Chapter 1: Financial Statements PDF

# Chapter 1: Financial Statements ## Technical Knowledge * To identify the components of financial statements. * To know the objective of financial statements. * To know the objective of financial reporting. * To understand the primary responsibility for the preparation of financial statements. *...

# Chapter 1: Financial Statements ## Technical Knowledge * To identify the components of financial statements. * To know the objective of financial statements. * To know the objective of financial reporting. * To understand the primary responsibility for the preparation of financial statements. * To identify the general features in the preparation of financial statements. ## Financial Statements Financial statements are the means by which the information accrued and processed in financial accounting is periodically communicated to the users. Financial statements are a structured financial representation of the financial position and financial performance of an entity. ### General Purpose Financial Statements General purpose financial statements are those statements intended to meet the needs of users who are not in a position to require an entity to prepare reports tailored to their particular information needs. Reports prepared at the request of an entity's management or bankers are not general purpose financial statements because they are prepared specifically to meet the needs of management or bankers. ### Components Of Financial Statements A complete set of financial statements comprises the following components: 1. Statement of financial position 2. Income statement 3. Statement of comprehensive income 4. Statement of changes in equity 5. Statement of cash flows 6. Notes, comprising a summary of significant accounting policies and other explanatory information. Many entities also present reports and statements such as environmental reports and value added statements, particularly in industries in which environmental factors are significant and when employees are regarded as an important user group. However, such statements and reports are *not* components of financial statements. ## Objective of Financial Statements The objective of general purpose financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Financial statements also show the results of the stewardship of management of the resources entrusted to it. To meet this objective, financial statements provide information about the following: * Assets * Liabilities * Equity * Income and expenses, including gains and losses * Contributions by and distributions to owners in their capacity as owners * Cash flows Such information, along with other information in the notes, would assist users of financial statements in predicting the entity's cash flows and in particular their timing and certainty. However, financial statements do *not* provide all the information that users may need to make economic decisions. The reason is that the financial statements largely portray the financial effects of past events and do not necessarily provide nonfinancial information. ## Financial Position The financial position comprises the assets, liabilities and equity of an entity at a particular moment in time. Specifically, financial position pertains to the liquidity, solvency, and the need of the entity for additional financing. This information is pictured in the statement of financial position. ## Financial Performance The financial performance comprises the revenue, expenses and net income or loss of an entity for a period of time. *Performance* is the level of income earned by the entity through the efficient and effective use of its resources. The financial performance of an entity is also known as results of operations and is portrayed in the income statement and statement of comprehensive income. ## Cash Flows Cash flows are the cash receipts and cash payments arising from the operating, investing and financing activities of the entity. The information about cash receipts and cash payments is presented in the statement of cash flows. Cash flow information is useful in assessing the ability of the entity to generate cash and cash equivalents. ## Financial Reporting Financial reporting is the provision of financial information about an entity to external users that is useful to them in making economic decisions and for assessing the effectiveness of the entity's management. The principal way of providing financial information to external users is through the annual financial statements. However, financial reporting encompasses *not* only financial statements but also other means of communicating information that relates directly or indirectly to the financial accounting process. Financial reports include *not* only financial statements but also other information such as financial highlights, summary of important financial figures, analysis of financial statements and significant ratios. Financial reports also include *nonfinancial* information such as description of major products and a listing of corporate officers and directors. ## Objective of Financial Reporting Under the Conceptual Framework for Financial Reporting, the objective of financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity. Simply stated, the overall objective of financial reporting is to provide information that is useful for decision making. ## Target Users of Financial Reporting General purpose financial reporting is directed primarily to the existing and potential investors, lenders and other creditors which compose the *primary* user group. The reason is that existing and potential investors, lenders and other creditors have the most *critical* and *immediate* need for information in financial reports. As a matter of fact, the primary users of financial information are the parties that provide resources to the entity. Moreover, information that meets the needs of the specified primary users is likely to meet the needs of other users such as employees, customers, governments and their agencies. The management of a reporting entity is also interested in financial information about the entity. However, management need not rely on general purpose financial reports because it is able to obtain or access additional financial information internally. ## Specific Objectives of Financial Reporting Specifically, the Conceptual Framework for Financial Reporting states the following objectives of financial reporting: * To provide information useful in making *investing* and credit decisions about providing resources to the entity. * To provide information useful in *assessing* the cash flow prospects of the entity. * To provide information about *entity resources*, claims and changes in resources and claims. ## Limitations of Financial Reporting: * General purpose financial reports do *not* and *cannot* provide all of the information that existing and potential investors, lenders and other creditors need. * General purpose financial reports are *not* designed to show the value of a reporting entity but these reports provide information to help the primary users *estimate* the value of the entity. * General purpose financial reports are intended to provide *common* information to users and cannot accommodate every specific request for information. * To a large extent, financial reports are based on *estimate* and *judgment* rather than exact depiction. ## Responsibility For Financial Statements: The management of an entity has the *primary* responsibility for the preparation and presentation of financial statements. The *Board of Directors* in discharging its responsibilities reviews and authorizes the financial statements for issue before these are submitted to the shareholders of the entity. *Management* is *accountable* for the *safekeeping* of the resources and their proper, efficient and profitable use. Shareholders are interested in information that helps them assess how effectively management has fulfilled this role as this is relevant to the decision concerning their investment and the reappointment or replacement of management. ## General Features of Financial Statements: 1. Fair presentation and compliance with PFRS 2. Going concern 3. Accrual basis 4. Materiality and aggregation 5. Offsetting 6. Frequency of reporting 7. Comparative information 8. Consistency of presentation ## Fair Presentation: The financial statements shall present fairly the financial position, financial performance and cash flows of an entity. Virtually, in all circumstances, fair presentation is achieved if the financial statements are prepared in accordance with the *Philippine Financial Reporting Standards* which *represent the GAAP in the Philippines*. The application of *Philippine Financial Reporting Standards*, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation. An entity whose financial statements comply with PFRS shall make an *explicit* and *unreserved* statement of such compliance in the notes. Fair presentation is defined as faithful representation of the effects of transactions and other events in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses laid down in the Conceptual Framework. Fair presentation requires an entity: * To select and apply accounting policies in accordance with PFRS. * To present information, including accounting policies, in a manner that provides relevant and faithfully represented financial information. * To provide additional disclosures necessary for the users to understand the entity's financial statements.' An entity cannot rectify *inappropriate* accounting policies either by disclosure of the accounting policies used or by notes or explanatory information. ## Departure From Standard In the extremely rare circumstances in which management concludes that compliance with a requirement in a standard would be so misleading, the entity shall depart from that requirement provided the relevant regulatory Conceptual Framework requires, or otherwise does not prohibit, such a departure. Thus, an entity is permitted to depart from a standard: * In extremely rare circumstances. * When management concludes’ that compliance with the standard would be misleading. * When the departure from the standard is necessary to achieve fair presentation. * When the regulatory Conceptual Framework requires or otherwise does not prohibit such a departure. In such circumstances, it is incumbent upon the entity to disclose the following: 1. The management has concluded that the financial statements present fairly the financial position, financial performance and cash flows of the entity. 2. That the entity has complied with applicable standards except that it has departed from a particular requirement to achieve a fair presentation. 3. The title of the standard from which the entity has departed, the nature of the departure, including the treatment that the standard would require, the reason why that treatment would be so misleading and the treatment adopted. 4. For each period presented, the financial impact of the departure on each item in the financial statements that would have been reported in complying with the requirement. ## Going Concern Going concern means that the accounting entity is viewed as continuing in operation *indefinitely* in the absence of evidence to the contrary. Going concern is also known as *continuity assumption*. 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 standards require measurement of certain assets at fair value. Going concern is particularly relevant when management shall make an estimate of the expected outcome of *future* events, such as the recoverability of accounts receivable and the useful life of noncurrent assets. This postulate is the very foundation of the *cost principle*. Financial statements shall be prepared on a going concern basis unless management intends to liquidate the entity or cease trading or has no realistic option but to do so. When upon assessment it becomes evident that there are *material* uncertainties regarding the ability of the entity to continue as a going concern, those uncertainties shall be *fully disclosed*. In making the assessment about the going concern assumption, management shall take into account all available information about the *future* which is at least twelve months from the end of reporting period. If the financial statements are *not* prepared on a going concern basis, such fact shall be disclosed together with the measurement basis and the reason therefor. ## Accrual Basis An entity shall prepare the financial statements, using the accrual basis of accounting except for cash flow information. Under accrual basis, the effects of transactions and other events are recognized when they occur and *not* as cash or cash equivalent is received or paid, and they are recorded and reported in the financial statements of the periods to which they relate. In the simplest language, accrual basis means that assets are recognized when *receivable* rather than when physically received, and liabilities are recognized *payable* rather than when actually paid. Accrual accounting means that income is recognized when *earned* regardless of when received and expense is recognized when *incurred* regardless of when paid. The essence of accrual accounting is the recognition of accounts receivable, accounts payable, prepaid expenses, accrued expenses, deferred income, and accrued income. ## Materiality And Aggregation An entity shall present separately each *material* class of similar items. An entity shall present separately items of *dissimilar* nature or function unless they are immaterial. Financial statements result from processing large number of transactions or other events that are aggregated into classes according to their nature or function. The final stage in the process of aggregation and classification is the presentation of condensed and classified data which form *line items* in the financial statements. For example, cash on hand, petty cash fund, cash in bank and cash equivalent shall be presented as one item "cash and cash equivalents". Finished goods, goods in process, raw materials and manufacturing supplies are aggregated and presented as one item "inventories". If a line item is *not* individually material, it is aggregated with other items *either* in those statements or in the notes. For example, an investor's share in the net income of an associate is presented as a separate line item in the income statement. However, if this amount is *not* individually material, it may be aggregated with other income. Materiality dictates that "an entity *need not* provide a specific disclosure required by PFRS if the information is *not* material". ## When Is An Item Material? There is *no* strict or uniform rule for determining whether an item is material or not. Very often, this 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 the decision of the *informed* users of the financial statements. Information is material if the omission or misstatement could influence the economic decision that users *make* on the basis of the financial statements. For example, small expenditures for tools are often expensed *immediately* rather than depreciated over their useful life to save on clerical costs of recording depreciation. In such a case, the effect on the financial statements is *not* large enough to affect economic decision. Another example is the common practice of large entities of rounding amounts to the nearest thousand pesos in their financial statements. Small entities may round off to the nearest peso. ## 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. ## Factors Of Materiality In the exercise of judgment in determining materiality, the following factors may be considered: * Relative size of the item in relation to the total of the group to which the item belongs. For example, the amount of advertising in relation to total distribution costs, the amount of office salaries to total administrative expenses, the amount of prepaid expenses to total current assets and the amount of leasehold improvements to total property, plant and equipment. * Nature of the item - An item may be inherently material because by its very nature it affects economic decision. For example, the discovery of a P20,000 bribe is a material event even for a very large entity. ## Offsetting Assets and liabilities, and income and expenses, when material, shall *not* be offset against each other. Offsetting may be done when it is required or permitted by another PFRS. ## Examples Of Offsetting * Gains and losses on disposal of noncurrent assets are reported by deducting from the proceeds the carrying amount of the assets and the related selling expenses. * Expenditure related to a provision and reimbursed under a contractual arrangement with a third party may be netted against the related reimbursement. In other words, the expenditure related to a provision and any reimbursement from a third party can be offset, and only the net expenditure is presented as expense. * In addition, gains and losses arising from a group of similar transactions are reported on a *net* basis. For example, foreign exchange gains and losses or gains and losses arising from trading securities are netted against the other. However, if material, such gains and losses are reported separately. * The measurement of assets net of valuation allowance is permitted because technically this is *not* offsetting. Thus, accounts receivable may be shown *net* of allowance for doubtful accounts. ## Frequency of Reporting An entity shall present a complete set of financial statements at least annually. When an entity changes the end of the reporting period and presents financial statements for a period longer or shorter than one year, the entity shall disclose: * The period covered by the financial statements. * The reason for using a longer or shorter period. * The fact that amounts presented in the financial statements are *not* entirely comparable. ## Comparable Information Except when permitted or required otherwise by PFRS, an entity shall disclose comparable information in respect of the previous period for all amounts reported in the current period's financial statements. In other words, the financial statements of the current period shall be presented with *comparative* figures of the financial statements of the immediately preceding year. Comparative information shall be included for narrative and descriptive information when it is relevant to an understanding of the current period's financial statements. For example, details of a legal dispute, the outcome of which was uncertain at the end of the preceding reporting period and is yet to be resolved, are disclosed in the current period. Users shall benefit from information that an uncertainty existed at the end of the immediately preceding reporting period, and steps have been taken during the current period to resolve the uncertainty. ## Third Statement Of Financial Position A third statement of financial position is required when an entity: * Applies an accounting policy retrospectively. * Makes retrospective restatement of items in the financial statements. * Reclassifies items in the financial statements. 'Under these circumstances, an entity shall present three statements of financial position as at: * The end of the current period * The end of the previous period * The beginning of the earliest comparative period ## Consistency of Presentation Implicit in the presentation of comparable information is the principle of consistency. The principle of consistency requires that the accounting methods and practices shall be applied on a *uniform* basis from period to period. The presentation and classification of financial statement items shall *not* change form from one accounting period to the next. 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. Consistency is desirable and essential to achieve comparability of financial statements. However, consistency does *not* mean that no change in accounting method can be made. If the change will result to information that is faithfully represented and more relevant to the users of financial statements, then such change should be made. But there should be *full disclosure* of the change and the peso effect of the change. A change in the presentation and classification of items in the financial statements is allowed: * When it is required by another PFRS. * When a significant change in the nature of the operations of the entity will demonstrate a more appropriate revised presentation and classification. It is *inappropriate* for an entity to leave accounting policies unchanged when better and acceptable alternatives exist. ## Identification of Financial Statements Financial statements shall be *clearly* identified and *distinguished* from other information in the same published document. Each component of the financial statements shall be clearly identified. In addition, the following information shall be prominently displayed: * The name of the reporting entity. * Whether the financial statements cover the individual entity or a group of entities. * The end of the reporting period or the period covered by the financial statements or notes. * The presentation currency. * The level of rounding used in the amounts in the financial statements. Financial statements are often made more understandable by presenting information in thousands or millions of units of the presentation currency. This is acceptable as long as the level of rounding in presentation is disclosed and relevant and material information is *not* lost or omitted. ## Problems **Problem 1-1 Multiple Choice (PAS 1)** 1. A complete set of financial statements includes all of the following components, except * Statement of financial position * Statement of changes in equity * Notes to financial statements * Environmental reports and value added statements 2. What is the objective of financial statements? * To provide information about the financial position, financial performance and changes in financial position useful to a wide range of users * To prepare a statement of financial position and statement of comprehensive income * To present relevant, reliable, comparable and understandable information * To prepare financial statements in accordance with all applicable standards 3. The primary responsibility for the preparation of the financial statements is reposed in * Management of the entity * Internal auditor * External auditor * Controller 4. The major financial statements include all, except * Statement of financial position * Income statement * Statement of cash flows * Statement of retained earnings 5. The major financial statements include all, except * Statement of financial position * Statement of changes in financial position * Statement of comprehensive income * Statement of changes in equity **Problem 1-2 Multiple Choice (IFRS)** 1. When an entity changed the reporting period longer or shorter than one year, an entity shall disclose all of the following, except * Period covered by the financial statements. * The reason for using a longer or shorter period. * The fact that amounts presented in the financial statements are not entirely comparable. * The fact that similar entities in the geographical area in which the entity operates have done so. 2. Which of the following is not a component of the financial statements? * Statement of financial position * Statement of changes in equity * Report of board of directors * Notes to financial statements 3. Which of the following is included in a complete set of financial statements? * A statement by the board of directors of compliance with local legislation * A statement of changes in equity * Statements of financial position for the last five years * Value added statement 4. Which of the following is included within the financial statements? * A statement of retained earnings * Accounting policies * An auditor's report * Board of directors' report 5. An entity shall clearly identify each financial statement and display all of the following, except * Name of the reporting entity. * Names of major shareholders of the entity. * The presentation currency. * Whether the financial statements cover the individual entity or a group of entities **Problem 1-3 Multiple Choice (PAS 1)** 1. Which statement is incorrect concerning fair presentation of financial statements? * Fair presentation requires the faithful representation of the effects of transactions and other events. * Financial statements shall present fairly the financial position, financial performance and cash flows of an entity. * In virtually all circumstances, a fair presentation is achieved by compliance with applicable PFRS. * An entity whose financial statements comply with PFRS shall not make an explicit and unreserved statement of such compliance in notes. 2. Which of the following cannot be considered fair presentation of financial statements? * To present information in a manner that provides relevant and faithfully represented financial information. * To provide additional disclosures when compliance with specific PFRS is insufficient to understand the financial position and financial performance. * To select and apply accounting policies in accordance with applicable PFRS. * To rectify inappropriate accounting policies either by disclosure of the accounting policies used or by notes or explanatory information. 3. Which statement indicates a going concern? * Management intends to liquidate the entity. * Management intends to cease the operations of the entity. * Management has no realistic alternative but to cease the operations of the entity. * None of these would indicate going concern 4. An entity is permitted to depart from a particular standard if all of the following conditions are satisfied, except * In extremely rare circumstances.. * When management concludes that compliance with the standard would be misleading. * When the departure from the standard is necessary to achieve fair presentation. * When the Conceptual Framework for Financial Reporting prohibits such a departure. 5. The effects of transactions and other events on economic resources and claims are depicted in the periods in which those effects occur even if the resulting cash receipts and payments occur in a different period. * Accrual accounting * Cash accounting * Modified accrual accounting * Modified Cash accounting 6. Financial statements must be prepared at least * Annually * Quarterly * Semiannually * Every two years 7. Technically, offsetting in financial statements is accomplished when * The allowance for doubtful accounts is deducted from accounts receivable.. * The accumulated depreciation is deducted from property, plant and equipment. * The total liabilities are deducted from total assets. * Gain or loss from disposal of noncurrent asset is reported by deducting from the proceeds the carrying amount of the asset and the related disposal cost. 8. The presentation and classification of items in the financial statements shall be retained from one accounting period to the next. * Consistency of presentation * Materiality * Aggregation * Comparability 9. A third statement of financial position as at beginning of the earliest comparative period presented is required * When an entity applies an accounting policy retrospectively. * When an entity makes a retrospective restatement of items in the financial statements. * When an entity reclassifies items in the financial statements. * Under all of these circumstances 10. Which statement in relation to financial statements in incorrect? * General purpose financial statements do not and cannot provide all of the information that primary users need. * General purpose financial statements are designed to show the value of the reporting entity. * General purpose financial statements are intended to provide common information to users. * Financial statements are largely based on estimate and judgment rather than exact depiction. **Problem 1-4 Multiple Choice (IFRS)** 1. Items of dissimilar nature or function * Must always be presented separately. * Must not be presented separately. * Must be presented separately if material. * Must be presented separately even if immaterial. 2. Materiality depends on * The nature of the omission or misstatement. * The absolute size of the omission or misstatement. * The relative size and nature of the omission or misstatement judged in the surrounding circumstances. * The judgment of management. 3. An entity must disclose comparative information for * The previous comparable period for all amounts. * The previous comparable period for all amounts and for all narrative and descriptive information. * The previous comparable period for all amounts and for all narrative and descriptive information when it is relevant to an understanding of the current period's financial statements. * The previous two comparable periods for all amounts. 4. When the classification of items in the financial statements is changed, the entity * Must not reclassify the comparative amounts. * Can choose whether or not to reclassify. * Must reclassify the comparative amounts unless it is impracticable to do so. * Must reclassify the current year amounts only. 5. An entity shall present * The statement of cash flows more prominently. * The statement of financial position more prominently. * The income statement more prominently. * Each financial statement with equal prominence. **Problem 1-5 Multiple Choice (IAA)** 1. The overall objective of financial reporting is to provide information * That is useful for decision making * About assets, liabilities and equity * About financial performance during a period * That assesses performance of management 2. The objective of financial reporting is based on * The need for conservatism * Reporting on management stewardship * Generally accepted accounting principles * The needs of the users of the information 3. Which is an objective of financial reporting? * To provide information that is useful in making investing and credit decisions. * To provide information that is useful to management. * To provide information to investors. * To provide information about internal and external conflicts. 4. Which is an objective of financial reporting? * To provide information useful to management. * To identify nonfinancial transactions. * To provide information useful to assess the amount, timing and uncertainty of prospective cash receipts. * To provide information that excludes claims. 5. An objective of financial reporting is to provide * Information about the investors in the entity. * Information about the liquidation value of the entity. * Information useful in assessing cash flow prospects. * Information that will attract new investors. **Problem 1-6 Multiple Choice (AICPA Adapted)** 1. During a period when an entity is under the direction of a particular management, financial reporting will directly provide information about * Entity performance and management performance * Management performance but not entity performance * Entity performance but not management performance * Neither entity nor management performance 2. Financial reporting pertains to * Individual business entities, rather than to industries or an economy or to members of society as consumers * Individual business entities and an economy or to members of society as consumers * Individual business entities and an economy rather than to industries or to consumers * Individual business entities, industries and an economy rather than to members of society as consumers 3. Which is not an objective of financial reporting? * Financial reporting shall provide information about resources, claims against resources and changes in them. * Financial reporting shall provide information useful in evaluating stewardship of management. * Financial reporting shall provide information useful in investment, credit and similar decision. * Financial reporting shall provide information useful in assessing cash flow prospects. 4. Which is not an objective of financial reporting? * To provide information about assets and claims against those assets * To provide information useful in assessing cash flows * To provide information useful in lending and investing decisions * To provide information about the liquidation value of an entity **Problem 1-7 Multiple Choice (IAA)** 1. Which would likely prepare the most accurate financial forecast for an entity based on empirical evidence? * Investors using statistical models * Corporate management * Financial analysts * Independent certified public accountants 2. What is the most useful information in predicting future cash flows? * Information about current cash flows * Current earnings based on accrual accounting * Information regarding the accounting policies used * Information regarding the results obtained by using a wide variety of accounting policies 3. The accrual basis of accounting is most useful for * Determining the amount of income tax liability. * Predicting short-term financial performance. * Predicting long-term financial performance. * Determining the amount of dividends to shareholders. 4. In measuring financial performance, accrual accounting is used because * Cash flows are considered less important. * It provides a better indication of ability to generate cash flows than cash basis. * It recognizes revenue when cash is received and expenses when cash is paid. * It is one of the implicit assumptions. 5. The financial statements prepared under GAAP * Do not articulate with one another. * Reflect a single measurement which is historical cost. * Are not highly precise because estimate and judgment must be made. * Contain a limited number of future projections. **Problem 1-8 Multiple Choice (IAA)** 1. Which statement is incorrect concerning the concept of materiality? * It is often difficult to determine what is material. * Information is material if it could influence the economic decision of informed users. * The evaluation of materiality is based solely on the absolute amount or percentage of an item. * The nature of an item may make it material regardless of its relative size. **Problem 1-9 Multiple Choice (IAA)** 1. Which of the following statements about accrual accounting is incorrect? * It is a basis of accounting that recognizes revenues when earned and expenses when incurred, regardless of when cash is received or paid. * It is used to help companies measure financial performance and position over time. * Its application leads to a better understanding of the economic events that underlie a business. * It is the most appropriate basis for accounting for businesses with a large number of transactions. **Problem 1-10 Multiple Choice (IAA)** 1. Why is a statement of cash flows important to financial statement users? * It provides information about the liquidity and solvency of the company. * It helps to explain changes in the company's net income from one period to the next. * It helps to assess the company's ability to generate future cash flows. * All of the above. **Problem 1-11 Multiple Choice (IAA)** 1. Which of the following statements about going concern is incorrect? * The going concern assumption is fundamental to the preparation of financial statements. * If there are material uncertainties about an entity's going concern, the financial statements should disclose this fact. * The going concern assumption assumes that an entity will continue to operate for the foreseeable future. * It assumes that the entity will be liquidated in the near future. **Problem 1-12 Multiple Choice (IAA)** 1. Which of the following statements about the conceptual framework is incorrect? * It provides a set of guidelines that helps to interpret accounting standards. * It establishes a theoretical foundation for accounting. * It specifies the exact way that financial statements should be prepared. * It is intended to guide the development of accounting standards. **Problem 1-13 Multiple Choice (IAA)** 1. Which of the following statements about financial reporting is incorrect? * Financial reporting is designed to provide information that is useful to both internal and external users. * The overall objective of financial reporting is to provide information that is useful for decision-making. * Financial reporting should be based on the concept of going concern unless there is evidence to the contrary. * Financial reporting should only focus on financial information and exclude nonfinancial information. **Problem 1-14 Multiple Choice (IFRS)** 1. Items of dissimilar nature or function * Must always be presented separately. * Must not be presented separately. * Must be presented separately if material. * Must be presented separately even if immaterial. 2. Materiality depends on: * The nature of the omission or misstatement. * The absolute size of the omission or misstatement. * The relative size and nature of the omission or misstatement judged in the surrounding circumstances. * The judgment of management. 3. An entity must disclose comparative information for: * The previous comparable period for all amounts. * The previous comparable period for all amounts and for all narrative and descriptive information. * The previous comparable period for all amounts and for all narrative and descriptive information when it is relevant to an understanding of the current period's financial statements. * The previous two comparable periods for all amounts. 4. When the classification of items in the financial statements is changed, the entity: * Must not reclassify the comparative amounts. * Can choose whether or not to reclassify. * Must reclassify the comparative amounts unless it is impracticable to do so. * Must reclassify the current year amounts only. 5. An entity shall present: * The statement of cash flows more prominently. * The statement of financial position more prominently. * The income statement more prominently. * Each financial statement with equal prominence. **Problem 1-15 Multiple Choice (IAA)** 1. The overall objective of financial reporting is to provide information: * That is useful for decision‐making * About assets, liabilities and equity * About financial performance during a period * That assesses performance of management 2. The objective of financial reporting is based on: * The need for conservatism * Reporting on management stewardship * Generally accepted accounting principles * The needs of the users of the information 3. Which is an objective of financial reporting? * To provide information that is useful in making investing and credit decisions. * To provide information that is useful to management. * To provide information to investors. * To provide information about internal and external conflicts. 4. Which is an objective of financial reporting? * To provide information useful to management. * To identify nonfinancial transactions. * To provide information useful to assess the amount, timing and uncertainty of prospective cash receipts. * To provide information that excludes claims. 5. An objective of financial reporting is to provide: * Information about the investors in the entity. * Information about the liquidation value of the entity. * Information useful in assessing cash flow prospects. * Information that will attract new investors. **Problem 1-16 Multiple Choice (AICPA Adapted)** 1. During a period when an entity is under the direction of a particular management, financial reporting will directly provide information about: * Entity performance and management performance * Management performance but not entity performance * Entity performance but not management performance * Neither entity nor management performance 2. Financial reporting pertains to: * Individual business entities, rather than to industries or an economy or to members of society as consumers. * Individual business entities and an economy or to members of society as consumers. * Individual business entities and economy rather than to industries or to consumers * Individual business entities, industries and an economy rather than to members of society as consumers 3. Which is not an objective of financial reporting? * Financial reporting shall provide information about resources, claims against resources and changes in them.