ICAEW AF · Chapter 1
Accounting concepts, the Conceptual Framework and regulation MCQs with Answers
11 multiple-choice questions on Accounting concepts, the Conceptual Framework and regulation for ICAEW AF Accounting Fundamentals. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Under the IFRS Conceptual Framework for Financial Reporting, which TWO qualitative characteristics are described as fundamental?
- A) Relevance and timeliness
- B) Faithful representation and verifiability
- C) Comparability and understandability
- D) Relevance and faithful representation
Show answer & explanation
Answer: D) Relevance and faithful representation
The Conceptual Framework identifies relevance and faithful representation as the fundamental qualitative characteristics of useful financial information. Comparability, verifiability, timeliness and understandability are enhancing characteristics that improve the usefulness of information that is already relevant and faithfully represented.
Question 2
Which of the following is an enhancing qualitative characteristic of useful financial information under the IFRS Conceptual Framework?
- A) Comparability
- B) Relevance
- C) Faithful representation
- D) Going concern
Show answer & explanation
Answer: A) Comparability
Comparability is one of the four enhancing qualitative characteristics, along with verifiability, timeliness and understandability. Relevance and faithful representation are the fundamental characteristics, while going concern is the underlying assumption on which financial statements are normally prepared.
Question 3
How does the IFRS Conceptual Framework define an asset?
- A) A resource from which future economic benefits are certain to flow to the entity
- B) A present economic resource controlled by the entity as a result of past events
- C) Any item owned by the entity that has a measurable cost
- D) A present obligation of the entity to transfer an economic resource as a result of past events
Show answer & explanation
Answer: B) A present economic resource controlled by the entity as a result of past events
The Conceptual Framework defines an asset as a present economic resource controlled by the entity as a result of past events, and an economic resource is a right that has the potential to produce economic benefits. Benefits do not need to be certain, and legal ownership is not required because the test is control. The last definition is the definition of a liability.
Question 4
A trader has decided to close the business and sell off all of its assets within the next few months. On what basis should its financial statements now be prepared?
- A) The cash basis, recognising only cash received and paid
- B) The break-up basis, with assets stated at the amounts expected to be realised
- C) The going concern basis, because the business is still trading at the reporting date
- D) The accrual basis, with assets stated at historical cost less depreciation
Show answer & explanation
Answer: B) The break-up basis, with assets stated at the amounts expected to be realised
Financial statements are normally prepared on the assumption that the entity is a going concern. Where the entity intends to cease trading, that assumption no longer holds, so the break-up basis is used. Assets are then measured at the amounts they are expected to realise on sale, and any extra liabilities caused by closure are recognised.
Question 5
Which of the following best describes the accrual basis of accounting?
- A) Assets are recorded at their current market values at each reporting date
- B) The effects of transactions are recorded in the periods in which they occur, even if the cash is received or paid in a different period
- C) Expenses are recorded when they are approved for payment, and income when it is invoiced
- D) Income and expenses are recorded only when cash is received or paid
Show answer & explanation
Answer: B) The effects of transactions are recorded in the periods in which they occur, even if the cash is received or paid in a different period
Under the accrual basis, the effects of transactions and other events are recognised when they occur rather than when the related cash moves. Recording income and expenses only when cash changes hands is the cash basis. Measuring assets at market value is about measurement, not the accrual basis.
Question 6
According to the IFRS Conceptual Framework, when is information material?
- A) When the auditors have identified it as an error
- B) When omitting, misstating or obscuring it could reasonably be expected to influence the decisions that primary users make on the basis of the financial statements
- C) When it is more than 5% of profit before tax
- D) When it relates to a transaction recorded in the general ledger
Show answer & explanation
Answer: B) When omitting, misstating or obscuring it could reasonably be expected to influence the decisions that primary users make on the basis of the financial statements
Materiality is an entity-specific aspect of relevance, based on the nature or size (or both) of the items the information relates to. The test is whether omitting, misstating or obscuring the information could reasonably be expected to influence the decisions of primary users. Percentage rules of thumb may help in practice but are not the definition.
Question 7
Which body is responsible for developing and issuing IFRS Accounting Standards?
- A) The IFRS Advisory Council
- B) The IFRS Foundation Trustees
- C) The International Accounting Standards Board (IASB)
- D) The IFRS Interpretations Committee
Show answer & explanation
Answer: C) The International Accounting Standards Board (IASB)
The IASB is the independent standard-setting body that develops and issues IFRS Accounting Standards. The IFRS Foundation Trustees oversee the organisation, appoint board members and secure funding. The IFRS Interpretations Committee issues interpretations of existing standards, and the IFRS Advisory Council gives strategic advice.
Question 8
In which circumstances does IAS 1 Presentation of Financial Statements allow an entity to depart from a requirement of an IFRS?
- A) Whenever the entity's auditors agree that the requirement is not appropriate
- B) Whenever the effect of compliance would reduce reported profit by a material amount
- C) In extremely rare circumstances where management concludes that compliance would be so misleading that it would conflict with the objective of financial statements
- D) Whenever the directors believe that an alternative treatment is more prudent
Show answer & explanation
Answer: C) In extremely rare circumstances where management concludes that compliance would be so misleading that it would conflict with the objective of financial statements
IAS 1 requires fair presentation, which is normally achieved by complying with IFRS. A departure is allowed only in extremely rare circumstances when compliance would be so misleading that it would conflict with the objective of financial statements set out in the Conceptual Framework. The entity must disclose the departure, the reasons for it and its financial effect. This is the IFRS equivalent of the 'true and fair override' found in UK company law.
Question 9
A business buys inventory on credit for £7,500. What is the effect of this transaction on the accounting equation?
- A) Assets increase by £7,500 and liabilities increase by £7,500; equity is unchanged
- B) Liabilities increase by £7,500 and equity decreases by £7,500
- C) Assets increase by £7,500 and liabilities decrease by £7,500
- D) Assets increase by £7,500 and equity increases by £7,500
Show answer & explanation
Answer: A) Assets increase by £7,500 and liabilities increase by £7,500; equity is unchanged
Inventory is an asset, so assets rise by £7,500. Because the goods have not been paid for, a trade payable (a liability) of the same amount arises. No income or expense has yet been recognised, so equity is unaffected and the equation assets = equity + liabilities still balances.
Question 10
In its first year of trading, a business made credit sales of £84,000 and received £76,500 from customers. It paid expenses of £41,000, of which £2,500 relates to the following year. At the year end, expenses of £1,800 for the current year were unpaid. What is the profit for the year on the accrual basis?
- A) £45,500
- B) £43,700
- C) £41,200
- D) £35,500
Show answer & explanation
Answer: B) £43,700
On the accrual basis, revenue is the sales made in the year, £84,000, regardless of cash received. Expenses = £41,000 paid - £2,500 prepaid + £1,800 accrued = £40,300. Profit = £84,000 - £40,300 = £43,700. The cash surplus of £35,500 (£76,500 - £41,000) would be the result under the cash basis.
Question 11
Under the IFRS Conceptual Framework, which of the following is NOT one of the characteristics that a perfectly faithful representation of a phenomenon would have?
- A) Complete
- B) Neutral
- C) Timely
- D) Free from error
Show answer & explanation
Answer: C) Timely
To be a perfectly faithful representation, a depiction would be complete, neutral and free from error. Timeliness is an enhancing qualitative characteristic: it means having information available to decision-makers in time to influence their decisions, and it is not one of the components of faithful representation.