Test 1

1. What is meant by general-purpose financial statements?
General purpose financial statements are those financial statements released to a

broad group of users. They are intended for a wide range of uses, such as credit analysis and
stock valuations. General purpose financial statements are usually issued to the investment
community and lenders.
The general purpose of the financial statements is to provide information about the
results of operations, financial position, and cash flows of an organization. This information
is used by the readers of financial statements to make decisions regarding the allocation of
resources.
2. Who is the primary user group for general-purpose financial statements? Why ?
The primary user group for general-purpose financial statements include: potential
investors, lenders, and other creditors. They need general-purpose financial statements to
provide information to users for decision-making. They need information to assess the
company's potential for success and profitability.
3. What is the “expectations gap”? Can expectation gap be removed ? Explain.
Expectation gap generally refers to the difference between a gap in public perception.
Expectation gap is the difference between what the public expects from the auditing
profession and what the auditing profession actually provides.
The expectation gap cannot be eliminated because the public always has opinions,
expectations, and perceptions such as the nature and ability to think of every human being.
Chapter 2
1. What is a conceptual framework? Why is a conceptual framework necessary in financial

accounting?
A conceptual framework is defined as a system of ideas and objectives that lead to the
creation of a consistent set of rules and standards. A conceptual framework is a coherent
system of interrelated objectives and fundamentals that can lead to consistent standards
and that prescribes the nature, function, and limits of financial accounting and financial
statements.
Conceptual framework is necessary in financial accounting for some reasons:
 It enables the FASB to issue more useful and consistent standards in the future.
 New issues will be more quickly solvable by reference to an existing framework of basic
theory.
 It increases financial statement users' understanding of and confidence in financial
reporting.
 It enhances comparability among companies' financial statements.
2. What is meant by the term “qualitative characteristics of accounting information”?
Qualitative Characteristics of accounting information that distinguish better

information from inferior information for decision-making purposes. The demand for
accounting information by financial statement user (investors, lenders, creditors, etc)
creates fundamental qualitative characteristics that are desirable in accounting information.
Two of the six qualitative characteristics are fundamental (relevance and representational
faithfulness), while the remaining four qualitative characteristics are enhancing (verifiability,
timeliness, understandability, comparability).
3. Briefly describe the two fundamental qualities of useful accounting information.
Qualitative characteristics are fundamental
 Relevance : Relevance refers to how helpful the information is for financial decision-
making processes. It’s include confirmatory value (provides information about past
events) and predictive value (provides predictive power regarding possible future
events)
 Representational faithfulness : Representational faithfulness is the extent to which
information accurately reflects a company’s resources, obligatory claims, and
transactions. For accounting information to possess representational faithfulness, it
must be: complete (financial statements should not exclude any transaction), neutral
(the degree to which information is free from bias), and free from error (the degree to
which information is free from errors).
4. How are materiality (and immateriality) related to the proper presentation of financial
statements?
Materiality and immateriality relates to the significance of transactions, balances and
errors contained in the financial statements. Materiality defines the threshold or cutoff point
after which financial information becomes relevant to the decision making needs of the
users. Information contained in the financial statements must therefore be complete in all
material respects in order for them to present a true and fair view of the affairs of the entity.
An accounting misstatement is said to be material if knowledge of the misstatement

will affect the decisions of the average informed reader of the financial statements. Financial
statements are misleading if they omit a material fact or include so many immaterial matters
as to be confusing. In the examination, the auditor concentrates efforts in proportion to
degrees of materiality and relative risk and disregards immaterial items.
5. What are the enhancing qualities of the qualitative characteristics? What is the role of
enhancing qualities in the Conceptual Framework?
Enhancing qualities are qualitative characteristics that are complementary to the

fundamental qualitative characteristics. These characteristics distinguish more-useful
information from less-useful information. Enhancing characteristics are comparability,
verifiability, timeliness, and understandability.
6. What are the basic elements of the Conceptual Framework?

 Assets : Probable future economic benefits obtained or controlled by a particular entity
as a result of past transactions or events.
 Liabilities : 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 : Residual interest in the assets of an entity that remains after deducting its
liabilities. In a business enterprise, the equity is the ownership interest.
 Income : Increases in equity from peripheral or incidental transactions of an entity and
from all other transactions and other events and circumstances affecting the entity
during a period except those that result from revenues or investments by owners.
 Expenses : Decreases in equity from peripheral or incidental transactions of an entity
and from all other transactions and other events and circumstances affecting the entity
during a period except those that result from expenses or distributions to owners.
7. What are the five basic assumptions that underlie the financial accounting structure?
 An economic entity assumption : company keeps its activity separate from its owners
and other business unit.
 A going concern assumption : company to last long enough to fulfill objectives and
commitments.
 A monetary unit assumption : money is the common denominator.
 A periodicity assumption : company can divide its economic activities into time periods.
 A accrual basis of accounting assumption : transactions are recorded in the periods in
which the events occur.
8. The chairman of the board of directors of the company for which you are chief accountant
has told you that he has little use for accounting figures based on historical cost. He believes
that fair values are of far more significance to the board of directors than “out-of-date
costs.” Present some arguments to convince him that accounting data should still be based
on historical cost.
 Cost is definite and reliable; other values would have to be determined arbitrarily and
there would be considerable disagreement as to the amounts to be used.
 Amounts determined by other bases would have to be revised frequently.
 Comparison with other companies is supported if cost is employed.
 The costs of getting replacement values could outweigh the benefits derived.

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1. What is meant by general-purpose financial statements?

General purpose financial statements are those financial statements released to a

3. What is the “expectations gap”? Can expectation gap be removed ? Explain.

1. What is a conceptual framework? Why is a conceptual framework necessary in financial

Conceptual framework is necessary in financial accounting for some reasons:

2. What is meant by the term “qualitative characteristics of accounting information”?

Qualitative Characteristics of accounting information that distinguish better

3. Briefly describe the two fundamental qualities of useful accounting information.

Qualitative characteristics are fundamental

An accounting misstatement is said to be material if knowledge of the misstatement

Enhancing qualities are qualitative characteristics that are complementary to the

6. What are the basic elements of the Conceptual Framework?

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