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Modern Advanced Accounting in Canada 8th Edition Solution Manual

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    Solutions Manual, Chapter 1 1 Chapter 1 Conceptual & Case Analysis Frameworks for Financial Reporting

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    2 Modern Advanced Accounting in Canada, Eighth Edition A brief description of the major points covered in each case and problem. CASES Case 1 - 1 In this case, students are introduced to the difference in accounting for R&D costs between IFRS and ASPE and asked to provide arguments to support the different standards . Case 1 - 2 (adapted from a case prepared by Peter Secord, Saint Mary’s University) In this real life case, students are asked to discuss the merits of historical costs vs. replacement costs. Actual note disclosure from a company’s financial statements is provided as background material. Case 1 - 3 (adapted from a case prepared by Peter Secord, Saint Mary’s University) A Canadian company has just acquired a non - controlling interest in a U.S. public company. It must decide whether to use IFRS or U.S. GAAP for the U.S. subsidiary. Financial statement information is provided under IFRS and U.S. GAAP. The reasons for some of the differences in numbers must be explained and an opinion provided as to which method best reflects economic reality. Case 1 - 4 This case is adapted from a CPA Canada case. A private company is planning to go public. Analysis and recommendations are required for accounting issues related to purchase and installation of new information system, revenue recognition, convertible debentures and doubtful accounts receivable. Case 1 - 5 This case is adapted from a CPA Canada case. A private company is planning to transition from ASPE to IFRS . Analysis and recommendations are required for accounting issues related to convertible debentures, extraordinary item, revenue recognition, contingency and impairment. PROBLEMS Problem 1 - 1 (40 min.)

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    Solutions Manual, Chapter 1 3 A single asset is acquired, and students are asked to prepare and compare financial statement numbers during the life of the asset using both a historical cost and a current value model. Problem 1 - 2 (40 min.) Details of a European company that reports using IFRS are given along with specific details relating to certain account balances. Students are asked to show how these balances should be reported under 1) ASPE and 2) IFRS using the facts provided. Students are also asked to reconcile Net Income and Shareholders` Equity from IFRS to ASPE . Problem 1 - 3 (50 min.) A private company plans to convert to IFRS go public within 5 years. It wants to know the impact on net income and shareholders’ equity if it converts from ASPE to IFRS for impaired loans, interest costs, actuarial gains, compound financial instrument and income taxes. Problem 1 - 4 (40 min.) A private company plans to convert to IFRS and wants to know the impact on the debt - to - equity ratio and return on total shareholder’s equity. The major issues pertain to impairment of intangible assets, revaluation of PP&E, R&D costs and redeemable preferred shares. Problem 1 - 5 ( 25 min.) A private company plans to convert to IFRS . It wants to know the impact on three key ratios if it converts from ASPE to IFRS for i mpaired loans , c apitalization of interest and a ctuarial gains/losses . Problem 1 - 6 (5 0 min.) A private company plans to convert from ASPE to IFRS and wants to know the impact on three key ratios if it converts from ASPE to IFRS for impairment losses, convertible bonds and income taxes. SOLUTIONS TO REVIEW QUESTIONS 1. There are times when external users may want financial reports that do not follow GAAP. For example, users may need financial statements using non - GAAP accounting policies

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    4 Modern Advanced Accounting in Canada, Eighth Edition required for legislative or regulatory purposes, or for contract compliance. A prospective lender may want to receive a balance sheet with assets reported at fair value rather than historical cost. Accountants have the skills and abilities to provide financial information in a variety of formats or using a variety of accounting policies. When the financial statements use non - GAAP accounting policies, the accounting policies must be disclosed in the notes to the financial statements. The accountant’s report would make reference to these accounting policies. 2. The three main areas where judgment needs to be applied are as follows: - Choosing accounting policies that are appropriate for the company’s situation - Making estimates to accurately reflect the company’s financial position and results of operations - Deciding what to disclose and how to disclose it in the notes to the financial statements. 3. The GAAP - based f inancial statements are prepared primarily for the benefit of external users. The financial statements provide a summary of the financial position and results of operations for the company. Management has access to the detailed information available within the company. Therefore, the formal financial statements should give priority to the needs of the external users. 4. T he main reason the Accounting Standards Board decided to create a separate section of the CPA Canada Handbook for private enterprises was to address the cost/benefit discrepancy with respect to smaller private companies’ ability to comply with GAAP. GAAP has become increasingly complex and for smaller private enterprises this often means that the cost of complying with such requirements outweighs the benefit received from compliance. In 2002, the AcSB adopted differential reporting, which allowed private enterprises choices with the respect to certain complex accounting standards (e.g. the option to use the cost method for investments that would otherwise require the equity method). In 2009, the AcSB decided to create a self - contained set of standards for private enterprises. These standards were effective for fiscal periods beginning on or after January 1, 2011. 5. There are a few reasons why a private company would want to comply with IFRS even though it is not required to do so. It may have plans to become publicly listed at some point in the future and will then be required to comply with IFRS . In this case it would make sense to prepare IFRS compliant statements in anticipation of the public transaction since the company would have to provide multiple years of comparative financial statements that comply with IFRS. A private company may have users of their financial statements that find IFRS statements more useful for their purposes (e.g. creditors, customers, partners, and

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    Solutions Manual, Chapter 1 5 other stakeholders that may receive the company’s financial statements). Given the global economy and the increased number of countries that have converted to IFRS, this is more likely than it once might have been. 6. The following financial statement items could have different account balance s under ASPE as compared to IFRS : i mpaired loans, property, plant, & equipment, development costs, post - employment benefits, income taxes, compound financial instrument s , preferred shares and convertible bonds 7. For the item listed in Exhibit 1. 1 , all items except for disclosure would likely change when a company switched from ASPE to IFRS . 8. The return on assets or return on equity is typically used to assess profitability. The current ratio is typically used to assess liquidity. The debt - to - equity ratio is typically used to assess solvency. 9. If XZY Co. had capitalized rather than expenses the development costs in Year 1, the company’s key ratios would change as follows: - the current ratio would increase if the development costs were classified as a current asset because current assets would increase and current liabilities would remain the same; the current ratio would not change if the development costs were classified as a non - current asset because both current assets and current liabilities would remain the same; - the debt - to - equity ratio would decrease because debt would remain the same and equity would increase - the return on equity change would increase because net income and equity would increase by the same dollar amount but net income would be a higher percentage of equity after the change 10. The six steps of the case framework are as follows: - Determine Your Role and Requirements - Identify Users & Their Needs - Identify & Rank Issues - Identify Viable Alternatives for Each Major Issue - Analyze Alternatives Using Criteria for Resolving - Communicate Practical Recommendations/Conclusions 11. The report recipient is the direct recipient of your report or memo e.g. the partner who asked you to prepare the memo. The primary users are the users who will be affected by the actions taken as a result of your recommendations e.g. bankers and shareholders who will

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    6 Modern Advanced Accounting in Canada, Eighth Edition receive the financial statements. The primary users should be given priority in financial reporting because they are primary recipients of the financial statements; they are directly affected by the financial statements. If they did not want to receive the financial statements, we would not be preparing them and would not have to write a memo to the partner with respect to the financial statements. 12. T he biggest factor to be used when ranking the importance of issues to be resolved is the materiality of the item. If one problem involves a $10,000 item and another problem involves a $10 million item, then the $10 million item likely is the most important item. After that, issues are typically ranked in the following order of priority: - controversial or highly contentious items - items with errors - complex items 13. The final case report should contain your recommendations along with the analysis and arguments supporting your recommendations. It does not need to discuss the alternatives for each issue unless the issue was very contentious. If in the analysis stage, you determined that there was clearly a right answer for a problem, then your report would provide only the recommendation with the supporting arguments. If two or more alternatives were nearly equal in benefits, then your final report could present the arguments for both alternatives along with your recommendation as to the best option in this contentious situation. SOLUTIONS TO CASES Case 1 - 1 Students may assume that IFRS is superior and that all reporting issues can (or should) be resolved by following IFRS . However, the reporting of research and development costs is a good example of a requirement where many different approaches can be justified when one considers the cost and benefits involved. IFRS requires capitalization of development costs when certain criteria are met. ASPE allows a policy choice between expensing all development costs without assessing whether they will provide future benefits or capitalizing those developments costs that are expected to provide future benefits.

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    Solutions Manual, Chapter 1 7 The issue is not whether costs that will have future benefits should be capitalized. Most accountants around the world would recommend capitalizing a cost that leads to future revenues that are in excess of that cost. The real issue is whether criteria can be developed for identifying projects that will lead to the recovery of those costs. One could argue that it is too subjective to determine whether future benefits will be realized and the assessment could be open to manipulation. History has shown that the amount of research and development costs capitalized tended to vary as a company experienced good years and bad. Conversely, under IFRS, development costs must be recognized as an intangible asset when an enterprise can show that the six criteria mentioned in the question can be met. How easy is it for an accountant to determine whether the development project will result in an intangible asset, such as a patent, that will generate future economic benefits? Do the benefits of making a determination of future benefits outweigh the cost of making this determination? No definitive answer exists for that question. Therefore, the option to simply expense all development costs under ASPE may be a good approach especially when there is lots of judgment involved in determining whether there will be future benefits. Case 1 - 2 (a) Can any alternative to historical cost provide for fair presentation in financial reports or are the risks too great? Discuss. W hen we refer to “ present fairly ” in the preparation of financial statements, we generally qualify the statement (as the auditors here have): “in accordance with generally accepted accounting principles.” That is, fair presentation has a contextual, rather than an absolute, meaning. In order for any presentation to be fair to the user, the basis of presentation must be known and understood, but does not necessarily have to follow any one particular model. F inancial statements may be considered to “present fairly” whether prepared in accordance with the historical cost convention, replacement cost, general price level adjusted model, or net realized value . The important issue is that the model employed is known, understood, and consistently followed.

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    8 Modern Advanced Accounting in Canada, Eighth Edition Arguably, fair value accounting is the model most likely to provide fair presentation, especially where asset values are volatile, as historical costs become rapidly out of date. For many long - established companies, historical costs for some assets are significantly out of date and of no value in support of managerial decisions. In managerial accounting, we have long recognized that the relevant costs are the current costs. In some European countries, an approach to financial reporting has developed that adopts more of a managerial approach and seeks to provide the most relevant information for decision - making. As a result, many companies follow alternatives to historical cost, generally fair values , in the financial statements. There are risks, however, that arise from the adoption of alternatives to historical cost. Some of these are the same risks that arise from the historical cost model in that the recorded amount may soon be out of date. Prices may go up or down, and even “ fair values ” of prior periods may display no relationship to fair values at the present date. Cost is always cost in a particular context and a cost determined for a particular context or decision may not be valid for a different context or decision and the user should be aware of this. The question of objective determination also arises. The reported values in fair value based financial statements are not directly supportable by arms’ length transactions. This introduces the risk of an important (and potentially deliberate) misstatement. This is the principal risk arising from fair value accounting, and leads many countries to have highly detailed rules for the preparation, audit, and publication of financial statement asset values under fair values . (b) Discuss the relative merits of historical cost accounting and fair value accounting. Consider the question of the achievement of a balance between relevance and reliability when trying to “present fairly ” the financial position of the reporting entity . Students will provide a wide range of responses to this question; at this stage (unless they have been provided with supplementary material or have background from other courses) responses will just scratch the surface. The following note may be helpful: Historical cost accounting has the advantage that it is verifiable, and therefore tends to be more reliable and free from bias than fair value accounting. Historical cost amounts are based on objective information and are more likely to have the “paper trail” of an actual transaction that provides support. Historical costs, however, are sunk costs and have limited value in support of

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    Solutions Manual, Chapter 1 9 decisions. They are particularly deficient if a long time has passed since the transaction occurred, or if there have been significant technical developments. These are serious difficulties which the accounting profession has tried to address through a variety of different mechanisms, but no other method has become universally acceptable as an answer to the problem and so historical cost accounting persists, largely because of inertia, and because no better model has emerged. Fair value accounting has the advantage of enhanced relevance because the values included have been determined at the current time, rather than at some uncertain past date. These amounts may therefore be better for investment decisions than historical costs. However, fair values may be potentially deficient in that they might not be objectively determined and lack reliability. At the worst, they could contain bias to support a particular management policy or decision. In other cases, they could be guesses or otherwise based on invalid information. Also, the use of fair value in financial statements in no manner makes the financial statements more “accurate,” although (if the amounts are carefully and objectively determined) there may be advantages in the fairness of presentation and therefore the relevance of financial statement amounts. With respect to income measurement, in a period of inflation, historical cost accounting will result in an overstatement of income. Income is overstated, as a portion of the reported profits must be reinvested in the business to maintain the productive capacity and not all profits are available for distribution. If all profits are distributed, the business will not have the capacity to replace the items that have been consumed in the process of earning income. Fair value accounting will alleviate this problem by charging to expense the fair value of all items consumed. With fair value charged to expense, the income remaining is a true income, potentially available for distribution without impairment of the productive capacity of the enterprise. A further important point is that both the preparer and the user of financial statements should understand the basis of preparation of the statements, and the strengths and weaknesses of the approach employed. (c) Financial statements are now beyond the comprehension of the average person. Many of the accounting terms and methods of accounting used are simply too complex to understand just from reading the financial statements. Additional explanations should be

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    10 Modern Advanced Accounting in Canada, Eighth Edition provided with, or in, the financial statements, to help investors understand the financial statements. Discuss. It is true that financial statements are complicated by accounting methods, such as the method of accounting for deferred income taxes, foreign currency translation, and so on. However, some of these complexities cannot be avoided. The business environment and business transactions are themselves more complex. Since the financial statements try to reflect these business events, it is inevitable that the financial statements will be more complex. Thus, it is not accounting methods per se that make financial statements difficult to understand. Financial statements are not directed at the average person, so they cannot be criticized on the grounds that they are beyond the comprehension of the “average person”. Instead, they are intended for users with a reasonable understanding of financial statements. The question then becomes should additional explanations be provided for users who have a reasonable understanding of the financial statements? The answer depends on what type of information the “explanations” will contain. Additional explanations might be of three types: - They could provide more detail on information that is already contained in financial statements. For example, certain dollar amounts reported in the financial statements might be broken down into more detail, or the significance of certain amounts might be discussed; - They could make information that is currently in the financial statements easier to understand by explaining technical accounting terms and concepts used in the statements; or - They could provide entirely new information not included in financial statements that might help users better understand the significance of the information that appears in the financial statements. In all three cases, the information provided might concern the future or the past. It is important to note that for publicly accountable enterprises, there is already a considerable amount of supplemental information provided in a company’s MD&A. This document provides supplementary discussion of financial results and in many cases explanations of accounting treatments used in a company’s financial statements for the period. Further, it is important to note that at some point additional information may “overload” the user. Too much information

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    Solutions Manual, Chapter 1 11 may achieve the undesired result of making financial statements more difficult to understand. This must be taken into account when considering supplemental information and explanations. CASE 1 - 3 Case Note Ajax Communications presents the classic case of the conflict among the accounting standards that are in force in different jurisdictions. Each set of requirements can be seen to be correct, although dramatically different amounts may be presented on a variety of dimensions. Certainly, the standard - setters (and, generally, the accounting practitioners) of each jurisdiction believe that the requirements in place locally are the best requirements available, in that they present results that are consistent with the prevailing views on a fair presentation of both financial performance and financial position. Although the conceptual frameworks are very similar under IFRS and U.S. GAAP, the actual requirements in place are quite different in some areas, and there is no guidance in choosing the right set of accounting standards to base decisions upon. Harmonization efforts are ongoing to resolve these differences, yet regardless of the changes in accounting standards, there will remain differences in interpretation of the requirements and differences in the practices that are in place. Responses to specific questions: (a) As John McCurdy, outline the initial approach that you will take in order to determine the reasons for the difference in the numbers. Items throughout the income statement differ between the two sets of financial statements, as do all the aspects of the balance sheet presented. Although it is not unusual to have some differences between U.S. GAAP and IFRS , the magnitude of the differences would not usually be of the size in the Waqaas case. As a start, McCurdy may be able to determine where some of the difference arises by examining the summary of significant accounting policies included with the financial statements. This source will not identify all of the accounting policies in place. More detailed knowledge of the accounting policies in place could come from the specific notes to the financial statements. In addition , he should search for publications or web sites that discuss differences in accounting policies among countries. A website provided by Deloitte (www.iasplus.com) could also provide useful information.

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    12 Modern Advanced Accounting in Canada, Eighth Edition (b) List some of the obvious items that need resolution and indicate some of the possible causes of the discrepancies. • Why are operating income and income before extraordinary items higher under IFRS for the same period? • What is the nature of the extr aordinary item, classified as such in the United States, and how is it reported un der IFRS ? • What is the nature of the accounting policy differences that have led to such dramatic differences in asset valuation between the two sets of financial statements? (Two possible reasons: (1) consolidation of some investments under IFRS that would not be consolidated in the U.S. financial statements; this might explain the differences in the investments account, and arises because there are different requirements for the determination of when an investment is classified as a subsidiary and consolidated; and (2) the use of LIFO in the U.S. and FIFO under IFRS might produce different results if there have been major changes in inventory costs during the year.) • Given the higher asset values under IFRS , the company may be using the revaluation option under IFRS. • What items, if any, have been deferred and are being amortized under IFRS that are directly expensed in the U.S. statements? (R&D comes to mind) Does this account for the difference in intangibles? • A variety of other specific points could be raised, including, for example, policies associated with tax allocation. (c) In your opinion, which GAAP best reflects economic reality? Briefly explain. Without knowing what has caused the difference, it is hard to determine which GAAP best reflects economic reality. Although the differences represent a dilemma to the Board of Directors in this case, neither set of financial statements may be said to be unequivocally superior to the other for the purpose of making investment decisions. This is the general dilemma of international comparisons, and a principal reason why accounting harmonization is so important. CASE 1 - 4 Memorandum To: Partner

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    Solutions Manual, Chapter 1 13 From: CPA Re: Roman Systems Inc. Financial Reporting Issues Roman Systems Inc. (RSI) has been using IFRS over the past few years presumably because it plans to go public within the next year . RSI’s bias is to maximize revenue, net income and shareholder’s equity in order to attract potential investors. The major financial reporting issues arising from our interim work are: I. Accounting for the costs of the new accounting system II. Revenue recognition a. Maintenance and contract revenue b. Product revenue c. ABM revenue III. Convertible debentures IV. Receivable from Mountain Bank Accounting for new accounting system costs During fiscal Year 12, RSI implemented a new general ledger package. The new package has been functioning in parallel with the old system since April 1, Year 12, and will no longer be used in parallel effective July 1, Year 12. The new package has been used to generate RSI’s financial results since April. RSI has incurred $720,000 in third - party costs associated with the new general ledger package, together with $70,000 of internal salary costs. These costs have all been capitalized in Year 12. IAS 38 offers guidance as to the costs that may be capitalized when internally developing intangible assets. In particular: The cost of an internally generated intangible asset comprises all directly attributable costs necessary to create, produce, and prepare the asset to be capable of operating in the manner intended by management. Examples of directly attributable costs are: (a) costs of materials and services used or consumed in generating the intangible asset; and

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    14 Modern Advanced Accounting in Canada, Eighth Edition (b) costs of employee benefits (as defined in IAS 19) arising from the generation of the intangible asset; The following are not components of the cost of an internally generated intangible asset: (a) selling, administrative and other general overhead expenditure unless this expenditure can be directly attributed to preparing the asset for use; (b) identified inefficiencies and initial operating losses incurred before the asset achieves planned performance; and (c) expenditures on training staff to operate the asset. Based on the above: - Costs of $110,000 related to initial review and recommendations would be considered business process re - engineering activities and not directly related to the creation of the new system. These costs should be expensed. - Costs of $320,000 for new software and implementation costs represent a betterment, as they extend the life of the accounting system and enhance the service capacity. They should be capitalized. - Training costs of $225,000 should be expensed, as the costs are not directly attributable to the development, betterment, or acquisition of the software. - The monthly support fee of $25,000 (and all future monthly fees) is an operational cost of the system and should be expensed. - The other consulting fees of $40,000 should be reviewed in more detail, but they appear to be part of the ongoing costs of the new system with no specific value added, and should likely be expensed. - The salaries of $70,000 could be capitalized if they are directly attributable to the implementation of the new software package. Since only two additional individuals were hired to handle the work previously done by the four employees, it is questionable whether the four employees were 100% dedicated to the task of implementing the new software. Only the costs related to the implementation should be capitalized. Effective July 1, RSI should start amortizing the new system and effective June 30, Year 12, it should write off the remaining carrying amount of the old system.

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    Solutions Manual, Chapter 1 15 Revenue Recognition Product Revenue Product revenue is recognized at the time of delivery and installation. Customer acceptance is evidenced by customer sign - off once installation is complete. It is RSI’s standard practice to obtain such evidence of acceptance. It would therefore be inappropriate to recognize revenue without such evidence of customer acceptance. In performing the interim work, we determined that revenue of $640,000 was recorded prior to obtaining customer sign - off. This has not been an issue in the past and may be an isolated case related to new employees who may be unfamiliar with RSI ’ s standard procedures. We need to ensure that Marge communicated the policy to all staff members and ensure that customer sign - off is obtained for all installations prior to year - end. Since it is early June, Marge would have a month to ensure that there are no issues at year - end. Maintenance contracts During the year, the company changed its revenue recognition policy on maintenance contracts. Assuming that the company previously recognized maintenance revenue on a straight - line basis over the course of the contract, the new method will recognize a greater proportion of the revenue earlier in the contract life. This new method recognizes 25% of the revenue in each of the first two months and may not be appropriate. Maintenance services must be provided over the full life of the contract. The preventive maintenance is entirely at the discretion of the company. It may not be continued in the future and may not consistently reduce future service calls. As well, the study serving as a basis for the policy is two years old, and may no longer be an accurate reflection of the pattern of maintenance calls. Revenue recognition for service contracts should be based on the service obligation over the term of the contract. ABM business RSI began selling ABMs in fiscal Year 12. The machines are purchased from an electronic manufacturer and resold at margins of 5%. It is important to consider whether RSI is recording revenue on a gross or net basis.

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