www.elsolucionario.net CHAPTER Financial Accounting and Accounting Standards Topics Questions Cases Subject matter of accounting Environment of accounting 2, 3, 29 6, Role of principles, objectives, standards, and accounting theory 4, 5, 6, 1, 2, 3, Historical development of GAAP 8, 9, 10, 11 Authoritative pronouncements and rulemaking bodies 12, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22, 23 3, 9, 11, 12, 13, 14, 16, 17 Role of pressure groups 23, 24, 25, 26, 27, 28 10, 19, 20 Ethical issues 30 15, 18 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net ASSIGNMENT CLASSIFICATION TABLE 1-1 www.elsolucionario.net Item Description Level of Difficulty Time (minutes) CA1-1 CA1-2 CA1-3 CA1-4 CA1-5 CA1-6 CA1-7 CA1-8 CA1-9 CA1-10 CA1-11 CA1-12 CA1-13 CA1-14 CA1-15 CA1-16 CA1-17 CA1-18 CA1-19 CA1-20 FASB and standard-setting GAAP and standard-setting Financial reporting and accounting standards Financial accounting Objective of financial reporting Accounting numbers and the environment Need for GAAP AICPA’s role in rule-making FASB role in rule-making Politicalization of GAAP Models for setting GAAP GAAP terminology Accounting organizations and documents issued Accounting pronouncements Rule-making Issues Securities and Exchange Commission Rule-making process Financial reporting pressures Economic consequences GAAP and economic consequences Simple Simple Simple Simple Moderate Simple Simple Simple Simple Complex Simple Moderate Simple Simple Complex Moderate Moderate Moderate Moderate Moderate 15–20 15–20 15–20 15–20 20–25 10–15 15–20 20–25 20–25 30–40 15–20 30–40 15–20 10–15 20–25 30–40 25–35 25–35 25–35 25–35 1-2 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net ASSIGNMENT CHARACTERISTICS TABLE www.elsolucionario.net SOLUTIONS TO CODIFICATION EXERCISES CE1-1 There is no answer to this requirement as it asks the student to register to use the Codification CE1-2 (a) The Codification Overview module illustrates three items (1) the topic structure (2) different methods of accessing and viewing content, and (3) a summary of the unique features of the Codification Research System www.elsolucionario.net (b) The Codification is intended to (1) become the single source of U.S accounting standards and (2) supersede all of the non-SEC documents used to populate the Codification CE1-3 The “What’s New” page provides links to Codification content that has been recently issued During the verification phase, updates may result from either the issuance of Codification update instructions that accompany new Standards or from changes to the Codification due to incorporation of constituent feedback Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 1-3 www.elsolucionario.net ANSWERS TO QUESTIONS Financial accounting measures, classifies, and summarizes in report form those activities and that information which relate to the enterprise as a whole for use by parties both internal and external to a business enterprise Managerial accounting also measures, classifies, and summarizes in report form enterprise activities, but the communication is for the use of internal, managerial parties, and relates more to subsystems of the entity Managerial accounting is management decision oriented and directed more toward product line, division, and profit center reporting If a company’s financial performance is measured accurately, fairly, and on a timely basis, the right managers and companies are able to attract investment capital To provide unreliable and irrelevant information leads to poor capital allocation which adversely affects the securities market The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in decisions about providing resources to the entity through equity investments and loans or other forms of credit Information that is decision-useful to capital providers (investors) may also be useful to other users of financial reporting who are not investors Investors are interested in financial reporting because it provides information that is useful for making decisions (referred to as the decision-usefulness approach) When making these decisions, investors are interested in assessing the company’s (1) ability to generate net cash inflows and (2) management’s ability to protect and enhance the capital providers’ investments Financial reporting should therefore help investors assess the amounts, timing, and uncertainty of prospective cash inflows from dividends or interest, and the proceeds from the sale, redemption, or maturity of securities or loans In order for investors to make these assessments, the economic resources of an enterprise, the claims to those resources, and the changes in them must be understood A common set of standards applied by all businesses and entities provides financial statements which are reasonably comparable Without a common set of standards, each enterprise could, and would, develop its own theory structure and set of practices, resulting in noncomparability among enterprises General-purpose financial statements are not likely to satisfy the specific needs of all interested parties Since the needs of interested parties such as creditors, managers, owners, governmental agencies, and financial analysts vary considerably, it is unlikely that one set of financial statements is equally appropriate for these varied uses 1-4 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net Financial statements generally refer to the four basic financial statements: balance sheet, income statement, statement of cash flows, and statement of changes in owners’ or stockholders’ equity Financial reporting is a broader concept; it includes the basic financial statements and any other means of communicating financial and economic data to interested external parties Examples of financial reporting other than financial statements are annual reports, prospectuses, reports filed with the government, news releases, management forecasts or plans, and descriptions of an enterprise’s social or environmental impact www.elsolucionario.net Questions Chapter (Continued) The SEC has the power to prescribe, in whatever detail it desires, the accounting practices and principles to be employed by the companies that fall within its jurisdiction Because the SEC receives audited financial statements from nearly all companies that issue securities to the public or are listed on the stock exchanges, it is greatly interested in the content, accuracy, and credibility of the statements For many years the SEC relied on the AICPA to regulate the profession and develop and enforce accounting principles Lately, the SEC has assumed a more active role in the development of accounting standards, especially in the area of disclosure requirements In December 1973, in ASR No 150, the SEC said the FASB’s statements would be presumed to carry substantial authoritative support and anything contrary to them to lack such support It thereby supports the development of accounting principles in the private sector www.elsolucionario.net The Committee on Accounting Procedure was a special committee of the American Institute of CPAs that, between the years of 1939 and 1959, issued 51 Accounting Research Bulletins dealing with a wide variety of timely accounting problems These bulletins provided solutions to immediate problems and narrowed the range of alternative practices But, the Committee’s problem-by-problem approach failed to provide a well-defined and well-structured body of accounting theory that was so badly needed The Committee on Accounting Procedure was replaced in 1959 by the Accounting Principles Board 10 The creation of the Accounting Principles Board was intended to advance the written expression of accounting principles, to determine appropriate practices, and to narrow the differences and inconsistencies in practice To achieve its basic objectives, its mission was to develop an overall conceptual framework to assist in the resolution of problems as they became evident and to substantive research on individual issues before pronouncements were issued 11 Accounting Research Bulletins were pronouncements on accounting practice issued by the Committee on Accounting Procedure between 1939 and 1959; since 1964 they have been recognized as accepted accounting practice unless superseded in part or in whole by an opinion of the APB or an FASB standard APB Opinions were issued by the Accounting Principles Board during the years 1959 through 1973 and, unless superseded by FASB Statements, are recognized as accepted practice and constitute the requirements to be followed by all business enterprises FASB Statements are pronouncements of the Financial Accounting Standards Board and currently represent the accounting profession’s authoritative pronouncements on financial accounting and reporting practices 12 The explanation should note that generally accepted accounting principles or standards have “substantial authoritative support.” They consist of accounting practices, procedures, theories, concepts, and methods which are recognized by a large majority of practicing accountants as well as other members of the business and financial community Bulletins issued by the Committee on Accounting Procedure, opinions rendered by the Accounting Principles Board, and statements issued by the Financial Accounting Standards Board constitute “substantial authoritative support.” 13 It was believed that FASB Statements would carry greater weight than APB Opinions because of significant differences between the FASB and the APB, namely: (1) The FASB has a smaller membership, (2) full-time compensated members; (3) the FASB has greater autonomy, (4) increased independence; (5) the FASB has broader representation than the APB 14 The technical staff of the FASB conducts research on an identified accounting topic and prepares a “preliminary views” that is released by the Board for public reaction The Board analyzes and evaluates the public response to the preliminary views, deliberates on the issues, and issues an “exposure draft” for public comment The preliminary views merely present all facts and alternatives related to a specific topic or problem, whereas the exposure draft is a tentative “statement.” After studying the public’s reaction to the exposure draft, the Board may reevaluate its position, revise the draft, and vote on the issuance of a final statement Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 1-5 www.elsolucionario.net Questions Chapter (Continued) 15 Statements of financial accounting standards constitute generally accepted accounting principles and dictate acceptable financial accounting and reporting practices as promulgated by the FASB The first standards statement was issued by the FASB in 1973 16 Rule 203 of the Code of Professional Conduct prohibits a member of the AICPA from expressing an opinion that financial statements conform with GAAP if those statements contain a material departure from an accounting principle promulgated by the FASB, or its predecessors, the APB and the CAP, unless the member can demonstrate that because of unusual circumstances the financial statements would otherwise have been misleading Failure to follow Rule 203 can lead to a loss of a CPA’s license to practice This rule is extremely important because it requires auditors to follow FASB standards 17 FASB Standards, FASB Technical Bulletins, AICPA Practice Bulletins 18 The chairman of the FASB was indicating that too much attention is put on the bottom line and not enough on the development of quality products Managers should be less concerned with shortterm results and be more concerned with the long-term results In addition, short-term tax benefits often lead to long-term problems The second part of his comment relates to accountants being overly concerned with following a set of rules, so that if litigation ensues, they will be able to argue that they followed the rules exactly The problem with this approach is that accountants want more and more rules with less reliance on professional judgment Less professional judgment leads to inappropriate use of accounting procedures in difficult situations In the accountants’ defense, recent legal decisions have imposed vast new liability on accountants The concept of accountant’s liability that has emerged in these cases is broad and expansive; the number of classes of people to whom the accountant is held responsible are almost limitless 19 FASB Staff Positions (FSP) are used to provide interpretive guidance and to make minor amendments to existing standards The due process used to issue a FSP is the same used to issue a new standard 20 The Emerging Issues Task Force often arrives at consensus conclusions on certain financial reporting issues These consensus conclusions are then looked upon as GAAP by practitioners because the SEC has indicated that it will view consensus solutions as preferred accounting and will require persuasive justification for departing from them Thus, at least for public companies which are subject to SEC oversight, consensus solutions developed by the Emerging Issues Task Force are followed unless subsequently overturned by the FASB It should be noted that the FASB took greater direct ownership of GAAP established by the EITF by requiring that consensus positions be ratified by the FASB 1-6 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net Statements of financial accounting concepts not establish generally accepted accounting principles Rather, the concepts statements set forth fundamental objectives and concepts that the FASB intends to use as a basis for developing future standards The concepts serve as guidelines in solving existing and emerging accounting problems in a consistent, sound manner Both the standards statements and the concepts statements may develop through the same process from discussion memorandum, to exposure draft, to a final approved statement www.elsolucionario.net Questions Chapter (Continued) 21 The Financial Accounting Standards Board Accounting Standards Codification (Codifications) is a compilation of all GAAP in one place Its purpose is to integrate and synthesize existing GAAP and not to create new GAAP It creates one level of GAAP which is considered authoritative The FASB Codification Research Systems (CRS) is an-on-line real time data base which provides easy access to the Codification The Codification and the related CRS provide a topically organized structure which is subdivided into topic, subtopics, sections, and paragraphs 22 Hopefully, the codification will help users to better understand what GAAP is If this occurs, companies will be more likely to comply with GAAP and the time to research accounting issues will be substantially reduced In addition, through the electronic web-based format, GAAP can be easily updated which will help users stay current 23 The sources of pressure are innumerable, but the most intense and continuous pressure to change or influence accounting principles or standards come from individual companies, industry associations, governmental agencies, practicing accountants, academicians, professional accounting organizations, and public opinion www.elsolucionario.net 24 Economic consequences means the impact of accounting reports on the wealth positions of issuers and users of financial information and the decision-making behavior resulting from that impact In other words, accounting information impacts various users in many different ways which leads to wealth transfers among these various groups If politics plays an important role in the development of accounting rules, the rules will be subject to manipulation for the purpose of furthering whatever policy prevails at the moment No matter how well intentioned the rule maker may be, if information is designed to indicate that investing in a particular enterprise involves less risk than it actually does, or is designed to encourage investment in a particular segment of the economy, financial reporting will suffer an irreplaceable loss of credibility 25 No one particular proposal is expected in answer to this question The students’ proposals, however, should be defensible relative to the following criteria: (1) The method must be efficient, responsive, and expeditious (2) The method must be free of bias and be above or insulated from pressure groups (3) The method must command widespread support if it does not have legislative authority (4) The method must produce sound yet practical accounting principles or standards The students’ proposals might take the form of alterations of the existing methodology, an accounting court (as proposed by Leonard Spacek), or governmental device 26 Concern exists about fraudulent financial reporting because it can undermine the entire financial reporting process Failure to provide information to users that is accurate can lead to inappropriate allocations of resources in our economy In addition, failure to detect massive fraud can lead to additional governmental oversight of the accounting profession 27 The expectations gap is the difference between what people think accountants should be doing and what accountants think they can It is a difficult gap to close The accounting profession recognizes it must play an important role in narrowing this gap To meet the needs of society, the profession is continuing its efforts in developing accounting standards, such as numerous pronouncements issued by the FASB, to serve as guidelines for recording and processing business transactions in the changing economic environment Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 1-7 www.elsolucionario.net Questions Chapter (Continued) 28 The following are some of the key provisions of the Sarbanes-Oxley Act: • Establishes an oversight board for accounting practices The Public Company Accounting Oversight Board (PCAOB) has oversight and enforcement authority and establishes auditing, quality control, and independence standards and rules • Implements stronger independence rules for auditors Audit partners, for example, are required to rotate every five years and auditors are prohibited from offering certain types of consulting services to corporate clients • Requires CEOs and CFOs to personally certify that financial statements and disclosures are accurate and complete and requires CEOs and CFOs to forfeit bonuses and profits when there is an accounting restatement • Requires audit committees to be comprised of independent members and members with financial expertise • Requires codes of ethics for senior financial officers 29 Some major challenges facing the accounting profession relate to the following items: Nonfinancial measurement—how to report significant key performance measurements such as customer satisfaction indexes, backlog information and reject rates on goods purchased Forward-looking information—how to report more future oriented information Soft assets—how to report on intangible assets, such as market know-how, market dominance, and well-trained employees Timeliness—how to report more real-time information 30 Accountants must perceive the moral dimensions of some situations because GAAP does not define or cover all specific features that are to be reported in financial statements In these instances accountants must choose among alternatives These accounting choices influence whether particular stakeholders may be harmed or benefited Moral decision-making involves awareness of potential harm or benefit and taking responsibility for the choices 1-8 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net In addition, Section 404 of the Sarbanes-Oxley Act requires public companies to attest to the effectiveness of their internal controls over financial reporting www.elsolucionario.net TIME AND PURPOSE OF CONCEPTS FOR ANALYSIS CA 1-1 (Time 15–20 minutes) Purpose—to provide the student with an opportunity to answer questions about FASB and standard setting CA 1-2 (Time 15–20 minutes) Purpose—to provide the student with an opportunity to answer questions about FASB and standard setting CA 1-3 (Time 15–20 minutes) Purpose— to provide the student with an opportunity to answer questions about financial reporting and accounting standards topics www.elsolucionario.net CA 1-4 (Time 15–20 minutes) Purpose— to provide the student with an opportunity to distinguish between financial accounting and managerial accounting, identify major financial statements, and differentiate financial statements and financial reporting CA 1-5 (Time 20–25 minutes) Purpose—to provide the student with an opportunity to explain the basic objective of financial reporting CA 1-6 (Time 10–15 minutes) Purpose—to provide the student with an opportunity to describe how reported accounting numbers might affect an individual’s perceptions and actions CA 1-7 (Time 15–20 minutes) Purpose— to provide the student with an opportunity to evaluate the viewpoint of removing mandatory accounting rules and allowing each company to voluntarily disclose the information it desired CA 1-8 (Time 20–25 minutes) Purpose—to provide the student with an opportunity to explain the evolution of accounting rule-making organizations and the role of the AICPA in the rule making environment CA 1-9 (Time 20–25 minutes) Purpose—to provide the student with an opportunity to identify the sponsoring organization of the FASB, the method by which the FASB arrives at a decision, and the types and the purposes of documents issued by the FASB CA 1-10 (Time 30–40 minutes) Purpose—to provide the student with an opportunity to focus on the types of organizations involved in the rule making process, what impact accounting has on the environment, and the environment’s influence on accounting CA 1-11 (Time 15–20 minutes) Purpose—to provide the student with an opportunity to focus on what type of rule-making environment exists in the United States In addition, this CA explores why user groups are interested in the nature of GAAP and why some groups wish to issue their own rules CA 1-12 (Time 30–40 minutes) Purpose—to provide the student with an opportunity to identify and define acronyms appearing in the first chapter Some are self-evident, others are not so Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 1-9 www.elsolucionario.net Asset turnover Inventory turnover = Net sales Average total assets = $30,500 ($17,000 + $16,000) ÷ = 1.85 times = Cost of goods sold Average inventory = $17,600 ($6,000 + $5,400) ÷ = 3.09 times (b) The analytical use of each of the six ratios presented above and what investors can learn about RNA’s financial stability and operating efficiency are presented below Current ratio • Measures the ability to meet short-term obligations using shortterm assets • RNA’s current ratio has declined over the last three years from 1.62 to 1.57 This declining trend, coupled with the fact that it is below the industry average, is not yet a major concern; however, the company should be watched in the future as the ratio assumes that noncash current assets (particularly inventory) can be quickly converted to cash at or close to book value Acid-test ratio • Measures the ability to meet short-term debt using the most liquid assets • 24-48 RNA’s acid-test ratio has remained stable over the last three years; however, it is still below the industry average Furthermore, a quick ratio below indicates that RNA may have difficulty meeting its shortterm obligations if inventory does not turn over fast enough Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net *FINANCIAL STATEMENT ANALYSIS CASE (Continued) www.elsolucionario.net *FINANCIAL STATEMENT ANALYSIS CASE (Continued) Times interest earned • Measures the ability to meet interest commitments from current earnings The higher the ratio, the more safety for long-term creditors • RNA’s ratio has been improving over the last three years and is above the industry average This provides an indication that RNA has been paying down or refinancing debt and/or increasing sales and profits, which indicates long-term stability www.elsolucionario.net Profit margin on sales • Measures the net income generated by each dollar of sales It provides some indication of the ability to absorb cost increases or sales declines • RNA’s profit margin has been improving and is currently above the industry average, indicating a trend towards marginal operating efficiency Furthermore, it improves the ability to absorb soft economic periods, pay down debt, or take on additional debt for expansion Total asset turnover • Measures the efficiency of resource use; i.e., the ability to generate sales through the use of assets • RNA’s ratio has been steadily improving and is above the industry average, indicating good use of assets and ability to generate sales Inventory turnover • Measures how quickly inventory is sold, as well as how effectively investment in inventory is used It also provides a basis for determining if obsolete inventory is present or pricing problems exist • RNA’s ratio has been steadily declining and is below the industry average This slower-than-average situation may indicate a decline in operating efficiency, hidden obsolete inventory, or overpriced stock items Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 24-49 www.elsolucionario.net *FINANCIAL STATEMENT ANALYSIS CASE (Continued) (c) Limitations of ratio analysis include: • Difficulty making comparisons among firms in the same industry due to accounting differences Different accounting methods may cause different results in straight-line depreciation versus accelerated methods, LIFO versus FIFO, etc www.elsolucionario.net • The fact that no one ratio is conclusive 24-50 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net ACCOUNTING, ANALYSIS, AND PRINCIPLES Accounting Integral Approach 2nd Quarter 3rd Quarter 4th Quarter $320,000 $600,000 $2,200,000 $480,000 32,000 64,000 60,000 120,000 220,000 440,000 48,000 96,000 28,000 52,500 192,500 42,000 96,000 $100,000 180,000 $187,500 660,000 $ 687,500 144,000 $150,000 www.elsolucionario.net Sales Less: Variable manufacturing costs Fixed manufacturing costs Variable non-manufacturing costs Fixed non-manufacturing costs Net income 1st Quarter Sales = (Number of units X $4.00) Variable manufacturing costs = (Number of units X $0.40) Variable non-manufacturing costs = (Number of units X $0.35) Fixed manufacturing costs = Number of units X ($720,000 ÷ 900,000) Fixed non-manufacturing costs = Number of units X ($1,080,000 ÷ 900,000) Discrete Approach Sales Less: Variable manufacturing costs Fixed manufacturing costs Variable non-manufacturing costs *Fixed non-manufacturing costs Net income (Loss) 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $320,000 $600,000 $2,200,000 $480,000 32,000 64,000 60,000 120,000 220,000 440,000 48,000 96,000 52,500 270,000 $ 97,500 192,500 270,000 $1,077,500 42,000 270,000 $ 24,000 28,000 270,000 ($ 74,000) *$1,080,000 ữ Copyright â 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 24-51 www.elsolucionario.net ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) Analysis Profit margin on sales = Net income ÷ Net sales Integral approach: Net income (Loss) Net sales Profit margin on sales 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $100,000 320,000 31.3% $187,500 600,000 31.3% $687,500 2,200,000 31.3% $150,000 480,000 31.3% 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter $(74,000) 320,000 (23.1%) $97,500 600,000 16.3% $1,077,500 2,200,000 49.0% $24,000 480,000 5.0% Net income (Loss) Net sales Profit margin on sales The integral approach smoothes variation in profit margin on sales across quarters relative to the discrete approach This smoothing happens because the integral approach allocates fixed costs across quarters according to the sales occurring in the quarter The discrete approach, however, allocates fixed costs across quarters evenly (an equal amount each quarter) Because the sales vary from quarter-to-quarter, an even allocation of fixed costs to the quarter’s results in more variation in net income Principles The concept underlying the integral approach is that an individual quarter is part of a larger time interval about which we have more information In this problem, for example, we know that sales are seasonal So, we know that a greater proportion of the revenue generating process occurs in the third quarter than in the other quarters Arguably, then, a greater proportion of the fixed costs for the year should be allocated to the third quarter than to the other quarters Part of the reason we incur fixed costs at the level we is so that we can handle the volume of the third quarter Allocating the same amount of fixed costs to each quarter paints a picture of the firm’s profitability across quarters that is arguably inaccurate 24-52 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net Discrete approach: www.elsolucionario.net PROFESSIONAL RESEARCH (a) According to FASB ASC 235-10-50: www.elsolucionario.net 50-3 Disclosure of accounting policies shall identify and describe the accounting principles followed by the entity and the methods of applying those principles that materially affect the determination of financial position, cash flows, or results of operations In general, the disclosure shall encompass important judgments as to appropriateness of principles relating to recognition of revenue and allocation of asset costs to current and future periods; in particular, it shall encompass those accounting principles and methods that involve any of the following: a A selection from existing acceptable alternatives b Principles and methods peculiar to the industry in which the entity operates, even if such principles and methods are predominantly followed in that industry c Unusual or innovative applications of GAAP (b) According to FASB ASC 235-10-50 Examples of Disclosures 50-4 Examples of disclosures by an entity commonly required with respect to accounting policies would include, among others, those relating to the following: a Basis of consolidation b Depreciation methods c Amortization of intangibles d Inventory pricing e Accounting for recognition of profit on long-term constructiontype contracts f Recognition of revenue from franchising and leasing operations Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 24-53 www.elsolucionario.net PROFESSIONAL SIMULATION Analysis The acid-test ratio is an unfavorable indication as to solvency, especially when the current ratio increase is also considered This decline is also unfavorable to the going-concern prospects of the client because it reflects a declining cash position and raises questions as to reasons for the increases in other current assets, such as inventories The increase in the ratio of property, plant, and equipment to stockholders’ equity cannot alone tell anything about either solvency or going-concern prospects There is no way to know the amount and direction of the changes in the two items If assets increased, one must know whether the new assets are immediately productive or need further development A reduction in stockholders’ equity at this point would cause much concern for the creditors of this client The decrease in the ratio of sales to stockholders’ equity is in itself an unfavorable indicator because the most likely reason is a sales decline However, this decline, which is more relevant to going-concern prospects than to solvency, is largely offset by the fact that net income has significantly increased The increase in net income is a favorable indicator for both solvency and going-concern prospects although much depends on the quality of receivables generated from sales and how quickly they can be converted into cash A significant factor here may be that despite a decline in sales, the client’s management has been able to reduce costs to produce this increase Indirectly, the improved income picture may have a favorable impact on solvency and going-concern potential by enabling the client to borrow currently to meet cash requirements 24-54 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net The current-ratio increase is a favorable indication as to solvency, but alone tells little about the going-concern prospects of the client From this ratio change alone, it is impossible to know the amount and direction of the changes in individual accounts, total current assets, and total current liabilities Also unknown are the reasons for the changes www.elsolucionario.net PROFESSIONAL SIMULATION (Continued) The 32-percent increase in earnings per common share, which is identical to the percentage increase in net income, is an indication that there has probably been no change in the number of shares of common stock outstanding This in turn indicates that financing was not obtained through the issuance of common stock It is not possible to reach conclusions about solvency and going-concern prospects without additional information about the nature and extent of financing www.elsolucionario.net The percentage increases in book value per common share demonstrate nothing so far as solvency and going-concern potential are concerned It is probable that the smaller percentage increase in the current year only reflects the larger base value created in the preceding year It is not possible to tell from these figures what the dividend policy of the client is or whether there is an increase in net assets which is capable of generating future earnings, thus making it possible to raise capital for current needs by the issue of additional common stock The collective implications of these data alone are that the client entity is about as solvent and as viable as a going concern at the end of the current year as it was at the beginning although there may be a need for short-term operating cash Explanation The creditors will probably ask for the information listed below to overcome the limitations inherent in the ratios discussed above and to obtain more evidence to support the conclusions drawn from them Additional ratios and other comparative data may be requested They are likely to include such items as the following: (a) Changes in current assets other than quick assets (b) Receivables turnover, inventory turnover, and the number of days it takes to complete the cycle from cash to inventories to receivables to cash (c) Liabilities to stockholders’ equity The creditors will probably want explanations for the changes in ratios during the current year The client should be prepared to respond to questions about the age and collectibility of the receivables, the condition and salability of the inventories, the cause of the quickasset position in the current year, the nature of increases in property, Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 24-55 www.elsolucionario.net PROFESSIONAL SIMULATION (Continued) plant, and equipment and their potential for providing greater sales or cost reductions in the future, the presence of long-term debt and the dates when it must be repaid, and the manner of controlling costs so that a larger net income was shown in the current year (The comparative financial statements themselves will answer many of these questions and will provide insight into the client’s capability of meeting current obligations as well as continuing profitable operations.) The client may also be expected to provide information about future plans and projections The creditors may also ask for ratios and related information for several recent years These data may demonstrate trends and can be compared to data for other companies and for the industry Although a quick evaluation of a reporting entity can be made using only a few ratios and comparing these with past ratios and industry statistics, the creditors should realize the limitations of such analysis even from the best prepared statements carrying a CPA’s unqualified opinion A limitation on comparisons with industry statistics or other companies within the industry exists because material differences can be created through the use of alternative (but acceptable) accounting methods Further, when evaluating changes in ratios or percentages, the evaluation should be directed to the nature of the item being evaluated because very small differences in ratios or percentages can represent significant changes in dollar amounts or trends The creditors should evaluate conclusions drawn from ratio analysis in the light of the current status of, and expected changes in, such things as general economic conditions, the client’s competitive position, the public’s demand (for the product itself, increased quality of the product, control of noise and pollution, etc.), and the client’s specific plans 24-56 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net www.elsolucionario.net IFRS CONCEPTS AND APPLICATION IFRS24-1 The IFRS standards addressing related party disclosures are: IAS (“First Time Adoption of IFRS”); IAS 24 (“Related Party Disclosures”); disclosure and recognition of post-balance sheet events in IAS 10 (“Events after the Balance Sheet Date”); segment reporting provisions in IFRS (“Operating Segments”); and interim reporting requirements are presented in IAS 34 (“Interim Financial Reporting”) www.elsolucionario.net IFRS24-2 There are two types of subsequent events: (a) (b) (c) (d) (e) (f) (g) (h) (1) Those which affect the financial statements directly and should be recognized therein through appropriate adjustments (2) Those which not affect the financial statements directly and require no adjustment of the account balances but whose effects may be significant enough to be disclosed with appropriate figures or estimates shown Probably adjust the financial statements directly Disclosure Disclosure Disclosure Neither adjustment nor disclosure necessary Neither adjustment nor disclosure necessary Probably adjust the financial statements directly Neither adjustment nor disclosure necessary Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 24-57 www.elsolucionario.net IFRS24-3 (1) Net income will decrease by $10,000 ($160,000 –$170,000) as a result of the adjustment of the liability The settlement of the liability is the type of subsequent event which provides additional evidence about conditions that existed at the statement of financial position date (2) The flood loss ($80,000) is an event that provides evidence about conditions that did not exist at the statement of financial position date but are subsequent to that date and does not require adjustment of the financial statements (a) The issuance of ordinary shares is an example of a subsequent event which provides evidence about conditions that did not exist at the statement of financial position date but arose subsequent to that date Therefore, no adjustment to the financial statements is recorded However, this event should be disclosed either in a note, a supplemental schedule, or even proforma financial data (b) The changed estimate of income taxes payable is an example of a subsequent event which provides additional evidence about conditions that existed at the statement of financial position date The income tax liability existed at December 31, 2012, but the amount was not certain This event affects the estimate previously made and should result in an adjustment of the financial statements The correct amount ($1,320,000) would have been recorded at December 31 if it had been available Therefore, Keystone should increase income tax expense in the 2012 income statement by $220,000 ($1,320,000 – $1,100,000) In the statement of financial position, income taxes payable should be increased and retained earnings decreased by $220,000 IFRS24-5 (a) (c) (b) (b) (c) (b) 24-58 Copyright © 2011 John Wiley & Sons, Inc (c) (c) (a) 10 11 12 Kieso, Intermediate Accounting, 14/e, Solutions Manual (c) (a) (b) (For Instructor Use Only) www.elsolucionario.net IFRS24-4 www.elsolucionario.net IFRS24-6 Interim reports are unaudited financial statements normally prepared four times a year A complete set of interim financial statements is often not provided because this information is not deemed crucial over a short period of time; the income figure has much more relevance to interim reporting The accounting problems related to the presentation of interim data are as follows: (a) The difficulty of allocating costs, such as income taxes, pensions, etc., to the proper quarter (b) Problems of fixed cost allocation www.elsolucionario.net IFRS24-7 A company records losses from inventory write-downs in an interim period similar to how it would record them in annual financial statements However, if an estimate from a prior interim period changes in a subsequent interim period of that year, the write-down is adjusted in the subsequent interim period IFRS24-8 While U.S GAAP has a preference for the integral approach, IFRS leans toward the discrete approach to interim reports Thus, if an IFRS company expenses interim amounts, like advertising expenditures that could benefit later interim periods, it may be difficult to compare to a U.S company that would spread the cost across interim periods IFRS24-9 (a) The company should report its quarterly results as if each interim period is discrete Under the discrete approach the amounts should be reported as the company’s revenue and expenses would be reported as follows on its quarterly report prepared for the first quarter of the 2012–2013 fiscal year: Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 24-59 www.elsolucionario.net IFRS24-9 (Continued) Sales revenue Cost of goods sold Variable selling expenses Fixed selling expenses Advertising Other $60,000,000 36,000,000 1,000,000 2,000,000 1,000,000 (b) The financial information to be disclosed to its shareholders in its quarterly reports as a minimum include: 24-60 Statement that the same accounting policies and methods of computation are followed in the interim financial statements as compared with the most recent annual financial statements or, if those policies or methods have been changed, a description of the nature and effect of the change Explanatory comments about the seasonality or cyclicality of interim operations The nature and amount of items affecting assets, liabilities, equity, net income, or cash flows that are unusual because of their nature, size, or incidence The nature and amount of changes in accounting policies and estimates of amounts previously reported Issuances, repurchases, and repayments of debt and equity securities Dividends paid (aggregate or per share) separately for ordinary shares and other shares Segment information, as required by IFRS 8, “Operating Segments.” Changes in contingent liabilities or contingent assets since the end of the last annual reporting period Effect of changes in the composition of the company during the interim period, such as business combinations, obtaining or losing control of subsidiaries and long-term investments, restructurings, and discontinued operations Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net Sales revenue and cost of goods sold and other expenses receive the same treatment as if this were an annual report Costs and expenses other than product costs should be charged to expense in interim periods as incurred or allocated among interim periods www.elsolucionario.net IFRS24-9 (Continued) 10 Other material events subsequent to the end of the interim period that have not been reflected in the financial statements for the interim period IFRS24-10 (a) According to IAS 1, paragraph 117, “An entity shall disclose in the summary of significant accounting policies: the measurement basis (or bases) used in preparing the financial statements, and (2) the other accounting policies used that are relevant to an understanding of the financial statements.” www.elsolucionario.net (1) (b) (1) A few examples taken from IAS 1: • Paragraph 118: It is important for an entity to inform users of the measurement basis or bases used in the financial statements • Paragraph 120: Each entity considers the nature of its operations and the policies that the users of its financial statements would expect to be disclosed for that type of entity • Paragraph 122: An entity shall disclose, in the summary of significant accounting policies or other notes, the judgements, apart from those involving estimations (see paragraph 125), that management has made in the process of applying the entity’s accounting policies and that have the most significant effect on the amounts recognised in the financial statements • Paragraph 124: Some of the disclosures made in accordance with paragraph 122 are required by other IFRSs For example, IAS 27 requires an entity to disclose the reasons why the entity’s ownership interest does not constitute control, in respect of an investee that is not a subsidiary even though more than half of its voting or potential voting power is owned directly or indirectly through subsidiaries IAS 40 Investment Property requires disclosure of the criteria developed by the entity to distinguish investment property from owner-occupied property and from property held for sale in the ordinary course of business, when classification of the property is difficult Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 24-61 www.elsolucionario.net IFRS24-11 (b) M&S reported segments for its UK and International UK was further segmented into general merchandise and food International was segmented into wholesale and retail The UK segment is the largest segment in terms of revenue and assets M&S does not report its largest customer (c) The only interim information reported are the provisional dates for interim dividends that are expected to occur in 2010 (subsequent to the report date) 24-62 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net (a) The specific items M&S discusses in Note are basis of preparation; accounting convention; basis of consolidation; revenue; exceptional items; dividends; pensions; intangible assets; property, plant and equipment; investment properties; leasehold prepayments; inventories; provisions; share-based payments; foreign currencies; taxation; financial instruments; derivative financial instruments and hedging activities; critical accounting estimates and judgments; and non-GAAP performance measures ... Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) www.elsolucionario.net Statements of financial accounting concepts not establish generally accepted accounting. .. generally accepted accounting principles Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 2-11 www.elsolucionario.net SOLUTIONS... John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 1-3 www.elsolucionario.net ANSWERS TO QUESTIONS Financial accounting measures, classifies,