SASB LEVEL 1 BASIC EXAM
QUESTIONS WITH COMPLETE
SOLUTIONS
How did the Supreme Court use a probability and magnitude test to assess materiality?
- Answer- According to this test, the determination of materiality should also consider
the probability that an event will happen and the magnitude of the occurrence of the
event. For example, a relatively small transaction for the company, or one that involves
a small price premium, will not likely meet the probability and magnitude test for
materiality.
What is GAAP? - Answer- Generally Accepted Accounting Principles
What is historical cost accounting? - Answer- Measurement of an assets value as the
actual cost paid for the asset at the time of purchase. Under this accuracy-focused
approach, the original nominal value is reported on the balance sheet even if the value
of the asset changes over time.
Explain the conflict around standardization in accounting, specifically around the mid-
19th century? - Answer- On the one hand, non-standardized accounting practices cater
to the needs of more reporting companies, in that companies can disclose information in
the manner they feel best represents their business. On the other hand, the
fragmentation that exists in the absence of standardization reduces the usefulness of
disclosed information in the market. The higher the variation of disclosure, the less
comparable, decision-useful, and actionable the information becomes to investors,
creditors, and lenders
Explain the shift from strict historical asset valuation to decision usefulness in the 1960s
- Answer- Accounting measurements were recast to serve a specific purpose (to inform
decisions) rather than to perform a singular function (to provide accurate measurement).
In other words, the accounting profession recognized the importance of providing
forward-looking information rather than just historical accuracy
What is the IFRS? - Answer- The International Accounting Standards Board (IASB) is
an independent standard-setting organization with robust governance and due process.
Today, IASB oversees the development of the International Financial Reporting
Standards (IFRS Standards), the goal of which is to "develop, in the public interest, a
single set of high quality, understandable, enforceable and globally accepted financial
reporting standards based upon clearly articulated principles.
What is FASB? - Answer- One month after the IASC was formed, the Financial
Accounting Standards Board (FASB) was established in the US to replace the APB. The
,FASB emerged to serve as an independent, full-time organization dedicated to the
development of financial accounting standards
Why do companies report information not required by GAAP? - Answer- Historically,
companies use non-GAAP reporting to supplement core financial statements
and highlight information not required by
standardized disclosure, such as a change in
operating structure or the impacts of a merger
or acquisition.
What are some examples of non-GAAP reporting? - Answer- Earnings before interest,
taxes, depreciation,
and amortization (EBITDA), changes in
operating structure, the impacts of a merger or acquisition, and adjusted earnings (when
the company believes an adjusted metric provides a better understanding of the
business to investors)
What are intangible assets? - Answer- Intellectual capital, customer relationships,
brand value, and other "soft" assets.
How have intangible assets affected the importance of traditional financial statements? -
Answer- Intangible assets now hold up to 90% of market value in the US, compared to
17% in 1973. Thus, traditional financial statements tell an increasingly
smaller part of the story—by some estimates,
as little as five percent. In addition, intangible assets are particularly
sensitive to impairment. FASB has acknowledged the importance of non-financial
resources—things like human, social, and natural capital; but has fallen short of labeling
them as "assets"
How did leading companies disclose non-financial information before widespread
adoption? - Answer- The Management Commentary portion of financial disclosures
aligned with IFRS Standards and the Management's Discussion and Analysis (MD&A)
of regulatory filings
What are the two key principles the IFRS Standards recommends for Management
Commentary? - Answer- 1. ASSESS PERFORMANCE: "Provide management's view
of the entity's performance, position and progress (including forward looking
information).
2. ADD INFORMATION: "Supplement and complement information presented in the
financial statements (and possess the qualitative characteristics described in the IFRS
Conceptual Framework for Financial Reporting)."
What are the three fundamental (and four enhancing) characteristics of qualitative
information as defined by the IFRS? - Answer- 1.Relevance, materiality, and faithful
representation.
2. Comparability, verifiability, timeliness, and understandability
, What five elements should be included in Management Commentary, according to the
IFRS? What have they since recommended be added? - Answer- 1. Historical
financials
2. Other subject matter disclosures (including climate disclosure)
3. Business description
4. Management information and market data
5. Management perspectives.
They have since recommended that companies include "matters that could affect an
entity's long-term prospects; the entity's intangible resources and relationships; and
ESG matters."
What are the four key recommendations for the MD&A section, as defined by the SEC?
- Answer- 1. Focus on material information
2. Include key performance indicators
3. Disclose known trends and uncertainties that are reasonably likely
4. Analyze the information that is disclosed
What is the role of corporate governance codes? - Answer- Where financial statements
cannot, corporate governance codes help companies communicate how boards make
decisions and ultimately lead the company, thus granting investors insight into a board's
oversight of issues with the potential to harm enterprise value.
What is ECA? - Answer- Environmental Cost Accounting. ECA aims to analyze cause-
and-effect relationships to identify the source of and measure environmental impacts
What is EP&L? - Answer- Environmental Profit and Loss. EP&L seeks to assign a
monetary value to the environmental costs associated with certain business activities
What is short-termism and why is it important? - Answer- A growing pressure put on
corporate executives to meet near-term earnings projections at the expense of long-
term value creation. Although short-term investors increase market liquidity, critics
argue that persistent, extreme short-termism will result in diminished public confidence,
depressed economic growth, and reduced investment returns.
What is the importance of sustainability risk in investing? - Answer- As the market value
of equities has become less tangible, sensitivities to sustainability risks, the
management of those risks, and regulatory attempts to address them have risen.
Investors factor risk into the returns they require for accepting such risk, raising a firm's
cost of capital. In other words, as risk (or the perception of risk) increases, costs of
capital and discount rates increase—leading to higher hurdle rates and decreases in
valuations—and vice versa.
What is fiduciary duty? How is it changing? - Answer- Fiduciary obligations exist to
ensure that trustees who manage other people's money act in the best interests of their
QUESTIONS WITH COMPLETE
SOLUTIONS
How did the Supreme Court use a probability and magnitude test to assess materiality?
- Answer- According to this test, the determination of materiality should also consider
the probability that an event will happen and the magnitude of the occurrence of the
event. For example, a relatively small transaction for the company, or one that involves
a small price premium, will not likely meet the probability and magnitude test for
materiality.
What is GAAP? - Answer- Generally Accepted Accounting Principles
What is historical cost accounting? - Answer- Measurement of an assets value as the
actual cost paid for the asset at the time of purchase. Under this accuracy-focused
approach, the original nominal value is reported on the balance sheet even if the value
of the asset changes over time.
Explain the conflict around standardization in accounting, specifically around the mid-
19th century? - Answer- On the one hand, non-standardized accounting practices cater
to the needs of more reporting companies, in that companies can disclose information in
the manner they feel best represents their business. On the other hand, the
fragmentation that exists in the absence of standardization reduces the usefulness of
disclosed information in the market. The higher the variation of disclosure, the less
comparable, decision-useful, and actionable the information becomes to investors,
creditors, and lenders
Explain the shift from strict historical asset valuation to decision usefulness in the 1960s
- Answer- Accounting measurements were recast to serve a specific purpose (to inform
decisions) rather than to perform a singular function (to provide accurate measurement).
In other words, the accounting profession recognized the importance of providing
forward-looking information rather than just historical accuracy
What is the IFRS? - Answer- The International Accounting Standards Board (IASB) is
an independent standard-setting organization with robust governance and due process.
Today, IASB oversees the development of the International Financial Reporting
Standards (IFRS Standards), the goal of which is to "develop, in the public interest, a
single set of high quality, understandable, enforceable and globally accepted financial
reporting standards based upon clearly articulated principles.
What is FASB? - Answer- One month after the IASC was formed, the Financial
Accounting Standards Board (FASB) was established in the US to replace the APB. The
,FASB emerged to serve as an independent, full-time organization dedicated to the
development of financial accounting standards
Why do companies report information not required by GAAP? - Answer- Historically,
companies use non-GAAP reporting to supplement core financial statements
and highlight information not required by
standardized disclosure, such as a change in
operating structure or the impacts of a merger
or acquisition.
What are some examples of non-GAAP reporting? - Answer- Earnings before interest,
taxes, depreciation,
and amortization (EBITDA), changes in
operating structure, the impacts of a merger or acquisition, and adjusted earnings (when
the company believes an adjusted metric provides a better understanding of the
business to investors)
What are intangible assets? - Answer- Intellectual capital, customer relationships,
brand value, and other "soft" assets.
How have intangible assets affected the importance of traditional financial statements? -
Answer- Intangible assets now hold up to 90% of market value in the US, compared to
17% in 1973. Thus, traditional financial statements tell an increasingly
smaller part of the story—by some estimates,
as little as five percent. In addition, intangible assets are particularly
sensitive to impairment. FASB has acknowledged the importance of non-financial
resources—things like human, social, and natural capital; but has fallen short of labeling
them as "assets"
How did leading companies disclose non-financial information before widespread
adoption? - Answer- The Management Commentary portion of financial disclosures
aligned with IFRS Standards and the Management's Discussion and Analysis (MD&A)
of regulatory filings
What are the two key principles the IFRS Standards recommends for Management
Commentary? - Answer- 1. ASSESS PERFORMANCE: "Provide management's view
of the entity's performance, position and progress (including forward looking
information).
2. ADD INFORMATION: "Supplement and complement information presented in the
financial statements (and possess the qualitative characteristics described in the IFRS
Conceptual Framework for Financial Reporting)."
What are the three fundamental (and four enhancing) characteristics of qualitative
information as defined by the IFRS? - Answer- 1.Relevance, materiality, and faithful
representation.
2. Comparability, verifiability, timeliness, and understandability
, What five elements should be included in Management Commentary, according to the
IFRS? What have they since recommended be added? - Answer- 1. Historical
financials
2. Other subject matter disclosures (including climate disclosure)
3. Business description
4. Management information and market data
5. Management perspectives.
They have since recommended that companies include "matters that could affect an
entity's long-term prospects; the entity's intangible resources and relationships; and
ESG matters."
What are the four key recommendations for the MD&A section, as defined by the SEC?
- Answer- 1. Focus on material information
2. Include key performance indicators
3. Disclose known trends and uncertainties that are reasonably likely
4. Analyze the information that is disclosed
What is the role of corporate governance codes? - Answer- Where financial statements
cannot, corporate governance codes help companies communicate how boards make
decisions and ultimately lead the company, thus granting investors insight into a board's
oversight of issues with the potential to harm enterprise value.
What is ECA? - Answer- Environmental Cost Accounting. ECA aims to analyze cause-
and-effect relationships to identify the source of and measure environmental impacts
What is EP&L? - Answer- Environmental Profit and Loss. EP&L seeks to assign a
monetary value to the environmental costs associated with certain business activities
What is short-termism and why is it important? - Answer- A growing pressure put on
corporate executives to meet near-term earnings projections at the expense of long-
term value creation. Although short-term investors increase market liquidity, critics
argue that persistent, extreme short-termism will result in diminished public confidence,
depressed economic growth, and reduced investment returns.
What is the importance of sustainability risk in investing? - Answer- As the market value
of equities has become less tangible, sensitivities to sustainability risks, the
management of those risks, and regulatory attempts to address them have risen.
Investors factor risk into the returns they require for accepting such risk, raising a firm's
cost of capital. In other words, as risk (or the perception of risk) increases, costs of
capital and discount rates increase—leading to higher hurdle rates and decreases in
valuations—and vice versa.
What is fiduciary duty? How is it changing? - Answer- Fiduciary obligations exist to
ensure that trustees who manage other people's money act in the best interests of their
