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Chapter 2: Question 7Q (page 61)

According to the FASB conceptual framework, the objective of financial reporting for business enterprises is based on the needs of the users of financial statements. Explain the level of sophistication that the Board assumes about the users of financial statements.

Short Answer

Expert verified

Users of financial information such as investors, creditors, and their representatives are expected to have a sound knowledge ofaccounting concepts, financial statements as well as business and economic activities. They are also expected to be prepared to study and translate information carefully.

Step by step solution

01

Meaning of financial statements 

Financial statements are the statements prepared by all types of organizations to ascertain the result of operating and non-operating activities of business and help in determining the financial position as on the date of closing the books of accounts for an accounting year.

02

Sophistication assumed by the Boards about the users of financial statements

The Board relies on general-purpose statements to provide information to users of the financial statements. The main purpose of such statements is to provide the most useful information to various user groups.

The primary purpose of this assumption is that users need a reasonable knowledge of business and financial matters in order to understand the information contained in the financial statements. This means that the level of reasonable knowledge that can be assumed affects the manner and extent to which the information is reported when preparing financial statements.

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Most popular questions from this chapter

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.

Three expense recognition methods (associating cause and effect, systematic and rational allocation, and immediate recognition) were discussed in the text under the expense recognition principle. Indicate the basic nature of each of these expense recognition methods and give two examples of each.

Question: An accountant must be familiar with the concepts involved in determining earnings of a business entity. The amount of earnings reported for a business entity is dependent on the proper recognition, in general, of revenues and expenses for a given time period. In some situations, costs are recognized as expenses at the time of product sale. In other situations, guidelines have been developed for recognizing costs as expenses or losses by other criteria.Instructions

  1. Explain the rationale for recognizing costs as expenses at the time of product sale.
  2. What is the rationale underlying the appropriateness of treating costs as expenses of a period instead of assigning the costs to an asset? Explain.
  3. In what general circumstances would it be appropriate to treat a cost as an asset instead of as an expense?
  4. Some expenses are assigned to specific accounting periods on the basis of systematic and rational allocation of asset cost. Explain the underlying rationale for recognizing expenses on the basis of systematic and rational allocation of asset cost.
  5. Identify the conditions under which it would be appropriate to treat a cost as a loss.

GROUPWORK (Accounting Principles and Assumptions鈥擟omprehensive) Presented below are a number of business transactions that occurred during the current year for Gonzales, Inc.

Instructions

In each of the situations, discuss the appropriateness of the journal entries in terms of generally accepted accounting principles.

(a) The president of Gonzales, Inc. used his expense account to purchase a new Suburban solely for personal use. The following journal entry was made.Miscellaneous Expense 29,000Cash 29,000

(b) Merchandise inventory that cost \(620,000 is reported on the balance sheet at \)690,000, the expected selling price less estimated selling costs. The following entry was made to record this increase in value.Inventory 70,000Sales Revenue 70,000

(c) The company is being sued for \(500,000 by a customer who claims damages for personal injury apparently caused by a defective product. Company attorneys feel extremely confident that the company will have no liability for damages resulting from the situation. Nevertheless, the company decides to make the following entry.Loss from Lawsuit 500,000Liability for lawsuit 500,000

(d) Because the general level of prices increased during the current year, Gonzales, Inc. determined that there was a \)16,000 understatement of depreciation expense on its equipment and decided to record it in its accounts. The following entryDepreciation Expense 16,000Accumulated Depreciation Equipment 16,000

(e) Gonzales, Inc. has been concerned about whether intangible assets could generate cash in case of liquidation. As a consequence, goodwill arising from a purchase transaction during the current year and recorded at \(800,000 was written off as follows.

(f) Because of a 鈥渇ire sale.鈥� equipment obviously worth \)200,000 was acquired at a cost of $155,000. The following entry was made.Equipment 2000Cash 155,000Sales Revenue 45,000

The chairman of the company鈥檚 board of directors for which you are the chief accountant has told you that he has little use for accounting figures based on historical cost. He believes that replacement values are of far more significance to the board of directors than 鈥渙ut-of-date costs.鈥� Present some arguments to convince him that accounting data should still be based on historical cost.
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