Chapter 7

The FASBs Conceptual Framework

TRUE/FALSE
1.

The conceptual framework is an attempt to provide a methatheoretical structure

for financial accounting
ANS: T

2.

The most important new issue brought up in the discussion memorandum that
preceded the conceptual framework was predictive ability.
ANS: F

3.

The discussion memorandum that preceded the conceptual framework was

perhaps the most extensive ever published by the FASB.
ANS: T

4.

The six statements making up the conceptual framework establish generally

accepted accounting principles.
ANS: F

5.

SFAC No. 1 maintains that financial statements should be geared toward specific
needs of particular user groups.
ANS: F

6.

The conceptual framework maintains that accounting reports should become the
only relevant source of information about enterprises.
ANS: F

7.

SFAC No. 1 takes the position that users of financial statements must be assumed
to be knowledgeable about financial information and reporting.
ANS: T

8.

With regard to users, SFAC No. 1 established that financial statements should be
aimed at a common core of similar information users.
ANS: T

9.

The quality of understandability is a characteristic influenced by both users and

preparers of accounting information.
ANS: T

10.

The benefits of accounting information pertain to how useful the accounting

information is relative to the capital maintenance and accountability objectives.
ANS: F

11.

Competitive disadvantage is an indirect cost of published information.

ANS: T

12.

The indirect costs of information pertain to gathering, preparation, and

dissemination of information.
ANS: F

13.

There is a conflict between timeliness and the other aspects of relevance.

ANS: T

14.

According to SFAC No. 4, earnings is the indicator of a non-business

organizations performance that is comparable to income in the profit sector.
ANS: F

15.

SFAC No. 5 makes clear that the concepts discussed in the conceptual framework
apply to other means of disclosure in addition to financial statements.
ANS: F

16.

SFAC No. 5 appears to deny one of the main tenets of the efficient-markets
hypothesis.
ANS: T

17.

The definitions of SFAC No. 6 are virtually identical to those in SFAC No. 3
except that they are extended to non-business organizations.
ANS: T

18.

Comprehensive income as defined by SFAC No. 6 includes all changes in equity

during a period.
ANS: F

19.

Relevance and reliability are the primary characteristics that standard setters
should be concerned with.
ANS: T

20.

Timeliness and predictive value are the two main aspects of relevance.
ANS: F

21.

Economic consequences is not part of the conceptual framework.

ANS: T

22.

The concept of consistency was referred to as a convention in SFAC No. 2.

ANS: F

23.

Timeliness is a constraint on both of the other aspects of relevance.

ANS: T

24.

Codification is a justification of the standard-setting process itself rather than of

the individual standards that result from that process.
ANS: T

25.

The jurisprudential view of the FASB is concerned with the theory embodied in
the conceptual framework.
ANS: F

MULTIPLE CHOICE
1.

Which of the following is not true regarding the FASBs conceptual framework?
a.
It is supposed to embody a system of interrelated objectives.
b.
It is an attempt to provide a metatheoretical structure for financial
accounting.
c.
It establishes generally accepted accounting principles. XXXXX
d.
It includes six statements of financial accounting concepts.

2.

Which of the following is not true regarding the discussion memorandum that
preceded the conceptual framework?
a.
It represented the end product of the FASBs deliberations related to the
conceptual framework project. XXXXX
b.
The most important new issue brought up in the document was capital
maintenance.
c.
It brought up three views of financial accounting and financial statements.
d.
It presented various definitions for basic accounting terms.

3.

Which statement in the conceptual framework deals with qualitative

characteristics of accounting information?
a.
SFAC No. 1
b.
SFAC No. 2 XXXXX
c.
SFAC No 3
d.
SFAC No. 5

4.

Which statement in the conceptual framework is concerned with the objectives of

business financial reporting?
a.
SFAC No. 1 XXXXX
b.
SFAC No. 2
c.
SFAC No. 3
d.
SFAC No. 5

5.

The qualitative characteristics of accounting information detailed in the

conceptual framework proceeded directly from which of the following
documents?
a.
The Trueblood Report
b.
SATTA
c.
APB Statement 4
d.
ASOBAT XXXXX

6.

The objectives of business financial reporting detailed in the conceptual

framework proceeded directly from which of the following documents?
a.
The Trueblood Report XXXXX
b.
SATTA
c.
APB Statement 4
d.
ASOBAT

7.

Which of the following is a value judgment found in SFAC No. 1?

a.
Accounting reports should become the only relevant source of information
about enterprises.
b.
Cash basis accounting is extremely useful in assessing and predicting
earning power and cash flows of an enterprise.
c.
Information is not costless to provide, so benefits of usage should exceed
costs of production. XXXXX
d.
Users of accounting information have limited ability regarding financial
information and reporting.

8.

The qualitative characteristics of accounting that the conceptual framework has

centered on come under the general heading of:
a.
Relevance
b.
Materiality
c.
Representational faithfulness
d.
Decision usefulness XXXXX

9.

Which of the following is a pervasive constraint of the qualitative characteristic of

accounting?
a.
Decision usefulness
b.
Understandability
c.
Materiality XXXXX
d.
Neutrality

10.

Which of the following are aspects of relevance?

a.
Comparability and neutrality
b.
Timeliness and verifiability
c.
Representational faithfulness and decision usefulness
d.
Predictive value and feedback value XXXXX

11.

Which component of the conceptual framework is perhaps the most difficult to

apply in practice?
a.
Materiality
b.
Timeliness
c.
Benefits greater than costs XXXXX
d.
Neutrality

12.

The quality of being capable of making a difference in a decision by helping

users to form predictions about the outcomes of past, present, and future events or
to confirm or correct expectations is referred to in the conceptual framework as:
a.
Reliability
b.
Relevance XXXXX
c.
Representational faithfulness
d.
Understandability

13.

The degree of consensus among measurers is referred to in the conceptual

framework as:
a.
Reliability XXXXX
b.
Relevance
c.
Representational faithfulness
d.
Understandability

14.

The idea that a measurement should correspond with the phenomenon it is

attempting to measure is referred to in the conceptual framework as:
a.
Reliability
b.
Relevance
c.
Representational faithfulness XXXXX
d.
Understandability

15.

Which of the following is a true statement regarding feedback value.

a.
It concerns confirming or correcting decision makers earlier expectations.
b.
It refers to assessing where the firm presently stands.
c.
It is closely related to accountability.
d.
All of the above XXXXX

16.

The three components of reliability are:

a.
Predictive value, feedback value, timeliness
b.
Verifiability, neutrality, representational faithfulness XXXXX
c.
Verifiability, predictive value, feedback value
d.
Relevance, comparability, materiality

17.

Which qualitative characteristic pertains wholly to the attitude of board members

as opposed to being more directly concerned with specific aspects of information
contained in the financial statements?
a.
Representational faithfulness
b.
Verifiability
c.
Consistency
d.
Neutrality XXXXX

18.

Which of the following is not part of the conceptual framework?

a.
Conservatism
b.
Economic consequences XXXXX
c.
Consistency
d.
None of the above are in the conceptual framework

19.

SFAC designated which of the following as the term to indicate the

comprehensive or total change in net assets occurring during the period as a result
of operations?
a.
Income XXXXX
b.
Earnings
c.
Revenue
d.
Profits

20.

Which of the following is a true statement?

a.
SFAC No. 5 makes clear that the concepts discussed in the conceptual
framework apply to other means of disclosure in addition to financial
statements.
b.
SFAC No. 5 appears to deny one of the main tenets of the efficientmarkets hypothesis, that disclosure outside of the body of financial
statements is as effective as disclosure within statements themselves.
XXXXX
c.
SFAC No. 5 made a clear attempt to resolve the issues of recognition and
measurement.
d.
SFAC No. 5 was successful because it addressed measurement prior to
discussing recognition.

21.

Which of the following is not a true statement?

a.
Codification is a justification of the standard-setting process itself rather
than of the individual standards that result from that process.
b.
The codificational approach results in a selection of the best possible
accounting standards. XXXXX
c.
The conceptual framework is said to embody aspects of both a constitution
and a theory.
d.
The codificational approach requires good reasons for the choice of
accounting standards.

22.

Which of the following is a true statement?

a.
The six SFACs that comprise the conceptual framework were not
evolutionary because they were derived from previous documents such as
the Trueblood Report and ASOBAT.
b.
The definitions of SFAC No. 6 were basically a restatement of the
definitions of APB Statement 4.
c.
The Achilles heel of the document is SFAC No. 5, which reaffirmed
historical cost as the basic measurement system. XXXXX
d.
The key document in the series of SFACs that comprise the conceptual
framework is SFAC No. 1.

23.

Which of the following concepts was referred to as a convention in SFAC No. 2?

a.
Consistency
b.
Materiality
c.
Comparability
d.
Conservatism XXXXX

24.

Which of the following is not a true statement?

a.
SFAC No. 3 defines 10 elements of financial statements.
b.
SFAC No. 3 is a resolution of the definitions presented in the discussion
memorandum for the conceptual framework project.
c.
SFAC No. 3 was amended by SFAC No. 6
d.
SFAC No. 3 discusses in detail the three views of financial accounting
mentioned in the discussion memorandum. XXXXX

25.

Which of the following is a true statement?

a.
Predictive value refers to usefulness of inputs for predictions rather than
being an actual prediction itself. XXXXX
b.
Timeliness complements rather than conflicts with the other aspects of
relevance because information is more complete and accurate if it is
timely.
c.
The conceptual framework stressed predictive value rather than the
importance of decision-making by outside users.
d.
Timeliness and predictive value are the two main aspects of relevance.

ESSAY QUESTIONS
1.

Do the SFACs that constitute the conceptual framework establish generally

accepted accounting principles? What are the benefits and limitations of this
approach?

ANSWER: The SFACs that constitute the conceptual framework do not establish
generally accepted accounting principles. This avoids the possibility of a crisis
arising from a failure to comply with the statements. Also, the process of arriving
at a workable and utilitarian metatheoretical-type structure must be acknowledged
as a slow, evolutionary process. The tentative nature of the statements may make
it easier to change components as the need arises. On the other hand, the
possibility also exists that the statements will have a purely cosmetic effect.
2.

Why might SFAC No. 5 be considered a failure?

ANSWER: SFAC No. 5 did not deal extensively with the issues of recognition
and measurement. It backed away from considering possible criteria for change,
which suggests a continued use of present measurement attributes and reliance on
an evolutionary approach. It dealt with recognition ahead of measurement, but
the issue of when to recognize an element cannot be discussed until we know the
measurement characteristics that are to be recognized. In addition, the move
toward the asset-liability viewpoint in the first three SFACs was a shift toward
current valuation and away from matching. The counterreformation of SFAC No.
5, particularly its statement to the effect that change should occur in a gradual and
evolutionary manner, effectively stymied this reform.

3.

a.
b.

How is net income different from earnings in SFAC No. 5?

What is comprehensive income?

ANSWER:
a.
One of the principal concerns of SFAC No. 5 was the format and
presentation of changes in owners equity that do not arise from
transactions with owners. Earnings would replace net income and
would differ from the latter by excluding the cumulative effect on prior
years of a change in accounting principle. Earnings would thus be a better
indicator of current operating performance than net income.
b.
Comprehensive income includes all changes in owners equity during the
period except for transactions with owners. A cumulative effect of a
change in accounting principle would be included in comprehensive
income as would such items as the income effect of recognized gains and
losses of marketable securities that are not classified as current assets,
foreign currency translation adjustments, and prior period adjustments.
4.

Explain the hierarchy of accounting qualities identified in SFAC No. 2.

ANSWER: Decision-makers are at the top of the hierarchy. The specific

qualitative characteristics of accounting come under the general heading of
decision usefulness, continuing the emphasis on decision-makers and their needs.
The two primary, decision-specific qualities are relevance and reliability.
Comparability is a secondary qualitative characteristic. Relevance is defined as
being capable of making a difference in a decision by helping users to form
predictions about the outcomes of past, present, and future events or to confirm or
correct expectations. Relevance has two main aspects predictive value and
feedback value and one minor one, timeliness. Predictive value refers to
usefulness of inputs for predictions while feedback value concerns confirming or
correcting the expectations of decision-makers. Timeliness is really a constraint
on both of the other aspects of relevance. To be relevant, information must be
timely, which means that it must be available to decision makers before it loses
its capacity to influence decisions.
Reliability is composed of three components: verifiability, representational
faithfulness, and neutrality. Verifiability refers to the degree of consensus among
measurers. Representational faithfulness refers to the idea that the measurement
itself should correspond with the phenomenon it is attempting to measure.
Neutrality refers to the belief that the policy-setting process should be primarily
concerned with relevance and reliability rather than the effect a standard or rule

might have on a specific user group or the enterprise itself.

These qualities are applied within the constraints of benefits greater than cost and
materiality. Materiality addresses whether an item is large enough to influence
users decisions.
5.

Define the elements of financial statements identified in SFAC No. 3 and SFAC
No. 6.

ANSWER: Assets are probable future economic benefits obtained or controlled

by a particular entity as a result of past transactions or events.
Liabilities are probable future sacrifices of economic benefits arising from present
obligations of a particular entity to transfer assets or provide services to other
entities in the future as a result of past transactions or events.
Equity (or net assets) is the residual interest in the assets of an entity that remains
after deducting its liabilities.
Investments by owners are increases in equity resulting from transfers to it from
other entities of something valuable to obtain or increase ownership interests
(equity) in it.
Distributions to owners are decreases in equity resulting from transferring assets,
rendering services, or incurring liabilities by the enterprise to owners.
Comprehensive income is the change in equity during a period from transactions
and other events and circumstance from non-owner sources. It includes all
changes in equity during a period except those resulting from investments by
owners and distributions to owners.
Revenues are inflows or other enhancements of assets or settlements of its
liabilities from delivering or producing goods, rendering services, or other
activities that constitute the entitys ongoing major or central operations.
Expenses are outflows or other depletion of assets or incurrences of liabilities
from delivering or producing goods, rendering services, or carrying out other
activities that constitute the entitys ongoing major or central operations.
Gains are increase in equity from peripheral or incidental transactions of an entity
and form all other transactions and other events and circumstances affecting the
entity except those that result from revenues or investment by owners.

Losses are decreases in equity from peripheral or incidental transactions of an

entity and from all other transactions and other events and circumstance affecting
the entity except those that result from expenses or distribution to owners.
6.

Discuss the criticisms that have been aimed at SFAC No. 6.

ANSWER: The definitions of the elements of financial statements have been

criticized on the grounds that the various criteria for each of the categories is
necessary but not sufficient to determine whether a general type of accounting
event falls into a particular definitional category. However, it would be
impossible to completely specify all characteristic of elements. The lack of
completeness must be complemented by the professional judgment capabilities of
the accountant and auditor.
It has also been argued that the FASB definition of assets that emphasized future
economic benefits is grounded in future revenue and income measurement.
Consequently, the matching concept is the primary focus of the definition. It has
been argued that the asset definition should concentrate on property rights that are
concerned with wealth, which provides a true balance sheet orientation. This
would result in certain deferred charges being expensed immediately even though
their incurrence may bring about future economic benefits.
Another argument related to the definitions of SFAC No. 6 concerns how broadly
the term past transactions can be interpreted under the asset and liability
definitions.