Decision makers vary widely in the types of decisions they make, how they make decisions, the information they already possess or can obtain from other sources, and their ability to process the information. For information to be useful, there must be a connection (linkage) between these users and the decisions they make. This link, understandability, is the quality of information that lets reasonably informed users see its significance.

For example, assume that IBM Corp. issues a three-months' report that shows interim earnings have declined significantly. This interim report provides relevant and reliable information for decision-making purposes. Now say that some users, upon reading the report, decide to sell their stock. Other users, however, do not understand the report's content and significance. They are surprised when IBM declares a smaller year-end dividend and the value of the stock declines. Thus, although IBM presented highly relevant and reliable information, it was useless to those who did not understand it.

Relevance and reliability are the two primary qualities that make accounting information useful for decision making. As stated in FASB Concepts Statement No. 2, "the qualities that distinguish 'better' (more useful) information from 'inferior' (less useful) information are primarily the qualities of relevance and reliability, with some other characteristics that those qualities imply."^[17]

Relevance. To be relevant, accounting information must be capable of making a difference in a decision.^[18] Information with no bearing on a decision is irrelevant. Relevant information helps users predict the ultimate outcome of past, present, and future events. That is, it has predictive value. Relevant information also helps users confirm or correct prior expectations; it has feedback value. For example, when UPS (United Parcel Service) issues an interim report, the information in it is relevant because it provides both a basis for forecasting annual earnings and feedback on past performance.

Finally, relevant information is available to decision makers before it loses its capacity to influence their decisions. It has timeliness. If UPS waited to report its interim results until six months after the end of the period, the information would be much less useful for decision-making purposes. For information to be relevant, it needs predictive or feedback value, presented on a timely basis.

Reliability. Accounting information is reliable to the extent that it is verifiable, is a faithful representation, and is reasonably free of error and bias. Reliability is a necessity, because most users have neither the time nor the expertise to evaluate the factual content of the information.

International Insight

In the proposed converged conceptual framework, reliability will be replaced with "faithful representation" as one of the primary qualitative characteristics that must be present for information to be useful. Faithful representation is attained when the substance of an economic phenomenon is depicted completely, accurately, and neutrally.

Verifiability occurs when independent measurers, using the same methods, obtain similar results. For example, would several independent auditors reach the same conclusion about a set of financial statements? If not, then the statements are not verifiable. Auditors could not render an opinion on such statements.

Representational faithfulness means that the numbers and descriptions match what really existed or happened. If General Motors' income statement reports sales of $225 billion when it had sales of $193.5 billion, then the statement fails to faithfully represent the proper sales amount.

Neutrality means that a company cannot select information to favor one set of interested parties over another. Unbiased information must be the overriding consideration. For example, in the notes to financial statements, tobacco companies such as R. J. Reynolds should not suppress information about the numerous lawsuits that have been filed because of tobacco-related health concerns—even though such disclosure is damaging to the company.

Neutrality in rule-making has come under increasing attack. Some argue that the FASB should not issue pronouncements that cause undesirable economic effects on an industry or company. We disagree. GAAP must be free from bias, or we will no longer have credible financial statements. Without credible financial statements, individuals will no longer use this information. An analogy demonstrates the point: In the United States, many individuals bet on boxing matches because such contests are assumed not to be fixed. But nobody bets on wrestling matches. Why? Because the public assumes that wrestling matches are rigged. If financial information is biased (rigged), the public will lose confidence and no longer use it.

Information about a company is more useful if decision makers can compare it with similar information about another company and with similar information about the same company at other points in time. The first of these qualities is comparability, and the second is consistency.

Comparability. Information that is measured and reported in a similar manner for different companies is considered comparable. Comparability enables users to identify the real similarities and differences in economic events between companies.

International Insight

Japan is considering adopting iGAAP, which would move the accounting for pensions more in line with U.S. GAAP.

For example, historically the accounting for pensions in the United States differs from that in Japan. U.S. companies record pension cost as incurred. In Japan, companies generally recorded little or no charge to income for these costs. As a result, it is difficult to compare and evaluate the financial results of General Motors or Ford to Japanese competitors. Also, resource allocation decisions involve evaluating alternatives. A valid evaluation can be made only if comparable information is available.

Consistency. When a company applies the same accounting treatment to similar events, from period to period, the company shows consistent use of accounting standards. The idea of consistency does not mean, however, that companies cannot switch from one accounting method to another. A company can change methods, but it must first demonstrate that the newly adopted method is preferable to the old. If approved, the company must then disclose the nature and effect of the accounting change, as well as the justification for it, in the financial statements for the period in which it made the change.^[19] When a change in accounting principles occurs, the auditor refers to it in an explanatory paragraph of the audit report. This paragraph identifies the nature of the change and refers the reader to the note in the financial statements that discusses the change in detail.^[20]

The economic entity assumption means that economic activity can be identified with a particular unit of accountability. In other words, a company keeps its activity separate and distinct from its owners and any other business unit. At the most basic level, the economic entity assumption dictates that Panera Bread Company record the company's financial activities separate from those of its owners and managers. Equally important, financial statement users need to be able to distinguish the activities and elements of different companies, such as General Motors, Ford, and Chrysler. If users could not distinguish the activities of different companies, how would they know which company financially outperformed the other?

International Insight

Phase D of the conceptual framework convergence project addresses the reporting entity. An exposure draft is expected sometime in 2009.

The entity concept does not apply solely to the segregation of activities among competing companies, such as Best Buy and Circuit City. An individual, department, division, or an entire industry could be considered a separate entity if we choose to define it in this manner. Thus, the entity concept does not necessarily refer to a legal entity. A parent and its subsidiaries are separate legal entities, but merging their activities for accounting and reporting purposes does not violate the economic entity assumption.^[22]

Most accounting methods rely on the going concern assumption—that the company will have a long life. Despite numerous business failures, most companies have a fairly high continuance rate. As a rule, we expect companies to last long enough to fulfill their objectives and commitments.

This assumption has significant implications. The historical cost principle would be of limited usefulness if we assume eventual liquidation. Under a liquidation approach, for example, a company would better state asset values at net realizable value (sales price less costs of disposal) than at acquisition cost. Depreciation and amortization policies are justifiable and appropriate only if we assume some permanence to the company. If a company adopts the liquidation approach, the current/non-current classification of assets and liabilities loses much of its significance. Labeling anything a fixed or long-term asset would be difficult to justify. Indeed, listing liabilities on the basis of priority in liquidation would be more reasonable.

The going concern assumption applies in most business situations. Only where liquidation appears imminent is the assumption inapplicable. In these cases a total revaluation of assets and liabilities can provide information that closely approximates the company's net realizable value. You will learn more about accounting problems related to a company in liquidation in advanced accounting courses.

The monetary unit assumption means that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis. That is, the monetary unit is the most effective means of expressing to interested parties changes in capital and exchanges of goods and services. The monetary unit is relevant, simple, universally available, understandable, and useful. Application of this assumption depends on the even more basic assumption that quantitative data are useful in communicating economic information and in making rational economic decisions.

International Insight

Due to their experiences with persistent inflation, several South American countries produce "constant-currency" financial reports. Typically, companies in these countries use a general price-level index to adjust for the effects of inflation.

In the United States, accounting ignores price-level changes (inflation and deflation) and assumes that the unit of measure—the dollar—remains reasonably stable. We therefore use the monetary unit assumption to justify adding 1980 dollars to 2010 dollars without any adjustment. The FASB in SFAC No. 5 indicated that it expects the dollar, unadjusted for inflation or deflation, to continue to be used to measure items recognized in financial statements. Only if circumstances change dramatically (such as if the United States experiences high inflation similar to that in many South American countries) will the FASB again consider "inflation accounting."

To measure the results of a company's activity accurately, we would need to wait until it liquidates. Decision makers, however, cannot wait that long for such information. Users need to know a company's performance and economic status on a timely basis so that they can evaluate and compare firms, and take appropriate actions. Therefore, companies must report information periodically.

The periodicity (or time period) assumption implies that a company can divide its economic activities into artificial time periods. These time periods vary, but the most common are monthly, quarterly, and yearly.

The shorter the time period, the more difficult it is to determine the proper net income for the period. A month's results usually prove less reliable than a quarter's results, and a quarter's results are likely to be less reliable than a year's results. Investors desire and demand that a company quickly process and disseminate information. Yet the quicker a company releases the information, the more likely the information will include errors. This phenomenon provides an interesting example of the trade-off between relevance and reliability in preparing financial data.

The problem of defining the time period becomes more serious as product cycles shorten and products become obsolete more quickly. Many believe that, given technology advances, companies need to provide more online, real-time financial information to ensure the availability of relevant information.

We presently have a "mixed-attribute" system that permits the use of various measurement bases. The most commonly used measurements are based on historical cost and fair value. Here, we discuss each.

Historical Cost. GAAP requires that companies account for and report many assets and liabilities on the basis of acquisition price. This is often referred to as the historical cost principle. Historical cost has an important advantage over other valuations: It is generally thought to be reliable.

To illustrate this advantage, consider the problems if companies select current selling price instead. Companies might have difficulty establishing a value for unsold items. Every member of the accounting department might value the assets differently. Further, how often would it be necessary to establish sales value? All companies close their accounts at least annually. But some compute their net income every month. Those companies would have to place a sales value on every asset each time they wished to determine income. Critics raise similar objections against current cost (replacement cost, present value of future cash flows) and any other basis of valuation except historical cost.

What about liabilities? Do companies account for them on a cost basis? Yes, they do. Companies issue liabilities, such as bonds, notes, and accounts payable, in exchange for assets (or services), for an agreed-upon price. This price, established by the exchange transaction, is the "cost" of the liability. A company uses this amount to record the liability in the accounts and report it in financial statements. Thus, many users prefer historical cost because it provides them with a verifiable benchmark for measuring historical trends.

Fair Value. 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. [1] Recently GAAP has increasingly called for use of fair value measurements in the financial statements. This is often referred to as the fair value principle. Fair value information may be more useful than historical cost for certain types of assets and liabilities and in certain industries. For example, companies report many financial instruments, including derivatives, at fair value. Certain industries, such as brokerage houses and mutual funds, prepare their basic financial statements on a fair value basis.

At initial acquisition, historical cost equals fair value. In subsequent periods, as market and economic conditions change, historical cost and fair value often diverge. Thus, fair value measures or estimates often provide more relevant information about the expected future cash flows related to the asset or liability. For example, when long-lived assets decline in value, a fair value measure determines any impairment loss. The FASB believes that fair value information is more relevant to users than historical cost. Fair value measurement, it is argued, provides better insight into the value of a company's asset and liabilities (its financial position) and a better basis for assessing future cash flow prospects.

Recently the Board has taken the additional step of giving 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. [2] The Board considers fair value more relevant than historical cost 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.

Use of fair value in financial reporting is increasing. However, measurement based on fair value introduces increased subjectivity into accounting reports, when fair value information is not readily available. To increase consistency and comparability in fair value measures, the FASB established a fair value hierarchy that provides insight into the priority of valuation techniques to use to determine fair value. As shown in Illustration 2-3, the fair value hierarchy is divided into three broad levels.

Figure 2-3. Fair Value Hierarchy

As Illustration 2-3 indicates, 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 measurement.^[23]

It is easy to arrive at fair values when markets are liquid with many traders, but fair value answers are not readily available in other situations. For example, how do you value the mortgage assets of subprime lenders, like Countrywide and New Century, given that the market for these securities has essentially disappeared? A great deal of expertise and sound judgment will be needed to arrive at appropriate answers. GAAP also provides guidance on estimating fair values when market-related data is not available. In general, these valuation issues relate to Level 3 fair value measurements. These measurements may be developed using expected cash flow and present value techniques, as described in Statement of Financial Accounting Concepts No. 7, "Using Cash Flow Information and Present Value in Accounting," discussed in Chapter 6.

As indicated above, we presently have a "mixed-attribute" system that permits the use of historical cost and fair value. Although the historical cost principle continues to be an important basis for valuation, recording and reporting of fair value information is increasing. The recent measurement and disclosure guidance should increase consistency and comparability when fair value measurements are used in the financial statements and related notes.

A crucial question for many companies is when to recognize revenue. Revenue recognition generally occurs (1) when realized or realizable and (2) when earned. This approach has often been referred to as the revenue recognition principle.

A company realizes revenues when it exchanges products (goods or services), merchandise, or other assets for cash or claims to cash. Revenues are realizable when assets received or held are readily convertible into cash or claims to cash. Assets are readily convertible when they are salable or interchangeable in an active market at readily determinable prices without significant additional cost.

In addition to the first test (realized or realizable), a company delays recognition of revenues until earned. Revenues are considered earned when the company substantially accomplishes what it must do to be entitled to the benefits represented by the revenues.^[24] Generally, an objective test, such as a sale, indicates the point at which a company recognizes revenue. The sale provides an objective and verifiable measure of revenue—the sales price. Any basis for revenue recognition short of actual sale opens the door to wide variations in practice. Recognition at the time of sale provides a uniform and reasonable test.

However, as Illustration 2-4 shows, exceptions to the rule exist. We discuss these exceptions in the following sections.

Figure 2-4. Timing of Revenue Recognition

During Production. A company can recognize revenue before it completes the job in certain long-term construction contracts. In this method, a company recognizes revenue periodically, based on the percentage of the job it has completed. Although technically a transfer of ownership has not occurred, the earning process is considered substantially completed at various stages of construction. If it is not possible to obtain dependable estimates of cost and progress, then a company delays revenue recognition until it completes the job.

At End of Production. At times, a company may recognize revenue after completion of the production cycle but before the sale takes place. This occurs if products or other assets are salable in an active market at readily determinable prices without significant additional cost. An example is the mining of certain minerals. Once a company mines the mineral, a ready market at a quoted price exists. The same holds true for some agricultural products.

Upon Receipt of Cash. Receipt of cash is another basis for revenue recognition. Companies use the cash-basis approach only when collection is uncertain at the time of sale.

One form of the cash basis is the installment-sales method. Here, a company requires payment in periodic installments over a long period of time. Its most common use is in retail, such as for farm and home equipment and furnishings. Companies frequently justify the installment-sales method based on the high risk of not collecting an account receivable. In some instances, this reasoning may be valid. Generally, though, if a sale has been completed, the company should recognize the sale; if bad debts are expected, the company should record them as separate estimates.

To summarize, a company records revenue in the period when realized or realizable and when earned. Normally, this is the date of sale. But circumstances may dictate application of the percentage-of-completion approach, the end-of-production approach, or the receipt-of-cash approach.

As indicated in the discussion of financial statement elements, expenses are defined as outflows or other "using up" of assets or incurring of liabilities (or a combination of both) during a period as a result of delivering or producing goods and/or rendering services. It follows then that recognition of expenses is related to net changes in assets and earning revenues. In practice, the approach for recognizing expenses is, "Let the expense follow the revenues." This approach is the expense recognition principle.

To illustrate, companies recognize expenses not when they pay wages or make a product, but when the work (service) or the product actually contributes to revenue. Thus, companies tie expense recognition to revenue recognition. That is, by matching efforts (expenses) with accomplishment (revenues), the expense recognition principle is implemented in accordance with the definition of expense (outflows or other using up of assets or incurring of liabilities).^[25]

Some costs, however, are difficult to associate with revenue. As a result, some other approach must be developed. Often, companies use a "rational and systematic" allocation policy that will approximate the expense recognition principle. This type of expense recognition involves assumptions about the benefits that a company receives as well as the cost associated with those benefits. For example, a company like Intel or Motorola allocates the cost of a long-lived asset over all of the accounting periods during which it uses the asset because the asset contributes to the generation of revenue throughout its useful life.

Companies charge some costs to the current period as expenses (or losses) simply because they cannot determine a connection with revenue. Examples of these types of costs are officers' salaries and other administrative expenses.

Costs are generally classified into two groups: product costs and period costs. Product costs, such as material, labor, and overhead, attach to the product. Companies carry these costs into future periods if they recognize the revenue from the product in subsequent periods. Period costs, such as officers' salaries and other administrative expenses, attach to the period. Companies charge off such costs in the immediate period, even though benefits associated with these costs may occur in the future. Why? Because companies cannot determine a direct relationship between period costs and revenue. Illustration 2-5 summarizes these expense recognition procedures.

Figure 2-5. Expense Recognition

In deciding what information to report, companies follow the general practice of providing information that is of sufficient importance to influence the judgment and decisions of an informed user. Often referred to as the full disclosure principle, it recognizes that the nature and amount of information included in financial reports reflects a series of judgmental trade-offs. These trade-offs strive for (1) sufficient detail to disclose matters that make a difference to users, yet (2) sufficient condensation to make the information understandable, keeping in mind costs of preparing and using it.

Users find information about financial position, income, cash flows, and investments in one of three places: (1) within the main body of financial statements, (2) in the notes to those statements, or (3) as supplementary information.

As discussed in Chapter 1, the financial statements are the balance sheet, income statement, statement of cash flows, and statement of owners' equity. They are a structured means of communicating financial information. To be recognized in the main body of financial statements, an item should meet the definition of a basic element, be measurable with sufficient certainty, and be relevant and reliable.^[26]

Disclosure is not a substitute for proper accounting. As a former chief accountant of the SEC noted, "Good disclosure does not cure bad accounting any more than an adjective or adverb can be used without, or in place of, a noun or verb." Thus, for example, cash-basis accounting for cost of goods sold is misleading, even if a company discloses accrual-basis amounts in the notes to the financial statements.

The notes to financial statements generally amplify or explain the items presented in the main body of the statements. If the main body of the financial statements gives an incomplete picture of the performance and position of the company, the notes should provide the additional information needed. Information in the notes does not have to be quantifiable, nor does it need to qualify as an element. Notes can be partially or totally narrative. Examples of notes include descriptions of the accounting policies and methods used in measuring the elements reported in the statements, explanations of uncertainties and contingencies, and statistics and details too voluminous for inclusion in the statements. The notes can be essential to understanding the company's performance and position.

Supplementary information may include details or amounts that present a different perspective from that adopted in the financial statements. It may be quantifiable information that is high in relevance but low in reliability. For example, oil and gas companies typically provide information on proven reserves as well as the related discounted cash flows.

Supplementary information may also include management's explanation of the financial information and its discussion of the significance of that information. For example, many business combinations have produced financing arrangements that demand new accounting and reporting practices and principles. In each of these situations, the same problem must be faced: making sure the company presents enough information to ensure that the reasonably prudent investor will not be misled.

We discuss the content, arrangement, and display of financial statements, along with other facets of full disclosure, in Chapters 4, 5, and 24.

Too often, users assume that information is free. But preparers and providers of accounting information know that it is not. Therefore, companies must consider the cost-benefit relationship: They must weigh the costs of providing the information against the benefits that can be derived from using it. Rule-making bodies and governmental agencies use cost-benefit analysis before making final their informational requirements. In order to justify requiring a particular measurement or disclosure, the benefits perceived to be derived from it must exceed the costs perceived to be associated with it.

A corporate executive made the following remark to the FASB about a proposed rule: "In all my years in the financial arena, I have never seen such an absolutely ridiculous proposal. ... To dignify these 'actuarial' estimates by recording them as assets and liabilities would be virtually unthinkable except for the fact that the FASB has done equally stupid things in the past. ... For God's sake, use common sense just this once."^[27] Although extreme, this remark indicates the frustration expressed by members of the business community about rule-making, and whether the benefits of a given pronouncement exceed the costs.

The difficulty in cost-benefit analysis is that the costs and especially the benefits are not always evident or measurable. The costs are of several kinds: costs of collecting and processing, of disseminating, of auditing, of potential litigation, of disclosure to competitors, and of analysis and interpretation. Benefits to preparers may include greater management control and access to capital at a lower cost. Users may receive better information for allocation of resources, tax assessment, and rate regulation. As noted earlier, benefits are generally more difficult to quantify than are costs.

The recent implementation of the provisions of the Sarbanes-Oxley Act of 2002 illustrates the challenges in assessing costs and benefits of standards. One study estimated the increased costs of complying with the new internal-control standards related to the financial reporting process to be an average of $7.8 million per company. However, the study concluded that "... quantifying the benefits of improved more reliable financial reporting is not fully possible."^[28]

Despite the difficulty in assessing the costs and benefits of its rules, the FASB attempts to determine that each proposed pronouncement will fill a significant need and that the costs imposed to meet the rule are justified in relation to overall benefits of the resulting information. In addition, the Board seeks input on costs and benefits as part of its due process.^[29]

The materiality constraint concerns an item's impact on a company's overall financial operations. An item is material if its inclusion or omission would influence or change the judgment of a reasonable person.^[30] It is immaterial, and therefore irrelevant, if it would have no impact on a decision maker. In short, it must make a difference or a company need not disclose it.

The point involved here is of relative size and importance. If the amount involved is significant when compared with the other revenues and expenses, assets and liabilities, or net income of the company, sound and acceptable standards should be followed in reporting it. If the amount is so small that it is unimportant when compared with other items, applying a particular standard may be considered of less importance.

It is difficult to provide firm guidelines in judging when a given item is or is not material. Materiality varies both with relative amount and with relative importance. For example, the two sets of numbers in Illustration 2-6 indicate relative size.

Figure 2-6. Materiality Comparison

During the period in question, the revenues and expenses, and therefore the net incomes of Company A and Company B, are proportional. Each reported an unusual gain. In looking at the abbreviated income figures for Company A, it appears insignificant whether the amount of the unusual gain is set out separately or merged with the regular operating income. The gain is only 2 percent of the net income. If merged, it would not seriously distort the net income figure. Company B has had an unusual gain of only $5,000. However, it is relatively much more significant than the larger gain realized by A. For Company B, an item of $5,000 amounts to 50 percent of its income from operations. Obviously, the inclusion of such an item in ordinary operating income would affect the amount of that income materially. Thus we see the importance of the relative size of an item in determining its materiality.

Companies and their auditors generally adopt the rule of thumb that anything under 5 percent of net income is considered immaterial. However, the SEC indicates that a company may use this percentage for an initial assessment of materiality, but it must also consider other factors.^[31] For example, companies can no longer fail to record items in order to meet consensus analysts' 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, companies must consider both quantitative and qualitative factors in determining whether an item is material.

The SEC also indicated that in determining materiality, companies must consider each misstatement separately and the aggregate effect of all misstatements. For example, at one time, General Dynamics disclosed that its Resources Group improved its earnings by $5.8 million. At the same time, it disclosed that one of its other subsidiaries had taken write-offs of $6.7 million. Although both numbers exceeded the $2.5 million that General Dynamics as a whole earned for the year, the company disclosed neither as unusual because it considered the net effect on earnings as immaterial. This practice is prohibited because each item must be considered separately. In addition, even though an individual item may be immaterial, it may be considered material when added to other immaterial items. Companies must disclose such items.

Materiality factors in a great many internal accounting decisions, too. Examples of such judgments that companies must make include: the amount of classification required in a subsidiary expense ledger, the degree of accuracy required in prorating expenses among the departments of a company, and the extent to which adjustments should be made for accrued and deferred items. Only by the exercise of good judgment and professional expertise can reasonable and appropriate answers be found, which is the materiality constraint sensibly applied.

Another practical consideration is industry practices. The peculiar nature of some industries and business concerns sometimes requires departure from basic theory. For example, public-utility companies report noncurrent assets first on the balance sheet to highlight the industry's capital-intensive nature. Agricultural companies often report crops at fair value because it is costly to develop accurate cost figures on individual crops.

Such variations from basic theory are infrequent, yet they do exist. Whenever we find what appears to be a violation of basic accounting theory, we should determine whether some peculiarity of the industry explains the violation before we criticize the procedures followed.

Few conventions in accounting are as misunderstood as the constraint of conservatism. Conservatism means when in doubt, choose the solution that will be least likely to overstate assets and income. Note that the conservatism convention does not urge that net assets or net income be understated. Unfortunately, some interpret conservatism to mean just that.

All that conservatism does, properly applied, is provide a reasonable guide in difficult situations: Refrain from overstatement of net income and net assets. Examples of conservatism in accounting are the use of the lower-of-cost-or-market approach in valuing inventories, and the rule that companies recognize accrued net losses on firm purchase commitments for goods for inventory. When in doubt, it is better to understate than overstate net income and net assets. Of course, if no doubt exists, there is no need to apply this constraint.

As discussed in Chapter 1, the International Accounting Standards Board (IASB) develops accounting standards for many international companies. The IASB also has developed a conceptual framework to help guide the setting of accounting standards. Following is an Overview of the IASB Framework.

Instructions

Identify at least three similarities and at least three differences between the FASB and IASB conceptual frameworks as revealed in the above Overview.

Your aunt recently received the annual report for a company in which she has invested. The report notes that the statements have been prepared in accordance with "generally accepted accounting principles." She has also heard that certain terms have special meanings in accounting relative to everyday use. She would like you to explain the meaning of terms she has come across related to accounting.

Instructions

Access the FASB Statements of Financial Accounting Concepts at the FASB website (http://www.fasb.org) and respond to the following items. (Provide paragraph citations.) When you have accessed the documents, you can search them using the search tool in your Internet browser.

Go to the book's companion website, at www.wiley.com/college/kieso, to find an interactive problem that simulates the computerized CPA exam. The professional simulation for this chapter asks you to address questions related to the FASB's conceptual framework.