BEECHY/CONROD, INTERMEDIATE ACCOUNTING, 4th EDITION

SOLUTIONS TO CONCEPT REVIEW QUESTIONS

VOLUME 1

CHAPTER 1

Page 3

1. A bookkeeper isresponsible for recording transactions. An accountant isresponsible for setting the accounting policies that determine how those transactions will be recorded—for example, how to classify and record transactions, how to disclose those transactions in the financial statements, and how to measure the value of assets and liabilities and their related revenues and expenses.

2.Financial reportingisconcerned mainly with producing, for use by both internal and external stakeholders, financial statements that report on the economic wellbeing of an organization and on the flow of its resources. In contrast, management accounting is concerned mainly with the preparation and analysis of information for the exclusive use of internal users (i.e., management). The level of detail is much greater, and the basis of accountability may differ from that presented in the organization’s financial statements.

3.Point statements are prepared at a specific point in time and represent the stock or balance at that time of certain accounts. The balance sheet is a point statement. Flow statements report changes in accounts over time. Examples include the income statement, statement of changes in retained earnings, and cash flow statement.

Page 6

1.A public corporation issues securities (debt or equity) to the public; a private corporation does not. A public corporation must be registered with the securities commissions in each province in which its securities are traded and must comply with the reporting requirements of those commissions. In the Canadian economy, most corporations are privately owned.

2.A corporation can obtain capital from external investors without registering with provincial securities commissions (i.e., going public) by raising funds privately through institutional investors. Another alternative is to ensure that each individual investor invests capital of at least a minimum amount of $150,000. Such investors are presumed to be sophisticated and so to not require the protection offered by provincial regulations.

3.A control block exists when a small number of related or affiliated shareholders hold a majority of the voting shares, thereby having the ability to control the corporation.

Page 13

1.Not all Canadian generally accepted accounting principles are found in the CICA Handbook. A vast amount of accounting practice exists beyond the Handbook and is derived from historical precedent and acceptance. Also, GAAP for specialized industries is not found in the Handbook.

2.EIC Abstracts, while issued by the CICA and included as a primary source of GAAP, constitute expert opinion only and do not have the same authority as the recommendations in the CICA Handbook itself. They have a lower ranking in the hierarchy within the primary sources of GAAP.

3.Qualifying private corporations are allowed to use differential reporting.

4.As recognized in the CICA Handbook, the purpose of financial statements is to meet the common information needs of external users of financial information about an entity. In certain situations, GAAP may not be able to satisfy such needs. A company may therefore opt for a disclosed basis of accounting (DBA) instead of GAAP as a means to produce “custom designed” financial information that will meet the informational needs of its stakeholders.

Page 24

1.Before one accounting policy is selected over another, the financial reporting objectives of a company must be established. That is, the financial reporting objectives of an enterprise must be known in order to ensure that the accounting policies chosen will achieve those objectives (in the face of the multitude of possible accounting treatments available to the accountant).

2.A public company must provide financial information to a wide variety of stakeholders with diverse objectives. For example, a public company may focus on the perception of profitability for the purposes of sustaining or improving market confidence in their stock. Therefore, the financial reporting objectives of the public company may be tilted toward income maximization, income smoothing, or stewardship evaluation. In contrast, a private company is not concerned with the informational requirements or perceptions of the general public visà-vis its financial statements, and may be able to focus on objectives such as income tax minimization, cash flow prediction, anal contract compliance (with specific stakeholders such as banks).

3.Shareholders’ agreements may influence a company’s financial reporting objectives by stipulating the accounting methods to be used. For example, since there is no public market for the shares of private corporations, the shareholders’ agreement may stipulate that the share prices will be a function of accounting income or accounting asset values. The agreement will also stipulate the accounting policies to be used in determining such values.

4.The objectives of financial statement users may conflict with the motivations of managers if the users lack the power to enforce the dominance of their objectives. For example, a manager may wish to maximize income in order to convey the perception of exceptional performance (perhaps for the sake of her annual bonus), while shareholders may prefer cash flow projection statements, or income minimization statements (to minimize tax and therefore improve cash flow for dividends). When the shareholders/users do not have the power to impose their demands on management, management’s objectives inpreparing statements will conflict with those of the users.

CHAPTER 2

Page 43

1. Financial statement concepts are used by the following:

  • standard setters.
  • those working to understand the rationale for standards.
  • accountants who seek to establish appropriate accounting policy in areas where there are no standards.
  • financial statement users who are interpreting information prepared in conformity with the concepts.

2.Generalpurpose financial statements are those prepared for distribution to a wide, undefined public. As such, the statements have not been designed, and may not be suitable, for use in specific decisions.

3.In exercising ethical professional judgment, a professional accountant must take into account a variety of factors including, but not limited to,the following:

• The users of the financial statements, and their specific informational needs.

• The motivations of managers.

• The organization’s operations (e.g., type of ownership, sources of
financing, nature of its operating cycle).

• Reporting constraints, if any.

Page 48

1.The separate entity assumption may not be valid for a small corporation with a single shareholder, as the shareholder may enter into various (nonarm’s length) transactions with the corporation, thereby blurring entity definitions. While a corporation is legally a separate entity, the owner of a small corporation, having full control over the affairs of the corporation, may mix business and personal affairs by, for example, intermingling cash funds and interchanging business and personal assets. The owner may extend loans to the corporation that are, in substance, equity infusions. In recognition of this, a bank may require personal guarantees from the owner of the corporation’s debts.

2.The continuity assumption may not be valid in two instances;first, if the business is a limited-life venture intended only to exist for a limited period of time;second, when a business is in financial difficulty and is expected to be shut down or liquidated.

3.The alternative to the proprietary concept is the entity concept. The entity concept considers that the owners (shareholders) are but one of many participants in the enterprise and that the net value added by the enterprise is distributed to the various factors of production. Factors of production include the providers of capital and labour, and the government; the residual represents reinvestment in the enterprise (the entity).

4.In a country with extreme annual inflation rates, the nominal dollar financial capital maintenance assumption is not appropriate. In such countries, a business is deemed to have earned a profit only if it has generated enough earnings to maintain the purchasing power of the owners’ equity. Due to high inflation, capital assets and income measured in nominal dollars may materially misrepresent financial performance, as their purchasing power may be severely eroded from period to period.

Page 53

1.The concept of relevance isthe most important qualitative characteristic of accounting information. If the accounting information is to be of any use, it must be relevant to its intended use.

2.The criterion of understandability does not imply that all information must be reduced to the lowest common level or simplified so that the least sophisticated investor would understand it. Rather, it is presumed that investors and creditors have a reasonable understanding of business and economic activities, as well as some understanding of accounting.

3.The three components of reliability are representational faithfulness (including substance over form), verifiability, and freedom from bias (or neutrality).

4.The four characteristics of objectivity are quantifiability, verifiability, freedom from bias, and non-arbitrariness.

5.There are often tradeoffs between different qualitative criteria, as a given qualitative criterion may be satisfied only at the expense of another. For example, consider the concepts of relevance versus reliability: while financial information may become more reliable as time goes on and facts are confirmed, such information may be more relevant now, when decisions must be made.

Page 58

1.The seven elements of financial statements are: assets, liabilities, equity/net assets (balance sheet), revenue, expenses, gains, and losses (income statement).

2. To justify recognition of an item in the financial statements, the following three criteria must be met:

  • The item meets the definition of one of the seven elements.
  • The item has an appropriate basis of measurement, and a reasonable estimate can be made of the amount.
  • For assets and liabilities, it is probable that the economic benefits will be received or given up, i.e., realized.

3.Realization is the process of converting an asset, liability, or commitment into a cash flow (transactional event). Recognition isthe process of measuring and including an item in the financial statements (accounting event). Recognition may precede realization (e.g., in accrual accounting); however, once realization has occurred, recognition must occur because there has been a cash flow impact that cannot be ignored in the accounts.

4.Accrual accounting means that assets and liabilities are recognized in the period in which the rights and obligations pertaining to them are established. Interperiod allocation isthe recognition as expenses of those amounts that were originally recognized as assets, or the recognition of income for an item previously recognized as a liability. Interperiod allocation follows accrual accounting, bringing into income (or expense) assets or liabilities recognized in the accrual accounting entry (in a previous period).

Page 62

1.Inventories are usually measured at historical cost, but will be reported at net realizable value (NRV) if NRV is less than cost. Certain types of inventories, such as agricultural and mineral inventories, may be valued at market value.

2. The three explicit conditions that must be met to recognize revenue are:

1. All significant acts required of the seller have been performed, and the risks and rewards of ownership have passed to the buyer.

2. The consideration is measurable.

3. Collection is reasonably assured.

3.Period costs are only indirectly related to specific revenuegenerating activities. They do not lend themselves easily to matching to specific revenues. Therefore, period costs are usually recognized as expenses during the time period in which they are incurred.

4.Full disclosure means that the financial statements should contain all relevant information bearing on the economic affairs of a business. However, it is not practical to provide all available information in the disclosure notes. The goal is to disclose enough supplemental information to keep from misleading the users of the statements.

CHAPTER 3

Page 81

1. The income statement links a company’s beginning and ending balance sheets for a given accounting period. That is, the net change in the balance sheet (change in retained earnings) is represented by the net income for the accounting period (assuming there were no capital transactions or transactions charged to retained earnings).

2. The events approach to accounting recognizes changes in the economic wealth or value of assets regardless of whether a transaction has occurred. The transaction approach relies on the occurrence of completed transactions (e.g., a sale of an asset or purchase of an asset) to recognize income. Economic income is based on the events approach, whereas accounting income is based on the transactions approach.

3. The vast majority of recognized changes in assets and liabilities are reported on the income statement. However, there are some changes in value that are recognized on the balance sheet, but which have not yet been realized. These are generally value changes (1) that will be recognized in income only when realized, or (2) that will be matched by an offsetting gain or loss in a future period. These excluded items are reported in the statement of comprehensive income. Other items excluded from the income statement are cumulative changes to retained earnings that are the result of (1) changes in accounting policy or (2) corrections of errors in prior periods. These items are reported in the statement of retained earnings.

Page 88

1.The three basic sections of an income statement required by the CICA Handbook are income from continuing operations, discontinued operations, and extraordinary items.

2.In a single-step income statement, interest in respect of long-term debt appears in the expenses or losses section, where operating and non-operating expenses are aggregated. In a multiple-step income statement, interest in respect of long-term debt may appear in the non-operations section or in another classification, depending on the underlying activity funded by the debt.

3.Operating expenses relate to operations but are not included in cost of sales. Other expenses reflect non-operating expenses, such as interest expense and foreign exchange losses.

Page 91

1.A company may choose to have a year-end other than December 31 for the following reasons:

• If it is a low point in their seasonal pattern.

• To have the same year-end as other companies in their industry.

• To have the same year-end as their parent for easier consolidation.

• If legislation mandates a certain year-end.

2. A Canadian company may choose to prepare its financial statements in U.S. dollars because most of the company’s business is conducted in U.S. dollars; or, the company’s major user groups (shareholders and/or lenders) may reside or operate in the United States and for that reason prefer statements denominated in U.S. dollars.

3. Comparative data are usually provided so that the company’s performance can be analyzed in relation to the prior year. Trends in financial information are much more revealing than information for only one period.

Page 99

1. The three basic subsections of an income statement required by Canadian GAAP are income from continuing operations, discontinued operations, and extraordinary items.

2. Intraperiod tax allocation refers to the allocation of tax expense within a period and within the income statement (and retained earnings statement) to various items (e.g., the allocation of tax expense to continuing operations, discontinued operations, and extraordinary items).

3. It is important to disclose discontinued operations separately, as the sale or disposal of a segment of a business has important implications for predicting future income and cash flow. Doing so highlights for users that a portion of the business has been divested /disposed of, and that the revenues and costs associated with that segment will therefore not be recurring.

4. The three criteria that a gain or loss must satisfy before it can be classified as extraordinary are as follows:

(1)It is not expected to occur frequently over several years.

(2)It does not typify the normal business activities of the entity.

(3)It does not depend primarily on decisions or determinations by managementor owners (management cannot directly cause the gain /loss).

5. Extraordinary items have become rare in Canadian financial statements because of the third criterion set out in the answer to question 4 above. Very few transactions are considered to be outside the control of managers or owners.

Unusual items, by definition, are events or transactions that have a significant impact on earnings but which are not part of normal operations. Management has considerable discretion in determining what constitutes an unusual item and hence they have become much more commonplace. Examples include restructuring costs, writedowns of capital assets, and severance payments.

Page 103

1. The components of other comprehensive income are unrealized gains and losses on available-for-sale financial assets, unrealized gains and losses from translating the financial statements of foreign subsidiaries, unrealized gains and losses on cash flow hedges, and unfunded pension liabilities that have not yet been recognized as a gain.

2. An alternative title for “other comprehensive income” is “other changes in shareholders’ equity.”

3. A financial asset is any contractual asset that gives the holder the right to receive cash, and includes debt and shares of other corporations, as well as short-term money market instruments. Available-for-sale financial assets are those that are available for sale if the holder needs cash. This would exclude financial assets that the holder intends to hold to maturity, such as long-term bonds, and also excludes strategic investments that give the holder control over the issuer.

4. Comprehensive income is reported in the statement of comprehensive income and in the statement of retained earnings.

Page 108

1. The five major components of a statement of retained earnings are:

• Net income or loss for the period.

• Dividends.

• Prior-period error corrections.

• Cumulative effect of retrospective changes in accounting policy.

• Other changes such as capital transactions, appropriations, and restrictions.

2.Restrictions of retained earnings result from legal requirements, such as a statutory requirement that retained earningsbe restricted for dividend purposesby the cost of any treasury stock held (an externally imposed requirement). Appropriations of retained earnings result from formal decisions by the corporation to set aside a specific amount of retained earnings (an internally imposed requirement).

3. The normal approach to accounting for a change in accounting policy is to retroactively apply the new policy and then restate the financial statements of prior periods to reflect such changes, including the required adjustment to opening retained earnings.