Intermediate Accounting 16 Ed By Donald E. Kieso – Solution Manual
- What is a conceptual framework? Why is a conceptual framework necessary in financial accounting?
2. What is the primary objective of financial reporting?
3. What is meant by the term “qualitative characteristics of accounting information”?
4. Briefly describe the two fundamental qualities of useful accounting information.
5. How is materiality (or immateriality) related to the proper presentation of financial statements? What factors and measures should be considered in assessing the materiality of a misstatement in the presentation of a financial statement?
6. What are the enhancing qualities of the qualitative characteristics?
What is the role of enhancing qualities in the conceptual framework?
7. According to the FASB conceptual framework, the objective of financial reporting for business enterprises is based on the needs of the users of financial statements. Explain the level of sophistication that the Board assumes about the users of financial statements.
8. What is the distinction between comparability and consistency?
9. Why is it necessary to develop a definitional framework for the basic elements of accounting?
10. Expenses, losses, and distributions to owners are all decreases in net assets. What are the distinctions among them?
11. Revenues, gains, and investments by owners are all increases in net assets. What are the distinctions among them?
12. What are the four basic assumptions that underlie the financial accounting structure?
13. The life of a business is divided into specific time periods, usually a year, to measure results of operations for each such time period and to portray financial conditions at the end of each period.
(a) This practice is based on the accounting assumption that the life of the business consists of a series of time periods and that it is possible to measure accurately the results of operations for each period. Comment on the validity and necessity of this assumption.
(b) What has been the effect of this practice on accounting? What is its relation to the accrual system? What influence has it had on accounting entries and methodology?
14. What is the basic accounting problem created by the monetary unit assumption when there is significant inflation? What appears to be the FASB position on a stable monetary unit?
15. The chairman of the board of directors of the company for which you are chief accountant has told you that he has little use for accounting figures based on historical cost.
He believes that replacement values are of far more significance to the board of directors than “out-of-date costs.” Present some arguments to convince him that accounting data should still be based on historical cost.
16. What is the definition of fair value?
17. What is the fair value option? Explain how use of the fair value option reflects application of the fair value principle.
18. Briefly describe the fair value hierarchy.
19. Explain the revenue recognition principle.
20. What is a performance obligation, and how is it used to determine when revenue should be recognized?
21. What are the five steps used to determine the proper time to recognize revenue?
22. Selane Eatery operates a catering service specializing in business luncheons for large corporations. Selane requires customers to place their orders 2 weeks in advance of the scheduled events. Selane bills its customers on the tenth day of the month following the date of service and requires that payment be made within 30 days of the billing date. Conceptually, when should Selane recognize revenue related to its catering service?
23. Mogilny Company paid $135,000 for a machine. The Accumulated Depreciation—Equipment account has a balance of $46,500 at the present time. The company could sell the machine today for $150,000. The company president believes that the company has a “right to this gain.”
What does the president mean by this statement? Do you agree?
24. Three expense recognition methods (associating cause and effect, systematic and rational allocation, and immediate recognition) were discussed in the text under the expense recognition principle. Indicate the basic nature of each of these expense recognition methods and give two examples of each.
25. Statement of Financial Accounting Concepts No. 5 identifies four characteristics that an item must have before it is recognized in the financial statements. What are these four characteristics?
26. Briefly describe the types of information concerning financial position, income, and cash flows that might be provided (a) within the main body of the financial statements,
(b) in the notes to the financial statements, or (c) as supplementary information.
27. In January 2018, Janeway Inc. doubled the amount of its outstanding stock by selling on the market an additional 10,000 shares to finance an expansion of the business. You propose that this information be shown by a footnote on the balance sheet as of December 31, 2017. The president objects, claiming that this sale took place after December 31, 2017, and therefore should not be shown. Explain your position.
28. Describe the major constraint inherent in the presentation of accounting information.
29. What are some of the costs of providing accounting information?
What are some of the benefits of accounting information? Describe the cost-benefit factors that should be considered when new accounting standards are being proposed.
30. The treasurer of Landowska Co. has heard that conservatism is a doctrine that is followed in accounting and, therefore, proposes that several policies be followed that are conservative in nature. State your opinion with respect to each of the policies listed.
(a) The company gives a 2-year warranty to its customers on all products sold. The estimated warranty costs incurred from this year’s sales should be entered as an expense this year instead of an expense in the period in the future when the warranty is made good.
(b) When sales are made on account, there is always uncertainty about whether the accounts are collectible.
Therefore, the treasurer recommends recording the sale when the cash is received from the customers.
(c) A personal liability lawsuit is pending against the company. The treasurer believes there is an even chance that the company will lose the suit and have to pay damages of $200,000 to $300,000. The treasurer recommends that a loss be recorded and a liability created in the amount of $300,000.
BE2-1 (L03) Match the qualitative characteristics below with the following statements.
1. Relevance 5. Comparability
2. Faithful representation 6. Completeness
3. Predictive value 7. Neutrality
4. Confirmatory value 8. Timeliness
(a) Quality of information that permits users to identify similarities in and differences between two sets of economic phenomena.
(b) Having information available to users before it loses its capacity to influence decisions.
(c) Information about an economic phenomenon that has value as an input to the processes used by capital providers to form their own expectations about the future.
(d) Information that is capable of making a difference in the decisions of users in their capacity as capital providers.
(e) Absence of bias intended to attain a predetermined result or to induce a particular behavior.
BE2-2 (L03) Match the qualitative characteristics below with the following statements.
1. Timeliness 5. Faithful representation
2. Completeness 6. Relevance
3. Free from error 7. Neutrality
4. Understandability 8. Confirmatory value
(a) Quality of information that assures users that information represents the economic phenomena that it purports to represent.
(b) Information about an economic phenomenon that corrects past or present expectations based on previous evaluations.
(c) The extent to which information is accurate in representing the economic substance of a transaction.
(d) Includes all the information that is necessary for a faithful representation of the economic phenomena that it purports to represent.
(e) Quality of information that allows users to comprehend its meaning.
BE2-3 (L03) Discuss whether the changes described in each of the cases below require recognition in the CPA’s audit report as to consistency. (Assume that the amounts are material.)
(a) The company changed its inventory method to FIFO from weighted-average, which had been used in prior years.
(b) The company disposed of one of the two subsidiaries that had been included in its consolidated statements for prior years.
(c) The estimated remaining useful life of plant property was reduced because of obsolescence.
BE2-4 (L03) Identify which qualitative characteristic of accounting information is best described in each item below. (Do not use relevance and faithful representation.)
(a) The annual reports of Best Buy Co. are audited by certified public accountants.
(b) Black & Decker and Cannondale Corporation both use the FIFO cost flow assumption.
(c) Starbucks Corporation has used straight-line depreciation since it began operations.
(d) Motorola issues its quarterly reports immediately after each quarter ends.
BE2-5 (L03) Presented below are three different transactions related to materiality. Explain whether you would classify these transactions as material.
(a) Blair Co. has reported a positive trend in earnings over the last 3 years. In the current year, it reduces its bad debt allowance to ensure another positive earnings year. The impact of this adjustment is equal to 3% of net income.
(b) Hindi Co. has an unusual gain of $3.1 million on the sale of plant assets and a $3.3 million loss on the sale of investments.
It decides to net the gain and loss because the net effect is considered immaterial. Hindi Co.’s income for the current year was $10 million.
(c) Damon Co. expenses all capital equipment under $25,000 on the basis that it is immaterial. The company has followed this practice for a number of years.
BE2-6 (L04) For each item below, indicate to which category of elements of financial statements it belongs.
(a) Retained earnings (e) Depreciation (h) Dividends
(b) Sales (f) Loss on sale of equipment (i) Gain on sale of investment
(c) Additional paid-in capital (g) Interest payable (j) Issuance of common stock
BE2-7 (L04) Explain how you would decide whether to record each of the following expenditures as an asset or an expense.
Assume all items are material.
(a) Legal fees paid in connection with the purchase of land are $1,500.
(b) Eduardo, Inc. paves the driveway leading to the office building at a cost of $21,000.
(c) A meat market purchases a meat-grinding machine at a cost of $3,500.
(d) On June 30, Monroe and Meno, medical doctors, pay 6 months’ office rent to cover the month of July and the next 5 months.
(e) Smith’s Hardware Company pays $9,000 in wages to laborers for construction on a building to be used in the business.
(f) Alvarez’s Florists pays wages of $2,100 for the month to an employee who serves as driver of their delivery truck.
BE2-8 (L05) Identify which basic assumption of accounting is best described in each item below.
(a) The economic activities of FedEx Corporation are divided into 12-month periods for the purpose of issuing annual reports.
(b) Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation.
(c) Walgreen Co. reports current and noncurrent classifications in its balance sheet.
(d) The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes.
BE2-9 (L05) If the going concern assumption is not made in accounting, discuss the differences in the amounts shown in the financial statements for the following items.
(a) Land. (d) Inventory.
(b) Unamortized bond premium. (e) Prepaid insurance.
(c) Depreciation expense on equipment.
BE2-10 (L06) Identify which basic principle of accounting is best described in each item below.
(a) Norfolk Southern Corporation reports revenue in its income statement when the performance obligation is satisfied instead of when the cash is collected.
(b) Yahoo! recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue.
(c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements.
(d) Gap, Inc. reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair value is greater.
BE2-11 (L06) Vande Velde Company made three investments during 2017. (1) It purchased 1,000 shares of Sastre Company, a start-up company. Vande Velde made the investment based on valuation estimates from an internally developed model. (2) It purchased 2,000 shares of GE stock, which trades on the NYSE. (3) It invested $10,000 in local development authority bonds.
Although these bonds do not trade on an active market, their value closely tracks movements in U.S. Treasury bonds. Where will Vande Velde report these investments in the fair value hierarchy?
BE2-12 (L06) What accounting assumption, principle, or constraint would Target Corporation use in each of the situations below?
(a) Target was involved in litigation over the last year. This litigation is disclosed in the financial statements.
(b) Target allocates the cost of its depreciable assets over the life it expects to receive revenue from these assets.
(c) Target records the purchase of a new Dell PC at its cash equivalent price.
CA1-15 ETHICS (Financial Reporting Pressures) Presented below is abbreviated testimony from Troy Normand in the WorldCom case. He was a manager in the corporate reporting department and is one of five individuals who pleaded guilty. He is testifying in hopes of receiving no prison time when he is ultimately sentenced.
- Mr. Normand, if you could just describe for the jury how the meeting started and what was said during the meeting?
- I can’t recall exactly who initiated the discussion, but right away Scott Sullivan acknowledged that he was aware we had problems with the entries, David Myers had informed him, and we were considering resigning.
He said that he respected our concerns but that we weren’t being asked to do anything that he believed was wrong.
He mentioned that he acknowledged that the company had lost focus quite a bit due to the preparations for the Sprint merger, and that he was putting plans in place and projects in place to try to determine where the problems were, why the costs were so high.
He did say he believed that the initial statements that we produced, that the line costs in those statements could not have been as high as they were, that he believed something was wrong and there was no way that the costs were that high.
I informed him that I didn’t believe the entry we were being asked to do was right, that I was scared, and I didn’t want to put myself in a position of going to jail for him or the company. He responded that he didn’t believe anything was wrong, nobody was going to be going to jail, but that if it later was found to be wrong, that he would be the person going to jail, not me.
He asked that I stay, don’t jump off the plane, let him land it softly, that’s basically how he put it. And he mentioned that he had a discussion with Bernie Ebbers, asking Bernie to reduce projections going forward and that Bernie had refused.
- Mr. Normand, you said that Mr. Sullivan said something about don’t jump out of the plane. What did you understand him to mean when he said that?
- Not to quit.
- During this meeting, did Mr. Sullivan say anything about whether you would be asked to make entries like this in the future?
- Yes, he made a comment that from that point going forward we wouldn’t be asked to record any entries, high-level late adjustments, that the numbers would be the numbers.
- What did you understand that to be mean, the numbers would be the numbers?
- That after the preliminary statements were issued, with the exception of any normal transaction, valid transaction, we wouldn’t be asked to be recording any more late entries.
- I believe you testified that Mr. Sullivan said something about the line cost numbers not being accurate. Did he ask you to conduct any analysis to determine whether the line cost numbers were accurate?
- No, he did not.
- Did anyone ever ask you to do that?
- Did you ever conduct any such analysis?
- No, I didn’t.
- During this meeting, did Mr. Sullivan ever provide any accounting justification for the entry you were asked to make?
- No, he did not.
- Did anything else happen during the meeting?
- I don’t recall anything else.
- How did you feel after this meeting?
- Not much better actually. I left his office not convinced in any way that what we were asked to do was right. However, I did question myself to some degree after talking with him wondering whether I was making something more out of what was really there.
Answer the following questions.
(a) What appears to be the ethical issue involved in this case?
(b) Is Troy Normand acting improperly or immorally?
(c) What would you do if you were Troy Normand?
(d) Who are the major stakeholders in this case?
CA1-16 (Economic Consequences) Presented below are comments made in the financial press.
Prepare responses to the requirements in each item.
(a) Rep. John Dingell, at one time the ranking Democrat on the House Commerce Committee, threw his support behind the FASB’s controversial derivatives accounting standard and encouraged the FASB to adopt the rule promptly. Indicate why a member of Congress might feel obligated to comment on this proposed FASB standard.
(b) In a strongly worded letter to Senator Lauch Faircloth (R-NC) and House Banking Committee Chairman Jim Leach (R-IA), the American Institute of Certified Public Accountants (AICPA) cautioned against government intervention in the accounting standard-setting process, warning that it had the potential of jeopardizing U.S. capital markets. Explain how government intervention could possibly affect capital markets adversely.
CA1-17 GROUPWORK (GAAP and Economic Consequences) The following letter was sent to the SEC and the FASB by leaders of the business community.
The FASB has been struggling with accounting for derivatives and hedging for many years. The FASB has now developed, over the last few weeks, a new approach that it proposes to adopt as a final standard. We understand that the
Board intends to adopt this new approach as a final standard without exposing it for public comment and debate, despite the evident complexity of the new approach, the speed with which it has been developed and the significant changes to the exposure draft since it was released more than one year ago. Instead, the Board plans to allow only a brief review by selected parties, limited to issues of operationality and clarity, and would exclude questions as to the merits of the proposed approach.
As the FASB itself has said throughout this process, its mission does not permit it to consider matters that go beyond accounting and reporting considerations. Accordingly, the FASB may not have adequately considered the wide range of concerns that have been expressed about the derivatives and hedging proposal, including concerns related to the potential impact on the capital markets, the weakening of companies’ ability to manage risk, and the adverse control implications of implementing costly and complex new rules imposed at the same time as other major initiatives, including the Year 2000 issues and a single European currency. We believe that these crucial issues must be considered, if not by the FASB, then by the Securities and Exchange Commission, other regulatory agencies, or Congress.
We believe it is essential that the FASB solicit all comments in order to identify and address all material issues that may exist before issuing a final standard. We understand the desire to bring this process to a prompt conclusion, but the underlying issues are so important to this nation’s businesses, the customers they serve and the economy as a whole that expediency cannot be the dominant consideration. As a result, we urge the FASB to expose its new proposal for public comment, following the established due process procedures that are essential to acceptance of its standards, and providing sufficient time to affected parties to understand and assess the new approach.
We also urge the SEC to study the comments received in order to assess the impact that these proposed rules may have on the capital markets, on companies’ risk management practices, and on management and financial controls. These vital public policy matters deserve consideration as part of the Commission’s oversight responsibilities.
We believe that these steps are essential if the FASB is to produce the best possible accounting standard while minimizing adverse economic effects and maintaining the competitiveness of U.S. businesses in the international marketplace.
Very truly yours,
(This letter was signed by the chairs of 22 of the largest U.S. companies.)
Answer the following questions.
(a) Explain the “due process” procedures followed by the FASB in developing a financial reporting standard.
(b) What is meant by the term “economic consequences” in accounting standard-setting?
(c) What economic consequences arguments are used in this letter?
(d) What do you believe is the main point of the letter?
(e) Why do you believe a copy of this letter was sent by the business community to influential members of the U.S. Congress?
USING YOUR JUDGMENT
Financial Reporting Problem
Beverly Crusher, a new staff accountant, is confused because of the complexities involving accounting standard-setting. Specifically, she is confused by the number of bodies issuing financial reporting standards of one kind or another and the level of authoritative support that can be attached to these reporting standards. Beverly decides that she must review the environment in which accounting standards are set, if she is to increase her understanding of the accounting profession.
Beverly recalls that during her accounting education there was a chapter or two regarding the environment of financial accounting and the development of GAAP. However, she remembers that her instructor placed little emphasis on these chapters.
(a) Help Beverly by identifying key organizations involved in accounting rule-making.
(b) Beverly asks for guidance regarding authoritative support. Please assist her by explaining what is meant by authoritative support.
(c) Give Beverly a historical overview of how rule-making has evolved so that she will not feel that she is the only one to be confused.
(d) What authority for compliance with GAAP has existed throughout the history of rule-making?
BRIDGE TO THE PROFESSION
CE1-1 Describe the main elements of the link labeled “Help, FAQ, Learning Guide, and About the Codification.”
CE1-2 Describe the procedures for providing feedback.
CE1-3 Briefly describe the purpose and content of the “What’s New” link.
Codification Research Case
As a newly enrolled accounting major, you are anxious to better understand accounting institutions and sources of accounting literature. As a first step, you decide to explore the FASB Conceptual Framework.
Go to the FASB website, http://www.fasb.org, to access the FASB Concepts Statements. When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following items. (Provide paragraph citations.)
(a) What is the objective of financial reporting?
(b) What other means are there of communicating information, besides financial statements?
(c) Indicate some of the users and the information they are most directly concerned with in economic decision making.
IFRS CONCEPTS AND APPLICATION
IFRS1-1 What organizations are the two key international players in the development of international accounting standards?
Explain their role.
IFRS1-2 What might explain the fact that different accounting standard-setters have developed accounting standards that are sometimes quite different in nature?
IFRS1-3 What is the benefit of a single set of high-quality accounting standards?
IFRS1-4 Briefly describe the FASB/IASB convergence process and the principles that guide their convergence efforts.
Financial Reporting Case
IFRS1-5 The following comments were made at an Annual Conference of the Financial Executives Institute (FEI).
There is an irreversible movement toward the harmonization of financial reporting throughout the world. The international capital markets require an end to:
- The confusion caused by international companies announcing different results depending on the set of accounting standards applied.
- Companies in some countries obtaining unfair commercial advantages from the use of particular national accounting standards.
- The complications in negotiating commercial arrangements for international joint ventures caused by different accounting requirements.
- The inefficiency of international companies having to understand and use a myriad of different accounting standards depending on the countries in which they operate and the countries in which they raise capital and debt. Executive talent is wasted on keeping up to date with numerous sets of accounting standards and the never-ending changes to them.
- The inefficiency of investment managers, bankers, and financial analysts as they seek to compare financial reporting drawn up in accordance with different sets of accounting standards.
(a) What is the International Accounting Standards Board?
(b) What stakeholders might benefit from the use of International Accounting Standards?
(c) What do you believe are some of the major obstacles to convergence?
IFRS1-6 As a newly enrolled accounting major, you are anxious to better understand accounting institutions and sources of accounting literature. As a first step, you decide to explore the IASB’s The Conceptual Framework for Financial Reporting.
(a) What is the objective of general-purpose financial reporting?
(b) What other means are there of communicating information, besides financial statements?
(c) Indicate some of the users and the information they are most directly concerned with in economic decision-making.
IFRS1-7 The financial statements of M&S are presented in Appendix E. The company’s complete annual report, including the notes to the financial statements, is available online.
Refer to M&S’s financial statements and the accompanying notes to answer the following questions.
(a) What is the company’s main line of business?
(b) In what countries does the company operate?
(c) What is the address of the company’s corporate headquarters?
(d) What is the company’s reporting currency?
CONCEPTS FOR ANALYSIS
CA1-1 (FASB and Standard-Setting) Presented below are four statements which you are to identify as true or false. If false, explain why the statement is false.
- GAAP is the term used to indicate the whole body of FASB authoritative literature.
- Any company claiming compliance with GAAP must comply with most standards and interpretations but does not have to follow the disclosure requirements.
- The primary governmental body that has influence over the FASB is the SEC.
- The FASB has a government mandate and therefore does not have to follow due process in issuing a standard.
CA1-2 (GAAP and Standard-Setting) Presented below are four statements which you are to identify as true or false. If false, explain why the statement is false.
- The objective of financial statements emphasizes a stewardship approach for reporting financial information.
- The purpose of the objective of financial reporting is to prepare a balance sheet, an income statement, a statement of cash flows, and a statement of owners’ or stockholders’ equity.
- Because they are generally shorter, FASB interpretations are subject to less due process, compared to FASB standards.
- The objective of financial reporting uses an entity rather than a proprietary approach in determining what information to report.
CA1-3 (Financial Reporting and Accounting Standards) Answer the following multiple-choice questions.
- GAAP stands for:
(a) governmental auditing and accounting practices.
(b) generally accepted attest principles.
(c) government audit and attest policies.
(d) generally accepted accounting principles.
- Accounting standard-setters use the following process in establishing accounting standards:
(a) Research, exposure draft, discussion paper, standard.
(b) Discussion paper, research, exposure draft, standard.
(c) Research, preliminary views, discussion paper, standard.
(d) Research, discussion paper, exposure draft, standard.
- GAAP is comprised of:
(a) FASB standards, interpretations, and concepts statements.
(b) FASB financial standards.
(c) FASB standards, interpretations, EITF consensuses, and accounting rules issued by FASB predecessor organizations.
(d) any accounting guidance included in the FASB Codification.
- The authoritative status of the conceptual framework is as follows.
(a) It is used when there is no standard or interpretation related to the reporting issues under consideration.
(b) It is not as authoritative as a standard but takes precedence over any interpretation related to the reporting issue.
(c) It takes precedence over all other authoritative literature.
(d) It has no authoritative status.
- The objective of financial reporting places most emphasis on:
(a) reporting to capital providers.
(b) reporting on stewardship.
(c) providing specific guidance related to specific needs.
(d) providing information to individuals who are experts in the field.
- General-purpose financial statements are prepared primarily for:
(a) internal users.
(b) external users.
(d) government regulators.
- Economic consequences of accounting standard-setting means:
(a) standard-setters must give first priority to ensuring that companies do not suffer any adverse effect as a result of a new standard.
(b) standard-setters must ensure that no new costs are incurred when a new standard is issued.
(c) the objective of financial reporting should be politically motivated to ensure acceptance by the general public.
(d) accounting standards can have detrimental impacts on the wealth levels of the providers of financial information.
- The expectations gap is:
(a) what financial information management provides and what users want.
(b) what the public thinks accountants should do and what accountants think they can do.
(c) what the governmental agencies want from standard-setting and what the standard-setters provide.
(d) what the users of financial statements want from the government and what is provided.
CA1-4 (Financial Accounting) Omar Morena has recently completed his first year of studying accounting. His instructor for next semester has indicated that the primary focus will be the area of financial accounting.
(a) Differentiate between financial accounting and managerial accounting.
(b) One part of financial accounting involves the preparation of financial statements. What are the financial statements most frequently provided?
(c) What is the difference between financial statements and financial reporting?
CA1-5 (Objective of Financial Reporting) Karen Sepan, a recent graduate of the local state university, is presently employed by a large manufacturing company. She has been asked by Jose Martinez, controller, to prepare the company’s response to a current
Preliminary Views published by the Financial Accounting Standards Board (FASB). Sepan knows that the FASB has a conceptual framework, and she believes that these concept statements could be used to support the company’s response to the
Preliminary Views. She has prepared a rough draft of the response citing the objective of financial reporting.
(a) Identify the objective of financial reporting.
(b) Describe the level of sophistication expected of the users of financial information by the objective of financial reporting.
CA1-6 (Accounting Numbers and the Environment) Hardly a day goes by without an article appearing on the continuing fallout from the financial crisis of 2008. An overheated real estate market, fueled by home purchase incentives, poor lending practices, and securitization through high-risk, mortgage-backed securities, led to a near collapse of global capital markets. As a consequence, many have argued that if the financial institutions had been required to report their loans (and loan-backed investments) at fair value instead of cost, large losses would have been reported earlier. This would have signaled regulators to the problems in the mortgage markets and therefore minimized the losses to U.S. taxpayers.
Explain how reported accounting numbers might affect an individual’s perceptions and actions. Cite two examples.
CA1-7 WRITING (Need for GAAP) Some argue that having various organizations establish accounting principles is wasteful and inefficient. Rather than mandating accounting rules, each company could voluntarily disclose the type of information it considered important. In addition, if an investor wants additional information, the investor could contact the company and pay to receive the additional information desired.
Comment on the appropriateness of this viewpoint.
CA1-8 (AICPA’s Role in Rule-Making) One of the major groups that has been involved in the standard-setting process is the American Institute of Certified Public Accountants. Initially, it was the primary organization that established accounting principles in the United States. Subsequently, it relinquished its power to the FASB.
(a) Identify the two committees of the AICPA that established accounting principles prior to the establishment of the FASB.
(b) Speculate as to why these two organizations failed. In your answer, identify steps the FASB has taken to avoid failure.
(c) What is the present role of the AICPA in the rule-making environment?
CA1-9 (FASB Role in Rule-Making) A press release announcing the appointment of the trustees of the new Financial Accounting
Foundation stated that the Financial Accounting Standards Board (to be appointed by the trustees) “. . . will become the established authority for setting accounting principles under which corporations report to the shareholders and others” (AICPA news release July 20, 1972).
(a) Identify the sponsoring organization of the FASB and the process by which the FASB arrives at a decision and issues an accounting standard.
(b) Indicate the major types of pronouncements issued by the FASB and the purposes of each of these pronouncements.
CA1-10 WRITING (Politicization of GAAP) Some accountants have said that politicization in the development and acceptance of generally accepted accounting principles (i.e., rule-making) is taking place. Some use the term “politicization” in a narrow sense to mean the influence by governmental agencies, particularly the Securities and Exchange Commission, on the development of generally accepted accounting principles. Others use it more broadly to mean the compromise that results when the bodies responsible for developing generally accepted accounting principles are pressured by interest groups (SEC, American Accounting Association, businesses through their various organizations, Institute of Management Accountants, financial analysts, bankers, lawyers, and so on).
(a) The Committee on Accounting Procedure of the AICPA was established in the mid- to late 1930s and functioned until 1959, at which time the Accounting Principles Board came into existence. In 1973, the Financial Accounting Standards Board was formed and the APB went out of existence. Do the reasons these groups were formed, their methods of operation while in existence, and the reasons for the demise of the first two indicate an increasing politicization (as the term is used in the broad sense) of accounting standard-setting? Explain your answer by indicating how the CAP, the APB, and the FASB operated or operate. Cite specific developments that tend to support your answer.
(b) What arguments can be raised to support the “politicization” of accounting rule-making?
(c) What arguments can be raised against the “politicization” of accounting rule-making? (CMA adapted)
CA1-11 (Models for Setting GAAP) Presented below are three models for setting GAAP.
- The purely political approach, where national legislative action decrees GAAP.
- The private, professional approach, where GAAP is set and enforced by private professional actions only.
- The public/private mixed approach, where GAAP is basically set by private-sector bodies that behave as though they were public agencies and whose standards to a great extent are enforced through governmental agencies.
(a) Which of these three models best describes standard-setting in the United States? Provide justification for your answer.
(b) Why do companies, financial analysts, labor unions, industry trade associations, and others take such an active interest in standard-setting?
(c) Cite an example of a group other than the FASB that attempts to establish accounting standards. Speculate as to why another group might wish to set its own standards.
CA1-12 GROUPWORK (GAAP Terminology) Wayne Rogers, an administrator at a major university, recently said, “I’ve got some CDs in my IRA, which I set up to beat the IRS.” As elsewhere, in the world of accounting and finance, it often helps to be fluent in abbreviations and acronyms.
Presented below is a list of common accounting acronyms. Identify the term for which each acronym stands, and provide a brief definition of each term.
(a) AICPA (e) FAF (i) FASB
(b) CAP (f) FASAC (j) SEC
(c) EITF (g) GAAP (k) IASB
(d) APB (h) CPA
CA1-13 ETHICS (Rule-Making Issues) When the FASB issues new pronouncements, the implementation date is usually 12 months from date of issuance, with early implementation encouraged. Karen Weller, controller, discusses with her financial vice president the need for early implementation of a rule that would result in a fairer presentation of the company’s financial condition and earnings. When the financial vice president determines that early implementation of the rule will adversely affect the reported net income for the year, he discourages Weller from implementing the rule until it is required.
Answer the following questions.
(a) What, if any, is the ethical issue involved in this case?
(b) Is the financial vice president acting improperly or immorally?
(c) What does Weller have to gain by advocacy of early implementation?
(d) Which stakeholders might be affected by the decision against early implementation? (CMA adapted)
CA1-14 (Securities and Exchange Commission) The U.S. Securities and Exchange Commission (SEC) was created in 1934 and consists of five commissioners and a large professional staff. The SEC professional staff is organized into five divisions and several principal offices. The primary objective of the SEC is to support fair securities markets. The SEC also strives to foster enlightened stockholder participation in corporate decisions of publicly traded companies. The SEC has a significant presence in financial markets, the development of accounting practices, and corporation-shareholder relations, and has the power to exert influence on entities whose actions lie within the scope of its authority.
(a) Explain from where the Securities and Exchange Commission receives its authority.
(b) Describe the official role of the Securities and Exchange Commission in the development of financial accounting theory and practices.
(c) Discuss the interrelationship between the Securities and Exchange Commission and the Financial Accounting
Standards Board with respect to the development and establishment of financial accounting theory and practices.
CONCEPTS FOR ANALYSIS
CA10-1 WRITING (Acquisition, Improvements, and Sale of Realty) Tonkawa Company purchased land for use as its corporate headquarters. A small factory that was on the land when it was purchased was torn down before construction of the office building began. Furthermore, a substantial amount of rock blasting and removal had to be done to the site before construction of the building foundation began. Because the office building was set back on the land far from the public road, Tonkawa Company had the contractor construct a paved road that led from the public road to the parking lot of the office building.
Three years after the office building was occupied, Tonkawa Company added four stories to the office building. The four stories had an estimated useful life of 5 years more than the remaining estimated useful life of the original office building.
Ten years later, the land and building were sold at an amount more than their net book value, and Tonkawa Company had a new office building constructed in another state for use as its new corporate headquarters.
(a) Which of the expenditures above should be capitalized? How should each be depreciated or amortized? Discuss the rationale for your answers.
(b) How would the sale of the land and building be accounted for? Include in your answer an explanation of how to determine the net book value at the date of sale. Discuss the rationale for your answer.
CA10-2 (Accounting for Self-Constructed Assets) Troopers Medical Labs, Inc., began operations 5 years ago producing stetrics, a new type of instrument it hoped to sell to doctors, dentists, and hospitals. The demand for stetrics far exceeded initial expectations, and the company was unable to produce enough stetrics to meet demand.
The company was manufacturing its product on equipment that it built at the start of its operations. To meet demand, more efficient equipment was needed. The company decided to design and build the equipment, because the equipment currently available on the market was unsuitable for producing stetrics.
In 2017, a section of the plant was devoted to development of the new equipment and a special staff was hired. Within 6 months, a machine developed at a cost of $714,000 increased production dramatically and reduced labor costs substantially.
Elated by the success of the new machine, the company built three more machines of the same type at a cost of $441,000 each.
(a) In general, what costs should be capitalized for self-constructed equipment?
(b) Discuss the propriety of including in the capitalized cost of self-constructed assets:
(1) The increase in overhead caused by the self-construction of fixed assets.
(2) A proportionate share of overhead on the same basis as that applied to goods manufactured for sale.
(c) Discuss the proper accounting treatment of the $273,000 ($714,000 − $441,000) by which the cost of the first machine exceeded the cost of the subsequent machines. This additional cost should not be considered research and development costs.
CA10-3 WRITING (Capitalization of Interest) Vania Magazine Company started construction of a warehouse building for its own use at an estimated cost of $5,000,000 on January 1, 2016, and completed the building on December 31, 2016. During the construction period, Vania has the following debt obligations outstanding…
Total cost amounted to $5,200,000, and the weighted average of accumulated expenditures was $3,500,000.
Jane Esplanade, the president of the company, has been shown the costs associated with this construction project and capitalized on the balance sheet. She is bothered by the “avoidable interest” included in the cost. She argues that, first, all the interest is unavoidable—no one lends money without expecting to be compensated for it. Second, why can’t the company use all the interest on all the loans when computing this avoidable interest? Finally, why can’t her company capitalize all the annual interest that accrued over the period of construction?
(Round the weighted-average interest rate to two decimal places.)
You are the manager of accounting for the company. In a memo, explain what avoidable interest is, how you computed it (being especially careful to explain why you used the interest rates that you did), and why the company cannot capitalize all its interest for the year. Attach a schedule supporting any computations that you use.
CA10-4 WRITING (Nonmonetary Exchanges) You have two clients that are considering trading machinery with each other.
Although the machines are different from each other, you believe that an assessment of expected cash flows on the exchanged assets will indicate the exchange lacks commercial substance. Your clients would prefer that the exchange be deemed to have commercial substance, to allow them to record gains. Here are the facts:…