Solution manual – CH 1

1-1. Which Body Should Set Accounting Standards in the Caribbean? Should Each Individual
Territory be Able to Determine Which Individual Standards they are Willing
To Accept?
Argument:
Argument 1: Argue that international bodies such as IFAC and the IASB should set accounting
standards in the Caribbean. Identify four perceived benefits which flow to a country that adopts
international accounting standards. Identify some of the consequences of not adopting international
accounting standards.
2: Argue that regional and local bodies such as ICAC/ICAB/ICAJ/ICAG, etc. should set
accounting standards in the Caribbean. Identify four perceived benefits which may flow to a country
that designs their own accounting standards. Identify some of the consequences associated with
adopting international accounting standards for undeveloped economies.
1-2. Should the Scope of Accounting Standards be Narrowed Further?
Argument Debate:
Argument 1: You are management, argue against the narrowing of accounting choices.
Argument 2: You are a prospective investor, argue for the narrowing of accounting choices.

Debate 1-2 Should the scope of accounting standards be narrowed further?

Team 1.
This question should prompt the student to investigate how management might benefit from

alternative accounting choices. They can go to the web and find out that accounting choices

provide managerial incentives that are either income increasing or income decreasing. They may

also find instances that management can choose methods of presenting financial information that

make the company appear less risky.

Income-increasing choices afford management the ability to paint a better picture of company

performance. Management may be inclined to select income increasing policies because

 they believe the stock market will react favorably and their own personal wealth and position

in the firm may be more secure.

 their bonus may be tied to the bottom line.

 The company may appear better able to pay suppliers and thus may be in a better position to

negotiate favorable terms with suppliers

 The company may appear better able to repay debt and thus look good to a lender.
 Students can cite real-world examples, eg., World Com capitalized expenses

Income-decreasing choices may be selected by companies that

 Are highly regulated, such as utility companies. Poor performance can support the notion

that the company deserves a rate increase

 If a company is having a bad year, it may choose to load up the income statement with

expenses and losses so that it will appear better off in future years.

 Have labor unions hope to fare better in negotiations for labor contracts

Companies have used off-balance sheet financing to improve the perception of a company’s

riskiness. Enron is a prime example. Enron used special purpose entities to hide debt from
investors.

The student can also argue that accounting choice can be used to provide more relevant financial

statements. For example, SFAS 115 provides choices that are intended to result in financials that

better disclose the results of management investment choices.

Team 2.
All of the above can be used as arguments against the proliferation of accounting choices.

Narrowing accounting choices has been a goal of accounting professionals for many years. For

example, one of the objectives of the APB was to narrow areas of difference in GAAP.

Critics maintain that management is allowed too much leeway in the selection of the accounting

procedures used in corporate financial reports. These criticisms revolve around two issues (1)

Executive compensation is frequently tied to reported earnings, so management is inclined to

adopt accounting principles that increase current revenues and decrease current expenses and (2)

the value of a firm in the marketplace is determined by its stock price. This value is highly

influenced by financial analysts’ quarterly earnings estimates. Managers are fearful that failing to

meet these earnings estimates will trigger a sell-off of the company’s stock and a resultant decline

in the market value of the firm.

The large number of accounting frauds that were evident during recent years provide examples of

the ways that management has manipulated financial statement in order to fool the public. Many

of these cases might not have occurred if management were not afforded the discretion to choose

accounting procedures and practices. In short, accounting choice can result in earnings

management, fraudulent financial reporting, a lack of financial statement transparency, financial

statements that are not reliable, and financial statements that are biased.
Case 1-6 Accounting in Crisis
During the early 2000’s, the role of accounting and the auditing profession changed and several
accounting scandals were discovered.
Required:
a. what conditions caused accounting and the auditing profession role to change during this time?
b. what major changes occurred as a result of the accounting scandals at that time?

Case 1-6
a. Historically, accounting has been considered a highly trustworthy profession. Public accounting

firms trained new accountants in the audit function with oversight from senior partners who

believed that their firm’s integrity rode on every engagement. That is, new auditors were assigned

client responsibility after minimal formal audit training. Most of the training of new accountants

took place on-site, and the effectiveness of the new auditor depended on the effectiveness of the

instructor.

CPA firms have always called their customers “clients” and have worked hard to cultivate them.

Partners routinely entertained clients at sporting events, country clubs, and restaurants, and many

CPA firm employees later moved on to work in their clients’ firms. Any conflicts in these

relationships were, at least partially, offset by the CPA firm’s commitment to professional ethics.

These relationships changed as information technology advisory services grew in the late 1970s

and early ’80s. Also in the mid-1980s, the AICPA lifted its ban on advertising. As a result,

revenue generation became more critical to partners’ compensation. Thereafter, the profit

structure of CPA firms changed dramatically and in 1999, revenues for management consulting

accounted for more than 50 percent of the then Big Five’s revenue.

As a result, the audit function evolved into a loss leader that public accounting firms offered in

conjunction with vastly more lucrative consulting engagements. But as pubic accounting firms

competed more aggressively on price for audit engagements, they were forced by cost

considerations to reduce the number of procedures performed for each client engagement. This

resulted in increased test of controls and statistical models, and fewer of the basic, time-

consuming tests of transactions that increase the likelihood of detecting fraud. In addition, junior

auditors were frequently assigned the crucial oversight roles usually filled by senior partners, who

were otherwise engaged in marketing activities to prospective clients. This reduced the
effectiveness of the instructor–new accountant training process.

b. 1. Arthur Andersen, formerly one the Big Five audit firms, has gone out of business.

2. In July 2002, President George W. Bush signed into law the Sarbanes-Oxley Bill, which

imposes a number of corporate governance rules on publicly traded companies

3. Establishment of PCAOB.
 Solution manual – CH 2
Case 2-8 The IFRS’s Conceptual Framework
Discuss the structure of the IFRS’s conceptual framework for financial accounting and
reporting. Identify and discuss the benefits expected to be derived from the IFRS’s conceptual
framework revisions.

Case 2-8
The conceptual framework contains three levels. The apex, the first level, identifies the
objective of financial reporting —that is, the purpose of financial reporting. The
second level outlines the fundamentals, which are the qualitativecharacteristics that
make accounting information useful, and the elements offinancial statements (assets,
liabilities, and so on). The third level identifies the implementation guidelines of
recognition, measurement, and disclosure used in establishing and applying
accounting standards and the specific concepts to put into practice the objective. These
guidelines include the assumptions, principles, and constraints that describe the present
reporting environment.
Case 2-13 Principles Based vs. Rule Based Accounting Standards
Discuss the issue of principles based vs. rule based accounting standards.

Case 2-13
During the early 2000s, the FASB noted that concerns were being expressed about the
quality and transparency of accounting information. One of the main concerns was the
increasing complexity of FASB standards. The Board concluded that much of the detail
and complexity associated with accounting standards was the result of rule-driven
implementation guidance, which allows “accounting engineering” to get around the rules
thereby allowing companies to circumvent the intent and spirit of the standards.
Additionally, the FASB noted that its Conceptual Framework has not provided all of the
necessary tools for resolving accounting problems. This deficiency was attributed to the
fact the certain aspects of the Conceptual Framework are internally inconsistent and
incomplete. As a result, the Board is considering the need to develop an overall
reporting framework similar to International Accounting Standard No. 1. Such a
framework would provide guidance on issues such as materiality assessments, going
concern assessments, professional judgment, consistency and comparability. It would
also allow few, if any, exceptions and fewer implementation guidelines.

To illustrate the difference between rules based and principles based standards, the
standard setting process can be viewed as a continuum ranging from highly rigid
standardson one end to general definitions of economics-based concepts on the other
end. For example, consider accounting for the intangible asset goodwill. An example of
the extremely rigid end of the continuum is the previously acceptable practice:
Goodwill is to be amortized over a 40 year life until it is fully amortized.
This requirement leaves no room for judgment or disagreement about the amount of
amortization expense to be recognized. Comparability and consistency across firms and
through time is virtually assured under such a rule. However, the requirement lacks
relevance because it does not reflect the underlying economics of the reporting entity,
which differ across firms and through time.

At the opposite end of the continuum is the FASB’s new rule:

Goodwill is not amortized. Any recorded goodwill is to be tested for impairment
and if impaired, written down to its current fair value on an annual basis.
This requirement necessitates the application of judgment and expertise by both managers and
auditors. The goal is to record the economic deterioration of the asset, goodwill.
Case 2-17 Conceptual Framework

a. What is the most important quality for accounting information as identified in the conceptual
framework? Explain why it is the most important.
b. Statement of Financial Accounting Concepts No. 8 describes a number of key characteristics
or qualities for accounting information. Briefly discuss the importance of any three of these
qualities for financial reporting purposes.

Case 2-17

a. FASB’s Conceptual Framework should provide benefits to the accounting community

such as:
1. Guiding the FASB in establishing accounting standards on a consistent basis.
2. Determining bounds for judgment in preparing financial statements by prescribing the
nature, functions and limits of financial accounting and reporting.
3. Increasing users’ understanding of and confidence in financial reporting.

b. The most important quality for accounting information as usefulness for decision making.
Relevance and faithful representation are the primary qualities leading to this decision
usefulness. Usefulness is the most important quality because, without usefulness, there
would be no benefits from information to set against its costs.
c. There are a number of key characteristics or qualities that make accounting information
desirable. The importance of three of these characteristics or qualities is discussed
below.
Understandability—information provided by financial reporting should be comprehensible
to those who have a reasonable understanding of business and economic activities and
are willing to study the information with reasonable diligence. Financial information is a
tool and, like most tools, cannot be of much direct help to those who are unable or
unwilling to use it, or who misuse it.
Relevance—the accounting information is capable of making a difference in a decision
by helping users to form predictions about the outcomes of past, present, and future
events or to confirm or correct expectations (including is material).
Faithful representation—the faithful representation of a measure rests on whether the numbers
and descriptions matched what really existed or happened, including completeness, neutrality,
and free from error.
 Solution manual – CH 3

Q. (from Case 2-2 b.) Discuss the standards overload problem.

Case 3-1 Discuss the advantages and disadvantages of harmonizing
accounting standards. (references to articles in the actual question in the
text).
Case 3-1
The greatest advantage attributed by advocates of the harmonization of accounting
standards is that international financial information would be comparable. Consequently,
the concerns about the reliability of foreign financial statements would be alleviated ;and
the free flow of international investments would be enhanced. Harmonization is also seen
as resulting in improved risk analysis which would result in the lowering of interest rates.

Another advantage is that the time and money now spent to consolidate divergent financial
information would be saved. Presently, many adjustments, often arbitrary and sometimes
base on faulty assumptions are needed.

A third advantage would be the tendency for accounting standards to be raised to the
highest level to be consistent with local economic, legal and social conditions. This is
seen as overcoming the presently deficient accounting information presently supplied by
developing economies.

Critics of harmonization hold that it is neither practical nor perhaps even valuable. They
point to the spotty record of domestic standard setters in the United States where they are
well-funded and widely supported. They also argue that a well-developed global capital
market already exists and has evolved without uniform accounting standards;
consequently, there is no compelling need to harmonize standards. Other critics indicate
that widespread cultural differences, especially language, make harmonization an almost
impossible goal. Finally, some individuals feel that the issue of legal enforcement of
standards may be an insurmountable problem
Case 3-2 Discuss the five approaches to transnational financial reporting.
Identify the advantages and disadvantages of each approach. Which approach
do you favour? State why.
Case 3-2
a. A company may take different approaches in preparing financial statements for users in
foreign companies. These are as follows:

1. Send the same set of financial statements to all users (domestic or foreign). This is,
in essence, a do nothing approach, and puts the entire burden of understanding the
financial reports on the user. On the other hand, if a company raises very little capital
outside its home country, the added expense of taking another approach may not be
worthwhile. Also, some companies using foreign investment may sell directly to
sophisticated users who are able to use the unadjusted financial statements such as
pension funds.

2. Translate the financial statements sent to foreign users into the language of the foreign
nation's users. This is termed convenience translation and is a relatively inexpensive
method of accommodation of foreign users. The user is saved the inconvenience of
dealing with a foreign language, but still must understand another country's accounting
practices and monetary unit. This is a low-cost alternative to the do nothing approach.

3. Translate the financial statements sent to foreign users into the foreign nation's
language and currency. This is termed preparing convenience statements. Although
this process makes the statements easy for foreign users to read, it may mislead them
into believing that the statements were prepared using the foreign country's accounting
principles.

4. Prepare two sets of financial statements, one using the home country language,
currency and accounting principles, the second using the language, currency and
accounting principles of the foreign countries users. This is a large step in the direction
of accommodating foreign users and should only be considered when the perceived
benefits exceed the costs.

5. Prepare one set of financial statements based on worldwide accepted accounting

principles. This is a utopian approach. At the present time there are no worldwide
accepted accounting standards. This approach can only be taken if international
accounting standards are harmonized.

No correct answer. Asks for an opinion.

 Solution manual – CH 4
Debate 4-2 Critical Perspective versus Mainstream Accounting
Proponents of critical perspectives research believe that mainstream accounting research relies on
assumptions that are considered in a vacuum, which does not mirror reality.
Arguments
Argument 1: Present arguments supporting critical perspective research
Argument 2: Present arguments supporting traditional, mainstream accounting research

Debate 4-2 Critical perspective versus mainstream accounting

Team 1 Present arguments supporting critical perspectives research.

Critical perspectives proponents argue that accounting is not objective. Rather, the
accounting procedures and standards resulted from a complex web of economic, political,
and accidental co-occurrences. For example, the recent pronouncements related to
accounting for fair value and accounting for stock options created pressure on Congress
to interfere in the standard setting process. Similarly the pronouncement on loan
impairments created outside pressures for the FASB to promulgate accounting rules
taking the present value of future cash flows into consideration. The result is that debtors
and creditors of impaired loans, in particular troubled debt restructures, account for the
same economic event in different ways. It is difficult to explain how this kind of accounting
asymmetry provides information that is representationally faithful and therefore objective.

Critical perspectives proponents also argue that accounting has been unduly influenced
by utility based, marginalist economics. That is, the profit motive is all that matters. This
viewpoint overlooks many other goals of business organizations, such as social goals. In
addition they argue that accountants aid profit oriented groups to the detriment of others.

Critical perspectives proponents view organizations in both a historic and a societal

context. Accordingly, accounting should serve the good of society as well as business
organizations. It should concern itself with the powerful multinational corporation and how
these corporations affect the benefits received by and the costs to society. For example,
accounting reports should provide information regarding the social costs of polluting the
environment.
Team 2 Arguments supporting traditional mainstream accounting research

Traditional mainstream accounting research is concerned with unbiased, objective

reporting of results of economic transactions and events. Accounting serves a
stewardship function for investors, creditors and other users. Because the modern
corporation is characterized by separation of management and ownership, accounting has
a responsibility to owners to report how management has utilized the resources entrusted
to it and how the company has actually performed during the accounting period.
Accounting does have a duty to society. But, that duty is not to try to cause corporations
to provide benefit to the society at large. Rather, in a free market economy, business
serves society by providing goods and services to the public. In return, business
provides a return to owners, jobs for societies people, and profits to other businesses by
buying goods and services from them. It is the accountant's job to report on these
activities so that users of accounting information can assess the value of the company.
It is not the accountant’s job to pass judgment on the activities themselves or to bias
reporting so that a societal goal can be reached.
Debate 4-3 Positive versus Normative Accounting Theory
A comprehensive theory of accounting has yet to be developed.
Arguments
Argument 1: Present arguments that support reliance on positive theory to develop a general
theory of accounting.
Argument 2: Present arguments that support reliance on normative theory to develop a general
theory of accounting.
Debate 4-3 Positive versus normative accounting theory

Team 1Support reliance on positive theory to develop a general theory of accounting

Proponents of the positive theory of accounting maintain that it provides a description of

existing accounting practice. In fact, this theory has arisen because existing theoretical
constructs do not fully explain accounting practice. Stated differently, positive theory
explains what is, rather than what should be. Thus, it can be used to explain why
companies make the accounting choices that they do.

Positive accounting can be associated with the contractual view of the firm in which
accounting practices have evolved to mitigate contracting costs by establishing
agreement among varying parties. For example, a positivist would say that
conservatism has origins in the contract markets, including managerial compensation
contracts and lender debt contracts. To prove their point, one would argue that, absent
conservatism, managerial compensation agreements may reward managers based on
current performance that may later prove unwarranted.

According to Watts and Zimmerman, positive accounting theory should help us to better
understand the sources of pressures that drive the accounting standard-setting process
and how accounting standards affect individuals and individual behavior and thus the
allocation of resources. According to the theory, managers of firms make accounting
choices because of their own self interests. If we can better understand how accounting
standards affect management, then we can do a better job of writing standards to help
bring about appropriate, rather than dysfunctional management behavior. If we don’t
know how accounting standards will be used, then it is unlikely that the goals of
transparency and better reporting will be achieved.

Positive, not normative accounting theory, explains observed accounting practice.

Unlike normative accounting theory it does not rely on consensus of accounting
professionals. Because there is no set of goals that is universally accepted by
accountants, normative accounting theory development may not provide appropriate,
 practical accounting standards. Thus, since normative accounting theories rely upon
acceptability, the resulting theoretical development may be suspect.

Team 2 1Support reliance on normative theory to develop a general theory of accounting

Normative accounting theory is based on sets of goals which prescribe the way financial
reporting should be, not just how it is. If we do not know what we should be reporting,
how can we expect to develop accounting standards whose use will produce financial
reports that can be relied upon to present the true financial picture of the reporting
entity?
Accountants typically agree with the Conceptual Framework’s goal of providing decision-
relevant financial information to users. Decision-relevant financial reports provide the
user with information which they can use to predict future performance and to compare
companies. Only accounting standards that are based on what ought to be are likely
provide management with a consistent choice and application of accounting policies so
that reported results are unbiased and transparent. Accounting standards derived from
normative theory can result in financial statements that are consistent across time and
among companies. Knowledge of how managers can use accounting information to bias
financial results is useful, but does not provide accountants with what they need to
prepare decision-relevant financials.

Accounting standards should be based on clearly stated objectives that can be used to derive
logical and consistent principles and practices. Just because there is no universally accepted
set of objectives, does not mean that there should not be. There is, at least, a relatively wide
acceptance of the underlying objectives and assumptions outlined in the FASB’s Conceptual
Framework. These assumptions can certainly be relied upon to aid in the development of
logical and consistent accounting standards. We can use these objectives and assumptions to
logically derive accounting standards using a deductive approach. In other words, deduction,
based on agreed upon assumptions, is an appropriate approach to accounting theory
development. This is the normative approach.