1.10 Cases

Discussion Case 1: How Should I Invest?

Assume that you just inherited $1 million. You are aware that numerous studies have shown that investments in equity securities (stocks) give the highest rate of return over the long run. However, you are not sure in which companies you should invest. You send for and receive the annual reports of several companies in three growth industries.

In making your investment decision, what useful information would you expect to find in the following?

1. The balance sheet

2. The income statement

3. The statement of cash flows

Discussion Case 2: The Advantage of Internal Users

Emilio Valdez worked for several years as a loan analyst for a large bank. He recently left the bank and took a management position with Positron, a high-tech manufacturing firm. Emilio prepared for his first management meeting by extensively analyzing Positron’s external financial statements. However, in the meeting, the other managers referred to lots of information that Emilio hadn’t found in the financial statements. In addition to using the financial statements, the other managers were using computer printouts and reports unlike anything Emilio had seen in his years at the bank. After the meeting, Monique Vo, one of Emilio’s associates, offered the following advice: “Emilio, you have to remember that you are an internal user now, not an external user.” What does Monique mean?

Discussion Case 3: We Aren’t Getting What We Expect

Quality Enterprises, Inc. issued its 20X1 financial statements on February 22, 20X2. The auditors expressed a “clean” opinion in the audit report. On July 14, 20X2, the company filed for bankruptcy as a result of the inability to meet currently maturing long-term debt obligations. Reasons cited for the action include (1) large losses on inventory due to overproduction of product lines that did not sell, (2) failure to collect on a large account receivable due to the customer’s bankruptcy, and (3) a deteriorating economic environment caused by a severe recession in the spring of 20X2. Joan Stevens, a large stockholder with a large number of Quality shares, is concerned about the fact that a company with a clean audit opinion could have financial difficulty leading to bankruptcy just four months after the audit report was issued. “Where were the auditors?” she inquired. In reply, the auditors contend that on December 31, 20X1, the date of the financial statements, the statements were presented in accordance with GAAP. What is an auditor’s responsibility for protecting users from losses? Are auditors and investors in agreement on what an audit should provide?

Discussion Case 4: Does Lobbying Improve the Quality of Accounting Standards?

The “due process” system of the FASB encourages public input into the standard-setting process. It invites written comments, holds public hearings, and often changes proposed standards in response to this input. However, some observers have suggested that this process makes the setting of accounting standards less a technical exercise and more a political one. Parties are known to lobby for or against proposed standards according to their economic interests.

1. How would accounting standard setting be improved by eliminating lobbying?

2. How would accounting standard setting be harmed by eliminating lobbying?

Discussion Case 5: How Important Are Economic Consequences?

FASB ASC Subtopic 715-60 requires companies to recognize a liability for their obligation to pay for retirees’ health care. Prior to this rule, most companies recognized no liability for their health care promises to employees, although an economic liability certainly existed. Many companies used the adoption of the FASB rule as an excuse to cut retiree health benefits, claiming that the FASB had suddenly created this liability. Thus, it seems that an FASB accounting rule had an economic impact on retirees. Recognizing that accounting rules can have economic consequences, sometimes unintended and undesirable, should the impact on society be an important consideration for the FASB in setting accounting standards?

Discussion Case 6: Who Needs International Accounting?

Tom Obstinate is disgusted by all of the emphasis being put on international accounting issues. Tom plans to practice accounting in the United States, with U.S. companies, using U.S. GAAP. Accordingly, Tom sees no reason to know anything about the IASB or cross-national differences in accounting practices. Is there any merit in Tom’s view? What might you say to Tom to get him to reconsider his position?

Disucssion Case 7: You Need More Education!

For more than three decades, accounting professionals, accounting educators, and accounting bodies have debated requiring more education for those entering the public accounting profession. In 1988, the AICPA passed a resolution mandating 150 college credit hours as a minimum educational requirement for all new members of its organization after 1999. This requirement placed added pressure on state legislators to pass new accounting legislation, and during the 1990s, an increasing number of states passed the “150-hour rule.” Some groups, however, oppose this move and argue that it is restrictive to entry of minority groups and that it will unnecessarily reduce the number of accounting graduates and put accounting educators “out of work” as students opt for less expensive educational alternatives.

Why does the accounting profession recommend more education for new accounting professionals? Why would some groups resist this move? As an accounting student, were you deterred in your decision to major in accounting because of the “150-hour rule”? Why or why not?

Discussion Case 8: Let’s Play by the IRS Rules

Little attempt is made to reconcile the accounting standard differences between the IRS and the FASB. These differences are recognized as arising from differences in the objectives of the two bodies. However, the existence of differences requires companies to keep two different sets of records in some areas: records that follow the FASB pronouncements and those that follow the IRS rules and regulations.

Historically, the financial accounting standards in some countries have closely followed the tax rules established by the respective government. What applies for taxes often applies for the balance sheet and the income statement as well.

What are the advantages of merging accounting standards for taxes and financial reporting? What are the disadvantages? What would it take to change a system so deeply ingrained in the business fabric of either the United States or other countries?

Discussion Case 9: Cash Flow versus Earnings

The FASB concluded that investors and creditors are interested in an enterprise’s future cash flows. However, the Board further stated that the primary focus of financial reporting is information about earnings. If an investor or creditor is interested in future cash flows, why isn’t the focus on an examination of a firm’s past cash flows? What are the limitations associated with using cash flows to measure the performance of an enterprise? Conversely, what are the risks to an investor or creditor of focusing solely on accrual-based earnings figures?

Discussion Case 10: What Is an Asset?

Conserv Corporation, a computer software company, is trying to determine the appropriate accounting procedure to apply to its software development costs. Management is considering capitalizing the development costs and amortizing them over several years. Alternatively, they are considering charging the costs to expense as soon as they are incurred. You, as an accountant, have been asked to help settle this issue. Which definitions of financial statement elements would apply to these costs? Based on this information, what accounting procedure would you recommend and why?

Discussion Case 11: Which Measurement Attribute Is Right for Bonds Payable?

Companies regularly obtain money through the issuance of bonds. The market value of bonds changes daily and on any given day is a function of many factors including economic variables, interest rates, industry developments, and firm specific information. Should bonds be reported on the books of the issuer at their market value on the balance sheet date? at their historical selling price? at their discounted present value? or at their eventual maturity value? For each of these measurement attributes, identify and discuss the issues associated with each attribute.

Discussion Case 12: But We Need Only One Accounting Standard—Fairness

In the 1970s, a leader in the accounting profession proposed that there really needed to be only one underlying standard to govern the establishment of generally accepted accounting principles. That standard was identified as fairness. Financial statements should be prepared so that they are fair to all users: management, labor, investors, creditors. As changes occur in society, financial reporting should change to fairly reflect each user’s needs. Because the financial statements are the responsibility of management, such a standard would require management to determine what reporting methods would be fair. What advantages do you see to this proposal? What would be management’s most serious problem in applying a fairness standard?

Discussion Case 13: And Then There Were Four

The existence of just four large CPA firms that service virtually all of the major industrial and financial companies and thus dominate the accounting profession has led to criticism through the years.

1. What dangers do you see from the dominance of a few large CPA firms? What advantages?

2. During the 1980s and 1990s, mergers among the large public accounting firms reduced the Big 8 to the Big 5. The death of Arthur Andersen (because of the Enron scandal) reduced the number to four. One reason offered for the mergers was that they improved the ability of the merging firms to provide the broad array of consulting services that provided an increasing share of the revenues of the large accounting firms. What problems do you think intensified as public accounting firms earned an ever-larger share of their income from consulting?

Case 14: Deciphering Financial Statements (The Walt Disney Company)

Locate the 2009 financial statements for The Walt Disney Company on the Internet and consider the following questions:

1. How well did Disney do financially during the year ended October 3, 2009? (Hint: Look at the income statement.)

2. Comment on the level of detail in Disney’s balance sheet. Should there be more balance sheet categories or fewer?

3. In 2009, was Disney’s net cash from operations sufficient to pay for its investments in parks, resorts, and other property and in the acquisition of other businesses?

4. Look at the notes to the financial statements. You will find 18 of them. Which ones seem to give you the most new information?

5. Find the auditor’s opinion. Who is Disney’s auditor? Was the 2009 audit opinion unqualified?

Case 15: Deciphering Financial Statements (McDonald’s Corporation)

The following information comes from the 2009 financial statements of McDonald’s Corporation.

Conventional franchise arrangements generally include a lease and a license and provide for payment of initial fees, as well as continuing rent and royalties to the Company based upon a percent of sales with minimum rent payments that parallel the Company’s underlying leases and escalations (on properties that are leased). Under this arrangement, franchisees are granted the right to operate a restaurant using the McDonald’s System and, in most cases, the use of a restaurant facility, generally for a period of 20 years. These franchisees pay related occupancy costs including property taxes, insurance and maintenance. Affiliates and developmental licensees operating under license agreements pay a royalty to the Company based upon a percent of sales, and may pay initial fees.

The results of operations of restaurant businesses purchased and sold in transactions with franchisees were not material to the consolidated financial statements for periods prior to purchase and sale.

Revenues from franchised restaurants consisted of:

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McDonald’s, 2009, 10K Report

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Future minimum rent payments due to the Company under existing franchise arrangements are:

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McDonald’s, 2009, 10K Report

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This $26.0 billion amount represents the future minimum payments that McDonald’s expected to receive from its franchisees as of December 31, 2009.

1. Using the element definition from the conceptual framework, should this $26.0 billion be recorded as an asset in McDonald’s 2009 balance sheet? Why or why not?

2. If your answer in part (1) is yes, what measurement attribute should be used in reporting the asset?

Case 16: Writing Assignment (Should the SEC replace the FASB?)

Imagine that you have been selected to compete with students from other universities in presenting a case considering whether the FASB should be abolished and its standard-setting role taken over by the SEC.

Prepare a one-page summary outlining the major arguments for and against the SEC replacing the FASB.

Case 17: Ethical Dilemma (Should you manipulate your reported income?)

Accounting standards place limits on the set of allowable alternative accounting treatments, but the accountant must still exercise judgment to choose among the remaining alternatives. In making those choices, which of the following should the accountant seek to do?

1. Maximize reported income.

2. Minimize reported income.

3. Ignore the impact of the accounting choice on income and just focus on the most conceptually correct option.

Would your answer change if this were a tax accounting class? Why or why not?