Financial Accounting Theory And Analysis: Text And Cases, 10th Edition Solution Manual
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1 Accounting Theory and Analysis 10 th Edition Solutions Manual and Test Bank By Richard G. Schroeder University of North Carolina at Charlotte Myrtle W. Clark University of Kentucky Jack M. Cathey University of North Carolina at Charlotte
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2 Table of Contents Page number Using the Codification to Solve the FASB ASC Cases 3 Solutions Manual Chapter 1 6 Chapter 2 32 Chapter 3 58 Chapter 4 65 Chapter 5 74 Chapter 6 100 Chapter 7 127 Chapter 8 144 Chapter 9 167 Chapter 10 184 Chapter 11 211 Chapter 12 254 Chapter 13 276 Chapter 14 291 Chapter 15 307 Chapter 16 337 Chapter 17 359
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4 Using the Codification to Solve the FASB ASC Cases Prior to attempting to use the codification website to solve the FASB ASC cases, it is recommended that you read “Test Driving the Codification,” by Carolyn Ford and C. William Thomas, Journal of Accountancy , December, 2008 . Available at http://www.journalofaccountancy.com/Issues/2008/Dec/TestDrivingtheCodification.htm , and review the tutorials on the codification website. Overview of the Codification The Financial Accounting Standards Board codification (FASB ASC) is organized into general topics listed on the left - hand side of the home page (General Principles, Presentation, etc.). Clicking on any of the general topics will bring up what the FASB terms a “landing page.” Each landing page contains a list of sub topics for that link. For example clicking on the general topic Assets brings up list of seven sub topics (Cash and Cash Equivalents, Receivables, etc.). Notice that each of the subtopics is identified by a three digit number. This allows for access via the go to function that we will discuss later. Clicking on any of the subtopics brings up a second link to what are termed sections and contain the content specific area of the FASB ASC. All Subtopics have a set of standard Sections unless there is nothing to include in a particular standard section, in which case that standard Section is left out of the Subtopic and therefore the FASB ASC. There are sixteen standa rd Sections for each Subtopic. Sections are indicated by a two digit number between 00 and 99 . Some of the most frequently used sections are: 25 Recognition, 30 Initial Measurement 35 Subsequent Measurement, 50 Disclosure and Implementa tion Guidance and Instructions. Each Section has Paragraph numbers that start over at the beginning of each Section. Each Paragraph, therefore, has a two - part number. The first number is the Section number, and the second part is the Paragraph number within that Section. The Paragraphs are where “ substantive content” of the FASB ASC is found. The rest of the levels only exist to o rganize the information in the P aragraphs and help navigate to the information contained in them. In order to view the specific content areas, it is necessary to click on the JOIN ALL SECTIONS tab found on each section page. For example, assume we are interested in the authoritative literature on accounting for sales of products when a right to return exists. First, click on the topic Revenue at the left - hand side of the home page, then on the landing page Revenue Recognition. Next, click on the products subsection. Finally click the JOIN ALL SECTIONS tab and all of the paragraph content will appear. Page down through the material and you will find that Paragraph 25 - 1 contains the authoritative guidance for accounting for sales of products with a right to return. The home page also gives other options for navigating the FASB ASC. Two of these are the SEARCH function and the GO TO option. We have found that using these functions is an easy way to start navigating the FASB ASC. To use the search method of navigating the FASB ASC, first, type the general topic in the search box at the top right of the FASB ASC home page. This will give you some references to specific FASB ASC sections where the topic is discussed. Choose the section that seems most appropriate and type the reference number in the GO TO box at the top left - hand side of the FASB ASC homepage. Once you are redirected to the desired section, click combine sections and all of the information on the topic will be
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5 displayed. You can then browse through the material to find the appropriate subsection that addresses the case issue. Let’s use this option to find the authoritative literature on accounting for sales of products with a right to return Type “right to return,” in the search box at the top right of the FASB ASC web page.You will get references to the place where this issue is discussed. Seven possibilities appear, but in reviewing we see that the criteria are contained in 605 - 15 - 25 - 1. Type this number in the box next to the GO TO link at the top left - hand side of the FASB ASC homepage. This will redirect you to the content specific paragraph that discusses accounting for sales of products where a right of return exists. (Note: in some searches you may be redirected to the section outline. If so, click the JOIN ALL SECTIONS tab and all of the paragraph content will appear. If the issue involves accessing a previous specific pronouncement, it is also possible to access the topic through the cross reference function. On the home page, select Cross Reference. This feature allows you to access the relevant FASB ASC section by citing the original source. To use this feature, first access the drop down menu under Standard Type. (Standard Type refers to the authoritative body that originally issued the pronouncement. For example the Financial Accounting Standards Boards uses the acronym FAS. A discussion of the acronyms for the various standard types is contained through a link in the directions). Next, use the drop down menu under standard number and choose the appropriate number. Then click GENERATE REPORT . When the results appear, click on the first paragraph number at the far right side. Next, click on the 3 digit topic at the top under Table of Contents. When the results appear, click and expand and all of the subtopics will appear. Choose the subtopic you wish to view and then combine sections and the relevant authoritative literature will be displayed. For example, to answer case 9 - 3, choose FAS from the drop down Standard Type menu. Then choose 143 from the standard number drop down menu . (Please note that the standard number for asset retirement obligations was misidentified in the case. It should be 143 not 144). Click on GENERATE REPORT and when the results appear, click on 05 - 4 on the first line under paragraph number. When the results appear, click 410 Asset Retirement and Environmental Obligations. When the results appear, the most appropriate section seems to be 20 Asset Retirement Obligations. Select it and then click the JOIN ALL SECTIONS tab and all of the paragraph content will appear. Finding original source material still contained in the Codification Several of the FASB ASC cases ask for EITF pronouncements related to a particular topic. In order to find original source material from the EITF or any other authoritative body use the following steps: 1. Find the relevant topic in the FASB ASC 2. Click expand for the relevant subtopic 3. Click the JOIN ALL SECTIONS tab 4. From the menu select Printer - friendly with sources 5. Page through the material to find content originally sourced from the EITF ƒ Page/Print functions
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6 CHAPTER 1 Case l - 1 a. The FASB had three primary goals in developing the Codification: 1. Simplify user access by codifying all authoritative US GAAP in one spot. 2. Ensure that the codified content accurately represented authoritative US GAAP as of July1, 2009. 3. Create a codification research system that is up to date for the released results of standard - setting activity . b. The Codification is expected to improve accounting practice by : 1. Reducing the amount of time and effort required to solve an accounting research issue 2. Mitigating the risk of noncompliance through improved usability of the literature 3. Provide accurate information with real - time updates as Accounting Standards Updates are released 4. Assist ing the FASB with the research and convergence efforts. c. The FASB ASC is composed of the following literature issued by various standard setters: 1. Financial Accounting Standards Board (FASB) a. Statements (FAS) b. Interpretations (FIN) c. Technical Bulletins (FTB) d. Staff Positions (FSP) e. Staff Implementation Guides (Q&A) f. Statement No. 138 Examples. 2. Emerging Issues Task Force (EITF) a. Abstracts b. Topic D. 3. Derivative Implementation Group (DIG) Issues 4. Accounting Principles Board (APB) Opinions 5. Accounting Research Bulletins (ARB) 6. Accounting Interpretations (AIN) 7. American Institute of Certified Public Accountants (AICPA) a. Statements of Position (SOP) b. Audit and Accounting Guides (AAG) — only incremental accounting guidance c. Practice Bulletins (PB), including the Notices to Practitioners elevated to Practice Bulletin status by Practice Bulletin 1 d. Technical Inquiry Service (TIS) — only for Software Revenue Recognition Additionally, in an effort to increase the utility of the FASB ASC for public companies, relevant portions of authoritative content issued by the SEC and selected SEC staff interpretations and administrative guidance have been included for reference in the Codification, such as: 1. Regulation S - X (SX) 2. Financial Reporting Releases (FRR)/Accounting Series Releases (ASR) 3. Interpretive Releases (IR)
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7 4. SEC Staff guidance in: a. Staff Accounting Bulletins (SAB) b. EITF Topic D and SEC Staff Observer co mments d. The FASB ASC contains all current authoritative accounting literature. However, if the guidance for a particular transaction or event is not specified within it, the first source to consider is accounting principles for similar transactions or events within a source of authoritative GAAP. If no similar transactions are discovered, nonauthoritative guidance from other sources may be considered. Accounting and financial reporting practices not included in the Codification are nonauthoritative. Sources of nonauthoritative accounting guidance and literature include, for example, the following: i. Practices that are widely recognized and prevalent either generally or in the industry ii. FASB Concepts Statements iii. American Institute of Certified Public Accountants (AICPA) Issues Papers iv. International Financial Reporting Standards of the International Accounting Standards Board Pronouncements of professional associations or regulatory agencies v. Technical Information Service Inquiries and Replies included in AICPA Technical Practice Aids vi. Accounting textbooks, handbooks, and articles Case 1 - 2 a. Inclusion or omission of information that materially affects net income harms particular stakeholders. Accountants must recognize that their decision to implement (or delay) reporting requirements will have immediate consequences for some stakeholders. b. Yes. Because the FASB standard results in a fairer presentation, it should be implemented as soon as possible -- regardless of its impact on net income. c. The accountant's responsibility is to provide financial statements that present fairly the financial condition of the company. By advocating early implementation , Hoger fulfills this task. d. Potential lenders and investors, who read the financial statement and rely on its fair representation of the financial condition of the company, have the most to gain by early implementation. A stockholder who is considering the sale of stock may be harmed by early implementation that lowers net income (and may lower the value of the stock). Case 1 - 3 a. CAP. The Committee on Accounting Procedure, CAP, which was in existence from 1939 to 1959, was a natural outgrowth of AICPA (then AIA) committees, which were in existence during the period 1933 to 1938. The committee was formed in direct response to the criticism received by the accounting profession during the financial crisis of 1929 and the years thereafter. The authorization to issue pronouncements on matters of accounting principles and procedures was based on the belief that the AICPA had the responsibility to establish practices that would become generally accepted by the profession and by corporate management. As a general rule, the CAP directed its attention, almost entirely, to resolving specific accounting problems and topics rather than to the development of generally accepted accounting principles. The committee voted on the acceptance of specific Accounting Research Bulletins published by the committee. A two - thirds majority was required to issue a particular research bulletin. The
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8 CAP did not have the authority to require acceptance of the issued bulletins by the general membership of the AICPA, but rather received its authority only upon general acceptance of the pronouncement by the members. That is, the bulletins set forth normative accounting procedures that "should be" followed by the accounting profession, but were not "required" to be followed. It was not until well after the demise of the CAP, in 1964, that the Council of the AICPA adopted recommendations that departures from effective CAP Bulletins should be disclosed in financial statements or in audit reports of members of the AICPA. The demise of the CAP could probably be traced by four distinct factors: (1) the narrow nature of the subjects covered by the bulletins issued by the CAP, (2) the lack of any theoretical groundwork in establishing the procedures presented in the bulletins, (3) the lack of any real authority by the CAP in prescribing adherence the procedures described by the bulletins, and (4) the lack of any formal representation on the CAP of interest groups such as corporate managers, governmental agencies, and security analysts. APB. The objectives of the APB were formulated mainly to correct the deficiencies of the CAP as described above. The APB was thus charged with the responsibility of developing written expression of generally accepted accounting principles through consideration of the research done by other members of the AICPA in preparing Accounting Research Studies. The committee was in turn given substantial authoritative standing in that all opinions of the APB were to constitute substantial authoritative support for generally accepted accounting principles. If an individual member of the AICPA decided that a principle of procedure outside of the official pronouncements of the APB had substantial authoritat ive support, the member had to disclose the departure from the official APB opinion in the financial statements of the firm in question. The membership of the committee comprising the APB was also extended to include representation from industry, government, and academe. The opinions were also designed to include minority dissents by members of the board. Exposure drafts of the proposed opinions were readily distributed. The demise of the APB occurred primarily because the purposes for which it was created were not being accomplished. Broad generally accepted accounting principles were not being developed. The research studies supposedly being undertaken in support of subsequent opinions to be expressed by the APB were often ignored. The committee in essence became a simple extension of the original CAP in that only very specific problem areas were being addressed. Interest groups outside of the accounting profession questioned the appropriateness and desirability of having the AICPA directly responsible for the establishment of GAAP. Politicization of the establishment of GAAP had become a reality because of the far - reaching effects involved in the questions being resolved. FASB. The formal organization of the FASB represents an attempt to vest the responsibility of establishing GAAP in an organization representing the diverse interest groups affected by the use of GAAP. The FASB is independent of the AICPA. It is independent, in fact, of any private or governmental organization. Individual CPAs, firms of CPAs, accounting educators, and representatives of pri vate industry will now have an opportunity to make known their views to the FASB through their membership on the Board. Independence is facilitated through the funding of the organization and payment of the members of the Board. Full - time members are
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9 paid by the organization and the organization itself is funded solely through contributions. Thus, no one interest group has a vested interest in the FASB. Conclusion. The evolution of the current FASB certainly does represent "increasing politicization of accounting standard setting." Many of the efforts extended by the AICPA can be direc tly attributed to the desire to satisfy the interests of many groups within our society. The FASB represents, perhaps, just another step in this evolutionary process. b. Arguments for politicization of the accounting rule - making process: 1. Accounting depends in large part on public confidence for its success. Consequently, the critical issues are not solely technical, so all those having a bona fide interest in the output of accounting should have some influence on that output. 2. There are numerous conflicts between the various interest groups. In the face of this, compromise is necessary, particularly since the critical issues in accounting are value judgments, not the type which are solvable, as we have traditionally assumed, using deterministic models. Only in this way (reasonable compromise) will the financial community have confidence in the fairness and objectivity of accounting rule making. 3. Over the years, accountants have been unable to establish, on the basis of technical accounting elements, rules, which would bring about the desired uniformity and acceptability. This inability itself indicates rule setting is primarily consensual in nature. 4. The public accounting profession, through bodies such as the Accounting Principles Board, made rules which business enterprises and individuals "had" to follow. For many years, these businesses and individuals had little say as to what the rules would be, in spite of the fact that their economic well being was influenced to a substantial degree by those rules. It is only natural that they would try to influence or control the factors that determine their economic well being. c. Arguments against the politicization of the accounting rule - making process: 1. Many accountants feel that accounting is primarily technical in nature. Consequently, they feel that substantive, basic research by objective, independent and fair - minded researchers ultimately will result in the best solutions to critical issues, such as the concepts of income and capital, even if it is accepted that there isn't necessarily a single "right" solution. 2. Even if it is accepted that there are no "absolute truths" as far as critical issues are concerned, many feel that professional accountants, taking into account the diverse interests of the various groups using accounting information, are in the best position, because of their independence, education, training, and objectivity, to decide what generally accepted accounting principles ought to be. 3. The complex situations that arise in the business world require that trained accountants develop the appropriate accounting principles. 4. The use of consensus to develop accounting principles would decrease the professional status of the accountant.
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10 5 This approach would lead to "lobbying" by various parties to influence the establishment of accounting principles. Case 1 - 4 a. The term "accounting principles" in the auditor's report includes not only accounting princ iples but also \ practices and the methods of applying them. Although the term quite naturally emphasizes the primary or fundamental character of some principles, it includes general rules adopted or professed as guides to action in prac tice. The term does not however, mean rules from which there can be no deviation. In some cases the question is which of several partially relevant principles has determining applicability. Neither is the term "accounting principles" necessarily synonymous with accounting theory. Accounting theory is the broad area of inquiry devoted to the definition of objectives to be served by accounting, the development and elaboration of relevant concepts, the promotion of consistency through logic, the elimination of faulty reasoning, and the evaluation of accounting practice. b. Generally accepted accounting p rinciples are those principles (whether or not they have only limited usage) that have substantial authoritative support. Whether a given principle has authoritative support is a question of fact and a matter of judgment. Since September 15, 2009 the primary source of GAAP has been the FASB’s accounting standards codification. However, i f the guidance for a transaction or event is not specified within a source of authoritative GAAP for that entity, an entity shall first consider accounting principles for similar transactions or events within a source of authoritative GAAP for that entity and then consider nonauthoritative guidance from other sources (FASB ASC 105 - 10 - 5 - 2). . The CPA is responsible for collecting the available evidence of authoritative support and judging whether it is sufficient to bring the practice within bounds of generally accepted accounting principles c. The auditor’s report states that a company’s financial statements present “fairly,” in all material respects, its financial position, based on his or her judgment as to whether the accounting princ iples selected and applied have general acceptance and that the accounting principles selected are a ppropriate given the circumstances. This statement is necessary because there are many areas where companies make choices among and between accounting principles ( Depreciation method , inventory cost flow assumptions, etc). Therefore, , it is expected that financial reports are prepared in a manner that reflects the underlying economic events and activities of the reporting entity. This expectation was stressed in SAS No. 90 which stated, "In each SEC engagement, the auditor should discuss with the audit committee the auditor's judgments about the quality, not just the acceptability, of the entity's accounting principles appli ed in its financial reporting . The discussion should also include items that have a significant impact on the representational faithfulness, verifiability, and neutrality of the accounting information included in the financial statements. “ As a consequence, the choices of accounting principles made by one company are often different than those made by another company. Case 1 - 6 Another factor that influenced the development of accounting during the 19th century was the evolution of joint ventures into business corporations in England. The fact that many individuals, external to the business, needed information about the corporation's activities created the necessity for periodic reports. Additionally, the emerging existence of corporations created the need to distinguish between capital and income. The statutory establishment of corporations in England in 1845 stimulated the development of accounting standards, and laws were subsequently passed that were designed to safeguard
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11 shareholders against improper actions by corporate officers. Dividends were required to be paid from profits, and accounts were required to be kept and audited by persons other than the directors. However, initially anyone could claim to be an accountant, as there were no organized professions or standards of qualifications. The industrial revolution and the succession of Companies Acts in England also served to increase the need for professional standards and accountants. In the later part of the 19th century, the industrial revolution arrived in the United States, and with it came the need for more formal accounting procedures and standards. This period was also characterized by widespread speculation in the securities markets, watered stocks, and large monopolies that controlled segments of the United States economy. In the 19 th century the progressive movement was established in the United States, and in 1898 the Industrial Commission was formed to investigate and report on questions relating to immigration, labor, agriculture, manufacturing, and business. Although no accountants were either on the Commission or used by the Commission, a preliminary report issued in 1900 suggested that an independent public accounting profession should be established in order to curtail observed corporate abuses. Although most accountants did not necessarily subscribe to the desirability of the progressive reforms, the progressive movement conferred specific social obligations on accountants. As a consequence accountants generally came to accept three general levels of progressiveness: (1) a fundamental faith in democracy, a concern for morality and justice and a broad acceptance of the efficiency of education as a major tool in social amelioration; (2) an increased awareness of the social obligation of all segments of society and introduction of the idea of accountability to the public of business and political leaders; and (3) an acceptance of pragmatism as the most relevant operative philosophy of the day. The major concern of accounting during the early 1900s was the development of a theory that could cope with corporate abuses that were occurring at that time, and capital maintenance emerged as a concept. This concept evolved from maintaining invested capital intact, to the maintenance of the physical productive capacity of the firm, to the maintenance of real capital. In essence this last view of capital maintenance was an extension of the economic concept of income (see Chapter 3) that there could be no increase in wealth unless the stockholder or the firm were better off at the end of the period than at the beginning. During the period 1900 - 1915 the concept of income determination was not well developed. There was, however, a debate over which financial statement should be viewed as most important, the balance sheet or the income statement. Implicit in this debate was the view that either the balance sheet or the income statement must be viewed as fundamental and the other residual, and that relevant values could not be disclosed in both statements. The 1904 International Congress of Accountants marked the initial development of the organized accounting profession in the United States, although there had been earlier attempts to organize and several states had state societies. At this meeting, the American Association of Public Accountants was formed as the professional organization of accountants in the United States. In 1916, after a decade of bitter interfactional disputes, this group was reorganized into the American Institute of Accountants (AIA).
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12 The American Association of the University Instructors in Accounting was also formed in 1916. Initially this group focused on matters of curriculum development, and it was not until much later that it attempted to become involved in the development of accounting theory. World War I changed the public's attitude toward the business sector. Many people believed that the successful completion of the war could be, at least partially, attributed to the ingenuity of American businesses. As a consequence, the public perceived that business had reformed, and external regulation was no longer necessary. The accountant's role changed from a protector of third parties to the protector of business interests. Critics of accounting theory during the 1920s suggested that accountants abdicated the stewardship role, placed too much emphasis on the needs of management, and permitted too much flexibility in financial reporting. During this time financial statements were viewed as the representations of management, and accountants did not have the ability to require businesses to use accounting principles they did not wish to employ. Case 1 - 7 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
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13 3. Establishment of PCAOB. Case 1 - 7 a. The structure of the FASB is as follows. A board of trustees nominated by organizations whose members have special knowledge and interest in financial reporting is selected. The organizations originally chosen to select the trustees were the American Accounting Association; the AICPA; the Financial Executives Institute; the National Association of Accountants (The NAA’s name was later changed to Institute of Management Accountants in 1991) and the Financial Analysts Federation. In 1997 the Board of Trustees added four members from public interest organizations. The board that governs the FASB is the Financial Accounting Foundation (FAF). The FAF appoints the Financial Accounting Standards Advisory Council (FASAC), which advises the FASB on major policy issues, the selection of task forces, and the agenda of topics. The number of members on the FASAC varies from year to year. The bylaws call for at least twenty members to be appointed. However, the actual number of members has grown to about thirty in recent years to obtain representation from a wider group of interested parties. The FAF appoints the Financial Accounting Standards Advisory Council, which advises the FASB on major policy issues, the selection of task forces, and the agenda of topics. The FAF is also responsible for appointing the seven members of the FASB and raising the funds to operate the FASB. The FAF currently collects in excess of $11 million a year to support the activities of the FASB. b. The members of the Financial Accounting Foundation are nominated by electors from nine organizations that support the activities of the FASB. These nine organizations are the AICPA, the Financial Executives Institute, the National Association of Accountants, the Financial Analysts Federation, the American Accounting Association, the Security Industry Association, and three not - for - profit organizations. c. A number of key characteristics or qualities that make accounting information desirable are described in the Statement of Financial Accounting Concepts No. 2. The importance of three of these characteristics or qualities are discussed below. 1. 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. 2. 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. 3. Reliability -- the reliability of a measure rests on the faithfulness with which it represents what it purports to represent, coupled with an assurance for the user, which comes through verification, that it has representational quality. (Note to instructor: Other qualities might be discussed by the student, such as secondary qualities. All of these qualities are defined in the textbook.)
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14 FASB ASC 1 - 1 Variable Interest Entities Entities (VI Es) Special purpose entities are accounted for by using the requirements for variable interest entities (VIEs). The information for this question is found by searching the topic “variable interest entities.” 1. The definition of variable interest entities is contained in FASB ASC 810 - 10 - 05 Overview and Background Consolidation of VIEs 05 - 8 The Variable Interest Entities Subsections clarify the application of the General Subsections to certain legal entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the legal entity to finance its activities without additional subordinated financial support . Paragraph 810 - 10 - 10 - 1 states that consolidated financial statements are usually necessary for a fair presentation if one of the entities in the consolidated group directly or indirectly has a controlling financial interest in the other entities. Paragraph 810 - 10 - 15 - 8 states that the usual condition for a controlling financial interest is ownership of a majority voting interest. However, application of the majority voting interest requirement in the General Subsections of this Subtopic to certain types of entities may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that do not involve voting interests. 05 - 9 The Variable Interest Entities Subsections explain how to identify variable interest entities (VIEs) and how to determine when a reporting entity should include the assets, liabilities, noncontrolling interests , and results of activities of a VIE in its consolidated financial statements. Transactions involving VIEs have become increasingly common. Some reporting entities have entered into arrangements using VIEs that appear to be designed to avoid reporting assets and liabilities for which they are responsible, to delay reporting losses that have already been incurred, or to report gains that are illusory. At the same time, many reporting entities have used VIEs for valid business purposes and have properly accounted for those VIEs based on guidance and accepted practice. 05 - 10 Some relationships between reporting entities and VIEs are similar to relationships established by majority voting interests, but VIEs often are arranged without a governing board or with a governing board that has limited ability to make decisions that affect the VIE's activities. A VIE's activities may be limited or predetermined by the articles of incorporation, bylaws, partnership agreements, trust agreements, other establishing documents, or contractual agreements between the parties involved with the VIE. A reporting entity implicitly chooses at the time of its investment to accept the activities in which the VIE is permitted to engage. That reporting entity may not need the ability to make decisions if the activities are predetermined or limited in ways the reporting entity chooses to accept. Alternatively, the reporting entity may obtain an ability to make decisions that affect a VIE's activities through contracts or the VIE's governing documents. There may be other techniques for protecting a reporting entity's interests. In any case, the reporting entity may receive benefits similar to those received from a controlling financial interest and be exposed to risks similar to those received from a controlling financial interest without holding a majority voting interest (or without holding any voting interest). Risks, benefits, or both are the determinants of consolidation in the Variable Interest Entities Subsections. The ability to make decisions is considered an indication that a reporting entity may have sufficient benefits and risks to require consolidation. However, another key indicator is an ability to benefit from the results of those decisions. Therefore, the Variable Interest Entities Subsections provide guidance on determining whether fees paid to a decision maker should be considered a variable interest in a VIE. That guidance is provided to
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15 distinguish between decision making of the kind performed by a hired agent or employee from decision making that is a key indicator of a controlling financial interest. 05 - 11 VIEs often are created for a single specified purpose, for example, to facilitate securitization, leasing, hedging, research and development, reinsurance, or other transactions or arrangements. The activities may be predetermined by the documents that establish the VIEs or by contracts or other arrangements between the parties involved. However, those characteristics do not define the scope of the Variable Interest Entities Subsections because other entities may have those same characteristics. The distinction between VIEs and other entities is based on the nature and amount of the equity investment and the rights and obligations of the equity investors. 05 - 12 Because the equity investors in an entity other than a VIE generally absorb losses first, they can be expected to resist arrangements that give other parties the ability to significantly increase their risk or reduce their benefits. Other parties can be expected to align their interests with those of the equity investors, protect their interests contractually, or avoid any involvement with the entity. 05 - 13 In contrast, either a VIE does not issue voting interests (or other interests with similar rights) or the total equity investment at risk is not sufficient to permit the legal entity to finance its activities without additional subordinated financial support. If a legal entity does not issue voting or similar interests or if the equity investment is insufficient, that legal entity's activities may be predetermined or decision - making ability is determined contractually. If the total equity investment at risk is not sufficient to permit the legal entity to finance its activities, the parties providing the necessary additional subordinated financial support most likely will not permit an equity investor to make decisions that may be counter to their interests. That means that the usual condition for establishing a controlling financial interest as a majority voting interest does not apply to VIEs. Consequently, a standard for consolidation that requires ownership of voting stock or some other form of decision - making ability is not appropriate for such entities. 2. The guidance of the consolidation of VIEs is contained in 810 - 10 - 15 - 14 to 17. 15 - 14 A legal entity shall be subject to consolidation under the guidance in the Variable Interest Entities Subsections if, by design, any of the following conditions exist (The phrase by design refers to legal entities that meet the conditions in this paragraph because of the way they are structured. For example, a legal entity under the control of its equity investors that originally was not a variable interest entity [VIE] does not become one because of operating losses. The design of the legal entity is important in the application of these provisions.): a. The total equity investment (equity investments in a legal entity are interests that are required to be reported as equity in that entity’s financial statements) at risk is not sufficient to permit the legal entity to finance its activities without additional subordinated financial support provided by any parties, including equity holders. For this purpose, the total equity investment at risk has all of the following characteristics: 1. Includes only equity investments in the legal entity that participate significantly in profits and losses even if those investments do not carry voting rights 2. Does not include equity interests that the legal entity issued in exchange for subordinated interests in other VIEs 3. Does not include amounts provided to the equity investor directly or indirectly by the legal entity or by other parties involved with the legal entity (for example, by fees, charitable contributions, or other payments), unless the provider is a parent , subsidiary , or
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16 affiliate of the investor that is required to be included in the same set of consolidated financial statements as the investor 4. Does not include amounts financed for the equity investor (for example, by loans or guarantees of loans) directly by the legal entity or by other parties involved with the legal entity, unless that party is a parent, subsidiary, or affiliate of the investor that is required to be included in the same set of consolidated financial statements as the investor. b. As a group the holders of the equity investment at risk lack any one of the following three characteristics of a controlling financial interest: 1. The direct or indirect ability through voting rights or similar rights to make decisions about a legal entity's activities that have a significant effect on the success of the legal entity. The investors do not have that ability through voting rights or similar rights if no owners hold voting rights or similar rights (such as those of a common shareholder in a corporation or a general partner in a partnership). Legal entities that are not controlled by the holder of a majority voting interest because of minority veto rights as discussed in paragraphs 810 - 10 - 25 - 2 through 25 - 14 are not VIEs if the shareholders as a group have the power to control the entity and the equity investment meets the other requirements of the Variable Interest Entities Subsections. 2. The obligation to absorb the expected losses of the legal entity. The investor or investors do not have that obligation if they are directly or indirectly protected from the expected losses or are guaranteed a return by the legal entity itself or by other parties involved with the legal entity. See paragraphs 810 - 10 - 25 - 55 through 25 - 56 and Example 1 (see paragraph 810 - 10 - 55 - 42 ) for a discussion of expected losses. 3. The right to receive the expected residual returns of the legal entity. The investors do not have that right if their return is capped by the legal entity's governing documents or arrangements with other variable interest holders or the legal entity. For this purpose, the return to equity investors is not considered to be capped by the existence of outstanding stock options, convertible debt, or similar interests because if the options in those instruments are exercised, the holders will become additional equity investors. The objective of this provision is to identify as VIEs those legal entities in which the total equity investment at risk does not provide the holders of that investment with the characteristics of a controlling financial interest. If interests other than the equity investment at risk provide the holders of that investment with the characteristics of a controlling financial interest or if interests other than the equity investment at risk prevent the equity holders from having the necessary characteristics, the entity is a VIE. c. T he equity investors as a group also are considered to lack the characteristic in (b)(1) if both of the following conditions are present: 1. The voting rights of some investors are not proportional to their obligations to absorb the expected losses of the legal entity, their rights to receive the expected residual returns of the legal entity, or both. 2. Substantially all of the legal entity's activities (for example, providing financing or buying assets) either involve or are conducted on behalf of an investor that has disproportionately few voting rights. This provision is necessary to prevent a primary
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17 beneficiary from avoiding consolidation of a VIE by organizing the legal entity with nonsubstantive voting interests. Activities that involve or are conducted on behalf of the related parties of an investor with disproportionately few voting rights shall be treated as if they involve or are conducted on behalf of that investor. The term related parties in this paragraph refers to all parties identified in paragraph 810 - 10 - 25 - 43 , except for de facto agents under paragraph 810 - 10 - 25 - 43(d)(1) . For purposes of applying this requirement, reporting entities shall consider each party’s obligations to absorb expected losses and rights to receive expected residual returns related to all of that party’s interests in the legal entity and not only to its equity investment at risk. 15 - 15 Portions of legal entities or aggregations of assets within a legal entity shall not be treated as separate entities for purposes of applying the Variable Interest Entities Subsections unless the entire entity is a VIE. Some examples are divisions, departments, branches, and pools of assets subject to liabilities that give the creditor no recourse to other assets of the entity. Majority - owned subsidiaries are legal entities separate from their parents that are subject to the Variable Interest Entities Subsections and may be VIEs. 15 - 16 Because reconsideration of whether a legal entity is subject to the Variable Interest Entities Subsections is required only in certain circumstances, the initial application to a legal entity that is in the development stage is very important. Guidelines for identifying a development stage entity appear in paragraph 915 - 10 - 05 - 2 . A development stage entity is a VIE if it meets any of the conditions in paragraph 810 - 10 - 15 - 14 . A development stage entity does not meet the condition in paragraph 810 - 10 - 15 - 14(a) if it can be demonstrated that the equity invested in the legal entity is sufficient to permit it to finance the activities it is currently engaged in (for example, if the legal entity has already obtained financing without additional subordinated financial support) and provisions in the legal entity’s governing documents and contractual arrangements allow additional equity investments. However, sufficiency of the equity investment should be reconsidered as required by paragraph 810 - 10 - 35 - 4 , for example, if the legal entity undertakes additional activities or acquires additional assets. 15 - 17 The following exceptions to the Variable Interest Entities Subsections apply to all legal entities in addition to the exceptions listed in paragraph 810 - 10 - 15 - 12 : a. Not - for - profit entities (NFPs) are not subject to the Variable Interest Entities Subsections, except that they may be related parties for purposes of applying paragraphs 810 - 10 - 25 - 42 through 25 - 44 . In addition, if an NFP is used by business reporting entities in a manner similar to a VIE in an effort to circumvent the provisions of the Variable Interest Entities Subsections, that NFP shall be subject to the guidance in the Variable Interest Entities Subsections. b. Separate accounts of life insurance entities as described in Topic 944 are not subject to consolidation according to the requirements of the Variable Interest Entities Subsections. c. A reporting entity with an interest in a VIE or potential VIE created before December 31, 2003, is not required to apply the guidance in the Variable Interest Entities Subsections to that entity if the reporting entity, after making an exhaustive effort, is unable to obtain the information necessary to do any one of the following: 1. Determine whether the legal entity is a VIE 2. Determine whether the reporting entity is the VIE's primary beneficiary
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18 3. Perform the accounting required to consolidate the VIE for which it is determined to be the primary beneficiary. This inability to obtain the necessary information is expected to be infrequent, especially if the reporting entity participated significantly in the design or redesign of the legal entity. The scope exception in this provision applies only as long as the reporting entity continues to be unable to obtain the necessary information. Paragraph 810 - 10 - 50 - 6 requires certain disclosures to be made about interests in legal entities subject to this provision. Paragraphs 810 - 10 - 30 - 7 through 30 - 9 provide transition guidance for a reporting entity that subsequently obtains the information necessary to apply the Variable Interest Entities Subsections to a legal entity subject to this exception. d. A legal entity that is deemed to be a business need not be evaluated by a reporting entity to determine if the legal entity is a VIE under the requirements of the Variable Interest Entities Subsections unless any of the following conditions exist (however, for legal entities that are excluded by this provision, other generally accepted accounting principles [GAAP] should be applied): 1 . The reporting entity, its related parties (all parties identified in paragraph 810 - 10 - 25 - 43 , except for de facto agents under paragraph 810 - 10 - 25 - 43(d)(1) ), or both participated significantly in the design or redesign of the legal entity. However, this condition does not apply if the legal entity is an operating joint venture under joint control of the reporting entity and one or more independent parties or a franchisee. 2. The legal entity is designed so that substantially all of its activities either involve or are conducted on behalf of the reporting entity and its related parties. 3. The reporting entity and its related parties provide more than half of the total of the equity, subordinated debt, and other forms of subordinated financial support to the legal entity based on an analysis of the fair values of the interests in the legal entity. 4. The activities d financings or single - lessee leasing arrangements. A legal entity that previously was not evaluated to determine if it was a VIE because of this provision need not be evaluated in future periods as long as the legal entity continues to meet the conditions in (d). Transition Date: December 15, 2008 Transition Guidance: 860 - 10 - 65 - 2 The following exceptions to the Variable Interest Entities Subsections apply to all legal entities in addition to the exceptions listed in paragraph 810 - 10 - 15 - 12 : a. Not - for - profit entities (NFPs) are not subject to the Variable Interest Entities Subsections, except that they may be related parties for purposes of applying paragraphs 810 - 10 - 25 - 42 through 25 - 44 . In addition, if an NFP is used by business reporting entities in a manner similar to a VIE in an effort to circumvent the provisions of the Variable Interest Entities Subsections, that NFP shall be subject to the guidance in the Variable Interest Entities Subsections. b. Separate accounts of life insurance entities as described in Topic 944 are not subject to consolidation according to the requirements of the Variable Interest Entities Subsections. c. A reporting entity with an interest in a VIE or potential VIE created before December 31, 2003, is not required to apply the guidance in the Variable Interest Entities Subsections to that entity if the
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19 reporting entity, after making an exhaustive effort, is unable to obtain the information necessary to do any one of the following: 1. Determine whether the legal entity is a VIE 2. Determine whether the reporting entity is the VIE's primary beneficiary 3. Perform the accounting required to consolidate the VIE for which it is determined to be the primary beneficiary. This inability to obtain the necessary information is expected to be infrequent, especially if the reporting entity participated significantly in the design or redesign of the legal entity. The scope exception in this provision applies only as long as the reporting entity continues to be unable to obtain the necessary information. Paragraphs 810 - 10 - 50 - 6 (for a nonpublic entity) and 810 - 10 - 50 - 16 (for a public entity) require certain disclosures to be made about interests in legal entities subject to this provision. Paragraphs 810 - 10 - 30 - 7 through 30 - 9 provide transition guidance for a reporting entity that subsequently obtains the information necessary to apply the Variable Interest Entities Subsections to a legal entity subject to this exception. d. A legal entity that is deemed to be a business need not be evaluated by a reporting entity to determine if the legal entity is a VIE under the requirements of the Variable Interest Entities Subsections unless any of the following conditions exist (however, for legal entities that are excluded by this provision, other generally accepted accounting principles [GAAP] should be applied): 1. The reporting entity, its related parties (all parties identified in paragraph 810 - 10 - 25 - 43 , except for de facto agents under paragraph 810 - 10 - 25 - 43(d)(1) ), or both participated significantly in the design or redesign of the legal entity. However, this condition does not apply if the legal entity is an operating joint venture under joint control of the reporting entity and one or more independent parties or a franchisee. 2. The legal entity is designed so that substantially all of its activities either involve or are conducted on behalf of the reporting entity and its related parties. 3. The reporting entity and its related parties provide more than half of the total of the equity, subordinated debt, and other forms of subordinated financial support to the legal entity based on an analysis of the fair values of the interests in the legal entity. 4. The activities of the legal entity are primarily related to securitizations or other forms of asset - backed financings or single - lessee leasing arrangements. A legal entity that previously was not evaluated to determine if it was a VIE because of this provision need not be evaluated in future periods as long as the legal entity continues to meet the conditions in (d). FASB ASC 1 - 2 Status of ARBs Revenue and Gains
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20 Search ARB 43 in cross reference 605 25 - 1 to 5 25 - 1 The recognition of revenue and gains of an entity during a period involves consideration of the following two factors, with sometimes one and sometimes the other being the more important consideration: a. Being realized or realizable. Revenue and gains are generally not recognized until realized or realizable. Paragraph 83(a) of FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises , states that revenue and gains are realized when products (goods or services), merchandise, or other assets are exchanged for cash or claims to cash. That paragraph states that revenue and gains are realizable when related assets received or held are readily convertible to known amounts of cash or claims to cash. b. Being earned. Paragraph 83(b) of FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises , states that revenue is not recognized until earned. That paragraph states that an entity's revenue - earning activities involve delivering or producing goods, rendering services, or other activities that constitute its ongoing major or central operations, and revenues are considered to have been earned when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues. That paragraph states that gains commonly result from transactions and other events that involve no earning process, and for recognizing gains, being earned is generally less significant than being realized or realizable. 25 - 2 See paragraphs 605 - 10 - 25 - 3 through 25 - 4 for the limited circumstances in which revenue and gains may be recognized using the installment or cost - recovery methods. > Installment and Cost Recovery Methods of Revenue Recognition 25 - 3 Revenue should ordinarily be accounted for at the time a transaction is completed, with appropriate provision for uncollectible accounts. Paragraph 605 - 10 - 25 - 1(a) states that revenue and gains generally are not recognized until being realized or realizable and until earned. Accordingly, unless the circumstances are such that the collection of the sale price is not reasonably assured, the installment method of recognizing revenue is not acceptable. 25 - 4 There may be exceptional cases where receivables are collectible over an extended period of time and, because of the terms of the transactions or other conditions, there is no reasonable basis for estimating the degree of collectibility. When such circumstances exist, and as long as they exist, either the installment method or the cost recovery method of accounting may be used. As defined in paragraph 360 - 20 - 55 - 7 through 55 - 9 , the installment method apportions collections received between cost recovered and profit. The apportionment is in the same ratio as total cost and total profit bear to the sales value. Under the cost recovery method, equal amounts of revenue and expense are recognized as collections are made until all costs have been recovered, postponing any recognition of profit until that time.) 25 - 5 In the absence of the circumstances referred to in this Subtopic or other guidance, such as that in Sections 360 - 20 - 40 and 360 - 20 - 55 , the installment method is not acceptable. Treasury Stock 505 - 30 - 25 and 30 use print function printer friendly with sources to find relevant sections 505 - 30 - 25 - 2 [ Laws of some states govern the circumstances under which an entity may acquire its own stock and prescribe the accounting treatment therefor. If such requirements are at variance with the requirements of paragraphs 505 - 30 - 25 - 7 and 505 - 30 - 30 - 6 through 30 - 10 , the accounting shall conform to the applicable law. [ ARB 43, paragraph Ch. 1B Par. 11A, sequence 128.1 ] ]
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21 Subsequent Resale of Shares Repurchased 505 - 30 - 25 - 7 After an entity's repurchase of its own outstanding common stock, sometimes it may either retire the repurchased shares and issue additional common shares, or, as an alternative, resell the repurchased shares. In either case, the price received may differ from the amount paid to repurchase the shares. [ While the net asset value of the shares of common stock outstanding in the hands of the public may be increased or decreased by such repurchase and retirement, such transactions relate to the capital of the corporation and do not give rise to corporate profits or losses. There is no essential difference between the following: [ ARB 43, paragraph Ch. 1B Par. 7, sequence 118.2.1 ] ] a. [ The repurchase and retirement of a corporation's own common stock and the subsequent issue of common shares [ ARB 43, paragraph Ch. 1B Par. 7, sequence 118.2.2.1 ] ] b. [ The repurchase and resale of its own common stock. [ ARB 43, paragraph Ch. 1B Par. 7, sequence 118.2.2.2 ] ] 505 - 30 - 25 - 8 [ Even though there may be cases where the transactions involved are so inconsequential as to be immaterial, as a broad general principle, such transactions shall not be reflected in retained earnings (either directly or through inclusion in the income statement). [ ARB 43, paragraph Ch. 1B Par. 10, sequence 126 ] ][ The qualification shall not be applied to any transaction that, although in itself inconsiderable in amount, is a part of a series of transactions that in the aggregate are of substantial importance. [ ARB 43, paragraph Ch. 1B Par. 11, sequence 127 ] ] 505 - 30 - 25 - 9 [ The difference between the repurchase and resale prices of a corporation's own common stock shall be reflected as part of the capital of a corporation and allocated to the different components within stockholder equity as required by paragraphs 505 - 30 - 30 - 5 through 30 - 10 . [ ARB 43, paragraph Ch. 1B Par. 5, sequence 116 ] ] Allocating the Cost of Treasury Shares to Components of Shareholder Equity Upon Formal or Constructive Retirement 505 - 30 - 30 - 6 [ Once the cost of the treasury shares is determined under the requirements of this Section, and if a corporation's stock is acquired for purposes other than retirement (formal or constructive), or if ultimate disposition has not yet been decided, paragraph 505 - 30 - 45 - 1 permits the cost of acquired stock to either be shown separately as a deduction from the total of capital stock, additional paid - in capital, and retained earnings, or be accorded the following accounting treatment appropriate for retired stock. [ ARB 43, paragraph Ch. 1B Par. 7, sequence 122.1 ] ] 505 - 30 - 30 - 7 [ The difference between the cost of the treasury shares and the stated value of a corporation's common stock repurchased and retired, or repurchased for constructive retirement, shall be reflected in capital. [ ARB 43, paragraph Ch. 1B Par. 7, sequence 118.1 ] ] 505 - 30 - 30 - 8 [ When a corporation's stock is retired, or repurchased for constructive retirement (with or without an intention to retire the stock formally in accordance with applicable laws), [ ARB 43, paragraph Ch. 1B Par. 7, sequence 119 ] ][ an excess of repurchase price over par or stated value may be allocated between additional paid - in capital and retained earnings. [ ARB 43, paragraph Ch. 1B Par. 7, sequence 120.1.1 ] ][ Alternatively, the excess may be charged entirely to retained earnings in recognition of the fact that a corporation can always capitalize or allocate retained earnings for such purposes. [ ARB 43, paragraph Ch. 1B Par. 7, sequence 120.2.2.2.2 ] ][ If a portion of the excess is allocated to additional
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22 paid - in capital, it shall be limited to the sum of both of the following: [ ARB 43, paragraph Ch. 1B Par. 7, sequence 120.1.2 ] ] a. [ All additional paid - in capital arising from previous retirements and net gains on sales of treasury stock of the same issue [ ARB 43, paragraph Ch. 1B Par. 7, sequence 120.2.1 ] ] b. [ The pro rata portion of additional paid - in capital, voluntary transfers of retained earnings, capitalization of stock dividends, and so forth, on the same issue. [ ARB 43, paragraph Ch. 1B Par. 7, sequence 120.2.2.1 ] ][ For this purpose, any remaining additional paid - in capital applicable to issues fully retired (formal or constructive) is deemed to be applicable pro rata to shares of common stock. [ ARB 43, paragraph Ch. 1B Par. 7, sequence 120.2.2.2.1 ] ] 505 - 30 - 30 - 9 [ When a corporation's stock is retired, or repurchased for constructive retirement (with or without an intention to retire the stock formally in accordance with applicable laws), an excess of par or stated value over the cost of treasury shares shall be credited to additional paid - in capital. [ ARB 43, paragraph Ch. 1B Par. 7, sequence 121 ] ] 505 - 30 - 30 - 10 [ Gains on sales of treasury stock not previously accounted for as constructively retired shall be credited to additional paid - in capital; losses may be charged to additional paid - in capital to the extent that previous net gains from sales or retirements of the same class of stock are included therein, otherwise to retained earnings. [ ARB 43, paragraph Ch. 1B Par. 7, sequence 122.2 ] ] Comparative Financial Statements 205 - 10 - 45 Use print function printer friendly with sources 205 - 10 - 45 - 1 [The presentation of comparative financial statements in annual and other reports enhances the usefulness of such reports and brings out more clearly the nature and trends of current changes affecting the entity. Such presentation emphasizes the fact that statements for a series of periods are far more significant than those for a single period and that the accounts for one period are but an installment of what is essentially a continuous history. [ARB 43, paragraph Ch. 2A Par. 1, sequence 130] ] 205 - 10 - 45 - 2 [In any one year it is ordinarily desirable that the statement of financial position, the income statement, and the statement of changes in equity be presented for one or more preceding years, as well as for the current year. [ARB 43, paragraph Ch. 2A Par. 2, sequence 131.1] ] 205 - 10 - 45 - 3 [Prior - year figures shown for comparative purposes shall in fact be comparable with those shown for the most recent period. Any exceptions to comparability shall be clearly brought out as described in Topic 250 . [ARB 43, paragraph Ch. 2A Par. 3, sequence 132] ] 205 - 10 - 45 - 4 [Notes to financial statements, explanations, and accountants' reports containing qualifications that appeared on the statements for the preceding years shall be repeated, or at least referred to, in the comparative statements to the extent that they continue to be of significance. [ARB 43, paragraph Ch. 2A Par. 2, sequence 131.2.1] ] FASB ASC 1 - 3 Accounting for the Investment Tax Credit
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23 Search investment tax credit 740 - 10 - 25 - 46 While it shall be considered preferable for the allowable investment credit to be reflected in net income over the productive life of acquired property (the deferral method), treating the credit as a reduction of federal income taxes of the year in which the credit arises (the flow - through method) is also acceptable. 740 - 10 - 47 - 27 & 28 Statement of Financial Position 45 - 27 The reflection of the allowable credit as a reduction in the net amount at which the acquired property is stated (either directly or by inclusion in an offsetting account) may be preferable in many cases. However, it is equally appropriate to treat the credit as deferred income, provided it is amortized over the productive life of the acquired property. > > Income Statement 45 - 28 It is preferable that the statement of income in the year in which the allowable investment credit arises should be affected only by the results which flow from the accounting for the credit set forth in paragraph 740 - 10 - 25 - 46 . Nevertheless, reflection of income tax provisions, in the income statement, in the amount payable (that is, after deduction of the allowable investment credit) is appropriate provided that a corresponding charge is made to an appropriate cost or expense (for example, to the provision for depreciation) and the treatment is adequately disclosed in the financial statements of the first year of its adoption. 740 - 10 - 25 - 45 Anticipated Future Tax Credits In the separate financial statements of an entity that pays dividends subject to the tax credit to its shareholders, a deferred tax asset shall not be recognized for the tax benefits of future tax credits that will be realized when the previously taxed income is distributed; rather, those tax benefits shall be recognized as a reduction of income tax expense in the period that the tax credits are included in the entity's tax return. 740 - 10 - 50 - 20 Investment Tax Credit Recognition Policy 50 - 20 Paragraph 740 - 10 - 25 - 46 identifies the deferral method and the flow - through method as acceptable methods of accounting for investment tax credits. Whichever method of accounting for the investment credit is adopted, it is essential that full disclosure be made of the method followed and amounts involved, when material. FASB ASC 1 - 4 SEC Comments a. Search revenue recognition customer payment and incentives 605 - 50
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24 Comments Made by SEC Observer at Emerging Issues Task Force (EITF) Meetings > > > SEC Observer Comment: Accounting for Consideration Given by a Vendor to a Customer (Including Reseller of the Vendor's Products) S99 - 1 The following is the text of SEC Observer Comment: Accounting for Consideration Given by a Vendor to a Customer (Including Reseller of the Vendor's Products). As it relates to consideration given by a vendor to a customer the SEC staff believes that the expense associated with a "free" product or service delivered at the time of sale of another product or service should be classified as cost of sales. b. Search debt with conversions and other options 470 - 20 Comments Made by SEC Observer at Emerging Issues Task Force (EITF) Meetings > > > SEC Observer Comment: Debt Exchangeable for the Stock of Another Entity S99 - 1 The following is the text of the SEC Observer Comment: Debt Exchangeable for the Stock of Another Entity . An issue has been discussed involving an enterprise that holds investments in common stock of other enterprises and issues debt securities that permit the holder to acquire a fixed number of shares of such common stock. These types of transactions are commonly affected through the sale of either debt with detachable warrants that can be exchanged for the stock investment or debt without detachable warrants (the debt itself must be exchanged for the stock investment - also referred to as "exchangeable" debt). Those debt issues differ from traditional warrants or convertible instruments because the traditional instruments involve exchanges for the equity securities of the issuer. There have been questions as to whether the exchangeable debt should be treated similar to traditional convertibles as specified in Subtopic 470 - 20 or whether the transaction requires separate accounting for the exchangeability feature. The SEC staff believes that Subtopic 470 - 20 does not apply to the accounting for debt that is exchangeable for the stock of another entity and therefore separation of the debt element and exchangeability feature is required c. Search software cost of sales and services 985 - 705 Comments Made by SEC Observer at Emerging Issues Task Force (EITF) Meetings > > > SEC Observer Comment: Accounting for the Film and Software Costs Associated with Developing Entertainment and Educational Software Products S99 - 1 The following is the text of SEC Observer Comment: Accounting for the Film and Software Costs Associated with Developing Entertainment and Educational Software Products. The SEC staff has become aware of diversity in the application of generally accepted accounting principles to exploitation, film, and other software development costs associated with EE products. The SEC staff has learned that certain registrants are recording all costs incurred in the development of EE products pursuant to the provisions of Topics 340 , 720 , and 985 . Other registrants are separating exploitation and film costs from other software development costs and accounting for the other software development costs using Topic 985 and capitalizing film and exploitation costs as film cost inventory as described in Topic 926 . Still other registrants, principally film production companies, are capitalizing all costs relating to the development of EE products as film cost inventory.
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25 The SEC staff views stated here are not intended to apply to costs incurred to produce computer - generated special effects and images used in products that are exhibited in theaters or licensed to television stations because those costs are addressed by Topic 926 . Topic 985 establishes standards of financial accounting and reporting for the costs of all computer software to be sold, leased, or otherwise marketed as a separate product or as part of a product or process, whether internally developed and produced or purchased. The SEC staff believes that EE products that are sold, leased, or otherwise marketed are subject to the accounting requirements of Topic 985 . The SEC staff does not believe that other standards of financial accounting and reporting or that industry practice are acceptable alternatives to those requirements. The SEC staff also believes that film costs incurred in the development of an EE product should be accounted for under the provisions of Topic 985 , not the provisions of Topic 926 . In addition, exploitation costs should be expensed as incurred unless those costs include advertising costs that qualify for capitalization in accordance with the provisions of Topics 340 and 720 . FASB ASC 1 - 5 GAAP Guidelines Search “generally accepted accounting principles.” 105 Generally Accepted Accounting Principles 10 Overall 105 - 10 - 05 Overview and Backgroun d General 05 - 1 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 This Topic establishes the Financial Accounting Standards Board (FASB) Accounting Standards Codification ™ (Codification) as the source of authoritative generally accepted accountin g principles (GAAP) recognized by the FASB to be applied by nongovernmental entities . Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. In addition to the SEC’s rules and interpretive releases, the SEC staff issues Staff Accounting Bulletins that represent practices followed by the staff in administering SEC disclosure requirements, and it utilizes SEC Staff Announcements and Observer comments made at Emerging Issues Task Force meetings to publicly announce its views on certain accounting issues for SEC registrants. 05 - 2 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 If the guidance for a transaction or event is not specified within a source of authoritative GAAP for that entity, an entity shall first consider accounting principles for similar transactions or events within a source of authoritative GAAP for that entity and then consider nonauthoritative guidance from other sources. An entity shall not follow the accounting treatment specified in accounting guidance for similar transactions or events in cases in which those accounting principles either prohibit the application of the accounting treatment to the particular transaction or event or indicate that the accounting treatment should not be applied by analogy. 05 - 3 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1
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26 Accounting and financial reporting practices not included in the Codification are nonauthoritative. Sources of nonauthoritative accounting guidance and literature include, for example, the following: a. Practices that are widely recognized and prevalent either generally or in the industry b. FASB Concepts Statements c. American Institute of Certified Public Accountants (AICPA) Issues Papers d. International Financial Reporting Standards of the International Accounting Standards Board e. Pronouncements of professional associations or regulatory agencies f. Technical Information Service Inquiries and Replies included in AICPA Technical Practice Aids g. Accounting textbooks, handbooks, and articles. The appropriateness of other sources of accounting guidance depends on its relevance to particular circumstances, the specificity of the guidance, the general recognition of the issuer or author as an authority, and the extent of its use in practice. 05 - 4 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 The Codification contains the authoritative standards that are applicable to both public nongovernmental entities and nonpublic nongovernmental entities. Content contained in the SEC Sections (designated by an “S” preceding the Section number) is provided for convenience and relates only to SEC registrants. The SEC Sections do not contain the entire population of SEC rules, regulations, interpretive releases, and staff guidance. Content in the SEC Sections is expected to change over time, and there may be delays between SEC and staff changes to guidance and Accounting Standards Updates. The Codification does not replace or affect guidance issued by the SEC or its staff for public entities in their filings with the SEC. 05 - 5 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 As of the effective date in paragraph 105 - 10 - 65 - 1(a) , the FASB will not consider Accounting Standards Updates as authoritative in their own right. Instead, new Accounting Standards Updates will serve only to update the Codification, provide background information about the guidance, and provide the bases for conclusions on the change(s) in the Codification. Other than the standards listed in paragraph 105 - 10 - 65 - 1(d) , all nongrandfathered non - SEC accounting guidance not included in the Codification is superseded and deemed nonauthoritative. 05 - 6 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 The provisions of the Codification need not be applied to immaterial items. 105 - 10 - 10 Objectives General 10 - 1 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 The objective of this Topic is to establish the Financial Account ing Standards Board (FASB) Accounting Standards Codification ™ as the source of authoritative principles and standards recognized by the FASB to be applied by nongovernmenta l entities in the preparation of financial statements in conformity with generally accepted accounting principles (GAAP). Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. 10 - 2
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27 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 This Topic also identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with GAAP in the United States (the GAAP hierarchy). 105 - 10 - 15 Scope and Scope Exceptions General > Entities 15 - 1 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 The Financial Accounting Standards Board (FASB) Accounting Standards Codification ™ applies to financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP). 15 - 2 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 Content in the Securities and Exchange Commission (SEC) Sections of the Codification is provided for convenience and relates only to financial statements of SEC registrants that are presented in conformity with GAAP. 105 - 10 - 20 Glossary Nongovernmental Entity Note : The following definition is Pending Content; see Transition Guidance in 105 - 10 - 65 - 1 . An entity that is not required to issue financial reports in accordance with guidance promulgated by the Governmental Accounting Standards Board or the Federal Accounting Standards Advisory Board. Nonpublic Entity Note: The following definition is Pending Content; see Transition Guidance in 105 - 10 - 65 - 1 . Any entity that does not meet any of the following conditions: a. Its debt or equity securities trade in a public market either on a stock exchange (domestic or foreign) or in an over - the - counter market, including securities quoted only locally or regionally. b. It is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over - the - counter market, including local or regional markets). c. It files with a regulatory agency in preparation for the sale of any class of debt or equity securities in a public market. d. It is required to file or furnish financial statements with the Securities and Exchange Commission. e. It is controlled by an entity covered by criteria (a) through (d).
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28 105 - 10 - 65 Transition and Open Effective Date Information General > Transition Related to FASB Statem ent No. 168, The FASB Accounting Standards Codification ™ and the Hierarchy of Generally Accepted Accounting Principles 65 - 1 The following represents the transition and effective date information related to FASB Stateme nt No. 168, The FASB Accounting Standards Codification ™ and the Hierarchy of Generally Accepted Accounting Principles: a. The pending content that links to this paragraph shall be effective for financial statements issued for interim and annual periods e nding after September 15, 2009. b. The Financial Accounting Standards Board (FASB) Accounting Standards Codification ™ shall become the source of authoritative generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities . Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. c. As of the effective date stated in paragraph 105 - 10 - 65 - 1(a) , all then - existing non - SEC accounting and reporting standards that had been included in levels ( a ) through ( d ) GAAP are superseded, except as noted in paragraph 105 - 10 - 65 - 1(d) and as described in Section 105 - 10 - 70 . Concurrently, all nongrandfathered, non - SEC accounting literature not included in the Codification is deemed nonauthoritative. d. The following standards shall remain authoritative until such time that each is integrated into the Codification: 1. FASB Statement No. 164, Not - for - Profit Entities: Mergers and Acquisitions 2. FASB Statement No. 166, Accounting for Transfers of Financial Assets 3. FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R) 4. FASB State ment No. 168, The FASB Accounting Standards Codification ™ and the Hierarchy of Generally Accepted Accounting Principles. e. Nonpublic nongovernmental entities that previ ously have not applied the guidance in the paragraphs listed below shall account for the adoption of that guidance as a change in accounting principle on a prospective basis for revenue arrangements entered into or materially modified in those fiscal years beginning on or after December 15, 2009, and interim periods within those years: 1. Paragraph 855 - 10 - 60 - 4 2. Paragraphs 985 - 605 - 15 - 3 through 15 - 4 3. Paragraphs 985 - 605 - 55 - 4 through 55 - 118 4. Paragraphs 985 - 605 - 55 - 186 through 55 - 203
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29 5. Paragraphs 985 - 845 - 25 - 1 through 25 - 7 6. Paragraphs 985 - 845 - 55 - 1 through 55 - 8 . f. The appropriate disclosures related to that adoption shall be made in accordance with Section 250 - 10 - 50 . 105 - 10 - 70 Grandfathered Guidance General 70 - 1 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 Financial Accounting Standards Board (FASB) Statement No. 162, The Hierarchy of Generally Accepted Accounting Principles, contained a description of the categories of the generally accepted accounting principles (GAAP) hierarchy that existed before the Codification. An entity that has followed, and continues to follow, an accounting treatment that was previously in category ( c ) or category ( d ) of that GAAP hierarchy as of March 15, 1992, need not change to an accounting treatment in a higher category (( b ) or ( c )) of that hierarchy if its effective date was before March 15, 1992. For example, a nongovernmental entity that followed a prevalent industry practice (category ( d )) as of March 15, 1992, does not have to change to an accounting treatment included in a standard in category ( b ) or category ( c ) (such as an accounting principle in a cleared American Institute of Certified Public Accountants [AICPA] Statement of Position or Accounting Standards Executive Committee Practice Bulletin) whose effective date is before March 15, 1992. For standards whose effective date is after March 15, 1992, and for entities initially applying an accounting principle after March 15, 1992 (except for Emerging Issues Task Force consensus positions issued before March 16, 1992, which become effective in the hierarchy for initial application of an accounting principle after March 15, 1993), an entity shall follow guidance in the Codification. 70 - 2 Pending Content: Transition Date: September 15, 2009 Transition Guidance: 105 - 10 - 65 - 1 Certain accounting standards have allowed for the continued application of superseded accounting standards for transactions that have an ongoing effect in an entity’s financial statements. That superseded guidance has not been included in the Codification, shall be considered grandfathered, and shall continue to remain authoritative for those transactions after the effective date of FASB Statement No. 168, The FASB Accounting Standards Codification ™ and the Hierarchy of Generally Accepted Accounting Principles. While not comprehensive, the following are examples of such grandfathered items: a. Pooling of interests in a business combinat ion (originally addressed by APB Opinion No. 16, Business Combinations ) described in paragraph B217 of FASB Statement No. 141, Business Combinations b. Pension transition assets or obligations described in paragraph 77 of FASB Statement No. 87, Employers’ Accounting for Pensions c. Employee stock ownership plan shares (originally addressed by AICPA Statement of Position 76 - 3, Accounting Practices for Certain Employee Stock Ownership Plans ) purchased by, and held as of, December 31, 1992, as described in paragraphs 97 and 102 of AICPA Statement of Position 93 - 6, Employers’ Accounting for Employee Stock Ownership Plans
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30 d. Loans restructured in a troubled debt restructuring before the effective date of FASB Statement No. 114, Accounting by Creditors for Impairment of a Loan, described in paragraph 24 of FASB Statement No. 118, Accounting by Creditors for Impairment of a Loan — Income Recognition and Disclosures e. Stock compensation for nonpublic and other entities (originally addressed by FASB Statement No. 123, Accounting for Stock - Based Compensation, or APB Opinion No. 25, Accounting for Stock Issued to Employees ) described in paragraph 83 of FASB Statement No. 123 (revised 2004), Share - Based Payment f. For nonpublic entities electing the deferral of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, FASB Statement No. 109, Accounting for Income Taxes, and related standards g. For business combinations with an acquisition date before the first annual reporting period beginning on or after December 15, 2008, Statement 141 and any other relevant standards h. For not - for - profit entities, pooling of interests as allowed for under Opinion 16, even though it has been superseded by Statement 141 until FASB Statement No. 164, Not - for - Profit Entities: Mergers and Acquisitions, is effective i. For goodwill and intangible assets arising from a combination between two or more not - for - profit entities or acquired in the acquisition of a for - profit business entity by a not - for - profit entity until Statement 164 is effective, Opinion 16 and APB Opinion No. 17, Intangible Assets. Room for Debate Debate 1 - 1 This question has no one correct answer. It is meant to get students talking about something that they probably haven’t thought about before. Students in favor of the SEC being the rule making body could argue that the FASB has failed to ensure that financial statements fairly present the resultsofoperations . They could then cite the recent scandals. They could argue that the SEC has the power to regulate and they don’t see why the profession should then need to be self regulated. They could also argue that under the FASB there is too much flexibility and too much reliance on managerial intent, thereby allowing management to manage earnings and otherwise manipulate its financial statements. Moreover, lack of exercise of government direct oversight could result in diminish ing the effectiveness of accountants to audit due to a potential erosion of independence. They could point to Sarbanes - Oxley. Students in favor of the FASB making the rules could argue against big government. They could point out that government sets accounting standards in countries that are not capitalistic. The result in those countries is a cookie cutter approach to financial statements and lack of flexibility that leaves no room for professional judgment. Whereas, the standards provided by the FASB are aimed to provide financial statements that fairly present financial statements, taking into consideration the circumstances in which a company operates. They could also argue that accountants, not government officials, best understand their role and how best to measure and report financial information.
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31 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 performan ce. 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. T he 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
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