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Chapter 2: 11CA (page 36)

Question: The AICPA Special Committee on Financial Reporting proposed the following constraints related to financial reporting.

  1. Business reporting should exclude information outside of management鈥檚 expertise or for which management is not the best source, such as information about competitors.

  2. Management should not be required to report information that would significantly harm the company鈥檚 competitive position.

  3. Management should not be required to provide forecasted financial statements. Rather, management should provide information that helps users forecast themselves the company鈥檚 financial future.

  4. Other than for financial statements, management need report only the information it knows. That is, management should be under no obligation to gather information it does not have, or does not need, to manage the business.

  5. Companies should present certain elements of business reporting only if users and management agree they should be reported- a concept of flexible reporting.

  6. Companies should not have to report forward-looking information unless there are effective deterrents to unwarranted litigation that discourages companies from doing so.

Instructions

For each item, briefly discuss how the proposed constraint addresses concerns about the costs and benefits of financial reporting.

Short Answer

Expert verified

  1. In this case, the cost is probably greater than the advantages received.

  2. Here, the costs are going to higher than the benefit.

  3. In this case, the cost is presumed to exceed the benefit.

  4. Here, the cost is assumed to be greater than the advantage.

  5. In this case, the cost probably exceeds the benefit.

  6. Here, the advantage is likely to be higher than the cost.

Step by step solution

01

Meaning of Financial Reporting

Financial reporting is the method of registering and conveying commercial activities and performance over particular time periods, basically on a yearly or quarterly basis.

02

Explanation for statement ‘a’

Competitor鈥檚 information might be beneficial for standardizing the firm鈥檚 outcome but if the management is not skilled in facilitating the information, it could be greatly subjective. Moreover, it is probably expensive for the management to assemble adequately confirmable information of this nature.

03

Explanation for statement ‘b’

Users of accounting statements might get advantage from obtaining internal information like firm鈥檚 plans and budgets, side by side, competitors might also be able to use this information to acquire a competitive benefit associated with the disclosing company.

04

Explanation for statement ‘c’

For the purpose of providing forecasted accounting statements, management would have to prepare various assumptions and estimates, which would be expensive in the basis of time and data assembled. Due to the involvement of subjectivity, the forecasted statements would not be true presentations, thus lessening from any possible advantages. Additionally, while management鈥檚 forecasts of future possibility or amounts of balance sheet could be of advantage, firms could be liable to shareholder lawsuits, if the amounts in the forecasted statements are not obtained.

05

Explanation for statement ‘d’

It would be highly expensive for firms to assemble and report information that is not beneficial in managing the business.

06

Explanation for statement ‘e’

Adjustable reporting grants firms to adjust their financial reporting to meet the information needs of its diverse users. Therefore, they can evade the cost of supplying information that is not desired by its users.

07

Explanation for statement ‘f’

With regard to forecasted financial statements, if managers report forward-looking information, the firm could be prone to liability if investors unduly depend on the information in preparing investment decisions. Therefore, if firms get security from unwarranted lawsuits, then they might be eager to supply reasonably beneficial forward-looking information.

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Most popular questions from this chapter

GROUPWORK (Accounting Principles and Assumptions鈥擟omprehensive) Presented below are a number of business transactions that occurred during the current year for Gonzales, Inc.

Instructions

In each of the situations, discuss the appropriateness of the journal entries in terms of generally accepted accounting principles.

(a) The president of Gonzales, Inc. used his expense account to purchase a new Suburban solely for personal use. The following journal entry was made.Miscellaneous Expense 29,000Cash 29,000

(b) Merchandise inventory that cost \(620,000 is reported on the balance sheet at \)690,000, the expected selling price less estimated selling costs. The following entry was made to record this increase in value.Inventory 70,000Sales Revenue 70,000

(c) The company is being sued for \(500,000 by a customer who claims damages for personal injury apparently caused by a defective product. Company attorneys feel extremely confident that the company will have no liability for damages resulting from the situation. Nevertheless, the company decides to make the following entry.Loss from Lawsuit 500,000Liability for lawsuit 500,000

(d) Because the general level of prices increased during the current year, Gonzales, Inc. determined that there was a \)16,000 understatement of depreciation expense on its equipment and decided to record it in its accounts. The following entryDepreciation Expense 16,000Accumulated Depreciation Equipment 16,000

(e) Gonzales, Inc. has been concerned about whether intangible assets could generate cash in case of liquidation. As a consequence, goodwill arising from a purchase transaction during the current year and recorded at \(800,000 was written off as follows.

(f) Because of a 鈥渇ire sale.鈥� equipment obviously worth \)200,000 was acquired at a cost of $155,000. The following entry was made.Equipment 2000Cash 155,000Sales Revenue 45,000

Question: For each item below, indicate to which category of elements of financial statements it belongs.

(a) Retained earnings (f) Loss on sale of equipment

(b) Sales (g) Interest payable

(c) Additional paid-in capital (h) Dividends

(d) Inventory (i) Gain on sale of investment

(e) Depreciation (j) Issuance of common stock

Accounting information provides useful information about business transactions and events. Those who provide and use financial reports must often select and evaluate accounting alternatives. The FASB statement on qualitative characteristics of accounting information examines the characteristics of accounting information that make it useful for decision-making. It also points out that various limitations inherent in the measurement and reporting process may necessitate trade-offs or sacrifices among the characteristics of useful information.

Instructions

a) Describe briefly the following characteristics of useful accounting information.

1. Relevance (4) Comparability

2. Faithful representation (5) Consistency

3. Understandability

b)For each of the following pairs of information characteristics, give an example of a situation in which one of the characteristics may be sacrificed in return for a gain in the other.

1. Relevance and faithful representation.

2. Relevance and consistency.

3. Comparability and consistency.

4. Relevance and understandability.

c) What criterion should be used to evaluate trade-offs between information characteristics?

What is the basic accounting problem created by the monetary unit assumption when there is significant inflation? What appears to be the FASB position on a stable monetary unit?

Identify which basic principle of accounting is best described in each item below.(a) Norfolk Southern Corporation reports revenue in its income statement when the performance obligation is satisfied instead of when the cash is collected.(b) Yahoo! recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue.(c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements.(d) Gap, Inc. reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair value is greater.
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