Kap 1 5th workbook te ch 3 PDF

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Chapter 3 THE ACCOUNTING FRAMEWORK LEARNING OBJECTIVES LO 1

Describe the users of accounting information

LO 5

Identify the key financial statement foundations

LO 2

Describe the fields of accounting

LO 6

LO 3

Compare the different forms of business organization

Illustrate the similarities and differences between ASPE and IFRS

LO 7

Explain the importance of ethics in accounting

LO 4

Identify the objective and qualitative characteristics of financial information Access ameengage.com for integrated resources including tutorials, practice exercises, the digital textbook and more.

Assessment Questions AS-1 LO 1 What is an internal user? What do internal users use financial information for? Internal users are people who own the business and/or work in the business. Internal users use financial information to enable them to manage the business efficiently.

AS-2 LO 1 What is an external user? What do external users use financial information for? External users are people or organizations that are outside the business. External users use financial information to ensure that their investments in the business are protected.

AS-3 LO 2 Briefly define financial accounting. Financial accounting is concerned with keeping records of the business and preparing the financial statements for external users.

AS-4 LO 2 Briefly define managerial accounting. Managerial accounting serves the internal users of the business by preparing specialized reports to assist in management decision-making.

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AS-5 LO 3 What is a sole proprietorship? What is the title of a sole proprietorship’s equity section? A sole proprietorship is a business that is owned and generally operated by a single owner. A sole proprietorship’s equity section is called “owner’s equity.” AS-6 LO 3 Explain the concept of unlimited liability. Unlimited liability means that an owner is personally liable for the activities of the business. If the business is unable to pay its debts, creditors of the business can force the owner to sell his or her personal assets to pay off the debts of the business. AS-7 LO 3 What is a partnership? A partnership is a business owned by two or more persons called partners.

AS-8 LO 3 What are the three types of partnerships that can be created? The three types of partnerships that can be created are general partnership, limited partnership and limited liability partnership (LLP). AS-9 LO 3 What is the difference between a general partnership and a limited partnership? A general partnership is a partnership in which all partners are subject to unlimited liability. In this situation, all partners are considered to be general partners. A limited partnership includes at least one general partner who accepts unlimited liability and one or more limited partners with liability limited to the amount they invested. AS-10 LO 3 Describe a corporation. A corporation is a business that is registered with the provincial or federal government and is a separate legal entity from its owners, the shareholders. As a separate legal entity, the corporation has all the rights of a person and is responsible for its own activities. It is responsible for its own debts. AS-11 LO 3 What is a non-profit organization? A non-profit organization is an organization whose profits may be paid out (redistributed) to the community by providing services.

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AS-12 LO 3 Provide four examples of non-profit organizations. Non-profit organizations include religious organizations, community care centres, charitable organizations and hospitals.

AS-13 LO 4 6 Briefly define and explain GAAP. What are the two frameworks that have evolved from Canadian GAAP? Generally Accepted Accounting Principles (GAAP) is a set of standards providing guidance on how to report financial information. Canadian GAAP has evolved into ASPE (Accounting Standards for Private Enterprises) and IFRS (International Financial Reporting Standards).

AS-14 LO 4 What are the qualitative characteristics of effective and useful financial information? The main qualitative characteristics are relevance, faithful representation, verifiability, comparability, timeliness and understandability. AS-15 LO 4 Describe the characteristic of relevance. Relevance means that all information useful for decision-making is present in the financial statements. In other words, if a piece of relevant information is omitted or misstated, the user’s interpretation of the statement would change.

AS-16 LO 4 Describe the characteristic of timeliness. Information is timely if there is no delay in the reporting of crucial information.

AS-17 LO 4 Describe the characteristic of faithful representation. Faithful representation means that information is free from material error and bias. Financial information must be meaningful and complete, reporting the activities of an organization as accurately as possible.

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AS-18 LO 4 Describe the characteristic of verifiability. Information is verifiable if it is based on objective evidence (i.e. there are documents to back up the reported information). AS-19 LO 4 Describe the characteristic of understandability. Understandability means that the financial information can be reasonably understood by its users if they have a basic knowledge of the business and of accounting. AS-20 LO 4 What is neutrality? Neutrality is a component of which characteristic? Neutrality states that financial information must report the activities of a business as accurately as possible and be free from bias. Neutrality is a component of faithful representation. AS-21 LO 4 Describe the characteristic of comparability. Comparability means the financial statements of a company must be prepared in a similar way year after year. This allows for a comparison of the current year’s performance to past years. AS-22 LO 4 Describe what is meant by consistency in financial reporting. Consistency prevents businesses from changing accounting methods for the sole purpose of manipulating figures on the financial statements. Consistency falls under the qualitative characteristic of comparability.

AS-23 LO 4 Describe what is meant by materiality in financial reporting. A piece of information is considered material if it could influence or change a user’s decision. The level of materiality is entity specific, and organizations need to ensure material amounts are correctly recorded on the financial statements.

AS-24 LO 5 Describe the business entity assumption. The business entity assumption states that the accounting records for a business must be kept separate from those of the owner(s).

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AS-25 LO 5 Explain what the basis of accounting means. The basis of accounting refers to the method used to determine when items, transactions and events should be recognized. The two types are accrual-based and cash-based. Businesses should use accrual-based accounting. AS-26 LO 5 Describe what is meant by the term “going concern” in financial reporting. Going concern assumes that a business will continue to operate into the foreseeable future.

AS-27 LO 5 Describe the monetary unit assumption. The monetary unit assumption requires that the accounting records are expressed in terms of a single currency.

AS-28 LO 5 Describe what is meant by measurement in financial reporting. Measurement is the process of determining the amount at which an item is recorded in the financial statements. Primarily, items must be recorded at their historical cost. Measurement and recognition are two important aspects of financial reporting. AS-29 LO 5 Describe the revenue recognition process in financial reporting. Revenue recognition states that revenue can only be recorded when certain criteria have been met. The ownership of the good or service must have been transferred to the buyer. The buyer must have agreed to pay, or have already paid, a specified price for the good or service. AS-30 LO 5 Describe the expense recognition process in financial reporting. Expense recognition states that, when possible, expenses must be recorded in the same accounting period in which they were used to produce revenue.

AS-31 LO 5 Describe what is meant by disclosure in financial reporting. Disclosure states that any and all information that affects the full understanding of a company’s financial statements must be included with the financial statements or in the notes to the financial statements.

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AS-32 LO 6 What is ASPE and which forms of organization can adhere to it? ASPE stands for Accounting Standards for Private Enterprises. It is a set of accounting standards available to sole proprietorships, partnerships and private corporations.

AS-33 LO 6 What is IFRS and which forms of organization can adhere to it? IFRS stands for International Financial Reporting Standards. It is a set of accounting standards that allows for better comparison of companies across countries. Public corporations must adhere to IFRS, but any organization may choose to adhere to IFRS.

AS-34 LO 7 List two ethical standards for accountants. Answers may vary. 1. Acting with trustworthiness, integrity and objectivity. 2. Adhering to acknowledged principles and standards of professional practice.

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Application Questions Group A AP-1A LO 3 Match each form of an organization with the appropriate description. A

Sole Proprietorship

B

Partnership

C

Corporation

D

Non-Profit Organization

D

This type of organization usually does not have an identifiable owner.

B

There are two types: one that limits the liability of the owners and one that does not.

A

This type of business is operated by a single owner.

C

This type of business often elects a board of directors.

AP-2A LO 4 Match each of the following financial statement reporting terms to the appropriate description in the table below.

Term (fill in)

Description

Neutrality

Concept that financial information is free from bias

Benefit versus cost

Cost of providing perfect financial information should not exceed benefit to the users

Freedom from material error Financial information is free from intentional omissions Prudence

Exercising professional judgment

Substance over form

Reporting an accurate economic representation of transactions or events

AP-3A LO 4 Identify the qualitative characteristic(s) of financial information violated in each of the following scenarios. a)

Thorn Company has reported several gains for the period but has not provided any explanation or proof of how they occurred. Faithful representation, verifiability

b) Due to recent layoffs, Monte Carlo Ltd. was not able to complete and issue its 2018 financial statements and accompanying notes. The information was instead included with the 2019 financial report in the following year. Relevance, timeliness c)

To value inventory, Toland and Sons uses a different accounting policy from the rest of the companies in the same industry. There is no justification for the use of this accounting policy in the notes to the financial statements. Comparability

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d) Eris Laboratories used many uncommon medical terms and scientific language in the notes to the financial statements. This language was not explained anywhere else. Understandability e)

A bank decided not to grant a loan to Mida Ltd. after a customer filed a substantial lawsuit. Mida Ltd. did not include any mention of the lawsuit in the financial statements or in the notes to the financial statements. Relevance

AP-4A LO 4 5 Identify the financial statement qualitative characteristic or foundation that has been violated in each of the following scenarios. a)

Bill Co. purchased a two-year insurance policy and expensed the entire amount in period of purchase. Expense recognition

b) Charlie Co. listed inventory at its market value of $31,000 on the balance sheet, even though it was purchased for $20,000. Measurement c)

Percy Co. did not include the details of its property, plant and equipment, even though this information is relevant to the users. Disclosure

d) Fred Co. made a sale on the last day of the accounting period. The customer paid for the item in the following month, so this sale was included in the next period’s financial statements. Revenue recognition e)

George Co. has plans to restructure its operations next year and will sell off about half of the business. This information was not included in the notes to the financial statements because it does not affect the current financial information. Disclosure, relevance

f)

Ron Co. applied a certain accounting policy that allowed the company to report higher assets and net income. A different accounting policy was available that would have resulted in a lower balance of assets and net income. Faithful representation

g) Ginny Co. changed the accounting policy used to value property, plant, and equipment after using a different policy for 10 years. There was no justification for the change. Comparability (consistency) AP-5A LO 4 Sood Supplies is in the business of selling electronic components to computer manufacturers. Sood Supplies’ financial statements are issued on an annual basis for a large number of users, such as investors and the bank. The financial reporting of the company is based on ASPE. Prior to the issuance of the current year’s financial statements, the head of engineering and the accounting manager had a discussion regarding the amount of warranty expense that should be recognized for the year. The head of engineering believes that only 2% of sales needs to be calculated as a provision for the warranty expense, while the accounting manager believes that 6% of sales should be recorded as an expense. The accounting manager argues that the 6% is estimated based on historical trends of the company and the industry; however, the engineering department claims that its new method of quality assurance will reduce the future warranty expenses. The engineering department could

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not submit any documents to support the claim. Eventually, the accounting manager decides to trust the engineering department and uses the 2% calculation. Do you believe any of the qualitative characteristics of financial accounting or related considerations have been violated by Sood Supplies? Explain. Timeliness is violated, as Sood Supplies prepares financial statements only on an annual basis. The company has a large number of shareholders that would benefit from more timely financial statements (e.g. quarterly). A related consideration, prudence, is violated. Prudence involves exercising caution when making estimates and not overstating revenues and assets or understating expenses and liabilities. If estimates are required in financial statement reporting, choosing the estimate that results in a lower balance of assets or lower net income should be chosen. In this scenario, the accountant should have chosen the more prudent approach of estimating the warranty expense for the year—which was 6%—resulting in lower income, as opposed to the income calculated with only 2% warranty expense. Further, there doesn’t seem to be any justification for the engineering department reducing the warranty expense estimate from 6% to 2%.

AP-6A LO 4 5 6 Hawkton Publishing Corporation is a publisher of math textbooks. The company is a large, well-known publicly traded corporation with thousands of shareholders. It produces financial statements on an annual basis. The most recent financial statements (for the year ended December 31, 2019) showed comparative balances for 2019 and 2018. The 2019 balances were derived using accrual-based accounting whereas the 2018 balances were derived using cash-based accounting. Which characteristic(s) of information did Hawkton fail to represent? Explain. Hawkton did not achieve the characteristic of timeliness. This is because its financial statements are produced only on an annual basis. For a well-known corporation with thousands of shareholders, it would be beneficial to produce financial statements more frequently (such as quarterly). Hawkton also failed to achieve comparability because cash-based accounting was used for 2018 and accrualbased accounting was used for 2019. There is inconsistency in the financial information between the two years. As a more serious violation, cash-based accounting does not comply with IFRS. It violates the processes of revenue and expense recognition. AP-7A LO 4 6 Suppose that a company has changed its policy for depreciation from one year to the next. An employee in the accounting department addressed this change with the owner. The employee asked the owner why the accounting policy was changed and why the reasoning for the change was not disclosed in the financial statements. The owner replied, “IFRS gives you the option to use a different depreciation method from one year to the next. We also are not required to explain our choices.” Is the owner correct in his reasoning? Explain. The owner is wrong. The qualitative characteristic of comparability (consistency) prevents people from changing accounting methods for the sole purpose of manipulating figures. The depreciation method should be the same each year, unless the company can provide a valid reason for the change. This company did not do this. The readers of financial statements have the right to assume that consistency has been applied if there is no statement to the contrary. The company did not incorporate this requirement to provide consistency in its financial statement reporting, thereby impacting the usefulness of the statements to the users.

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AP-8A LO 5 Match each of the following financial statement foundations to the appropriate description in the table below.

Term (fill in)

Description

Revenue recognition

Sales must be recorded when ownership of a good transfers from the seller to the buyer

Going concern

Assumes that a business will continue to operate into the foreseeable future

Monetary unit assumption

Financial reports should be expressed in a single currency

Business entity assumption

Accounting for a business must be kept separate from the personal affairs of its owner or any other business Purchases must be recorded at their values on the date of purchase

Measurement AP-9A LO 5

Alton Floral is a new company that operates in the gardening industry. The owner of the company has decided not to hire an accountant, rather maintain the financial records on his own. He has reported his employees as assets on the balance sheet in an account called “Human Resources.” He has valued them at the present value of their future salaries on the balance sheet. Also, the financial statements are not supported by notes explaining some of the figures. Which of the basic finan...