Chapter 2: Question 19Q (page 61)
Explain the revenue recognition principle.
The revenue recognition principle under generally accepted accounting principles provides guidance that a firm should recognize revenue when it is realized or realizable and when it is earned.
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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.
Match the qualitative characteristics below with the following statements.1. Timeliness 5. Faithful representation2. Completeness 6. Relevance3. Free from error 7. Neutrality4. Understandability 8. Confirmatory value
What is the basic accounting problem created by the monetary unit assumption when there is significant inflation? What appears to be the FASB position on a stable monetary unit?
Question: The issues that the FASB and IASB must address in developing a conceptual framework include all of the following except:
(a) should the characteristic of relevance be traded-off in favor of information that is verifiable?
(b) should a single measurement method such as historical cost be used?
(c) what are the key elements of asset and liability definitions?
(d) should the role of financial reporting focus on internal decision-making as well as providing information to assist users in decision-making?
What is the primary objective of financial reporting?
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