Solution Manual for Intermediate Accounting: Reporting and Analysis, 3rd Edition

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1-1CHAPTER 1The Demand for and Supply of Financial Accounting InformationCONTENT ANALYSIS OF END-OF-CHAPTER ASSIGNMENTSNUMBERTOPICCONTENTLO ADAPTEDDIFFICULTYTIMEEST.AACSBAICPABLOOM’S1-1Role of FinancialReportingFinancial accounting;financial reporting1Easy5AnalyticMeasurement Comprehension1-2Financial ReportingStakeholdersMajor categories of financialreporting stakeholders1Easy5AnalyticMeasurement Comprehension1-3Financial ReportingStakeholdersDifferent information needsof investors and creditors1Easy5AnalyticMeasurement Application1-4InformationAsymmetryInformation asymmetrybetween financial reportingpreparers and users1Easy5AnalyticMeasurement Comprehension1-5Financial ReportingInformationDemand for financialreporting information1Easy5AnalyticMeasurement Application1-6AccountingStandards andAuditsDemand for accountingstandards and auditverification1Easy5AnalyticMeasurement Comprehension1-7Generally AcceptedAccountingPrinciplesDefinition of U.S. GAAP1Easy5AnalyticMeasurement Comprehension1-8Standard SettingSupply of accountinginformation2Easy5AnalyticMeasurement Comprehension1-9Standard SettingRole of SEC2Easy5AnalyticMeasurement Comprehension1-10Standard SettingRole of FASB3Easy5AnalyticMeasurement Comprehension1-11Standard SettingRole of EITF3Easy5AnalyticMeasurement Comprehension1-12Standard SettingFASB Accounting StandardsCodification4Easy5AnalyticMeasurement Application

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1-2NUMBERTOPICCONTENTLO ADAPTEDDIFFICULTYTIMEEST.AACSBAICPABLOOM’S1-13Standard SettingProcess for issuingaccounting standardupdate4Easy5AnalyticMeasurement Comprehension1-14Standard SettingFASB; IASB5Easy5AnalyticMeasurement Analysis1-15Standard SettingDefinition of IFRS5Easy5AnalyticMeasurement Application1-16Standard SettingChanging standards overtime; U.S. GAAP; IFRS5Easy5AnalyticMeasurement Comprehension1-17Standard SettingThe impact of pure theory vs.politics in standard setting5Easy5AnalyticMeasurement Analysis1-18Financial StatementsBalance sheet; financialreporting stakeholders6Easy5AnalyticReportingApplication1-19Financial StatementsIncome statement; financialreporting stakeholders6Easy5AnalyticReportingApplication1-20Financial StatementsStatement of cash flows;financial reportingstakeholders6Easy5AnalyticReportingApplication1-21Financial StatementsStatement of shareholders'equity; financial reportingstakeholders6Easy5AnalyticReportingApplication1-22Financial StatementsPurpose of footnotes;disclosure of financialinformation6Easy5AnalyticReportingApplication1-23Earnings and theStock MarketEconomic consequences ofearnings information7Easy5AnalyticMeasurement Analysis1-24EthicsEthics7Easy5AnalyticMeasurement Application1-25EthicsEthics; code of professionalconduct7Easy5AnalyticMeasurement Comprehension

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1-3NUMBERTOPICCONTENTLO ADAPTEDDIFFICULTYTIMEEST.AACSBAICPABLOOM’SE1-1PronouncementsFASB Accounting StandardsCodification; differentsources of GAAP4Easy15 AnalyticMeasurement ComprehensionC1-1Accounting Principles Describe the meaning of theterms “accountingprinciples” and “generallyaccepted”3 AICPA Easy10 AnalyticMeasurement ApplicationC1-2Standard SettingDescribe why there ispolitical action and socialinvolvement in the standard-setting process3 CMAEasy10 AnalyticMeasurement ApplicationC1-3Organization of theFASBSummarize the structure ofthe FASB and its operatingprocedures3Easy15 AnalyticMeasurement ApplicationC1-4Code of ProfessionalConductIdentify, briefly discuss, andprovide examples to illustratethe first five principles of CPC7Easy10 AnalyticMeasurement ApplicationC1-5Lobbying the FASBDiscuss pros and cons oflobbying the FASB byinterested parties3Easy5AnalyticMeasurement ApplicationC1-6InternationalConvergenceDiscuss convergence of U.S.GAAP and internationalaccounting standards;include discussion of SECand its role in thisconvergence; includes IFRS5Moderate10 AnalyticMeasurement ApplicationC1-7Starbucks’s FinancialStatementsIdentify two important piecesof information from each ofthe four primary financialstatements andmanagement discussion andanalysis6Moderate20 AnalyticReportingApplication

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1-4NUMBERTOPICCONTENTLO ADAPTEDDIFFICULTYTIMEEST.AACSBAICPABLOOM’SC1-8Nestlé’s FinancialStatementsIdentify two important piecesof information from each ofthree primary financialstatements6Moderate20 AnalyticReportingApplicationC1-9Coca Cola's FinancialStatementsIdentify two important piecesof information from each ofthree primary financialstatements6Moderate20 AnalyticReportingApplicationC1-10Ethical Responsibilities Discuss steps to take in anethical dilemma(“misplaced” book in library)7Moderate5ReflectiveThinkingMeasurement AnalysisC1-11Ethical Responsibilities Discuss steps to take in anethical dilemma (cheatingby friend on exam)7Moderate5ReflectiveThinkingMeasurement AnalysisC1-12CodificationPrepare a memo to explainand demonstrate theCodification to anintroductory accountingstudent, who is familiar withthe financial statements andaccountsModerate25 AnalyticMeasurement ApplicationC1-13CodificationSearch the Codification todetermine how a companyshould account for the costof a new desktop computerfor use in the officeModerate15 AnalyticMeasurement ApplicationC1-14CodificationSearch the Codification todetermine how a companyshould account forrecognition of retail revenueswith the right to returnModerate25 AnalyticMeasurement Application

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1-5ANSWERS TO GOT IT?1-1The role of financial accounting is to identify, measure, record, and report relevantand reliable financial information about companies to present and potential futurestakeholders. Financial reporting is the process of communicating financialaccounting information about a company to existing and potential future investors,creditors, and other external decision makers and stakeholders.An important way acompany’s financial accounting information is reported is in its quarterly and annualreports. The role of financial reporting is to inform investors, creditors, and otherstakeholders. Financial reporting also provides information to mitigate agencyproblems which stem from the separation of ownership and control of resources.1-2The primary stakeholders that are important users of financial information includeinvestors, creditors, banks, suppliers, customers, employees, executives, labor unions,pension funds, government regulatory authorities, tax authorities, local communities,and many others (see Exhibit 1.1). The instructor can discuss how these stakeholderscan be divided into two major categories: external users and internal users. These twogroups do not have the same decision-making information needs because of theirdiffering relationships with the company providing economic information. Of thesegroups, FASB has stated the primary purpose of financial reporting is to informinvestors and creditors.1-3Investors and creditors take different risks and enjoy different potential upside gainsfrom investing or lending. Equity investors are the residual risk bearers of corporations,but stand to enjoy potentially greater upside if the company is successful andprofitable. Creditors face less risk of loss of their investments because they havesuperior claim in bankruptcy over equity investors. But creditors do not share in thesame upside potential as equity investors. As a result of these differences, theirinformation needs differ. Equity investors are more concerned with profitability,whereas creditors tend to be more focused on cash flows.1-4Information asymmetry arises from the separation of ownership and control ofresources. Financial reporting helps reduce (but not eliminate) informationasymmetry problems by enabling managers (agents) to provide relevant andfaithfully represented information to investors and creditors (principals), therebyreducing information asymmetry.1-5The demand for financial accounting information, as an economic good in society,arises from the needs of equity shareholders, creditors, and various other stakeholdersfor information to make resource allocation decisions. This demand arises becausebusinesses have to compete for and attract scarce economic resources, such asequity and debt capital, productive resources, employees, supplier and customerrelationships, and so forth. In order to compete for these valuable resources,companies must provide relevant and faithfully represented information to those whocan provide the resources.

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1-61-6To solve the problems that would arise from biases in a self-reporting accountingsystem, a natural demand arises foraccounting standards and audits. The demandfor accounting information drives the demand for professionally establishedaccounting standards that provide authoritative guidance on how to measure andreport economic activities in financial statements. In addition, the demand foraccounting information also drives the demand for auditing—independentverification and attestation of whether the financial statements have been fairlypresented in accordance with professional accounting standards.1-7Generally Accepted Accounting Principles (GAAP) are the principles, concepts,guidelines, procedures, and practices that U.S. companies that are listed in theUnited States and subject to SEC regulation are required to use in recording andreporting the accounting information in audited financial statements.1-8The supply of accounting information that companies report to external stakeholdersis determined primarily by the interactions between two sets of forces:•The authoritative professional accounting standards that govern in thecompany’s country of incorporation, such as U.S. GAAP or IFRS, and•the many choices, methods, estimates, and judgments that the company mustmake in order to apply those accounting standards to measure and report theirfinancial statements.1-9The stated mission of the U.S. Securities and Exchange Commission is to “protectinvestors, maintain fair, orderly, and efficient markets, and facilitate capitalformation.” The U.S. Congress created the SEC to administer the Securities Act of 1933and the Securities Exchange Act of 1934. Under these Acts, the SEC has the legalauthority to prescribe accounting principles and reporting practices for allcorporations issuing publicly traded securities within the U.S. capital markets. The SEChas mandated that the information communicated to external users in financialreporting must be based on professionally established accounting principles, such asGAAP for U.S companies and IFRS for non-U.S. companies.The SEC delegates the authority over standard setting to private standard-settingbodies within the accounting profession, such as the Financial Accounting StandardsBoard (FASB) establishing GAAP for U.S. companies and the International AccountingStandards Board (IASB) establishing IFRS for companies from many other countriesaround the world. The SEC monitors closely and oversees the standards beingdeveloped by these standard setters. From time to time, the SEC exerts pressure onthe standard setters to adopt, or not adopt, specific standards.1-10The FASB is responsible for identifying financial accounting issues, conductingresearch to address these issues, and resolving them by issuing new accountingstandards applicable to U.S. companies.The FASB fulfills its responsibility by:•establishing standards that are the most acceptable, given the various affectedconstituencies, and•continually monitoring the consequences of its actions so that revised standardscan be issued where appropriate.

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1-71-11In assisting the FASB, the primary objectives of the EITF are:•to identify significant emerging accounting issues (i.e., unique transactions andaccounting problems) that it feels the FASB should address.•to develop consensus positions on the implementation issues involving theapplication of standards. In some cases, these consensus positions may beviewed as the ‘‘best available guidance’’ on GAAP, particularly as they relate tonew accounting issues.1-12The Codification is an electronic database that integrates and topically organizesthe U.S. GAAP into one coherent body of literature. There are six levels in theframework of Codification: Areas, Topics, Subtopics, Sections, Subsections, andParagraphs. The Topics level contains a collection of related guidance on aparticular subject Area. The Subtopics level includes subsets of a Topic. The Sectionslevel characterizes the nature of the content in a Subtopic (e.g., Recognition,Measurement, Disclosure). The Subsections level provides finer breakdown of thecontent in a Section. Paragraphs contain the guidance that constitutes GAAP.The FASB issued six types of pronouncements prior to the Codification:1.Statements of Financial Accounting Standards. These pronouncementsestablished GAAP. They indicated the methods and procedures required onspecific accounting issues.2.Interpretations. These pronouncements provided clarifications of conflicting orunclear issues relating to previously issuedFASB Statements of FinancialAccounting Standards,APB Opinions, orAccounting Research Bulletins.3.Staff Positions. The staff of the FASB issued these pronouncements to provide moretimely and consistent application guidance in regard to FASB literature, as well asto make narrow and limited revisions of GAAP.4.Technical Bulletins. The staff of the FASB issued these pronouncements to clarify,explain, and elaborate on accounting and reporting issues related toStatementsof StandardsorInterpretations.5.Statements of Financial Accounting Concepts. These pronouncementsestablished a theoretical foundation upon which to base GAAP. They are theoutput of the FASB’s “conceptual framework” project.6.Other Pronouncements. On a major topic, the staff of the FASB may have issuedaGuide for Implementation.The Codification did not change GAAP per se, in that it did not issue or rescind anystandards. Instead, the FASB developed the Codification to achieve three goals:•Simplify user access by codifying all authoritative U.S. GAAP in one spot.•Ensure the codified content accurately represented all authoritative U.S. GAAP.•Create a codification research system that is up to date, including the mostrecently released standards.

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1-81-13Before issuing an Accounting Standards Update, the FASB generally completes amultistage process as follows:(1)identifies topic(2)appoints task force(3)conducts research(4)issues Discussion Memorandum or Invitation to Comment(5)holds public hearings(6)deliberates on findings(7)issues Exposure Draft(8)holds public hearings(9)modifies Exposure Draft(10)votesAfter a super-majority vote (five votes out of seven) is attained, the FASB issues anAccounting Standards Update.1-14The FASB and IASB are structured very similarly, in organizations that are overseen andsupported by Boards of Trustees, and supported by large staffs of professional andtechnical experts and administrative support. Both Boards follow similar open, carefuldue processes in deliberating new accounting standards. Whereas the FASB is aseven-member Board consisting of only U.S. members, the IASB is larger, with 16 full-time members. The composition of the IASB is structured to contain representationfrom different countries and regions of the world. The IASB issuesInternationalFinancial Reporting Standards (IFRS). To do so, its operating procedures include studyof the topic, issuance of an Exposure Draft, evaluation of comments, andconsideration of a revised draft. If approved by at least nine members of the IASB,theInternational Financial Reporting Standardis issued.1-15They are the principles, concepts, guidelines, procedures, and practices thatcompanies from the roughly 130 countries that have adopted IFRS are required touse in recording and reporting the accounting information in audited financialstatements. In the United States, the SEC has decided to allow non-U.S. companiesthat are listed in the United States and subject to SEC regulation to use IFRS forpreparation of financial statements filed with the SEC.1-16The FASB and the IASB have worked together toward convergence since the“Norwalk Agreement” in 2002. At that time, the two Boards entered into thisagreement to work together on the development of high-quality, compatibleaccounting standards that could be used for both “domestic” and “cross-border”financial reporting. The Boards in 2009 and 2010 identified a number of majorprojects they undertook jointly. The Boards have completed most of these majorprojects. These joint projects have helped achieve greater convergence inaccounting standard for revenue recognition (issued 2014), consolidated financialstatements (issued 2011), fair value measurement (issued 2011), and financialstatement presentation (amendments to reporting comprehensive incomecompleted in 2011; other joint work discontinued).

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1-91-17Because of the substantial economic consequences of new standards, keyconstituents often disagree about the objectives for new standards. Because theBoards hold public hearings and open meetings, various external user groups (e.g.,investors and creditors) and other interested parties (e.g., affected corporations andCPA firms) exert pressure to influence the new standards, continue existing standards,or change existing standards in their own best interests. In addition, research resultsabout the likely effects of new standards are sometimes conflicting, and only “bestguesses” can be made of the future consequences of current standards. A particulardifficulty is that costs of complying with new standards are often significant andmeasurable, whereas the benefits of new information to decision makers are diffuseand hard to quantify. As a consequence, the FASB and the IASB often makedecisions about new accounting standards that sometimes require compromisebetween conflicting views and interests.1-18The balance sheet, or statement of financial position, presents a snapshot of theresources of a firm (assets) and the claims on the company (liabilities andshareholders’ equity) as of a specific date (usually the last day of the fiscal quarter orthe fiscal year). The balance sheet reports the following equality:Assets = Liabilities + Shareholders’ EquityMost stakeholders in a company, particularly investors and creditors, will be interestedin balance sheet information because it reports the financial position (resources andobligations) of the company.1-19The income statement measures and reports the financial results of a firm’sperformance for a period of time, usually a quarter or a year. The income statementprovides information about the profits (or losses) the firm has generated during theperiod by conducting operating, investing, and financing activities. Moststakeholders in a company, particularly equity investors, will be interested in incomestatement information because it reports the profits and losses that accrue to thecommon equity shareholders of the company. The chapter shows empirical researchevidence on how changes in earnings are associated with changes in stock prices.1-20The statement of cash flows reports for a period of time the net cash flows (inflowsminus outflows) from the three principal categories of business activities: operating,investing, and financing. The purpose of the statement of cash flows is important butsimple: to provide useful information about how a firm is generating and using cash.The statement of cash flows provides information to complement the incomestatement, demonstrating how cash flows differ from accrual-based income.Cash flow information is very helpful to financial statement users who want to gaugehow the firm is executing its strategy. The statement is particularly useful to creditorsand other stakeholders with claims on future cash flows of a firm. The statement ofcash flows helps them evaluate the firm’s cash-generating ability, giving theminformation about the likelihood of future cash flows for future payments of theirobligations.

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1-101-21The statement of shareholders’ equity (sometimes called thestatement of changes inshareholders’ equity) provides information about the common shareholders’ equityclaims on the company, and how those claims changed during the period. The year-end amounts reported in this statement for the various common shareholders’ equityaccounts will match the amounts reported in the shareholders’ equity section of thebalance sheet. Equity investors will be particularly interested in the information in thisstatement.1-22A firm’s accounting system records the results of transactions, events, andcommercial arrangements and generates the financial statements, but the financialstatements do not stand alone. To provide more relevant and representationallyfaithful information for financial statement users, firms typically provide a substantialamount of important additional information with the financial statements, includingthe Notes, Management Discussion and Analysis, and Managers’ and IndependentAuditors’ Attestations. The notes to the statements explain the methods, assumptions,and estimates the firm has used in measuring and reporting the accountinginformation in the financial statements.1-23To illustrate the striking links between accounting earnings and stock returns, thechapter provides a brief discussion of the results from empirical research by D. CraigNichols and James Wahlen. They studied the average cumulative market-adjustedstock returns generated by firms during the 12 months leading up to and includingthe month in which each firm announced annual earnings numbers. For a sample of31,923 firm-years between 1988 and 2001, they found that the average firm thatannounced an increase in earnings (over the prior year’s earnings) experiencedstock returns that beat market average returns by roughly 19.2 percent. On the otherhand, the average firm that announced a decrease in earnings experienced stockreturns that were roughly 16.4 percent lower than the market average. Their resultssuggest that merely the sign of the change in earnings was associated with a 35.6percent stock return differential in one year, on average, over their sample period.The results show that earnings information has important economic consequences,because changes in earnings are strongly associated with significant changes inshare prices.1-24As accountants, we create valuable financial information that stakeholders use tomake informed resource allocation decisions about companies. Accountinginformation triggers substantial economic consequences for a wide array of differentstakeholders in a company. Because accounting information has such importantconsequences for so many different stakeholders, being an accountant requires theability to bear this great responsibility while behaving ethically.1-25TheCode of Professional Conductis a document published by the AICPA to helpguide members in public practice, industry, government, and education inperforming their responsibilities in an ethical and professional manner. The six areascovered by the Principles include: (1) responsibilities, (2) public interest, (3) integrity,(4) objectivity and independence, (5) due care, and (6) scope and nature ofservices.

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1-11SOLUTION TO EXERCISEE1-11.e2.c3.b4.d5.f6.a7.fANSWERS TO CASESC1-1[AICPA Adapted]1.The term “accounting principles” in the auditor’s report includes not only accountingprinciples but also concepts, practices, and the methods of applying them. The auditor'sreport typically refers to “accounting principles” being applied by the firm being audited.The independent auditor's attestation as to the fairness of a company's financialstatements relative to U.S. GAAP or IFRS is an essential element for the reliability offinancial statements.2.Generally accepted accounting principles are those principles that have substantialauthoritative support. The SEC has deemed the FASB’s Accounting StandardsCodification as GAAP for U.S. companies. In addition, the SEC has deemed IFRS asgenerally accepted accounting principles for non-U.S. companies that are listed in theUnited States. The FASB and the IASB follow extensive, due processes to deliberateand develop new accounting standards that, if adopted, become “generallyaccepted.”C1-2[CMA Adapted]Financial accounting standards inspire or encourage political action and social involvementduring the standard-setting process because the effects and economic consequences ofaccounting standards are wide-ranging and impact many varying groups. The setting ofaccounting standards is a social decision and the user groups play a significant role and haveconsiderable influence.The economic consequences of financial accounting standards inspire companies,stakeholders, and special interest groups to become vocal and critical when standards arebeing formulated. The reporting of financial information impacts companies’ financialstatements and the wealth and decision-making of stakeholders in differing ways. Companiesand stakeholders may want particular economic events accounted for in particular ways andare willing to fight for what they want.The formulation of accounting standards has political roots in the Securities and Exchange Actsof 1933 and 1934. Although the SEC was vested with complete authority to define and formulateaccounting standards, it has, for the most part, delegated this authority to the private sector.The SEC supports the FASB in this endeavor and encourages its “due process” system ofstandard setting. Financial accounting standards issued are considered to be “generallyaccepted accounting principles” and, as such, they must be followed in the preparation offinancial statements. Therefore, the formulation of standards is of vital interest to companiesresponsible for preparing the financial statements, stakeholders that use the statements, andauditors.

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1-12C1-3The Financial Accounting Foundation is the parent organization of the FASB. It is governed by a14- to 18-member Board of Trustees appointed from the memberships of eight organizations (theAICPA, Financial Executives Institute, Institute of Management Accountants, CFA Institute,American Accounting Association, Securities Industry and Financial Markets Association,Government Finance Officers Association, and National Association of State Auditors,Comptrollers, and Treasurers) interested in the formulation of accounting principles. The primaryresponsibilities of the Financial Accounting Foundation are to provide general oversight to itsoperations and appoint the members of the Financial Accounting Standards Advisory Council(FASAC) and the FASB. The FASAC consists of about 33 members; it is responsible for advising theFASB about major policy issues, the priority of topics, the selection of task forces, the suitability oftentative decisions, and other matters.There are seven members of the FASB. Appointees to the FASB are full-time, fully paid memberswith no other organizational ties and are selected to represent a wide cross-section of interests.Each Board member is required to have a knowledge of, and experience in, accounting,finance, investing, business, and accounting education and research; high intelligence, integrity,and discipline; and a concern for the public interest regarding investing, financial accounting,and financial reporting. The FASB is responsible for identifying financial accounting issues,conducting research to address these issues, and resolving them. The FASB is supported by aresearch and technical staff that performs numerous functions such as researching issues,communicating with constituents, and drafting preliminary findings. The administrative staffassists the FASB by handling library, publications, personnel, and other activities.Operating Procedures and Pronouncements. Before issuing an accounting standards update,the FASB generally completes a multistage process, although the sequence and numbers ofsteps may vary. Initially, a topic or project is identified and placed on the FASB’s agenda. Thistopic may be the result of suggestions from the FASAC, the accounting profession, industry, orother interested parties. On major issues, a Task Force may be appointed to advise and consultwith the FASB’s Research and Technical Staff on such matters as the scope of the project andthe nature and extent of additional research. The Staff then conducts any research specificallyrelated to the project.A Preliminary Views document or Invitation to Comment, which outlines the research related tothe issues, is then usually published and a public comment period is set. During this period, publichearings, similar to those conducted by Congress, may be held. The intent is to receiveinformation from and views of interested individuals and organizations on the issues. Manyparties submit written comments (“position papers”) or make oral presentations. These partiesinclude representatives of CPA firms and interested corporations, security analysts, members ofprofessional accounting associations, and academicians, to name a few. After deliberatingon the views expressed and information collected, the FASB issues an Exposure Draft of theproposed Accounting Standards Update. Interested parties generally have 30–90 days toprovide written comments of reaction. On major issues, more public hearings may be held.Sometimes, a “field test” of the proposed standard is conducted with selected companies toevaluate implementation issues. A modified draft is prepared, if necessary, and brought to theFASB for a final vote. After a super-majority vote (at least five of seven votes in favor) is attained,theFASB Accounting Standards Updateis issued.

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1-13C1-4The first five principles of the AICPA’sCode of Professional Conductare as follows:1.Responsibilities: In carrying out their responsibilities as professionals, members shouldexercise sensitive professional and moral judgments in all their activities. For example,when a member chooses a depreciation method, she must carefully analyze eachalternative based upon well-defined criteria before making a final choice.2.The Public Interest: Members should act in a way that will serve the public interest, honorthe public trust, and demonstrate a commitment to professionalism. When a memberrefuses to ignore internal control deficiencies in a company with publicly traded stock,but instead enumerates these deficiencies in the Auditor’s report, she is adhering to thepublic interest principle.3.Integrity: To maintain and broaden public confidence, members should perform allprofessional responsibilities with the highest sense of integrity. For example, a memberwho carefully and conscientiously performs each step of an audit without skipping thosesteps that are tedious or of less interest is exercising the integrity principle.4.Objectivity and Independence: A member should be objective and be free fromconflicts of interest in discharging professional responsibilities. A member in publicpractice should be independent in fact and appearance when providing auditing andother attestation services. For example, a member who declines to audit the financialstatements of the company for which his father is a marketing vice president is adheringto this principle.5.Due Care: A member should observe the profession’s technical and ethical standards,strive continually to improve competence and the quality of standards, strive continuallyto improve competence and the quality of services, and discharge professionalresponsibility to the best of the member’s ability. When a member reads currentaccounting literature and strives to employ current principles and procedures, she isexercising due care.C1-5On balance, most people would agree that it is a good idea for the FASB to allow writtencomments and oral presentations in which interested parties can lobby for a particular ruling.However, there are both pros and cons to allowing interested parties to provide input to itsdeliberation process. They include:Advantages•Enables FASB to get input from different perspectives•Provides users a forum to express concerns•Provides preparers a forum to express concerns•Provides auditors a forum to express concerns•Overcomes criticism of failing to listen to constituencies•Allows for consideration of views of all interested parties•Rulings appear more fair to all constituencies

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1-14C1-5(concluded)•Rulings consider the costs and benefits of implementation•Standards are established that are the most acceptable•Allows for clarification of rules•Allows for corrections of any errors•Allows for consideration of implementation issuesDisadvantages•Rulings sometimes appear to be biased in favor of certain user groups•Rulings sometimes are inconsistent with other Statements of Standards•Rulings sometimes are inconsistent with Statements of Concepts•Rulings sometimes appear illogical•FASB is too slow in establishing standards•Standards are too complex and difficult to implementC1-6Currently, U.S. corporations are subject to the accounting standards (called U.S. GAAP)established by the FASB, while foreign corporations are subject to international standards calledIFRS (international financial reporting standards) established by the International AccountingStandards Board (IASB) or by their national accounting standards boards. These differences inaccounting standards have led to differences among U.S. and foreign corporations’ financialstatements. These differences, in turn, have made it difficult for investors and creditors to makevalid comparisons across corporations and to make effective buy-sell-hold decisions in the U.S.and foreign capital markets.To overcome this problem, the FASB and the IASB have been working together towardconvergence since the “Norwalk Agreement” in 2002. At that time, the two Boards entered intothis agreement to work together on the development of high-quality, compatible accountingstandards that could be used for both “domestic” and “cross-border” financial reporting. Toachieve this compatibility, the Boards agreed to work together to achieve “short-term”convergence on a number of individual differences between U.S. and international accountingstandards. They also agreed to coordinate their future agendas on substantial long-termprojects which both Boards would address concurrently. Finally, they agreed to continueworking on joint projects they were currently undertaking. This overall collaboration is sometimesreferred to as theconvergenceorharmonizationof accounting standards.The Boards in 2009 and 2010 identified a number of major joint projects to undertake jointly, aswell as short-term projects (in which convergence can occur fairly quickly). The Boards havecompleted most of their joint efforts to complete these major projects. The major projects theBoards have completed have achieved great convergence in accounting standards for:•Consolidated financial statements•Fair value measurement•Financial statement presentation•Revenue recognition

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1-15C1-6(continued)Moving forward, the FASB will continue to work on global accounting issues with the IASBthrough its membership in the Accounting Standards Advisory Forum (ASAF), a newly establishedadvisory body comprising twelve standard setters from across the globe. Both Boards alsoprovide quarterly progress reports which can be downloaded from their web sites.The SEC has moved forward on two fronts: (1) changing its filing regulations for foreigncompanies and (2) considering changing its filing requirements for U.S. companies.In the past, a foreign company filing its financial statements with the SEC that used accountingstandards other than U.S. GAAP had to file a form which “reconciled” certain amounts reportedin its financial statements with the amounts that would have been reported using U.S. GAAP.However, in late 2007 the SEC rescinded this rule for foreign companies that use English-language IFRS (with no exceptions) to prepare their financial statements. These companies nolonger have to file a reconciliation.In July 2012, the SEC staff issued its final report considering incorporating IFRS into the financialreporting system for U.S. companies. The report was the final phase of a work plan, initiated inFebruary 2010, to consider specific issues relevant to the SEC’s determination as to where, when,and how the current financial reporting system for U.S. issuers should be transitioned to a systemincorporating IFRS.The 2012 report summarized the staff’s findings regarding key issues surrounding the potentialincorporation of IFRS into U.S. financial reporting, but did not make any recommendation to theCommission. “Additional analysis and consideration of this threshold policy question is necessarybefore any decision by the Commission concerning the incorporation of IFRS into the financialreporting system for the U.S. issuers can occur,” the report said.In the report, the staff identified a number of unresolved issues relating to the potentialincorporation of IFRS into the U.S. financial reporting system. These issues include the diversity inhow IFRS are interpreted, applied, and enforced in various jurisdictions around the world; thepotential cost to U.S. issuers of adopting or incorporating IFRS; investor education; andgovernance.The movement by more foreign companies to using IFRS has created two potential problems forU.S. companies using U.S. GAAP (“regulated companies”) and that operate globally. First, theirfinancial statements are likely to be different from those of the foreign companies with whichthey are competing for capital, creating difficulties for investors in comparing companies.Second, if they have subsidiaries operating in foreign countries, they may be required to preparetheir subsidiaries’ financial statements according to IFRS for local filings. Since they still have toprepare their financial statements using U.S. GAAP to file with the SEC, this creates potentialcostly inefficiencies. As a result, the SEC has begun a study of whether it should require or allowU.S. companies to use IFRS in their financial statements filed with the SEC. There are many issuesrelated to this possible change, and they are very complex and far reaching. These include:(1)Many U.S. companies (particularly smaller ones) filing with the SEC do not operateglobally so they would not see any advantage to using IFRS. If IFRS were required, itwould likely be very costly for them to switch from U.S. GAAP to IFRS, thereby affectingtheir profitability during the conversion period.

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