GAAP Application-Conceptual Framework of Accounting the Conceptual Framework all
ID: 2385714 • Letter: G
Question
GAAP Application-Conceptual Framework of Accounting the Conceptual Framework allows for the systematic adaptation of accounting standards to a changing business environment. The FASB uses the conceptual framework to aid in an organized and consistent development of new accounting standards. The conceptual framework outlines the objectives of financial reporting and the qualities of good accounting information, precisely defines commonly used terms such as asset and revenue, and provides guidance about appropriate recognition, measurement, and reporting. Understanding the terminology associated with the framework is imperative. Match the numbered statements below with the lettered terms. An answer (letter) may used more than once, and some terms require more than one answer (letter). 1. Key ingredients in quality of relevance. 2. Traditional assumptions that influence the FASB's conceptual framework. 3. The idea that information should represent what it purports to represent. 4. An important constraint relating to costs and benefits. 5. An example of conservatism 6. The availability of information when it is needed. 7. Recording an item in the accounting records. 8. Determines the threshold for recognition. 9. Implies consensus. 10. Transactions between independent parties. a) Cost-effectiveness b) Representational faithfulness c) Recognition d) Verifiability e) Time periods f) Unrealized g) Completeness h) Timeliness i) Materiality j) Predictive value k) Economic entity l) Lower-of-cost-or-market rule m) Phrenology n) Arm's-length transactions Now that you have reviewed the terminology, for each situation listed below, indicate by letter the appropriate qualitative characteristic(s) or accounting concept(s) applied. A letter may be used more than once, and more than one characteristic or concept may apply to a particular situation. Explain why you chose your answer.1. Goodwill is recorded in the accounts only when it arises from the purchase of another entity at a price higher than the fair market value of the purchased entity's identifiable assets. 2. Land is valued at cost. 3. All payments out of petty cash are debited to Miscellaneous Expense. 4. Plant assets are classified separately as land or buildings, with an accumulated depreciation account for buildings. 5. Periodic payments of $1,500 per month for services of H. Hay, who is the sole proprietor of the company, are reported as withdrawals. 6. Small tools used by a large manufacturing firm are^ recorded as expenses when purchased. 7. Investments in equity securities are initially recorded at cost. 8. A retail store estimates inventory rather than taking a complete physical count for purposes of preparing monthly financial statements. 9. A note describing the company's possible liability in a lawsuit is included with the financial statements even though no formal liability exists at the balance sheet date. 10. Depreciation on plant assets is consistently computed each year by the straight-line method. a) Understandability b) Verifiability c) Timeliness d) Representational faithfulness e) Neutrality f) Relevance g) Going concern h) Economic entity i) Historical cost j) Measurability k) Materiality l) Comparability
Explanation / Answer
A conceptual framework establishes the concepts that underlie financial reporting. A conceptual framework is a coherent system of concepts that flow from an objective. The objective identifies the purpose of financial reporting. The other concepts provide guidance on (1) identifying the boundaries of financial reporting; (2) selecting the transactions, other events, and circumstances to be represented; (3) how they should be recognized and measured; and (4) how they should be summarized and reported. 1 Need for a Conceptual Framework Why do we need a conceptual framework? First, to be useful, rule-making should build on and relate to an established body of concepts. A soundly developed conceptual framework thus enables the IASB to issue more useful and consistent pronouncements over time, and a coherent set of standards should result. Indeed, without the guidance provided by a soundly developed framework, standardsetting ends up being based on individual concepts developed by each member of the standard-setting body. The following observation by a former standard-setter highlights the problem. “As our professional careers unfold, each of us develops a technical conceptual framework. Some individual frameworks are sharply defined and firmly held; others are vague and weakly held; still others are vague and firmly held. . . . At one time or another, most of us have felt the discomfort of listening to somebody buttress a preconceived conclusion by building a convoluted chain of shaky reasoning. Indeed, perhaps on occasion we have voiced such thinking ourselves. . . . My experience . . . taught me many lessons. A major one was that most of us have a natural tendency and an incredible talent for processing new facts in such a way that our prior conclusions remain intact. 2 In other words, standard-setting that is based on personal conceptual frameworks will lead to different conclusions about identical or similar issues than it did previously. As a result, standards will not be consistent with one another, and past decisions may not be indicative of future ones. Furthermore, the framework should increase financial statement users’ understanding of and confidence in financial reporting. It should enhance comparability among companies’ financial statements. Second, as a result of a soundly developed conceptual framework, the profession should be able to more quickly solve new and emerging practical problems by referring to an existing framework of basic theory. For example, Sunshine Mining (USA) sold two issues of bonds. It can redeem them either with $1,000 in cash or with 50 ounces of silver, whichever is worth more at maturity. Both bond issues have a stated interest rate of 8.5 percent.
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