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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

What accounting assumption, principle, or constraint would Target Corporation use in each of the situations below?

(a) Target was involved in litigation over the last year. This litigation is disclosed in the financial statements.

(b) Target allocates the cost of its depreciable assets over the life it expects to receive revenue from these assets.

(c) Target records the purchase of a new Dell PC at its cash equivalent price.

(Assumptions, Principles, and Constraint) Presented below are the assumptions, principles, and constraints used in this chapter.

1. Economic entity assumption 6. Measurement principle (fair value)2. Going concern assumption 7. Expense recognition principle3. Monetary unit assumption 8. Full disclosure principle4. Periodicity assumption 9. Cost constraint5. Measurement principle (historical cost) 10. Revenue recognition principle

Instructions

Identify by number the accounting assumption, principle, or constraint that describes each situation below. Do not use a number more than once

.(a) Allocates expenses to revenues in the proper period.

(b) Indicates that fair value changes subsequent to purchase are not recorded in the accounts. (Do not use revenue recognition principle.)

(c) Ensures that all relevant financial information is reported.

(d) Rationale why plant assets are not reported at liquidation value. (Do not use historical cost principle.)

(e) Indicates that personal and business record keeping should be separately maintained.(f) Separates financial information into time periods for reporting purposes.

(g) Assumes that the dollar is the 鈥渕easuring stick鈥� used to report on financial performance.

E2-4 (L03) (Qualitative Characteristics) The qualitative characteristics that make accounting information useful for decision-making purposes are as follows.

Relevance Neutrality Verifiability

Faithful representation Completeness Understandability

Predictive value Timeliness Comparability

Confirmatory value Materiality Free from error

InstructionsIdentify the appropriate qualitative characteristic(s) to be used given the information provided below.

(a) Qualitative characteristic being employed when companies in the same industry are using the same accounting principles.

(b) Quality of information that confirms users鈥� earlier expectations.

(c) Imperative for providing comparisons of a company from period to period.

(d) Ignores the economic consequences of a standard or rule.

(e) Requires a high degree of consensus among individuals on a given measurement.

(f) Predictive value is an ingredient of this fundamental quality of information.

(g) Four qualitative characteristics that are related to both relevance and faithful representation.

(h) An item is not recorded because its effect on income would not change a decision.

(i) Neutrality is an ingredient of this fundamental quality of accounting information.

(j) Two fundamental qualities that make accounting information useful for decision-making purposes.

(k) Issuance of interim reports is an example of what enhancing quality of relevance?

(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.

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?
See all solutions

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