Chapter 3

The Accounting Framework

learning OBJECTIVES
LO 1 Describe the users of accounting information LO 5 
Identify the key financial statement foundations
LO 2 Describe the fields of accounting LO 6 
Illustrate the similarities and differences between
ASPE and IFRS
LO 3 
Compare the different forms of business
organization LO 7 Explain the importance of ethics in accounting
LO 4 
Identify the objective and qualitative
characteristics of financial information

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Assessment Questions

AS-1 LO 1

What is an internal user? What do internal users use financial information for?
Internal users are people who own the business and/or work in the business. Internal users use financial
information to enable them to manage the business efficiently.

AS-2 LO 1

What is an external user? What do external users use financial information for?
External users are people or organizations that are outside the business. External users use financial information
to ensure that their investments in the business are protected.

AS-3 LO 2

Briefly define financial accounting.

Financial accounting is concerned with keeping records of the business and preparing the financial statements
for external users.

AS-4 LO 2

Briefly define managerial accounting.

Managerial accounting serves the internal users of the business by preparing specialized reports to assist in
management decision-making.

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AS-5 LO 3

What is a sole proprietorship? What is the title of a sole proprietorship’s equity section?
A sole proprietorship is a business that is owned and generally operated by a single owner. A sole
proprietorship’s equity section is called “owner’s equity.”

AS-6 LO 3

Explain the concept of unlimited liability.

Unlimited liability means that an owner is personally liable for the activities of the business. If the business is
unable to pay its debts, creditors of the business can force the owner to sell his or her personal assets to pay off
the debts of the business.

AS-7 LO 3

What is a partnership?
A partnership is a business owned by two or more persons called partners.

AS-8 LO 3

What are the three types of partnerships that can be created?

The three types of partnerships that can be created are general partnership, limited partnership and limited
liability partnership (LLP).

AS-9 LO 3

What is the difference between a general partnership and a limited partnership?

A general partnership is a partnership in which all partners are subject to unlimited liability. In this situation, all
partners are considered to be general partners. A limited partnership includes at least one general partner who
accepts unlimited liability and one or more limited partners with liability limited to the amount they invested.

AS-10 LO 3

Describe a corporation.
A corporation is a business that is registered with the provincial or federal government and is a separate legal
entity from its owners, the shareholders. As a separate legal entity, the corporation has all the rights of a person
and is responsible for its own activities. It is responsible for its own debts.

AS-11 LO 3

What is a non-profit organization?

A non-profit organization is an organization whose profits may be paid out (redistributed) to the community
by providing services.

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AS-12 LO 3

Provide four examples of non-profit organizations.

Non-profit organizations include religious organizations, community care centres, charitable organizations and
hospitals.

AS-13 LO 4 6

Briefly define and explain GAAP. What are the two frameworks that have evolved from Canadian GAAP?
Generally Accepted Accounting Principles (GAAP) is a set of standards providing guidance on how to report
financial information. Canadian GAAP has evolved into ASPE (Accounting Standards for Private Enterprises) and
IFRS (International Financial Reporting Standards).

AS-14 LO 4

What are the qualitative characteristics of effective and useful financial information?
The main qualitative characteristics are relevance, faithful representation, verifiability, comparability, timeliness
and understandability.

AS-15 LO 4

Describe the characteristic of relevance.

Relevance means that all information useful for decision-making is present in the financial statements. In other
words, if a piece of relevant information is omitted or misstated, the user’s interpretation of the statement would
change.

AS-16 LO 4

Describe the characteristic of timeliness.

Information is timely if there is no delay in the reporting of crucial information.

AS-17 LO 4

Describe the characteristic of faithful representation.

Faithful representation means that information is free from material error and bias. Financial information must
be meaningful and complete, reporting the activities of an organization as accurately as possible.

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AS-18 LO 4

Describe the characteristic of verifiability.

Information is verifiable if it is based on objective evidence (i.e. there are documents to back up the reported
information).

AS-19 LO 4

Describe the characteristic of understandability.

Understandability means that the financial information can be reasonably understood by its users if they have a
basic knowledge of the business and of accounting.

AS-20 LO 4

What is neutrality? Neutrality is a component of which characteristic?

Neutrality states that financial information must report the activities of a business as accurately as possible and
be free from bias. Neutrality is a component of faithful representation.

AS-21 LO 4

Describe the characteristic of comparability.

Comparability means the financial statements of a company must be prepared in a similar way year after year.
This allows for a comparison of the current year’s performance to past years.

AS-22 LO 4

Describe what is meant by consistency in financial reporting.

Consistency prevents businesses from changing accounting methods for the sole purpose of manipulating
figures on the financial statements. Consistency falls under the qualitative characteristic of comparability.

AS-23 LO 4

Describe what is meant by materiality in financial reporting.

A piece of information is considered material if it could influence or change a user’s decision. The level of
materiality is entity specific, and organizations need to ensure material amounts are correctly recorded on the
financial statements.

AS-24 LO 5

Describe the business entity assumption.

The business entity assumption states that the accounting records for a business must be kept separate from
those of the owner(s).

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AS-25 LO 5

Explain what the basis of accounting means.

The basis of accounting refers to the method used to determine when items, transactions and events should be
recognized. The two types are accrual-based and cash-based. Businesses should use accrual-based accounting.

AS-26 LO 5

Describe what is meant by the term “going concern” in financial reporting.

Going concern assumes that a business will continue to operate into the foreseeable future.

AS-27 LO 5

Describe the monetary unit assumption.

The monetary unit assumption requires that the accounting records are expressed in terms of a single currency.

AS-28 LO 5

Describe what is meant by measurement in financial reporting.

Measurement is the process of determining the amount at which an item is recorded in the financial statements.
Primarily, items must be recorded at their historical cost. Measurement and recognition are two important
aspects of financial reporting.

AS-29 LO 5

Describe the revenue recognition process in financial reporting.

Revenue recognition states that revenue can only be recorded when certain criteria have been met. The
ownership of the good or service must have been transferred to the buyer. The buyer must have agreed to pay,
or have already paid, a specified price for the good or service.

AS-30 LO 5

Describe the expense recognition process in financial reporting.

Expense recognition states that, when possible, expenses must be recorded in the same accounting period in
which they were used to produce revenue.

AS-31 LO 5

Describe what is meant by disclosure in financial reporting.

Disclosure states that any and all information that affects the full understanding of a company’s financial
statements must be included with the financial statements or in the notes to the financial statements.

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AS-32 LO 6

What is ASPE and which forms of organization can adhere to it?

ASPE stands for Accounting Standards for Private Enterprises. It is a set of accounting standards available to sole
proprietorships, partnerships and private corporations.

AS-33 LO 6

What is IFRS and which forms of organization can adhere to it?

IFRS stands for International Financial Reporting Standards. It is a set of accounting standards that allows for
better comparison of companies across countries. Public corporations must adhere to IFRS, but any organization
may choose to adhere to IFRS.

AS-34 LO 7

List two ethical standards for accountants.

Answers may vary.
1. Acting with trustworthiness, integrity and objectivity.
2. Adhering to acknowledged principles and standards of professional practice.

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Application Questions Group A

AP-1A LO 3

Match each form of an organization with the appropriate description.

A Sole Proprietorship
B Partnership
C Corporation
D Non-Profit Organization

D This type of organization usually does not have an identifiable owner.

B There are two types: one that limits the liability of the owners and one
that does not.
A This type of business is operated by a single owner.
C This type of business often elects a board of directors.

AP-2A LO 4

Match each of the following financial statement reporting terms to the appropriate description in the table below.

• Benefit versus cost

• Prudence
• Substance over form
• Freedom from material error
• Neutrality

Term (fill in) Description

Neutrality Concept that financial information is free from bias
Benefit versus cost Cost of providing perfect financial information should not exceed benefit to the users
Freedom from material error Financial information is free from intentional omissions
Prudence Exercising professional judgment
Substance over form Reporting an accurate economic representation of transactions or events

AP-3A LO 4

Identify the qualitative characteristic(s) of financial information violated in each of the following scenarios.

a) Thorn Company has reported several gains for the period but has not provided any explanation or proof of how they
occurred.
Faithful representation, verifiability

b) Due to recent layoffs, Monte Carlo Ltd. was not able to complete and issue its 2018 financial statements and
accompanying notes. The information was instead included with the 2019 financial report in the following year.
Relevance, timeliness

c) To value inventory, Toland and Sons uses a different accounting policy from the rest of the companies in the same
industry. There is no justification for the use of this accounting policy in the notes to the financial statements.
Comparability

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d) Eris Laboratories used many uncommon medical terms and scientific language in the notes to the financial
statements. This language was not explained anywhere else.
Understandability

e) A bank decided not to grant a loan to Mida Ltd. after a customer filed a substantial lawsuit. Mida Ltd. did not include
any mention of the lawsuit in the financial statements or in the notes to the financial statements.
Relevance

AP-4A LO 4 5

Identify the financial statement qualitative characteristic or foundation that has been violated in each of the following
scenarios.

a) Bill Co. purchased a two-year insurance policy and expensed the entire amount in period of purchase.
Expense recognition

b) Charlie Co. listed inventory at its market value of $31,000 on the balance sheet, even though it was purchased for
$20,000.
Measurement

c) Percy Co. did not include the details of its property, plant and equipment, even though this information is relevant to
the users.
Disclosure

d) Fred Co. made a sale on the last day of the accounting period. The customer paid for the item in the following month,
so this sale was included in the next period’s financial statements.
Revenue recognition

e) George Co. has plans to restructure its operations next year and will sell off about half of the business. This
information was not included in the notes to the financial statements because it does not affect the current financial
information.
Disclosure, relevance

f) Ron Co. applied a certain accounting policy that allowed the company to report higher assets and net income. A
different accounting policy was available that would have resulted in a lower balance of assets and net income.
Faithful representation

g) Ginny Co. changed the accounting policy used to value property, plant, and equipment after using a different policy
for 10 years. There was no justification for the change.
Comparability (consistency)

AP-5A LO 4

Sood Supplies is in the business of selling electronic components to computer manufacturers. Sood Supplies’ financial
statements are issued on an annual basis for a large number of users, such as investors and the bank. The financial
reporting of the company is based on ASPE.

Prior to the issuance of the current year’s financial statements, the head of engineering and the accounting manager had
a discussion regarding the amount of warranty expense that should be recognized for the year. The head of engineering
believes that only 2% of sales needs to be calculated as a provision for the warranty expense, while the accounting
manager believes that 6% of sales should be recorded as an expense. The accounting manager argues that the 6% is
estimated based on historical trends of the company and the industry; however, the engineering department claims
that its new method of quality assurance will reduce the future warranty expenses. The engineering department could

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not submit any documents to support the claim. Eventually, the accounting manager decides to trust the engineering
department and uses the 2% calculation.

Do you believe any of the qualitative characteristics of financial accounting or related considerations have been violated
by Sood Supplies? Explain.

Timeliness is violated, as Sood Supplies prepares financial statements only on an annual basis. The company has a large
number of shareholders that would benefit from more timely financial statements (e.g. quarterly).
A related consideration, prudence, is violated. Prudence involves exercising caution when making estimates and not
overstating revenues and assets or understating expenses and liabilities. If estimates are required in financial statement
reporting, choosing the estimate that results in a lower balance of assets or lower net income should be chosen. In this
scenario, the accountant should have chosen the more prudent approach of estimating the warranty expense for the
year—which was 6%—resulting in lower income, as opposed to the income calculated with only 2% warranty expense.
Further, there doesn’t seem to be any justification for the engineering department reducing the warranty expense
estimate from 6% to 2%.

AP-6A LO 4 5 6

Hawkton Publishing Corporation is a publisher of math textbooks. The company is a large, well-known publicly traded
corporation with thousands of shareholders. It produces financial statements on an annual basis. The most recent financial
statements (for the year ended December 31, 2019) showed comparative balances for 2019 and 2018. The 2019 balances
were derived using accrual-based accounting whereas the 2018 balances were derived using cash-based accounting.
Which characteristic(s) of information did Hawkton fail to represent? Explain.
Hawkton did not achieve the characteristic of timeliness. This is because its financial
statements are produced only on an annual basis. For a well-known corporation with thousands of shareholders,
it would be beneficial to produce financial statements more frequently (such as quarterly).
Hawkton also failed to achieve comparability because cash-based accounting was used for 2018 and accrual-
based accounting was used for 2019. There is inconsistency in the financial information between the two years.
As a more serious violation, cash-based accounting does not comply with IFRS. It violates the processes of
revenue and expense recognition.

AP-7A LO 4 6

Suppose that a company has changed its policy for depreciation from one year to the next. An employee in the
accounting department addressed this change with the owner. The employee asked the owner why the accounting
policy was changed and why the reasoning for the change was not disclosed in the financial statements. The owner
replied, “IFRS gives you the option to use a different depreciation method from one year to the next. We also are not
required to explain our choices.” Is the owner correct in his reasoning? Explain.
The owner is wrong. The qualitative characteristic of comparability (consistency) prevents people from changing
accounting methods for the sole purpose of manipulating figures. The depreciation method should be the
same each year, unless the company can provide a valid reason for the change. This company did not do this.
The readers of financial statements have the right to assume that consistency has been applied if there is no
statement to the contrary. The company did not incorporate this requirement to provide consistency in its
financial statement reporting, thereby impacting the usefulness of the statements to the users.

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AP-8A LO 5

Match each of the following financial statement foundations to the appropriate description in the table below.
• Business entity assumption
• Going concern
• Monetary unit assumption
• Revenue recognition
• Measurement

Term (fill in) Description

Revenue recognition Sales must be recorded when ownership of a good transfers from the seller to the buyer
Going concern Assumes that a business will continue to operate into the foreseeable future
Monetary unit assumption Financial reports should be expressed in a single currency
Business entity assumption Accounting for a business must be kept separate from the personal affairs of its owner or
any other business
Measurement Purchases must be recorded at their values on the date of purchase

AP-9A LO 5

Alton Floral is a new company that operates in the gardening industry. The owner of the company has decided not to hire
an accountant, rather maintain the financial records on his own. He has reported his employees as assets on the balance
sheet in an account called “Human Resources.” He has valued them at the present value of their future salaries on the
balance sheet. Also, the financial statements are not supported by notes explaining some of the figures.

Which of the basic financial statement foundations has Alton Floral violated? Explain.
Alton Floral has violated the requirement of disclosure because the financial statements do not contain notes to
explain the stated amounts.
Also, the monetary unit assumption has been violated because the employees are included as assets on the
balance sheet. A value cannot be easily assigned to the event of hiring an employee.

AP-10A LO 5 6

Heggy Company, a privately owned corporation, is producing cellphone accessories. It relies on ASPE to prepare its
financial statements. The company is doing well and is planning to expand its product line. Assume you are a newly hired
accountant reviewing Heggy’s financial statements.
You realize that the company recently purchased machinery for $700,000 as part of its expansion strategy. After a long
negotiation, Heggy’s purchasing department was able to negotiate the price well below the market value of $740,000.
The machinery has been recorded in Heggy’s books at $740,000.
Also, Heggy Company has paid $15,000 for the cost of the plant’s insurance for the upcoming year and expensed the
whole amount. Heggy believes that this expensing would be an effective cost-saving strategy in the long run, as it will
avoid the extra bookkeeping associated with updating the prepaid insurance account.
Has Heggy Company violated any of the financial statement foundations of ASPE? Explain.

The measurement process has been violated, as Heggy Company has recorded the machinery (i.e. property, plant
and equipment) at the market price. Measurement states that purchases must be recorded at their historical
cost. Therefore, Heggy Company should record the machinery at its original purchase price of $700,000 and not
what it is worth in the market.

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Expense recognition is also violated as the insurance amount of $15,000 has been recorded as an expense
instead of an asset. Expense recognition requires expenses to be recorded at the time they are incurred,
regardless of when the payment is made. Since the expense has not yet been incurred, it should be recorded as
prepaid insurance and be recognized as an asset at the time of purchase. As the insurance is “used up,” insurance
expense should be recorded (i.e. month by month).

AP-11A LO 5 6

Tasai Corporation is a Canadian manufacturer of wings for commercial aircrafts. Tasai is a large public company that is
famous for the unique design of its wings. You are appointed as its audit manager.
As you go through the financial statements you notice, on the income statement, that the company has set aside one
line item under revenue that shows an amount of 800,000 in Brazilian currency (reals). In the notes related to this item,
it is indicated that the company has completed a project in Brazil; due to the large amount of foreign exchange loss, the
company has decided to report the figure in reals. The accounting department thinks this practice is permitted under
IFRS as long as it is clearly explained in the notes.
You also note this year’s travel expense is significantly larger than last year’s. As part of the audit procedures, you examine
travel documents and invoices and realize that one of the owners included his personal travel expenses as part of his
business-related travels. In addition, Tasai Corporation has changed one of its accounting policies and disclosed the
nature, impact and reason of this change in the notes.
As the audit manager, discuss if any accounting assumptions or principles have been violated.

The monetary unit assumption is violated. As a Canadian company, Tasai should report in a single currency, Canadian
dollars. Although the company has received revenue in a foreign currency and decided not to exchange it for
financial reporting purposes, IFRS requires reporting of all amounts on the financial statements in a single currency.
The fact that this deviation has been disclosed to the users of the financial statements cannot justify it because
this is a clear violation of the assumption.
The business entity assumption is violated. This assumption states that accounting for a business must be kept
separate from the personal affairs of its owners. This means that the owner of a business cannot record personal
transactions on the financial statements of the business. In this case, the owner’s personal travel expenses are not
allowed to affect the operating results of Tasai Corporation.
Note that the change of the accounting policy is in compliance with IFRS since the nature, affect and reason of

this change is clearly stated and justified in the notes.

AP-12A LO 6

Assume you are running a small business as a sole proprietorship. You need to borrow money from the bank, and they
have asked you for your most recent financial statements. Would you report the financial statements using IFRS or ASPE?
Explain your answer.

I would choose ASPE as it is a private company. Private companies in Canada only need to report using ASPE, which
is considered simpler and easier to implement. It is possible that the bank may require some other disclosures
normally required under IFRS, but it is unlikely they would need a full set of statements prepared under IFRS.

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AP-13A LO 5 7

Joan is a senior accountant who recently agreed to give a professional review of the financial statements of Baker
Consulting Inc. Joan is a personal friend of the president of this company and has an outstanding loan to the company.
Baker Consulting Inc. is having cash flow issues that may force it to lay off some employees, but the owner has assured
Joan that everything is under control and that the company is about to land several large sales contracts. He also
explained that if the financial statements revealed any issues, the company would lose potential customers and suppliers.
After some discussion, Joan decided to issue a positive opinion of the financial statements and not disclose any issues.
Has Joan violated any ethical standards of accounting? Discuss.

Joan has a conflict of interest because she has a personal relationship with the president of the company and
a financial interest in the company in the form of a loan. Therefore, Joan is not independent in the presentation
of the financial statement. She is motivated to present the information more favourably than it is in reality,
which is unethical and misleading to the users. An important foundation of financial statement reporting is
disclosure, requiring that all information that affects the full understanding of a company’s financial statements
must be included.

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Application Questions Group B

AP-1B LO 3

Match each form of an organization with the appropriate description.

A Sole Proprietorship
B Partnership
C Corporation
D Non-Profit Organization

D An organization aimed to improve society in some way

C A business that can be set up as either public or private
A A business in which the owner receives all the net income and suffers
from any net loss

B A business operated by two or more people

AP-2B LO 4

Match each of the following financial statement reporting terms with the appropriate definition.
• Completeness
• Timeliness
• Neutrality
• Verifiability
• Materiality

Term (fill in) Description

Timeliness Financial information should be received before it is no longer able to influence decisions
Materiality Refers to the significance of information to users’ decisions
Neutrality Concept that financial information is free from bias
Verifiability Documentation that supports financial information being reported on
Completeness Financial statements contain all information regarding transactions or events related to the
reporting period

AP-3B LO 4

Identify the qualitative characteristic that describes each of the following scenarios.

a) Titus Group presented its financial information in a way that allowed informed users to comprehend the meaning of
the information.
Understandability

b) Hunt Manufacturing included references to source documents to explain where certain financial figures originated
from.
Verifiability

c) Arloc Games Company uses the same accounting methods each year when preparing the financial statements.
Comparability (consistency)

d) Crypt Technologies reported all financial information that could have an impact on the decisions of the users of the
financial statements.
Relevance

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AP-4B LO 4 5

Identify the qualitative characteristic or financial statement foundation that describes each of the following scenarios.

a) Pangea Construction recorded revenue for a five-year construction contract evenly over the five years.
Revenue recognition

b) Athena Spa has committed to opening a second location in the next eight months. Details regarding this expansion
were included in the financial information.
Disclosure

c) Zeus Electric used the same accounting policy for depreciation as last year, even though it could have reported a
higher net income by switching to a different method.
Comparability (consistency)

d) Neptune Water Supply grouped small expenses such as pens, staplers and notepads together as office supplies
expense because the cost of recording them in separate accounts outweighed the benefits.
Materiality

e) Hermes Athletics had its land appraised at $60,000. The land was listed on the balance sheet at $50,000, which was
the price originally paid for it.
Measurement

f) Hera Consulting prepaid cash for its annual insurance policy. The amount was expensed on a monthly basis as it was
used up.
Expense recognition

AP-5B LO 4 5 6

Imzy Company is a small private company that relies on ASPE to prepare financial statements. During the year, the
company has experienced a number of tax disputes with the government. This issue was not included in the notes to the
financial statements, as the bookkeeper believes this type of tax dispute is common for a small business. In addition, the
bookkeeper does not keep purchase invoices because he thinks the costs of holding all those receipts would outweigh
their benefits for a small company. Explain whether any accounting foundations or qualitative characteristics have been
violated by the bookkeeper.
Disclosure states that any and all information that affects a full understanding of a company’s financial position must
be included with the financial statements. The tax dispute should have been disclosed in the notes accompanying the
statements, as it will affect users’ understanding of the company’s financial situation.
Relevance as a qualitative characteristic is violated. A piece of information is relevant if its omission means that users’
decisions would change. Since a major tax dispute would affect the users’ understanding, it should have been disclosed in
the notes.
The characteristic of verifiability is violated. The purchases are not verifiable because the associated invoices are not kept
by the company.

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AP-6B LO 4 6

Reflex Sports Inc. is a manufacturer of sports equipment for children. It relies on IFRS to prepare its financial statements.
The nature of its accounting transactions can be quite complex at times. However, the financial statements have no
additional notes to support them. The company also does not keep all invoices on record to back up expense amounts
reported on the financial statements. Which characteristic(s) of information did Reflex Sports fail to represent? Explain.
Reflex Sports has not achieved the characteristic of understandability because the financial statements do not
contain notes to explain the complex transactions.
Also, verifiability can be questioned since the expense amounts cannot be verified (i.e. there are no invoices for
backup purposes).

AP-7B LO 4 5

Team Toro Inc., a unionized company, is in the business of planning and hosting events for various colleges and
universities. Its service includes a wide range of activities such as decor and design, accommodation for guests and
catering. At the end of the year, prior to issuance of its financial statements, the head of the accounting department
realized that the union was not able to negotiate a collective agreement with the board, and it is planning to go on strike
legally at the beginning of next year. After discussing the matter with the board members, the accounting manager
decides not to disclose this issue, since the strike will happen next year and this year’s financial statements are not
affected. In addition, the accounting manager thinks the disclosure may have an unnecessarily negative impact on the
company’s financial position and reputation in the market. Discuss whether any accounting foundations or qualitative
characteristics have been violated.
Faithful representation is being violated in this situation, since all information useful for decision-making is not
being presented in the financial statements. In this case, the future strike of the union will affect a user’s
interpretation of the statement, so this is a relevant piece of information that should be disclosed in the notes.
The principle of disclosure is violated as it states that any and all information that affects the full understanding
of a company’s financial statements must be included with the financial statements. The future strike should be
disclosed in the notes to financial statements as this issue is known and highly certain prior to issuance of the
statements. Since the company’s overall financial position is not mentioned, there is not enough information to
comment on whether a going concern note should be disclosed.

AP-8B LO 4 5

Match each of the following terms to the appropriate description in the table below.
• Comparability
• Disclosure
• Expense recognition
• Faithful representation
• Relevance
• Understandability

Term (fill in) Description

Faithful representation Information is free from material error and bias
Comparability The financial statements of a company should be prepared in a similar way year after year
Understandability Financial information can be comprehended by users with a reasonable knowledge of the business
Relevance All information for decision-making is present in the financial statements
Expense recognition The costs of doing business must be recorded in (or matched to) the same accounting period as
the revenues that they helped to generate
Disclosure Any and all information that affects the full understanding of a company’s financial statements
must be included with the financial statements

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AP-9B LO 5

Mackenzie Attire is currently preparing its annual financial statements for the past fiscal year. The company uses cash-
based accounting. The company’s policy includes receiving payment for its services well before the service is performed.
The owner recently purchased a fish tank for his home and the transaction included a decrease to Mackenzie Attire’s
equity (an expense was recorded in the income statement). The value of inventory is adjusted annually to be stated at fair
value. Which of the financial statement foundations has Mackenzie Attire violated? Explain.
Mackenzie Attire has violated the principles of revenue recognition and expense recognition.
Revenue recognition states that revenue must be recorded at the time the duties are performed. Expense
recognition states that an expense must be recorded in the same accounting period in which it was used to
produce revenue. These principles are violated by using cash-based accounting.
Also, the owner’s personal transaction of purchasing the fish tank affected the accounting records of the
business. Therefore, the business entity assumption was violated.
Lastly, the value of inventory is adjusted annually to be stated at fair value. Therefore, the principle of
measurement has not been achieved, since assets should always be recorded at historical cost.

AP-10B LO 5

IMORI is large publicly traded construction company. IMORI has entered into a three-year construction contract with
Siano Company. Siano paid upfront for the full value of the contract, and IMORI has recorded the entire amount as
revenue immediately. Explain the financial statement foundation that has been violated.
Revenue recognition has been violated. The principle states that revenue must be recorded (recognized) at the
time the duties are performed, and the nature of the contract is that it will take three years to complete. IMORI
cannot recognize the full amount received as revenue, since the service is not completely rendered. It should
also be noted that IMORI need not wait until the project is entirely completed before it recognizes the revenue.
Periodically, the company should recognize revenue for the work completed at various stages.

AP-11B LO 5

Blossoma Inc. is a private supplier of organic beauty products. The company prepares its financial statements in
compliance with ASPE. Due to recent economic difficulties, Blossoma Inc. had to file for bankruptcy. The company’s
property, plant and equipment are listed on the balance sheet at what they could be sold for, which is lower than their
original purchase price. Has Blossoma Inc. violated any of the financial statement foundations? Explain.
Although the property, plant and equipment are listed on the balance sheet at a price different from their
costs (original price), Blossoma Inc. has not violated the principle of measurement. Since Blossoma is going out
of business and has filed for bankruptcy, its property, plant and equipment should be reported at the value it
can realistically be sold for. This is the going concern principle. When a company is going out of business,
the value of the assets usually suffers because they have to be sold under unfavourable circumstances.

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AP-12B LO 6

A private corporation is planning on going public next year. Explain how this decision may impact the financial reporting
requirements of the business.

A private corporation can report using either ASPE or IFRS. Since public corporations are required to use IFRS, it
would be ideal for a private corporation planning on going public to adopt IFRS earlier. While it can be costly
to implement and take time to provide the extra disclosures required, it would be better for comparability when
the company does end up going public to have the prior years reported using the same standards.

AP-13B LO 7

Marcus is the senior accountant for a small accounting firm. He is currently performing the year-end audit of a particular
client: Le Jardin Oak Inc. (LJO), a manufacturer of high-quality furniture. After Marcus met with Le Jardin’s CEO in a
restaurant, the CEO noticed that Le Jardin’s financial records, which were provided to Marcus, were scattered on the
ground. The CEO was extremely disappointed because the records were meant for internal use only. Which ethical
standard did Marcus violate? Explain.
Marcus is required to act in the interest of his accounting firm’s clients. It is in the interest of Le Jardin to ensure
that its key files are protected and in safe hands. Furthermore, accountants shall not disclose any confidential
information concerning the affairs of any client, former client, employer or former employer. Marcus clearly
violated this ethical standard.

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Case Study
CS-1 LO 1 4 5 6

Gordon is the majority owner of Gordon House Restaurant (GHR), a publicly traded chain of family restaurants. GHR has
adopted ASPE for recording accounting transactions. The company is owned by hundreds of shareholders who expect
timely, reliable and accurate financial statements. GHR produces financial statements periodically.
It is now June 15, 2019. The accountant has prepared the financial statements for the eight-month period ended May 31,
2019. The previous financial statements covered a one-year period.
GHR was recently sued by another company, the details of which are not disclosed in the financial statements. The court
proceedings have not yet ended. However, as of May 31, 2019, it was believed that GHR was very likely to lose the case
and would eventually have to pay a significant amount in damages to the plaintiff.
Also consider the following information:
• Cash disbursements are not supported by additional source documents
• GHR has recognized revenue in a different accounting period from that in which the costs associated with producing
that revenue were recognized

Required
a) Which of the qualitative characteristics of financial information has GHR failed to apply? Explain.

Relevance
The information regarding the lawsuit is definitely relevant. GHR is likely to lose the case and pay a
“significant” amount of damages. The words “very likely” and “significant” should serve as cues to indicate
that the information is relevant. GHR has not disclosed the information related to the lawsuit.

Timeliness
GHR prepared only two sets of financial statements in the past 20 months. For a corporation with hundreds
of shareholders who want timely reports, this practice is not timely.
Verifiability
Because the cash disbursements are not supported by backup documents, the cash balance and total
expenses are not verifiable.
Comparability
Since the current financial statement covers a period of eight months and the previous one covered 12
months, the two statement are not easily comparable.

b) Which of the financial statement foundations has GHR violated? Explain.

Disclosure
GHR did not disclose the crucial information regarding the lawsuit. This information is likely to change the
judgment of the company’s performance and financial position by the users of financial statements (e.g.
shareholders).
Expense Recognition
Costs were recorded in a different accounting period from when they were used to produce the related
revenue.

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c) Based on the information provided, should GHR have adopted ASPE or IFRS? Explain.

Since GHR is a publicly traded company, it must follow IFRS to record accounting transactions.

d) Who would be the internal or external users of GHR’s financial information?

Internal users: Management and shareholders of GHR

External users: Creditors (banks and vendors), taxing authorities

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Notes

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