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

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    1-1 CHAPTER 1 The Demand for and Supply of Financial Accounting Information CONTENT ANALYSIS OF END-OF-CHAPTER ASSIGNMENTS N UMBER T OPIC C ONTENT LO A DAPTED D IFFICULTY T IME E ST . AACSB AICPA B LOOM ’ S 1-1 Role of Financial Reporting Financial accounting; financial reporting 1 Easy 5 Analytic Measurement Comprehension 1-2 Financial Reporting Stakeholders Major categories of financial reporting stakeholders 1 Easy 5 Analytic Measurement Comprehension 1-3 Financial Reporting Stakeholders Different information needs of investors and creditors 1 Easy 5 Analytic Measurement Application 1-4 Information Asymmetry Information asymmetry between financial reporting preparers and users 1 Easy 5 Analytic Measurement Comprehension 1-5 Financial Reporting Information Demand for financial reporting information 1 Easy 5 Analytic Measurement Application 1-6 Accounting Standards and Audits Demand for accounting standards and audit verification 1 Easy 5 Analytic Measurement Comprehension 1-7 Generally Accepted Accounting Principles Definition of U.S. GAAP 1 Easy 5 Analytic Measurement Comprehension 1-8 Standard Setting Supply of accounting information 2 Easy 5 Analytic Measurement Comprehension 1-9 Standard Setting Role of SEC 2 Easy 5 Analytic Measurement Comprehension 1-10 Standard Setting Role of FASB 3 Easy 5 Analytic Measurement Comprehension 1-11 Standard Setting Role of EITF 3 Easy 5 Analytic Measurement Comprehension 1-12 Standard Setting FASB Accounting Standards Codification 4 Easy 5 Analytic Measurement Application

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    1-2 N UMBER T OPIC C ONTENT LO A DAPTED D IFFICULTY T IME E ST . AACSB AICPA B LOOM ’ S 1-13 Standard Setting Process for issuing accounting standard update 4 Easy 5 Analytic Measurement Comprehension 1-14 Standard Setting FASB; IASB 5 Easy 5 Analytic Measurement Analysis 1-15 Standard Setting Definition of IFRS 5 Easy 5 Analytic Measurement Application 1-16 Standard Setting Changing standards over time; U.S. GAAP; IFRS 5 Easy 5 Analytic Measurement Comprehension 1-17 Standard Setting The impact of pure theory vs. politics in standard setting 5 Easy 5 Analytic Measurement Analysis 1-18 Financial Statements Balance sheet; financial reporting stakeholders 6 Easy 5 Analytic Reporting Application 1-19 Financial Statements Income statement; financial reporting stakeholders 6 Easy 5 Analytic Reporting Application 1-20 Financial Statements Statement of cash flows; financial reporting stakeholders 6 Easy 5 Analytic Reporting Application 1-21 Financial Statements Statement of shareholders' equity; financial reporting stakeholders 6 Easy 5 Analytic Reporting Application 1-22 Financial Statements Purpose of footnotes; disclosure of financial information 6 Easy 5 Analytic Reporting Application 1-23 Earnings and the Stock Market Economic consequences of earnings information 7 Easy 5 Analytic Measurement Analysis 1-24 Ethics Ethics 7 Easy 5 Analytic Measurement Application 1-25 Ethics Ethics; code of professional conduct 7 Easy 5 Analytic Measurement Comprehension

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    1-3 N UMBER T OPIC C ONTENT LO A DAPTED D IFFICULTY T IME E ST . AACSB AICPA B LOOM ’ S E1-1 Pronouncements FASB Accounting Standards Codification; different sources of GAAP 4 Easy 15 Analytic Measurement Comprehension C1-1 Accounting Principles Describe the meaning of the terms “accounting principles” and “generally accepted” 3 AICPA Easy 10 Analytic Measurement Application C1-2 Standard Setting Describe why there is political action and social involvement in the standard- setting process 3 CMA Easy 10 Analytic Measurement Application C1-3 Organization of the FASB Summarize the structure of the FASB and its operating procedures 3 Easy 15 Analytic Measurement Application C1-4 Code of Professional Conduct Identify, briefly discuss, and provide examples to illustrate the first five principles of CPC 7 Easy 10 Analytic Measurement Application C1-5 Lobbying the FASB Discuss pros and cons of lobbying the FASB by interested parties 3 Easy 5 Analytic Measurement Application C1-6 International Convergence Discuss convergence of U.S. GAAP and international accounting standards; include discussion of SEC and its role in this convergence; includes IFRS 5 Moderate 10 Analytic Measurement Application C1-7 Starbucks’s Financial Statements Identify two important pieces of information from each of the four primary financial statements and management discussion and analysis 6 Moderate 20 Analytic Reporting Application

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    1-4 N UMBER T OPIC C ONTENT LO A DAPTED D IFFICULTY T IME E ST . AACSB AICPA B LOOM ’ S C1-8 Nestlé’s Financial Statements Identify two important pieces of information from each of three primary financial statements 6 Moderate 20 Analytic Reporting Application C1-9 Coca Cola's Financial Statements Identify two important pieces of information from each of three primary financial statements 6 Moderate 20 Analytic Reporting Application C1-10 Ethical Responsibilities Discuss steps to take in an ethical dilemma (“misplaced” book in library) 7 Moderate 5 Reflective Thinking Measurement Analysis C1-11 Ethical Responsibilities Discuss steps to take in an ethical dilemma (cheating by friend on exam) 7 Moderate 5 Reflective Thinking Measurement Analysis C1-12 Codification Prepare a memo to explain and demonstrate the Codification to an introductory accounting student, who is familiar with the financial statements and accounts Moderate 25 Analytic Measurement Application C1-13 Codification Search the Codification to determine how a company should account for the cost of a new desktop computer for use in the office Moderate 15 Analytic Measurement Application C1-14 Codification Search the Codification to determine how a company should account for recognition of retail revenues with the right to return Moderate 25 Analytic Measurement Application

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    1-5 ANSWERS TO GOT IT? 1-1 The role of financial accounting is to identify, measure, record, and report relevant and reliable financial information about companies to present and potential future stakeholders. Financial reporting is the process of communicating financial accounting information about a company to existing and potential future investors, creditors, and other external decision makers and stakeholders. An important way a company’s financial accounting information is reported is in its quarterly and annual reports. The role of financial reporting is to inform investors, creditors, and other stakeholders. Financial reporting also provides information to mitigate agency problems which stem from the separation of ownership and control of resources. 1-2 The primary stakeholders that are important users of financial information include investors, 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 stakeholders can be divided into two major categories: external users and internal users. These two groups do not have the same decision-making information needs because of their differing relationships with the company providing economic information. Of these groups, FASB has stated the primary purpose of financial reporting is to inform investors and creditors. 1-3 Investors and creditors take different risks and enjoy different potential upside gains from investing or lending. Equity investors are the residual risk bearers of corporations, but stand to enjoy potentially greater upside if the company is successful and profitable. Creditors face less risk of loss of their investments because they have superior claim in bankruptcy over equity investors. But creditors do not share in the same upside potential as equity investors. As a result of these differences, their information needs differ. Equity investors are more concerned with profitability, whereas creditors tend to be more focused on cash flows. 1-4 Information asymmetry arises from the separation of ownership and control of resources. Financial reporting helps reduce (but not eliminate) information asymmetry problems by enabling managers (agents) to provide relevant and faithfully represented information to investors and creditors (principals), thereby reducing information asymmetry. 1-5 The demand for financial accounting information, as an economic good in society, arises from the needs of equity shareholders, creditors, and various other stakeholders for information to make resource allocation decisions. This demand arises because businesses have to compete for and attract scarce economic resources, such as equity and debt capital, productive resources, employees, supplier and customer relationships, and so forth. In order to compete for these valuable resources, companies must provide relevant and faithfully represented information to those who can provide the resources.

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    1-6 1-6 To solve the problems that would arise from biases in a self-reporting accounting system, a natural demand arises for accounting standards and audits . The demand for accounting information drives the demand for professionally established accounting standards that provide authoritative guidance on how to measure and report economic activities in financial statements. In addition, the demand for accounting information also drives the demand for auditing—independent verification and attestation of whether the financial statements have been fairly presented in accordance with professional accounting standards. 1-7 Generally Accepted Accounting Principles (GAAP) are the principles, concepts, guidelines, procedures, and practices that U.S. companies that are listed in the United States and subject to SEC regulation are required to use in recording and reporting the accounting information in audited financial statements. 1-8 The supply of accounting information that companies report to external stakeholders is determined primarily by the interactions between two sets of forces: • The authoritative professional accounting standards that govern in the company’s country of incorporation, such as U.S. GAAP or IFRS, and • the many choices, methods, estimates, and judgments that the company must make in order to apply those accounting standards to measure and report their financial statements. 1-9 The stated mission of the U.S. Securities and Exchange Commission is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” The U.S. Congress created the SEC to administer the Securities Act of 1933 and the Securities Exchange Act of 1934. Under these Acts, the SEC has the legal authority to prescribe accounting principles and reporting practices for all corporations issuing publicly traded securities within the U.S. capital markets. The SEC has mandated that the information communicated to external users in financial reporting must be based on professionally established accounting principles, such as GAAP for U.S companies and IFRS for non-U.S. companies. The SEC delegates the authority over standard setting to private standard-setting bodies within the accounting profession, such as the Financial Accounting Standards Board (FASB) establishing GAAP for U.S. companies and the International Accounting Standards Board (IASB) establishing IFRS for companies from many other countries around the world. The SEC monitors closely and oversees the standards being developed by these standard setters. From time to time, the SEC exerts pressure on the standard setters to adopt, or not adopt, specific standards. 1-10 The FASB is responsible for identifying financial accounting issues, conducting research to address these issues, and resolving them by issuing new accounting standards applicable to U.S. companies. The FASB fulfills its responsibility by: • establishing standards that are the most acceptable, given the various affected constituencies, and • continually monitoring the consequences of its actions so that revised standards can be issued where appropriate.

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    1-7 1-11 In assisting the FASB, the primary objectives of the EITF are: • to identify significant emerging accounting issues (i.e., unique transactions and accounting problems) that it feels the FASB should address. • to develop consensus positions on the implementation issues involving the application of standards. In some cases, these consensus positions may be viewed as the ‘‘best available guidance’’ on GAAP, particularly as they relate to new accounting issues. 1-12 The Codification is an electronic database that integrates and topically organizes the U.S. GAAP into one coherent body of literature. There are six levels in the framework of Codification: Areas, Topics, Subtopics, Sections, Subsections, and Paragraphs. The Topics level contains a collection of related guidance on a particular subject Area. The Subtopics level includes subsets of a Topic. The Sections level characterizes the nature of the content in a Subtopic (e.g., Recognition, Measurement, Disclosure). The Subsections level provides finer breakdown of the content 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 pronouncements established GAAP. They indicated the methods and procedures required on specific accounting issues. 2. Interpretations . These pronouncements provided clarifications of conflicting or unclear issues relating to previously issued FASB Statements of Financial Accounting Standards , APB Opinions , or Accounting Research Bulletins . 3. Staff Positions . The staff of the FASB issued these pronouncements to provide more timely and consistent application guidance in regard to FASB literature, as well as to 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 to Statements of Standards or Interpretations . 5. Statements of Financial Accounting Concepts . These pronouncements established a theoretical foundation upon which to base GAAP. They are the output of the FASB’s “conceptual framework” project. 6. Other Pronouncements . On a major topic, the staff of the FASB may have issued a Guide for Implementation . The Codification did not change GAAP per se, in that it did not issue or rescind any standards. 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 most recently released standards.

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    1-8 1-13 Before issuing an Accounting Standards Update, the FASB generally completes a multistage 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) votes After a super-majority vote (five votes out of seven) is attained, the FASB issues an Accounting Standards Update . 1-14 The FASB and IASB are structured very similarly, in organizations that are overseen and supported by Boards of Trustees, and supported by large staffs of professional and technical experts and administrative support. Both Boards follow similar open, careful due processes in deliberating new accounting standards. Whereas the FASB is a seven-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 representation from different countries and regions of the world. The IASB issues International Financial Reporting Standards (IFRS) . To do so, its operating procedures include study of the topic, issuance of an Exposure Draft, evaluation of comments, and consideration of a revised draft. If approved by at least nine members of the IASB, the International Financial Reporting Standard is issued. 1-15 They are the principles, concepts, guidelines, procedures, and practices that companies from the roughly 130 countries that have adopted IFRS are required to use in recording and reporting the accounting information in audited financial statements. In the United States, the SEC has decided to allow non-U.S. companies that are listed in the United States and subject to SEC regulation to use IFRS for preparation of financial statements filed with the SEC. 1-16 The FASB and the IASB have worked together toward convergence since the “Norwalk Agreement” in 2002. At that time, the two Boards entered into this agreement to work together on the development of high-quality, compatible accounting standards that could be used for both “domestic” and “cross-border” financial reporting. The Boards in 2009 and 2010 identified a number of major projects they undertook jointly. The Boards have completed most of these major projects. These joint projects have helped achieve greater convergence in accounting standard for revenue recognition (issued 2014), consolidated financial statements (issued 2011), fair value measurement (issued 2011), and financial statement presentation (amendments to reporting comprehensive income completed in 2011; other joint work discontinued).

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    1-9 1-17 Because of the substantial economic consequences of new standards, key constituents often disagree about the objectives for new standards. Because the Boards hold public hearings and open meetings, various external user groups (e.g., investors and creditors) and other interested parties (e.g., affected corporations and CPA firms) exert pressure to influence the new standards, continue existing standards, or change existing standards in their own best interests. In addition, research results about the likely effects of new standards are sometimes conflicting, and only “best guesses” can be made of the future consequences of current standards. A particular difficulty is that costs of complying with new standards are often significant and measurable, whereas the benefits of new information to decision makers are diffuse and hard to quantify. As a consequence, the FASB and the IASB often make decisions about new accounting standards that sometimes require compromise between conflicting views and interests. 1-18 The balance sheet, or statement of financial position, presents a snapshot of the resources of a firm (assets) and the claims on the company (liabilities and shareholders’ equity) as of a specific date (usually the last day of the fiscal quarter or the fiscal year). The balance sheet reports the following equality: Assets = Liabilities + Shareholders’ Equity Most stakeholders in a company, particularly investors and creditors, will be interested in balance sheet information because it reports the financial position (resources and obligations) of the company. 1-19 The income statement measures and reports the financial results of a firm’s performance for a period of time, usually a quarter or a year. The income statement provides information about the profits (or losses) the firm has generated during the period by conducting operating, investing, and financing activities. Most stakeholders in a company, particularly equity investors, will be interested in income statement information because it reports the profits and losses that accrue to the common equity shareholders of the company. The chapter shows empirical research evidence on how changes in earnings are associated with changes in stock prices. 1-20 The statement of cash flows reports for a period of time the net cash flows (inflows minus outflows) from the three principal categories of business activities: operating, investing, and financing. The purpose of the statement of cash flows is important but simple: to provide useful information about how a firm is generating and using cash. The statement of cash flows provides information to complement the income statement, demonstrating how cash flows differ from accrual-based income. Cash flow information is very helpful to financial statement users who want to gauge how the firm is executing its strategy. The statement is particularly useful to creditors and other stakeholders with claims on future cash flows of a firm. The statement of cash flows helps them evaluate the firm’s cash-generating ability, giving them information about the likelihood of future cash flows for future payments of their obligations.

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    1-10 1-21 The statement of shareholders’ equity (sometimes called the statement of changes in shareholders’ equity ) provides information about the common shareholders’ equity claims on the company, and how those claims changed during the period. The year- end amounts reported in this statement for the various common shareholders’ equity accounts will match the amounts reported in the shareholders’ equity section of the balance sheet. Equity investors will be particularly interested in the information in this statement. 1-22 A firm’s accounting system records the results of transactions, events, and commercial arrangements and generates the financial statements, but the financial statements do not stand alone. To provide more relevant and representationally faithful information for financial statement users, firms typically provide a substantial amount of important additional information with the financial statements, including the Notes, Management Discussion and Analysis, and Managers’ and Independent Auditors’ Attestations. The notes to the statements explain the methods, assumptions, and estimates the firm has used in measuring and reporting the accounting information in the financial statements. 1-23 To illustrate the striking links between accounting earnings and stock returns, the chapter provides a brief discussion of the results from empirical research by D. Craig Nichols and James Wahlen. They studied the average cumulative market-adjusted stock returns generated by firms during the 12 months leading up to and including the month in which each firm announced annual earnings numbers. For a sample of 31,923 firm-years between 1988 and 2001, they found that the average firm that announced an increase in earnings (over the prior year’s earnings) experienced stock returns that beat market average returns by roughly 19.2 percent. On the other hand, the average firm that announced a decrease in earnings experienced stock returns that were roughly 16.4 percent lower than the market average. Their results suggest that merely the sign of the change in earnings was associated with a 35.6 percent 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 in share prices. 1-24 As accountants, we create valuable financial information that stakeholders use to make informed resource allocation decisions about companies. Accounting information triggers substantial economic consequences for a wide array of different stakeholders in a company. Because accounting information has such important consequences for so many different stakeholders, being an accountant requires the ability to bear this great responsibility while behaving ethically. 1-25 The Code of Professional Conduct is a document published by the AICPA to help guide members in public practice, industry, government, and education in performing their responsibilities in an ethical and professional manner. The six areas covered by the Principles include: (1) responsibilities, (2) public interest, (3) integrity, (4) objectivity and independence, (5) due care, and (6) scope and nature of services.

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    1-11 SOLUTION TO EXERCISE E1-1 1. e 2. c 3. b 4. d 5. f 6. a 7. f ANSWERS TO CASES C1-1 [AICPA Adapted] 1. The term “accounting principles” in the auditor’s report includes not only accounting principles but also concepts, practices, and the methods of applying them. The auditor's report 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 financial statements relative to U.S. GAAP or IFRS is an essential element for the reliability of financial statements. 2. Generally accepted accounting principles are those principles that have substantial authoritative support. The SEC has deemed the FASB’s Accounting Standards Codification as GAAP for U.S. companies. In addition, the SEC has deemed IFRS as generally accepted accounting principles for non-U.S. companies that are listed in the United States. The FASB and the IASB follow extensive, due processes to deliberate and develop new accounting standards that, if adopted, become “generally accepted.” C1-2 [CMA Adapted] Financial accounting standards inspire or encourage political action and social involvement during the standard-setting process because the effects and economic consequences of accounting standards are wide-ranging and impact many varying groups. The setting of accounting standards is a social decision and the user groups play a significant role and have considerable influence. The economic consequences of financial accounting standards inspire companies, stakeholders, and special interest groups to become vocal and critical when standards are being formulated. The reporting of financial information impacts companies’ financial statements and the wealth and decision-making of stakeholders in differing ways. Companies and stakeholders may want particular economic events accounted for in particular ways and are willing to fight for what they want. The formulation of accounting standards has political roots in the Securities and Exchange Acts of 1933 and 1934. Although the SEC was vested with complete authority to define and formulate accounting 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 of standard setting. Financial accounting standards issued are considered to be “generally accepted accounting principles” and, as such, they must be followed in the preparation of financial statements. Therefore, the formulation of standards is of vital interest to companies responsible for preparing the financial statements, stakeholders that use the statements, and auditors.

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    1-12 C1-3 The Financial Accounting Foundation is the parent organization of the FASB. It is governed by a 14- to 18-member Board of Trustees appointed from the memberships of eight organizations (the AICPA, 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 primary responsibilities of the Financial Accounting Foundation are to provide general oversight to its operations 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 the FASB about major policy issues, the priority of topics, the selection of task forces, the suitability of tentative decisions, and other matters. There are seven members of the FASB. Appointees to the FASB are full-time, fully paid members with 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 a research and technical staff that performs numerous functions such as researching issues, communicating with constituents, and drafting preliminary findings. The administrative staff assists 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 of steps may vary. Initially, a topic or project is identified and placed on the FASB’s agenda. This topic may be the result of suggestions from the FASAC, the accounting profession, industry, or other interested parties. On major issues, a Task Force may be appointed to advise and consult with the FASB’s Research and Technical Staff on such matters as the scope of the project and the nature and extent of additional research. The Staff then conducts any research specifically related to the project. A Preliminary Views document or Invitation to Comment, which outlines the research related to the issues, is then usually published and a public comment period is set. During this period, public hearings, similar to those conducted by Congress, may be held. The intent is to receive information from and views of interested individuals and organizations on the issues. Many parties submit written comments (“position papers”) or make oral presentations. These parties include representatives of CPA firms and interested corporations, security analysts, members of professional accounting associations, and academicians, to name a few. After deliberating on the views expressed and information collected, the FASB issues an Exposure Draft of the proposed Accounting Standards Update. Interested parties generally have 30–90 days to provide 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 to evaluate implementation issues. A modified draft is prepared, if necessary, and brought to the FASB for a final vote. After a super-majority vote (at least five of seven votes in favor) is attained, the FASB Accounting Standards Update is issued.

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    1-13 C1-4 The first five principles of the AICPA’s Code of Professional Conduct are as follows: 1. Responsibilities: In carrying out their responsibilities as professionals, members should exercise sensitive professional and moral judgments in all their activities. For example, when a member chooses a depreciation method, she must carefully analyze each alternative 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, honor the public trust, and demonstrate a commitment to professionalism. When a member refuses 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 the public interest principle. 3. Integrity: To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity. For example, a member who carefully and conscientiously performs each step of an audit without skipping those steps that are tedious or of less interest is exercising the integrity principle. 4. Objectivity and Independence: A member should be objective and be free from conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services. For example, a member who declines to audit the financial statements of the company for which his father is a marketing vice president is adhering to 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 continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member’s ability. When a member reads current accounting literature and strives to employ current principles and procedures, she is exercising due care. C1-5 On balance, most people would agree that it is a good idea for the FASB to allow written comments 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 its deliberation 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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    1-14 C1-5 (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 issues Disadvantages • 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 implement C1-6 Currently, 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 called IFRS (international financial reporting standards) established by the International Accounting Standards Board (IASB) or by their national accounting standards boards. These differences in accounting standards have led to differences among U.S. and foreign corporations’ financial statements. These differences, in turn, have made it difficult for investors and creditors to make valid 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 toward convergence since the “Norwalk Agreement” in 2002. At that time, the two Boards entered into this agreement to work together on the development of high-quality, compatible accounting standards that could be used for both “domestic” and “cross-border” financial reporting. To achieve this compatibility, the Boards agreed to work together to achieve “short-term” convergence on a number of individual differences between U.S. and international accounting standards. They also agreed to coordinate their future agendas on substantial long-term projects which both Boards would address concurrently. Finally, they agreed to continue working on joint projects they were currently undertaking. This overall collaboration is sometimes referred to as the convergence or harmonization of accounting standards. The Boards in 2009 and 2010 identified a number of major joint projects to undertake jointly, as well as short-term projects (in which convergence can occur fairly quickly). The Boards have completed most of their joint efforts to complete these major projects. The major projects the Boards 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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    1-15 C1-6 (continued) Moving forward, the FASB will continue to work on global accounting issues with the IASB through its membership in the Accounting Standards Advisory Forum (ASAF), a newly established advisory body comprising twelve standard setters from across the globe. Both Boards also provide 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 foreign companies 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 accounting standards other than U.S. GAAP had to file a form which “reconciled” certain amounts reported in 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 no longer have to file a reconciliation. In July 2012, the SEC staff issued its final report considering incorporating IFRS into the financial reporting system for U.S. companies. The report was the final phase of a work plan, initiated in February 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 system incorporating IFRS. The 2012 report summarized the staff’s findings regarding key issues surrounding the potential incorporation of IFRS into U.S. financial reporting, but did not make any recommendation to the Commission. “Additional analysis and consideration of this threshold policy question is necessary before any decision by the Commission concerning the incorporation of IFRS into the financial reporting 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 potential incorporation of IFRS into the U.S. financial reporting system. These issues include the diversity in how IFRS are interpreted, applied, and enforced in various jurisdictions around the world; the potential cost to U.S. issuers of adopting or incorporating IFRS; investor education; and governance. The movement by more foreign companies to using IFRS has created two potential problems for U.S. companies using U.S. GAAP (“regulated companies”) and that operate globally. First, their financial statements are likely to be different from those of the foreign companies with which they 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 prepare their subsidiaries’ financial statements according to IFRS for local filings. Since they still have to prepare their financial statements using U.S. GAAP to file with the SEC, this creates potential costly inefficiencies. As a result, the SEC has begun a study of whether it should require or allow U.S. companies to use IFRS in their financial statements filed with the SEC. There are many issues related 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 operate globally so they would not see any advantage to using IFRS. If IFRS were required, it would likely be very costly for them to switch from U.S. GAAP to IFRS, thereby affecting their profitability during the conversion period.

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