sticeSOL_04final - CHAPTER 4 QUESTIONS 1 The objective of...

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CHAPTER 4 QUESTIONS 1. The objective of financial reporting is to provide useful information for users of the financial statements. The relevant informa- tion for decision making is future data, es- pecially information dealing with cash flows. The primary financial statements reflect economic transactions and events that have taken place. The past is used to help project the future. Income, however, is only one of many sources of cash flow. The bal- ance sheet and statement of cash flows also furnish relevant information upon which the investor may project other future cash flows. In summary, the income state- ment contains only some of the information that is relevant for making economic de- cisions. 2. Two approaches can be used to measure income: the capital maintenance approach and the transaction approach. The capital maintenance approach uses the balance sheet elements to determine the change in total equity after eliminating any invest- ments and withdrawals of resources by owners. The transaction approach determ- ines income by analyzing individual trans- actions and events and their effect on re- lated assets, liabilities, and owners’ equity. Although the method of determining income differs, both approaches arrive at the same total income figure if the same attributes and measurements are used. However, the transaction approach produces more detail as to the composition of income than does the capital maintenance approach. 3. Measurement methods that could be ap- plied to net assets in the capital mainten- ance approach to income determination are as follows: (a) The historical cost of net assets ac- quired in exchange transactions, re- duced by an allowance for their use. (b) The historical cost of net assets ac- quired in exchange transactions, re- duced by an allowance for their use and adjusted for a change in price levels since original acquisition. (c) The current value of net assets ac- quired in exchange transactions as de- termined by either their replacement or market values. (d) Some variation of the above (a through c) but including in assets all resources and claims to resources, not just those acquired in exchange transactions. 4. The objectives of reporting income for in- come tax purposes and for financial re- porting to users are not the same. Those formulating income tax laws are usually concerned with fairness among taxpayers and with their ability to pay taxes. Users, on the other hand, are concerned with a meas- ure that distinguishes between a return on investment and a return of investment. They want a measure that matches ex- penses against recognized revenue. In most cases, the same accounting method can be used for both purposes. This will re- duce both the cost and the confusion of using more than one accounting method for the same transaction. In some cases, however, the generally accepted account- ing method is different from that required by income tax regulations. This results in a temporary difference between the tax re-
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sticeSOL_04final - CHAPTER 4 QUESTIONS 1 The objective of...

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