CHAPTER 3

CONCEPTUAL FRAMEWORK
QUALITATIVE
CHARACTERISTIC
QUESTION 3-1
 Define qualitative characteristics of financial
statements.
ANSWER 3-1
Qualitative characteristics are the qualities or
attributes that make financial accounting information
useful to the users
In deciding which information should be included in
financial statements, the objective is to ensure that
the information is useful to the users in making
economic decisions.
Qualitative characteristics are classified into:
a. Fundamental qualitative characteristics
b. Enhancing qualitative characteristics
QUESTION 3-2
 Explain fundamental qualitative characteristics,
ANSWER 3-2
The fundamental qualitative characteristics relate
to the content or substance of financial
information
The fundamental qualitative characteristics are:
a. Relevance
b. Faithful representation
Information must be both relevant and faithfully
represented if it is to be useful.
QUESTION 3-3
 Explain enhancing qualitative characteristics.
ANSWER 3-3
The enhancing qualitative characteristics are
intended increase the usefulness of the financial
information relevant and faithfully represented.
The enhancing qualitative characteristics relate
presentation or form of financial information.
The enhancing qualitative characteristics are:
a. Understandability
b. Comparability
c. Verifiability
d. Timeliness
QUESTION 3-4
 Explain the qualitative characteristic of relevance.
ANSWER 3-4
Relevance is the capacity of the information to influence a decision.
Relevance is the capacity to make a difference in a decision made
by users.
Relevance requires that the financial information should be related
or pertinent to the economic decision.
Information that does not bear on an economic decision is useless.
To be useful, the information must be relevant to the decision
making needs of users.
Broadly, the statement of financial position is relevant in determining
financial position and the income statement is relevant in
determining financial performance.
Specifically, the earnings per share information is more relevant
than book value per share in determining the attractiveness of an
investment
QUESTION 3-5
 Explain the major ingredients of relevant information
ANSWER 3-5
The ingredients of relevance are predictive value and
confirmatory value
Information has predictive value when it can help users
increase the likelihood of correctly predicting or forecasting
outcome of events.
For example, information about financial position and
financial performance is frequently used in predicting
dividend and wage payments and the ability of the entity to
meet maturing commitments.
The net cash provided by operating activities is valuable in
predicting loan payment or default.
Financial information has confirmatory value if it provides
feedback about previous evaluations.
In other words, financial information has
confirmatory value when it enables users confirm or
correct earlier expectations.
For example, a net income measure has
confirmatory value if it can help shareholders
confirm or revise their expectation about an entity's
ability to generate earnings Often, information has
both predictive and confirmatory value.
The predictive and confirmatory roles of information
are interrelated.
An example is an interim income statement which
provides feedback about income to date and serves
as a basis for predicting the annual income.
The interim income statement for the first quarter
shows net income of P2,000,000. This is the
confirmatory value,
If this trend continues for the entire year, it is
logical to assume that the net income after four
quarters or one year would be P8,000,000. This
is the predictive value.
QUESTION 3-6
 Explain materiality an relation to relevance.
ANSWER 3-6
Materiality is a practical rule in accounting which die that strict
adherence to GAAP is not required when items are not significant
enough to affect the evaluation decision and fairness of the financial
statements.
Materiality is also known as the doctrine of convenience
Materiality is really a "quantitative threshold" linked closely to the
qualitative characteristic of relevance.
The relevance of information is affected by its nature and materiality.
In other words, materiality is a "subquality of relevance based on
nature and magnitude of the item to which the information relates.
Materiality is a relativity.
Materiality of an item depends on relative size rather than absolute
size. What is material for one entity may be immaterial for another.
An error of P100.000 in the financial statements of a multinational
entity may not be important but may be so critical for a small entity.
QUESTION 3-7
 When is an item material?
ANSWER 3-7
The Conceptual Framework does not specify a
uniform quantitative threshold for materiality.
Very often, materiality is dependent on good
judgment, professional expertise and common
sense.
However, a general guide may be given, to wit:
An item is material if knowledge of it would affect
or influence the decision of the primary users of
the financial statements
QUESTION 3-8
 What is the new definition of materiality as promulgated by
IASB?
ANSWER 3-8
Information is material if omitting, misstating or obscuring it
could reasonably be expected to influence the economic
decisions that primary users of general purpose financial
statements make on the basis of those statements which
provide financial information about a specific reporting entity.
Simply stated, an information is material if the omission,
misstatement and obscuring of the information could
reasonably affect the economic decision of primary users.
The revised definition of materiality highlights three important
aspects:
a. Could reasonably be expected to influence
b. b. Obscuring information
c. c. Primary users
QUESTION 3-9
 Explain the "could reasonably to expected to influence" threshold
for materiality.
ANSWER 3-9
The "could reasonably be expected to influence" threshold means
that materiality of information is relevant only to primary users and
not to other users.
The could reasonably be expected to influence threshold adds an
element of reasonability of financial information on which economic
decision is based.
By including the term could reasonably be expected to influence in
the new definition, material information shall be limited to the
economic decision of primary users rather than to all users which is
too broad in scope
Moreover, the could reasonably be expected to influence threshold
insures that information capable of influencing economic decisions
of the primary users shall be included in the financial statements.
QUESTION 3-10
 Explain the "obscuring information" threshold
for materiality.
ANSWER 3-10
Obscuring information is a new concept added to
the new definition of materiality.
Information is obscured if presenting or
communicating it would have a similar effect as
omitting or misstating the information.
Obscuring information means the presentation of
financial information not readily understood or
not clearly expressed..
Obscuring information may be characterized by
deliberate vagueness, ambiguity and
abstruseness.
Examples of obscured material information are:
a. The language is vague, unclear or
incomprehensible.
b. The information is scattered throughout the
financial statements.
c. Dissimilar items are aggregated
inappropriately.
d. Similar items are disaggregated
inappropriately
QUESTION 3-11
 Explain why materiality of information is relevant only to
primary users.
ANSWER 3-11
The new definition of materiality narrows the definition to
primary users who are primarily affected by general purpose
financial statements.
The primary users include the existing and potential investors,
lenders and other creditors.
The new definition specified that only primary users of financial
statements are considered because these groups are the users
to whom general purpose financial statements are primarily
directed.
Such users cannot require reporting entities to provide
information directly to them and therefore must rely on general
purpose financial reports for how much financial information is
needed.
QUESTION 3-12
 What is faithful representation?
ANSWER 3-12
Faithful representation means that financial reports
represent economic phenomena or transactions in
words and numbers.
Stated differently, the descriptions and figures match
what really existed or happened.
Simply worded, faithful representation means that the
actual effects of the transactions shall be properly
accounted for and reported in the financial statements.
For example, if the entity reports purchases of
P5,000,000 when the actual amount is P8,000,000,
the information would not be faithfully represented.
To record a sale of merchandise as
miscellaneous income would not also be a
faithful representation of the sale transaction.
When ending inventory is misstated, either
understated or overstated, the presentation or
reporting lacks faithful representation.
The recognition of an impairment loss on
property, plant and equipment is an application
of faithful representation.
QUESTION 3-13
 What are the ingredients of faithful
representation?
ANSWER 3-13
To be a perfectly faithful representation, a
depiction should have three characteristics,
namely:
a. Completeness
b. Neutrality
c. Free from error
QUESTION 3-14
 Explain completeness of financial statements and the
standard of adequate disclosure.
ANSWER 3-14
Completeness requires that relevant information show
presented in a way that facilitates understanding and
avoids erroneous implication.
Completeness is the result of the adequate disclosure
standards or the principle of full disclosure.
The standard of adequate disclosure means that all
significant and relevant information leading to the
preparation of financial statements shall be clearly
reported
Adequate disclosure however does not mean
disclosure of just any data
The accountant shall disclose a material fact
known to him which is not disclosed in the
financial statements but disclosure of which is
necessary in order that the statements would not
be misleading.
In other words, the standard of adequate
disclosure is best described by disclosure of any
financial facts significant enough to influence the
judgment of informed users.
Actually, to be complete, the financial statements
shall be accompanied by "notes to financial
statements".
The purpose of the notes is to provide the
necessary disclosures required by Philippine
Financial Reporting Standards.
Notes to financial statements provide narrative
description or disaggregation of the items
presented in the financial statements and
information about items that do not quality for
recognition.
QUESTION 3-15
 Explain neutrality of financial statements.
ANSWER 3-15
Neutrality means that the financial statements should not
be prepared so as to favor one party to the detriment of
another party
To be neutral the information contained in the financial
statements must be free from bias. A neutral depiction is
"without bias" in the selection or presentation of financial
information.
Neutrality is synonymous with the all-encompassing
"principle of fairness".
To be neutral is to be fair.
The information is directed to the common needs of many
users and not to the particular needs of specific users.
QUESTION 3-16
 Explain the characteristic of "free from error"
ANSWER 3-16
Free from error means there are no errors or
omissions in the description of the phenomenon or
transactions.
The process used to produce the reported
information has been selected and applied with no
errors in the process.
In this context, free from error does not mean
perfectly accurate in all respects.
For example, an estimate of an unobservable price
or value cannot be determined to be accurate or
inaccurate..
However, a representation of that estimate can
be faithful if the amount is described clearly and
accurately as an estimate.
Moreover, the nature and limitations of the
estimating process are explained.
No errors have been made in applying an
appropriate process for developing the estimate
QUESTION 3-17
 Explain the concept of substance over form
Answer 3-17
If information is to represent faithfully purports to represent, it is
necessary that the transaction accounted for in accordance with
their economic substance and reality and not merely their legal
form.
In other words, if there is a conflict between substance and
economic substance of the transaction shall prevail over the
legal form.
The economic substance of transactions and events are usually
emphasized when economic substance differs from legal form.
Substance over form is not considered a separate component
of faithful representation because it would be redundant.
Faithful representation inherently represents the substance of
an economic phenomenon or transaction rather than merely
representing its legal form.
QUESTION 3-18
Explain prudence.
ANSWER 3-18 The Revised Conceptual
Framework has reintroduced the concept of
prudence.
Prudence is the exercise of care and caution
when dealing with the uncertainties in the
measurement process such sets or income are
not overstated and liabilities of expenses are not
understated.
Neutrality is supported by the exercise of
prudence.
QUESTION 3-19
 Explain the concept of conservatism.
ANSWER 3-19
Conservatism is synonymous with prudence.
Conservatism means that when alternatives exist, the
alternative which has the least effect on equity shall be
chosen.
Stated differently, managers, investors and accountants
have generally preferred that possible errors in
measurement be in the direction of understatement
rather than overstatement of net income and net assets.
In the simplest terms, conservatism means "in case of
doubt, record any loss and do not record any gain."
For example, if there is a choice between two
acceptable asset values, the lower figure is selected.
Accordingly, inventories are measured at the
lower of cost and net realizable value.
Contingent loss is recognized as a "provision" if
the loss is probable and the amount can be
reliably measured.
Contingent gain is not recognized but disclosed
only.
Conservatism is not a license to deliberately
understate net income and net assets.
For example, if an entity has a cash of P500,000
and reports only P100,000, this is not
conservatism but fraud or inaccurate reporting.
QUESTION 3-20
 Explain the qualitative characteristic of
understandability
ANSWER 3-20
Understandability requires that financial information
must be comprehensible or intelligible if it is to be useful.
Accordingly, the information should be presented in a
form and expressed in terminology that a user
understands.
Classifying, characterizing and presenting information
"clearly and concisely" makes it understandable.
An essential quality of the information provided in
financial statements is that it is readily understandable
by users.
But the complex economic activities make it
impossible to reduce the financial information to
the simplest terms.
Accordingly, the users should have an
understanding of the complex economic
activities, the financial accounting process and
the terminology in the financial statements.
Financial statements cannot realistically be
understandable to everyone
Financial reports are prepared for users who
have a reasonable knowledge of business and
economic activities and who review and analyze
the information diligently.
QUESTION 3-21
 Explain the qualitative characteristic of
comparability.
ANSWER 3-21
Comparability means the ability to bring together
for the purpose of noting points of likeness and
difference.
Comparability is the enhancing qualitative
characteristic that enables users to identify and
understand similarities and dissimilarities among
items.
Comparability may be made within an entity or
between and across entities.
QUESTION 3-22
 What are the two kinds of comparability?
ANSWER 3-22
The two kinds of comparability are comparability
within an entity and comparability across entities.
Comparability within an entity is the quality of
information that allows comparisons within a single
entity through time or from one accounting period to
the next.
Comparability within an entity is also known as
horizontal comparability or intracomparability.
Comparability across entities is the quality of
information that allows comparisons between two or
more entities engaged in the same industry.
This comparability is also known as
intercomparability or dimensional comparability.
The financial statements of different entities are
compared in order to evaluate their relative
financial position, financial performance and
cash flows.
Users' decisions involve choosing between
alternatives.
Consequently, relevant and faithfully represented
information is most useful if it can be compared
with similar information about the same entity for
the previous period and with similar information
reported by other entities.
QUESTION 3-23
 Explain the principle of consistency.
ANSWER 3-23
Implicit in the qualitative characteristic of comparability
the principle of consistency.
In a broad sense, consistency refers to the use of the se
method for the same item, either from period to per
within an entity or in a single period accross entities.
Consistency is not the same as comparability.
Comparability is the goal and consistency helps to
achieve that goal.
Consistency is desirable and essential to achieve
comparability of financial statements. In a limited sense,
consistency is the uniform application of accounting
method from period to period within an entity.
On the other hand, comparability is the uniform
application of accounting method between and across
entities in the same industry.
An entity cannot use the FIFO method of inventory
valuation in one year, the average method in the next
year, another method in succeeding year and so on.
If the FIFO method is adopted in one year, such
method is followed from year to year.
However, consistency does not mean that no change
accounting method can be made.
If the change will result to more useful and meaningful
information, then such change should be made. But
there should be full disclosure of the change and peso
effect thereof.
QUESTION 3-24
Explain verifiability.
ANSWER 3-24
Verifiability means that different knowledgeable and
independent observers could reach consensus that a
particular depiction is a faithful representation.
Verifiability implies consensus.
The information is verifiable in the sense that it is
supported by evidence so that an accountant that
would look into the same evidence would arrive at
the same decision or conclusion
Verifiable financial information provides results that
would be substantially duplicated by measurers using
the same measurement method
QUESTION 3-25
 Explain the enhancing quality of timeliness.
ANSWER 3-25
Timeliness means having information available to
decision makers in time to influence their decisions.
In other words, timeliness requires that financial
information must be available or communicated
early enough when a decision is to be made.
Relevant and faithfully represented financial
information furnished after a decision is made is
useless or of no value.
Relevant information may lose relevance if there is
undue delay in the reporting.
Timeliness enhances the truism that "without
knowledge of the past, the basis for prediction
will usually be lacking and without interest in the
future, knowledge of the past is sterile."
What happened in the past would become the
basis of what would happen in the future.
QUESTION 3-26
 Explain the cost constraint on useful information.
ANSWER 3-26
Cost is a pervasive constraint on the information that can
be provided by financial reporting.
Reporting financial information imposes cost and it is
important that such cost is justified by the benefit derived
from the financial information.
In other words, the cost constraint is a consideration of the
cost incurred in generating financial information against
the benefit to be obtained from having the information.
The benefit derived from the information should exceed
the cost incurred in obtaining the information.
Otherwise, the financial accounting information may not
be reported.
However, the evaluation of the cost constraint is
a judgmental process.
Assessing whether the cost of reporting
outweighs or fall short of the benefit is difficult to
measure and becomes matter of professional
judgment.
QUESTION 3-27 Multiple choice (IAA)
1. What are qualitative characteristics of financial
statements?
a. Qualitative characteristics are the attributes that
make the information provided in financial
statements useful to users.
b. Qualitative characteristics are broad classes of
financial effects of transactions and other events.
c. Qualitative characteristics are nonqualitative
aspects of financial position and financial
performance.
d. Qualitative characteristics measure the extent to
which an entity has complied with all relevant
standards and interpretations.
2. Qualitative characteristics
a. Are considered either fundamental or enhancing.
b. Contribute to the decision-usefulness of financial
reporting information.
c. Distinguish better information from inferior
information for decision-making purposes.
d. All of the choices are correct.
3. The fundamental qualitative characteristics are
e. Relevance and faithful representation
f. Relevance, faithful representation and materiality
g. Relevance and reliability
h. Faithful representation and materiality
4. Accounting information is considered relevant when it
a. Can be depended upon to represent the economic
conditions and events that it is intended to represent.
b. Is capable of making a difference in a decision.
c. Is understandable by reasonably informed users.
d. Is verifiable and neutral.
5. The ingredients of relevant financial information are
e. Predictive value and confirmatory value
f. Predictive value, confirmatory value and timeliness
g. Predictive value, confirmatory value and materiality
h. Predictive value, confirmatory value and timeliness
6 What is the quality of information that gives
assurance that it is reasonably free from error and
bias?
a. Relevance
b. Faithful representation
c. Verifiability
d. Neutrality
7. Which is the best description of faithful
representation in relation to information in financial
statements?
a. Influence on the economic decision of users
b. Inclusion of a degree of caution
c. Freedom from material error
d. Comprehensibility to users
8. To achieve faithful representation, the financial
statements
a. Must have predictive and confirmatory value.
b. Must be complete, neutral and free from error
c. Are understandable, comparable, verifiable and
timely.
d. Must possess all of these.
9. The financial accounting information is directed
toward the common needs of users.
a Relevance
b. Verifiability
c. Neutrality
d. Completeness
10. The economic substance of a transaction
shall prevail over the legal form.
a. Form over substance
b. Substance over form
c. Relevance
d. Completeness
Answer 3-27
1. A
2. D
3. A
4. B
5. A
6. B
7. C
8. B
9. C
10. B
QUESTION 3-28 Multiple choice (IAA)
1. The enhancing qualitative characteristics of financial
information are
a. Comparability and understandability
b. Verifiability and timeliness
c. Comparability, understandability and verifiability
d. Comparability, understandability, verifiability and
timeliness
2. Financial information exhibits consistency when
e. Accounting procedures are adopted which smooth net
income and make results consistent between years.
f. Gains and losses are shown separately.
g. Accounting entities give similar events the same
accounting treatment each period.
h. Expenditures are reported as expenses.
3. When information about two different entities engaged in
the same industry has been prepared and presented in
similar manner, the information exhibits the enhancing
qualitative characteristic of
a. Relevance
b. Faithful representation
c. Consistency
d. Comparability
4. The characteristic that is demonstrated when a high
degree of consensus can be secured among independent
measurers using the same measurement method is
e. Relevance
f. Understandability
g. Verifiability
h. Neutrality
5. Which concept of accounting holds that, to the
maximum extent possible, financial statements shall be
based on arm's length transactions?
a. Revenue realization
b. Verifiability
c. Monetary unit
d. Matching
6. An entity issuing the annual financial reports within
one month at the end of reporting period is an example
of which enhancing quality of accounting information?
e. Neutrality
f. Timeliness
g. Predictive value
h. Representational faithfulness
7. Allowing entities to estimate rather than physically
count inventory at an interim period is an example of a
tradeoff between
a. Verifiability and comparability
b. Timeliness and comparability
c. Timeliness and verifiability
d. Neutrality and consistency
8. Which qualitative characteristic of financial information
requires that information should not be biased in favor of
one group of users to the detriment of others?
e. Relevance
f. Free from error
g. Completeness
h. Neutrality
9. For information to be more useful, the linkage between
the users and the decisions made is
a. Relevance
b. Faithful representation
c. Understandability
d. Verifiability
10. Which statement is true in relation to the enhancing
qualitative characteristic of understandability?
e. Users have a reasonable knowledge of business and
economic activities and review the information with
reasonable diligence.
f. Users are expected to have significant business
knowledge.
g. Financial statements shall exclude complex matters.
h. Financial statements shall be free from material error.
Answer 3-28
1. D
2. C
3. D
4. A
5. D
6. C
7. A
8. B
9. D
10. B
QUESTION 3-29 Multiple choice (IAA)
1. The overriding qualitative characteristic of
accounting information is
a. Relevance
b. Understandability
c. Faithful representation
d. Decision usefulness
2. Which of the following terms best describes
information that influences the economic decisions of
users?
e. Reliable
f. Prospective
g. Relevant
h. Understandable
3. What is the quality of information that enables
users to better forecast future operations?
a. Faithful representation
b. Materiality
c. Comparability
d. Relevance
4. According to the Conceptual Framework,
predictive value and confirmatory value are
ingredients of
e. Relevance
f. Faithful representation
g. Understandability
h. Comparability
5. Which concept of accounting holds that, to the
maximum extent possible, financial statements
shall be based on arm's length transactions? ]
a. Revenue realization
b. Verifiability
c. Monetary unit
d. Matching
6. What is meant by comparability when discussing
financial accounting information?
a. Information has predictive and confirmatory value
b. Information is reasonably free from error
c. Information is measured and reported in a similar
fashion across entities.
d. Information is timely.
7. What is meant by consistency when discussing
financial accounting information?
a. Information is measured and reported in a similar
fashion across points in time.
b. Information is timely.
c. Information is measured similarly across the industry
d. Information is verifiable.
8. Which qualitative characteristic of financial
information requires that information should not be
biased in favor of one group of users to the detriment
of others?
a. Relevance
b. Free from error
c. Completeness
d. Neutrality
9. For information to be more useful, the linkage
between the users and the decisions made is
e. Relevance
f. Faithful representation
g. Understandability
h. Verifiability
10. Which statement is true in relation to the
enhancing qualitative characteristic of
understandability?
a. Users have a reasonable knowledge of
business and economic activities and review
the information with reasonable diligence.
b. Users are expected to have significant
business knowledge.
c. Financial statements shall exclude complex
matters.
d. Financial statements shall be free from
material error.
Answer 3-29
1. D
2. C
3. D
4. A
5. D
6. C
7. A
8. B
9. D
10. B
QUESTION 3-30 Multiple choice (IAA)
1. When there is agreement between a measure or
description and the phenomenon it purports to
represent, the information possesses which
characteristic?
a. Verifiability
b. Predictive value
c. Faithful representation
d. Timeliness
2. The qualitative characteristic of faithful representation
includes
e. Predictive value
f. Neutrality
g. Confirmatory value
h. Timeliness
3. Enhancing qualitative characteristics of accounting
information include all of the following, except
a. Timeliness
b. Materiality
c. Comparability
d. Verifiability
4.The enhancing quality of understandability means
that information should be understood by
e. Those who are experts in the interpretation of
financial information
b. Those who have a reasonable understanding of
business and economic activities
c. Financial analysts
d. CPAs
5. Enhancing qualitative characteristics of
accounting information include
a. Relevance and comparability
b. Comparability and timeliness
c. Understandability and relevance
d. Neutrality and comparability
6. When different accountants independently agree
on the amount and method of reporting an economic
event, when is the concept demonstrated?
e. Reliability
b. Comparability
c. Completeness
d. Verifiability
7. Verifiability implies
a. Legal evidence b.
b. Logic
c. Consensus
d. Legal verdict
8. When an entity has started placing its quarterly
financial statements on its web page, thereby reducing
by ten days the time to get information to investors
and creditors, the qualitative concept involved is
e. Comparability
f. Consistency
g. Timeliness
h. Faithful representation
9. When an entity changed the inventory valuation
method, which characteristic is jeopardized by this
change?
a. Comparability
b. Representational faithfulness
c. Consistency
d. Feedback value
10. Recognizing expected loss immediately but
deferring expected gain is an example of
e. Materiality
f. Conservatism
g. Cost effectiveness
h. Timeliness
Answer 3-30
1. C
2. B
3. B
4. B
5. B
6. D
7. C
8. C
9. C
10. B
QUESTION 3-31 Multiple choice (AICPA Adapted)
1. The ability through consensus among measurers to ensure
that information represents what it purports to represent is
an example of the concept of
a. Relevance
b. Verifiability
c. Comparability
d. Feedback value
2. Which of the following accounting concepts states that an
accounting transaction shall be supported by sufficient
evidence to allow two or more qualified individuals to arrive at
essentially similar conclusion?
e. Conservatism
f. Objectivity
g. Periodicity
h. Stable monetary unit
3. Objectivity is assumed to be achieved when a
transaction
a. Is recorded in a fixed amount of pesos
b. Involves the payment or receipt of cash
c. Involves an arm's length transaction between two
independent parties
d. Allocates revenue and expenses in a rational and
systematic manner
4. The principle of objectivity includes the concept of
b. Summarization
b. Classification
c. Conservatism
d. Verifiability
5. Proponents of historical cost maintain that
statements prepared using historical cost are more
a. Objective
b. Relevant
c. Indicative of purchasing power
d. Conservative
6. The consistency standard requires that
b. Expenses should be reported when incurred.
b. The effect of accounting changes upon income
should be properly disclosed.
c. Gains and losses should not be recognized.
d. Accounting procedures should be adopted when
the result is a consistent rate of return
7. Which of the following relates to both relevance and
faithful representation?
a. Comparability
b. Feedback value
c. Neutrality
d. Free from error
8. Which violates the concept of faithful
representation?
a. Financial statements were issued nine months late.
b. Expected risks are not reported.
c. Property, plant and equipment with carrying amount
increased to management estimate of market value.
d. Management reports regularly refer to new projects.
9. What is the underlying concept governing the
GAAP pertaining to recording gain contingencies?
a. Conservatism
b. Relevance
c. Consistency
d. Reliability
10. The usefulness of providing information in
financial statements is subject to the constraint of
b. Consistency
c. Cost-benefit
d. Reliability
e. Representational faithfulness
Answer 3-31
1. B
2. B
3. C
4. D
5. A
6. B
7. A
8. C
9. A
10. B
QUESTION 3-32 Multiple choice (IAA)
1. Which statement about materiality is true?
a. An item must make a difference or it need not be
disclosed.
b. Materiality is a matter of relative size or importance.
c. An item is material if the inclusion or omission would
influence the judgment of a primary user.
d. All of these statements are true about materiality
2. An item would be considered material when
b. The expected benefits exceed additional costs.
b. The impact on earnings is greater than 10%.
c. The standard definition of materiality is met.
d. The omission or misstatement would make a •
difference to the primary users.
3. The Conceptual Framework includes which
constraint?
a. Prudence
b. Conservatism
c. Cost
d. All of the choices are constraints
4. Which best describes the cost-benefit constraint?
b. The benefit of the information must be greater than
the cost of providing it.
b. Financial information should be free from cost.
c. Cost of providing financial information is not always
evident or measurable but must be considered.
d. All of the choices are correct.
5. Conservatism is selecting an accounting
alternative that
a. Understates assets and net income
b. Has the least favorable impact on equity
c. Overstates liabilities
d. Is least likely to mislead
Answer 3-32
1. D
2. D
3. C
4. A
5. B
CHAPTER 4

FINANCIAL STATEMENTS AND

REPORTING ENTITY
UNDERLYING ASSUMPTIONS
QUESTION 4-1
 Explain the general objective of financial
statements.
ANSWER 4-1
Financial statements provide information about
economic resources of the reporting entity, claims
against the entity and changes in the economic
resources and claims.
Financial statements provide financial information
about an entity's assets, liabilities, equity, income and
expenses useful to users of financial statements in:
a. Assessing future cash flows to the reporting entity
b. b. Assessing management stewardship of the
entity's economic resources.
QUESTION 4-2
 Explain the types of financial statements under the
Revised Conceptual Framework.
ANSWER 4-2
The Revised Conceptual Framework recognizes three
types of financial statements:
1. Consolidated financial statements - These are the
financial statements prepared when the reporting entity
comprises both the parent and its subsidiaries.
2. Unconsolidated financial statements - These are the
financial statements prepared when the reporting entity
is the parent alone.
3. 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.
QUESTION 4-3
 Explain consolidated financial statements.
ANSWER 4-3
Consolidated financial statements provide information about
the assets, liabilities, equity, income and expenses of both
the parent and its subsidiaries as a single reporting entity.
The parent is the entity that exercises control over the
subsidiaries.
Consolidated information is useful for existing and potential
investors, lenders ad other creditors of the parent in their
assessment of future net cash inflows to the parent. This is
because net cash inflows to the parent include distributions
to the parent from its subsidiaries.
Consolidated financial statements are not designed to
provide separate information about the assets, liabilities
equity, income and expenses of a particular subsidiary.
QUESTION 4-4
 Explain unconsolidated financial statements.
ANSWER 4-4
Unconsolidated financial statements are designed to provide
information about the parent's assets, liabilities, income and
expenses and not about those of the subsidiaries.
Such information can be useful to the existing and potential
investors, lenders and other creditors of the parent because
a claim against the parent typically does not give the holder
of that claim against subsidiaries. Information provided in
unconsolidated financial statements is typically not sufficient
to meet the requirement needs of primary users.
Accordingly, when consolidated financial statements are
required, unconsolidated financial statements cannot serve
as substitute for consolidated financial statements.
QUESTION 4-5
 Explain reporting entity.
ANSWER 4-5
A reporting entity is an entity that is required or prepare
financial statements.
The reporting entity can be a single entity or a portion entity,
or can comprise more than one entity.
A reporting entity is not necessarily a legal entity.
The following can be considered a reporting entity:
a. Individual corporation, partnership or proprietorship
b. The parent alone
c. The parent and its subsidiaries as single reporting entity
d. Two or more entities without parent and subsidiary
relationship as a single reporting entity
e. A reportable business segment of an entity
QUESTION 4-6
• Explain reporting period.
ANSWER 4-6
The reporting period is the period when financial
statements are prepared for general purpose
financial reporting.
Financial statements may be prepared on an
interim basis. for example, three months, six
months or nine months. Interim financial
statements are not required but optional.
However, financial statements must be prepared
on an annual basis or a period of twelve months.
Financial statements provide information about:
a. Assets, liabilities and equity at the end of the
reporting period.
b. Income and expenses during the reporting
period.
To help users of financial statements to identify
and assess change in trends, financial
statements also provide comparative information
for at least one preceeding reporting period.
Financial statements may include information
about transactions and other events that
occurred after the end of reporting period.
QUESTION 4-7
 What are accounting assumptions?
ANSWER 4-7
Accounting assumptions or accounting postulates are the basic
notions or fundamental premises on which the accounting
process is based.
Like a building structure that requires a solid foundation to avoid
or prevent future collapse and provide room for expansion, and
so with accounting.
Accounting assumptions serve as the foundation or bedrock of
accounting in order to avoid misunderstanding but rather
enhance the understanding and usefulness of the financial
statements.
The Conceptual Framework for Financial Reporting mentions
only one assumption, namely going concern. However, implicit
in accounting are the basic assumptions of accounting entity,
time period and monetary unit.
QUESTION 4-8 .
 Explain the going concern assumption. ANSWER 4-8
Going concern or continuity assumption means that the
accounting entity is viewed as continuing in operation
indefinitely in the absence of evidence to the contrary.
In other words, financial statements are prepared
normally on the assumption that the entity shall
continue in operation for the foreseeable future.
Thus, assets are normally recorded at original
acquisition cost. As a rule, market values are ignored.
However, some new standards require measurement of
certain assets at fair value. This postulate is the very
foundation of the cost principle.
QUESTION 4-9
 Explain the accounting entity assumption.
ANSWER 4-9
In financial accounting, the accounting entity is the
business enterprise, which may be a proprietorship
partnership or corporation.
Under this assumption, the entity is separate from the
owner managers, and employees who constitute the
entity.
Accordingly, the transactions of the entity should not be
merged with the transactions of the owners. The
personal transactions of the owners should not be
allowed to distort the financial statements of the entity.
The reason for this assumption is to have a fair
presentation of financial statements.
QUESTION 4-10
 Explain the time period assumption.
ANSWER 4-10
The time period assumption requires that the indefinite life
of an entity is subdivided into accounting periods which are
usually of equal length for the purpose of preparing reports
on financial position, financial performance and cash flows.
By convention, the accounting period or fiscal period is one
year or a period of twelve months.
The "one-year period" is traditionally the accounting period
because usually it is after one year that government
reports are required
The accounting period may be a calendar year or a natural
business year. A calendar year is a twelve-month period
that ends on December 31.
QUESTION 4-11
Explain the monetary unit assumption.
ANSWER 4-11
The monetary unit assumption has two aspects, namely
quantifiability and stability of the peso.
The quantifiability aspect means that the assets, liabilities,
equity, income and expenses should be stated in terms of a
unit of measure which is the peso in the Philippines.
The stability of the peso assumption means that the
purchasing power of the peso is stable or constant and that
its instability is insignificant and therefore may be ignored.
The stable peso postulate is actually an amplification of the
going concern assumption so much so that adjustments are
unnecessary to reflect any changes in purchasing power.
QUESTION 4-12 Multiple choice (Conceptual
Framework
1. What is the general objective of financial statements
a. To provide information about economic resources an
entity, claims against the entity and changes in the
economic resources and claims.
b. To assess future cash flows to the entity.
c. To assess management stewardship.
d. To satisfy the information needs of primary users.
2. A reporting entity is a. Necessarily
a legal entity.
b. Necessarily an economic entity.
c. An entity that is required or chooses to prepare financial
statements.
d. A regulatory government authority.
3. A reporting entity
a. Can be a single entity
b. Can be a portion of a single entity
c. Can comprise more than one entity
d. All of these can be considered a reporting entity
4. If the reporting entity comprises both the parent
and its subsidiaries, the financial statements are
referred to as
b. Consolidated financial statements
b. Unconsolidated financial statements
c. Combined financial statements
d. Separate financial statements
5. Combined financial statements provide
financial information about
a. The parent and its subsidiaries
b. The parent
c. The subsidiaries
d. Two or more entities without a parent-
subsidiary relationship
Answer 4-12
1. A
2. C
3. D
4. A
5. D
QUESTION 4-18 Multiple choice (IAA)
1. Which best describes the term going concern? users.
a. When current liabilities exceed current assets
b. The ability of the entity to continue in operation for the
foreseeable future
c. The potential to contribute to the flow of cash and cash
equivalents to the entity
d. The expenses exceed income
2. Which is an implication of the going concern assumptions ?
b. The historical cost principle is credible.
b. Depreciation and amortization policies are justifiable and
appropriate.
c. The current and noncurrent classification of assets and
liabilities is justifiable and significant
d. All of these are an implication of going concern.
3. The relatively stable economic, political and
social environment supports nd its to as
a. Conservatism
b. Materiality
c. Timeliness
d. Going concern
4. Which of the following is not a basic
assumption underlying financial accounting?
b. Economic entity assumption
b. Going concern assumption
c. Periodicity assumption
d. Historical cost assumption
5. Which basic assumption may not be followed
when an entity in bankruptcy reports financial
results?
a. Economic entity assumption
b. Going concern assumption
c. Periodicity assumption
d. Monetary unit assumption
6. The economic entity assumption
b. Is inapplicable to unincorporated businesses
b. Recognizes the legal aspects of business
organization
c. Requires periodic income measurement.
d. Is applicable to all forms of business organization
7. What is being violated if an entity provides financial
reports in connection with a new product introduction?
a. Economic entity
b. Periodicity
c. Monetary unit
d. Continuity
8. Which underlying assumption serves as the basis
for preparing financial statements at artificial points in
time?
b. Accounting entity
b. Going concern
c. Accounting period
d. Stable monetary unit
9. Which basic accounting assumption is
threatened by the existence of severe inflation in
the economy?
a. Monetary unit assumption
b. Periodicity assumption
c. Going concern assumption
d. Economic entity assumption
10. Inflation is ignored in accounting due to
a. Economic entity assumption
b. Going concern assumption
c. Monetary unit assumption
d. Time period assumption
Answer 4-13
1. B
2. D
3. D
4. D
5. B
6. D
7. A
8. C
9. A
10. C