7-9 accounting assumptions and principles

Chapter One(1). The job of an accountant is to record transactions and post them to the ledgers.（F）(2). Double-entry bookkeeping developed in Europe in the Middle Ages. （T）(3). The functions of accounting have increased with the rapid development of management science. （T）(4). There are only two fields of accounting: financial accounting and managerial accounting.（F）(5). Only the management needs the financial information about an economic entity.（F）(6). Financial accounting prepares information for the management.（F）(7). Private accountants work for private people.（F）(8). Public accountants earn salaries for their professional work.（F）(9).Securities and Exchange Commission issues regulations for preparing financial statements in the U.S.. （T）(10). American Accounting Association is an organization primarily for accounting educators. （T）(11). The expenses of the owners of proprietorship should be recorded in a business’s expense accounts.（F）(12). After the financial statements are prepared a company will continue its business. （T）(13). The usual time period for a business is a year, called the financial/fiscal year. （T）(14). As a result of inflation, the purchasing power of money will decrease, so the accountants should record the value of assets in their decreased values.（F）(15). According to Materiality Principle, the purchase of stationery can be recorded as an expense. （T）(16). Objectivity Principle and Cost Principle are mutually supported. （T）(17). Objectivity Principle and Materiality Principle are somewhat contradictory. （T）Chapter Two(1). The simplest form of business organizations is Proprietorship. （T）(2).The proprietorship has a single owner. （T）(3).Partners of partnership have limited liability for debts.（F）(4). If a corporation goes bankrupt, shareholders need not pay for the debts with their personal assets.（T）(5).In the proprietorship, the owner’s equity is capital. （T）(6).The accounting equation can also be expressed as “Assets – Liabilities = Owner’s Equity”.（T）(7).An owner’s investment in a business increases assets and capital. （T）(8).When a business buys equipment, it can either pay cash or make the purchase on account. （T）(9).Buying something on account creates a liability. （T）(10).When a business provides goods or service, it receives revenue from its customers or clients.（T）(11).The payment of Accounts Payable decreases assets and liability. （T）(12).The payment of expenses decreases assets and owner’s equity.（T）(13).The owner of proprietorship can withdraw money for personal use.（T）(14).When the owner of proprietorship pays for expenses with his personal funds, the accountant need not record the event. （T）Chapter Three(1) The double-entry system is based on the principle of duality.（T）(2) Every transaction affects at least two accounts.（T）(3) The entry for $50000 cash investment in a business isDr. Cash 50000Cr. Capital 50000 （T）(4) The Expenses in the owner’s house paid with his personal fund should not be recorded in the business’s accounts.（T）(5) Debit means increase while credit means decrease.（F）(6) The remaining amount of an account is called its balance.（T）(7)The journal is a chronological record of the business’s transactions.（T）(8) Posting is the process of transferring information from the ledger to the journal.（F）(9) The normal balances of asset accounts are debits.（T）(10) Withdrawal of cash by the owner is a deduction of capital.（T）Chapter Four(1) The three major financial statements are the income statement, the statement of owner’s equity and the balance sheet.（T）(2)The income statement reflects the revenues and expenses of a specific date.（F）(3)The statement of owner’s equity reflects the changes in owner’s equity for a specific period.（T）(4)The balance sheet shows the balances of assets, liabilities and owner’s equity for a specific period of time.（F）(5)The three major financial statements are related to one another.（T）(6)Current liabilities do not include long-term liabilities due within this accounting period.（F）(7)Patents，trademarks and goodwill are all assets, so they should appear in an entity’s financial statements. （F）(8)Liquidity is a measure of how quickly an item can be converted to cash.（T）(9)Current ratio is the ratio of an entity’s current assets to its current liabilities.（T）(10)It is desirable for an entity to maintain a low debt ratio.（T）(11)For an entity, the higher its gross margin percentage is, the better.（T）(12)An entity wants to maintain a low inventory turnover.（F）Chapter Five(1) Revenues enhance an entity’s assets. （T）(2) Expenses are incurred in the course of an entity’s revenue-making activities.（T）(3) Revenues result in a decrease in the owner’s equity while expenses result in an increase in the owner’s equity.（F）(4)Revenue and expense accounts are permanent.（F）(5)Asset, liability and owner’s equity accounts have balances at the end of the accounting period.（T）(6)Under accrual basis, revenues are recognized when cash is received.（F）(7)When a doctor renders services to a patient, this activity creates revenue no matter whether the cash is received or not.（T）(8)Financial statements pertain to a definite period.（T）(9)Expenses must go with the revenues they help to produce.（T）(10)Unearned revenues are revenues which have been earned but the cash has not been received.（F）(11)Accrued revenues are revenues which you have received but have not rendered services for the clients.（F）(12)Prepaid expenses are expenses which have been paid for before they are incurred.（T）(13)At the end of the accounting period, supplies used are recorded as a debit to Supplies Expense and a credit to Supplies.（T）(14)The cost of depreciation is recorded as a debit to Depreciation Expense and a credit to the Fixed Asset account. （F）(15)Accumulated Depreciation appears in the Balance Sheet as a separate account.（F）(16)Adjusted Trial Balance has only Asset, Liability and Owner’s Equity Accounts. （T）Chapter Six(1) The accounting cycle starts with the analysis of transaction source documents. （T）(2) The accounting cycle ends with the preparation of financial statements. （F）(3) The balances in the trial balance of the work sheet are the beginning balances of the accounts. （F）(4) The balances of the expense and revenue accounts in the trial balance of the work sheet include all the expenses and revenues for the accounting period. （F）(5) The total of the debit side does not equal to the credit side for the Income Statement in the work sheet. （T）(6) The amount for the Capital account in the work sheet is the beginning balance of the accounting period. （T）(7) The total for the debit side of the Balance Sheet in the work sheet is the total of Assets. （F）(8) At the end of the accounting period, only the revenue and expense accounts should be closed. （F）Chapter Seven(1) A merchandising business needs to purchase the goods it sells first.（T）(2) When a merchandising business purchases goods, the journal entry is a debit to Inventory and a credit to Cash. （F）(3) A discount is made by the seller to the buyer for prompt payment.（T）(4) A sales return is the amount which the returned goods from sellers cost.（F）(5) Cost of goods sold = Beginning Inventory + Net Purchase – Ending Inventory （F）(6) Purchase discount is not computed on the freight charges.（T）(7) Inventory is an Expense account.（F）(8) Purchase is an asset account.（F）(9) In the work sheet, the Inventory account has two balances, both the beginning balance and the ending balance.（T）(10)The adjusting entries of a merchandising business are the same as those of a service business.（T）(11)Both the beginning and the ending balances of the Inventory account should be closed.（T）(12) Purchase Discounts and Purchase Returns and Allowances accounts have Debit balances.（F）Chapter Eight(1)All the sales are recorded in a Sales Journal.（F）(2)Only the credit sales are recorded in a Sales Journal. （T）(3)All the purchases are recorded in a Purchase Journal.（F）(4)Only the purchases of merchandise are recorded in a Purchase Journal. （（F）(5)All the amounts that are posted to the general ledger are totals.（F）(6)All the postings are made at the end of an accounting period.（F）(7)All the accounts have its subsidiary accounts. （F）(8)General Journals are not used by merchandising businesses.（F）。

Chapter 9International Financial Statement AnalysisDiscussion Questions1. a. Business strategy analysisDifficulties in cross-border business strategy analysis: Identifying key profit drivers and business risk in two or more countries can be daunting. Business and legal environments and corporate objectives vary around the world. Many risks (such as regulatory risk, foreign exchange risk, and credit risk) need to be evaluated and brought together coherently. In some countries, sources of information are limited and may not be accurate.b. Accounting analysisDifficulties in accounting analysis: Two issues are important here. The first is cross-country variation in accounting measurement quality, disclosure quality, and audit quality. National characteristics that cause this variation include required and generally accepted practices, monitoring and enforcement, and extent in managerial discretion in financial reporting. The second issue concerns the difficulty in obtaining information needed to conduct accounting analysis. The level of credibility and rigor of financial reporting in Anglo-American countries generally is much higher than that found elsewhere. In fact, financial reporting quality can be surprisingly low in both developed and emerging-market countries.c. Financial analysis (ratio analysis and cash flow analysis)Difficulties in financial analysis: Extensive evidence reveals substantial cross-country differences in profitability, leverage, and other financial statement ratios and amounts that result from both accounting and non-accounting factors. Differences in financial statement items caused by national differences in accounting principles can be significant, and unpredictable in amount. Even after financial statement amounts are made reasonably comparable, interpretation of those amounts must consider cross-country differences in economic, competitive, and other conditions.d. Prospective analysis (forecasting and valuation)Difficulties in prospective analysis: Exchange rate fluctuations, accounting differences, different business practices and customs, capital market differences, and many other factors have major effects on international forecasting and valuation. Application of price multiples in a cross-border setting requires that the determinants of each multiple, and reasons why multiples vary across firms, be thoroughly understood. National differences in accounting principles are one source of cross-country variations in these ratios.Finally, all four stages of business analysis may be affected by:i. information access,ii. timeliness of informationiii. foreign currency issuesiv. differences in financial statement formatsv. language and terminology barriers.2. Here we will consider the information needs of investors, creditors, regulators, and competitors.Investors have high information needs at all stages of business analysis. They need to be able to accurately assess the merits of the company’s business strategy, the quality of its accounting, the company’s financial strength, and its future prospects. Since each step in the business analysis process builds on its predecessors, each step is critical in its turn. It can’t be said that any one step is more or less important than the others.Creditors need to go through much the same analysis, but are advantaged in that through direct contact with the companies they often have more extensive and detailed information than do investors. The goal of analysis is also often somewhat different. Many investors, hoping that their shares will increase in value, are interested in prospective analysis. The creditor’s interest is more often limited to being sure (with a margin of safety) that the loan will be repaid. For the creditor, the accounting analysis, financial analysis, and forecasting, all are important; valuation is less so. Regulators have much different interests. Since regulators have no direct interest in the future earnings of the companies they regulate, a prospective analysis (in most cases) is of limited value to them. However, if regulators need to be aware of the financial strength of the companies they regulate, they will need to conduct accounting analysis and (in many cases) financial analysis, particularly when assessing how much of an economic burden can be imposed on companies resulting from a particular regulation.Competitors are intensely interested in finding out as much about a company as possible. Business strategy analysis of one’s competitors is an important part of formulating one’s own business strategy, especially in terms of assessing strengths and weaknesses. Accounting and financial analysis also can uncover strengths and weaknesses. Prospective analysis may be important if a merger or acquisition is contemplated.3. Information accessibility is a major condition for an efficient capital market, that is, information must be rapidly analyzed and made available to investors capable of acting on it. In the United States and other broadly-based financial markets, a whole industry specializing in information analysis and dissemination has developed. Similar investment analysis services in many non-U.S. capital markets are at an earlier stage of development.4. Investment analysis almost always involves paired comparisons, even if the benchmark alternative is to do nothing. In evaluating the risk and return characteristics of a non-domestic company differences in accounting measures of risk and return are often due as much to differences in measurement rules between countries as they are to real economic differences. Corporate transparency compounds the problem by depriving analysts of information necessary to adjust for national measurement differences. Many analysts consider the disclosure issue to be even more important than measurement differences.5. One way of coping with GAAP differences is to restate foreign accounting measures to an internationally recognized set of principles or the reporting framework of the investor’s home country. An alternative tack is to develop a detailed understanding of accounting practices in the investee’s country.Students will definitely disagree on this one. Eventually some will offer a compromise: use the former coping mechanism if the investee company is being compared with a firm in the investor’s home country and adopt a “multiple principles capability” when comparing the investee company to another company in the same country. Another tack would be to examine who is making the market for the investee’s shares. If local investors are making th e market, one should not ignore local norms. However, if investors in the investor’s country are making the market; e.g., U.S. institutional investors, then restatement to the investor’s home country GAAP makes sense.6. Prospective analysis invo lves forecasting a firm’s future cash flows and then valuing those cash flows. As future cash flow estimates are based on accounting measurements, differences in measurement rules between countries complicate this effort. The range of accounting choicesavailable abroad add to this complexity. However, measurement differences are only one of the variables that complicates prospective analysis, Differences in environmental variables such as rates of inflation, sovereign risk, business practices, and institutions complicate both forecasting and valuation. Different institutions include financial norms, tax regimes and market enforcement mechanisms. In terms of valuation, while P/E multiples may be popular in one country, discounted dividends may be more popular in another. Even if two countries employ the same valuation framework, differences in investment horizons and methods of calculating discount rates/cost of capital will vary.7. Translation of foreign financial statements for the convenience of domestic readers is fundamentally distinct from the translation of branch or subsidiary accounts for purposes of consolidation. In the latter case, translation involves a remeasurement process. In most countries, foreign accounts first are restated to the accounting principles of the parent country prior to restatement to parent currency. Convenience translations merely involve a restatement process in the sense that foreign accounts are multiplied by a constant to change the currency of denomination fro m domestic currency to the currency of the reader’s domicile.8. Rules of thumb can vary substantially from one country to another due to both accounting and non-accounting factors. Japan provides a striking example. Many Japanese companies are members of large trading groups (keiretsu) with large commercial banks at their core. Keiretsu often postpone interest and principal payments, so that long-term debt in Japan works more like equity in the United States. Short-term debt is attractive to Japanese companies because short-term obligations typically have lower interest rates than long-term obligations, and normally are renewed or “rolled over” rather than repaid. Thus, debt has a much different nature and purposein Japan than in the United States.The acid test ratio specifically involves cash, marketable securities and receivables as the numerator in the equation, and current liabilities as the denominator. But what counts as current liabilities versus long-term debt (or how long-term debt is viewed) is very different in Japan than in the U.S. In Japan, high short-term debt is less likely to indicate a lack of liquidity, for the reasons stated above. Banks often are willing to renew these loans because it allows them to adjust their interest rates to changing market conditions. Thus, short-term debt works like long-term debt elsewhere, and Japanese companies can operate successfully with a quick ratio at a level that would be entirely unacceptable in the United States. Note, however, that banking practices in Japan are changing rapidly, and the tolerance in Japan for high levels of debt financing may well decrease in the future.9. Important recommendations include the following:•Be aware that national differences in accounting measurement rules c an add “noise” to reported performance comparisons. The reader should be prepared to unwind accounting differences where necessary.•Use a structured approach, such as the one presented in this chapter, to ensure that all relevant factors are considered.•Cash flow-related measures are less affected by accounting principle differences than are earnings-based measures, thus making them potentially valuable in international analysis.•Audit quality varies dramatically across countries. Become familiar with the level of audit quality in a particular country before reaching conclusions using financialstatements prepared by companies in that country.•Corporate transparency also varies dramatically across countries. Be sure to assess accurately the quality of financial disclosures before reaching conclusions based on them.•Above all, appreciate that measurement and disclosure practices are environmentally based. Appreciation for institutional differences will greatly aid in proper interpretation of accounting based performance and risk measures.10. The following list describes in general fashion what probable effect the Dutch translation practice would have on selected financial ratios in comparison with the temporal method. The analysis assumes that the original financial statements of the two companies are identical in all respects save for the currency translation method used. Inventories are assumed to be carried at cost._________________________________ _______________________________________________ Devaluation ___ R evaluationCurrent ratio (liquidity) decrease increaseInv. At mkt goes downInv at mkt goes upDebt ratio (solvency) increase decreaseLoss goes in ATA so eq. smallerGain in ata eq lrg.Fixed asset turnover (efficiency) increase decreaseNet sales/assets assets smaller so inc.A ssets larger so dec.Return on assets (profitability) increase decreaseloss not in incomeGain not in incomeAs can be seen, the current rate method can have a significant effect on key financial indicators. Accordingly, security analysts must be careful to distinguish between the currency in which a foreign account is denominated and the currency in which it is measured.11. The attest function is what gives credibility to the financial statements. If this function is important in the domestic case, it is even more important internationally where statement readers are separated from the companies they are interested in not only by physical distance but also by cultural distance.12. Internal control is an activity performed by a firm’s int ernal auditors that helps to assure that management’s policies and procedures are being carried out effectively, that financial transactions are being properly reported both internally and externally and that the assets of the firm are safeguarded. Intern al control is relied upon by a firm’s external auditors in determining to what extent their work should replicate the work of the internal auditor. The role of the internal auditor has become even more important in assuring the reliability of management’s financial representations owing to the large number of financial scandals that has rocked the U.S. and other financial markets during the start of this decade. Recent legislation in the U.S., which is increasingly being emulated elsewhere, has made management responsible for assuring that their system of internal controls are not only in place but are working well. This has beennecessary to reduce investor uncertainty regarding the quality and reliability of a firm’s published financial accounts.In the absence of a strong system of internal controls, investors will adopt a more passive approach to investing as opposed to relying on firm-specific information. This involves taking a mutual fund approach to investing which attempts to diversify away information risk, although at the cost of lesser performance.Exercises1. The trend of dividends from a U.S. dollar perspective can be ascertained by translating the peso dividend stream using the $/P exchange rate prevailing at the beginning of the time series or the end. Use of the ending exchange rate provides the following trend data:20X6 ________ 20X7 ________ 20X8 ______Net income (P) 8,500 10,800 15,900Dividends (P mill’s)2,550 3,240 4.770Dividends ($000) 850 1,080 1,590Percentage change --- 27.1% 47.2%2.How the statement of cash flows appearing in Exhibit 9.5 was derived:Beg. Bal. DR. CR. End. Bal.Cash 2,400 3.990New fixed assets 8,500 (3) 2,695 (2) 555 10,640ST $ payable 500 500LT debt 4,800 (3) 1,584 6,384Capital stock 3,818 3,818Retained earnings 1,782 (1) 250 2,030Translation adjustment 1,898Sources Usesof ofFunds FundsSources:Net income (1) 250Depreciation (2) 555Increase in LT debt (3) 1,584Translation adjustment (4) 1,898Uses of funds:Increase in fixed assets (3) 2,6954,287 2,695Net increase in cash 1,5924,287 4,2873. Consolidated Funds Statement(figures appearing in parentheses denote changes due primarily to translation effects) Sources:Net income 250Depreciation 555Increase in LT debt 1,584 (1,584)Translation adjustment 1,898 (1,898)less intercompany payable 138Uses of funds:Increase in fixed assets 2,695 (2,695)Net increase in cash 1,590 (924) The $924 translation effect is that part of the $1,898 gain on the translation of net worth which is related to the translation of cash. It is derived as follows.a. Opening cash of 24,000 krona translated at .10 =$2,400Opening cash retranslated at 12/31 at .133 = 3,192Gain 792b. 6,000 krona increase in cash during the yearinitially translated at .111 =$6666,000 krona retranslated at 12/31 at .133 = 798Gain 132Total translation gain applicable to cash 9244. Yes, Infosys added value for its shareholders as its EVA was a positive RPE 1,540. Operating income more than covered the company’s cost of debt and equity.5. Debit: Cost of goods sold ¥250,000,000Taxes payable 87,500,000Credit Inventories ¥250,000,000Tax expense 87,500,0006. a.20X6 20X7 20X8Sales revenue (£) 23,500 28,650 33,160Sales revenue ($) 49,350 63,030 53,056b. Percentage change 20X7/20X6 20X8/20X7Pounds 21.9% 15.7%Dollars 27.8% -15.8%The two time series do not move in parallel fashion because of changes in exchange rates used to perform the convenience translations.c. This problem can be minimized by translating the time series using the 20X6 exchange rate or by using the 20X8 exchange rate. Trend analysis can also be performed in the local currency.7. a. ROE (per Swedish GAAP) = 4,709/88,338 = 5.3%ROE (per U.S. GAAP) = 3,127/84,761 = 3.7%b. Some students will favor using the ROE based on Swedish GAAP, especially if Volvo’sperformance is being compared with that of another company in Sweden. Others willfavor basing their performance assessment on ROE per U.S. GAAP, especially if Volvois being compared to a U.S. counterpart. The latter at least minimizes the apples tooranges issue. It is not clear which viewpoint is correct, and this question should provoke good discussion of the value of restated accounting numbers.c. Even if students all agreed that an ROE based on U.S. GAAP were preferable, the user ofthis information should take into account all institutional considerations, such asdifferences in tax laws, financial norms and business practices that affect all ratios in the Swedish business environment. In the absence of such analysis, restated ratios are likely to be misinterpreted.8. Assessing reasons for P/E ratio trends and cross-country comparisons is difficult. Thetext discusses two studies that have analyzed differences in P/E ratios between Japan and the United States in the late 1980s. The studies differ greatly in their explanations of the(then) much higher Japanese P/E ratios, and neither study claims to explain more than apart of the difference. Part but not all of the reasons were attributable to accountingmeasurement differences. We suspect that differences in institutional factors probablyexert the dominant reason for observed differences internationally.9. Students answers will naturally vary. However, they should recognize that audit practiceare influenced as much by differences in social, economic and political environments as are measurement standards. They should also recognize that standard setting is as mucha political process as it is a process of logic or sound principles.10. Judging from information provided in Exhibit 9-22, liability cases vary far more bycountry than by auditor – with 35 cases in the U,.S., over twice as many as in the nexthighest country (the U.K., with 17). No audit firms had cases in every country, and thetotal number for each auditor is relatively similar, ranging from 11 (Arthur Andersen) to18 (KPMG). The country where liability cases were least frequent was the Netherlands,with only one case.Why? Laws and regulations in the Anglo-American countries, including the UnitedStates, stress investor protection. This places more liability on the auditor and makes iteasier for companies or shareholders to bring or prove a suit. In response to the threat of litigation, auditors are probably more careful in the United States, and more willing tosubject themselves to strict regulations.Implications? It is reasonable to argue that financial reporting quality is positivelycorrelated with frequency of audit litigation. For example, the patterns of auditorlitigation shown in the table above are consistent with the relatively high financialreporting quality found in the U.S., the U.K., Australia and Canada.11. Student opinions are likely to vary on this one as well. Some will argue for opinionscoined by private professional bodies. Others, in light of Enron, et. al., will opt for more legal opinions. In the end, students should conclude that enforcement mechanisms arealso very important. Recent U.S. indictments of company officers for accountingviolations as well as mandated prison terms is unprecedented. Together with increasing recourse to the courts by aggrieved investors, the imbalance between an auditor’sresponsibility and authority is being redressed.12. Reasonable criteria for judging the merits of a database for company research include(but are not limited to):-coverage (number of companies, countries, years of data).-amount of information for each company (number of financial, market-based measures per company).-reliability, ease of use, language translations, search features.-cost (a re only some of the data “freely available?”).-access and links to other Web sites provided?Case 9-1Sandvik1.a. There are several advantages that accrue to Swedish firms employing the system of special reserves. First, political dividends accrue to firms that align their goals with those of the government. Second, there are tax advantages as expenses recognized in establishing a reserve are tax deductible. Third, the use of reserving allows companies to manage their earnings. Disadvantages include the risk of reducing a company’s reporting credibility with the international investing community. This, in turn, may limit the company’s external financing flexibility.2. The government benefits from the reserving system in that it has ally in maintaining full employment. That is to say, its macroeconomic tool kit is expanded in that it yet another vehicle for managing the economy in addition to monetary and fiscal policy.3. The use of reserves makes it difficult for statement readers who are unfamiliar with Swedish reporting practices to assess the risk and return attributes of the firm. For example, it will not be clear to what extent observed differences in financial ratios between a Swedishcompany and a non-Swedish company are due to accounting differences as opposed to real economic differences in the attributes being measured.4. The use of reserves had a dampening effect on Sandvik’s reported earnings.5. The entries used to increase the reserves can be determined by examining the change in Untaxed Reserves in the balance sheet as well as examining the relevant notes to the financial statements. The entries were:Depreciation expense 172Excess depreciation reserve 172Other expenses 13Other untaxed reserves 136. With reserves Without reservesROS 3,731/15,242 3,731 + 185(1-.03)/15,242= 24.5% = 25.7%ROA 3,731 + 1 + 633 3,731 + 1 + 633 + 185(38,142 + 22,286)/ 2 [(38,142 – 185) + (22,286 + 85)] /2= 14.4% = 15.1%Case 9-2Continental A.G.Students will first gravitate to the notes to the financial statements dealing with Special Reserves and Provisions. Their instincts are correct. The problem facing an external analyst is that it is difficult to determine which of the reserve and provision items are legitimate and which are not. It turns out that two important keys to this case are to be found in footnotes 21 and 22. Focusing on the consolidated figures, we see that Continental is using entries under Other operating income and Other operating expenses to smooth reported earnings. The following analysis backs out 1) Credit to income from the reversal of provisions, 2) Credit to income from the reduction of the general bad debt reserve, and 3) Credit to income from the reversal of special reserves appearing in note 21 and Allocation to special reserves under note 22.Adjustments:19X9Operating income DM68,029Provisions DM33,559General B/D Reserve 2,014Special reserve 32,456Special reserves 1,278Operating income 1,27820X0Operating income DM57,237Provisions DM17,312General B/D Reserves 1,101Special Reserves 38,824Special Reserves 168Operating income 168To determine the net overstatement on an after-tax basis, the students should attempt to approximate Continental’s effective tax rate. Information to do this are contained in footnote 24 and Continental’s income statement.Effective Taxes: 19X9 20X0Income tax 141,476 59,884Income after tax 227,838 93,435Income before tax 369,314 153,319Effective rate: 141,476/369,314 59,884/153,319= 39% = 39%Reduction in taxes:66,751 X .39 57,069 X .39= 26,033 = 22,257Net overstatement:66,751 57,069-26,033 -22,25740,718 34,812This overstatement, as a percentage of reported consolidated earnings, was 18% for 19X9and 37% for 20X0. Dietrich and Marissa have cau se to pay Continental’s CFO a visit.。

Principle of AccountingJ.Wild 19th editionEnglish-Chinese convenient dictionaryChapter 1Items of Accounting EquationAssets 资产Equity 所有者权益Liabilities 负债Kinds of accountingFinancial accounting 财务会计Managerial accounting 管理会计财务会计：企业会计的一个分支，与管理会计同为企业会计的两大分支。

因其侧重于满足企业外部有关方面的决策需要，以外提供财务报告，故也称“对外报告会计”。

管理会计：管理会计是会计的一种，它更侧重于管理尤其是对成本的管理。

管理会计也称内部会计，因其主要为企业内部人员，尤其是管理者使用。

目的是找出管理上的问题，尤其是成本控上的问题。

因此，管理会计也称成本会计。

4 principlesMatching principle 配比原则Cost principle 成本原则Full disclosure principle 充分披露原则Revenue recognition principle4 assumptionsBusiness entity assumption 会计主体假设Going-concern assumption 持续经营假设Monetary unit assumption 货币计量假设Time period assumption 会计分期假设StatementsIncome statement 损益表Balance sheet 资产负债表Statement of cash flows 现金流量表Statement of owner’s equity 所有者权益表Some committeesFASB(Financial Accounting Standards Board) 财务会计准则委员会（美国）GAAP(Generally Accepted Accounting Principles) 公认会计准则IASB(International Accounting Standards Board) 国际会计准则理事会SEC(Securities and Exchange Commission) 美国证券交易委员会OthersCommon stock 普通股股票Ethics 伦理External users 外部使用者Internal users 内部使用者Chapter 2~4Compound journal entry 复合分录T-account T型账户Posting reference (PR) column 过账根据栏Interim financial statements 期中财务报表LedgerLedger 分类账General ledger 总分类账Subsidiary ledger 辅助分类账(chpt7)AdjustingAdjusting entry 调整分录。

Chapter 8Global Accounting and Auditing StandardsDiscussion Questions1.Argument for measurement:•Discrepancies in international measurement may produce accounting amounts that are vastly different (even where financial transactions and position areidentical), leading to incorrect comparisons. Here it doesn’t matter what isdisclosed; no reliable comparisons are possible anyway.Arguments for disclosure:•If companies do not disclose complete information, they can hide losses or future problems from financial statement users. For example, losses can behidden by offsetting them against gains. Expected future problems related toloss contingencies can be hidden simply by not disclosing them. Thus, ifdisclosure is incomplete, even the application of similar measurementprinciples will lead to incorrect comparisons.Clearly, international accounting convergence requires that both measurement anddisclosure be made comparable.2. The term convergence is associated with the International Accounting StandardsBoard. Before the IASB, harmonization was the commonly used term.Harmonization means that standards are compatible; they do not contain conflicts.Harmonization was generally taken to mean the elimination of differences inexisting accounting standards, in other words, finding a common ground amongexisting standards. Convergence means the gradual elimination of differences innational and international accounting standards. Thus, the terms harmonizationand convergence are closely aligned. However, convergence might also involvecoming up with a new accounting treatment not in any current standards.3.a. Reciprocity, or mutual recognition, exists when regulators outside of thehome country accept a foreign firm’s financial sta tements based on the homecountry’s principles, or perhaps IFRS. For example, the London Stock Exchangeaccepts U.S. GAAP-based financial statements in filings made by non-U.K. foreigncompanies. Reciprocity does not increase cross-country comparability offinancial statements, and it can create an unlevel playing field in that foreigncompanies may be allowed to apply standards that are less rigorous than thoseused by domestic companies.b. With reconciliation, foreign firms can prepare financial statements using theaccounting standards of their home country or IFRS, but also must provide areconciliation between accounting measures (such as net income andshareholders’ equity) of the home country and the country where the financial statements are being filed. Reconciliations are less costly than preparing a full set of financial statements under a different set of accounting principles, but provide only a summary, not the full picture of the enterprise.c. International standards are a result of either international or political agreement, or voluntary (or professionally encouraged) compliance. When accounting standards are applied through political, legal, or regulatory procedures, statutory rules typically govern the process. All other international standards efforts in accounting are voluntary in nature.include:a. A growing body of evidence indicates that the goal of internationalconvergence of accounting, disclosure and auditing has been widely accepted.b.All dimensions of accounting are becoming converged worldwide.c.Increasing numbers of highly credible organizations strongly support the goalsof the IASB.d.National differences in the underlying factors that lead to variation inaccounting, disclosure, and auditing practices are narrowing as capital and product markets become more international.e.International standards will improve the comparability of internationalfinancial information.f.Time and money will be saved on international consolidations, the componentsof which now are subject to different national laws and practices.g.There may be a tendency for accounting standards throughout the world to beraised to the highest possible level.h.Widespread application of IFRS might also result in:•Improved managerial decision making within multinational enterprises.•Improved allocations of corporate investment money worldwide.•Better international understandability of financial statements.•Cost reductions in accounting information processing and financial disclosure costs for multinational enterprises.•Greater international credibility for published financial statements.a.Accounting has built-in flexibility. Its ability to adapt to widelydifferent situations is one of its most important features. Critics doubtthat international standards can be flexible enough to handle differencesin national backgrounds, traditions, and economic environments, and may bea politically unacceptable challenge to sovereignty.b.It is claimed that international accounting standard setting is a tactic ofthe large international accounting service firms to expand their marketshare.c.International standards may create standards overload for companies that dobusiness internationally.d.National political concerns frequently intrude on accounting standards.International political influences would compromise internationalaccounting standards.e.International standards are not suitable for small and medium-sizedcompanies, particularly unlisted ones with no public accountability.f.Risks of misinformation —uniform standards may give the appearance ofsimilarities when in fact countries and companies may be highly dissimilar.g.Political costs of the necessary international treaties on financialaccounting and reporting which would have to be negotiated to enforce theuse of IFRS.6.Evidence indicating wide acceptance of IFRS around the world:a.Growing numbers of companies are adopting IFRS voluntarily and refer totheir use of IFRS in their annual reports.b.Dozens of countries base their national accounting standards on IFRS.c.Some 7,000 EU listed companies now use IFRS in their consolidated financialstatements.d.Many international organizations, such as IOSCO, endorse the use of IFRS.e.IFRS are used as an international benchmark in many major industrializedcountries.f.IFRS are accepted by many stock exchanges and securities regulators.g.IFRS are recognized by the European Commission (EC) and other supranationalbodies.h.Norwalk Agreement committed FASB and IASB to convergence.7. The International Accounting Standards Board is overseen by the International Accounting Standards Committee, consisting of 22 trustees: six from North America, six from Europe, six from the Asia-Pacific region, and four from any area. The trustees appoint the members of the IASB. The IASB receives advice from the Standards Advisory Council on its agenda and priorities. The SAC consists of around 30 members appointed by the IASC trustees and they represent a diversity of geographic and professional backgrounds.The IASB consists of 14 members, 12 full-time and two part-time. It follows a due process in setting accounting standards. For each standard, the board normally publishes a discussion paper that sets out the various possible requirements for the standard and the arguments for and against each one. Later, the board publishes an exposure draft for public comment, and it then examines the arguments put forward in the comment process. A final standard is issued when nine of the 14 board members have voted in its favor.8.Accounting harmonization in the EU is just one element of the overall project of harmonizing the legal and economic systems of the member states, and is part of the process of harmonizing company law.The Fourth Directive illustrates the concept of harmonization, and specifies accounting measurement (valuation) and disclosure requirements. It provides format rules for the balance sheet and the profit and loss account. The true and fair view is the overriding requirement and holds for footnote disclosures as well as the financial statements. The Fourth Directive also sets out the requirements for financial statement audits.The Seventh Directive addresses consolidated financial statements. It requires consolidations for groups of companies above a certain size, specifies disclosures and notes, and requires a directors’ report. When it was issued in 1983, consolidated financial statements were the exception rather than the rule in Europe.The Eighth Directive addressed various aspects of the qualifications of professionals authorized to carry out legally required (statutory) audits. Now referred to as the Statutory Audit Directive, it was substantially amended in 2006. The new directive tightens oversight of the audit profession and has standards for, among other points, auditor appointment and rotation, and continuing professional education.The EU abandoned its approach to harmonization to one favoring the IASB for practical and political reasons. The Fourth and Seventh Directives were incomplete and essentially remained as they were issued. Improvements to them proved difficult to achieve and the directives did not achieve the comparability expected. Some saw a set of Europe-wide standards as an unnecessary redundancy given the emergence of comprehensive IFRS. Others saw U.S. GAAP as a rival to IFRS. The EU cannot influence U.S. GAAP, but can influence IFRS. By putting its weight behind the IASB, the EU could serve as a counterweight to U.S. GAAP.9.International accounting harmonization/convergence should address many, if not most, investor concerns about cross-national differences in accounting practices. The key issue here is comparability –investors want to make “apples to apples” comparisons of financial statements of companies from countries around the world. However, converged standards are only the beginning. Standards must also becomparably applied and they must be rigorously enforced. The financial statements must also be similarly audited to ensure comparable reliability.10.Convergence of auditing standards will help ensure that audit quality will reach acceptable levels worldwide. Auditing convergence may be less difficult to achieve than accounting convergence because auditing is more technically oriented and there is wider agreement as to what constitutes best practices in auditing than there is for accounting principles.IFAC is a worldwide organization of over 160 member organizations in 120 countries. Its mission includes establishing and promoting adherence to high-quality auditing and other professional standards, and furthering the international convergence of such standards. Its work is done through standard setting boards and standing committees. Among its standard setting boards are:•International Accounting Education Standards Board•International Auditing and Assurance Standards Board•International Ethics Standards Board for AccountantsIts work spans the entire array of professional responsibilities of auditors and includes standards covering professional education, the conduct of the audit, and professional ethics.11.IOSCO consists of securities regulators from more than 100 countries. Together, IOSCO members are responsible for regulating more than 90 percent of global securities markets. One of IOSCO’s objectives is promoting “high standards of regulation in order to maintain just, ef ficient, and sound markets.” IOSCO has worked extensively on international disclosure and accounting standards to facilitate the ability of companies to raise capital efficiently in global securities markets. It has a technical committee whose sole focus is multinational disclosure and accounting. Model disclosure standards were published in 1998 and 2002.IOSCO’s disclosure harmonization work is important because it has established a set of high quality disclosure standards, globally recognized, that serves as a model for nations around the world as they develop national requirements for cross-border offerings and initial listings.12.The UN and OECD now play supporting roles in harmonizing accounting and auditing standards. The IASB and IFAC are now the clear leaders in this endeavor, but in the 1970s and 1980s, both the UN and OECD were potential rivals. Most of the effort of the UN and OECD is directed toward providing technical accounting assistance to developing countries. For example, the UN has focused much attention on Russia and countries of the former Soviet bloc, and on African countries.Exercises1.One of the main problems with mutual recognition (or reciprocity) is that itactually may make financial statements within the home market noncomparable. If many different accounting standards are acceptable, then companies domiciled in countries with rigorous standards (such as the United States) would be at a disadvantage to companies whose home country standards are not as stringent, but still would be acceptable. Investors also would face the difficult task of having to master many sets of accounting principles in order to be able to understand the associated financial statements.The U.S. SEC considers reconciliation to be a cost-effective means to allow foreign firms to list on a domestic exchange. With reconciliation, differences between accounting standards are identified and quantified without the need to prepare a second set of financial statements. However, significant differences between domestic and foreign accounting principles can increase the burdens associated with reconciliation, and reconciliations do not provide a full picture of the enterprise as would result from a second set of financial statements.The use of International Financial Reporting Standards would provide many benefits for cross-border listings. Companies would have to provide only one set of financial statements for all nondomestic capital markets, and investors would have to be familiar with only one set of accounting principles to properly understand and interpret nondomestic financial statements. However, as with reconciliation, domestic companies required to comply with domestic standards still would compete for capital with nondomestic companies that would be required to comply with a different (and possibly less stringent) standard.Preferred approaches from perspectives of different groups:a.Investors might prefer international standards, as they would increase theease in understanding information from nondomestic companies. Knowledge ofonly one set of standards would be required to understand all nondomesticstatements. However, there is also a case for reconciliation, which presentsin an economical manner the significant differences between nondomestic anddomestic financial statements and does not require investors to be familiarwith any set of accounting standards other than the home country.pany management might prefer mutual recognition, as it does not require acompany to prepare any additional information and requires no additionalexpense or time commitments. However, companies in some countries mightadopt IFRS voluntarily to increase their credibility with investors andincrease the overall quality of their financial reporting.c.Regulatory authorities might prefer reconciliation as it places the burden oncompanies yet provides adequate disclosure and investor protection.d.Stock exchanges might prefer convergence as it is the only method thatprovides truly complete and identical information disclosure from companies outside the home market.e.Professional associations will take positions according to their constituents–associations of stockbrokers might prefer convergence to the extent that it would make company information easier to understand, whereas associations of company executives might prefer reciprocity.2.The following discussions are based on the respective organizations’ Web sites at the time of writing.International Federation of Accountants (IFAC)IFAC, an organization of national professional accountancy organizations, plays a critical role in the convergence of auditing standards and other international auditing initiatives. The organization has over 160 member organizations in 120 countries, representing more than 2.5 million accountants. Organized in 1977, IFAC’s goal is to develop the accountancy profession and converge its professional standards worldwide to enable accountants to provide services of consistently high quality in the public interest.To achieve its objective, IFAC develops and promotes technical, professional and ethical standards for accountants, provides leadership on emerging issues, and serves as a voice for the world’s accountants on issues of public and profess ional concern. IFAC fosters the advancement of strong national professional accountancy organizations, and works closely with regional accountancy organizations and outside agencies to accomplish this.The IFAC Council, comprised of one representative from each member body, provides overall leadership of IFAC. The council elects the IFAC Board, and is responsible setting policy and overseeing IFAC operations, the implementation of programs, and the work of IFAC’s standard setting groups and committees. The Public Interest Oversight Board (PIOB), an independent board, provides additional oversight. Day-to-day administration is provided by the IFAC chief executive located in New York, which is staffed by accounting professionals from around the world.IFAC’s professional work is done through its standard setting boards and standing committees. IFAC standard setting boards are:•International Accounting Education Standards Board•International Auditing and Assurance Standards Board•International Ethics Standards Board for Accountants•International Public Sector Accounting Standards BoardIFAC standing committees are the following:•Compliance Advisory Panel•Developing Nations Committee•Nominating Committee•Professional Accountants in Business Committee•Small and Medium Practices Committee•Transnational Auditors CommitteeIFAC issues standards in these key areas: auditing, assurance, and related services; education; ethics; and public sector accounting. IFAC’s International Auditing and Assurances Standards Board issues International Standards on Auditing (ISA), which are intended for international acceptance. ISA s deal with topics such as auditors’ responsibilities, risk assessment and evidence, and audit reporting.IFAC has close ties with organizations such as the IASB and IOSCO, and its pronouncements are receiving growing recognition for their quality and relevance. Financial statements of companies around the world are increasingly being audited in conformity with International Standards on Auditing.United Nations Intergovernmental Working Group of Experts on International Standards of Accounting and Reporting (ISAR)ISAR was created in 1982 and is part of the United Nations’ Conference on Trade and Development (UNCTAD). ISAR is the only intergovernmental working group devoted to accounting and auditing at the corporate level. Its objective “is to promote the transparency, reliability and comparability of corporate accounting and reporting as well as to improve disclosures on corporate governance by enterprises in developing countries and countries with economies in transition. ISAR achieves this through an integrated process of research, intergovernmental consensus building, information dissemination and technical cooperation.”In recent years, ISAR focused on important topics that other organizations were not yet ready to address, such as environmental accounting. It has also conducted technical assistance projects in a number of areas such as accounting reforms and retraining in the Russian Federation, Azerbaijan and Uzbekistan, and designing and developing a long-distance learning program in accountancy for French-speaking Africa. Topics discussed at recent ISAR conferences include practical implementation of IFRS, corporate responsibility reporting, and corporate governance disclosures.Organization for Economic Cooperation and Development (OECD)OECD is the international organization of 30 (mostly industrialized) market economy countries. It functions through its governing body, the OECD Council, and its extensive network of committees and working groups. Its publication Financial Market Trends, issued two times each year, assesses trends and prospects in the international and major domestic financial markets of the OECD area.The OECD often publishes reports on the structure and regulation of securities markets, and has played a leading role in promoting improved corporate disclosure and governance around the world. With its membership consisting of larger, industrialized countries, the OECD is often a counterweight to other bodies (such as the United Nations and the International Confederation of Free Trade Unions) that have built-in tendencies to act contrary to the interests of its members.3.As an example, consider the Financial Accounting Standards Board (FASB) in the United States. The FASB’s Web site presents detailed information on the FASB’s international activities, including an overview, convergence with IASB, cooperative efforts with other standards setters, and the FASB/IASB memorandum of understanding.The FASB’s objective for participating in international activities is to increase the international comparability and the quality of standards used in the United States. This objective is consisten t with the FASB’s obligation to its domestic constituents, who benefit from comparability of information across national borders. The FASB pursues that objective in cooperation with the International Accounting Standards Board (IASB) and national standard setters.The FASB believes that the ideal outcome of cooperative international accounting standard-setting efforts would be the worldwide use of a single set of high-quality accounting standards for both domestic and cross-border financial reporting. At present, a single set of high-quality international accounting standards that is accepted in all capital markets does not exist. In the United States, for example, domestic firms that are registrants with the SEC must file financial reports using U.S. GAAP. Foreign firms filing with the SEC can use U.S. GAAP, their home country GAAP, or international standards – although if they use their home country GAAP or international standards, foreign issuers must provide a reconciliation to U.S. GAAP.The FASB engages in a variety of activities in pursuit of the goals of high-quality international standards and increased convergence of the accounting standards used in different nations. Almost every FASB project is a matter of interest in some other country or with the IASB.4. a. Comparison of standard-setting proceduresEuropean UnionAccounting and auditing requirements are established under EU company law directives, which are legal instruments that member countries must implement. Thus, all accounting and auditing standards in EU directives become legally enforceable. The EU comprises several key organizations that need to be understood in order to understand how EU directives come into being. Briefly, the European Commission initiates EUp olicy and acts in the community’s general interest. Commissioners are completely independent and may not seek or take instructions from governments or interest groups. The Council of the European Commission is the EU’s decision-maker. Here, the member states legislate for the EU, deciding some matters by majority vote and others unanimously. The European Parliament represents the EU’s citizens. Its main functions are to enact legislation and to scrutinize and control the use of executive power. The Trea ty of European Union of 1993 strengthened the European Parliament’s responsibilities. Only the Commission can propose new directives. Proposals typically undergo many drafts. Proposed directives are submitted to the Council of the European Commission, which first seeks opinions of the Economic and Social Committee and the European Parliament. Next, a working party set up by the Council discusses the proposal. Member countries typically are allowed several years to implement a new directive after its final adoption. (Note to instructors: The information contained in this paragraph is based on information on the EU’s Web site at the time of writing.)IASBThe IASB follows due process in setting accounting standards. For each standard, the Board may publish a discussion paper that sets out the various possible requirements for the standard and the arguments for and against each one. Subsequently, the Board publishes an exposure draft for public comment, and then examines the arguments put forward in the comment process before deciding on the final form of the standard. An exposure draft and final standard can be issued only when nine (of 14) members of the board vote in favor of it.IFACThe standard setting boards of IFAC also follows a due process procedure. Meetings to discuss the development and approval of standards are open to the public and, where practicable, are broadcast over the Internet. Issues papers and draft standards are published on the IFAC Web site along with updated project summaries and meeting highlights. New projects are based on a review of national and international developments and comments from interested observers. An advisory group is consulted to determine priorities and activities. Task forces are usually assigned the responsibility for the development of new standards. These task forces conduct research and consult interested parties on the issues under consideration. One or more public forums or roundtables may be held before an exposure draft is issued. Re-exposure is sometimes necessary. Final standards are issued after considering comments to the exposure draft. (Note to instructors: The information contained in this paragraph is taken from IFAC’s Web site at the time of writing.)a.At what types and sizes of enterprises are their standards primarilydirected?EU company law directives apply both to public and private companies inthe EU, without respect to size.IFRS are financial reporting standards for business whose applicabilitydepends on the context. For example, if IFRS are adopted as nationalaccounting standards in a particular country, their applicability dependson the type of entities that are subject to those national standards.IFAC’s standards are directed toward the audits of both public and private companies.In summary, all three sets of standards are meant to apply to most (if notall) enterprises, without regard to size or whether the enterprises areprivate or public.b.Brief critique of statementIt is true that IFRS are particularly useful to companies that operate inmore than one country, because IFRS are widely recognized and are acceptablein many different countries and stock exchanges. However, as stated in thetext, IFRS also are used as the basis for national accounting standards inmany countries, and these national standards typically apply to a wide rangeof companies, not just multinational companies.5. Following is a sample essay on the 1995 European Commission adoption of a new approach to accounting harmonization. The essay is based on material in articles by Gerhard G. Mueller, "Harmonization: Efforts in the European Union," in Frederick D.S. Choi, ed., International Accounting and Finance Handbook, New York: John Wiley & Sons, 1997, page 11.28; and Peter Walton, “European Harmonization,” in Frederick D.S. Choi, ed., International Finance and Accounting Handbook, New York: John Wiley & Sons, 2003, page 17.7Beginning in the early 1990s, the Commission examined a number of alternative harmonization strategies. These included, among others, substantive revisions of the existing accounting Directives, creation of a Europe-wide accounting standards-setting board, exempting certain European companies from all EU accounting requirements so that these companies might apply accounting standards of other jurisdictions, or re-enforce its earlier push for mutual recognition.The reality of international pressures and the need of European multinationals to be listed on several stock exchanges finally made it clear that the creation of a strong European regional level of accounting regulation was simply adding an unnecessary third tier, sandwiched between national regulations and the international capital markets.In the end, the European Commission adopted a new accounting harmonization strategy on November 14, 1995 and forwarded respective recommendations to the European Council。

西方财务会计课后答案(第七章)Accounting PrinciplesASSIGNMENT CLASSIFICATION TABLEBrief A BStudy Objectives1.Explain the meaning of Questions1, 2Exercises1, 2Exercises Problems Problemsgenerally acceptedaccounting principles andidentify the key items ofthe conceptualframework.2. Describe the basic 3 3objectives of financialreporting.3. Discuss the qualitative 3, 4, 5 4, 5, 6characteristics ofaccounting informationand elements of financialstatements.4. Identify the basic 6 7 1, 2, 3 1A, 2A, 3A 1B, 2B, 3Bassumptions used byaccountants.5. Identify the basic princi- 7, 8, 9, 10, 7 1, 2, 3, 4 1A, 2A, 3A 1B, 2B, 3Bples of accounting. 126. Identify the two con- 11 7, 8 1, 2, 3 3A 3Bstraints in accounting.7. Understand and analyze 13, 14, 15, 9, 10, 11 5, 6, 7, 8, 4A, 5A 4B, 5Bclassified financialstatements.16 98. Explain the accounting 17, 18 10principles used in inter-national operations.7-1ASSIGNMENT CHARACTERISTICS TABLEProblem Difficulty TimeNumber1A DescriptionAnalyze transactions to identify accounting principle orLevelModerateAllotted (min.)2030 assumption violated, and prepare correct entries.2A Determine the appropriateness of journal entries in Moderate 2030 terms of generally accepted accounting principles orassumptions.3A Identify accounting assumptions, principles, and Moderate 2030 constraints.4A Prepare a classified balance sheet and analyze financial Moderate 3545 position.5A Prepare a multiple-step income statement and analyze Moderate 3545 profitability.1B Analyze transactions to identify accounting principle or Moderate 2030 assumption violated, and prepare correct entries.2B Determine the appropriateness of journal entries in Moderate 2030 terms of generally accepted accounting principles orassumptions.3B Identify accounting assumptions, principles, and Moderate 2030 constraints.4B Prepare a classified balance sheet and analyze Moderate 3545 financial position.5B Prepare a multiple-step income statement and analyze Moderate 3545 profitability.7-2C o r r e l a t i o n C h a r t b e t w e e n B l o o m ’s T a x o n o m y , S t u d y O b j e c t i v e s a n d E n d -o f -C h a p t e r E x e r c i s e s a n d P r o b l e m sK n o w l e d g e Q 7-1 Q 7-2 B E 7-2 B E 7-1 C o m p r e h e n s i o n A p p l i c a t i o n A n a l y s i s S y n t h e s i sE v a l u a t i o nS t u d y O b j e c t i v e1. E x p l a i n t h e m e a n i n g o f g e n e r - a l l y a c c e p t e d a c c o u n t i n g p r i n c i p l e s a n d i d e n t i f y t h e k e y i t e m s o f t h e c o n c e p t u a l f r a m e w o r k .Q 7-3 B E 7-3B E 7-4 B E 7-5 B E 7-6 B E 7-7 Q 7-6 E 7-1 E 7-3 Q 7-7 Q 7-8 Q 7-9 Q 7-10 Q 7-12 E 7-1 E 7-3Q 7-14 Q 7-15P 7-3A P 7-3BB E 7-8 Q 7-16 B E 7-9 B E 7-10 B E 7-11 E 7-5E 7-10E 7-6 E 7-7 E 7-8 E 7-9 E 7-1 E 7-3 P 7-3A P 7-3BQ 7-8 E 7-4 E 7-2 P 7-1A P 7-2A P 7-1BE 7-2Q 7-13 E 7-8 P 7-4A P 7-5A P 7-4B P 7-5B Q 7-13 P 7-4A P 7-5A P 7-4B P 7-3A P 7-3B E 7-2 P 7-1A P 7-2AP 7-1B P 7-2BP 7-2BQ 7-3 Q 7-4 Q 7-52. D e s c r i b e t h e b a s i c o b j e c t i v e s o f f i n a n c i a l r e p o r t i n g .3. D i s c u s s t h e q u a l i t a t i v e c h a r a c t e r i s t i c s o f a c c o u n t i n g i n f o r m a t i o n a n d e l e m e n t s o f f i n a n c i a l s t a t e m e n t s .4. I d e n t i f y t h e b a s i c a s s u m p t i o n s u s e d b y a c c o u n t a n t s .B E 7-7 5. I d e n t i f y t h e b a s i c p r i n c i p l e s o f a c c o u n t i n g .Q 7-11 B E 7-7Q 7-18 Q 7-176. I d e n t i f y t h e t w o c o n s t r a i n t s i n a c c o u n t i n g .7. U n d e r s t a n d a n d a n a l y z e c l a s s i f i e d f i n a n c i a l s t a t e m e n t s .P 7-5B8. E x p l a i n t h e a c c o u n t i n g p r i n c i p l e s u s e d i n i n t e r n a t i o n a l o p e r a t i o n s .B r o a d e n i n g Y o u r P e r s p e c t i v eC o m m u n i c a t i o n G r o u pD e c i s i o n I n t e r p r e t i n g F i n a n c i a l R e p o r t i n g F i n a n c i a l C a s e C o m m u n i c a t i o n S t a t e m e n t s C o m p . A n a l y s i s R e s e a r c h C a s e A G l o b a l F o c u s G r o u p D e c i s i o n I n t e r p r e t i n g F i n a n c i a l C a s e S t a t e m e n t s C o o k i e C h r o n i c l eE x p l o r i n g t h e W e b E t h i c s C a s eG r o u p D e c i s i o n C a s e C o m p . A n a l y s i s R e s e a r c h C a s e A G l o b a l F o c u s C o o k i e C h r o n i c l eBLOOM'S TAXONOMY TABLE7-3ANSWERS TO QUESTIONS1. (a)(b) Generally accepted accounting principles (GAAP) are a set of standards and rules, having substantial authoritative support, that are recognized as a general guide for financial reporting.The bodies that provide authoritative support for GAAP are the Financial Accounting Stan- dards Board (FASB) and the Securities and Exchange Commission (SEC).2.3.4.5.6.7.8.9. The FASB’s conceptual framework consists of the following:(1) Objectives of Financial Reporting.(2) Qualitative Characteristics of Accounting Information.(3) Elements of Financial Statements.(4) Operating Guidelines (Assumptions, Principles, and Constraints).(a) According to the FASB in its development of the conceptual framework, the objectives offinancial reporting are to provide information that: (1) is useful to those making investment and credit decisions, (2) is helpful in assessing future cash flows, and (3) identifies the eco- nomic resources (assets), the claims to those resources (liabilities), and the changes inthose resources and claims.(b) The qualitative characteristics are: (1) relevance, (2) reliability, (3) comparability, and (4)consistency.Curtis is correct. Consistency means using the same accounting principles and accounting meth- ods from period to period within a company. Without consistency in the application of accounting principles, it is difficult to determine whether a company is better off, worse off, or the same from period to period.Comparability results when different companies use the same accounting principles. Consistency means using the same accounting principles and methods from year to year within the same company.The going concern assumption is necessary because otherwise depreciation and amortization policies would not be justifiable and appropriate. Also, the current-noncurrent classification of assets and liabilities would lose much of its significance. Labeling anything as fixed or long-term would be difficult to justify. In addition, the going concern assumption lends credibility to the cost principle.Revenue should be recognized in the accounting period in which it is earned. The sales basis involves an exchange transaction between the seller and buyer and the sales price provides an objective measure of the amount of revenue realized.Expired costs generate revenues only in the current period and therefore are expensed immedi- ately. Unexpired costs will generate revenues in current and future periods and are recorded as assets.(a) The accountant discloses information about an entity’s financial position, operations, andcash flows in the financial statements, or in the notes that accompany the statements. (b) The trade-offs involved with disclosure balance the costs of preparing additional informationand the benefits from using it.7-4Questions Chapter 7 (Continued)10.11.12.13.14.15.16.17.18. Cost is used because it is both relevant and reliable. Cost is relevant because it represents the price paid, the assets sacrificed, or the commitment made at the date of acquisition. Cost is reliable because it is objectively measurable, factual, and verifiable. It is the result of an exchange transaction. As a result, cost is the basis used in preparing financial statements.The two constraints are materiality and conservatism. The materiality constraint means that an item may be so small that failure to follow generally accepted accounting principles will not influ- ence the decision of a reasonably prudent investor or creditor. The conservatism constraint means that when in doubt, the accountant chooses the accounting method that is least likely to overstate assets and net income.Recording Osterhaus’ additional investment of $5,000 as revenues is inappropriate. An invest- ment in a corporation increases the common stock account, not revenues.Three relationships that are helpful in assessing profitability are: (1) the profit margin percentage (or return on sales), (2) return on assets, and (3) return on common stockholders’ equity. More than one profitability relationship is useful in that the relationships help in different types of analy- sis. Return on sales, for example, measures the percentage of each sales dollar that is included in net income, whereas return on assets measures the contribution of each dollar of assets in generating income. The former, then, helps analyze profits in terms of revenues alone; the latter helps analyze profits in terms of the asset base in generating sales and profits. If the return on assets is lower than warranted, the company may not be using its assets effectively; if return on sales is lower than warranted, the company may not be controlling costs effectively.Natasha Company’s working capital (a) is $60,000 – $20,000 = $40,000, and its current ratio (b) is $60,000 ÷ $20,000 = 3:1.Whenever current assets are less than current liabilities, working capital is negative and the cur- rent ratio will be less than 1:1. (Whenever current assets are greater than current liabilities, working capital is positive and the current ratio is greater than 1:1.)A debt to total assets ratio of 62% is fairly substantial. But more is involved in a credit decision than just one financial statement relationship. Extension of additional credit will depend on Bozeman’s overall liquidity (current ratio) and profitability (ability to generate revenue and cash) over the life of the loan. Similarly, Boz eman’s credit history is important—its patterns of loan repayment in the past. No one analytical relationship can provide sufficient information to deter- mine granting of additional credit.There is little uniformity in accounting standards from country to country, although some efforts have been made in this area by the International Accounting Standards Committee.The International Accounting Standards Committee establishes international accounting stan- dards, although they are by no means universally applied.7-5SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 7-1(a) True.(b) False.(c) True.BRIEF EXERCISE 7-2(a) No.(b) Yes.(c) Yes.BRIEF EXERCISE 7-3(a) No.(b) Yes.(c) Yes.BRIEF EXERCISE 7-4(a)(b)(c)(d)(e) Predictive value. Feedback value. Consistency.Faithful representation. Verifiable.BRIEF EXERCISE 7-5(a) Relevant.(b) Reliability.(c) Consistency.7-6BRIEF EXERCISE 7-6(a)(b)(c)(d) 1.2.3.4.BRIEF EXERCISE 7-7(a)(b)(c)(d) 2.3.1.4.BRIEF EXERCISE 7-8(a)(b)(c)(d) Conservatism. Conservatism. Materiality. Materiality.BRIEF EXERCISE 7-9Current Assets Current LiabilitiesCashAccounts receivable Total $ 110,6001,674,400$1,785,000Accounts payableIncome taxes payableOther current liabilitiesTotal$ 584,60025,900608,500$1,219,000(a) Current ratio = Current assets ÷ Current liabilities= $1,785,000 ÷ $1,219,000= 1.46:1(b) Working capital = Current assets – Current liabilities= $1,785,000 – $1,219,000= $566,0007-7BRIEF EXERCISE 7-10Gross profitIncome from operations Other revenues and gains Income before income taxes Net incomeBRIEF EXERCISE 7-11 $907,000667,000 = Operating expenses (a) 240,00036,000276,00096,600 = Income tax expense (b) $179,400Earnings per share = Net income ÷ common shares outstanding= $179,400 ÷ 46,000= $3.907-8SOLUTIONS TO EXERCISES EXERCISE 7-11.2.3.4.5.6.7.8. Revenue recognition principle. Full disclosure principle. Matching principle.Going concern assumption. No violation.Time period assumption.Cost principle.Economic entity assumption.EXERCISE 7-2(a) This is a violation of the cost principle. The inventory was written up toits market value when it should have remained at cost. Thus, no jour- nal entry should have been made.(b) This is also a violation of the cost principle because the equipmentwas recorded at its estimated market value and not its exchange value.The correct journal entry is:Equipment..............................................................................Cash ................................................................................ 41,00041,000(c) This is a violation of the economic entity assumption. The accountingfor the transaction treats Mark Nabke and Vicki Prowitz Company as one entity when they are two separate entities. No journal entry should have been made since Nabke should have used personal assets topurchase the truck. If cash assets of the company were used, the debit entry could be to Accounts Receivable—M. Nabke.(d) This is a question of matching and materiality. The pencil sharpenercould be depreciated to match the expense with revenue since thepencil sharpener has an estimated useful life of 5 years. However, the pencil sharpener should not be depreciated because the cost of it is not material. Since the cost of the sharpener is not material, it should7-9EXERCISE 7-2 (Continued)be expensed immediately. The correct journal entry at the time of pur- chase is:Miscellaneous Expense .....................................................................Cash................................................................................................. EXERCISE 7-3 5050(a)(b)(c)(d)(e)(f)(g)(h) 2.1.7.3.9.4.6.5.Going concern assumption.Economic entity assumption.Full disclosure principle.Monetary unit assumption.Materiality.Time period assumption.Matching principle.Cost principle.EXERCISE 7-41.2.3.4. $9,000. The full amount of the policy should be recognized as revenue because the term expired within the current year.$30,000 ÷ 12 = $2,500; $2,500 X 4 = $10,000. By applying the revenue recognition principle, one can determine that 4 months of the lease re- ceipts should be recognized as revenue in 2006, while the remainder is revenue in 2007.$14,000. Ownership of the merchandise transfers at December 31 be- cause the terms are FOB shipping point. Thus, a sale has occurred and revenue should be recognized.$0. No revenue should be recognized until the sale of the inventory has occurred.7-10EXERCISE 7-5Net sales........................................................................Cost of goods sold.....................................................Gross profit ..................................................................Operating expensesSelling expenses................................................ $ 98,600 $696,000 409,200 286,800Administrative expenses ................................ 116,000 214,600 Income from operations...........................................Other revenues and gains ....................................... 17,50072,200Other expenses and losses .................................... Income before income taxes .................................. Income tax expense (at 30%).................................. Net income.................................................................... Earnings per share (10,000 shares)......................EXERCISE 7-6 (34,700) (17,200)55,00016,500$ 38,500$3.85(a)RevenuesWILKINSON CORPORATIONIncome StatementFor the Year Ended December 31, 2006Net sales ......................................................Gain on the sale of equipment .............Interest revenue ........................................Total revenues .................................. ExpensesCost of goods sold...................................Selling and administrativeexpenses.................................................Interest expense........................................Total expenses ................................. Income before income taxes ......................... Income tax expense.......................................... Net income........................................................... Earnings per share............................................7-11 $1,499,900340,75090,000$2,156,90080,000300,0002,536,9001,930,650606,250150,000$ 456,250$12.85EXERCISE 7-6 (Continued)(b) (1) Gross profit = Net sales – Cost of goods sold$2,156,900 – $1,499,900 = $657,000.(2) Income from operations = Gross profit – Selling and admin. exp.$657,000 – $340,750 = $316,250.(3) Net income is the same, regardless of format: $456,250.(c) Profit margin percentage (return on sales) = Net income ÷ Net sales= $456,250 ÷ $2,156,900= 21.15%EXERCISE 7-7(a)Relationship Debt to total assetsReturn on salesReturn on assetsIntelCorp.19.7%18.7%12.0%Johnson& Johnson44.3%17.2%14.9%Motorola,Inc.60.5%3.3%2.8%Return on commonstockholders’ equity14.9% 26.8% 7.0% (b) All three companies are manufacturers and distributors of products,each being a leader in its product industry—Intel as a manufacturer of high-tech computer chips and processors; Johnson & Johnson as amanufacturer of health care products; and Motorola as a manufacturer of electronics and communication products. Intel and Johnson &Johnson are the dominate players in their industries and enjoy com-petitive advantages and operating efficiencies that earn above average returns on sales, assets, and equity; both had very profitable perform- ances in 2003. Motorola in 2003 was still recovering (staging a turn-around) from several years of operating losses and a change in man-agement as well as a bursting of the high-tech industry bubble in1999–2003—therefore its low return on sales, assets, and equity.7-12EXERCISE 7-8(a)Relationship Debt to total assetsReturn on salesReturn on assetsReturn on equity SouthernCompany72.5%13.1%4.2%15.3%Toys 〝R〞Us, Inc.58.7%2.0%2.2%5.4%IntelCorp.19.7%18.7%12.0%14.9%(b) Much of the differences in the three companys’ ratios are due to theindustry differences—Southern Company is a large electric utility with steady, consistent but moderate sales and income from a heavyinvestment in plant and equipment. Southern Company can shoulder a large amount of debt (72.5% of total assets) because of its largeamount of assets, semi monopolistic business, and its steady income and cash flow.While Toys 〝R〞Us Inc. is a leading toy retailer, it is in a highly com- petitive industry with low returns and low margins.Intel is in the high-tech industry which can be cyclical, therefore more modestly, debt encumbered, but, because of Intel’s research and de- velopment, plants on micro chips and processors, and efficient opera- tions, it is highly competitive and profitable; thus, its high return onsales, assets, and equity.EXERCISE 7-9Working capital = Current assets – Current liabilities= $800,000Current assets = $800,000 + Current liabilitiesCurrent ratio =Current assetsCurrent liabilities= 2.6:12.6 = $800,000 + Current liabilitiesCurrent liabilities2.6 X Current liabilities2.6 X Current liabilities – Current liabilities1.6 X Current liabilitiesCurrent liabilities7-13 =====$800,000 + Current liabilities $800,000$800,000$800,000 ÷ 1.6$500,000EXERCISE 7-9 (Continued)Current assets = $800,000 + Current liabilities= $800,000 + $500,000= $1,300,000Long-term assets = 0.5 Total assets= Current assetsTotal assets = 2 X Current assets= 2 X $1,300,000= $2,600,000Total liabilities = 60% X Total assets= 0.6 X $2,600,000= $1,560,000Long-term liabilities = Total liabilities – Current liabilities= $1,560,000 – $500,000= $1,060,000Stockholders’ equity = Total assets – Total liabilities= $2,600,000 – $1,560,000= $1,040,000ARUBA CORPORATIONBalance SheetDecember 31, 2006Assets Liabilities and Current assets $1,300,000 Stockholders’ EquityLong-term assets Total assets1,300,000$2,600,000Current liabilitiesLong-term liabilitiesTotal liabilitiesStockholders’ equity$ 500,0001,060,0001,560,0001,040,000Total liabilities& stockholders’7-14equity $2,600,000EXERCISE 7-10(a)Current assetsBATTEN LTD.Partial Balance Sheet (in U.S. format)December 31, 2003(in thousands)AssetsCash ........................................................................................... $ 62,000Short-term investments.......................................................Accounts receivable .............................................................Inventories ...............................................................................Total current assets .....................................................Property, plant, and equipment .................................................Total assets ............................................................................. (b) Stockholders’ equi ty = 〝Total net assets〞= $1,096,0007-1553,000121,000300,000536,000900,000 $1,436,000SOLUTIONS TO PROBLEMSPROBLEM 7-1A1.2. Going concern assumption. Liquidation value is not appropriate be-cause it assumes that the enterprise will not continue. No entry is nec- essary. Only when liquidation appears imminent is the going concern assumption inapplicable.Matching principle. The purchase of equipment should not be ex-pensed immediately. Only costs which have no future benefit are rec- ognized immediately as expenses. Reporting a lower net income is nota legitimate reason for expensing a piece of equipment. Therefore, the following entry is necessary in 2006:Depreciation Expense ($36,000 ÷ 6 years) .................Accumulated Depreciation—Equipment............6,0006,0003. Matching principle. Plant assets should be expensed in a rational andsystematic manner. Deferring depreciation is not rational and system- atic. Therefore, the following entry is necessary in 2006:Depreciation Expense .......................................................Accumulated Depreciation ..................................... 18,00018,0004.5. Cost principle. Appreciation in value does not justify a gain until theland is sold. Appreciation does not involve an exchange transaction.No entry is necessary.Cost principle. Recording the transaction at its estimated market value would not be proper because estimated market value in this case doesnot represent an exchange price. The purchase should be recorded at cost, not at a market price that someone believes the equipment is worth. The correct entry is:Equipment .............................................................................Cash................................................................................7-1635,00035,000PROBLEM 7-2A1.2.3.4.5. The proper amount of depreciation expense is based on the cost ofthe asset and is not adjusted for changing price levels. Depreciation is not so much a matter of valuation as it is a means of cost allocation. Assets are not depreciated on the basis of a decline in their fair market value, but are depreciated on the basis of systematic charges of expired costs against revenues. (Note: It might be called to the stu- dents’ attention that the FASB does encourage supplemental disclo- sure of price-level information.)The cost principle indicates that assets and liabilities are to be accounted for on the basis of cost. If we were to select sales value, for example, we would have an extremely difficult time in attempting to establish a sales value for the given item without selling it. It should further be noted that the revenue recognition principle provides the answer to when revenue (gain) should be recognized. Revenue should be recognized when it is earned. In this situation, an earnings process has definitely not taken place.This entry violates the economic entity assumption. This assumption in accounting indicates that economic activity can be identified with a particular unit of accountability. In this situation, the company erred by charging this cost to the wrong economic entity.It appears from the information that the sale should be recorded in the next year instead of the current year. Regardless of whether the terms are FOB shipping point or FOB destination, the point is that the inven- tory is to be sold in the next year. Therefore, the revenue recognition principle is violated. It should be noted that if the company is employ- ing a perpetual inventory system in dollars and quantities, a debit to Cost of Goods Sold and a credit to Inventory are also necessary in the next year.A gain should not be recognized until the inventory is sold. Account- ants follow the cost approach and write-ups of assets are not permit- ted. It should also be noted that the revenue recognition principle indi- cates that revenue (gain) should not be recognized until it is earned.7-17PROBLEM 7-3A(a)(b)(c)(d)(e)(f)(g) 2. Going concern assumption.3. Monetary unit assumption.9. Materiality.7. Matching principle.1. Economic entity assumption.4. Time period assumption.6. Revenue recognition principle.(h) 10. Conservatism.(i) 5. Full disclosure principle.7-18PROBLEM 7-4A (a) QUAD CITIES TOURS INC.Balance SheetOctober 31, 2006Assets Current assetsCashInvestment in Iowa Trading Post, Inc.Accounts receivableInventoriesSuppliesPrepaid expenses ($17,000 + $9,000)Total current assetsProperty, plant, and equipmentLandBuildings$660,000 $653,000$ 36,000140,00015,000485,00012,00026,000714,000Less: Accum. deprec. Equipment 144,000840,000516,000Less: Accum. deprec.Total assets 715,000 125,000 1,294,000$2,008,000Liabilities and Stockholders’ Equity Current liabilitiesNotes payableAccounts payableInterest payableIncome taxes payableTotal current liabilitiesBonds payable 600,000 $ 164,000170,00030,00056,250420,250Mortgage payableTotal liabilitiesStockholders’ equityCommon stockRetained earningsTotal liabilities and stockholders’ equity7-19 247,750300,000440,000847,7501,268,000740,000$2,008,000PROBLEM 7-4A (Continued)(b) Current ratio: $714,000$420,250= 1.70:1Debt to total assets: $1,268,000$2,008,000= 63.1%Working capital: $714,000 – $420,250 = $293,750(c) Debt already represents a substantial portion of Quad Cities’ balancesheet. The current ratio is fairly solid, and working capital is signifi-cantly positive (it is enough to cover the outstanding long-term mort-gage, for example). The balance sheet does not provide any informa-tion about Quad Cities’ profitability and long-term prospects for gener- ating cash. Without information that would help you determine QuadCities’ cash-generating ability at least over the life of the requested loan, you would be unlikely to approve the request for added borrowings.That is, you need more information, especially about the income-generating ability of the company.7-20。