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Chapter 2: Q5BE (page 61)

Question: BE2-5 (L03) Presented below are three different transactions related to materiality. Explain whether you would classify these transactions as material.(

a) Blair Co. has reported a positive trend in earnings over the last 3 years. In the current year, it reduces its bad debt allowance to ensure another positive earnings year. The impact of this adjustment is equal to 3% of net income.

(b) Hindi Co. has an unusual gain of \(3.1 million on the sale of plant assets and a \)3.3 million loss on the sale of investments. It decides to net the gain and loss because the net effect is considered immaterial. Hindi Co.'s income for the current year was \(10 million.

(c) Damon Co. expenses all capital equipment under \)25,000 on the basis that it is immaterial. The company has followed this practice for a number of years.

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01

Materiality 

Materiality is one of the ingredients of the fundamental quality-relevance. It means that the transaction is not recorded or misstated which can influence the decision making of the users of financial statements.

It depends on the individual company to decide about the particular information to be material or irrelevant that can influence the decision making of the users of financial statements. In general, the transactions are considered material if the amount involved in such transaction is more than the percent of the net income for the period.

02

(a)

In current year, the allowance for bad debts is reduced to increase the net income. The impact of the transaction is percent of the net income for the current year which is less than the material transaction that is percent of the net income. Hence, the item is immaterial. However, the item is related to the bad debt allowance which will impact the decision making of the user of financial statement.

Thus, the transaction ismaterial.

(b)

The given statement has two transactions and the amount of income for the current year. Every transaction has to be analyzed separately to decide about the materiality. Two transactions are extraordinary items which will have impact on the decision making of the users of financial statements.

Thus, the transaction ismaterial.

(c)

In the current year, the Co. expenses all capital equipment on the basis of previous year鈥檚 practice. The transaction is of regular practice which does not impact the decision of the user of financial statement.

Thus, the transaction isimmaterial.

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Most popular questions from this chapter

Question: What are some of the costs of providing accounting information? What are some of the benefits of accounting information? Describe the cost-benefit factors that should be considered when new accounting standards are being proposed.

Question: Companies that use IFRS:

(a) must report all their assets on the statement of financial position (balance sheet) at fair value.

(b) may report property, plant, and equipment and natural resources at fair value.

(c) may refer to a concept statement on estimating fair values when market data are not available.

(d) may only use historical cost as the measurement basis in financial reporting.

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?

Identify which basic principle of accounting is best described in each item below.(a) Norfolk Southern Corporation reports revenue in its income statement when the performance obligation is satisfied instead of when the cash is collected.(b) Yahoo! recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue.(c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements.(d) Gap, Inc. reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair value is greater.

Homer Winslow and Jane Alexander are discussing various aspects of the FASB鈥檚 concepts statement on the objective of financial reporting. Homer indicates that this pronouncement provides little, if any, guidance to the practicing professional in resolving accounting controversies. He believes that the statement provides such broad guidelines that it would be impossible to apply the objective to present-day reporting problems. Jane concedes this point but indicates that the objective is still needed to provide a starting point for the FASB in helping to improve financial reporting.Instructions

  1. Indicate the basic objective established in the conceptual framework.
  2. What do you think is the meaning of Jane鈥檚 statement that the FASB needs a starting point to resolve accounting controversies?
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