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Chapter 2: Question 5Q (page 61)

How is materiality (or immateriality) related to the proper presentation of financial statements? What factors and measures should be considered in assessing the materiality of a misstatement in the presentation of a financial statement?

Short Answer

Expert verified

All the material items must be disclosed as per the financial reporting framework and guidelines provided by the accounting standard board.

Based on the significance of a specific item, situation, period, size of misstatement, nature of misstatement, etc., on the financial statement, the item is treated as material or immaterial, and material items are disclosed. All materials items must be disclosed by way of note of amount or fact since any changes will affect the decision and business of the users of financial statements.

Step by step solution

01

Materiality as an Accounting Policy & Proper presentation of financial statements

Accounting policies are certain principles and methods followed for the presentation of financial statements. One important policy is materiality.

Materiality related to the proper presentation of financial statements by

  • Disclosing all material items
  • Usefulness to all stakeholders
  • Avoiding misstatement and misunderstanding
  • Following accounting policy, Accounting Standards, IFRS, Audit Standards, financial reporting frameworks, etc
  • Presenting the statement as per the financial reporting framework.
02

Concept of Materiality & Disclosure Limit

Materiality concept means the financial statements must show a fair view and disclose all the items that may influence the decision of users of financial statements.

Certain limits are provided in case of materiality disclosure, such as disclosing income & expenditure based on 1percent of revenue from operations or 1,00,000, whichever is higher, disclosing the number of shares held by each shareholder when shares are more than 5 percent.

03

General Disclosure of Material Items & Related facts

The following must be disclosed since it鈥檚 a material item such:

  • All significant changes or items that have an effect on financial statements and users of financial statements must be disclosed
  • Any change in accounting policy in the preparation and presentation of financial statements also must be disclosed.
  • When an item is found to be material, and the amount is ascertained, then disclose the amount. If the amount is not ascertained, then disclose the fact.
  • If the specific item is not material now but would be material in a later period, then disclose the fact of such changes in a later period.
04

Factors considering Materiality of misstatement

Factors and measures that may be considered in assessing the materiality of a misstatement in the presentation of a financial statement:

  • Misstatement, including any omissions or errors, is considered material if it affects the decision taken by users of financial statements.
  • The size and nature of misstatement also affect the decisions about materiality.
  • The significance of an itemon the particular entity.
  • The presentation of financial statements and the effect of misstatement in such statements.
  • Uncorrected misstatements of the previous period.

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Most popular questions from this chapter

Briefly describe the fair value hierarchy.

The life of a business is divided into specific time periods, usually, a year, to measure results of operations for each such time period and to portray financial conditions at the end of each period.

  1. This practice is based on the accounting assumption that the life of the business consists of a series of time periods and that it is possible to measure accurately the results of operations for each period. Comment on the validity and necessity of this assumption.
  2. What has been the effect of the practice on accounting? What is its relation to the accrual system? What influence has it had on accounting entries and methodology?

E2-2 (L01,2,3) (Usefulness, Objective of Financial Reporting, Qualitative Characteristics) Indicate whether the following statements about the conceptual framework are true or false. If false, provide a brief explanation supporting your position.

  1. The fundamental qualitative characteristics that make accounting information useful are relevance and verifiability.
  2. Relevant information only has predictive value, confirmatory value, or both.
  3. (c)Information that is a faithful representation is characterized as having predictive or confirmatory value.
  4. Comparability pertains only to the reporting of information in a similar manner for different companies.
  5. Verifiability is solely an enhancing characteristic for faithful representation.
  6. In preparing financial reports, it is assumed that users of the reports have reasonable knowledge of business and economic activities.

Question: Describe the major constraint inherent in the presentation of accounting information.

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.)
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