ACCA FA Qualitative characteristics: practice questions with answers

Question 1

Which of the following statements about the qualitative characteristics of useful financial information in the IASB's Conceptual Framework for Financial Reporting is correct?

1. A Comparability, verifiability, timeliness and understandability enhance the usefulness of information that is already relevant and faithfully represented
2. B Free from error means that the amounts shown in the financial statements must be perfectly accurate in all respects
3. C Materiality is a fundamental qualitative characteristic and a single materiality threshold applies to all entities
4. D Prudence requires assets and income to be understated and liabilities and expenses to be overstated whenever there is uncertainty

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Answer: A. The two fundamental qualitative characteristics are relevance (including materiality) and faithful representation (complete, neutral and free from error). The four enhancing characteristics are comparability, verifiability, timeliness and understandability. Prudence supports neutrality: it means exercising caution under uncertainty, not deliberately misstating assets, liabilities, income or expenses.

Question 2

Merrow Co's reporting date is 31 December 20X6. Which of the following meets the Conceptual Framework definition of a liability of Merrow Co at that date?

1. A A purchase order placed with a supplier on 20 December 20X6 for goods to be delivered and paid for in February 20X7
2. B Operating losses that the directors expect Merrow Co to make during the year ending 31 December 20X7
3. C An amount owed to a supplier for goods delivered to Merrow Co on 18 December 20X6, payable in January 20X7
4. D Planned spending on a staff training programme that the board approved on 10 December 20X6 to run in 20X7

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Answer: C. Under the Conceptual Framework, a liability is a present obligation of the entity to transfer an economic resource as a result of past events. Goods already received create such an obligation. An unfulfilled purchase order, expected future losses and an internal spending decision do not create a present obligation at the reporting date.

Question 3

Which of the following is a recognised disadvantage of historical cost accounting when prices are rising?

1. A Depreciation based on the original cost of assets is less than the cost of replacing the assets used up, so profit is overstated in real terms
2. B Historical cost figures cannot be verified, because they depend on management's estimates of the current market value of each asset
3. C Non-current assets are shown at amounts above their current value, which overstates the capital employed by the business
4. D Assets must be revalued every year, which makes historical cost accounting expensive and time-consuming to apply

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Answer: A. Historical cost accounting is simple, objective and verifiable, but when prices rise:

- asset values in the statement of financial position become out of date (usually understated);
- depreciation and cost of sales are based on old, lower costs, so profit is overstated in real terms and paying it all out could erode the business's ability to replace its assets;
- comparisons over time are distorted.

Current value accounting addresses these problems but is more subjective and costly to apply.