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Chapter 2: Question 25Q (page 61)

Statement of Financial Accounting Concepts No.5 identifies four characteristics that an item must have before it is recognized in the financial statements. What are these four characteristics?

Short Answer

Expert verified

Four characteristics that an item must possess in order to be recognized in the financial statements include:

  • Understandability
  • Relevance
  • Reliability
  • Comparability

Step by step solution

01

Meaning of Financial Statements

Financial statements are annual statements that disclose the financial performance and business activities of a firm. These statements are regarded as a means for decision-making by the management as well as outsiders like investors and shareholders, government authorities as well as creditors and financiers.

02

Four characteristics of financial statements

Four characteristics are essential for an item to be recognized in the financial statements. They are:

  • Understandability: The information must be presented in such a way that it is easily understandable by the users of the financial statements. The additional information should also be provided as a supporting footnote so as to help in clarification.
  • Relevance: The information provided must be suitable to the needs of the users so that it influences their decisions. This may include reporting appropriate information or information whose misstatement could affect the economic decisions of users.
  • Reliability: The information must be reliable in nature, which means it must be free from error and should not mislead the users.
  • Comparability: The information must be comparable in nature, which means it can be used to compare with the financial information presented in previous or future accounting periods, so as to enable the users in assessing the performance and financial position of the business.

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Most popular questions from this chapter

What are some of the challenges to the IASB in developing a conceptual framework?

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Question: Wal-Mart Stores, Inc.

Wal-Mart Stores, Inc. provided the following disclosure in a recent annual report.

New accounting pronouncement (partial) . . . the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101—“Revenue Recognition in Financial Statements” (SAB 101). This SAB deals with various revenue recognition issues, several of which are common within the retail industry. As a result of the issuance of this SAB . . . the Company is currently evaluating the effects of the SAB on its method of recognizing revenues related to layaway sales and will make any accounting method changes necessary during the first quarter of [next year].

In response to SAB 101, Wal-Mart changed its revenue recognition policy for layaway transactions, in which Wal-Mart sets aside merchandise for customers who make partial payment. Before the change, Wal-Mart recognized all revenue on the sale at the time of the layaway. After the change, Wal-Mart does not recognize revenue until customers satisfy all payment obligations and take possession of the merchandise.

Instructions

(a) Discuss the expected effect on income (1) in the year that Wal-Mart makes the changes in its revenue recognition policy, and (2) in the years following the change.

(b) Evaluate the extent to which Wal-Mart’s previous revenue policy was consistent with the revenue recognition principle.

(c) If all retailers had used a revenue recognition policy similar to Wal-Mart’s before the change, are there any concerns with respect to the qualitative characteristic of comparability? Explain.

Question: Daniel Barenboim sells and erects shell houses, that is, frame structures that are completely finished on the outside but are unfinished on the inside except for flooring, partition studding, and ceiling joists. Shell houses are sold chiefly to customers who are handy with tools and who have time to do the interior wiring, plumbing, wall completion and finishing, and other work necessary to make the shell houses liveable dwellings.Barenboim buys shell houses from a manufacturer in unassembled packages consisting of all lumber, roofing, doors, windows and similar materials necessary to complete a shell house. Upon commencing operations in a new area, Barenboim buys or leases land as a site for its local warehouse, field office, and display houses. Sample display houses are erected at a total cost of \(30,000 to \)40,000 including the cost of the unassembled packages. The chief element of cost of display houses is the unassembled packages, in as much as erection is a short, low-cost operation. Old sample models are torn down or altered into new models every 3 to 7 years. Sample display houses have little salvage value because dismantling and moving costs amount to nearly as much as the cost of an unassembled package.Instructions

  1. A choice must be made between (1) expensing the costs of sample display houses in the periods in which the expenditure is made and (2) spreading the costs over more than one period. Discuss the advantages of each method.
  2. Would it be preferable to amortize the cost of display houses on the basis of (1) the passage of time or (2) the number of shell houses sold? Explain.

Question: Describe the major constraint inherent in the presentation of accounting information.
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