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Zerda, Jessa Mae P.

BSA 202
CHAPTER 3

QUESTIONS:
1. What is the meaning of qualitative characteristics of financial information?
Qualitative characteristics are the qualities or attributes that meet the decision
usefulness of financial information. These attributes are relevance, faithful
representation, comparability, understandability, verifiability, and timeliness.

2. What are fundamental qualitative characteristics? The fundamental or primary


qualitative characteristics are relevance and faithful representation. These
characteristics must be present for information to be useful in making decisions.

3. What are the two fundamental qualitative characteristics? The two


fundamental qualitative characteristics are relevance and faithful representation. The
information must be both relevant and faithfully represented if it is to be useful.

4. Explain the most efficient and effective process of applying the fundamental
qualitative characteristics.
The most efficient and effective process of applying the fundamental qualitative
characteristics would be to identify an economic phenomenon that is potentially
useful. Define the categories of knowledge on the phenomenon that will be most
important and can be adequately described. Next is to identify the type of information
that would be most relevant and faithfully represented. Lastly, determine whether the
information is available.

5. Explain relevance. Relevance is the capacity of the information to influence a


decision. To be relevant, the financial information must be capable of making a
difference in the decisions made by users. Financial information should be related to
economic decisions.

6. What are the two ingredients of relevance? The two ingredients of relevance are
predictive value and confirmatory value. Predictive value provides predictive power
regarding possible future events, while Confirmatory value gives information about
past events.

7. Explain predictive value. Financial information has predictive value if it can be


used as an input to the process employed by users to predict future outcomes. It ables
to help users increase the likelihood of correctly or accurately predicting or
forecasting the outcome of events. Financial analysts and investors can use past
financial statements to chart performance trends and make predictions about future
performance and profitability.
8. Explain confirmatory value. Financial information has confirmatory value if it
provides feedback about previous evaluations. It enables users to confirm or correct
earlier expectations. For example, a net income measure helps shareholders confirm
or revise their expectations about the company’s ability to generate earnings.

9. What is an item material? An item is material if its inclusion or omission


significantly impacts the economic decisions of the primary users of the financial
statements. There is no strict or uniform rule for determining whether an item is
material or not. It is only dependent on good judgment, professional expertise, and
common sense.

10. Explain the new definition of materiality. The new definition of materiality
states that information is material if the omission, misstatement, and obscuring of the
information could reasonably affect the economic decision of primary users.

11. What are the factors that may be considered in determining materiality?
The importance of the use of discretion by management; who the key recipients
of the financial statements are and what judgments they make based on such financial
statements; the need for quantitative and qualitative evaluation when applying the
concept; and the need to determine what information is material, both separately and
collectively. Applying materiality means determining the probability that adding or
missing content, or modifying the way it is viewed, would affect the choices taken by
consumers, which often proves not to be a simple task.

12. Explain the fundamental qualitative characteristics of faithful


representation. The financial information in the financial reports should represent
what it purports to represent. Meaning, it should show what are present and what
happened, as the case may be. This implies the financial information must be
accurate, neutral and error-free.

13. What are the three ingredients if faithful representation?


 Completeness (adequate or full disclosure of all necessary information)
 Neutrality (fairness and freedom from bias)
 Free from error (no inaccuracies and omissions)

14. Explain completeness of financial information. Completeness requires financial


information, transactions, and event to be presented in a way that facilitates
understanding and avoids erroneous implications. It is the result of the adequate
disclosure standard. It requires that relevant.

15. What is the standard of adequate disclosure? Adequate disclosure is the


concept that the complete package of an entity's financial statements and
accompanying disclosures should provide all key information needed by users to
understand the entity's financial situation. It is the ability of the financial statements,
footnotes, and supplemental schedules to provide a comprehensive and clear
description of a company's financial position.

16. Explain notes to financial statements in relation to completeness of financial


information. Notes to the financial statements disclose the detailed assumptions
made by accountants when preparing financial statements. The notes are essential to
fully understanding these documents. The main purpose of the notes to the financial
statements is to further clarify accounting procedures used by a company, as well as
to divulge information that has occurred during and immediately after the close of the
accounting period.

17. Explain neutrality of financial information. Neutrality of financial information


means that both in formulating or applying standards, the primary concern should be
the relevance and reliability of the information that results, not the effect that the new
rule may have on a particular interest. For accounting to be neutral, it suggests that all
the information in the financial statements should be unbiased. To be neutral is to be
fair.

18. What is prudence? Prudence is the exercise of care and caution when dealing
with the uncertainties in the measurement process such that assets or income are not
overstated, and liabilities or expenses are not understated.

19. Explain conservatism. Conservatism requires company accounts to be prepared


with caution and high degrees of verification. All probable losses are recorded when
they are discovered, while gains can only be registered when they are fully realized. If
an accountant has two solutions to choose from when facing an accounting challenge,
the one that yields inferior numbers should be selected. Conservatism may also mean
"in case of doubt, record any losses and do not record any gains."

20. Explain free from error financial information. Free of error means there are
no errors and inaccuracies in the description of the phenomenon, and no errors made
in the process by which the financial information was produced. It does not mean that
it is perfectly correct in all ways. The method used to generate the recorded
information has been chosen and implemented without mistakes in the process.

21. Explain the effect of measurement uncertainty to usefulness of financial


information. Measurement uncertainty happens when the numerical sums in the
accounting statement are not clearly measurable and must instead be calculated.
Measuring uncertainty will impact accurate representation if the degree of uncertainty
in supplying the estimation is high. A high degree of calculation uncertainty does not
impact the usefulness of financial details if the estimation is explicitly and specifically
defined and clarified.
22. Explain the concept of substance over form. Substance over form is a concept
that transactions recorded in the financial statements and accompanying disclosures of
a company must reflect their economic substance rather than their legal form.
The person who prepares the financial statements of a company needs to use their
judgment to derive the business sense from the transactions and events to present
them in a manner that best reflects their true essence.

23. What are enhancing qualitative characteristics? Enhancing qualitative


characteristics is intended to improve the utility of the appropriate and faithfully
portrayed financial details. It refers to the presentation or form of financial
information. The information would be most useful if it is comparable,
understandable, verifiable, and timely.

24. Enumerate the four enhancing qualitative characteristics


(1) Comparability
(2) Understandability
(3) Verifiability
(4) Timeliness

25. Explain comparability. Comparability means the ability to bring together for the
purpose of noting points of likeness and difference. It is the enhancing qualitative
characteristics that enables users to identify and understand similarities and
dissimilarities among items. It is may be made within an entity or between and across
entities. It enriches a firm's information environment by making it easier for investors
to understand financial statement information in light of comparable peer data. For
example, if a number of oil and gas firms consistently apply the same industry-
specific accounting standards to their financial statements, then there should be a high
level of comparability within that industry.

26. Explain comparability within a single entity. Comparability within a single


entity is the quality of information that allows comparisons within a single entity
through time or from one accounting period to the next. It is also known as horizontal
comparability or intracomparability.

27. Explain comparability between and across entities - Comparability between


and across entities is the quality of information that allows comparisons between two
or more entities engaged in the same industry. It is also known as intercomparability
or dimensional comparability.

28. What is consistency? Consistency refers to the use of the same method for the
same items, either from period to period within an entity or in a single period across
entities. For example, once you decide on an accounting method or principle to use in
your business, you need to stick with and follow this method consistently throughout
your accounting periods. The purpose is to ensure that transactions or events are
recorded in the same way, from one accounting year to the next.

29. Distinguish consistency from comparability - Consistency is not the same as


comparability. Consistency refers to the uniform application of accounting methods
from period to period within an entity. On the other hand, comparability is the goal
and the uniform application of accounting methods between and across entities in the
same industries. Comparability is the goal, and consistency helps to achieve that goal.

30. Explain understandability. Understandability is the concept that financial


information should be presented so that a reader can easily comprehend it. This
concept assumes a reasonable knowledge of business by the reader but does not
require advanced business knowledge to gain a high level of comprehension.
Adherence to a reasonable level of understandability would prevent an organization
from deliberately obfuscating financial information to mislead users of its financial
statements. To be understandable, information should be complete, concise, clear, and
organized.

31. Explain verifiability. Verifiability is the extent to which information is


reproducible given the same data and assumptions. For example, if a company owns
the equipment, the company and the accountant should be able to reproduce the same
result. If they cannot, the information is not considered verifiable. Verifiability
ensures consumers that the knowledge represents an economic event, or a transaction
that it purports to represent.

32. Distinguish direct verification and indirect verification. Direct verification


means verifying an amount or other representation through direct observations.
Meanwhile, indirect verification means checking the inputs to a model, formula, or
other technique and recalculating the inputs using the same methodology. An example
of direct verification is counting inventories to verify their quantity. In indirect
verification, the accounting measure is verified by checking the inputs and
recalculating the outputs, using the same accounting methodology.

33. Explain timeliness. Timeliness is how quickly information is available to users of


accounting information. The less timely, the less useful information is for decision-
making. Timeliness matters for accounting information because it competes with
other information. For example, if a company issues its financial statements a year
after its accounting period, users of financial statements would find it difficult to
determine how well the company is doing in the present.

34. Explain cost constraint on useful financial information. A cost constraint on


useful financial information arises when it is excessively expensive to report certain
information in the financial statements. When it is too expensive to do so, the
applicable accounting frameworks allow a reporting entity to avoid the related
reporting. There are four main types of constraints which are the cost-benefit
relationship, materiality, industry practices, and conservatism, and these constraints
are also accounting guidelines that border the hierarchy of qualitative.

35. What is the rule on cost constraint? The rule on cost constraint is that the
benefit derived from the information should exceed the cost incurred in obtaining the
information. The cost constraint is a GAAP constraint that stipulates that the benefits
of reporting financial information should justify and be greater than the costs imposed
on supplying it. It belongs to prescribed bounds.

PROBLEM 3-1 Multiple Choice (IAA)


1. A 6. B
2. D 7. D
3. A 8. B
4. B 9. C
5. A 10. B
PROBLEM 3-2 Multiple Choice (IAA)
1. D 6. B
2. A 7. B
3. D 8. D
4. C 9. A
5. A 10. A
PROBLEM 3-3 Multiple Choice (IAA)
1. D 6. C
2. C 7. A
3. D 8. B
4. A 9. Consistency
5. D 10. B
PROBLEM 3-4 Multiple Choice (IAA)
1. C 6. D
2. B 7. C
3. B 8. C
4. B 9. C
5. B 10. B
PROBLEM 3-5 Multiple Choice (IAA)
1. C 4. A
2. D 5. C
3. C
PROBLEM 3-6 Multiple Choice (IACPA Adapted)
1. B 6. B
2. B 7. C
3. C 8. C
4. D 9. B
5. A 10. B
PROBLEM 3-7 Identification (ACP)

RELEVANCE 1. Information that has no bearing on an economic decision to be


made is useless.

COMPARABILITY 2. It is the ability to bring together for the purpose of noting


points of likeness and difference.

UNDERSTANDABILITY 3. It requires that users have some knowledge of the


complex economic activities of entities, the accounting process and the technical
terminology in the statements.

NEUTRALITY 4. Preparers of statements should not try to increase the usefulness of


information to a few users to detriment of others who may have opposing interests.

SUBSTANCE OVER FORM 5. In case of conflict between economic substance and


legal form of a transaction, the economic substance shall prevail.

MATERIALITY 6. Small expenditures for tools are expensed immediately.

CONSERVATISM 7. When in doubt, recognize all losses and don’t recognize gains.

COMPLETENESS 8. The information should be presented in a manner that


facilitates understanding and avoids erroneous implication.

RELEVANCE 9. It is the capacity of the information to influence a decision.

FAITHFUL REPRESENTATION 10. The description and numbers or figures must


watch what really existed or happened.

NOTES TO FINANCIAL STATEMENTS 11. The financial statements shall be


accompanied by notes to financial statements.

FREE FROM ERROR 12. There are no errors or omissions in the description of the
phenomenon.

COMPARABILITY 13. It is the goal achieved by consistency.

VERIFIABILITY 14. This enhancing qualitative characteristics implies consensus.

TIMELINESS 15. The older the information. The less useful.


PROBLEM 3-8 True or False (IAA)
1. True 6. True 11. False
2. False 7. False 12. False
3. False 8. True 13. False
4. False 9. False 14. True
5. False 10.False 15. True

CHAPTER 4
QUESTIONS:
1. What is the general objective of financial statements? The general objective of
financial statements is to provide information about economic resources of the
reporting entity, claims against the entity, and changes in the economic resources and
claims.

2. Explain a reporting period.


A reporting period is a period when financial statements are prepared for general
purpose financial reporting. It is typically either for a month, quarter, or year.
Organizations use the same reporting periods from year to year so that their financial
statements can be compared to the ones produced for prior years.

3. Explain a reporting entity.


A reporting entity is an entity that is required or chooses to prepare financial
statements. The most obvious examples of a reporting entity are a single legal
structure, such as an incorporated company, and a group comprising a parent and its
subsidiaries.

4. Define consolidated financial statements, unconsolidated financial statements,


and combined financial statements.
 Consolidated financial statements – These are the financial statements prepared
when the reporting entity comprises both the parent and its subsidiaries.
 Unconsolidated financial statements – These are the financial statements
prepared when the reporting entity is the parent alone.
 Combined financial statements – These are the financial statements when the
reporting entity comprises two or more entities that are not linked by a parent
and subsidiary relationship.

5. Explain underlying assumptions in the preparation of financial statements.


Accounting assumptions, also known as postulates, are the basic notions or
fundamental premises on which the accounting process is based. Accounting
assumptions serve as the foundation or bedrock of accounting to avoid
misunderstanding but rather enhance the understanding and usefulness of financial
statements. The Conceptual Framework for Financial Reporting only mentions one
assumption – going concern. But implicit in accounting are the basic assumptions of
accounting entity, time period, and monetary unit.
6. Explain going concern assumption. Going concern or continuity assumption
means that in the absence of evidence to the contrary, the accounting entity is viewed
as continuing in operation indefinitely. Going concern assuming that the entity will
continue to be in operation for the foreseeable future. It has no intention to liquidate
or reduce the size of its operations.

7. Explain time period assumption.


Time period assumption is the accounting rule that time can be divided into
distinct and consecutive periods and that accounting transactions can be allocated to
these periods using criteria laid out by other rules and principles. It is one of the
fundamental accounting rules and principles that is common to cash basis accounting,
accrual basis accounting and their modifications. It requires that the indefinite life of
an entity is subdivided into accounting periods which are usually of equal length to
prepare financial reports on financial position, performance, and cash flows.

8. Distinguish calendar year and natural business year.


The accounting period may be a calendar year or a natural year. A calendar year is a
twelve-month period that ends on December 31. Meanwhile, a natural business year is
a twelve-month period that ends on any month when the business is at the lowest or
experiencing slack season.

9. Explain monetary unit assumption.


Monetary unit assumption states that only those events and transactions recorded
in the book of accounts of the business, which can be measured and expressed in
monetary terms. Under this concept, assets, liabilities, equity, income, and expenses
are stated in terms of a common unit of measure, which is the peso in the Philippines.
Moreover, the purchasing power of the peso is regarded as stable. Therefore, changes
in the purchasing power of the peso due to inflation are ignored. The monetary unit is
a simple and universally recognized basis for communicating financial information. It
is the most appropriate and effective basis for recording, communicating, and
analyzing financial data based on which rational business decisions can be made.

10. Explain quantifiability and stability of the peso in relation to monetary


assumption unit.
The quantifiability aspect means that the assets, liabilities, equity, income, and
expenses should be stated in terms of a unit measure which is peso in the Philippines.
On the other hand, the stability of the peso means that the purchasing power of the
peso is stable or constant and that its instability is insignificant and therefore may be
ignored.

PROBLEM 4-1 Multiple Choice (CF)


1. A 4. A
2. C 5. D
3. D
PROBLEM 4-2 Multiple Choice (IAA)
1. B 6. D
2. D 7. B
3. D 8. C
4. D 9. A
5. B 10. C
PROBLEM 4-3 Multiple Choice (AICPA Adapted)
1. D 4. A
2. B 5. B
3. C
PROBLEM 4-4 (IAA)
1. Going Concern
2. Monetary Unit & Accounting Entity
3. Monetary Unit
4. Time Period
5. Accounting Entity

PROBLEM 4-5 Identification (IAA)


1. Time Period
2. Going Concern
3. Accounting Entity
4. Monetary Unit
5. Time Period

PROBLEM 4-6 Identification (IAA)


1. Monetary Unit
2. Time Period
3. Monetary Unit
4. Going Concern
5. Accounting Entity

CHAPTER 5
QUESTIONS:

1. Define elements of financial statement.


Financial Position:
 Assets – are economic resources control by the entity that has resulted from
past events and from which the future economic benefits are expected to flow
the entity.
 Liabilities – are the present obligations that have resulted from past events and
can require you to give up economic resources when settling them.
 Equity – the residual interest in the assets of the entity after deducting all the
liabilities.
Financial Performance:
 Income – increase in the economic benefits during the accounting period in the
form of inflows or enhancements of assets or decrease of liabilities that result
in increases in equity, other than those relating to contributions from equity
participants.
 Expenses – it is defined as decrease in asset or increase of liabilities that result
in decrease in equity, other than those relating to contributions from equity
holders.

2. What are the elements directly related to the measurement of financial


position?
 Assets – are economic resources control by the entity that has resulted from
past events and from which the future economic benefits are expected to flow
the entity.
 Liabilities – are the present obligations that have resulted from past events and
can require you to give up economic resources when settling them.
 Equity – the residual interest in the assets of the entity after deducting all the
liabilities.

3. What are the elements directly related to the measurement of financial


performance?
 Income – increase in the economic benefits during the accounting period in the
form of inflows or enhancements of assets or decrease of liabilities that result
in increases in equity, other than those relating to contributions from equity
participants.
 Expenses – it is defined as decrease in asset or increase of liabilities that result
in decrease in equity, other than those relating to contributions from equity
holders.

4. Define an asset.
Assets are economic resources control by the entity that has resulted from past
events and from which the future economic benefits are expected to flow the entity.
Assets are considered the first element of financial statements, and they report only in
the balance sheets. They are staying on the top of the balance sheets. In general, assets
are classified into two types based on the company’s policies and following
international accounting standards.

Current asset- short-term assets and these kinds of assets do not depreciate. The
movement or usages of them are directly charged to the income statement. Examples
are inventories and account receivables.

Non-current asset- These kinds of assets refer to assets that use more than one year
and with large amounts. They are not for trading or holders for price appreciation. In
other words, these assets are the resources based on nature, converted into cash or
cash equivalent in more than one-year accounting period. Example is PPE (Properties,
Plant, and Equipment).

5. What are the essential characteristics of an asset?


 The asset is a present economic resource.
 The economic resource is a right that has the potential to produce economic
benefits.
 The economic resource is controlled by the entity as a result of past events.

6. Explain a right to produce economic benefit.


a. Rights that correspond to an obligation of another entity
 Right to receive cash
 Right to receive goods or services
 Right to exchange economic resources with another party on favorable terms
 Right to benefit from an obligation of another party if a specified uncertain
future event occurs

b. Rights that do not correspond to an obligation of another entity


 Right over physical objects, such as property, plant and equipment or
inventories
 Right to intellectual property

c. Rights established by contract or legislation such as owning a debt instrument or


an equity instrument or owning a registered patent.

7. Explain control of an economic resource.


An entity controls an economic resource if it has the present ability to direct
the use of the asset and obtain the economic benefits that result from it. Control also
requires the right to prevent others from using such asset and prevent them from
receiving economic profits from the asset. Control may arise if an entity asserts legal
rights. If there are no legal rights, it can still exist in other ways of ensuring that no
other person may profit from the asset. For example, an organization has access to
technological know-how and the right to keep this know-how confidential.

8. Define a liability.
Liabilities are the present obligations that have resulted from past events and
require you to give up economic resources when settling them. Liabilities are
classified into two different types:

Current Liabilities- refer to the kind of liabilities expected to settle within 12 months
after the reporting date. For example, salaries payable are classed as current liabilities
because you will pay to an employee in the following month.
Non-current liabilities- refer to the kind of liabilities expected to settle in more than
12 months. For example, a long-term loan from a bank that the term of payments is
more than 12.

9. What are the essential characteristics of a liability?


 The entity has an obligation. The entity liable must be identified. It is not
necessary that the payee or the entity to whom the obligation is owed be
identified.
 The obligation is to transfer an economic resource.
 The obligation is a present obligation that exists as a result of past event. This
means that a liability is not recognized until it is incurred.

10. Explain an obligation. An obligation is a duty or responsibility to pay a third


party on the terms of an underlying contract, such as a sales order, a mortgage, or a
bond issue. Obligations may be legally enforceable as a consequence of a binding
contract or statutory requirement. While constructive obligation is an obligation to
pay that arises out of conduct and intent rather than a contract. A constructive
obligation is shown on the balance sheet as a liability.

11. Explain transfer of economic resources.


The transfer of an economic resource embodies economic benefits that will
be required to settle the obligation, resulting in an outflow from the reporting entity to
a third party. Obligations to transfer an economic resource include paying cash,
delivering goods or noncash resources, provide services at some future time,
exchange economic resources with another party on unfavorable terms, and transfer
an economic resource if specified uncertain future event occurs.

12. Define income. Income is described as an increase in the economic benefits


during the accounting period in the form of inflows or enhancements of assets or
decrease of liabilities that result in increases in equity, other than those relating to
contributions from equity participants.

13. Distinguish income from revenue.


Revenue is the total amount of revenue generated by the sale of goods or
services related to the primary operation of the company. Income or net income is the
total income or profit of a company. Both revenue and net income are useful in
determining the financial strength of a company, but are not interchangeable.

14. Define an expense. Expense is defined as decrease in asset or increase of


liabilities that result in decrease in equity, other than those relating to contributions
from equity holders. Expenses are records as operational costs in the income
statement in the period they have occurred.

15. Distinguish expenses from loss.


Loss is a decrease in net income that is outside normal business operations.  
The expense is the cost of earning revenue in the main operations of the company.

Problems:

5-1 MC (ACP)
1. A 6. B
2. B 7. C
3. A 8. D
4. A 9. B
5. B 10. A

5-2 MC (Conceptual Framework)


1. D 6. A
2. D 7. B
3. D 8. D
4. D 9. C
5. B 10. C

5-3 MC (AICPA Adapted)


1. D 4. C
2. C 5. C
3. C

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