CHAPTER 11

Accounting principles

Summary of Questions by STUDY Objectives
and Bloom’s Taxonomy

Note: K = Knowledge C = Comprehension AP = Application

SUMMARY OF STUDY OBJECTIVES BY QUESTION TYPE

Note: TF = True-False MC = Multiple Choice Ma = Matching

summary of questions by LEVEL OF DIFFICULTY (LOD)

Note: E = Easy M = Medium H=Hard

CHAPTER STUDY OBJECTIVES

1. Explain the importance of having a conceptual framework of accounting, and list the key components. The conceptual framework ensures that there is a consistent and coherent set of accounting standards. Key components of the conceptual framework are the: (1) objective of financial reporting; (2) underlying assumption; (3) cost constraint; (4) elements of financial statements; (5) qualitative characteristics of accounting information; and (6) recognition and measurement criteria.

2. Identify and apply the objective of financial reporting, as well as the underlying assumption and cost constraint used by accountants. The objective of financial reporting is to provide useful information for investors and creditors in making decisions in their capacity as capital providers. The underlying assumption is that, unless otherwise stated, the financial statements have been prepared using the going concern assumption. The cost constraint exists to ensure the value of the information provided is more than the cost of preparing it.

3. Describe the fundamental and enhancing qualitative characteristics of financial reporting. The fundamental qualitative characteristics are relevance and faithful representation. Accounting information has relevance if it makes a difference in a decision. Materiality is an important component of relevance. An item is material when it is likely to influence the decision of a reasonably careful investor or creditor. Information is faithfully represented when it shows the economic reality and is complete, neutral, and free from material error.

The enhancing qualitative characteristics are comparability, verifiability, timeliness, and understandability. Comparability enables users to identify the similarities and differences between companies. The consistent use of accounting policies from year to year is part of the comparability characteristic. Information is verifiable if two knowledgeable and independent people would generally agree that it faithfully represents the economic reality. Timeliness means that accounting information is provided when it is still highly useful for decision-making. Understandability enables reasonably informed users to interpret and comprehend the meaning of the information provided in the financial statements.

4. Identify and apply the basic recognition and measurement concepts of accounting. The revenue recognition criteria require that revenue be recognized when assets have increased or liabilities have decreased as a result of a transaction with a customer. Expenses are recognized when there is a decrease in an asset or increase in a liability, excluding transactions with owners, which result in a decrease in owners’ equity. Three measurements used in accounting are cost, fair value, and amortized cost. Incorrect application of the basic recognition and measurement concepts can lead to material misstatements in the financial statements. Incorrect application can be due to error or intentional misstatement.

TRUE-FALSE STATEMENTS

1. Not every country uses the same conceptual framework or set of accounting standards.

2. IFRS will be the standard for all Canadian Companies.

3. Going forward, there will be two sets of accounting standards for Canadian for profit companies.

4. The conceptual framework will not be able to guide decisions about what to present in the financial statements.

5. A conceptual framework ensures we have a coherent set of standards.

6. The conceptual framework ensures that existing standards and practises are clear and consistent.

7. Canadian and International standards are based on specific rules for accounting.

8. The elements of financial statements are the key ratios which a company will use to manage its business.

9. The main objective of financial reporting is to provide useful information for decision making.

10. The main users of financial reporting are the employees of a company.

11. Capital providers are the main users of financial reporting.

12. To make decisions about allocating capital, users look for information in the financial statements about a company’s ability to maintain relationships with key customers.

13. If a company is not a going concern, then its assets will be presented at their net realizable value.

14. If the company is a going concern, the classification of assets and liabilities as current and noncurrent would not matter.

15. It is an underlying assumption that financial statements are prepared as if the company is NOT a going concern.

16. Claims on economic resources are defined as assets.

17. An error is considered to be a material error if the error in the accounting information could have an impact on an investor’s or creditor’s decision.

18. Under IFRS, a company can never change its accounting policies.

19. The cost constraint exists to ensure that the value of the information is more than the cost of providing it.

20. An item is material when it is unlikely to influence the decision of a reasonably careful investor or creditor.

21. In order for information to be useful in decision making, the information must demonstrate relevance and faithful representation.

22. Accounting information has relevance if it makes a difference in a decision.

23. Predictive value confirms or corrects prior expectations.

24. Confirmatory value helps users forecast future events.

25. Accounting information is complete if it includes all information necessary to show the economic reality of the transaction.

26. Accounting information is neutral if it makes a difference in a decision.

27. Comparability means that a company uses the same accounting principles and methods from year to year.

28. Consistency occurs when companies with similar circumstances use the same accounting principles.

29. Information is verifiable if two knowledgeable and independent people would generally agree that it faithfully represents the economic reality.

30. Timeliness means that accounting information is provided when it is still highly useful for decision-making.

31. Understandability enables users to have timely information that is useful for decision-makers.

32. Understandability is greater when the information is classified, characterized and presented clearly and concisely.

33. The qualitative characteristic which should be first applied is that of relevance.

34. The enhancing qualitative characteristics, such as comparability and timeliness must be applied first before the characteristic of relevance in order to provide the most usefulness to the decision makers.

35. Full disclosure means that the financial statements must be accompanied by notes to the financial statements.

36. Faithful representation means that accounting information reports on the economic reality of a transaction, not its legal form.

37. In the year of a change in an accounting policy, the change and its impact must be disclosed in the notes to the financial statement.

38. Revenue recognition criteria states that revenue is recognized at the same time that a decrease in an asset is recognized or an increase in a liability is recognized for profit generating activities.

39. One of the conditions of recognizing revenue from sales of goods is that costs relating to the sale of the goods can be reliably measured.

40. If goods are shipped FOB destination then the selling company can recognize revenue when the goods are shipped.

41. If goods are shipped FOB shipping point then the selling company cannot recognize the revenue until the goods are received at their destination.

42. Revenue can be recognized before the service has been fully provided.

43. One of the conditions that must be met for revenue to be recognized is that the amount of the revenue can be reliably measured.

44. If a company provides refunds to customers for goods returned then revenue is recognized at the time of the return of the goods.

45. When the percentage of completion method is used to recognize revenue, the amount of revenue recognized should NOT be based on the billings issued.

46. Under the contract based approach, a company can recognize revenue when it has transferred a promised good or service to a customer.

47. If the costs to completion can be reasonably estimated, the % of completion method can be used to recognize revenue.

48. The expense recognition criteria states that expenses are recognized when there is an increase in an asset or decrease in a liability, excluding transactions with owners.

49. There is a direct association between cost of goods sold and sales revenue.

50. If it is not possible to determine the future benefits arising from expenditure, then the costs will be capitalized.

51. When an asset ceases to have future value it should be expensed.

52. The cost model to report property, plant and equipment is where the carrying value on the balance sheet is the fair value less accumulated depreciation.

53. Fair value is the amount of cash expected to be collected if the asset is sold.

54. Management bonuses based on profit may encourage management to overstate profits.

55. When estimating amounts for accruals, it is NOT important that the estimate is supportable or verifiable because it is just an estimate.

56. The recognition of revenue is based on estimates of a project’s progress toward completion in the percentage-of-completion method.

ANSWERS TO TRUE-FALSE STATEMENTS

MULTIPLE CHOICE QUESTIONS

57. The conceptual framework of accounting

a. ensures that existing standards and practices are clear and consistent.

b. makes it possible to respond quickly to new issues.

c. increases the usefulness of the financial information presented in financial reports.

d. all of the above.

58. The conceptual framework does NOT include

a. the objective of financial reporting.

b. elements of financial statements.

c. recognition and measurement criteria.

d. specific standards to be followed in preparing financial statements.

59. Canadian accountants rely on ______________ to help them apply the conceptual framework to specific situations.

a. the Canadian Business Corporations Act

b. identifiable rules

c. the rules of the Income Tax Act

d. professional judgment

60. The organization that is working toward uniformity in accounting practices throughout the world is the

a. World Bank.

b. United Nations.

c. International Accounting Standards Board.

d. National Commission on Fraudulent Financial Reporting.

61. Which statement below is NOT true?

a. The conceptual framework includes specific rules for every situation.

b. The conceptual framework ensures the existing standards and practices are clear and consistent.

c. The conceptual framework provides guidance in responding to new issues and developing new standards.

d. The conceptual framework increases financial statement users’ understanding of and confidence in the financial statements.

62. Not every country uses the same conceptual framework. This lack of uniformity has arisen because

a. there are not enough members in the professional body.

b. no time is available to complete the framework.

c. there are differences in legal and government systems.

d. financial statements do not need to be comparable.

63. Which one of the following is the main objective of financial reporting according to the conceptual framework?

a. to provide information that will increase the value of the company

b. to provide information in assessing future cash flows

c. to provide information about the company’s capital providers

d. to provide financial information that is useful to existing and potential investors and creditors in making decisions about a business

64. The objective of financial reporting is to provide information that is mainly useful to

a. governmental taxing bodies.

b. employees and labour unions.

c. investors and creditors.

d. internal and external auditors.

65. The overriding criterion in evaluating the accounting information to be presented is

a. fairness.

b. legality.

c. management's goals.

d. decision usefulness.

66. Financial statements are designed to provide information about all of the following EXCEPT

a. the economic resources, obligations, and equity of the entity.

b. changes in economic resources, obligations, and equity of the entity.

c. management performance evaluations.

d. economic performance of the entity.

67. In order to assess the financial performance of a company, the financial statements must

a. be prepared on a monthly basis.

b. provide information on management’s use of the company’s resources.

c. be audited annually.

d. provide information concerning changes in the company’s share price.

68. When a private company is reporting under ASPE, and under the going concern assumption, the company will be reporting their equipment assets at

a. original cost.

b. net realizable value.

c. original cost less accumulated depreciation.

d. undepreciated capital cost.

69. The costs constraint

a. means that assets and revenues should be estimated at the lower end of their range.

b. means that assets and revenues should be estimated at the higher end of their range.

c. means the value of the information does not cost less than the cost to produce the information.

d. means the information would influence the decisions of a user of the financial information.

70. Which of the following is a constraint in financial reporting?

a. cost

b. comparability

c. consistency

d. going concern

71. A common application of the cost constraint is

1. recording assets at cost.

2. not disclosing information that is not material and not required in the notes.

3. use of the FIFO cost flow assumption for inventory valuation.

a. 1

b. 2

c. 3

d. 1 and 2

72. Financial statements are prepared for an economic business unit that is separate and distinct from its owners. This is referred to as

a. the going concern assumption.

b. the objective of financial reporting.

c. a cost constraint.

d. the economic entity concept.

73. _______________________ play(s) a fundamental role in the efficient functioning of the economy by providing capital (cash) to businesses.

a. Managers

b. Employees

c. Capital providers

d. IASB

74. A persuasive constraint that ensures the value of the information provided is greater than the costs of providing it.

a. financial reporting objective constraint

b. cost constraint

c. going concern constraint

d. economic entity constraint

75. In the conceptual framework for IFRS, which one of the following is NOT a qualitative characteristic of useful accounting information?

a. relevance

b. faithful representation

c. conservatism

d. comparability

76. In order for accounting information to be relevant, it must

a. have very little cost.

b. have predictive or confirmatory value.

c. be comparable.

d. be used by a lot of different firms.

77. If accounting information has confirmatory value, it

a. has been verified by external audit.

b. is prepared on an annual basis.

c. confirms or corrects prior expectations.

d. is neutral in its representations.

78. If accounting information has predictive value, it is useful in making predictions about

a. the economic environment the company operates in.

b. world events that impact the economy.

c. future interest rates and foreign currency exchange rates.

d. future events of a company.

79. Relevant accounting information

a. is information that has been audited.

b. must be reported within one year.

c. has been objectively determined.

d. is information that is capable of making a difference in a decision.

80. Which of the following is NOT a qualitative characteristic associated with faithful representation?

a. complete

b. comparability

c. neutrality

d. free from material error

81. A company can change to a new accounting principle if management can justify that the new principle results in

a. more relevant and faithful representation of the financial presentation in the statements.

b. a higher profit.

c. a lower profit for tax purposes.

d. less likelihood of clerical errors.

82. Which is NOT necessary to ensure that faithful representation is achieved?

a. Accounting information is reported on cash basis.

b. Accounting information is free from material error.

c. Accounting information is complete.

d. Accounting information is neutral.

83. Which of the following statements is NOT true?

a. Consistency means using the same accounting principles from year to year within a company.

b. Faithful representation is the quality of information that gives assurance that all amounts reported are known with certainty.

c. Relevant accounting information must be capable of making a difference in a decision.

d. Accounting standards for private entities has four principal qualitative characteristics.

84. Qualitative characteristics associated with relevant accounting information are

a. consistency, faithful representation, and timeliness.

b. predictive value, confirmatory value, and materiality.

c. neutrality, predictive value, and reliability.

d. going concern, cost principle, and materiality.

85. An item is considered to be material if

a. the assets would be larger than the liabilities.

b. the information would change an investor’s mind.

c. the company has a loss.

d. the company has never paid a dividend.

86. Accounting information is neutral if

a. it is free from bias.

b. the amount of assets equal the amount of liabilities.

c. the trial balance balances.

d. all of the information is present to show the economic reality of the transaction.

87. The qualitative characteristics should be applied in which order?

a. relevance, comparability and then faithful representation

b. faithful representation, relevance, and then comparability

c. Timeliness, faithful representation, and then comparability

d. relevance, faithful representation and then comparability

88. The summary of significant accounting policies footnoted in the financial statements would NOT normally discuss

a. depreciation methods.

b. board of directors salaries.

c. method of inventory costing.

d. revenue recognition policies.

89. Notes to the financial statements are required because the most important objective of financial reporting is to

a. provide information to the taxing authorities.

b. obtain uniformity with foreign countries.

c. provide information useful for decision-making.

d. provide information about the board of directors.

90. The information provided in the notes that accompany financial statements is required because of the

a. cost principle.

b. full disclosure principle.

c. matching principle.

d. revenue recognition principle.

91. The level of disclosure contained in the notes to the financial statements is limited by the

a. cost versus the benefit of providing the disclosures.

b. accounting policies selected by the business.

c. time period assumption.

d. going concern assumption.

92. Which of the following is an important component of relevance?

a. materiality

b. verifiability

c. consistency

d. comparability

93. Information that is prepared free from bias is considered

a. complete.

b. neutral.

c. comparable.

d. verifiable.

94. Information is understandable when it is understood by users

a. who have a reasonable understanding of financial reporting.

b. who have a reasonable knowledge of business and economic activities.

c. because the information provided is classified, and presented clearly and concisely.

d. all of the above.

95. In following the application of the qualitative characteristics, which characteristic would be immediately applied after the relevance characteristic?

a. faithful representation

b. comparability

c. timeliness

d. understandability

96. Under ASPE, the characteristic which ensures that when preparing financial statements, accountants should choose the accounting treatment or estimate that will be least likely to overstate assets, revenues and gains and the least likely to understate liabilities, expenses and losses is

a. conservatism.

b. understandability.

c. comparability.

d. relevance.

97. The percentage-of-completion method

a. is used in valuing inventories.

b. is applicable for long-term construction projects.

c. must be used by all companies.

d. should only be used if reliable estimates of total costs are not available.

98. Which revenue recognition method would most likely be used by a retailer?

a. point of sale

b. upon cash collection

c. during production

d. upon delivery

99. Retailers who sell a product with a warranty period can recognize revenue when

a. the warranty period has expired.

b. at the point of sale if the warranty amount can be estimated.

c. when cash is collected.

d. when the exact cost of the items sold is known.

100. One criterion for recognition of revenue is to recognize revenue when

a. cash is collected.

b. collection is not assured.

c. the seller does not have control over the goods.

d. all sales returns have been returned.

101. At the time of acquisition, long-lived assets are recorded at

a. amortized cost.

b. lower of cost and market.

c. at fair market value.

d. at cost.

102. There are several ways the recognition and measurement concepts can be violated. Which one of the following would not necessarily be considered a violation?

a. intentional misstatement of estimates

b. failure to record a revenue or expense

c. recognition of revenue or expense in the incorrect accounting period

d. a change in an accounting policy

ANSWERS TO MULTIPLE CHOICE QUESTIONS

MATCHING QUESTIONS

103. Match the items below by entering the appropriate code letter in the space provided.

A. Relevance H. Cost Benefit

B. Confirmatory value I. IASB

C. Comparability J. Revenue recognition criteria

D. Verifiability K. Revaluation model

E. Economic entity concept L. Complete

F. Going concern assumption M. Conceptual Framework

G. Percentage-of-completion method

1. A coherent system of interrelated objectives and fundamentals that can lead to consistent standards.

2. Standards setting body that is responsible for developing IFRS

3. The carrying value of property plant and equipment is its fair value less accumulated depreciation less subsequent impairment losses.

4. Economic events can be identified with a particular business.

5. Appropriate for certain long-term construction contracts

6. Assumes a company will exist long enough to carry out its existing objectives and commitments.

7. The cost of producing the information does not exceed the value of the information.

8. Information that has a bearing on a decision

9. Two knowledgeable and independent people would agree that information is faithfully represented.

10. When information confirms or corrects prior expectations.

11. Different companies using the same accounting principles.

12. Financial information includes all necessary information to show the economic reality of the underlying transactions or events.

13. This criterion allows revenue to be recognized when there is an increase in assets or decrease in liabilities from profit generating activities.

ANSWERS TO MATCHING QUESTIONS

103.

1. M

2. I

3. K

4. E

5. G

6. F

7. H

8. A

9. D

10. B

11. C

12. L

13. J

LEGAL NOTICE

Copyright © 2014 by John Wiley & Sons Canada, Ltd. or related companies. All rights reserved.

The data contained in these files are protected by copyright. This manual is furnished under licence and may be used only in accordance with the terms of such licence.

The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd.