Solution manual for intermediate accounting 12th edition update FASB by kieso

Chapter 2 outlines the development of a conceptual framework for financial accounting and reporting by the FASB.. 1 A conceptual framework in accounting is important because it can lead

CHAPTER 2 Conceptual Framework Underlying Financial Accounting

ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC)

Brief

Concepts for Analysis

1 Conceptual framework–general.

2 Objectives of financial reporting.

3 Qualitative characteristics

of accounting.

4 Elements of financial statements.

5 Basic assumptions 10, 11, 12 4, 8

6 Basic principles:

a Historical cost.

b Revenue recognition.

c Expense matching.

d Full disclosure.

13

14, 15, 16, 17, 18 19

20, 21, 22

5

6

5, 6

5, 6, 7, 8, 9, 11

7 Accounting principles–comprehensive.

7, 8

9 Comprehensive assign-ments on assumptions, principles, and constraints.

ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE)

1 Describe the usefulness of a conceptual frame work.

2 Describe the FASB’s efforts to construct a conceptual

framework.

3 Understand the objectives of financial reporting.

4 Identify the qualitative characteristics of accounting

information.

5 Describe the basic elements of financial statements 3, 10 3

6 Describe the basic assumptions of accounting 4, 8, 9 4, 5

7 Explain the application of the basic principles

of accounting.

5, 9 4, 5, 6, 7, 8

8 Describe the impact that constraints have on reporting

accounting information.

6, 7, 9 1, 4, 5

ASSIGNMENT CHARACTERISTICS TABLE

Level of Difficulty

Time (minutes)

E2-4 Assumptions, principles, and constraints Simple 15–20 E2-5 Assumptions, principles, and constraints Moderate 20–25

E2-7 Accounting principles–comprehensive Moderate 20–25 E2-8 Accounting principles–comprehensive Moderate 20–25

CA2-3 Objectives of financial reporting Moderate 25–35

CA2-5 Revenue recognition and matching principle Complex 25–30 CA2-6 Revenue recognition and matching principle Moderate 30–35

LEARNING OBJECTIVES

1 Describe the usefulness of a conceptual framework

2 Describe the FASB’s efforts to construct a conceptual framework

3 Understand the objectives of financial reporting

4 Identify the qualitative characteristics of accounting information

5 Define the basic elements of financial statements

6 Describe the basic assumptions of accounting

7 Explain the application of the basic principles of accounting

8 Describe the impact that constraints have on reporting accounting information

CHAPTER REVIEW

1 Chapter 2 outlines the development of a conceptual framework for financial accounting and reporting by the FASB The entire conceptual framework is affected by the environmental aspects discussed in Chapter 1 It is composed of basic objectives, fundamental concepts, and operational guidelines These notions are discussed in Chapter 2 and should enhance your understanding of the topics covered in intermediate accounting

Conceptual Framework

2 (S.O 1) A conceptual framework in accounting is important because it can lead to

consistent standards and it prescribes the nature, function, and limits of financial accounting and financial statements The benefits its development will generate can be characterized as follows: (a) it should be easier to promulgate a coherent set of standards and rules; and (b) practical problems should be more quickly solved

3 (S.O 2) The FASB recognized the need for a conceptual framework upon which a con-sistent set of financial accounting standards could be based The FASB has issued six Statements of Financial Accounting Concepts (SFAC) that relate to financial reporting They are listed and described briefly below:

SFAC No 1 “Objectives of Financial Reporting by Business Enterprises” presents the

goals and purposes of accounting

SFAC No 2 “Qualitative Characteristics of Accounting Information” examines the

characteristics that make accounting information useful

SFAC No 3 “Elements of Financial Statements of Business Enterprises” defines the

broad classifications of items found in financial statements

SFAC No 5 “Recognition and Measurement in Financial Statements of Business

Enterprises” gives guidance on what information should be formally incorporated into financial statements and when

SFAC No 6 “Elements of Financial Statements” replaces SFAC No 3 and expands its

scope to include not-for-profit organizations

SFAC No 7 “Using Cash Flow Information and Present Value in Accounting

Measurements,” provides a framework for using expected future cash flows and present values as a basis for measurement

Basic Objectives

4 (S.O 3) SFAC No 1 describes the objectives of financial reporting as the presentation of

information that is useful (a) in making investment and credit decisions, (b) in assessing cash flow prospects, and (c) in learning about economic resources, claims to those

resources, and changes in them SFAC No 2 identifies the primary and secondary

qualitative characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes

Primary Qualities

5 (S.O 4) The primary qualities that make accounting information useful for decision making are relevance and reliability.

Relevance Accounting information is relevant if it is capable of making a difference in

a decision For information to be relevant, it should have predictive or feedback value, and it must be presented on a timely basis

Reliability Accounting information is reliable to the extent that it is verifiable, is a faithful

representation, and is reasonably free of error and bias To be reliable, accounting information must possess three key characteristics: (a) verifiability, (b) representational faithfulness, and (c) neutrality

Secondary Qualities

6 The secondary qualities identified are comparability and consistency.

Comparability Accounting information that has been measured and reported in a similar

manner for different enterprises is considered comparable

Consistency Accounting information is consistent when an entity applies the same

accounting treatment to similar events from period to period

Basic Elements

7 (S.O 5) An important aspect of developing an accounting theoretical structure is the body of basic elements or definitions Ten basic elements that are most directly related to measuring the performance and financial status of an enterprise are formally defined in

SFAC No 6 These elements, as defined below, are further discussed and interpreted

throughout the text

Assets Probable future economic benefits obtained or controlled by a particular entity as

a result of past transactions or events

Liabilities Probable future sacrifices of economic benefits that arise from present

obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events

Equity Residual interest in the assets of an entity that remains after deducting its

liabilities In a business enterprise, the equity is the ownership interest

Investments by Owners Increases in net assets of a particular enterprise resulting from

transfers to it from other entities of something of value to obtain or increase ownership interests (or equity) in it Assets are most commonly received as investments by owners, but that which is received may include services or satisfaction or conversion of liabilities

of the enterprise

Distributions to Owners Decreases in net assets of a particular enterprise that result

from transferring assets, rendering services, or incurring liabilities by the enterprise to owners Distributions to owners decrease ownership interests (or equity) in an enterprise

Comprehensive Income Change in equity (net assets) of an entity during a period from

transactions and other events and circumstances from nonowner sources It includes all changes in equity during a period, except those resulting from investments by owners and distributions to owners

Revenues Inflows or other enhancements of assets of an entity or settlement of its

liabilities (or a combination of both) during a period from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations

Expenses Outflows or other using up of assets or incurrences of liabilities (or a combination

of both) during a period from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations

Gains Increases in equity (net assets) from peripheral or incidental transactions of an

entity 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

Losses Decrease in equity (net assets) from peripheral or incidental transactions of an

entity 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

Basic Assumptions

8 (S.O 6) In the practice of financial accounting, certain basic assumptions are important

to an understanding of the manner in which data are presented The following four basic assumptions underlie the financial accounting structure:

Economic Entity Assumption The economic activities of an entity can be accumulated

and reported in a manner that assumes the entity is separate and distinct from its owners

or other business units

Going Concern Assumption In the absence of contrary information, a business entity

is assumed to have a long life The current relevance of the historical cost principle is dependent on the going-concern assumption

Monetary Unit Assumption Money is the common denominator of economic activity

and provides an appropriate basis for accounting measurement and analysis The monetary unit is assumed to remain relatively stable over the years in terms of purchasing power In essence, this assumption disregards any inflation or deflation in the economy in which the entity operates

Periodicity Assumption The life of an economic entity can be divided into artificial time

periods for the purpose of providing periodic reports on the economic activities of the entity

As you progress through the remaining chapters in the text, the reasoning behind these assumptions should become more apparent

Basic Principles

9 (S.O 7) Certain basic principles are followed by accountants in recording the transactions

of a business entity These principles relate basically to how assets, liabilities, revenues,

and expenses are to be identified, measured, and reported The following is a brief

review of the basic principles considered in Chapter 2 of the text:

Historical Cost Principle Acquisition cost is considered a reliable basis upon which to

account for assets and liabilities of a business enterprise Cost has been found to be a more stable and consistent benchmark than other suggested valuation methods Recently, the FASB appears to support greater use of fair value measurements in the financial statements

Revenue Recognition Principle Revenue is recognized (1) when realized or relizable

and (2) when earned Recognition at the time of sale provides a uniform and reasonable

test Certain variations in the revenue recognition principle include: certain long-term

construction contracts, end-of-production recognition, and recognition upon receipt

of cash.

Matching Principle Accountants attempt to match expenses incurred while earning

revenues with the related revenues Use of accrual accounting procedures assists the

accountant in allocating revenues and expenses properly among the fiscal periods that compose the life of a business enterprise

Full Disclosure Principle In the preparation of financial statements, the accountant

should include sufficient information to permit the knowledgeable reader to make an informed judgment about the financial condition of the enterprise in question

Constraints

10 (S.O 8) Although accounting theory is based upon certain assumptions and the application

of basic principles, there are some exceptions to these assumptions These exceptions, often called constraints, sometimes justify departures from basic accounting theory The constraints presented in Chapter 2 are the following:

Cost-Benefit Relationship This constraint relates to the notion that the benefits to be

derived from providing certain accounting information should exceed the costs of providing that information The difficulty in cost-benefit analysis is that the costs and especially the benefits are not always evident or measurable

Materiality In the application of basic accounting theory, an amount may be considered

less important because of its size in comparison with revenues and expenses, assets and liabilities, or net income Deciding when an amount is material in relation to other amounts

is a matter of judgment and professional expertise The accounting for immaterial items need not follow GAAP

Industry Practices Basic accounting theory may not apply with equal relevance to

every industry that accounting must serve The fair presentation of financial position and results of operations for a particular industry may require a departure from basic accounting theory because of the peculiar nature of an event or practice common only to that industry

Conservatism When in doubt, an accountant should choose a solution that will be least

likely to overstate assets and income The conservatism constraint should be applied only when doubt exists An intentional understatement of assets or income is not acceptable accounting

LECTURE OUTLINE

The material in this chapter can usually be covered in two class sessions The first class session can be used for lecture and discussion of the concepts presented in the chapter The second class session can be used to develop student’s understanding of these concepts by applying them to specific accounting situations Students frequently believe that they understand the concepts but have difficulty correctly identifying improper accounting procedures in practical situations Apparently, students are not alone in this difficulty

The conceptual framework structure described in the chapter includes SFAC No 5,

“Recognition and Measurement in Financial Statements.” SFAC No 5 indicates that an

information item should meet four fundamental recognition criteria to be recognized in the financial statements:

measurable with sufficient reliability

Because current practice is generally consistent with these criteria, the overall approach of

Chapter 2 remains unchanged We have incorporated SFAC No 5 into the third level of

Illustrations 2-1 and 2-2 This was done by grouping the assumptions, principles, and constraints

of the third level under the heading “Recognition and Measurement Concepts.”

TEACHING TIP

The issues discussed in the chapter can be integrated by using the following illustrations

Illustration 2-1 might be put up first to show the relationship between objectives,

characteristics, elements, assumptions, principles, and constraints The relationship between

the three levels could be emphasized The Illustration 2-2 could be used to fill in the

details of the six categories of items by listing the objectives, characteristics, elements, etc.,

and describing each one in some detail Illustration 2-3 could then be used for a more

detailed discussion of the qualitative characteristics, pointing out their hierarchical nature,

the tradeoffs that are implied, and the components of the primary qualities Illustration 2-4

can be used in defining the elements of financial statements

A (L.O 1) Need for a Conceptual Framework

framework of basic theory