WTD FILE
ACCOUNTING THEORY:
A Conceptual and Institutional Approach

QUESTION 01.09

A great deal of interest is generated each week during the college football and college basketball seasons by the ratings of the teams by the Associated Press and United Press International.  Sports writers or coaches are polled on what they believe are the top 25 teams in the country.  Weightings are assigned (25 points for each first place vote, 24 for each second place vote,...one for each 25th place vote) and the results are tabulated.  The results appear as a weekly listing of the top 25 teams in the nation.  Do you think that these polls illustrate the process of measurement?  Discuss.

ANSWER 01.09
Chapter 01

An argument can be made that a number is assigned to a team on the basis of a property that might be called the "goodness" or "strength" of a team.  However, these measurements do not have a great deal of precision.  How good a team is relative to other teams is a property or quality that is extremely intangible compared to other measurements such as median weight of interior linemen, average speed of running backs per 100  meters, etc.  Unquestionably, the measurements are indirect.  The qualifications of the measurers are also opened to question.  Do sportswriter really "know" football?  Constraints are also present because the voters may have seen very few teams and they may also have regional biases.  The numbering scale used is basically ordinal because 1 is considered to be better than 2, which is better than 3.  However, the "goodness" of the interval between rankings is not uniform.  For example, a voter may feel it is a virtual "toss-up" between 1 and 2, both of which he considers to be vastly superior to 3.  As a result, the aggregating process is open to serious question.  It is also not clear whether the pollsters are making assessment or prediction measures.  The measures would be prediction measures if the voter presumes that 1 would beat 2 if they played the following week.  We suspect, however, than an assessment measure is being made.  The property being assessed is the team's record to date.  Hence, a team with a  6-0-0 record is usually ranked higher than a team with a 5-0-1 record.

QUESTION 01.11

Some individuals believe that valuation methods proposed by a standard-setting body such as FASB should be based on those measurement procedures having the highest degree of objectivity as defined by Equation (1.1).  Thus, some assets might be valued on the basis of replacement cost and others on net realizable value.  Do you see any problems with this proposal?  Discuss.

ANSWER 01.11
Chapter 01

The problem here is basically the opposite of that presented in question 10.  In this case, part of the measurement problem might be solved, but at the cost of sacrificing the theoretical base.  Hence, the cart is put before the horse, conceptually speaking.  However, there are other measurement problems presented by this proposal.  It is questionable whether replacement cost dollars and net realizable value dollars can be meaningfully added together, even if computed for the same point in time (this is the problem of additivity).  Moreover, if firms were given latitude to employ valuation methods for their various balance sheet items that were more objective in their own particular cases, there could well be a major problem of lack of comparability in the resulting financial statements between and among firms.

QUESTION 01.12

What type of measurement scale (nominal, ordinal, interval, or ratio) is being used in the following situations?

• Musical scales
  

• Insurance risk classes for automobile insurance
  

• Numbering of pages in a book
  

• A grocery scale
  

• A grocery scale deliberately set 10 pounds too high
  

• Assignment of students to advisers, based on major

ANSWER 01.12
Chapter 01

1. Interval -- There is no natural zero tonal point.
   

2. Ordinal -- Class 1 is "better" than Class 2 to the extent that people have had fewer accidents.  However, within classes people do not have uniform accident records, and the "accident interval" between classes is not totally uniform.
   

3. Interval (possibly nominal).
   

4. Ratio.
   

5. Interval -- In effect, the "zero" point is set at 10 pounds, but interval differences remain constant.
   

6. Nominal.

QUESTION 02.15

What is the relationship among scientific method, accounting research, and accounting policy making?

ANSWER 02.15
Chapter 02

Accounting research is an important input into the accounting policy-making process.  Most research today uses formal methods of deriving generalizations (deductive or inductive approaches).  Scientific method is, thus, a formalized means for carrying out research.

QUESTION 02.16

What are the two principal underlying assumptions of agency theory (positive accounting research)?  Criticize their role in constructing a theory of accounting.

ANSWER 02.16
Chapter 02

The two principal assumptions are that individuals act in their own best interest and that the firm is the locus or nexus of many competing types of contractual relationships.  The former is virtually true by definition while the latter (which is , of course, dependent upon the former) is an interesting assumption that is the cornerstone of the agency theory literature in accounting.  There can be other views of the enterprise, such as Chambers' coalition view.  This points out, once again, that positive research simply cannot shake off its normative underpinnings.

QUESTION 02.17

The "uncertainty principle" of the famous physicist, Werner Heisenberg, states that physical phenomena cannot be precisely measured because the very act of measuring affects the phenomenon being measured.  Which of the directions of accounting research discussed in the chapter does Heisenberg's uncertainty principle relate to most closely?

ANSWER 02.17
Chapter 02

The "uncertainty principle" clearly relates most closely to critical accounting.  Critical accounting believes that by investigating a topic we literally help to shape the reality that we are investigating.  The other research approaches see a "reality" out there that investigators do not directly affect.

QUESTION 03.13

Can any overall trend be detected in FASB pronouncements?  Explain and cite examples to substantiate your opinion.

ANSWER 03.13
Chapter 03

Yes, a trend in FASB pronouncements can be detected.  In general, there appears to be a movement toward cleaning up the balance sheet of questionable items and forcing their immediate recognition on the income statement.  Accounting for research and development costs (SFAS No. 2) and development stage enterprises (SFAS No. 7) are examples of this trend.

QUESTION 03.14

In terms of financial reporting in the future, do you expect greater refinement of measurements appearing in the body of the financial statements or increasing disclosure with less effort directed toward refinement of measurements?

ANSWER 03.14
Chapter 03

In the foreseeable future, if the recent past is any indication, accounting standards probably will be directed more toward increasing disclosure with less effort on refinement of measurement.  This is not necessarily acceptance by the FASB of the efficient-markets hypothesis, but rather the practicality of establishing accounting standards.  It is easier to obtain a consensus on disclosure than on changing the measurement of items that appear on financial statements.  Of course, stock options is an important counter-example, although disclosure is the final result!

QUESTION 03.15

What challenges have there been to the FASB's jurisdiction and independence?

ANSWER 03.15
Chapter 03

The challenges recently have been quite numerous.  Several congressional sub-committees have investigated the FASB on an "on again, off again" basis over the last 15 years.  There was recently a brouhaha with the GASB involving enterprises such as hospitals and universities, some of which are in the public sector and others of which are in the private sector.

Coming from within the AICPA is the AcSEC.  While it performs a liaison function between the AICPA and the FASB, it also prepares SOPs in Industry Accounting Guides, which deal with fairly narrow issues related to specific industries.  Many of these have eventually become SFASs (61, 63, and 65).

The EITF, created in 1984, has been concerned with extremely technical issues that could, however, have a very broad impact, such as financial instruments.  These have now reached the disclosure stage in SFAS No. 105.  While this group does not have any formal authority, it is a powerful group--its members are the senior technical partners of the major public accounting firms and the chief accountant of the SEC--and it could well be formulating accounting standards on a de facto basis.

Another threat has come from the FEI and the Accounting Principles Task Force of the very powerful Business Roundtable.  John Reed, Chairman of Citibank has been seen as the individual behind some of these maneuvers to gain more business representation on FAF and from there on the FASB itself.  Much of the business disgruntlement appears to be with the high cost of implementing accounting standards (SFAS Nos. 33, 96, and 106).

QUESTION 03.16

In late 1990, the "Wyden Amendment" was stricken from the Crime Bill passed by Congress.  The amendment would have required reporting by auditors on internal controls.  Letters sent by FEI members opposing the amendment were instrumental in its defeat.  The AICPA supported the amendment.  From an agency theory perspective, why do you think that the AICPA supported the amendment and the FEI was against it?  Explain.

ANSWER 03.16
Chapter 03

The AICPA supported it because its members would have generated more auditing fees from reporting on internal controls.  The FEI was against it because the firms, represented by its members, would be paying the increased fees to the public accounting firms.

QUESTION 04.03

Why is it difficult to evaluate the regulation question?

ANSWER 04.03
Chapter 04

The free-market position cannot be easily researched (empirically) because the market is regulated.  Benefits and costs of regulation are extremely difficult to identify and measure.  As a result, the arguments, both for and against regulation, have been largely deductive in nature.

QUESTION 04.04

Why does accounting information have some features of a public good?  What are the implications for information production in both unregulated and regulated markets?

ANSWER 04.04
Chapter 04

A public good is one that is characterized by non-rival consumption; that is, it can be consumed without reducing the opportunity for consumption by others.  In one sense, an accounting report can be read without reducing the information available to subsequent readers.  However, the usefulness of the information is highly related to time.  Reading a 1980 report in 1984 may convey the same message in both years, but the opportunity to use the information passes quickly (if the efficient-markets hypothesis is correct).  Finally, public goods are under-produced in free markets due to externalities and overproduced in regulated markets due to the free-rider problem. This is a paradox of regulation.

QUESTION 04.05

Why can't optimal regulation be determined?  If optimal accounting regulation cannot be determined, how can a regulatory body such as the SEC or FASB make good decisions?

ANSWER 04.05
Chapter 04

Arrow argues (in the Impossibility Theorem) that optimal regulation (resource allocation decisions) cannot be determined because individual preferences are not additive across individuals.  Therefore, one cannot determine if regulation is economically desirable.  So, the decision to regulate is achieved through imperfect revelation in the form of voting.  Given a democratic mandate for regulation, a regulatory agency should at least try to achieve a net social benefit.  Even here, determining costs and benefits is difficult due to measurement obstacles.

QUESTION 04.08

Can accounting standards and policy making be neutral?  In what sense is neutrality really important?

ANSWER 04.08
Chapter 04

Neutrality is not possible in the sense that someone benefits from regulation, and someone pays the costs.  Regulation creates wealth transfers.  However, neutrality is at least conceptually possible in the sense of providing information that is useful for investors and creators within a benefits exceeding costs (of production) framework.  The FASB has an extremely difficult balancing act to maintain.

CASES, PROBLEMS, AND WRITING ASSIGNMENTS 04.03

Discuss the economic consequences issues that are present in each of the following transaction situations.

1. SFAS No. 13 allows lease contracts to be set up so that the transaction can usually be set up as an operating lease rather than a capital lease.
   
   
   
   
   
   
   
   
   
   
   a. Answer
   This allows for a "better" measurement of debt-equity ratios from the perspective of shareholders--less of a problem of violating debt covenants--hence making it easier to pay dividends.  Shareholders thus benefit from the ability to more easily receive dividends, which can work to the detriment of the firm's bondholders.
   
   

2. When SFAS No. 19 was passed, medium-sized petroleum exploration firms campaigned hard to set it aside.  SFAS No. 19 would have allowed successful efforts only, whereas the lobbying firms wanted an unrestricted choice between full costing and successful efforts.
   
   
   
   
   
   
   
   
   b. Answer
   SFAS No. 19 would have lowered the income of firms using full costing.  These were generally medium-sized firms.  The claim was that the lower income under successful efforts would raise the cost of borrowing to firms that were using full costing.  Of course, efficient-market advocates would say that the market should be able to see behind the income difference between the two methods, but the lower debt-equity ratio that would result under successful efforts could indeed more easily threaten violation of debt covenants.  This could affect potential dividend payments and could, therefore, raise the cost of capital (see Chapter 8).  Of course, this latter effect could also lower the cost of debt capital, since it would be better protected, but that also depends upon players in the market understanding this issue.
   
   Use one method--successful efforts--rather than two methods might also benefit users of financial statements, who would not have the problem of reconciling incomes for different firms using different methods.  Use of one method would also improve verifiability.
   

3. A securities industry group objected to part of APB Opinion No. 10, which would have required that all convertible debt be broken down into debt and equity portions at the time of issue.  The debt portion (bonds payable plus premium or minus discount) would be booked at the effective rate without the conversion privilege with the equity portion credited to paid-in capital.  The industry group was pleased by APB Opinion No. 14, which did not break out the equity portion of convertible debt except if detachable stock warrants were issued.  Why was the securities industry group (which represented investment bankers who floated large loans for industry) unhappy with Opinion No. 10 and pleased with Opinion No. 14?
   
   
   
   
   
   
   
   
   
   c. Answer
   Zeff (1978) discusses this situation.  It appears that the crux of the problem under the break-out of debt and equity is that by assigning some of the credit to equity, the resulting lower carrying value of debt would raise the effective rate of interest (as opposed to no break-out of equity) and also lower the level of income by either reducing the premium or increasing the discount (as opposed to no break-out of equity).  The securities industry group may therefore have thought that convertible debt raised through their auspices had a higher cost than, in their opinion, it really had.
   
   Assume that a ten-year $1,000,000 convertible debt issue is sold at par.  Coupon rate is 10%, and $100,000 is assigned to equity (which would now create a $100,000 discount).  Straight-line amortization is used.  Entries for the first year would be:
   
   

   Cash	1,000,000
   Discount on bonds	100,000
   Bonds payable   Paid-in capital		1,000,000    100,000
   Interest expense	110,000
   Cash   Discount on bonds		100,000       10,000

   No break-out of equity would leave the interest expense at $100,000.
   
   
   
   

4. SFAS No. 87 does not show the full pension obligation or liability in the balance sheet (although a "minimum" liability may be present).
   
   
   
   
   
   
   
   
   
   d. Answer
   SFAS No. 87 results, in most cases, in keeping debt off of the balance sheet which benefits debt-equity ratios which are often used as debt covenants in bond indentures.  Hence it favors stockholders over bondholders.
   
   

5. SFAS No. 96 made it much more difficult to recognize deferred tax assets as opposed to deferred tax liability (a more even-handed treatment was used in recognizing deferred tax assets and liabilities in SFAS No. 109, which superceded SFAS No. 96).
   
   
   
   
   
   
   
   
   e. Answer
   SFAS No. 96 would have had a detrimental effect on debt-equity ratios and would likewise have resulted in lower income when deferred tax assets were not recognized.  Hence it would have been beneficial for bondholders over stockholders.  The lower income which would have resulted in some cases (where deferred tax assets would not have been recognized) might have resulted in lower security prices.
   

QUESTION 05.06

Why do you think the equity theories are less important today than they were, say, 30 years ago?

ANSWER 05.06
Chapter 05

Empirically testable hypotheses are much richer in terms of providing insights than the deductively derived equity theories.  The equity theories provide interesting outlooks, but they are simply too narrow in scope to provide extensive insights into complicated problems.

QUESTION 05.08

How does agency theory (Chapters 2 and 4) differ from the equity theories discussed in this chapter?

ANSWER 05.08
Chapter 05

 Agency theory is much richer in scope than the equity theories.  Agency theory is concerned not only with owners but also with managers and other parties such as lenders.  The firm itself is simply the connecting link among these parties.  Agency theory is rich enough to allow empirical testing of the hypotheses, whereas the equity theories do not appear to allow such testing.  One reason is that the firm itself is, behaviorally speaking, a purely passive entity.  Hence, the equity theories appear to be deductive statements that cannot be further extended or tested.

Cases, Problems, and Writing Assignments 05.01

Assume the following for the year 2000 for the Staubus company:

1. Determine the income under each of the following equity theories:
   
   Proprietary theory
   Entity theory (orthodox view)
   Entity theory (unorthodox view)
   Residual equity
   

2. Would any of your answers change if the preferred stock is convertible at any time at the ratio of 2 preferred shares for 1 share of common stock?

ANSWER Cases, Problems, and Writing Assignments 05.01
Chapter 05

1. Proprietary theory Entity theory (orthodox view) Entity theory (unorthodox view) Residual equity

   $220,000   300,000     90,000   190,000

    

2. Convertibility represents a potentially dilutive effect upon the common shareholders.  As long as the preferred shareholders have prior claims on dividends and in liquidation over the common shareholders, we do not believe they should be classified as a residual equity, despite the convertibility clause.  Therefore, we would still agree with the residual equity answer as given (but see question 20 above).  We would not give an income answer that would be a cognate to fully diluted earnings-per-share.  The other answers are totally unaffected by the convertibility issue.

QUESTION 07.02

What is the relationship between the economic consequences of accounting standards discussed in Chapter 4 and the quality of neutrality presented in SFAC No. 2?

ANSWER 07.02
Chapter 07

Accounting information must have distributional effects: it favors some parties at the expense of others.  That is the nature of economic consequences.  Neutrality refers to a "let the chips fall where they may" attitude insofar as accounting standards are concerned.  Nevertheless, this is supposed to be carried out in a context where the prime objective of financial statements is to provide useful information to external users such as investors and creditors.

QUESTION 07.08

Is neutrality inconsistent with the external user primary orientation of SFAC No. 1 and the pervasive constraint (benefits > costs) of SFAC No. 2?

ANSWER 07.08
Chapter 07

Rather than being inconsistent, the problem lies more in the nature of maintaining a delicate balancing act.  User primacy and the benefits > cost constraint both involve economic consequences as well as providing information that is useful for decision making.  Neutrality means attempting to provide the most meaningful information for external users given the pervasive constraint.  Theoretically speaking, additional aspects of economic consequences should be ignored (in reality, of course, they are not).

A simple example may help to demonstrate this point.  Assume the FASB has decided that a current value system is beneficial for external users and that benefits > costs.  Two choices are being examined: replacement cost and exit value (see Chapters 1 and 13).  Security prices of some firms might benefit from replacement cost and others from exit values.  For example, firms having highly specialized and immobile equipment would be subject to serious declines in market values if exit prices are chosen rather than replacement costs.  In turn, securities prices of these firms could be adversely affected, so these firms would favor replacement costs.  Firms not having this problem would appear relatively better under exit values.  The FASB's main task is with the comparative usefulness to external users and the cost of preparation, and not the distributive effects discussed above.

Cases, Problems, and Writing Assignments 07.02

Analyze three accounting standards promulgated by the FASB and show how economic consequences (rather than representational faithfulness) influenced the shaping of the standard (your professor may suggest particular standards for this case).

ANSWER Cases, Problems, and Writing Assignments 07.02
Chapter 07

SFAS No. 15, on troubled debt restructuring (now superseded by SFAS No. 114), is a classic example of economic consequences prevailing over representational faithfulness.  In cases of restructuring, no loss is recognized as long as the undiscounted amount of the restructured debt exceeds the present value of the existing debt.  The use of the undiscounted amount, particularly when being compared to a discounted amount, is virtually unprecedented in accounting (deferred tax assets and liabilities are also undiscounted, but the context is entirely different).  The restructuring can thus be easily set up without the need to recognize a loss, which clearly appears to have happened.

SFAS No. 13, on leases, while an improvement over APB Opinion Nos. 5 and 7, allows leases to be structured in a fashion in which bringing the debt on the balance sheet can be avoided.  Obviously, title should not pass to the lessee, nor should bargain purchase options be present.  That leaves the 75 percent test and the 90 percent test.  The 75 percent test is the easier to get around.  If an asset has a 20-year life, it should be leased for no more than 14 years, or estimated life should be "refigured" to come out a bit higher.  In the case of the 90 percent rule, having an outside party guarantee the residual value gives the lessor and lessee the means to design the lease so that the present value of minimum lease payments, excluding the guaranteed residual, will be less than 90 percent of the fair market value of the property being leased.

In SFAS No. 87, the projected benefit obligation approach is used for the purpose of determining service cost (and pension expense).  However, for the purpose of determining the minimum liability, the board somewhat inexplicably reverts to the accumulated benefit obligation which, of course, would result in a lower minimum liability.

Daley and Tranter (1990) have an excellent discussion of the economic consequences issue.  They also illustrate economic consequence aspects of SFAS No. 12 on marketable securities.  The single best example of the economic consequences issues arises in APB Opinion Nos. 2 and 4 on the investment tax credit (also discussed by Daley and Tranter).

QUESTION 08.03

What is the clean surplus theory?

ANSWER 08.03
Chapter 08

Clean surplus theory attempts to value equity of a firm by adding to the beginning of period book value of equity the discounted abnormal earnings of future periods.  Abnormal earnings are earnings in excess (either positive or negative) of normal earnings.

QUESTION 08.04

What is the role of dividends in the clean surplus theory?

ANSWER 08.04
Chapter 08

The role of dividends is finessed by working with beginning balance of owners' equity (which includes the effect of all dividends to date).  Thus, there is no need to predict future dividends.

QUESTION 08.06

Why does the concept of market efficiency (with respect to information) have no necessary relation to the quality of accounting information?  Why is this distinction important with respect to accounting policy making?

ANSWER 08.06
Chapter 08

Market efficiency (a regrettable choice of terms) refers only to the speed with which new information is incorporated into security prices.  It says nothing about the quality of the underlying information.  Although, in the extreme case, if the "information" were purely noise, one would not expect to see any evidence of information content, assuming that investors are sophisticated.

QUESTION 08.14

Why is it argued that capital market research cannot determine the optimality of accounting policies even for the limited investor-creditor group?

ANSWER 08.14
Chapter 08

This question was first addressed in Chapter 4.  Because of externalities associated with financial reporting (free-riders), a market mechanism does not operate to determine the optimal production of information.

QUESTION 08.19

Are the Lev paper, which talks about the low correlation between earnings and stock returns, and the Ou Penman paper, which sees the possibility of making abnormal returns based upon published financial data, in conflict with each other or complementary to each other?

ANSWER 08.19
Chapter 08

The papers, in fact, complement each other.  Since Ou and Penman see a predictive role for accounting in a market that may not be efficient, then Lev's call for improved accounting measures certainly makes sense.  Furthermore, even if the market were highly efficient, Lev's call for improved accounting standards can be interpreted as being concerned with the quality of the signal picked up by the market, which should result in the market providing a more meaningful equating of risk and return for individual securities.  Wyatt (1983) essentially makes this point.

QUESTION 10.01

What are the characteristics of assets, liabilities, and owners' equity, and how have they evolved over time?

ANSWER 10.01
Chapter 10

Assets have evolved from narrow definitions based on legal property to a broader concept based on economic resources.  Liabilities have evolved in a similar manner.  Owners' equity is usually treated as a residual (the net of assets minus liabilities), subject to legal capital requirements to comply with state laws of incorporation.  This is a proprietary approach.

QUESTION 10.02

Why is it difficult to define the basic accounting elements?

ANSWER 10.02
Chapter 10

In order to unambiguously define elements, the definitions would need to be very narrow, probably based on legal concepts.  This produces a very narrow balance sheet.  Broader definitions, while potentially more relevant, are also ambiguous.  There seems to be a tradeoff between reliability and relevance, even at the basic definitional level.

QUESTION 10.05

What do aggregated balance sheet totals represent?  This data is used for ratio analysis.  How useful to you think ratio analysis is?

ANSWER 10.05
Chapter 10

The answer to this question is really an extension of question 4.  The question of the lack of additivity and relevance is obviously at issue here which can severely impact ratio analysis.

QUESTION 10.09

Why have mutually unperformed executory contracts traditionally been excluded from financial statements?  Can this practice be justified in terms of asset and liability definitions?  How relevant is this approach for professional sports franchises?

ANSWER 10.09
Chapter 10

There is an implied offset of the unrecorded asset and liability.  Another way to explain it is that neither party is obligated because both have unfulfilled (and offsetting) future obligations.  There is a contractual benefit and promise, even though unexecuted.  Recognition has been prohibited on the more practical grounds of uncertainty or measurement problems.  For an operation such as a sports franchise, virtually all economic "assets" and "liabilities" are related to employment contracts (which are mutually unperformed).  In terms of relevance, a case can be made for recognizing these contracts.  Another issue is whether executory items should be used in the determination of current expense numbers as in the case of pensions (see Chapter 16).

QUESTION 10.14

Is the "available-for-sale" category for debt and equity securities used in SFAS No. 115 a homogeneous category?

ANSWER 10.14
Chapter 10

Distinctions between available-for-sale securities and the other two categories are not very airtight.  As noted in the text, transfers between available-for-sale and trading securities should be relatively easy.  Available-for-sale categories are not very clearly defined: they are simply everything not in the other two categories.  Furthermore, selection among categories is based upon management intent, which leaves the door open for manipulation.

QUESTION 10.18

Why is there an implicit recognition of fair value in the 1984 Revised Model Business Corporation Act?

ANSWER 10.18
Chapter 10

The act allows dividends to be paid as long as insolvency is avoided, one of the criteria of which is that fair value of liabilities exceeds fair value of assets.  Hence, as in the case of Holiday Inn, which declared a dividend exceeding owners' equity, implicit recognition of fair values occurs.

Cases, Problems, and Writing Assignments 10.02

Assume that an asset is being examined and it is determined that its cash flows would be $10,000 per year for four years (assume that all cash flows are received at the end of the year).  The carrying value of the asset is $35,000 and its replacement cost is $30,000.  The firm's cost of capital is 10 percent.

Required:

1. What would be the amount, if any, that should be written off because the asset is imapired under SFAS No. 121?
   

2. Why is your answer in part (a) anomalous and how does SFAS No. 121 justify it?
   

3. Would your answer to part (a) be different if the cash flows were $8,000 rather than $10,000?  Explain.
   

4. Is there anything unusual about your answer to part (c) since accounting rules are frequently concerned with conservatism?

ANSWER Cases, Problems, and Writing Assignments 10.02
Chapter 10

1. None, because the undiscounted cash flows exceed the carrying value of the asset.
   

2. The cash flows are undiscounted (reminiscent of troubled debt restructuring in SFAS No. 12) as well as carrying value also exceeding replacement cost (fair value).  The standards takes the view that "cost recoverability" is the issue of real concern to management.  this still flies in the face of the pervasiveness of present valuation.
   

3. Yes.  The undiscounted cash flows total $32,000, which is less than the carrying value of the asset, so write-down occurs.  The write-down will be $5,000 (down to the replacement cost of the asset).
   

4. The answer is anomalous for several reasons.  First, replacement cost may well exceed the discounted value of the cash flows.  Second, cash flows enter into the calculation of whether or not to write the asset down, but they are not part of the write-down measurement itself.

QUESTION 19.05

What is the disappearing asset problem?

ANSWER 19.05
Chapter 19

The disappearing asset problem occurs whenever the current exchange rate is used for translation purposes and the functional currency is experiencing rapid inflation much in excess of that experienced in the reporting currency.  The result is that the exchange rate deteriorates to such a point that the historical cost of fixed assets (as measured by the functional currency) is so small that it becomes misleading when translated into the reporting currency.  SFAS No. 52 states that in highly inflationary economies, defined as those with a cumulative inflation rate of approximately 100 percent over three years, the U.S. dollar should be used as if it were the functional currency.  Translations, therefore, are similar to the SFAS No. 8 approach, and fixed assets are translated at the historical rate.

QUESTION 19.10

What factors make it difficult to bring about a high degree of harmonization among accounting standards?

ANSWER 19.10
Chapter 19

One factor standing in the way of harmonization is nationalism.  Despite lip service paid to harmonization, it would not be easy to get national standard-setting organizations to give up power.  Another difficult factor is cultural differences.  As noted in the text, legal form takes precedence over economic substance in some nations.  As a result, capitalizing leases may be illegal in some nations.

QUESTION 19.16

What are the main distinctions between the Anglo-American and the continental models?

ANSWER 19.16
Chapter 19

Anglo-American countries are more user-oriented and less oriented toward the primary purposes of protecting creditors and determining income tax liability.  Anglo-American countries have stronger accounting professions than do the continental countries.  They are also more likely to have standard-setting agencies and conceptual frameworks, though these are much more recent developments.

QUESTION 19.17

How does the role of government differ in the United Kingdom and the United States relative to financial reporting?

ANSWER 19.17
Chapter 19

Standard setting in the United States is accomplished through private sector bodies such as the FASB, which are regulated by governmental bodies such as the SEC.  There is no United Kingdom equivalent of the SEC.  The main standard-setting thrust in the United Kingdom has come through the company laws in the past.  In addition, there have been some government-sponsored committees that have made recommendations in the United Kingdom in areas such as inflation accounting, but these committee's have included members from the profession.  The United Kingdom has been moving closer to the American model of standard-setting since 1970.