Solution Manual for Intermediate Accounting, 9th Edition

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Solutions Manual, Vol.1, Chapter 11–1Question 1–1Financial accounting is concerned with providing relevant financial informationabout various kinds of organizations to different types ofexternal users. The primaryfocus of financial accounting is on the financial information provided by profit-orientedcompanies to their present and potential investors and creditors.Question 1–2Resources are efficiently allocated if they are given to enterprises that will use themto provide goods and services desired by society and not to enterprises that will wastethem.The capital markets are the mechanism that fosters this efficient allocation ofresources.Question 1–3Two extremely important variables that must be considered in any investmentdecision are the expected rate of return and the uncertainty or risk of that expectedreturn.Question 1–4In the long run, a company will be able to provide investors and creditors with arate of return only if it can generate a profit. That is, it must be able to use the resourcesprovided to it to generate cash receipts from selling a product or service that exceed thecash disbursements necessary to provide that product or service.Question 1–5The primary objective of financial accounting is to provide investors and creditorswith information that will help them make investment and credit decisions.Question 1–6Net operating cash flows are the difference between cash receipts and cashdisbursements during a period of time from transactions related to providing goods andservices to customers. Net operating cash flows may not be a good indicator of futurecash flows because, by ignoring uncompleted transactions, they may not match theaccomplishments and sacrifices of the period.Chapter1Environment and Theoretical Structure ofFinancial Accounting

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1–2Intermediate Accounting, 10eAnswers to Questions (continued)Question 1–7GAAP (generally accepted accounting principles) are a dynamic set of both broadand specific guidelines that a company should follow in measuring and reporting theinformation in their financial statements and related notes.It is important that allcompanies follow GAAP so that investors can compare financial information acrosscompanies to make their resource allocation decisions.Question 1–8In 1934, Congress created the SEC and gave it the job of setting accounting andreporting standards for companies whose securities are publicly traded. The SEC hasretained the power, but has relied on private sector bodies to create the standards. Thecurrent private sector body responsible for setting accounting standards is the FASB.Question 1–9Auditorsareindependent,professionalaccountantswhoexaminefinancialstatements to express an opinion. The opinion reflects the auditors’ assessment of thestatements' fairness, which isdetermined by the extent to which they are prepared incompliance with GAAP. The auditor adds credibility to the financial statements, whichincreases the confidence of capital market participants relying on that information.

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Solutions Manual, Vol.1, Chapter 11–3Answers to Questions (continued)Question 1–10On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002.The most dramatic change to federal securities laws since the 1930s, the Act radicallyredesigns federal regulation of public company corporate governance and reportingobligations. It also significantly tightens accountability standards for directors andofficers, auditors, securities analysts, and legal counsel. Student opinions as to therelative importance of the key provisions of the act will vary. Key provisions in theorder of presentation in the text are:Creation of an Oversight BoardCorporate executive accountabilityNonaudit servicesRetention of work papersAuditor rotationConflicts of interestHiring of auditorInternal controlQuestion 1–11Newaccountingstandards,orchangesinstandards,canhavesignificantdifferential effects oncompanies, investors and creditors, and other interest groups bycausing redistribution of wealth. There also is the possibility that standards could harmtheeconomy as a whole by causing companies to change their behavior.Question 1–12The FASB undertakes a series of elaborate information gathering steps beforeissuing an accounting standard to determine consensus as to the preferred method ofaccounting, as well as to anticipate adverse economic consequences.Question 1–13The purpose of the conceptual framework is to guide the Board in developingaccounting standards by providing an underlying foundation and basic reasoning onwhich to consider merits of alternatives. The framework does not prescribe GAAP.

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1–4Intermediate Accounting, 10eAnswers to Questions (continued)Question 1–14Relevance and faithful representation are the primary qualitative characteristicsthat make information decision-useful.Relevant information will possess predictiveand/or confirmatory value.Faithful representation is the extent to which there isagreement between a measure or description and the phenomenon it purports torepresent.Question 1–15The components of relevant information are predictive value, confirmatory valueand materiality. The components of faithful representation are completeness, neutrality,and freedom from error.Question 1–16Thebenefitfromprovidingaccountinginformationisincreaseddecisionusefulness. If the information is relevant and possesses faithful representation, it willimprove the decisions made by investors and creditors.However, there are costs toprovidinginformation that include costs to gather, process, and disseminate thatinformation.There also are costs to users in interpreting the information as well aspossible adverse economic consequences that could result from disclosing information.Information should not be provided unless the benefits exceed the costs.Question 1–17Information is material if it is deemed to have an effect on a decision made by auser. The threshold for materiality will depend principally on the relative dollar amountof the transaction being considered. One consequence of materiality is that GAAP neednot be followed in measuring and reporting a transaction if that transaction is notmaterial. The threshold for materiality has been left to subjective judgment.

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Solutions Manual, Vol.1, Chapter 11–5Answers to Questions (continued)Question 1–181.Assets are probable future economic benefits obtained or controlled by a particularentity as a result of past transactions or events.2.Liabilities are probable future sacrifices of economic benefits arising from presentobligations of a particular entity to transfer assets or provide services to otherentities in the future as a result of past transactions.3.Equity is the residual interest in the assets of any entity that remains after deductingits liabilities.4.Investmentsbyownersare increasesin equityresultingfrom transfers ofresources, usually cash, to a company in exchange for ownership interest.5.Distributions to owners are decreases in equity resulting from transfers to owners.6.Revenues are inflows of assets or settlements of liabilities from delivering orproducing goods, rendering services, or other activities that constitute the entity’songoing major or central operations.7.Expensesare outflows or other using up of assets or incurrences of liabilitiesduring a period from delivering or producing goods, rendering services, or otheractivities that constitute the entity’s ongoing major or central operations.8.Gainsare defined as increases in equity from peripheral or incidental transactionsof an entity.9.Lossesrepresentdecreasesinequityarisingfromperipheralorincidentaltransactions of an entity.10.Comprehensive income is defined as the change in equity of an entityduring aperiod from nonowner transactions.Question 1–19The four basic assumptions underlying GAAP are (1) the economic entityassumption, (2) the going concern assumption, (3) the periodicity assumption, and (4)the monetary unit assumption.Question 1–20The going concern assumption means that, in the absence of information to thecontrary, it is anticipated that a business entity will continue to operate indefinitely.This assumption is important to many broad and specific accounting principles such asthe historical cost principle.

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1–6Intermediate Accounting, 10eAnswers to Questions (continued)Question 1–21The periodicity assumption relates to needs of external users to receive timelyfinancial information. This assumption requires that the economic life of a company bedivided into artificial periods for financial reporting. Companies usually report toexternal users at least once a year.Question 1–22Four accounting practices, often referred to as principles, that guide accountingpractice are (1) revenuerecognition, (2) expense recognition, (3) mixed-attributemeasurement (including historical cost), and (4) full disclosure.Question 1–23Two advantages to basing valuation on historical cost are (1) historical costprovides important cash flow information since it represents the cash or cash equivalentpaid for an asset or received in exchange for the assumption of a liability, and (2)historicalcostvaluationistheresultofanexchangetransactionbetweentwoindependent parties and the agreed upon exchange value is, therefore, objective andpossesses a high degree of verifiability.Question 1–24Companies recognize revenue when goods or services are transferred to customers.However, no revenue is recognized if it isn’t probable that the seller will collect theamounts it’s entitled to receive. The amount of revenue recognized is the amount thecompany expects to be entitled to receive in exchange for those goods or services.Revenue is recognized at a point in time or over a period of time, depending on whengoods or services are transferred to customers. So, revenue for the sale of most goodsis recognized upon delivery, but revenue for services like renting apartments or lendingmoney is recognized over time as those services are provided.

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Solutions Manual, Vol.1, Chapter 11–7Answers to Questions (continued)Question 1–25The four different approaches to implementing expense recognition are:1.Recognizing an expense based on an exact cause-and-effect relationshipbetween a revenue and expense event. Cost of goods sold is anexample of anexpense recognized by this approach.2.Recognizinganexpensebyidentifyingtheexpensewiththerevenuesrecognized in a specific time period.Office salaries are an example of anexpense recognized by this approach.3.Recognizing an expense by a systematic and rational allocation to specific timeperiods. Depreciation is an example of an expense recognized by this approach.4.Recognizingexpensesintheperiodincurred,withoutregardtorelatedrevenues.Advertising is an example of an expense recognized by thisapproach.Question 1–26In addition to the financial statement elements arrayed in the basic financialstatements, information is disclosed by means of parenthetical or modifying comments,notes, and supplemental schedules and tables.Question 1–27GAAP prioritizes the inputs companies should use when determining fair value.The highest and most desirable inputs, Level 1, are quoted market prices in activemarkets for identical assets or liabilities.Level 2 inputs are other than quoted pricesthatare observable, including quoted prices for similar assets or liabilities in active orinactive markets and inputs that are derived principally from observable related marketdata.Level 3 inputs, the least desirable, are inputs that reflect the entity’sownassumptions about the assumptions market participants would use in pricing the assetor liability based on the best information available in the circumstances.Question 1–28Common measurement attributes are historical cost, net realizable value, currentcost, present value, and fair value.

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1–8Intermediate Accounting, 10eAnswers to Questions (concluded)Question 1–29Under the revenue/expense approach, revenues and expenses are consideredprimary, and assets, liabilities, and equities are secondary in the sense of beingrecognized at the time and amount necessary to achieve proper revenue and expenserecognition.Under the asset/liability approach, assets and liabilities are consideredprimary, and revenues and expenses are secondary in the sense of being recognized atthe time and amount necessary to allow recognition and measurement of assets andliabilities as required by their definitions.Question 1–30Under IFRS, the conceptual framework provides guidance to accounting standardsetters but also provides GAAP when more specific accounting standards do not provideguidance.Question 1–31TheInternationalAccountingStandardsBoard(IASB)isresponsiblefordetermining IFRS. The IASB is funded by the IFRS Foundation. .Question 1–32The SEC staff’s Final Staff Report concludes that it is not feasible for the U.S. tosimply adopt IFRS, given (1) a need for the U.S. to have strong influence on the standardsetting process and insure that standards meet U.S. needs, (2) the high costs tocompanies of converting to IFRS, and (3) the fact that many laws, regulations andprivate contracts reference U.S. GAAP.

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Solutions Manual, Vol.1, Chapter 11–9BRIEF EXERCISESBrief Exercise 1–1Revenues($340,000 + 60,000)$400,000Expenses:Rent($40,0002)(20,000)Salaries(120,000)Utilities($50,000 + 2,000)(52,000)Net income$208,000Brief Exercise 1–2(1)Liabilities(2)Assets(3)Revenues(4)LossesBrief Exercise 1–31.The periodicity assumption2.The economic entity assumption3.Revenue recognition4.Expense recognitionBriefExercise 1–41.Expense recognition2.The historical cost (original transaction value) principle3.The economic entity assumptionBrief Exercise 1–51.Disagree—The full disclosure principle2.Agree—The periodicity assumption3.Disagree—Expense recognition4.Agree—Revenue recognition

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1–10Intermediate Accounting, 10eBrief Exercise 1–61.Obtains funding for the IFRS standard setting process: IFRS Foundation2.Determines IFRS: International Accounting Standards Board (IASB)3.Oversees the IFRS Foundation: Monitoring Board4.Provides input about the standard setting agenda: IFRS Advisory Council.5.Providesimplementationguidanceaboutrelativelynarrowissues:IFRSInterpretations Committee.

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Solutions Manual, Vol.1, Chapter 11–11Exercise 1–1Requirement 1Pete, Pete, and RoyOperating Cash FlowYear 1Year 2Cash collected$160,000$190,000Cash disbursements:Salaries(90,000)(100,000)Utilities(30,000)(40,000)Purchase of insurance policy(60,000)-0-Net operating cash flow$(20,000)$ 50,000Requirement 2Pete, Pete, and RoyIncome StatementsYear 1Year 2Revenues$170,000$220,000Expenses:Salaries(90,000)(100,000)Utilities(35,000)(35,000)Insurance(20,000)(20,000)Net Income$ 25,000$ 65,000Requirement 3Year 1:Amount billed to clients$170,000Less: Cash collected(160,000)Ending accounts receivable$ 10,000Year 2:Beginning accounts receivable$ 10,000Plus: Amounts billed to clients220,000$230,000Less: Cash collected(190,000)Ending accounts receivable$ 40,000EXERCISES

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1–12Intermediate Accounting, 10eExercise 1–2Requirement 1Year 2Year 3Revenues$350,000$450,000Expenses:Rent($80,0002)(40,000)(40,000)Salaries(140,000)(160,000)Utilities(30,000)(40,000)Advertising(25,000)(20,000)*Net Income$115,000$190,000Requirement 2Amount owed at the end of year one$ 5,000Advertising costsincurred in year two25,00030,000Amount paid in year two(15,000)Liability at the end of year two15,000Less cash paid in year three(35,000)Advertising expense in year three$20,000*

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Solutions Manual, Vol.1, Chapter 11–13Exercise 1–3Requirement 1FASB ASC 820:“Fair Value Measurements and Disclosures”Requirement 2The specific citation that describes the information that companies must discloseabout the use of fair value to measure assets and liabilities for recurring measurementsisFASBASC820–10–50:“FairValueMeasurementsandDisclosures-Overall-Disclosures.”

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1–14Intermediate Accounting, 10eExercise 1–4TheFASB Accounting Standards Codificationrepresents the single source ofauthoritative U.S. generally accepted accounting principles. The specificcitation for each of the following items is:1.The topic number forbusiness combinations:FASB ASC 805: “Business Combinations.”2.The topic number for related-party disclosures:FASB ASC 850: “Related Party Disclosures.”3.The topic, subtopic, and section number for theinitial measurementof internal-use software:FASB ASC 350–40–30: “Intangibles–Goodwill and Other–Internal–UseSoftware–Initial Measurement.”4.Thetopic,subtopic,andsectionnumberforthesubsequentmeasurement of asset retirement obligations:FASBASC410–20–35:“AssetRetirementandEnvironmentalObligations–Asset Retirement Obligations–Subsequent Measurement.”5.The topic, subtopic, and section number for the recognition of stockcompensation:FASB ASC 718–10–25: “Compensation–StockCompensation–Overall–Recognition.”Exercise 1–5OrganizationGroup1. Securities and Exchange CommissionUsers2. Financial Executives InternationalPreparers3. American Institute of Certified Public AccountantsAuditors4. Institute of Management AccountantsPreparers5. Association of Investment Management and ResearchUsers

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Solutions Manual, Vol.1, Chapter 11–15Exercise 1–61.Liability2.Distribution to owners3.Revenue4.Assets, liabilities and equity5.Comprehensive income6.Gain7.Loss8.Equity9.Asset10.Net income11.Investment by owner12.Expense

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