Intermediate Accounting Volume 1, Sixth Canadian Edition Solution Manual

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Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6thedition1-1Chapter 1: TheFramework forFinancial ReportingCase1-1Richard Ploughwright1-2Milton Kidd1-3International Fashions Inc.Suggested TimeTechnicalReviewTR1-1Chapter overview, true-false............................10TR1-2Chapter overview, true-false...........................10TR1-3GAAP and ReportingCurrency......................10TR1-4Acronyms.......................................................10AssignmentA1-1IASB Standard Setting...................................10A1-2International Comparisons.............................10A1-3Accounting Choices.......................................10A1-4Effect of AccountingPolicies (*W)...............15A1-5Reporting Alternatives...................................10A1-6Non-IFRS Situations......................................15A1-7Reporting Situations......................................20A1-8ReportingSituations......................................15A1-9Objectives of financial reporting....................20A1-10Impact of DifferingObjectives.......................20A1-11Accounting Policy Disagreement...................15A1-12Accounting Policies and ReportingObjectives10A1-13Policy Choice................................................20*WThe solution to thisassignmentis on the textwebsite, Connect.This solution is markedWEB.

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1-2Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6theditionQuestions1.A public company issues securities (debt and/or equity) to the public; a privatecompany does notissue securities to the public, but may raise capital through privateplacements.Publicand publicly-accountablecompanies mustuse IFRS. Privatecompanies(exceptpublicly-accountableenterprises)mayuseIFRS,CanadianAccounting Standards for Private Enterprises (ASPE)as provided in theCICAHandbook, or a disclosed basis of accounting(DBA).2.A control blockexistswhen a small number of related or affiliated shareholders ownenough shares to guarantee being able to cast a majority of shareholders’ votes.Controlling a majority of the votes enables the group to elect the board of directors.Financial reporting will often be tailored to the needs of thecontrollingshareholdersand not necessarilythose ofthe minority shareholders.3.Canadian accounting standards are set by the Accounting Standards Board(AcSB)which is a unit of the Canadian Institute of Chartered Accountants. For publiccompanies,theAcSBhasadoptedIFRS.Standardsforprivatecompaniesaredetermined by the AcSBand are maintained as Part IIoftheCICA Handbook.4.Canadian private companies can choose to use(a)IFRS,(b)Part II oftheCICAHandbook, or(c)a disclosed basis of accounting (DBA).5.A private companymaychoose to use IFRS if it is competing with international firmsfor debt or private equity funding. By being directly comparable to public companies,IFRS-basis statementsshouldmake it easier for prospective lenders or investors tocompare potential investees on a common basis. The company maytherebybe able tolower its average cost of capital as a result.6.A disclosed basis of accounting (DBA) is a set of accounting policies specificallychosentomeetspecificuserneeds,eitherforprivatecompaniesthatarenotconstrainedbyGAAP,orasspecial-purposestatementsintendedtomeettheaccounting measurement requirements of specific contractssuch as loan agreements.7.The most important objective of general purpose financial statements is to serve theinformation needs public companies’ suppliers ofdebt and equitycapital whonormally have no direct access to information and must rely on the company’sgeneral purpose financial reporting. Other users such asemployees, customers, andregulators will find the information useful, but they are secondary users.8.If an organization wishes to portray cash flows, accounting policies will be chosenthat minimize inter-period allocations and provide maximum disclosure of future cashflow patterns.

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Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6thedition1-39.Accounting policies that minimize revenues and maximize expenses (delay revenuerecognition and speed up expense recognition) help to minimize income tax.Thesepolicies are only successful in meeting the tax minimization objective if they can beused for filing tax returns as well as financial reporting.10.Income smoothing is the use of accountingpolicies andestimates to even-out periodicfluctuations in earnings. Income smoothing is intended to produce arelativelysmoothrecord of earnings, free from peaks and valleys that imply risk.One way ofaccomplishing this objective is to make relatively small adjustments to accountingestimates that can, cumulatively, have a significant impact on net earnings in aparticular period. The deliberate use of accounting estimates to manipulatenetearningsisanunethicalpractice.11.A “big bath”occurswhen a company, in the year of an operating loss, uses theopportunity torecognizeas many losses or write-offs in that year as possible,therebymaximizing the loss. This makes it easier to report a larger net income in future yearsbecause assets are written down, reducing amortization, and because pessimistic lossprovisions may be established.12.A covenant is a provision in a debt agreement that requires a company to maintain acertain level of performance, for example, a maximum debt/equity ratio, or minimumtimes-interest-earnedratios.Accountingpolicieschosenbyacompanywithrestrictive covenants would be those that help meet the restriction, such as maximizeearnings, minimize debt, etc.13.Managers may be motivated by self-interest rather thana desire to maximize returnfor shareholders.They may wish to maximize their compensation, reputation, orkeep lenders from getting edgy. Policies chosen to maximize net income are commonif managers receive bonuses based on net income.14.National practices concerning corporate debt differ between countries. In somecountries, a high debt loadindicates risk of banruptcy; in others, a high debt loadindicates that the banks and other lendershave confidence in the company and is agood sign.The world-wide use of IFRS may mislead investors into believing thatfinancial statements can be compared directly between companies based in differentcountries.15.Acompany’sfinancialreportingisaffectedbyitseconomicandpoliticalenvironment. Each company’s reporting objectives is designed to suit its localenvironment. For example, in countries that require tax-book conformity, accountingjudgements are driven by the tax law. In countries with high inflation, asset valuationwill be affected, such as with substantial asset write-ups to reflect the higher nominalvalue of assets.

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1-4Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6theditionCasesCase 1-1Richard PloughwrightDear Mr. Ploughwright:I am happy to respond to yourquestions regarding the accounting changes that the newbanker has requested.First, there is the issue of moving to the accrual basis. While it’s true that, ultimately,what you earn is the net cash in your pocket, the cash basis of accounting doesn’t whollycapture all of the cash flows that will happen in the future. Your banker wants to knowwhat liabilities you’ll have to pay in the coming months (and years), and what cash youcurrently are owed that will be collected in the future weeks or months. The accrualmethod really gives a clear picture of “cash flow”.It’s for much the same reason that he wishes you to show your cattle at market value. I’msure he recognizes that both your dairy cattle and your breeders are intended forcontinued use and are not for sale in the normal course of business.As saleable stock, thecattle represent a potential cash resource in the event of bankruptcy or default. After all,you probably use the cattle as collateral for loans, and he needs to know the value of thatcollateral.You should not try to estimate the value of your stock by yourself.Forcredibility, youshouldobtainanindependentestimate.Thevaluationwillrequireaprofessionalevaluation (and the cost thereof), but will be necessary in order to satisfy the bank.As for my bill, that may change somewhat in the first year due to switching to the accrualmethod. However, once the accrual approach has been put in place, the cost of the annualreview engagement will not be any higher than it would be had you continued to use thecash basis.Sincerely,Andrian

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Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6thedition1-5Case 1-2Milton KiddOverviewThis case is intended to get students to focus on the differences between companies andthe various factors that have a bearing on theirfinancial reporting objectives. Students arenot asked to provide the objectives, but rather to prioritize the factors or characteristicsthat are most likely to affect each company’s financial reporting.Company CharactericsAll three companies are private enterprises.Significant characteristics of each are asfollows:Breeze Inc.Saturn SoftwareIntern’l Auto PartsBusinessNew mobile phonenetworkCustom softwaredevelopmentAuto parts forinternational automakersOwnersPrivate investorsTwoentreprenuers, notwealthyWealthy familyOther capitalsourcesEgyptianfundPension fund—preferredsharesBank line of creditDebt throughinvestment fundsandby U.S. andCanadianbanksCapitalrequirementsCapital intensive start-upSalary-based operation;working capitalneededEstablished mgfr;expanding to gainforeign customersConstraintsEgypt fund has 3board seatsBank covenants:dividend/salarypayoutsnew debtPreferred dividendrequiredProbable debt covenantsFinancialstatementusersCRTCEgypt fund; JapanpartnerPension fundBankInvestment funds andbanksPotential new customersIPOprobable?Not in the foreseeablefutureUnlikelyYes, antipicpated in 2-3years

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1-6Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6theditionPrioritizationA possible ranking of significant factors may look as shown below. Thislistingis notdefinitive, butstudentsshould exhibit some logic as to why they rank some factors asmore important than others.From the most important to (possibly) the less important:Breeze Inc.Saturn SoftwareIntern’l Auto PartsMajorEgyptianinvestormust be kept happy—IFRS may be appropriateasASPE may not beunderstoodby theinvestorLiquidityrequirements—cash flow/predictionprimary objectiveIPO likely in near future—compliance with IFRSwill be necessary (ASPEnot appropriate)Important Japanese telecompartner that Breeze needsfor network supportContinuously profitable—but minimize incometaxes to conserve cashReflect good managementperformance to helpattract new autocompanies as customersContinuing need for majorcapital investmentBank covenants—protectlines of credit to be ableto pay preferred dividendsSatisfy investment funds’reporting expections (e.g.,re covenants)Cash needs to bepreserved—minimizecurrent incometaxesSalary information must beclearly disclosedExhibit sucess in attractingnew customersClear reporting of revenueson which 2% fee is basedis neededComplex reporting notnecessary; ASPEprobably bestMinimize income taxestoconserve cash

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Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6thedition1-7Case 1-3International Fashions Inc.Memo to:ManagerSubject:Reporting objectives for International Fashions Inc.I have reviewed the ownership, organization, and financing of International Fashions Inc.(IFI). There seem to be several conflicting financial reporting objectives. The principalfactors that affect the reporting objectives are as follows:The company has been internally financed. However, they expect to need additionalfinancing as they expand in China. The possible source of this financing has not beenidentified. If the source is from Canada or U.S.A., GAAP is likely to be a constraint.Financing might also be obtained through private equity sources or through debtsources in Asia (e.g., P.R.C., Hong Kong, Taiwan, or Singapore), in which caseIFRScompliance may not be necessary.Most of the IFI inventory is supplied by a parallel company that is under commonownership. The bulk of IFI’s activities is through related-party transactions, both forsupplying inventory and for profit transfer via management fees.There is a China-based partner for the P.R.C. subsidiary. The local partner is entitledto receive 35% of the subsidiary’s net income. This provides motivation for IFI tokeep the subsidiary’s profits down, perhaps by charging high prices for inventory thatis supplied by the owners’ Xiamen manufacturing facility.The company is privately owned. The two shareholders are the active managers of thecompany.ASPEis a viableoption for this company, provided that the reportingpolicies comply with any reporting requirements imposed by whomever provides theexternal financing.The IFI head office is a Canadian corporation. Essentially, it is a holding company forthe Asian subsidiaries. As a private company, they could use the option of notconsolidating their subsidiaries, in which case the parent company’s assets wouldconsist mainly of IFI’s investment in its subsidiaries.The company relies extensively on internal financing, but since there are no externalusers, there is no need to try to maximize earnings. Tax minimization (deferral) is a goodobjective because tax savings will retain earnings in the company for future expansion.In view of the tight control maintained by the owners,as well asthe intercompany andrelated company operating structure, I would recommend minimum compliance as aprincipal reporting objective. We must be careful to give proper disclosure of the relatedparty transactions, though, in order to give anethicalpresentation. We don’t want to beparty to hiding important information from possible future users of the statements.Because the future sources of financing are unclear, the company should use agenerally-accepted set of accounting standards. Since the company is Canadian, eitherCanadianaccountingstandardsforprivateenterprises(ASPE)orIRFSshouldbeadopted.I suggest using ASPE to simplify the statements and reduce accounting costs.

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1-8Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6theditionConsolidated statements may not be needed, since the owner-managers are in suchtight control. Nevertheless, the owners may want consolidated statements for their ownuse in order to get a better overview of the overall status of the company and itsoperations. The decision on consolidation should be left to the owners.In summary, I recommend the following policies:Cash flow prediction overall reporting objectiveTax minimizationASPE complianceFull disclosure of related party transactionsMinimum complianceThere is minimal conflict between these objectives. However, forethicalreasons, fulldisclosureofrelatedpartytransactionsshouldtakeprecedenceoverminimumcompliance.

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Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6thedition1-9Technical ReviewTechnical Review1-1F1.The International Accounting Standards Board has authority for setting Canadian accountingstandards.F2.All Canadian corporations must comply with international accounting standards.F3.Most Canadian corporations are listedon the Toronto Stock Exchange.F4.IFRS must be used for the financial statements of every Canadian public corporation.T5.The primary objective of general purpose financial reporting is to serve the information needsof the suppliers of capital—lenders and shareholders.F6.Theprimaryobjectiveoffinancialaccountingistorevealallinformationaboutanenterprise’s financial performance.T7.If a corporation has a restrictive bond covenant that specifies a minimum times-interest-earnedratio,thecorporation’smanagementwillbemotivatedtopickdiscretionaryaccounting policies that minimize income. (Note: Times-interest-earned is calculated asincome before interest and taxes, divided by interest.)F8.Income tax law has no impact on the accounting choices made by management.T9.The presence of a control block can have an impact on a public company’s choice ofaccounting policies.F10.Any company using U.S. GAAP must prepare its statements in U.S. dollars.

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1-10Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6theditionTechnical Review1-2F1.IFRS and theCICA Handbook, Part IIhave equal status in Canada for financial reporting.F2.In a private corporation, the needs of external users have no impact on the company’sfinancial reporting objectives.F3.Canadian companies must always prepare their annual financial statements in Canadiandollars.F4.Canadian accounting standards are governed by the Canada Business Corporations Act.F5.The debt and equity securities of a private company cannot be traded on public exchanges.Therefore, private companies have no external sources of financing.T6.A company may take a “big bath” in a loss year if management wishes to maximizefutureearnings.T7.A public company may not use DBA for external public financial reporting.F8.When anenterprise’s primary reporting objective is cash flow assessment, the enterprise willuse a cash basis of reporting rather than an accrual basis.T9.Any Canadian company may use IFRS.T10.The IASB cannot require transnational corporations to use IFRS.

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Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6thedition1-11Technical Review1-31.FMost private Canadian companies report on the basis of either IFRS or ASPE, both of whichare contained in theCICA Handbook. However, private companies mayinsteadchoose to usea disclosed basis of accounting, one in which the company’s accounting standards differ inone or more respects from the recommendations in theCICA Handbook, eitherPart IorPartII.2.FThere is no requirement that a company’s presentation currency be that of the country onwhich its accounting standards are based.3.FSame as above–the company’s presentation currency is not tied to its accounting standards.4.T5.FA reporting entity that is based outside the U.S. may use either U.S. standards or IFRS.6.FThe NYSE doesn’t control theaccounting standards—that is the function of the SEC.TheSEC permits foreign companies (including those based in Canada) touse either U.S. GAAPor IFRS.7.FAn individual country can choose to review each IFRS standard and accept it, reject it, ormodify it to suit the national reporting environment.8.FA private company can obtain “outside” capital from anywhere in the world from privateequity investors or from debt issues.9.FThe presentation currency usually is the functional currency, but that link is not required. Acompany may report in a currency other than its functional currency for the convenience of itsusers10.FThepresentation currency does not need to be the same as the functional currency; thesubsidiary can report in Britishpound sterling to be compatible with the parent’s presentationcurrency.

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1-12Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6theditionTechnical Review1-41.KIASB2.FASPE3.AAcSB4.EIFRS5.ITSX6.DOSC7.JKFC8.CCICA9.BSEC10.GFASB11.HDBA

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Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6thedition1-13AssignmentsAssignment1-1[Note:the website descriptions change slightly from time to time, so word-perfectresponses are not necessary. This suggested solution is based on the continuinggeneral description of the IASB’s processes.]The IASB website indicates six stages of IFRS development:1.Setting the agenda2.Planning the project3.Developing and publishing the discussion paper4.Developing and publishing the exposure draft5.Developing and publishing the standard6.After the standard is issuedThe last stage can properly be viewed by students as not being a part of developing thestandard, and thus a satisfactory response will focus on the first five stages.Setting the agendaItems are added to the agenda after receiving suggested topics from staff, from theStandardsAdvisoryCouncil,fromnationalstandard-settingbodies,andfromthecorporate sector. After deliberation, the IASB decides which topics merit developmentand which ones either are already covered adequately by current standards or are not ofsufficient economic importance to be added to the agenda.Planning the projectThe IASB decides how to go about developing a potential new standard. The IASB maydecide to develop a new standard on its own, or the Board may invite other standard-setting bodies (e.g., the U.S. FASB) to enter into a cooperative development plan. TheIASB may also choose establish a “working group” to help in developing the project.Discussion paperIn some projects (but not all), the Board may decide that there is sufficient complexityand/or controversy about the topic that the various viewsand researchshould be gatheredtogether and published as a discussion paper for broad circulation. The paper typicallyincludes:a comprehensive overview of the issue;possible approaches in addressing the issue;the preliminary views of its authors or the IASB; andaninvitation to comment.

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1-14Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6theditionExposure draftIssuance of an exposure draft(ED)is a mandatory step in the process. After the IASBcollects and analyzes responses to its discussion paperreceived from the public, theBoard begins deliberations that lead to an exposure draft, which is a draft of a proposedfinal standard. Issuance of the ED is followed by a limitedpubliccomment period.Afterthe comment period on the ED has ended, the Board considers the received comments. Ifthe comments indicate more discussion is necessary, the Board may take engage infurther discussions and issue new ED. and may make slight changes to the ED.Final standardAfter the comment period on a new or revised ED, the Board may make minoronlychangesto the exposed standard.Board members then vote on the proposed standard. Ifthe new standard is accepted, the Board then publishes the final standard.After the standard...(not required in the student responses)After an IFRS is issued, the staff and the IASB members hold regular meetings withinterestedparties,includingotherstandard-settingbodies,tohelpunderstandunanticipated issues related to the practical implementation and potential impact of itsproposals.

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Solutions Manualto accompanyIntermediate Accounting,Volume 1, 6thedition1-15Assignment 1-2Memo to:ManagerSubject:Viewpoint of conference speakerI attended the conference where I heard Mr. Steans claimed that the financial statementsof all companies can now easily be compared between nations because they all areprepared using IFRS.In my view, Mr. Stearns is somewhat naive about the economic realities that underliefinancial statements. Financial statements are a product of their reporting environment.TheapplicationofIFRSrequiresagreatmanyaccountingdecisions,especiallyaccountingestimates.Management’sestimateswillbeaffectedbytheirreportingobjectives, such as to minimize current income taxes or to maximize earnings in order tosupport their stock price. Each company’s legal, economic and political environmentaffects its financial reporting, as do the ways of doing business in a country. While IFRSgives the appearance of uniformity in financial statement presentation, there is a greatdeal of variance in the substance underlying the apparent comparability.As a banker, Mr. Stearns will be dealing withbothprivateandpublic companies. Thereporting requirements for private companies will vary among nations, and althoughprivate companies’ financial statementsmay look uniform, in fact they may be preparedon quite different bases.Although IFRS does establishe principles that can make the financial statements ofcompanies based in different countries much more similar in content and appearance, Mr.Streansover simplifies the situation because hedoesn’t take into consideration thesignificantnational differences in thepolitical, economic, and business environment.

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