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Chapter 2: Q3E (page 65)

E2-3 (L03,7) GROUPWORK (Qualitative Characteristics) SFAC No. 8 identifies the qualitative characteristics that make accounting information useful. Presented below are a number of questions related to these qualitative characteristics and underlying constraint.

(a) What is the quality of information that enables users to confirm or correct prior expectations?

(b) Identify the pervasive constraint developed in the conceptual framework.

(c) The chairman of the SEC at one time noted, 鈥淚f it becomes accepted or expected that accounting principles are determined or modified in order to secure purposes other than economic measurement, we assume a grave risk that confidence in the credibility of our financial information system will be undermined.鈥� Which qualitative characteristic of accounting information should ensure that such a situation will not occur? (Do not use faithful representation.)

(d) Muruyama Corp. switches from FIFO to average-cost to FIFO over a 2-year period. Which qualitative characteristic of accounting information is not followed?

(e) Assume that the profession permits the savings and loan industry to defer losses on investments it sells because immediate recognition of the loss may have adverse economic consequences on the industry. Which qualitative characteristic of accounting information is not followed? (Do not use relevance or faithful representation.)

(f) What are the two fundamental qualities that make accounting information useful for decision-making?

(g) Watteau Inc. does not issue its first-quarter report until after the second quarter鈥檚 results are reported. Which qualitative characteristic of accounting is not followed? (Do not use relevance.)

(h) Predictive value is an ingredient of which of the two fundamental qualities that make accounting information useful for decision-making purposes?

(i) Duggan, Inc. is the only company in its industry to depreciate its plant assets on a straight-line basis. Which qualitative characteristic of accounting information may not be followed?

(j) Roddick Company has attempted to determine the replacement cost of its inventory. Three different appraisers arrive at substantially different amounts for this value. The president, nevertheless, decides to report the middle value for external reporting purposes. Which qualitative characteristic of information is lacking in these data? (Do not use relevance or faithful representation.)

Short Answer

Expert verified

(a)Confirmatory value

(b)Cost constraint

(c)Neutrality

(d) Consistency and Comparability

(e) Neutrality

(f) Relevance and Faithful representation

(g) Timeliness

(h) Relevance

(i) Comparability

(j) Verifiability

Step by step solution

01

Meaning of Qualitative Characteristics

Qualitative characteristics are the qualities or traits that help users easily understand financial information.

02

An Explanation for part (a)

Confirmatory value 鈥� The information provides feedback on the earlier or previous evaluations and helps the users confirm or change their opinion based on the earlier expectations.

03

An Explanation for part (b)

Cost constraint 鈥� The cost constraint is developed in the conceptual framework, which is incurred when reporting financial information, and the cost should be justifiable.

04

An Explanation for part (c)

Neutrality 鈥� The neutrality concept says that the financial statements must be free from errors, and the financial statements should be neutral. The business should not prepare the financial statements to influence the decisions. The financial statements must be neutral.

05

An Explanation for part (d)

Consistency and comarability 鈥� The company must use the same methods, practices, and procedures while preparing the financial statements. If the company changes the methods from one year to another, it becomes very difficult to compare the results from one year to another. The company must maintain consistency.

06

An Explanation for part (e)

Neutrality 鈥揘eutrality means that the business entity must not change the financial statements to influence decisions. Neutrality means being neutral, and in the given statement, investments are sold to see the economic consequence, which is wrong.

07

An Explanation for part (f)

Relevance and faithful representation 鈥� The term relevance means being able to make decisions with the help of financial statements.

The term faithful representation means the financial statements must be error-free, neutral, and complete and should be able to make effective decisions.

08

An Explanation for part (g)

Timeliness 鈥� Timeliness means how quickly the financial information is reported to the users to make effective decisions. The accounting information needs to be reported on time to make better decisions.

09

An Explanation for part (h)

Relevance 鈥� Relevance is the fundamental qualitative characteristic that is useful for financial information. The term predictive value means the future outcomes. With the help of predictive value and relevant information, effective decisions can be taken for the future by the business.

10

An Explanation for part (i)

Comparability 鈥� Comparability means being able to compare the results from one year to another year, from one company to another company. When a company uses the same method, it becomes easy to compare the results from one period to another.

11

An Explanation for part  (j)

Variability 鈥� The value of the replacement cost of the inventory value differs from one appraiser to another appraiser. Hence the variability characteristic is missing because the value should be the same for all appraisers. The users cannot trust the financial statements because the values are different.

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Most popular questions from this chapter

Statement of Financial Accounting Concepts No.5 identifies four characteristics that an item must have before it is recognized in the financial statements. What are these four characteristics?

Discuss whether the changes described in each of the cases below require recognition in the CPA鈥檚 audit report as to consistency. (Assume that the amounts are material).

  1. The company changed its inventory method to FIFO from weighted-average, which had been used in prior years.
  2. The company disposed of one of the two subsidiaries that had been included in its consolidated statements for prior years.
  3. The estimated remaining useful life of plant property was reduced because of obsolescence.

Question: For each item below, indicate to which category of elements of financial statements it belongs.

(a) Retained earnings (f) Loss on sale of equipment

(b) Sales (g) Interest payable

(c) Additional paid-in capital (h) Dividends

(d) Inventory (i) Gain on sale of investment

(e) Depreciation (j) Issuance of common stock

(Elements of Financial Statements) Ten interrelated elements that are most directly related to measuring the performance and financial status of an enterprise are provided below.

Assets Distributions to owners Expenses Liabilities Comprehensive Income Gains Equity Revenues Losses Investments by owners

Instructions

Identify the element or elements associated with the 12 items below.(a) Arises from peripheral or incidental transactions.

(b) Obligation to transfer resources arising from a past transaction.

(c) Increases ownership interest.

(d) Declares and pays cash dividends to owners.

(e) Increases in net assets in a period from nonowner sources.

(f) Items characterized by service potential or future economic benefit.

(g) Equals increase in assets less liabilities during the year, after adding distributions to owners and subtracting investments by owners.

(h) Arises from income statement activities that constitute the entity鈥檚 ongoing major or central operations.

(i) Residual interest in the assets of the enterprise after deducting its liabilities.

(j) Increases assets during a period through sale of product.

(k) Decreases assets during the period by purchasing the company鈥檚 own stock.(l) Includes all changes in equity during the period, except those resulting from investments by owners and distributions to owners.

The Financial Accounting Standards Board (FASB) has developed a conceptual framework for financial accounting and reporting. The FASB has issued eight Statements of Financial Accounting Concepts. These statements are intended to set forth the objective and fundamentals that will be the basis for developing financial accounting and reporting standards. The objective identifies the goals and purposes of financial reporting. The fundamentals are the underlying concepts of financial accounting that guide the selection of transactions, events, and circumstances to be accounted for; their recognition and measurement; and the means of summarizing and communicating them to interested parties.

The purpose of the statement on qualitative characteristics is to examine the characteristics that make accounting information useful. These characteristics or qualities of information are the ingredients that make information useful and the qualities to be sought when accounting choices are made.

Instructions

(a) Identify and discuss the benefits that can be expected to be derived from the FASB鈥檚 conceptual framework.

(b) What is the most important quality for accounting information as identified in the conceptual framework? Explain why it is the most important.

(c) Statement of Financial Accounting Concepts No.8 describes a number of key characteristics or qualities for accounting information. Briefly discuss the importance of any three of these qualities for financial reporting purposes.
See all solutions

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