Accounting Theory Conceptual Issues in a Political and Economic Environment 9th Edition Wolk

Accounting Theory Conceptual Issues in a Political

and Economic Environment 9th Edition Wolk Test
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Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK

TRUE/FALSE

1. The conceptual framework is an attempt to provide a metatheoretical structure for financial

accounting.

ANSWER: T

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

ANSWER: F

3. The discussion memorandum that preceded the conceptual framework was perhaps the most
extensive ever published by the FASB.

ANSWER: T

4. The eight (8) statements making up the conceptual framework establish generally accepted
accounting principles.

ANSWER: F

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

ANSWER: F

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

ANSWER: F

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

ANSWER: T

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

ANSWER: T

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

accounting information.

ANSWER: T

10. The benefits of accounting information pertain to how useful the accounting information is
relative to the capital maintenance and accountability objectives.

ANSWER: F

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Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK
11. Competitive disadvantage is an indirect cost of published information.

ANSWER: T

12. The indirect costs of information pertain to gathering, preparation, and dissemination of
information.

ANSWER: F

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

ANSWER: T

14. According to SFAC No. 4, “earnings” is the indicator of a non-business organization’s

performance that is comparable to “income” in the profit sector.

ANSWER: 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.

ANSWER: F

16. SFAC No. 5 appears to deny one of the main tenets of the efficient markets hypothesis.

ANSWER: 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.

ANSWER: T

18. Comprehensive income as defined by SFAC No. 6 includes all changes in equity during a period.

ANSWER: F

19. Relevance and reliability are the primary characteristics that standard setters should be concerned
with.

ANSWER: T

20. Timeliness and predictive value are the two main aspect of relevance.

ANSWER: F

21. “Economic consequences” is not part of the conceptual framework.

ANSWER: T

22. SFAC No. 8 included the true and fair view in the qualitative characteristics of accounting.

ANSWER: F

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Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK

23. Timeliness is an enhancing qualitative characteristic of information about economic

phenomenon.

ANSWER: T

24. Codification is a justification of the standard-setting process itself rather than of the individual
standards that result from that process.

ANSWER: T

25. The jurisprudential view of the FASB is concerned with the theory embodied in the conceptual
framework.

ANSWER: F

26. Opinion is virtually unanimous that SFAC No. 5 on recognition and measurement is the low
point of the conceptual framework.

ANSWER: T

MULTIPLE CHOICE

1. Which of the following is not true regarding the FASB’s 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.
d. It includes seven statements of financial accounting concepts.
ANSWER: C

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 FASB’s deliberations related to the conceptual
framework project.
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.
ANSWER: A

3. Which statement in the conceptual framework deals with qualitative characteristics of accounting
information? Note that SFAC No. 8 replaces this older SFAC.
a. SFAC No. 1
b. SFAC No. 2
c. SFAC No. 3
d. SFAC No. 5
ANSWER: B

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Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK

4. Which statement in the conceptual framework is concerned with the objectives of business
financial reporting? Note that SFAC 8 replaces this SFAC.
a. SFAC No. 1
b. SFAC No. 2
c. SFAC No. 3
d. SFAC No. 5
ANSWER: A

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
ANSWER: D

6. The objectives of business financial reporting 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
ANSWER: A

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.
d. Users of accounting information have limited ability regarding financial information and
reporting.
ANSWER: C

8. The qualitative characteristics of accounting on which the conceptual framework is centered

come under the general heading of:
a. relevance.
b. materiality.
c. representational faithfulness.
d. decision usefulness.
ANSWER: D

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Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK

9. Which of the following is a pervasive constraint under the “original” qualitative characteristics of
accounting, pre-SFAC No. 8? It is an entity-specific constraint post SFAC No. 8.
a. Decision usefulness
b. Understandability
c. Materiality
d. Neutrality
ANSWER: C

10. Under SFAC No. 8, which of the following are aspects of relevance?
a. Comparability and understandability
b. Timeliness and comparability
c. Representational faithfulness and decision usefulness
d. Predictive value and confirmatory value
ANSWER: D

11. Which component of the conceptual framework is perhaps the most difficult to apply in practice?
a. Confirmatory value
b. Understandability
c. Benefits greater than costs
d. Faithful representation
ANSWER: C

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.
c. representational faithfulness.
d. understandability.
ANSWER: B

13. The degree of consensus among measurers is referred to in the conceptual framework as:
a. reliability.
b. relevance.
c. representational faithfulness.
d. understandability.
ANSWER: A

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. faithful representation.
d. understandability.
ANSWER: C

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Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK

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.
ANSWER: D

16. Pre-SFAC No. 8, the three components of reliability are:

a. predictive value, feedback value, timeliness.
b. verifiability, neutrality, representational faithfulness.
c. verifiability, predictive value, feedback value.
d. relevance, comparability, materiality.
ANSWER: B

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
ANSWER: D

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

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

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
b. Earnings
c. Revenue
d. Profits
ANSWER: A

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Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK

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 efficient markets hypothesis,
that disclosure outside of the body of financial statements is as effective as disclosure
within statements themselves.
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.
ANSWER: B

21. Which of the following is a true statement?

a. The eight 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.
d. The key document in the series of SFACs that comprise the conceptual framework is
SFAC No. 1.
ANSWER: C

22. Which of the following concepts was referred to as a convention in SFAC No. 2?
a. Consistency
b. Materiality
c. Comparability
d. Conservatism
ANSWER: D

23. 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.
ANSWER: D

24. 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.
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.
ANSWER: A

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Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK
25. Which of the following is not true regarding SFAC No. 7?
a. SFAC No. 7 requires that estimated future cash flows be used for asset measurement in
certain circumstances.
b. SFAC No. 7 concerns specific measurement issues rather than conceptual-type issues.
c. SFAC No. 7 applies only to initial recognition and not subsequent revaluations.
d. SFAC No. 7 is divided into two parts: asset measurement and income measurement.
ANSWER: D

ESSAY

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 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. Respond to the following:

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

b. 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 owner’s 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.

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Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK

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 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 entity’s
ongoing major or central operations.

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Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK

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 entity’s
ongoing major or central operations.

Gains are increases in equity from peripheral or incidental transactions of an entity and form all
other transactions and other event and circumstance 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 transaction and other events and circumstance affecting the entity except those that result
from expenses or distribution to owners.

6. Discuss the criticisms that of 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 characteristics 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.

7. Explain the main key points regarding asset and liability measurement made in SFAC No. 7.

ANSWER:

The most important point about asset measurement is that present value measurements are
intended to simulate fair value rather than the particular present value of the asset to the firm
itself. If a firm does not know the specific market value of a particular asset, it should strive for
that discount rate which would lead as closely as possible to estimated fair value. Discount rates
should also include risk and uncertainty which would reflect the assessment of the market toward
the asset’s value. If a particular asset has several possible cash flows within specific years, the
expected cash flows should be determined (the individual cash flows should be multiplied by
their expected probabilities) rather than using the single most likely cash flow.

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Accounting Theory Conceptual Issues in a Political and Economic Environment 9th Edition Wolk

Chapter 7—THE FASB’S CONCEPTUAL FRAMEWORK

The key point about liability measurement is that the discount rate must be tied to the credit
standing of the firm. This means that if the firm’s credit standing worsens, the valuation of the
liability decreases (because a poorer credit standing means that the applicable interest (discount)
rate would rise). Hence any firm acquiring the liability from the original creditor would pay less
to acquire the liability due to the debtor’s worsening credit standing.

Accounting Theory: 9th edition Page 11 of 11

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