procedures and practice. These pronouncements
were published as Accounting Research Bulletins. From the CAP's inception until 1953, it
issued 42 Accounting Research Bulletins, and in 1953 these pronouncements were
reviewed and codified into Accounting Research Bulletin No. 43. The CAP subsequently
issued eight more Accounting Research Bulletins, ending with No. 51. The CAP was
replaced by the APB in 1959, but all Accounting Research Bulletins still constitute generally
accepted accounting principles unless specifically superseded or amended by other
authoritative bodies.

1-5


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C1-3 (continued)
In 1959, the APB was formed by the AICPA as an attempt to (1) alleviate the criticism of the
methods of formulating accounting principles, and (2) create a policy-making body whose
rules would be binding rather than optional. The pronouncements of the APB were termed
Opinions of the Accounting Principles Board, and ultimately 31 of these Opinions were
issued. All APB Opinions are sources of generally accepted accounting principles, unless
specifically amended or rescinded. Many of these Opinions were based upon Accounting
Research Studies which were written by individuals commissioned by the APB.
By the late 1960s criticism again arose about the development of accounting principles.
This criticism centered on independence, representation, and response time. As a result,
the AICPA appointed the Wheat Committee which recommended that the APB be
abolished and that a new full-time body be established.

Thus, the APB was phased out and replaced in 1973 by the FASB. Appointees to the FASB
are full-time members with no other organizational ties and are selected to represent a
wider cross section of interests. The FASB issues four types of pronouncements: Statements
of Financial Accounting Standards, Interpretations, Technical Bulletins, and Statements of
Financial Accounting Concepts.
Statements of Financial Accounting Standards are releases indicating the methods and
procedures required on specific accounting issues. Interpretations provide clarification of
conflicting or unclear issues relating to previously issued FASB Statements of Standards, APB
Opinions, or Accounting Research Bulletins. Technical Bulletins are issued by the staff of the
FASB to provide guidance on accounting and reporting problems related to Statements of
Standards or Interpretations. Statements of Financial Accounting Concepts are a series
establishing a theoretical foundation upon which to base financial accounting and
reporting standards. They are the output of the FASB's "conceptual framework" project. All
of these pronouncements are sources of generally accepted accounting principles.
C1-4 (AICPA adapted solution)
1.

The term "accounting principles" in the auditor's report includes not only accounting
principles but also practices and the methods of applying them. Though the term quite
naturally emphasizes the primary or fundamental character of some principles, it includes
general rules adopted or professed as guides to action in practice. The term does not
connote, however, rules from which there can be no deviation. In some cases, the
question is which of several partially relevant principles has determining applicability.
Neither is the term "accounting principles" necessarily synonymous with accounting theory.
Accounting theory is the broad area of inquiry devoted to the definition of objectives to
be served by accounting, the development and elaboration of relevant concepts, the
promotion of consistency through logic, the elimination of faulty reasoning, and the
evaluation of accounting practice.

2.

Generally accepted accounting principles are those principles (whether or not they have
only limited usage) that have substantial authoritative support. Whether a given principle
has authoritative support is a question of fact and a matter of judgment. The CPA is
responsible for collecting the available evidence of authoritative support and judging
whether it is sufficient to bring the practice within the bounds of generally accepted
accounting practices.

1-6


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C1-4 (continued)
2. (continued)
Pronouncements of the FASB, APB, AICPA, and SEC, if there are any on the subject in
question, would be given greater weight than other single sources. Pronouncements of
the FASB, APB, and AICPA constitute substantial authoritative support, and the evidence
would tend to be conclusive if the SEC has issued an affirmative opinion on the same
subject. These pronouncements include FASB Statements of Standards and Interpretations,
APB Opinions, AICPA Accounting Research Bulletins, and SEC Regulation S-X and Financial
Reporting Releases for companies that file with the SEC. However, substantial authoritative
support also can exist for accounting principles in other pronouncements.
Other evidence of authoritative support may be found in the FASB's Technical Bulletins,
Questions and Answers, and Statements of Concepts, the AICPA's Interpretations, Audit
Guides, Accounting Guides, Statements of Position, Issue Papers, Technical Practice Aids,
and, Practice Bulletins, and the FASB EITF Consensus Positions. The affirmative opinions of
practitioners and academicians in articles, textbooks, and expert testimony may also
provide evidence. Similarly, the views of stock exchanges, commercial and investment
bankers, and regulatory commissions influence the general acceptance of accounting

principles and hence are considered in determining whether an accounting principle has
substantial authoritative support. Business practice also is a source of evidence. Finally,
because they influence business practice, the tax code and state laws are also sources of
evidence.
C1-5 (CMA adapted)
Financial accounting standards inspire or encourage political action and social
involvement during the standard setting process because the effects of accounting
standards are wide-ranging and impact many varying groups. The setting of accounting
standards is a social decision and the user groups play a significant role and have
considerable influence.
The economic consequences of financial accounting standards inspire special interest
groups to become vocal and critical when standards are being formulated. The reporting
of financial information impacts organizations' financial statements and the wealth and
decision-making of organizations in differing ways. In addition, some important
components of financial information, e.g., net income, cannot be verified empirically. The
way financial data is presented impacts user perceptions and influences investment
decisions. User groups may want particular economic events accounted for in particular
ways, and are willing to fight for what they want.
The formulation of accounting standards has political roots in the Securities and Exchange
Acts of 1933 and 1934. Although the SEC was vested with complete authority to define
and formulate accounting standards, it has, for the most part, delegated this authority to
the private sector. The SEC supports the FASB in this endeavor and encourages its "due
process" system of standard setting. Financial accounting standards issued are considered
to be "generally accepted accounting principles" and, as such, they must be followed in
the preparation of financial statements. Public accounting firms and independent CPAs
are prohibited from expressing opinions on financial statements unless they conform to
these principles. Therefore, the formulation of standards is of vital interest to these groups
as well as the client organizations responsible for the financial statements.

1-7

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C1-6
The Financial Accounting Foundation is the parent organization of the FASB. It is governed by a
16-member Board of Trustees appointed from the memberships of nine organizations (the AICPA,
Financial Executives Institute, Institute of Management Accountants, Association for Investment
Management and Research, American Accounting Association, Securities Industry Association,
Government Finance Officers Association, Comptrollers and Treasurers, and National Association
of State Auditors, Controllers, and Treasurers) interested in the formulation of accounting
principles. The primary responsibilities of the Financial Accounting Foundation are to provide
general oversight to its operations and appoint the members of the Financial Accounting
Standards Advisory Council (FASAC) and the FASB. The FASAC consists of about 33 influential
members; it is responsible for advising the FASB about major policy issues, the priority of topics,
the selection of task forces, the suitability of tentative decisions, and other matters.
There are seven members of the FASB. Appointees to the FASB are full-time, fully paid members
with no other organizational ties and are selected to represent a wide cross-section of interests.
Each Board member is required to have a knowledge of accounting, finance, and business;
high intelligence, integrity, and discipline; and a concern for the public interest regarding
financial reporting. Currently, the FASB includes (1) five members who are CPAs and who have
been in public practice, and (2) two members from other areas related to accounting (e.g.,
academia and industry). The FASB is responsible for identifying financial accounting issues,
conducting research to address these issues, and resolving them. The FASB is supported by a
research and technical staff that performs numerous functions such as researching issues,
communicating with constituents, and drafting preliminary findings. The administrative staff
assists the FASB by handling library, publications, personnel, and other activities.
The FASB issues several types of pronouncements:
1.

Statements of Financial Accounting Standards. These pronouncements establish generally
accepted accounting principles. They are releases indicating the methods and
procedures required on specific accounting issues.

2.

Interpretations. These pronouncements provide clarification of conflicting or unclear issues
relating to previously issued FASB Statements of Standards, APB Opinions, or Accounting
Research Bulletins. Interpretations also establish or clarify generally accepted accounting
principles.

3.

Technical Bulletins. These pronouncements are issued by the staff of the FASB to provide
guidance on accounting and reporting problems related to Statements of Standards or
Interpretations. The guidance may clarify, explain, or elaborate upon an underlying
standard.

4.

Statements of Financial Accounting Concepts. These pronouncements establish a
theoretical foundation upon which to base financial accounting and reporting standards.
These Statements are the output of the FASB's "Conceptual Framework" project.

5.

Other Pronouncements. On a major topic, the FASB staff may also issue a Guide for
Implementation which is in the form of questions and answers (referred to as FASB Q's and
A's).

1-8


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C1-6 (continued)
Before issuing a statement of concepts or standards, the FASB generally completes a multistage
process, although the sequence and numbers of steps may vary. Initially, a topic or project is
identified and placed on the FASB's agenda. This topic may be the result of suggestions from
the FASAC, the accounting profession, industry, or other interested parties. On major issues a
Task Force may be appointed to advise and consult with the FASB's Research and Technical
Staff on such matters as the scope of the project and the nature and extent of additional
research. The Staff then conducts any research specifically related to the project.
A Discussion Memorandum or Invitation to Comment, which outlines the research related to the
issues, is then usually published and a public comment period is set. During this period, public
hearings, similar to those conducted by Congress, may be held. The intent is to receive
information from and views of interested individuals and organizations on the issues. Many
parties submit written comments ("position papers") or make oral presentations. These parties
include representatives of CPA firms and interested corporations, security analysts, members of
professional accounting associations, and academicians, to name a few. After deliberating on
the views expressed and information collected, the FASB issues an Exposure Draft of the
proposed Statement. Interested parties generally have 30-90 days to provide written comments
of reaction. On major issues, more public hearings may be held. Sometimes, "field tests" of the
proposed standards are conducted with selected companies to evaluate implementation
issues. A modified draft is prepared, if necessary, and brought to the FASB for a final vote. After
4 to 3 positive vote is attained, the Statement is issued.
C1-7
The AICPA publishes numerous documents that may be considered as sources of GAAP. For
example, Industry Audit Guides and Industry Accounting Guides are publications designed to
assist independent auditors in examining and reporting on financial statements of various types

of entities in specialized industries. Statements of Position are publications intended to influence
the development of financial accounting principles that best serve the public interest. Practice
Bulletins are publications that provide guidance on specific technical issues. Issue Papers help
the FASB identify accounting areas that need to be addressed and clarified.
The AICPA also annually publishes Accounting Trends and Techniques which provides a study of
the latest accounting practices and trends, as identified from a survey of 600 published annual
reports. The AICPA has also issued numerous Accounting Interpretations to provide timely
guidance on accounting issues without the formal procedures necessary for an APB Opinion.
C1-8
The first five principles of the AICPA's Code of Professional Conduct are as follows:
1.

Responsibilities: In carrying out their responsibilities as professionals, members should
exercise sensitive professional and moral judgments in all their activities. For example,
when a member chooses a depreciation method, she must carefully analyze each
alternative based upon well-defined criteria before making a final choice.

2.

The Public Interest: Members should accept the obligation to act in a way that will serve
the public interest, honor the public trust, and demonstrate a commitment to
professionalism. When a member refuses to ignore internal control deficiencies in a
company with publicly traded stock, but instead enumerates these deficiencies in the
Auditor's report, she is adhering to the public interest principle.

1-9


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C1-8 (continued)
3.

Integrity: To maintain and broaden public confidence, members should perform all
professional responsibilities with the highest sense of integrity. For example, a member who
carefully and conscientiously performs each step of an audit without skipping those steps
that are tedious or of less interest is exercising the integrity principle.

4.

Objectivity and Independence: A member should maintain objectivity and be free from
conflicts of interest in discharging professional responsibilities. A member in public practice
should be independent in fact and appearance when providing auditing and other
attestation services. For example, a member who declines to audit the financial
statements of the company for which his father is a marketing vice president is adhering to
this principle.

5.

Due Care: A member should observe the profession's technical and ethical standards,
strive continually to improve competence and the quality of standards, strive continually to
improve competence and the quality of services, and discharge professional responsibility
to the best of the member's ability. When a member reads current accounting literature
and strives to employ current principles and procedures, she is exercising due care.

C1-9
The "rules" for financial accounting are called generally accepted accounting principles.
Generally accepted accounting principles (GAAP) are the guidelines, procedures, and
practices that a company is required to use in recording and reporting the accounting
information in its audited financial statements. GAAP define accepted accounting

practices at a particular time and provide a standard by which to report financial results.
They are like laws that must be followed in financial reporting.
There are several accounting policy-making bodies that have established GAAP, including
the Financial Accounting Standards Board (FASB), Accounting Principles Board (APB),
American Institute of Certified Public Accountants (AICPA), and Securities and Exchange
Commission (SEC). There is no single document that includes all the accounting standards.
[However, there are electronic data bases, such as the FASB Financial Accounting
Research System (FARS) that include most accounting standards.] In addition, the FASB
standards are published each year as part of the FASB's Accounting Standards series.
These standards are included in two-volume set entitled Original Pronouncements which
contains each major pronouncement as of its date of publication. Another two-volume
set entitled Current Text (General Standards and Industry Standards), is a topical
integration of currently effective accounting and reporting standards as of its date of
publication. The AICPA and SEC standards are also published on an annual basis.

1-10


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C1-9 (continued)
The following is a "hierarchy" of five categories of GAAP and the authoritative sources
applicable to each category for companies:
Categories

Authoritative Sources
(Pronouncements)
FASB Statements of Financial Accounting
Standards and Interpretations, APB Opinions,
and CAP (AICPA) Accounting Research Bulletins

(as well as SEC Regulation S-X and Financial
Reporting Releases for companies that file with
the SEC)

A.

Pronouncements of authoritative
bodies (FASB, APB, CAP, SEC)

B.

Pronouncements of bodies of expert
accountants that have been
exposed for public comment

FASB Technical Bulletins, AICPA Industry Audit
and Accounting Guides, and AICPA Statements
of Position

C.

Pronouncements of bodies of expert
accountants that have not been
exposed for public comment

FASB Emerging Issues Task Force Consensus
Positions and AICPA Practice Bulletins

D.

Widely accepted practices and
pronouncements representing
prevalent practice in a particular
industry or applications to specific
circumstances

AICPA Accounting Interpretations, FASB Q's and
A's, and AICPA Accounting Trends and
Techniques

E.

Other accounting literature

For instance, FASB Statements of Financial
Accounting Concepts, APB Statements, AICPA
Issue Papers, AICPA Technical Practice Aids,
and accounting texts and articles

These categories are listed in descending order of importance, with Category A as the most
important. Accountants must follow the GAAP established by the pronouncements applicable
to this category unless, in unusual circumstances, they result in misleading financial statements.
In these circumstances or in situations where the accounting for a transaction or event is not
specified by a pronouncement in category A, then pronouncements in categories B through D
may be used to identify GAAP. Generally, pronouncements in category B take precedence
over those in category C which, in turn, take precedence over those in category D. When none
of the pronouncements in categories A through D are applicable, then the accountant may
consider other accounting literature (category E).

1-11

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C1-10
On balance, most people would agree that it is a good idea for the FASB to allow written
comments and oral presentations in which interested parties can lobby for a particular ruling.
However, there are both pros and cons to allowing interested parties to provide input to its
deliberation process. They include:
Advantages
Enables FASB to get input from different perspectives
Provides users a forum to express concerns
Provides preparers a forum to express concerns
Provides auditors a forum to express concerns
Overcomes criticism of failing to listen to constituencies
Allows for consideration of views of all interested parties
Rulings appear more fair to all constituencies
Rulings consider the costs and benefits of implementation
Standards are established that are the most acceptable
Allows for clarification of rules
Allows for corrections of any errors
Allows for consideration of implementation issues
Disadvantages
Rulings sometimes appear to be biased in favor of certain user group
Rulings sometimes are inconsistent with other Statements of Standards
Rulings sometimes are inconsistent with Statements of Concepts
Rulings sometimes appear illogical
FASB is too slow in establishing standards
Standards are too complex and difficult to implement
C1-11

Note to Instructor: Listed below are some possible findings that students may discuss at each
step in the moral reasoning process:
I.

Gather facts: (A) What has occurred? (1) there is only one copy of the needed book,
(2) everyone in my class is required to use the book to write a report, (3) the book has
been intentionally misfiled. (B) Who are the stakeholders? (1) me, (2) classmate who
has misfiled the book, (3) other member of the class, (4) the professor, (5) other students
wanting to use the book, (6) library staff. (C) What are my responsibilities? (1) to write a
report (2) to be socially responsible.

1-12


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C1-11 (continued)
II.

Ask whether the action (my classmate misfiling the book) is acceptable according to
three ethical criteria: (A) Utility: Does the action optimize the satisfactions of all
stakeholders? (1) the classmate who misfiled the book can satisfactorily use the book
without having to wait his turn, (2) I am unable to use the book to finish my report,
(3) the rest of the class cannot use the book to finish their reports, (4) the professor
cannot collect the assignment on the regularly scheduled due date, (5) others wanting
to use the book cannot find it, (6) library staff will be forced to search for the book.
(B) Rights: Does the action respect the rights of all? (1) the classmate who misfiled the
book has the right to use the book, (2) other members of the class as well as other
students have the right to use the book, but cannot if it is misfiled, (3) the professor
cannot exercise his/her right to set due dates and expect them to be adhered to,

(4) the library staff cannot effectively and efficiently perform its job. (C) Justice: Is the
act fair and just? (1) purposely preventing others from completing an assignment is not
fair, (2) making it difficult for others to find a book is not just, (3) inhibiting the library
staff's ability to perform its job is not fair, (4) forcing the professor to accept late reports is
not just.

III.

Consider whether there are any overwhelming factors affecting criteria: In this situation,
there do not appear to be overwhelming factors but students may bring up issues like:
(1) classmate has full-time job, (2) classmate is disabled, (3) classmate has family (or
other) obligations, (4) library has limited hours.

IV.

Decide what ethical action to take: Students may decide on a number of alternative
courses of action, including: (1) doing nothing, (2) discussing with classmate, (3)
discussing with other students to exert pressure on classmate to refile book, (4) reporting
to professor (in person or anonymously).

C1-12
Note to Instructor: Listed below are some possible findings that students may discuss at each
step in the moral reasoning process:
I.

Gather facts: (A) What has occurred? (1) my friend copied an answer, (2) she
received an A on the test, (3) I received a B on the test, (4) our professor is unaware that
she cheated, (5) I am aware that she cheated. (B) Who are the stakeholders: (1) my
friend who cheated, (2) me, (3) student from whom my friend copied the answer,
(4) our professor, (5) other members of the class, (6) all students in other sections of the

same course, (7) all accounting students at my school who have taken the same class,
(8) all students who will be competing with my friend for jobs, (9) all accountants, (10)
company that hires her.

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C1-12 (continued)
II.

Ask whether the action (my friend's cheating) is acceptable according to three ethical
criteria: (A) Utility: Does the action optimize the satisfaction of all stakeholders? (1) her
copying led to a short-term satisfaction in the form of an A. However, in the long-run,
this A may prove to be harmful to her if she views the A as a reward for cheating and
continues to cheat in the future, (2) my receipt of a lower grade puts her at an unfair
advantage over me, (3) others in the class who received the same grade as her had to
rely on their own effort and intelligence, whereas she was rewarded with the same
grade for relying on someone else's work, (4) others in the class who received a lower
grade than her are at a disadvantage to her even though they may be equally
intelligent, (5) because recruiters compare the grades of all their applicants, she will
appear more qualified because her A will cause her GPA to increase, (6) the professor
may be placed in a position of giving her a higher recommendation than warranted,
(7) her future employer may be depending on higher qualifications than she has.
(B) Rights: Does the action respect the rights of all? (1) my friend forfeited her right to a
good grade by cheating, (2) others in the class had their rights violated because they
can no longer compete fairly, (3) the professor can no longer exercise his/her right to
distribute grades fairly, (4) recruiters cannot exercise their right to use GPA as a
quantitatively reliable guide for selecting employees. (C) Justice: Is the act fair and

just? (1) cheating is not generally accepted as being fair, (2) receiving a better grade
through deceit is not just, (3) having an advantage in recruiting due to dishonesty is not
fair.

III.

Consider whether there are any overwhelming factors between criteria: In this situation,
there do not appear to be overwhelming factors but students may bring up issues like:
(1) friend has full-time job, (2) friend is disabled, (3) friend has family (or other)
obligations, (4) friend was sick before class, (5) friend was an athlete.

IV.

Decide what ethical action to take: Students may decide on a number of alternative
courses of action, including: (1) doing nothing, (2) discussing with friend, (3) discussing
with student from whom friend copied (or other students) to exert pressure on friend to
confess action to professor, (4) reporting to professor (in person or anonymously).

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CHAPTER 2
FINANCIAL REPORTING: ITS CONCEPTUAL FRAMEWORK

CONTENT ANALYSIS OF CASES

Number

Content

Time Range
(minutes)

C2-1

Qualitative Characteristics. Matching of definitions to the
qualities of useful accounting information.

C2-2

Accounting Assumptions and Conventions. Matching of a list
of descriptive statements with a list of assumptions and
conventions.

C2-3

Objectives of Financial Reporting. Discuss general through
specific objectives.

15-30

C2-4

Qualitative Characteristics. Identify and discuss qualities of
useful accounting information.

20-40

C2-5

(AICPA adapted). Cost and Expense Recognition. Rationale
for expense recognition at time of sale, in an accounting
period, or due to systematic and rational allocation.

15-30

C2-6

(CMA adapted). Characteristics of Useful Information. Define
relevance and reliability (and their ingredients), as well as
comparability, consistency, and materiality.

20-30

C2-7

(CMA adapted). Objectives, Users, and Stewardship. Discuss
the primary objectives of financial reporting, the sophistication
level of users, and the stewardship responsibilities of
management.

20-30

C2-8

Segment Reporting. Discuss what types of useful information
for investment decision making is provided by a company's
disclosures of the revenues, operating profits, and assets of its

lines of business.

10-15

C2-9

Relevance Versus Reliability. Define relevance and reliability,
and ingredients of each. Discuss which is most important.

10-15

C2-10

(AICPA adapted). Inconsistent Statements about GAAP.
Evaluate and discuss two statements containing fallacies, halftruths, circular reasoning, errors, and inconsistencies.

15-30

C2-11

(AICPA adapted). Accounting Entity. Define and discuss an
accounting entity; give illustrations.

15-30

2-1

10-20
5-15

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Number

Content

Time Range
(minutes)

C2-12

(AICPA adapted). Timing of Revenue Recognition. Discuss
why point-of-sale recognition is usual. Discuss merits of
alternative revenue recognition bases.

20-40

C2-13

(AICPA adapted). Accruals and Deferrals. Discuss accrual
accounting, including accruals and deferrals. Contrast with
cash accounting.

10-15

C2-14

Revenue Recognition. Describe when revenue should be
recognized in four cases, and indicate what method should be

used.

15-20

C2-15

Violation of Assumptions and Conventions. For seven situations,
identify what accounting assumption or convention each
procedure or practice violates. Indicate what should be done
to rectify each violation.

15-25

C2-16

(CMA adapted). Conceptual Framework. Describe and
discuss benefits of FASB conceptual framework and qualities of
useful accounting information.

20-30

C2-17

Ethics and Income Reporting. Discuss the financial reporting
and ethical issues regarding revenue and expense recognition
based on cash receipts and payments.

10-15

ANSWERS TO CASES

Q2-1

The "conceptual framework" of the FASB is a theoretical foundation of interrelated
objectives and concepts that provides a logical structure and direction to financial
accounting and reporting. The titles of the "Statements of Concepts" issued by the
FASB are: Statement No. 1 "Objectives of Financial Reporting by Business Enterprises,"
Statement No. 2 "Qualitative Characteristics of Accounting Information," Statement
No. 3 "Elements of Financial Statements of Business Enterprises," (replaced by
Statement No. 6 "Elements of Financial Statements"), Statement No. 4 "Objectives of
Financial Reporting by Nonbusiness Organizations," and Statement No. 5 "Recognition
and Measurement in Financial Statements of Business Enterprises."

Q2-2

The most general objective is that financial reporting should provide useful
information for present and potential investors, creditors, and other external users in
making their investment, credit, and similar decisions. Investors include both equity
security holders (stockholders) and debt security holders (bondholders), while
creditors include suppliers, customers and employees with claims, individual lenders,
and lending institutions.

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Q2-3

The "derived external user objective" is to provide information that is useful to external
users in assessing the amounts, timing, and uncertainty of prospective cash receipts.

This objective is important because individuals and institutions make cash outflows for
investing and lending activities primarily to increase their cash inflows. Financial
information is needed to help establish expectations about the timing and amount of
prospective cash receipts (e.g., dividends, interest, proceeds from resale or
repayment) and assess the risk involved.

Q2-4

The "derived company objective" is to provide information to help investors, creditors,
and others in assessing the amounts, timing, and uncertainty of prospective net cash
inflows to the related company. Information about (1) a company's economic
resources, obligations, and owners' equity; (2) a company's comprehensive income
and its components; and (3) a company's cash flows should be reported to satisfy
the "derived company objective."

Q2-5

Information about the "economic resources and claims to those resources" of a
company is useful to external users for four reasons:
1. To identify the company's financial strengths and weaknesses and to assess its
liquidity;
2. To provide a basis to evaluate information about the company's performance
during a period;
3. To provide direct indications of the cash flow potentials of some resources and
the cash needed to satisfy obligations; and
4. To indicate the potential cash flows that are the joint result of combining various
resources in the company's operations.
Information about the "comprehensive income and its components" of a company is
useful to external users in:
1. Evaluating management's performance;

2. Estimating the "earning power" or other amounts perceived as representative of
its long-term income producing ability;
3. Predicting future income; and
4. Assessing the risk of investing in or lending to the company.
Information about the cash flows of a company is useful to external users:
1. To help understand its operations;
2. To evaluate its financing and investing activities;
3. To assess its liquidity; and
4. To interpret the comprehensive income information provided.

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Q2-6

The terms are defined as follows: (a) return on investment provides a measure of
overall company performance, (b) risk is the uncertainty or unpredictability of the
future results of a company, (c) financial flexibility is the ability of a company to take
effective actions to change the amounts and timing of cash flows, (d) liquidity is the
term used to describe how quickly an asset can be converted into cash or a liability
paid, and (e) operating capability refers to the ability of a company to maintain a
given physical level of operations.

Q2-7

Decision usefulness is the overall qualitative characteristic of useful accounting
information. The two primary qualities of decision usefulness are relevance and
reliability.

Q2-8

Accounting information is relevant if it can make a difference in a decision by
helping users predict the outcomes of past, present, and future events or confirm or
correct prior expectations. To be relevant, accounting information must be timely
and must have either predictive value or feedback value, or both. Predictive value is
present when the information helps decision makers forecast the outcome of past or
present events more accurately. Feedback value is present when the accounting
information enables decision makers to confirm or correct prior expectations.
Timeliness is having information available to decision makers before it loses its
capacity to influence decisions.

Q2-9

Accounting information is reliable if it is reasonably free from error and bias and
faithfully represents what it purports to represent. To be reliable the information must
be verifiable, neutral, and possess representational faithfulness. Verifiability is the
ability of accountants to agree that the selected method has been used without
error or bias. Representational faithfulness is the degree of correspondence between
the reported accounting measurements and the economic resources, obligations,
and the transactions and events causing changes in these items. Neutrality is present
when there is an absence of bias intended to influence behavior in a particular
direction. Neutrality also implies a completeness of information.

Q2-10

The secondary quality of useful accounting information is comparability.
Comparability of accounting information enables users to identify and explain
similarities and differences between two (or more) sets of economic phenomena.

Comparability is enhanced by consistency. Consistency means conformity from
period to period with unchanging accounting policies and procedures. Without
consistency, it would be difficult to determine whether differences in results were
caused by economic differences or simply differences in accounting methods.

Q2-11

Materiality refers to the magnitude of an omission or misstatement of accounting
information that makes it likely that the judgment of a reasonable person relying on
the information would have been influenced by the omission or misstatement.
Materiality is closely linked to relevance. Both characteristics are defined in terms of
the influences that affect a decision maker. However, relevance deals with the need
that the users may have for that information, while materiality results because the
amount is large enough to make a difference.

Q2-12

The continuity assumption (or going-concern assumption) is the assumption that a
company will continue to operate in the near future, unless substantial evidence to
the contrary exists. This assumption is important in financial accounting because it is
a necessary for many of the accounting procedures used by the company. For
example, its assets which are depreciated and its method of recording inventory
may be affected if the future economic benefits from these items are uncertain.
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Q2-13

The period-of-time assumption is the assumption that a company has adopted the
year, either calendar or fiscal, as the reporting period. This assumption is important to
financial accounting because it is the basis for the adjusting entry process in
accounting. If a company's financial statements were not prepared on a yearly (or
shorter time) basis, there would be no reason to determine the time frame affected
by particular transactions.

Q2-14

Historical cost is the exchange price that is retained in the accounting records as the
value of that item. Reliability provides the rationale behind the use of historical cost;
it possesses representational faithfulness, neutrality, and verifiability (i.e., source
documents are usually available to substantiate the recorded amount).

Q2-15

Realization is the process of converting noncash resources and rights into cash or
rights to cash. Recognition is the process of formally recording and reporting an item
in the financial statements of a company. Two other factors provide guidance for
revenue recognition. Revenues should be recognized when: (1) realization has
taken place, and (2) the revenues have been earned. Revenues are considered to
be earned when a company has substantially completed what it must do to be
entitled to the benefits generated by the revenues. Thus, revenue is usually
recognized at the point of sale.

Q2-16

Accrual accounting is the process of relating the financial effects of transactions,
events, and circumstances having cash consequences to the period in which they
occur rather than when the cash receipt or payment occurs. This process is related

to the matching principle, which states that to determine the income of a company
for an accounting period the company computes the total expenses involved in
obtaining the revenues of the period and relates these total expenses to (matches
them against) the total revenues recorded in the period.

Q2-17

The three principles for matching expenses against revenues are:
1. Associating cause and effect;
2. Systematic and rational allocation; and
3. Immediate recognition.

Q2-18

Conservatism states that when alternative accounting valuations are equally
possible, the accountant should select the alternative which is least likely to overstate
assets and income in the current period. Conservatism, however, can conflict with
neutrality. Conservative financial statements may be unfair to present stockholders
and biased in favor of prospective stockholders because the net valuation of the
company may not fully include future expectations. The result may be a relatively
lower current market price of the company's common stock.

Q2-19

A balance sheet (or statement of financial position) is a financial statement that
summarizes the financial position of a company on a particular date (usually the end
of the accounting period). There are three elements of a balance sheet: (a) assets,
(b) liabilities, and (c) equity.

Q2-20

An income statement is a financial statement that summarizes the results of a
company's operations (i.e., net income) for a period of time (generally a one-year or
one-quarter accounting period). There are four elements of an income statement:
(a) revenues, (b) expenses, (c) gains, and (d) losses.
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Q2-21

A statement of cash flows is a financial statement that summarizes the cash inflows
and outflows of a company for a period of time (generally one year or one-quarter).
There are three elements of a statement of cash flows: (a) operating cash flows, (b)
investing cash flows, and (c) financing cash flows.

Q2-22

A statement of changes in equity summarizes the changes in a company's equity for
a period of time (generally one year or one-quarter). There are two elements of a
statement of changes in equity: (a) investments by owners, and (b) distributions to
owners.

Q2-23

The IASC Framework states that the objective of financial statements is to provide
information about the financial position, performance, and changes in financial
position of a company that is useful to a wide range of users in making economic
decisions. The Framework has two underlying assumptions; that a company is a going

concern and uses accrual accounting. It identifies four qualitative characteristics of
financial statements–understandability, relevance (including materiality), reliability (
including faithful presentation, substance over form, neutrality, prudence, and
completeness), and comparability. Three constraints on relevant and reliable
information are identified; they include timeliness, balance between benefit and
cost, and balance between the qualitative characteristics. The Framework calls for
financial statements that present a true and fair view of the company and a fair
presentation of the company’s activities.

ANSWERS TO CASES
C2-1
H
G
C

1.
2.
3.

B
I
D

4.
5.
6.

E
J
A

7.
8.
9.

L
K
F

10.
11.
12.

A
G

1.
2.

E
C

3.
4.

B
F

5.
6.

D
H

7.
8.

C2-2

C2-3
The most general objective of financial reporting states that financial reporting should
provide useful information for present and potential investors, creditors, and other users in
making their investment, credit, and similar decisions. These external users are expected
to have a reasonable understanding of business and economic activities and be willing to
study the information with reasonable diligence in order to comprehend the financial
information.
The second objective is the "derived external user objective." It states that financial
reporting should provide information that is useful to external users in assessing the
amounts, timing, and uncertainty of prospective cash receipts. This objective is important
because to be successful, an investor or creditor must receive not only a return of
investment, but also a return on investment in proportion to the risk involved. Financial
information is needed to help establish expectations about the prospective cash receipts.
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C2-3 (continued)
The third objective is the "derived company objective." It states that financial reporting
should provide information to help external users in assessing the amounts, timing, and

uncertainty of prospective net cash inflows to the related company. Companies, like
external users, invest cash in noncash resources to earn more cash and receive a return on
their investment in addition to a return of their investment. The company's ability to
generate net cash inflows affects both its ability to pay dividends and interest and the
market prices of its securities, which, in turn, impact on investors' and creditors' cash flows.
The next three, more specific, objectives indicate the types of information about a
company that should be provided in financial reports. The first is to provide information
about a company's economic resources, obligations, and owners' equity. This information
is useful to external users for four reasons: (a) to identify the company's financial strengths
and weaknesses and to assess its liquidity, (b) to provide a basis to evaluate information
about the company's performance during a period, (c) to provide direct indications of
the cash flow potentials of some resources and the cash needed to satisfy obligations,
and (d) to indicate the potential cash flows that are the joint result of combining various
resources in the company's operations.
The second specific objective of financial reporting is to provide information about a
company's financial performance during a specified period. The primary focus here is
information concerning a company's comprehensive income and its components. This
information about a company is useful to external users in (a) evaluating management's
performance, (b) estimating the "earning power" or other amounts perceived as
representative of its long-term earning ability, (c) predicting future income, and
(d) assessing the risk of investing in or lending to the company.
Although comprehensive income is the primary concern, the third specific objective of
financial reporting is to provide information about a company's cash flows. External users
use cash (or cash and cash equivalents) flow information about a company (a) to help
understand its operations, (b) to evaluate its financing and investing activities, (c) to assess
its liquidity, and (d) to interpret the comprehensive income information provided.
Other issues (objectives) of financial reporting are to provide information about how the
management of a company has discharged its stewardship responsibility for the
company's resources and to provide for full disclosure to help external users understand
the information presented to them.

C2-4
There are several qualitative characteristics or "ingredients" that accounting information
should possess in order to be most useful. The following characteristics should be
considered when choosing one of several accounting alternatives: (a) understandability,
(b) decision usefulness, (c) relevance, (d) reliability, (e) comparability, and (f) consistency.
Understandability serves as a "link" between the decision makers and the accounting
information. Understandability means the quality of information that enables users to
perceive its significance. Accounting information should be comprehensible to users who
have a reasonable knowledge of business and economic activities and who are willing to
study the information with reasonable diligence.

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C2-4 (continued)
Decision usefulness is the overall qualitative characteristic to be used in judging the quality
of accounting information. Usefulness depends on the decision to be made, the way in
which the decision is made, the information already available, and the decision maker's
ability to process the information. To evaluate decision usefulness, however, this overall
quality can be separated into the primary qualities of relevance and reliability. If either of
these is completely missing, the information will not be useful.
Accounting information is relevant if it can make a difference in a decision by helping
users predict the outcomes of past, present, and future events or confirm or correct prior
expectations. To be relevant, accounting information must be timely and must possess
either predictive value or feedback value, or both. Timeliness refers to having information
available to decision makers before it loses its capacity to influence decisions. If
information is not available when needed, it lacks relevance and is of little or no use.
Predictive value refers to accounting information that helps decision makers forecast the

outcome of past or present events more accurately. Feedback value is present in
accounting information that enables decision makers to confirm or correct prior
expectations. Often, information has both predictive value and feedback value because
knowledge about the previous actions of a company will generally improve the decision
makers' abilities to predict the results of similar future actions.
Accounting information is reliable if it is reasonably free from error and bias and faithfully
represents what it purports to represent. Information is reliable when it has
representational faithfulness and is verifiable and neutral. Representational faithfulness is
the degree of correspondence between the reported accounting measurements or
descriptions and the economic resources and obligations and the transactions and events
causing changes in these items. Having a high degree of representational faithfulness is
useful in reducing measurement bias. Verifiability is the ability of measurers to agree that
the selected method has been used without error or bias. Verification is useful in reducing
measurer bias. Neutrality results when there is an absence of bias intended to attain a
predetermined result or to influence behavior in a particular direction. Neutrality implies a
completeness of information.
Comparability and consistency are secondary qualities, interacting with both relevance
and reliability to contribute to information usefulness. Comparability is an interactive
quality of the relationship between two or more items of information. Comparability of
accounting information enables users to identify and explain similarities and differences
between two (or more) sets of economic phenomena. Consistency means conformity
from period to period, with unchanging accounting policies and procedures. Consistency
is an important condition to enhance comparability across periods. Without consistency, it
would be difficult to determine whether differences in results were caused by economic
differences or simply differences in accounting methods. However, some sacrifice in
consistency must be made at certain times in order to improve the usefulness of
accounting information.
These characteristics, however, are bound by two constraints. One constraint is that in
order to justify providing the information, the benefits must be greater than the costs of the
information. The second constraint is materiality; the dollar amount of the information

must be large enough to make a difference in decision making.

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C2-5 (AICPA adapted solution)
Note to Instructor: Parts of this case may be slightly advanced for students at this point but
are included to stimulate discussion.
1.

Some costs are recognized as expenses on the basis of a presumed direct association with
specific revenue. This presumed direct association has been identified both as
"associating cause and effect" and as the "matching concept."
Direct cause-and-effect relationships can seldom be conclusively demonstrated, but
many costs appear to be related to particular revenue, and recognizing them as
expenses accompanies recognition of the revenue. Generally, the matching concept
requires that the revenue recognized and the expenses incurred to produce the revenue
be given concurrent periodic recognition in the accounting records. Only if effort is
properly related to accomplishment will the results, called income, have useful
significance concerning the efficient utilization of business resources. Thus, applying the
matching principle is a recognition of the cause-and-effect relationship that exists
between expense and revenue.
Examples of expenses that are usually recognized by associating cause and effect are
sales commissions, freight-out on merchandise sold, and cost of goods sold or services
provided.

2.

Some costs are assigned as expenses to the current accounting period because (a) their
incurrence during the period provides no discernible future benefits; (b) they are measures
of assets recorded in previous periods from which no future benefits are expected or can
be discerned; (c) they must be incurred each accounting year, and no build-up of
expected future benefits occurs; (d) by their nature they relate to current revenues even
though they cannot be directly associated with any specific revenues; (e) the amount of
cost to be deferred can be measured only in an arbitrary manner or great uncertainty
exists regarding the realization of future benefits, or both; (f) uncertainty exists regarding
whether allocating them to current and future periods will serve any useful purpose. Thus,
many costs are called "period costs" and are treated as expenses in the period incurred
because they have neither a direct relationship to revenue earned nor can their
occurrence be directly shown to give rise to an asset. The application of this principle of
expense recognition results in charging many costs to expense in the period in which they
are paid or accrued for payment. Examples of costs treated as period expenses would
include officers' salaries, advertising, research and development, and auditors' fees.

3.

In the absence of a direct basis for associating asset cost with revenue, and if the asset
provides benefits for two or more accounting periods, its cost should be allocated to these
periods (as an expense) in a systematic and rational manner. Thus, when it is impractical,
or impossible, to find a close cause-and-effect relationship between revenue and cost,
this relationship is often assumed to exist. Therefore, the asset cost is allocated to the
accounting periods by some method. The allocation method used should appear
reasonable to an unbiased observer and should be followed consistently from period to
period. Examples of systematic and rational allocation of asset cost would include
depreciation of fixed assets, amortization of intangibles, and allocation of rent and
insurance.

2-9

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C2-6 (CMA adapted)
1.

a.

Relevance means relating to the matter at hand. Therefore, relevant accounting
information has the capacity to:
make a difference in a decision.
help users to form predictions about the outcomes of future events (predictive
value).
confirm or correct prior expectations (feedback value).

2.

3.

b.

Predictive value is that quality of information that improves the decision-maker's
ability to determine expected outcomes. Feedback value is that quality of
information that assists the decision-maker to confirm or change previously
determined expected outcomes. The predictive and feedback qualities are
interactive in that knowledge of actual results (feedback) generally improves the
results of similar future actions (predictive). Timeliness is that quality of information
that makes it available to the user before it loses its capacity to influence the
decision. Timeliness may be a trade-off with a degree of precision; however, lack of

timeliness can reduce relevance.

a.

Reliability is the quality of accounting information that assures that it is reasonably
free from error and bias and faithfully represents what it purports to represent.
Reliability is the quality that gives users confidence that they can depend on the
information provided in financial statements because the level of accuracy is higher.

b.

Verifiability is that quality of information that assures that accounting information
would be substantially duplicated by independent measurers using the same
measurement methods. Verifiability implies a consensus among accountants on the
measurement of an economic event and the way it is reported. Neutrality is the
absence of bias in reported information with no intention to attain a predetermined
result or to induce a particular mode of behavior. Accounting information should be
arrived at by choosing the proper accounting alternatives without regard for the
outcome. Representational faithfulness is that quality of information that indicates an
agreement between an economic event and its measure or description.

a.

Comparability is that quality of accounting information that enables users to identify
similarities in and differences between two sets of economic phenomena.
Comparability allows users to relate accounting information over time and among
similar companies.

b.

Consistency is the application of accounting standards from period to period in the
same manner. Through the consistent application of accounting standards,
comparability of accounting information is enhanced.

c.

Materiality in the context of accounting information means being of substance or
significance. Materiality judgments are situation specific; however, the essence of
the materiality concept is stated in FASB Concepts Statement No. 2 as follows, "The
omission or misstatement of an item in a financial report is material if, in the light of
surrounding circumstances, the magnitude of the item is such that it is probable that
the judgment of a reasonable person relying upon the report would have been
changed or influenced by the inclusion or correction of the item."
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