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Modern Advanced Accounting in Canada, Sixth Canadian Edition Solution Manual

Modern Advanced Accounting in Canada, Sixth Canadian Edition Solution Manual simplifies even the toughest textbook questions with step-by-step solutions and easy explanations.

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    Solutions Manual, Chapter 1 1 Chapter 1 A Survey of International Accounting

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    2 Modern Advanced Accounting in Canada, Sixth Edition A brief description of the major points covered in each case and problem. CASES Case 1 In this case, students are introduced to the difference in accounting for R&D costs between IFRS and U.S. GAAP and asked to comment on whether one method is better than the other, as well as whether any part of R&D should be capitalized. Case 2 (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 3 (adapted from a case prepared by Peter Secord, Saint Mary’s University) A Canadian company prepares two sets of financial statement: one based on Canadian GAAP, and the other on U.S. GAAP. The reasons for some of the differences in numbers are investigated. Case 4 This case is based on Homburg Invest Inc.’s 2006 financial statements. A reconciliation of differences between two sets of financial statements is required along with a brief note explaining why differences exist. Case 5 This case is adapted from a CICA case. It provides details regarding a company`s activities as well as financial details that were revealed as part of planning and interim work performed in the context of an audit of the financial statements. It places the student in the role of CA, reporting to the audit partner, and asks for a memo on the results of the interim audit work as well as any issues that should be raised in an upcoming meeting between the partner and the client.

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    Solutions Manual, Chapter 1 3 PROBLEMS Problem 1 (40 min.) 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 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) U.S. GAAP, and 2) IFRS using the facts provided. Students are also asked to reconcile Net Income and Shareholders` Equity to from IFRS to U.S. GAAP. WEB - BASED PROBLEMS Problem 1 The student chooses a public company incorporated in China and listed on a U.S. stock exchange. The student answers a series of questions based on the company’s financial statements. The questions are aimed at highlighting the differences between IFRS and U.S. GAAP. Problem 2 The student chooses a public company incorporated in India and listed on a U.S. stock exchange. The student answers a series of questions based on the company’s financial statements. The questions are aimed at highlighting the differences between IFRS and U.S. GAAP. Problem 3 The student chooses a public company incorporated in Japan and listed on a U.S. stock exchange. The student answers a series of questions based on the company’s financial statements. The questions are aimed at highlighting the differences between IFRS and U.S. GAAP. Problem 4 The student compares the 2006 and most recent financial statements of Cadbury, a British chocolate manufacturer, and answers a series of questions aimed at highlighting the differences between IFRS and U.S. GAAP.

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    4 Modern Advanced Accounting in Canada, Sixth Edition Problem 5 The student compares the 2006 and most recent financial statements of Philips Electronics, a Dutch company, and answers a series of questions aimed at highlighting the differences between IFRS and U.S. GAAP. REVIEW QUESTIONS 1. Accounting students and professionals need to be aware of the differences between accounting practices in Canada and in other countries for three reasons. First, as the markets become more and more international, there is a higher chance that they may need to interpret financial statements from other countries at some point in their career. Second, they may want to move to another country to further their careers, and they should have an awareness of the different accounting practices that may exist. However, the most compelling reason is that the profession is quickly moving toward harmonization of accounting practices around the world. Canada has moved towards this end with mandating conversion to IFRS by January 1, 2011. Accounting students and practitioners need to be aware of the impact this move will have on their employers and clients. 2. One factor that is causing a shift towards a global capital market is that market - driven economies are replacing many former communist economies, and the demand for capital is increasing. As well, many countries are forming agreements with international allies, to increase their competitiveness. Finally, improvements in computer and communication technology are facilitating international trading and investing and allowing companies to list their shares on many exchanges throughout the world. 3. Five factors that have affected a particular country's accounting standards are: the role of taxation; the level of development of capital markets, especially the mix of debt and equity financing; differing legal systems; the ties, both current and historical, between the country and other countries; and inflation levels. 4. Countries with highly developed capital markets often have sophisticated investors who demand current and useful accounting information and full disclosure. This leads to the establishment of a body of generally accepted accounting principles that investors can rely

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    Solutions Manual, Chapter 1 5 upon and that companies must comply with. In countries where capital markets are not fully developed, there are fewer suppliers of capital and these suppliers demand and receive whatever information they require from companies. As a result there is less need for standardized accounting principles. 5. The assumption underlying many countries' accounting policies is that the monetary unit is stable. When this is the case, historical costs have meaning and there is no need for price level adjustments. When the inflation level is sufficiently high in a country to make historical costs meaningless, accounting adjustments that provide for the impact of inflation have been made in order to provide information that is useful. In these countries we have seen price level adjustments and/or current value accounting as part of the generally accepted accounting practices being used. 6. In Canada items are usually listed from current to non - current, whereas in some countries, long - term assets are listed before current assets, and owners’ equity is listed before liabilities. 7. Some of the differences between Canadian and U.S. GAAP are: • Canadians capitalize and amortize development costs (under certain circumstances) while they are expensed immediately in the U.S. • More U.S. companies use the LIFO method to calculate ending inventory and cost of goods sold, as it is allowable for tax purposes if used in the financial statements. Canadian companies favour weighted average and FIFO, as LIFO is not an acceptable alternative under GAAP. • There are also some differences in the accounting for post - retirement benefits. 8. The IASB works to develop a single set of high - quality, global accounting standards that will be used uniformly for financial reporting around the world. 9. The convergence project between FASB and the IASB hopes to have IASB standards acceptable for use by all companies required to report under the SEC rules in the United States. First, the two bodies will focus on the elimination of differences that appear capable of quick resolution and are not part of major projects of either of the boards. Then the two groups plan on working together on contentious issues so that any standards issued by the

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    6 Modern Advanced Accounting in Canada, Sixth Edition two boards will have similar outcomes. The two organizations have recently outlined a roadmap towards conversion that could result in U.S. domestic companies reporting in IFRS by 2014. Currently, foreign public companies filing on U.S. stock exchanges are permitted to file their financial statements in accordance with IFRS without reconciliation to U.S. GAAP. 10. At the end of 2009, over 100 countries had adopted IASB standards while a number of countries still did not allow their use. Three major holdouts were Canada, the United States, and Japan. In January 2006, the CICA announced it would adopt IASB standards for use by public companies effective January 1, 2011. The U.S. could convert as early as 2014 if major differences between U.S. GAAP and IFRS can be resolved by then. In August 2007, the ASBJ and the IASB agreed on a process for converging Japanese GAAP and IFRSs. Major differences between Japanese GAAP and IFRSs will be eliminated by 30 June 2011. The target date of 2011 does not apply to any major new IFRSs now being developed that will become effective after 2011. 11. In January 2006, the CICA announced it would adopt IASB standards for use by publicly accountable enterprises effective in January 2011. 12. Even if all the countries in the world adopt IFRSs, comparability will not completely exist if preparers do not interpret the standards on a consistent basis. The standards are broad based and require professional judgment. Also some countries are adding additional “home - grown standards” to cover local conditions. 13. The main reason the Accounting Standards Board decided to create a separate section of the CICA 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 rules outweighs the benefit received from compliance. In 2002, the AcSB adopted differential reporting, which allows 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 will be effective in January 2011 with earlier adoption allowed starting in 2009.

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    Solutions Manual, Chapter 1 7 14. There are a few reasons why a private company would want to comply with IFRSs 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 after January 1, 2011 as a publicly accountable enterprise. 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 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. 15. 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;

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    8 Modern Advanced Accounting in Canada, Sixth Edition - 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 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. MULTIPLE - CHOICE QUESTIONS 1. d 2. d 3. d 4. b 5. a 6. b 7. a 8. d 9. b 10. c 11. b 12. d 13. b 14. a 15. c

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    Solutions Manual, Chapter 1 9 CASES Case 1 Students often assume that U.S. GAAP is superior and that all reporting issues can (or should) be resolved by following U.S. rules. However, the reporting of research and development costs is a good example of a rule where many different approaches can be justified and the U.S. rule might be nothing more than an easy method to apply. In the United States, all such costs are expensed as incurred because of the difficulty of assessing the future value of these projects. IFRS, as well as countries such as Canada, Brazil, Japan, and Korea, allow capitalization of development costs when certain criteria are met. 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. In the U.S., the FASB felt that such decisions were too subjective and 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? For Korean businesses, research and development costs are capitalized when they are incurred in relation to a specific product or technology, when costs can be separately identified, and when the recovery of costs is reasonably expected. Can an accountant determine with appropriate accuracy whether the recovery of costs is reasonably expected? In the U.S., a conservative approach has been taken because of the difficulty of determining whether an asset has been or will be created. To ensure comparability, all companies are required to expense all R&D costs. As a result, some discoveries that prove to be very valuable to a company for years to come are expensed immediately. In other countries, companies will tend to capitalize a differing array of projects because of flexibility in their guidelines. Do the

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    10 Modern Advanced Accounting in Canada, Sixth Edition benefits of consistency and comparability (each company expenses all costs each year) outweigh the cost of producing financial statements that might omit valuable assets from the balance sheet? No definitive answer exists for that question. However, the reader of financial statements needs to be aware of the fundamental differences in approach that exist in accounting for research and development costs before making comparisons between companies from different countries. Case 2 (a) Can any alternative to historical cost provide for fair presentation in financial reports or are the risks too great? Discuss. In most countries, when we refer to “fair presentation” or a “true and fair view” 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. The first Company’s Act which included the phrase “a true and fair view” is now over 150 years old, and there is still some controversy as to whether the authors of this legislation intended “historical cost” to be a part of the model. The historical cost principle, as we know it, had not yet been fully articulated in textbooks and become a firm basis for accounting practice. As a result of these factors, financial statements may be considered to provide “fair presentation,” whether prepared in accordance with the historical cost convention, in terms of replacement cost, the purchasing power units in a general price level adjusted model, or a variety of hybrid models. Note that U.S. accounting is hardly a pure historical cost model, with many exceptions to historical cost involved (mostly downward adjustments) in the scheme of asset valuation and earnings determination. The important issue is that the model employed is known, understood, and consistently followed. Although in Europe (and especially in the Netherlands), it is common to encounter current value accounting, elsewhere (especially in Latin America) general price level accounting and its variations are more common when changing prices are a problem. Arguably, current value (replacement cost) accounting is the model most likely to provide fair presentation, especially where asset values are volatile, as historical costs become rapidly out

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    Solutions Manual, Chapter 1 11 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 replacement cost, 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 “current costs” of prior periods may display no relationship to current costs 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 current cost basis 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 issue arising from current value accounting, and leads many countries to have highly detailed rules for the preparation, audit, and publication of financial statement asset values under current cost. Current value accounting and general price level accounting are both responses to the problem of changing prices and the impact on financial reporting. Current value accounting departs from the historical cost basis of accounting , whereas general price level adjustment is not a departure from historical cost. General price level (“GPL”) accounting changes the measuring unit in which the historical cost is reported, but does not change the underlying basis of valuation for items on the income statement and balance sheet. Current value accounting changes this underlying basis of valuation. Historical cost is not restated; new values are determined, based on current information, for all items on the balance sheet (with the exception of monetary items which are not restated, as they are already stated at current values). Current value accounting has many variations, each of which uses a different valuation base. All of these models bear little relation to historical cost accounting, and in many ways less relationship to GPL - adjusted amounts. In all cases, the historical cost relationship among financial statement items is disregarded in favour of the new basis of accountability.

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    12 Modern Advanced Accounting in Canada, Sixth Edition (b) Discuss the relative merits of historical cost accounting and replacement cost accounting. Consider the question of the achievement of a balance between relevance and reliability and the provision of a “true and fair view” or “fair presentation” in financial reporting. 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 more reliable and free from bias than replacement cost accounting. Historical cost amounts are based on objective information and have the “paper trail” of an actual transaction that provides support. Historical costs, however, are sunk costs and have limited value in support of 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. Replacement cost 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, current costs are 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 current cost 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

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    Solutions Manual, Chapter 1 13 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. Replacement cost accounting will alleviate this problem by charging to expense the replacement cost of all items consumed. With replacement cost 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. CASE 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 rules 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 rules in place locally are the best rules available, in that they present results that are consistent with the prevailing views on a fair presentation of both financial performance and financial position. While the meaning of this concept can differ dramatically among jurisdictions, accounting standards in Canada and the United States may differ in the detail yet are quite similar at the conceptual level of user orientation. Despite the conceptual similarity, the actual rules in place are quite different in some areas, and there is no guidance for the user 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 rules and differences in the practices that are in place. For example, in Europe, more than 20 years of effort directed toward accounting harmonization did not completely resolve differences in accounting practices in the countries of the European Union. Efforts in North America are more recent but are proceeding rapidly. Responses to specific questions:

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    14 Modern Advanced Accounting in Canada, Sixth Edition (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, from total revenue through earnings per share, differ between the two sets of financial statements, as do all the aspects of the balance sheet presented. 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. One such publication is by the CICA under the title Significant Differences in GAAP in Canada, Chile, Mexico and the United States . A website provided by Deloitte (www.iasplus.com) could also provide useful information. (This website presents comparisons of international accounting standards with those of other countries including the United States and Canada.) (b) List some of the obvious items that need resolution and indicate some of the possible causes of the discrepancies. • Why is total revenue significantly higher in the U.S. for the same period? (Are their revenue recognition policies the same?) • Why are operating income and income before extraordinary items higher in Canada for the same period? (Revenue differences would be part of the answer, but are there also major differences in expenses?) • What is the nature of the extraordinary item, classified as such in the United States, and not so in the U.S.? Is classification as an extraordinary item appropriate? • What is the nature of the accounting policy differences that have lead to such dramatic differences in asset valuation between the two sets of financial statements? (Two possible reasons: (1) consolidation in Canada of some investments 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 rules 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 in Canada might produce different results if there have been major changes in inventory costs during the year.)

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    Solutions Manual, Chapter 1 15 • Given the higher asset values in the Canadian financial statements, the Canadian entity may be using the revaluation option under IFRS. • What items, if any, have been deferred and are being amortized for Canadian purposes 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. 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 4 (a) Net Income – Canadian GAAP $ (96,083) Unrealized valuation changes (286,060) Revenue less operating expenses and COS (8,306) Goodwill impairment loss 14,862 Depreciation and amortization 62,860 Income taxes 36,074 Net income – IFRS $ (276,653) (b) The major difference between the two net income numbers is contained in the accounting for the company’s development properties and investment properties. Under Canadian GAAP, these properties are valued at the lower of depreciated cost and market, whereas under IFRS, these properties are valued on a yearly basis at fair market value with the unrealized gains reported in income. The properties are not depreciated under IFRS. The difference in income tax is represented entirely by the future taxes that will be paid when (and if) these gains are actually realized. CASE 5 Memorandum

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