(Test Bank) Financial Reporting And Analysis

Gibson, 13

Business

Test Bank

13th Edition

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Financial Reporting and Analysis (13 Ed .) Charles H. Gibson Test Bank 2021 25 Chapter 1 Introduction to Financial Reporting QUESTIONS 1- 1. a. The AICPA is an organization of CPAs that prior to 1973 accepted the primary responsibility for the development of generally accepted accounting principles. Their role was substantially re duced in 1973 when the Financial Accounting Standards Board was established. Their role was further reduced with the establishment of the Public Company Accounting Oversight Board was established in 2002. b. The Financial Accounting Standards Board repl aced the Accounting Principles Board as the primary rule -making body for accounting standards . It is an independent organization and includes members other than public accountants. c. The SEC has the authority to determine generally accepted accounting principles and to regulate the accounting profession. The SEC has elected to leave much of the determination of generally accepted accounting principles to the private sec tor. T he Financial Accounting Standards Board has played the major role in establis hing accounting standards since 1973. Regulation of the accounting profession was substantially turned over to the Public Company Accounting Oversight Board in 2002. 1- 2. Consistency is obtained through the application of the same accounting principle f rom period to period. A change in principle requires statement disclosure. 1- 3. The concept of historical cost determines the balance sheet valuation of land. The realization concept requires that a transaction needs to occur for the profit to be recog nized. 1- 4. a. Entity e. Historical cost b. Realization f. Historical cost c. Materiality g. Disclosure d. Conservatism 1- 5. Entity concept 1- 6. Generally accepted accounting principles do not ap ply when a firm does not appear to be a go ing concern. If the decision is made that this is not a going concern, then the use of GAAP would not be appropriate. 26 1- 7. With the time period assumption, inaccuracies of accounting for the entity, short of its complete life span, are accepted. The assumption is made that the entity can be accounted for reasonably accurately for a particular period of time. In other words, the decision is made to accept some inaccuracy because of incomplete information about th e future in exchange for more timely reporting. The statements are considered to be meaningful because material inaccuracies are not acceptable. 1- 8. It is true that the only accurate way to account for the success or failure of an entity is to accumula te all transactions from the opening of business until the business eventually liquidates. But it is not necessary that the statements be completely accurate in order for them to be meaningful. 1- 9. a. A year that ends when operations are at a low ebb f or the year. b. The accounting time period is ended on December 31. c. A twelve -month accounting period that ends at the end of a month other than December 31. 1-10. Money. 1-11. When money does not hold a stable value, the financial statements can l ose much of their significance. To the extent that money does not remain stable, it loses usefulness as the standard for measuring financial transactions. 1-12. No. There is a problem with determining the index in order to adjust the statements. The it ems that are included in the index must be representative . In addition, the price s of items change because of various factors, such as quality, technology, and inflation. Yes. A reasonable adjustment to the statements can be made for inflation. 1-13. False. An arbitrary write -off of inventory cannot be justified under the conservatism concept. The conservatism concept can only be applied where there are alternative measurements and each of these alternative measurements has reasonable support. 1-14. Yes, inventory that has a market value below the historical cost should be written down in order to recognize a loss. This is done based upon the concept of conservatism. Losses that can be reasonably anticipated should be taken in order to reflect the l east favorable effect on net income of the current period. 27 1-15. End of production The realization of revenue at the completion of the production process is acceptable when the price of the item is known and there is a ready market. Receipt of cash This method should only be used when the prospects of collection are especially doubtful at the time of sale. During production This method is allowed for long -term construction projects because recognizing revenue on long -term construction projects as wor k progresses tends to give a fairer picture of the results for a given period in comparison with having the entire revenue realized in one period of time. 1-16. It is difficult to apply the matching concept when there is no direct connection between the c ost and revenue. Under these circumstances, accountants often charge off the cost in the period incurred in order to be conservative. 1-17. If the entity can justify the use of an alternative accounting method on the basis that it is rational , then the c hange can be made. 1-18. The accounting reports must disclose all facts that may influence the judgment of an informed reader. Usually this is a judgment decision for the accountant to make. Because of the complexity of many businesses and the increased expectations of the public, the full disclosure concept has become one of the most difficult concepts for the accountant to apply. 1-19. There is a preference for the use of objectivity in the preparation of financial statements, but financial statements cannot be completely prepared based upon objective data; estimates must be made in many situations. 1-20. This is a true statement. The concept of materiality allow s the accountant to handle immaterial items in the most economical and expedient manner possible. 1-21. Some industry practices lead to accounting reports that do not conform to generally accepted accounting principles. These reports are considered to be acceptable, but the accounting profession is making an effort to eliminate particular in dustry practices that do not conform to the normal generally accepted accounting principles. 1-22. Events that fall outside of the financial transactions of the entity are not recorded. An example would be the loss of a major customer. 28 1-23. True. The accounting profession is making an effort to reduce or eliminate specific industry practices. 1-24. The entity must usually use the accrual basis of accounting. Only under limited circumstances can the entity use the cash basis. 1-25. The FASB commenced the Accounting Standards Codification™ project to provide a single source of authoritative U.S. GAAP and provide one level of authoritative GAAP. 1-26. The separate entity concept directs that personal transactions of the owners must be kept separate fro m their business transactions. 1-27. At the point of sale 1-28. a. The building should b e recorded at cost, which is $50,000. b. Revenue should not be re corded for the savings between the cost of $50,000 an d the bid of $60,000. Revenue comes from sellin g, not from purchasing. 1-29. The materiality concept supports this policy. 1-30. The Securitie s and Exchange Commission (SEC) . 1-31. The basic problem with the monetary assumption when there has been significant inflation is that the monetary assumptio n assumes a stable dollar in terms of purchasing power. When there has been inflation, the dollar has not been stable in terms of purchasing power , and therefore, dollars are being compared that are not of the same purchasing power. 1-32. The matching pr inciple deals with the costs to be matched against revenue. The realization concept has to do with the determination of revenue. The combination of revenue and costs determine income. 1-33. The term "generally accepted accounting principles" is used to refer to accounting principles that have substantial authoritative support. 1-34. The process of considering a Statement of Financial Accounting Standards begins when the Board elects to add a topic to its technical agenda. The Board only considers topic s that are "broke n" for its technical agenda. On projects with a broad impact, a Discussion Memorandum or an Invitation to Comment is issued. The Discussion Memorandum or Invitation to Comment is distributed as a basis for public comment. After conside ring the written comments and the public hearing comments, the Board resumes deliberations in one or more public Board meetings. The final Statement on Financial Accounting Standards must receive a majority affirmative vote of the Board. 29 1-35. The FASB C onceptual Framework for Accounting and Reporting is intended to set forth a system of interrelated objectives and underlying concepts that will serve as the basis for evaluating existing standards of financial accounting and reporting. 1-36. a. A committe e of the AICPA that played an important role in the determination of generally accepted accounting principles in the United States between 1939 and 1959. b. A committee of the AICPA that played an important role in the defining of accou nting terminology between 1939 and 1959. c. An AICPA board that played a leading role in the development of generally accepted accounting principles in the United States between 1959 and 1973. d. The Board that has p layed the leading role in the development of generally accepted accounting principles in the United States since 1973. 1-37. Concepts Statement No. 1 indicates that the objectives of general -purpose external financial reporting are primarily for the needs of external users who lack the authority to prescribe the information they want and must rely on information management communicates to them. 1-38. Financial accounting is not designed to measure directly the value of a business enterprise. Concepts Statement No. 1 indicates that financial accounting is no t designed to measure directly the value of a business enterprise, but the information it provides may be helpful to those who wish to estimate its value. 1-39. According to Concepts Statement No. 2, to be relevant, information must be timely and it must have predictive value or feedback value , or both. To be reliable, information must have representational faithfulness and it must be verifiable and neutral. 1-40. 1. Definition 2. Measurability 3. Relevance 4. Reliability 1-41. 1. Historical co st 2. Current cost 3. Current market value 4. Net realizable value 5. Present value 30 1-42. The accrual basis income statement recognizes revenue when it is realized (realization concept) and expenses recognized when they are incurred (matching conc ept). The cash basis recognizes revenue when the cash is received and expenses when payments are made. 1-43. True. Usually the cash basis does not indicate when the revenue was earned and when the cost should be recognized. The cash basis recognizes ca sh receipts as revenue and cash payments as expenses. 1-44. When cash is received and when payment is made is important. For example, the timing of cash receipts and cash payments can have a bearing on a company's ability to pay bills on t ime. 1-45. Sarbanes -Oxley Section 404 requires companies to document adequate internal controls and procedures for financial reporting. They must be able to assess the effectiveness of the internal controls and financial reporting. 1-46. The financial statements auditor must report on management’s assertion as to the effectiveness of the internal controls and procedures as of the company’s year end. 1-47. There have been many benefits for implementing Sarbanes -Oxley. Companies have improved their internal controls, procedures, and financial reporting. Many companies have improved their fraud prevention. Systems put in place to review budgets will enable companies to be more proactive in preventing problems and improve their ability to be proactive. Users of financial statements benefit fr om an improved financial product that they review and analyze to make investment decisions. 1-48. Private companies are not required to report under Sarbanes -Oxley. 1-49. In many instances, the natural business year of a company ends on December 31. Other businesse s use the calendar year and thus end the accounting on December 31. For a fiscal year, the accounting period closes at the end of a month other than December. 1-50. Accounting Trends & Techniques is a compilation of data obtained by a survey of 600 annual repo rts to stockholders undertaken for the purpose of analyzing the accounting information disclosed in such reports. 1-51. The Sarbanes -Oxley Act of 2002 has put demands on management to detect and prevent material control weaknesses in a timely manner. 1-52. The PCAOB is the private sector corporation created by the Sarbanes -Oxley Act of 2002. They are responsible for overseeing the audits of public companies. They have broad authority over public accounting firms and auditors. Their actions are subject to the appro val of the Securities and Exchange Commission. 31 1-53. The Serious concerns were about the cost of adoption, the benefits of adoption compared to convergence, and whether IFRS were in fact as good as or better than U.S. GAAP. 1-54. The Financial Accounting Standards Bo ard (FASB) and the International Accounting Standards Board (IASB) met jointly in Norwalk, Connecticut on September 18, 2002. They acknowledge their commitment to the development of high -quality, compatible accounting standards that could be used for both domestic and cross -border financial reporting (this is known as the Norwalk Agreement). 1-55. The American Accounting Association Committee on Financial Reporting Policy concluded that eliminating the reconciliation in requirements was premature. Several of t heir points follow: 1. Material reconciling items exist between U.S. GAAP and IFRS and the reconciliation currently reflects information that participants in U.S. stock markets appear to impound to stock prices. 2. Cross -country institutional differences will l ikely result in differences in the implementation of any single set of standards. 3. Legal and institutional obstacles inhibit private litigation against foreign firms in the United States and the SEC rarely undertakes enforcement actions against cross -listed firms. 4. Differential implementation of standards across countries and a differential enforcement efforts directed toward domestic and cross -listed firms creates differences in financial reporting even with converged standards. 5. Harmonization appears to be o ccurring via the joint standard -setting activities of the FASB and the IASB; thus, special statutory intervention by the SEC appears to be unnecessary. 1-56. Professor Ball noted these problems with implementing IFRS: 1. On the con side, a deep concern is that th e differences in financial reporting quality that are inevitable among countries have been pushed down to the level of implementation and now will be concealed by a veneer of uniformity. 2. Despite increased globalization, most political and economic influenc es on financial reporting practice remain local. 3. The fundamental reason for being skeptical about uniformity of implementation in practice is that the incentives of preparers and enforcers remain primarily local. 4. Under its constitution, the IASB is a stand ard setter and does not have an enforcement mechanism for its standards. 5. Over time the IASB risks becoming a politicized, polarized, bureaucratic on - style body. 1-57. 2009. The issue of SMEs is not part of the roadmap of convergence between IFRSs and U.S. GAAP . 32 PROBLEMS PROBLEM 1 -1 1. b 3. h 5. d 7. e 9. g 2. a 4. c 6. i 8. f PROBLEM 1 -2 1. o 6. e 11. h 2. a 7. f 12. k 3. b 8. j 13. c 4. l 9. i 14. m 5. d 10 g 15 n PROBLEM 1 -3 a. 2 Typically, much judgment and estimates go in to the preparation of financial statements. b. 4 Financial accounting is not designed to measure directly the value of a business enterprise. The end result statements can be used as part of the data to aid in estimating the value of the busi ness. c. 4 FASB Statement of Concepts No. 2 lists ti meliness, predictive value, and feedback value as ingredients of the quality of relevance. d. 2 The Securities and Exchange Commission has the primary right and responsibility for generally acce pted accounting principles. They have primarily elected to have the private sector develop generally accepted accounting principles and have designated the Financial Accounting Standards Board as the primary source. e. 4 The concept of conservatism d irects that the measurement with the least favorable effect on net income and financial position in the current period be selected. f. 3 The Internal Revenue Service deals with Federal tax law, not generally accepted accounting principles. g. 5 Opinions were issued by The Accounting Principles Board. PROBLEM 1 -4 33 a. 1 Statements of Position have been issued by the AICPA. b. 2 This is the definition contained in SFAC No. 6 c. 2 This is the definition contained in SFAC No. 6. d. 5 Comparability is not one of the criteria for an item to be recognized. e. 2 Future cost is not one of the measurement attributes recognized in SFAC No. 5. f. 1 Revenue is usually recognized at point of sale. g. 1 Financial accounting is not designed to measure directly the value of a business enterprise. PROBLEM 1 -5 a. Sales on credit $ 80,000 Cost of inventory sold on credit (65,000) Payment to sales clerk (10,000 ) Income $ 5,0 00 b. Collections from customers $ 60,000 Payment for purchases (55,000) Payment to sales clerk (10,000 ) Loss $(5,000 ) PROBLEM 1 -6 1. a 6. d 11. l 16. g 2. r 7. f 12. m 17. e 3. o 8. h 13. p 18. c 4. q 9. i 14. n 19. s 5. b 10. j 15. k 34 CASES CASE 1 -1 STANDARD -SETTING: "A POLITICAL ASPECT" (This case provides an opportunity to view some of the political aspects of standard setting.) a. The hierarchy o f accounting qualities in SFAC No. 2 includes neutrality as one of the ingredients. SFAC No.2 indicates that, to be reliable, the information must be verifiable, subject to representational faithfulness, and neutral. To quote from the Beresford letter: "If financial statements are to be useful, they must report economic activity without coloring the message to influence behavior in a particular direction." b. Costs of transactions do exist whether or not the FASB mandates their recognition in financial statements. The markets may not be able to recognize these costs in the short run if they are not reported. Thus investors, creditors, regulators, and other users of financial reports may not be able to make reasonable business and economic decisions if the costs are not reported. c. Much of the standard setting in the U.S. is in the private sector. A major role in the private sector has been played by The American Institute of Certified Public Accountants. Since 1973 the primary role in the private se ctor has been played by The Financial Accounting Standards Board. It should be noted that the Securities Act of 1934 gave the SEC the authority to determine generally accepted accounting principles and to regulate the accounting profession. The Beresfor d letter recognizes that the SEC and congressional committees maintain an active oversight of the FASB. d. True. Quoting from the letter: "We expect that changes in financial reporting will have economic consequences, just as economic consequences are in herent in existing financial reporting practices." CASE 1 -2 POLITICIZATION OF ACCOUNTING STANDARDS – A NECESSARY ACT? 35 (This case addresses the role of the Emergency Economic Stabilization Act of 2008 and the subsequent role of the SEC and the FASB). a. This is an opinion question: A review of the accounting standard was likely justified considering the economic situation. Should the review have been done by the SEC or FASB independently of congress? b. Yes. The SEC has the authority to govern GAAP in the U.S. A case could be made that the SEC should have acted sooner. c. As indicated in (b), the SEC has the authority to govern GAAP. d. No. The time frame was very short. e. Probably not. In the long run, the involvement of congress is likely to be negative. CASE 1 -3 INDEPENDENCE OF ACCOUNTING STANDARD -SETTERS (This case provides a forum to discuss the independence of accounting standard - setters. The timing of this case (December 2008) was during the period when congress was putting pressure o n the SEC and the FASB to address the standard for fair value accounting). Some politicians and others thought that a standard change was needed to overt material write down of investments by financial institutions). a. Standard setters have traditionall y resisted using accounting standards as a fiscal policy tool. Standard setters have tried to use standards as a neutral and objective measurement of the financial performance of public companies. b. Should the deliberative process be waived when a natio nal emergency exists in the financial system? Note: In an Op Ed in the Washington Post, author A. Levitt, a former SEC chair, clearly disapproved of FASB’s expedited due process for new fair value guidance in FAS 157 -e. CASE 1 -4 LOOKING OUT FOR INVE STORS (The SEC plays an important role in “Looking Out for Investors.” This case provides an opportunity to discuss that role). 36 a. Mary Schapiro addresses some of the cost of over -regulation as stifling of innovation and the superior ability of markets to protect themselves from excess. Over regulation will be costly for businesses because compliance costs tend to be high and compliance sometimes takes time to put those controls into place e.g. internal controls related to Sarbanes -Oxley. b. Under -regulation can result in inefficient capital markets. To ensure that capital markets are efficient, Mary Schapiro indicates that the SEC will approach this in four ways as follows: 1. First, structured effectively 2. Second, that they’re fed by timely and reliable information 3. Third, that they’re well -served by financial intermediaries and other market professionals 4. And fourth, that they’re supported by a strong and focused enforcement arm that will not be afraid to prosecute securities fraud. c. This is an opinion question. CASE 1 -5 FLYING HIGH (This is a good case to discuss revenue recognition and compare program accounting with the percentage of completion and completed contract method of revenue recognition used by contractors .) a. It would be difficult t o separate contracts that contain provisions to earn incentive and award fees that can be reasonably estimated from contracts that cannot be reasonably estimated. b. It appears that Boeing Company is using a completed contract method for commercial airpla nes. It does not represent a difficult situation in determining sales, but sales may not be representative of the production for any particular time period. They are estimating costs of sales while sales are based on deliveries. c. It is probably not di fficult to determine service revenue. The service likely does not represent a long period of time. d. It should not be difficult to determine revenue from notes receivable. The terms of the notes would be objective. 37 CASE 1 -6 CENTERED IN HAWAII (This is a good case to discuss revenue recognition .) a. “In general, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery of the service or product has occurred, the sales price is fixed or determinable, and collectab ility is reasonably assured. b. Voyage Revenue Recognition. Yes, this could represent a challenge of matching cost with revenue. We likely have a situation here where expenses are incurred approximately at the same rate as the recognition of revenue. c. Yes. Appears to be a type of percentage -of-completion method. d. 1. Generally on closing date, “adequate initial and continuing investments have been received and collection of remaining balances, if any, is reasonably assured. 2. Percentage -of-comp letion method. Used when there is material continuing post -closing involvement. e. In general, recognizing revenue as rent over the time of the lease. For revenue related to contingent sales, the revenue is recognized only after the contingency has been r esolved. CASE 1 -7 GOING CONCERN? a. The going -concern assumption is that the entity in question will remain in business for an indefinite period of time. b. Yes. The potential problem is that the firm may not be able to continue in business as a going concern. This puts into question the recoverability and classification of assets or the amounts and classification of liabilities. c. This disclosure puts the user of the statements on warning that the statements may be misleading if the company cannot continue as a going concern. CASE 1 -8 ECONOMICS AND ACCOUNTING: THE UNCONGENIAL TWINS 38 a. No. Per Kenneth E. Boulding: "Ritual is always the proper response when a man has to give an answer to a question, the answer to which he cannot really know. Rit ual under these circumstances has two functions. It is comforting (and in the face of the great uncertainties of the future, comfort is not to be despised) and it is also an answer sufficient for action." b. No. Per Kenneth E. Boulding: "The wise busi nessman will not believe his accountant although he takes what his accountant tells him as important evidence. The quality of that evidence, however, depends in considerable degree on the simplicity of the procedures and the awareness which we have of the m." c. Per Kenneth E. Boulding: "It is the sufficient answer rather than the right answer which the accountant really seeks." Boulding indicates that accounting does not need to be accurate in order to serve a useful function. The financial statements does not attest that they are correct only that they are presented fairly in accordance with generally accepted accounting principles. CASE 1 -9 I OFTEN PAINT FAKES (This case is intended to serve as a forum for discussing the accuracy of financial statements prepared using generally accepted accounting principles.) a. Accounting reports prepared using generally accepted accounting principles are not exactly accurate. They are intended to be sufficient to aid in making informed decisions. Reports ar e only as good as the underlying numbers. If numbers are not reliable, then it doesn’t matter if GAAP is properly applied. b. No, accountants do not paint fakes. But, it may take an understanding of generally accepted accounting principles to reasonably comprehend the significance of the statements. CASE 1 -10 OVERSIGHT