Technical Review - Solutions Manual to accompany Intermediate Acco...

© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.Solutions Manual to accompany Intermediate Accounting, Volume 1, 6 th edition 2-1

Chapter 2: Accounting Judgements

Case 2-1 AeroTravel Inc.2-2 Dubois Limited 2-3 BLX Shipping Limited

Suggested Time Technical Review TR2-1 Underlying Assumptions 10 TR2-2 Qualitative Characteristics ............................... 15 TR2-3 Concepts Identification .................................... 15 TR2-4 Capital Maintenance ........................................ 15 TR2-5 Capital Maintenance ........................................ 20

Assignment A2-1 Relevance versus Reliability ............................ 15 A2-2 Relevance and Reliability ................................ 15 A2-3 Questions on Principles.................................... 15 A2-4 Questions on Principles.................................... 15 A2-5 Applications of Principles (*W) ...................... 10 A2-6 Realization versus Recognition ........................ 15 A2-7 Recognition of Elements .................................. 10 A2-8 Elements of Financial Statements .................... 10 A2-9 Questions on Principles (*W) .......................... 10 A2-10 Identification of Accounting Principles (*W) ... 10 A2-11 Revenue Recognition ....................................... 15 A2-12 Recognition and Elements ............................... 15 A2-13 Application of Principles ................................. 15 A2-14 Application of Principles ................................. 15 A2-15 Implementation of Principles ........................... 30 A2-16 Implementation of Principles (*W) .................. 30 A2-17 Implementation of Principles ........................... 30 A2-18 Recognition Criteria ......................................... 25 A2-19 Implementation of Principles (*W) ................. 30

*W The solution to this assignment is on the text website, Connect.This solution is marked WEB.

Intermediate Accounting Canadian Canadian 6th Edition Beechy Solutions Manual Visit TestBankDeal.com to get complete for all chapters

© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.2-2 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6 th edition Questions

1. Accounting principles include:

• Underlying assumptions—basic underlying assumptions that make accounting

possible.

• Qualitative characteristics—standards to judge policy choices in conjunction with

reporting objectives.

• Measurement methods—ways to measure results and financial position.

2. Underlying assumptions include:

• Time-period—financial information can be reported over a series of time spans

shorter than the total life of the enterprise.

• Separate-entity—financial reports relate to the activities of the business enterprise

separate from its owners.

• Continuity—the business entity will continue in operations for the foreseeable

future (going concern assumption).

• Proprietary approach—results are reported from the perspective of the owners,

who hold residual return and risk.

• Unit-of-measure—results can be meaningfully expressed in monetary terms.
• Nominal dollar financial capital maintenance—profits are earned after historical

cost is recovered; neither general inflation nor specific changing prices are considered.

• The time-period assumption requires accruals and deferrals in accounting because

cash transactions are not always completed in the accounting period to which the underlying transaction relates. Accruals and deferrals move income recognition to the year to which they relate. Accruals record revenues and expenses for which there have as yet been no cash transactions; deferrals delay recognition of revenues and expenses.

• The continuity assumption justifies the use of historical cost to record assets because

the cost will be recovered over the assets’ economic life in operations. If this assumption is not valid, assets should be valued at net recoverable amounts.

• Owners are viewed as the residual risk-takers in the proprietary view; they receive

the residual profit or loss after all other claims are met. Under the entity view, the shareholders are only one of several stakeholders in the financial success of an entity.

© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.Solutions Manual to accompany Intermediate Accounting, Volume 1, 6 th edition 2-3

• Inflation is a major factor when dealing with the nominal dollar financial capital

maintenance assumption. This presumes that income has been earned when the financial capital invested in an item, not adjusted for inflation, has been recouped.The stable dollar assumption is made.For example, if an item bought for $10 is sold for $14.50, $4.50 of income is earned. But if the invested capital of $10, has been eroded by inflation, then income is overstated. If inflation had been 10% during the holding period, the entity should retain $11 ($10 × 1.10) and only consider $3.50 ($14.50 – $11.00) income. This would be an application of constant dollar financial capital maintenance.

• Financial capital maintenance is the concept that residual (and distributable) income

remains only after preserving financial capital; the closing amount of net assets must exceed the amount at the start before net income is present. In contrast, physical capital maintenance is the concept that residual income results only after preserving physical capital or productive capacity.The difference between the two concepts relates to the amount of income earned through a given transaction. For example, if an item bought for $10 is sold for $14.50, $4.50 of income is earned under financial capital (measured in nominal dollars). But if it would cost $12 to replace the item, then income is only $14.50 – $12 = $2.50. The entity must retain $12.00 in order to replace its physical (or productive) capacity.

8. Three measures of income:

• Nominal dollar financial capital maintenance: $1,500 – $1,000 = $500. Income is

earned as long as the original investment, $1,000, is retained.

• Constant dollar financial capital maintenance: $1,500 – ($1,000 × 1.04) = $460.

Income is earned as long as the inflation-adjusted original investment, $1,040, is retained.

• Physical capital maintenance: $1,500 – $1,120 = $380. Income is earned as long

as the amount need for (physical capital) inventory replacement value is retained.

9. The two fundamental characteristics of accounting information are:

• Relevance—accounting measurements must be useful to the needs of financial

statement users for making decisions.

• Representational faithfulness—accounting measurements must be reasonably

accurate measures of what they purport to measure, without bias.

• To be relevant, information must be presented in a timely fashion. However, in many

instances, accuracy (i.e., representational faithfulness) can be improved with the passage of time when the ultimate outcomes of year-end balances (such as accounts receivable, inventory, contingent liabilities, etc.) become known. Such a delay makes the information less relevant, however, because it comes too late for effective decision-making by users.

© 2014 McGraw-Hill Ryerson Ltd. All rights reserved.2-4 Solutions Manual to accompany Intermediate Accounting, Volume 1, 6 th edition

• The statement is not true. Accounting measures complex economic phenomona and

the results cannot be understood unless the financial statement user is reasonably knowledgeable about (1) business and economic activities and (2) accounting concepts and measurement methods. Users who are not sophisticated or knowledgeable about accounting are expected to hire experts to provide interpretation and advice.

• Comparability is the ability to ascertain differences and similarities between two

pieces of information. Consistency eliminates differences between years, as it requires entities to use the same policies from year to year. Uniformity eliminates differences between companies, as it requires different companies to use the same policies for similar transactions, if all circumstances are similar.

• When evaluating cost/benefit effectiveness, costs refer to the costs to prepare the

information, and also the costs of, for example, making information available to the general public, which would include competitors. Benefits are felt by the user groups, in the form of ‘better’ decisions. The entity participates in these decisions only indirectly, through a ‘more accurate’ share price or loan cost.

• The definitions of assets and liabilities embody three components and three time

frames:

• Economic benefits must be received or given up in the future.
• The rights (obligations) to (for) economic benefits must be clear in the present.
• The asset or liability must be the result of a past event.

• IFRS makes no distinction between revenue and gains; all are simply part of

enterprise income. Under ASPE, however, revenue is derived from ordinary business activities of the enterprise; gains arise from peripheral or incidental transactions or events.

• Recognition means recording a transaction or event in the books, while realization

means cash flow. Realization always triggers simultaneous recognition because cash transactions require immediate recognition in the accounts.

• An orderly transaction is one in which neither the buyer nor the seller is under undue

pressure to enter the transaction.

• The fair value hierarchy specifies the correct sequence for estimating fair values. If a

direct observation of value is available, that value should be used. If the value of an item cannot be observed directly in the market place, an estimate based on market valuations for comparable items should be used. If that estimate also is not available, only then should an indirect valuation technique be used.