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SOLUTION TO CODIFICATION EXERCISES
(a) The master glossary provides three definitions of fair value that are found in GAAP:
Fair Value—The amount at which an asset (or Liability) could be bought (or incurred) or settled in a
current transaction between willing parties, that is, other than in a forced or liquidation sale.
Fair Value—The fair value of an investment is the amount that the plan could reasonably expect to
receive for it in a current sale between a willing buyer and a willing seller, that is, other than in a
forced or liquidation sale. Fair value shall be measured by the market price if there is an active market
for the investment. If there is no active market for the investment but there is a market for similar
investments, selling prices in that market may be helpful in estimating fair value. If a market price is
not available, a forecast of expected cash flows, discounted at a rate commensurate with the risk
involved, may be used to estimate fair value. The fair value of an investment shall be reported net of
the brokerage commissions and other costs normally incurred in a sale.
Fair Value is the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.
(b) Revenue—Revenue earned by an entity from its direct distribution, exploitation, or licensing of a film,
before deduction for any of the entity’s direct costs of distribution. For markets and territories in which
an entity’s fully or jointly-owned films are distributed by third parties, revenue is the net amounts
payable to the entity by third party distributors. Revenue is reduced by appropriate allowances,
estimated returns, price concessions, or similar adjustments, as applicable.
The glossary references a revenue definition for the SEC: (Revenue (SEC))—See paragraph
942-235-S599-1, Regulation S-X Rule 9-05(c)(2), for the definition of revenue for purposes of
Regulation S-X Rule 9-05.
This definition relates to segment reporting requirements for public companies.
(c) Comprehensive Income is defined as the change in equity (net assets) of a business entity during a
period from transactions and other events and circumstances from nonowner sources. It includes all
changes in equity during a period except those resulting from investments by owners and distributions
The FASB Codification’s organization is closely aligned with the elements of financial statements, as
articulated in the Conceptual Framework. This is apparent in the lay-out of the ―Browse‖ section, which has
primary links for Assets, Liabilities, Equity, Revenues, and Expenses.
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-5
The Importance of Industry Practices is reflected in the designation of several industries as top level links in
the Codification organization. There are separate links to sections for the following industries (section
numbers precede each name):
912 Contractors—Federal Government
915 Development Stage entities
922 Entertainment—Cable Television
930 Extractive Activities—Mining
932 Extractive Activities—Oil and Gas
940 Financial Services—Broker and Dealers
942 Financial Services—Depository and Lending
944 Financial Services—Insurance
946 Financial Services—Investment Companies
948 Financial Services—Mortgage Banking
950 Financial Services—Title Plant
954 Health Care Entities
956 Limited Liability Entities
958 Not-for-Profit Entities
960 Plan Accounting—Defined Benefit Pension Plans
962 Plan Accounting—Defined Contribution Pension Plans
965 Plan Accounting—Health and Welfare Benefit Plans
970 Real Estate—General
972 Real Estate—Common Interest Realty Associations
974 Real Estate—Real Estate Investment Trusts
976 Real Estate—Retail Land
978 Real Estate—Time-Sharing Activities
980 Regulated Operations
995 U.S. Steamship Entities
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ANSWERS TO QUESTIONS
1. 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. A conceptual framework is necessary in financial accounting for the
(1) It will enable the FASB to issue more useful and consistent standards in the future.
(2) New issues will be more quickly solvable by reference to an existing framework of basic theory.
(3) It will increase financial statement users’ understanding of and confidence in financial reporting.
(4) It will enhance comparability among companies’ financial statements.
2. The primary objectives of financial reporting are as follows:
(1) Provide information useful in investment and credit decisions for individuals who have a reasonable understanding of business.
(2) Provide information useful in assessing future cash flows.
(3) Provide information about enterprise resources, claims to these resources, and changes
3. ―Qualitative characteristics of accounting information‖ are those characteristics which contribute to the
quality or value of the information. The overriding qualitative characteristic of accounting information is
usefulness for decision making.
4. Relevance and reliability are the two primary qualities of useful accounting information. For informa-tion
to be relevant, it should have predictive value or feedback value, and it must be presented on a timely
basis. Relevant information has a bearing on a decision and is capable of making a difference in the
decision. Relevant information helps users to make predictions about the outcomes of past, present, and
future events, or to confirm or correct prior expectations. Reliable information can be depended upon to
represent the conditions and events that it is intended to represent. Reliability stems from
representational faithfulness, neutrality, and verifiability.
5. In providing information to users of financial statements, the Board relies on general-purpose financial
statements. The intent of such statements is to provide the most useful information possible at
minimal cost to various user groups. Underlying these objectives is the notion that users need
reasonable knowledge of business and financial accounting matters to understand
the information contained in financial statements. This point is important: it means that in the
preparation of financial statements a level of reasonable competence can be assumed; this has an
impact on the way and the extent to which information is reported.
6. Comparability facilitates comparisons between information about two different enterprises at a
particular point in time. Consistency facilitates comparisons between information about the same
enterprise at two different points in time.
7. At present, the accounting literature contains many terms that have peculiar and specific meanings.
Some of these terms have been in use for a long period of time, and their meanings have changed over
time. Since the elements of financial statements are the building blocks with which the statements are
constructed, it is necessary to develop a basic definitional framework for them.
8. Distributions to owners differ from expenses and losses in that they represent transfers to owners, and
they do not arise from activities intended to produce income. Expenses differ from losses in that they
arise from the entity’s ongoing major or central operations. Losses arise from peripheral or incidental
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-7
Questions Chapter 2 (Continued)
9. Investments by owners differ from revenues and gains in that they represent transfers by owners to
the entity, and they do not arise from activities intended to produce income. Revenues differ from
gains in that they arise from the entity’s ongoing major or central operations. Gains arise from
peripheral or incidental transactions.
10. The four basic assumptions that underlie the financial accounting structure are:
(1) An economic entity assumption.
(2) A going concern assumption.
(3) A monetary unit assumption.
(4) A periodicity assumption.
11. (a) In accounting it is generally agreed that any measures of the success of an enterprise for periods
less than its total life are at best provisional in nature and subject to correction. Measurement of
progress and status for arbitrary time periods is a practical necessity to serve those who must
make decisions. It is not the result of postulating specific time periods as measurable segments of
(b) The practice of periodic measurement has led to many of the most difficult accounting problems
such as inventory pricing, depreciation of long-term assets, and the necessity for revenue
recognition tests. The accrual system calls for associating related revenues and expenses. This
becomes very difficult for an arbitrary time period with incomplete transactions in process at both
the beginning and the end of the period. A number of accounting practices such as adjusting
entries or the reporting of corrections of prior periods result directly from efforts to make each
period’s calculations as accurate as possible and yet recognizing that they are only provisional in
12. The monetary unit assumption assumes that the unit of measure (the dollar) remains reasonably
stable so that dollars of different years can be added without any adjustment. When the value of the
dollar fluctuates greatly over time, the monetary unit assumption loses its validity.
The FASB in Concept No. 5 indicated that it expects the dollar unadjusted for inflation or deflation to
be used to measure items recognized in financial statements. Only if circumstances change
dramatically will the Board consider a more stable measurement unit.
13. Some of the arguments which might be used are outlined below:
(1) Cost is definite and reliable; other values would have to be determined somewhat arbitrarily and
there would be considerable disagreement as to the amounts to be used.
(2) Amounts determined by other bases would have to be revised frequently.
(3) Comparison with other companies is aided if cost is employed.
(4) The costs of obtaining replacement values could outweigh the benefits derived.
14. Fair value is defined as ―the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date.‖ Fair value is therefore
a market-based measure.
15. The fair value option gives companies the option to use fair value (referred to as the fair value option
as the basis for measurement of financial assets and financial liabilities.) The Board believes that fair
value measurement for financial instruments provides more relevant and understandable information
than historical cost. It considers fair value to be more relevant because it reflects the current cash
equivalent value of financial instruments. As a result companies now have the option to record fair
value in their accounts for most financial instruments, including such items as receivables,
investments, and debt securities.
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Questions Chapter 2 (Continued)
16. The fair value hierarchy provides insight into the priority of valuation techniques that are used to
determine fair value. The fair value hierarchy is divided into three broad levels.
Fair Value Hierarchy
Level 1: Observable inputs that reflect quoted prices for Most Reliable
identical assets or liabilities in active markets.
Level 2: Inputs other than quoted prices included in Level 1 that
are observable for the asset or liability either directly or
through corroboration with observable data.
Level 3: Unobservable inputs (for example, a company’s own
data or assumptions).
As indicated, Level 1 is the most reliable because it is based on quoted prices, like a closing stock
price in the Wall Street Journal. Level 2 is the next most reliable and would rely on evaluating similar
assets or liabilities in active markets. At the least-reliable level, Level 3, much judgment
is needed based on the best information available to arrive at a relevant and reliable fair value
17. Revenue is generally recognized when (1) realized or realizable, and (2) earned.
The adoption of the sale basis is the accountant’s practical solution to the extremely difficult problem
of measuring revenue under conditions of uncertainty as to the future. The revenue is equal to the
amount of cash that will be received due to the operations of the current accounting period, but this
amount will not be definitely known until such cash is collected. The accountant, under these
circumstances, insists on having ―objective evidence,‖ that is, evidence external to the firm itself, on
which to base an estimate of the amount of cash that will be received. The sale is considered to be the
earliest point at which this evidence is available in the usual case. Until the sale is made, any estimate
of the value of inventory is based entirely on the opinion of the manage-ment of the firm. When the sale
is made, however, an outsider, the buyer, has corroborated the estimate of management and a value
can now be assigned based on this transaction. The sale also leads to a valid claim against the buyer
and gives the seller the full support of the law in enforcing collection. In a highly developed economy
where the probability of collection is high, this gives additional weight to the sale in the determination
of the amount to be collected. Ordinarily there is a transfer of control as well as title at the sales point.
This not only serves as additional objective evidence but necessitates the recognition of a change in
the nature of assets. The sale, then, has been adopted because it provides the accountant with
objective evidence as to the amount of revenue that will be collected, subject of course to the bad
debts estimated to determine ultimate collectibility.
18. Revenues should be recognized when they are realized or realizable and earned. The most common
time at which these two conditions are met is when the product or merchandise is delivered or
services are rendered to customers. Therefore, revenue for Selane Eatery should be recognized at
the time the luncheon is served.
19. Revenues are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash. Revenues are realizable when related assets received or held are
readily convertible to known amounts of cash or claims to cash. Readily convertible assets have (1)
interchangeable (fungible) units and (2) quoted prices available in an active market that can rapidly
absorb the quantity held by the entity without significantly affecting the price.
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-9
Questions Chapter 2 (Continued)
20. Each deviation depends on either the existence of earlier objective evidence other than the sale or
insufficient evidence of sale. Objective evidence is the key.
(a) In the case of installment sales the probability of uncollectibility may be great due to the nature of
the collection terms. The sale itself, therefore, does not give an accurate basis on which to
estimate the amount of cash that will be collected. It is necessary to adopt a basis which will give
a reasonably accurate estimate. The installment sales method is a modified cash basis; income is
recognized as cash is collected. A cash basis is preferable when no earlier estimate of revenue is
(b) The opposite is true in the case of certain agricultural products. Since there is a ready buyer and
a quoted price, a sale is not necessary to establish the amount of revenue to be received. In fact,
the sale is an insignificant part of the whole operation. As soon as it is harvested, the crop can be
valued at its selling price less the cost of transportation to the market and this valuation gives an
extremely accurate measure of the amount of revenue for the period without the need of waiting
until the sale has been made to measure it. In other words, the sale proceeds are readily
realizable and earned, so revenue recognition should occur.
(c) In the case of long-term contracts, the use of the ―sales basis‖ would result in a distortion of the
periodic income figures. A shift to a ―percentage of completion basis‖ is warranted if objec-tive
evidence of the amount of revenue earned in the periods prior to completion is available. The
accountant finds such evidence in the existence of a firm contract, from which the ultimate
realization can be determined, and estimates of total cost which can be compared with cost
incurred to estimate percentage-of-completion for revenue measurement purposes. In general,
when estimates of costs to complete and extent of progress toward completion of long-term
contracts are reasonably dependable, the percentage-of-completion method is preferable to the
21. The president means that the ―gain‖ should be recorded in the books. This item should not be entered
in the accounts, however, because it has not been realized.
22. The cause and effect relationship can seldom be conclusively demonstrated, but many costs appear
to be related to particular revenues and recognizing them as expenses accompanies recognition of
the revenue. Examples of expenses that are recognized by associating cause and effect are sales
commissions and cost of products sold or services provided.
Systematic and rational allocation means that in the absence of a direct means of associating cause
and effect, and where the asset provides benefits for several periods, its cost should be allocated to
the periods in a systematic and rational manner. Examples of expenses that are recognized in a
systematic and rational manner are depreciation of plant assets, amortization of intangible assets, and
allocation of rent and insurance.
Some costs are immediately expensed because the costs have no discernible future benefits or the
allocation among several accounting periods is not considered to serve any useful purpose. Examples
include officers’ salaries, most selling costs, amounts paid to settle lawsuits, and costs of resources
used in unsuccessful efforts.
23. The four characteristics are:
(1) Definitions—The item meets the definition of an element of financial statements.
(2) Measurability—It has a relevant attribute measurable with sufficient reliability.
(3) Relevance—The information is capable of making a difference in user decisions.
(4) Reliability—The information is representationally faithful, verifiable, and neutral.
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Questions Chapter 2 (Continued)
24. (a) To be recognized in the main body of financial statements, an item must meet the definition of an
element. In addition the item must have been measured, recorded in the books, and passed
through the double-entry system of accounting.
(b) Information provided in the notes to the financial statements amplifies or explains the items
presented in the main body of the statements and is essential to an understanding of the performance and position of the enterprise. Information in the notes does not have to be quantifiable,
nor does it need to qualify as an element.
(c) Supplementary information includes information that presents a different perspective from that
adopted in the financial statements. It also includes management’s explanation of the financial
information and a discussion of the significance of that information.
25. The general guide followed with regard to the full disclosure principle is to disclose in the financial
statements any facts of sufficient importance to influence the judgment of an informed reader.
The fact that the amount of outstanding common stock doubled in January of the subsequent
reporting period probably should be disclosed because such a situation is of importance to present
stockholders. Even though the event occurred after December 31, 2010, it should be disclosed on the
balance sheet as of December 31, 2010, in order to make adequate disclosure. (The major point that
should be emphasized throughout the entire discussion on full disclosure is that there is normally no
―black‖ or ―white‖ but varying shades of grey and it takes experience and good judgment to arrive at an
26. Accounting information is subject to two constraints: cost/benefit considerations, and materiality.
Information is not worth providing unless the benefits it provides exceed the costs of preparing it.
Information that is immaterial is irrelevant, and consequently, not useful. If its inclusion or omission
would have no impact on a decision maker, the information is immaterial. However, if it is material, it
should be reported.
27. The costs of providing accounting information are paid primarily to highly trained accountants who
design and implement information systems, retrieve and analyze large amounts of data, prepare
financial statements in accordance with authoritative pronouncements, and audit the information
presented. These activities are time-consuming and costly. The benefits of providing accounting
information are experienced by society in general, since informed financial decisions help allocate
scarce resources to the most effective enterprises. Occasionally new accounting standards require
presentation of information that is not readily assembled by the accounting systems of most
companies. A determination should be made as to whether the incremental or additional costs of
providing the proposed information exceed the incremental benefits to be obtained. This determination
requires careful judgment since the benefits of the proposed information may not be readily apparent.
28. The concept of materiality refers to the relative significance of an amount, activity, or item to
informative disclosure and a proper presentation of financial position and the results of operations.
Materiality has qualitative and quantitative aspects; both the nature of the item and its relative size
enter into its evaluation.
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.
The relevant criteria for assessing materiality will depend upon the circumstances and the nature of
the item and will vary greatly among companies. For example, an error in current assets or current
liabilities will be more important for a company with a flow of funds problem than for one with adequate
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-11
Questions Chapter 2 (Continued)
The effect upon net income (or earnings per share) is the most commonly used measure of
materiality. This reflects the prime importance attached to net income by investors and other users of
the statements. The effects upon assets and equities are also important as are misstatements of
individual accounts and subtotals included in the financial statements. The auditor will note the effects
of misstatements on key ratios such as gross profit, the current ratio, or the debt/equity ratio and will
consider such special circumstances as the effects on debt agreement covenants and the legality of
There are no rigid standards or guidelines for assessing materiality. The lower bound of materiality has
been variously estimated at 5% to 20% of net income, but the determination will vary based upon the
individual case and might not fall within these limits. Certain items, such as a questionable loan to a
company officer, may be considered material even when minor amounts are involved. In contrast a large
misclassification among expense accounts may not be deemed material if there is no misstatement of
29. (a) Acceptable if reasonably accurate estimation is possible. To the extent that warranty costs can be
estimated accurately, they should be matched against the related sales revenue.
(b) Not acceptable. Most accounts are collectible or the company will be out of business very soon.
Hence sales can be recorded when made. Also, other companies record sales when made rather
than when collected, so if accounts for Landowska Co. are to be compared with other companies,
they must be kept on a comparable basis. However, estimates for uncollectible accounts should be
recorded if there is a reasonably accurate basis for estimating bad debts.
(c) Not acceptable. A provision for the possible loss can be made through an appropriation of retained
earnings but until judgment has been rendered on the suit or it is otherwise settled, entry of the loss
usually represents anticipation. Recording it earlier is probably unwise legal strategy as well. For
the loss to be recognized at this point, the loss would have to be probable and reasonably
estimable. (See FASB ASC 450-10-05 for additional discussion if desired.) Note disclosure is
required if the loss is not recorded.
(d) Acceptable because lower of cost or market is in accordance with generally accepted accounting
30. The IASB framework makes two assumptions. One assumption is that financial statements are
prepared on an accrual basis; the other is that the reporting entity is a going concern. The FASB
discuss accrual accounting extensively but does not identify it as an assumption. The going concern
concept is only briefly discussed. The going concern concept will undoubtedly be debated as to its
place in the conceptual framework.
31. While there is some agreement that the role of financial reporting is to assist users in decision-making,
the IASB framework has had more of a focus on the objective of providing information on
management’s performance—often referred to as stewardship. It is likely that there will be much
debate regarding the role of stewardship in the conceptual framework.
32. As indicated, the measurement project relates to both initial measurement and subsequent
measurement. Thus, the continuing controversy related to historical cost and fair value accounting
suggests that this issue will be controversial. The reporting entity project that addresses which entities
should be included in consolidated statements and how to implement such consolidations will be a
difficult project. Other difficult issues relate to the trade off between highly relevant information that is
difficult to verify? Or how do we define control when we are developing a definition of an asset? Or is
a liability the future sacrifice itself or the obligation to make the sacrifice?
2-12 Kieso, Intermediate Accounting, 13/e, Solutions Manual
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 2-1
(a) If the company changed its method for inventory valuation, the consistency, and therefore the comparability, of the financial statements have
been affected by a change in the method of applying the accounting
principles employed. The change would require comment in the auditor’s
report in an explanatory paragraph.
(b) If the company disposed of one of its two subsidiaries that had been
included in its consolidated statements for prior years, no comment as to
consistency needs to be made in the CPA’s audit report. The comparability
of the financial statements has been affected by a business transaction,
but there has been no change in any accounting principle employed or
in the method of its application. (The transaction would probably require
informative disclosure in the financial statements.)
(c) If the company reduced the estimated remaining useful life of plant
property because of obsolescence, the comparability of the financial
statements has been affected. The change is not a matter of consistency; it
is a change in accounting estimate required by altered conditions and
involves no change in accounting principles employed or in their
method of application. The change would probably be disclosed by a
note in the financial statements; if commented upon in the CPA’s report,
it would be as a matter of disclosure rather than consistency.
(d) If the company is using a different inventory valuation method from all
other companies in its industry, no comment as to consistency need be
made in the CPA’s audit report. Consistency refers to a given company
following consistent accounting principles from one period to another; it
does not refer to a company following the same accounting principles as
other companies in the same industry.
BRIEF EXERCISE 2-2
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-13
2-14 Kieso, Intermediate Accounting, 13/e, Solutions Manual
BRIEF EXERCISE 2-3
(h) Distributions to owners
(j) Investments by owners
BRIEF EXERCISE 2-4
(b) Monetary unit
(c) Going concern
(d) Economic entity
BRIEF EXERCISE 2-5
(a) Revenue recognition
(b) Expense recognition
(c) Full disclosure
(d) Historical cost
BRIEF EXERCISE 2-6
Investment 1—Level 3
Investment 2—Level 1
Investment 3—Level 2
BRIEF EXERCISE 2-7
(a) Industry practices
(c) Cost-benefit relationship
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-15
BRIEF EXERCISE 2-8
Companies and their auditors for the most part have adopted the general rule
of thumb that anything under 5% of net income is considered not material.
Recently, the SEC has indicated that it is okay to use this percentage for the
initial assessment of materiality, but other factors must be considered. For
example, companies can no longer fail to record items in order to meet
consensus analyst’s earnings numbers; preserve a positive earnings trend;
convert a loss to a profit or vice versa; increase management compensation, or
hide an illegal transaction like a bribe. In other words, both quantitative and
qualitative factors must be considered in determining when an item is
(a) Because the change was used to create a positive trend in earnings, the
change is considered material.
(b) Each item must be considered separately and not netted. Therefore each
transaction is considered material.
(c) In general, companies that follow an ―expense all capital items below a
certain amount‖ policy are not in violation of the materiality concept.
Because the same practice has been followed from year to year,
Damon’s actions are acceptable.
BRIEF EXERCISE 2-9
(a) Net realizable value.
(b) Would not be disclosed. Liabilities would be disclosed in the order to be
(c) Would not be disclosed. Depreciation would be inappropriate if the
going concern assumption no longer applies.
(d) Net realizable value.
(e) Net realizable value (i.e., redeemable value).
2-16 Kieso, Intermediate Accounting, 13/e, Solutions Manual
BRIEF EXERCISE 2-10
(b) Full disclosure
(c) Expense recognition principle
(d) Historical cost
BRIEF EXERCISE 2-11
(a) Should be debited to the Land account, as it is a cost incurred in acquiring
(b) As an asset, preferably to a Land Improvements account. The driveway will
last for many years, and therefore it should be capitalized and
(c) Probably an asset, as it will last for a number of years and therefore will
contribute to operations of those years.
(d) If the fiscal year ends December 31, this will all be an expense of the
current year that can be charged to an expense account. If statements
are to be prepared on some date before December 31, part of this cost
would be expense and part asset. Depending upon the circumstances, the
original entry as well as the adjusting entry for statement purposes should
take the statement date into account.
(e) Should be debited to the Building account, as it is a part of the cost of
that plant asset which will contribute to operations for many years.
(f) As an expense, as the service has already been received; the contribution to operations occurred in this period.
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-17
SOLUTIONS TO EXERCISES
EXERCISE 2-1 (20–30 minutes)
(a) Feedback Value. (f) Relevance and Reliability.
(b) Cost/Benefit and Materiality. (g) Timeliness.
(c) Neutrality. (h) Relevance.
(d) Consistency. (i) Comparability.
(e) Neutrality. (j) Verifiability.
EXERCISE 2-2 (15–20 minutes)
(a) Comparability. (f) Relevance.
(b) Feedback Value. (g) Comparability and Consistency.
(c) Consistency. (h) Reliability.
(d) Neutrality. (i) Relevance and Reliability.
(e) Verifiability. (j) Timeliness.
EXERCISE 2-3 (15–20 minutes)
(a) Gains, losses.
(c) Investments by owners, comprehensive income.
(also possible would be revenues and gains).
(d) Distributions to owners.
(Note to instructor: net effect is to reduce equity and assets).
(e) Comprehensive income.
(also possible would be revenues and gains).
(g) Comprehensive income.
(h) Revenues, expenses.
(k) Distributions to owners.
(l) Comprehensive income.
2-18 Kieso, Intermediate Accounting, 13/e, Solutions Manual
EXERCISE 2-4 (15–20 minutes)
(a) 7. Expense recognition principle.
(b) 5. Historical cost principle.
(c) 8. Full disclosure principle.
(d) 2. Going concern assumption.
(e) 12. Conservatism.
(f) 1. Economic entity assumption.
(g) 4. Periodicity assumption.
(h) 11. Industry practices.
(i) 10. Materiality.
(j) 3. Monetary unit assumption.
EXERCISE 2-5 (20–25 minutes)
Historical cost principle.
Full disclosure principle.
Expense recognition principle.
Industry practices or fair value
Economic entity assumption.
Full disclosure principle.
Revenue recognition principle.
Full disclosure principle.
(k) Revenue and expense recognition principles.
(l) Economic entity assumption.
(m) Periodicity assumption.
(n) Expense recognition principle.
(p) Historical cost principle.
(r) Expense recognition principle.
(a) It is well established in accounting that revenues, cost of goods sold
and expenses must be disclosed in an income statement. It might be
noted to students that such was not always the case. At one time, only net
income was reported but over time we have evolved to the present
(b) The proper accounting for this situation is to report the equipment as an
asset and the notes payable as a liability on the balance sheet.
Offsetting is permitted in only limited situations where certain assets are
contractually committed to pay off liabilities.
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-19
EXERCISE 2-6 (Continued)
(c) According to GAAP, the basis upon which inventory amounts are stated (lower
of cost or market) and the method used in determining cost (LIFO, FIFO,
average cost, etc.) should also be reported. The disclosure requirement
related to the method used in determining cost should be emphasized,
indicating that where possible alternatives exist in financial reporting,
disclosure in some format is required.
(d) Consistency requires that disclosure of changes in accounting princi-ples
be made in the financial statements. To do otherwise would result in
financial statements that are misleading. Financial statements are more
useful if they can be compared with similar reports for prior years.
(a) This entry violates the economic entity assumption. This assumption in
accounting indicates that economic activity can be identified with a
particular unit of accountability. In this situation, the company erred by
charging this cost to the wrong economic entity.
(b) The historical cost principle indicates that assets and liabilities are
accounted for on the basis of cost. If we were to select sales value, for
example, we would have an extremely difficult time in attempting to
establish a sales value for a given item without selling it. It should
further be noted that the revenue recognition principle provides the
answer to when revenue should be recognized. Revenue should be
recognized when (1) realized or realizable and (2) earned. In this situation,
an earnings process has definitely not taken place.
(c) Probably the company is too conservative in its accounting for this
transaction. The matching principle indicates that expenses should be
allocated to the appropriate periods involved. In this case, there appears
to be a high uncertainty that the company will have to pay. FASB
Statement No. 5 requires that a loss should be accrued only (1) when it
is probable that the company would lose the suit and
(2) the amount of the loss can be reasonably estimated. (Note to
instructor: The student will probably be unfamiliar with FASB Statement
No. 5. The purpose of this question is to develop some decision
framework when the probability of a future event must be assumed.)
2-20 Kieso, Intermediate Accounting, 13/e, Solutions Manual
EXERCISE 2-7 (Continued)
(d) At the present time, accountants do not recognize price-level adjustments in the accounts. Hence, it is misleading to deviate from the cost
principle because conjecture or opinion can take place. It should also be
noted that depreciation is not so much a matter of valuation as it is a
means of cost allocation. Assets are not depreciated on the basis of a
decline in their fair market value, but are depreciated on the basis of
systematic charges of expired costs against revenues. (Note to
instructor: It might be called to the students’ attention that the FASB does
encourage supplemental disclosure of price-level information.)
(e) Most accounting methods are based on the assumption that the business enterprise will have a long life. Acceptance of this assumption
provides credibility to the historical cost principle, which would be of
limited usefulness if liquidation were assumed. Only if we assume some
permanence to the enterprise is the use of depreciation and amortization
policies justifiable and appropriate. Therefore, it is incorrect to assume
liquidation as Gonzales, Inc. has done in this situation. It should be noted
that only where liquidation appears imminent is the going concern
(f) The answer to this situation is the same as (b).
(a) Depreciation is an allocation of cost, not an attempt to value assets. As a
consequence, even if the value of the building is increasing, costs
related to this building should be matched with revenues on the income
statement, not as a charge against retained earnings.
(b) A gain should not be recognized until the inventory is sold. Accountants follow the historical cost approach and write-ups of assets are not
permitted. It should also be noted that the revenue recognition principle
states that revenue should not be recognized until it is realized or
realizable and is earned.
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-21
EXERCISE 2-8 (Continued)
(c) Assets should be recorded at the fair market value of what is given up or
the fair market value of what is received, whichever is more clearly
evident. It should be emphasized that it is not a violation of the historical
cost principle to use the fair market value of the stock. Recording the
asset at the par value of the stock has no conceptual validity. Par value
is merely an arbitrary amount usually set at the date of incorporation.
(d) The gain should be recognized at the point of sale. Deferral of the gain
should not be permitted, as it is realized and is earned. To explore this
question at greater length, one might ask what justification other than the
controller’s might be used to justify the deferral of the gain. For example,
the rationale provided in GAAP, noncompletion of the earnings process,
might be discussed.
(e) It appears from the information that the sale should be recorded in 2011
instead of 2010. Regardless of whether the terms are f.o.b. shipping
point or f.o.b. destination, the point is that the inventory was sold in
2011. It should be noted that if the company is employing a perpetual
inventory system in dollars and quantities, a debit to Cost of Goods Sold
and a credit to Inventory is also necessary in 2011.
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TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS
CA 2-1 (Time 20–25 minutes)
Purpose—to provide the student with the opportunity to comment on the purpose of the conceptual
framework. In addition, a discussion of the Concepts Statements issued by the FASB is required.
CA 2-2 (Time 25–35 minutes)
Purpose—to provide the student with the opportunity to identify and discuss the benefits of the conceptual
framework. In addition, the most important quality of information must be discussed, as well as other key
characteristics of accounting information.
CA 2-3 (Time 25–35 minutes)
Purpose—to provide the student with some familiarity with Statement of Financial Accounting Concepts
No. 1. The student is asked to indicate the broad objectives of accounting, and to discuss how this
statement might help to establish accounting standards.
CA 2-4 (Time 30–35 minutes)
Purpose—to provide the student with some familiarity with Statement of Financial Accounting Concepts
No. 2. The student is asked to describe various characteristics of useful accounting information and to
identify possible trade-offs among these characteristics.
CA 2-5 (Time 25–30 minutes)
Purpose—to provide the student with the opportunity to indicate and discuss different points at which
revenues can be recognized. The student is asked to discuss the ―crucial event‖ that triggers revenue
CA 2-6 (Time 30–35 minutes)
Purpose—to provide the student with familiarity with an economic concept of income as opposed to the
GAAP approach. Also, factors to be considered in determining when net revenue should be recognized are
CA 2-7 (Time 20–25 minutes)
Purpose—to provide the student with an opportunity to assess different points to report costs as expenses.
Direct cause and effect, indirect cause and effect, and rational and systematic approaches are developed.
CA 2-8 (Time 20–25 minutes)
Purpose—to provide the student with familiarity with the expense recognition principle in accounting.
Specific items are then presented to indicate how these items might be reported using the expense
CA 2-9 (Time 20–30 minutes)
Purpose—to provide the student with a realistic case involving association of costs with revenues. The
advantages of expensing costs as incurred versus spreading costs are examined. Specific guidance is
asked on how allocation over time should be reported.
CA 2-10 (Time 20–30 minutes)
Purpose—to provide the student with the opportunity to discuss the relevance and reliability of financial
statement information. The student must write a letter on this matter so the case does provide a good
writing exercise for the students.
CA 2-11 (Time 20–25 minutes)
Purpose—to provide the student with the opportunity to discuss the ethical issues related to expense
CA 2-12 (Time 30–35 minutes)
Purpose—to provide the student with the opportunity to discuss the cost/benefit constraint.
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-23
SOLUTIONS TO CONCEPTS FOR ANALYSIS
(a) A conceptual framework is like a constitution. Its objective is to provide 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.
A conceptual framework is necessary so that standard setting is useful, i.e., standard setting should
build on and relate to an established body of concepts and objectives. A well-developed conceptual
framework should enable the FASB to issue more useful and consistent standards in the future.
Specific benefits that may arise are:
(1) A coherent set of standards and rules should result.
(2) New and emerging practical problems should be more quickly soluble by reference to an existing
(3) It should increase financial statement users’ understanding of and confidence in financial reporting.
(4) It should enhance comparability among companies’ financial statements.
(5) It should help determine the bounds for judgment in preparing financial statements.
(6) It should provide guidance to the body responsible for establishing accounting standards.
(b) The FASB has issued six Statements of Financial Accounting Concepts (SFAC) that relate to business enterprises. Their titles and brief description of the focus of each Statement are as follows:
(1) SFAC No. 1, ―Objectives of Financial Reporting by Business Enterprises,‖ presents the goals and
purposes of accounting.
(2) SFAC No. 2, ―Qualitative Characteristics of Accounting Information,‖ examines the character-istics
that make accounting information useful.
(3) SFAC No. 3, ―Elements of Financial Statements of Business Enterprises,‖ provides definitions of
the broad classifications of items in financial statements.
(4) SFAC No. 5, ―Recognition and Measurement in Financial Statements,‖ sets forth fundamental
recognition and measurement criteria and guidance on what information should be formally
incorporated into financial statements and when.
(5) SFAC No. 6, ―Elements of Financial Statements,‖ replaces SFAC No. 3, ―Elements of Financial
Statements of Business Enterprises,‖ and expands its scope to include not-for-profit organizations.
(6) SFAC No. 7, ―Using Cash Flow Information and Present Value in Accounting Measurements,‖
provides a framework for using expected future cash flows and present values as a basis for
(a) FASB’s conceptual framework study should provide benefits to the accounting community such as:
(1) guiding the FASB in establishing accounting standards on a consistent basis.
(2) determining bounds for judgment in preparing financial statements by prescribing the nature,
functions and limits of financial accounting and reporting.
(3) increasing users’ understanding of and confidence in financial reporting.
2-24 Kieso, Intermediate Accounting, 13/e, Solutions Manual
CA 2-2 (Continued)
(b) Statement of Financial Accounting Concepts No. 2 identifies the most important quality for
accounting information as usefulness for decision making. Relevance and reliability are the primary
qualities leading to this decision usefulness. Usefulness is the most important quality because, without
usefulness, there would be no benefits from information to set against its costs.
(c) The number of key characteristics or qualities that make accounting information desirable are
described in the Statement of Financial Accounting Concepts No. 2. The importance of three of
these characteristics or qualities are discussed below.
(1) Understandability—information provided by financial reporting should be comprehensible to those
who have a reasonable understanding of business and economic activities and are willing to
study the information with reasonable diligence. Financial information is a tool and, like most
tools, cannot be of much direct help to those who are unable or unwilling to use it, or who misuse
(2) Relevance—the accounting information is 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
(3) Reliability—the reliability of a measure rests on the faithfulness with which it represents what it
purports to represent, coupled with an assurance for the user, which comes through verification,
that it has representational quality.
(Note to instructor: Other qualities might be discussed by the student, such as secondary qualities. All of
these qualities are defined in the textbook.)
(a) The basic objectives in Statement of Financial Accounting Concepts No. 1 are to:
(1) provide information useful in investment and credit decisions for individuals who have a
reasonable understanding of business.
(2) provide information useful in assessing future cash flows.
(3) provide information about economic resources, claims to those resources, and changes in them.
(b) The purpose of this statement is to set forth fundamentals on which financial accounting and reporting
standards may be based. Without some basic set of objectives that everyone can agree to,
inconsistent standards will be developed. For example, some believe that accountability should be the
primary objective of financial reporting. Others argue that prediction of future cash flows is more
important. It follows that individuals who believe that accountability is the primary objective may arrive
at different financial reporting standards than others who argue for prediction of cash flow. Only by
establishing some consistent starting point can accounting ever achieve some underlying consistency
in establishing accounting principles.
It should be emphasized to the students that the Board itself is likely to be the major user and thus the
most direct beneficiary of the guidance provided by this pronouncement. However, knowledge of the
objectives and concepts the Board uses should enable all who are affected by or interested in
financial accounting standards to better understand the content and limitations of information provided
by financial accounting and reporting, thereby furthering their ability to use that informa-tion effectively
and enhancing confidence in financial accounting and reporting. That knowledge, if used with care,
may also provide guidance in resolving new or emerging problems of financial accounting and
reporting in the absence of applicable authoritative pronouncements.
Kieso, Intermediate Accounting, 13/e, Solutions Manual 2-25
(a) (1) Relevance is one of the two primary decision-specific characteristics of useful accounting
information. Relevant information is capable of making a difference in a decision. Relevant
information helps users to make predictions about the outcomes of past, present, and future
events, or to confirm or correct prior expectations. Information must also be timely in order to be
(2) Reliability is one of the two primary decision-specific characteristics of useful accounting information. Reliable information can be depended upon to represent the conditions and events that
it is intended to represent. Reliability stems from representational faithfulness and verifiability.
Representational faithfulness is correspondence or agreement between accounting information and
the economic phenomena it is intended to represent. Verifiability provides assurance that the
information is free from bias.
(3) Understandability is a user-specific characteristic of information. Information is understandable
when it permits reasonably informed users to perceive its significance. Understandability is a link
between users, who vary widely in their capacity to comprehend or utilize the information, and the
decision-specific qualities of information.
(4) Comparability means that information about enterprises has been prepared and presented in a
similar manner. Comparability enhances comparisons between information about two different
enterprises at a particular point in time.
(5) Consistency means that unchanging policies and procedures have been used by an enterprise
from one period to another. Consistency enhances comparisons between information about the
same enterprise at two different points in time.
(b) (Note to instructor: There are a multitude of answers possible here. The suggestions below are
intended to serve as examples.)
(1) Forecasts of future operating results and projections of future cash flows may be highly relevant to
some decision makers. However, they would not be as reliable as historical cost information about
(2) Proposed new accounting methods may be more relevant to many decision makers than exist-ing
methods. However, if adopted, they would impair consistency and make trend comparisons of an
enterprise’s results over time difficult or impossible.
(3) There presently exists much diversity among acceptable accounting methods and procedures. In
order to facilitate comparability between enterprises, the use of only one accepted account-ing
method for a particular type of transaction could be required. However, consistency would be
impaired for those firms changing to the new required methods.
(4) Occasionally, relevant information is exceedingly complex. Judgment is required in determining the
optimum trade-off between relevance and understandability. Information about the impact of
general and specific price changes may be highly relevant but not understandable by all users.
(c) Although trade-offs result in the sacrifice of some desirable quality of information, the overall result
should be information that is more useful for decision making.
(a) The various accepted times of recognizing revenue in the accounts are as follows:
(1) Time of sale. This time is currently acceptable when the costs and expenses related to the
particular transaction are reasonably determinable at the time of sale and when the collection of
the sales price is reasonably certain.