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Chapter 2: Question 9Q (page 61)

Why is it necessary to develop a definitional framework for the basic elements of accounting?

Short Answer

Expert verified

The primary objective is to provide clarity about the elements included in the accounting process, which is important for understanding the analytical concepts. It also aids in thedecision-making process of the firm.

Step by step solution

01

Definition of Definitional Framework

A definitional framework is a framework that provides a definite structure required to classify the basic elements to be included in the accounting. Three main definitional groups comprise the basics of accounting, such as assets, liabilities, and shareholder’s or owner’s equity.

02

Importance of definitional framework in the context of accounting elements

The importance of a definitional framework in relation to accounting elements is that it provides financial information about the reporting organization that is beneficial to the present and potential equity investors, lenders, and other creditors in making decisions about supplying resources to the organization.

Therefore, the elements of financial statements are considered as building blocks; by the help of which the statements are built or created, it is important to develop a basic definitional framework for them.

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Most popular questions from this chapter

Question: (Qualitative Characteristics) Recently, your uncle, Carlos Beltran, who knows that you always have your eye out for a profitable investment, has discussed the possibility of your purchasing some corporate bonds. He suggests that you may wish to get in on the “ground floor” of this deal. The bonds being issued by Neville Corp. are 10-year debentures which promise a 40% rate of return. Neville manufactures novelty/party items.

You have told Uncle Carlos that, unless you can take a look at Neville’s financial statements, you would not feel comfortable about such an investment. Believing that this is the chance of a lifetime, Uncle Carlos has procured a copy of Neville’s most recent, unaudited financial statements which are a year old. These statements were prepared by Mrs. Andy Neville. You peruse these statements, and they are quite impressive. The balance sheet showed a debt-to-equity ratio of 0.10 and, for the year shown, the company reported net income of $2,424,240.

The financial statements are not shown in comparison with amounts from other years. In addition, no significant note disclosures about inventory valuation, depreciation methods, loan agreements, etc. are available.

Instructions

Write a letter to Uncle Carlos explaining why it would be unwise to base an investment decision on the financial statements that he has provided to you. Be sure to explain why these financial statements are neither relevant nor representationally faithful.

What is the definition of fair value?

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.

The chairman of the company’s board of directors for which you are the chief accountant has told you that he has little use for accounting figures based on historical cost. He believes that replacement values are of far more significance to the board of directors than “out-of-date costs.” Present some arguments to convince him that accounting data should still be based on historical cost.

Mogilny Company paid \(135,000 for a machine. The Accumulated Depreciation- Equipment account has a balance of \)46,500 at the present time. The company could sell the machine today for $150,000. The company president believes that the company has a “right to this gain.” What does the president mean by this statement? Do you agree?
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