Chapter 3
Balance Sheet
QUESTIONS
3-1.
Assets - Resources of the firm
Liabilities – Debts or obligations of the firm; creditors' interest
Shareholders’ Equity - Owners' interest in the firm
3-2.
a. L
b. L
c. A
3-3.
a. TA
b. CA
3-4.
They are listed in order of liquidity, which is the ease with which they can be
converted to cash.
3-5.
Marketable securities are held as temporary investments or idle cash. They
are short-term, low risk, highly liquid, low yield. Examples are treasury bills
and commercial paper. Investments are long-term, held for control or future
use in operations. They are usually less liquid and expected to earn a
higher return.
3- 6.
Accounts receivable represents the money that the firm expects to collect;
accounts payable represents the debts for goods purchased by a firm.
3-7.
A retailing firm will have merchandise inventory and supplies. A
manufacturing firm will have raw materials, work in process, finished goods,
and supplies.
3-8.
Depreciation represents the allocation of an asset’s cost over the period it is utilized. Tools, machinery, and buildings are depreciated because they
wear out. Land is not depreciated, since its value typically does not decline.
If the land has minerals or natural resources, it may be subject to depletion.
3-9.
Straight-line depreciation is better for reporting, since it results in higher
profits than does accelerated depreciation. Double-declining balance is
preferable for tax purposes, since it allows the highest depreciation and,
thereby, lower taxes in the early years of the life of the asset. Using doubledeclining-balance for taxes increases the firm's cash flow in the short run.
d. A
e. A
f. A
c. IA
d. CA
g. L
h. A
i. A
j. E
k. E
l. A
e. IA
f. CA
m. L
n. L
o. A
g. TA
h. CA
p.
q.
r.
i. TA
j. CA
A
A
A
s.
A
k. IV
l. TA
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3-10.
The rent is treated as a liability because it is unearned. The rental agency
owes the tenant the use of the property until the end of the term of the
agreement. The rent should be recognized as income over the period
covered by the rent.
3-11.
a.
A bond will sell at a discount if its stated rate of interest is less than the
market rate. It sells to yield the market rate. It might also sell low if
there were a great deal of risk involved.
b.
The discount is shown as a reduction of the liability.
Bonds payable
Less: bond discount
$1000
(170)
$830
The bond discount is amortized, with the amortization shown as
interest expense on the income statement.
3-12.
Include noncontrolling interest as a long-term liability for primary analysis.
3-13.
Historical cost causes difficulties in analysis because cost does not measure
the current worth or value of the asset.
3-14.
At the option of the bondholder (creditor), the bond is exchanged for a
specified number of common shares (and the bondholder becomes a
common stockholder). Often convertible bonds are issued when the
common stock price is low, in the opinion of management, and the firm
eventually wants to increase its common equity. By issuing a convertible
bond, the firm may get more for the specified number of common shares.
When the common stock price increases sufficiently, the bondholder will
convert the bond to common stock.
3-15.
a.
b.
c.
d.
e.
3-16.
a.
CA
CA
CL
CL
E
f.
g.
h.
i.
j.
CA
E
NA
CA
E
k.
l.
m.
n.
o.
CL
NL
CL
CA
E
p.
q.
r.
s.
NA
CA
CL
CA
With the cumulative feature, if a corporation fails to declare the usual
dividend on the cumulative preferred stock, the amount of past
dividends becomes dividends in arrears. Common stockholders
cannot be paid any dividends until the preferred dividends in arrears
and the current preferred dividends are paid.
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b.
When preferred stock is participating, preferred stockholders may
receive an extra dividend beyond the stated rate. The terms of the
participation depend on the terms included with the stock certificates.
c.
Convertible preferred stock contains a provision that allows the
preferred stockholders, at their option, to convert the share of
preferred stock at a specific exchange ratio into another security of the
corporation.
d.
Callable preferred stock may be retired (recalled) by the corporation at
its option.
e.
When the corporation either files bankruptcy or liquidates the preferred
stockholders normally have preference to have their claims settled
prior to any payment to common stockholders.
3-17.
The account “unrealized exchange gains or losses” is an shareholders’
equity account that is used to record gains or losses from translating
financial statements in a foreign currency into U.S. dollars so entity can be
incorporated into the financial statements of an enterprise by consolidation,
combination, or the equity method of accounting.
3-18.
Treasury stock represents the stock of the company that has been sold,
repurchased, and not retired. It is subtracted from stockholders' equity so
that net stockholders' equity is for shares outstanding only.
3-19.
The $60, or any portion, will occur as cost of sales if the goods are sold and
as inventory if they are not sold.
3-20.
These subsidiaries are presented as an investment on the parent's balance
sheet.
3-21.
Noncontrolling interest is presented on a balance sheet when an entity in
which the parent company has less than 100% ownership is consolidated.
3-22.
If DeLand Company owns 100% of Little Florida, Inc., it will not have a
noncontrolling interest, since noncontrolling interest reflects ownership of
noncontrolling shareholders in the equity of consolidated subsidiaries that
are not wholly owned. If it only owns 60%, then there would be a
noncontrolling interest. Little Florida would not be consolidated when control
is temporary or does not rest with the majority owner.
3-23.
The account “unrealized decline in market value of noncurrent equity
investments” is an shareholders’ equity account that is used to record
unrealized losses on long-term equity investments.
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3-24.
Redeemable preferred stock is subject to mandatory redemption
requirements or has a redemption feature that is outside the control of the
issuer. Coupled with the typical characteristics of no vote and fixed return,
this security is more like debt than equity for the issuing firm.
3-25.
Fair value is the price that a company would receive to sell an asset (or
transfer a liability) in an orderly transaction between market participants on
the date of measurement.
3-26.
This represents the most objective active market.
3-27.
Level 3 valuation can be very subjective.
3-28.
A quasi-reorganization is an accounting procedure equivalent to an
accounting fresh start. A quasi-reorganization involves the reclassification
of a deficit in retained earnings to paid-in capital. It changes the carrying
values of assets and liabilities to reflect current values.
3-29.
An ESOP is a qualified stock-bonus, or combination stock-bonus and
money-purchase pension plan, designed to invest primarily in the employer's
securities.
3-30.
These institutions are willing to grant a reduced rate of interest because they
are permitted an exclusion from income for 50% of the interest received on
loans used to finance an ESOP's acquisition of company stock.
3-31.
Some firms do not find an ESOP attractive because it can result in a
significant amount of voting stock in the hands of employees. This will likely
dilute the control of management.
3-32.
This firm records the commitment as a liability and as a deferred
compensation deduction within stockholders' equity.
3-33.
Depreciation is the process of allocating the cost of building and machinery
over the periods of benefit. Spreading the cost of an intangible asset is
called amortization, while spreading the cost of a natural resource is called
depletion.
The three factors usually considered when computing depreciation are asset
cost, length of the life of the asset, and the salvage value when it is retired
from service.
3-34.
3-35.
A firm will often want to depreciate slowly for the financial statements
because this results in the highest immediate income. The same firm would
want to depreciate at a fast pace for income tax returns because this results
in the lowest immediate income and thus lower income taxes.
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3-36.
Over the life of an asset, the total depreciation will be the same, regardless
of the depreciation method selected.
3-37.
Yes. Depreciation is the process of allocating the cost of buildings and
machinery over the periods of benefit.
3-38.
Conceptually, this account balance represents retained earnings from other
comprehensive income.
3-39.
Donated capital results from donations to the company by stockholders,
creditors, or other parties.
3-40.
The land account under assets would be increased and the donated capital
account in stockholders’ equity would be increased. The donated
transaction would be recorded at the appraisal amount.
3-41.
1.
Those that require retroactive recognition (those require balance sheet
and income statement recognition).
2.
Those that do not require retroactive recognition but require disclosure
in the notes to the financial statements.
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PROBLEMS
PROBLEM 3-1
a.
Noncontrolling interest will be 20% of the total equity of $300,000, or
$60,000.
b.
The noncontrolling interest share of earnings will be 20% of $50,000, or
$10,000.
PROBLEM 3-2
a.
The dividends would not be shown on the balance sheet. The dividends
have reduced retained earnings. The ending balance of retained
earnings is shown on the balance sheet.
b.
You would disclose a contingent liability in note format.
c.
No accounting recognition is given for possible general business risks for
which losses cannot be estimated.
d.
This subsequent event requires a note.
e.
Restricted cash should be classified as a long-term asset.
f.
Securities held for control should be classified as long-term investments.
g.
Land must be listed at cost. It will have to be written back down.
h.
This would be disclosed in a note. (Also on the income statement, the
loss will be disclosed as an extraordinary item.) The asset should be
removed from the balance sheet.
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PROBLEM 3-3
a.
Year 1
Year 2
Preferred
Cumulative from year 1
10,000 shares x $100 par value =
$1,000,000 x 10%
Year 2 dividend
10,000 shares x $100 par value =
$1,000,000 x 10%
Total
Year 3
Preferred
Year 3 dividend
10,000 shares x $100 par value =
$1,000,000 x 10%
Common
The common gets the remaining
dividends because the preferred
is nonparticipating
Total
b.
Year 1
Year 2
Preferred
Arrears [See computation in (a)]
Year 2 dividend
[See computation in (a)]
Total
Preferred
0
Common
0
$100,000
100,000
$200,000
0
$100,000
$100,000
$ 120,000
$ 120,000
Preferred
0
Common
0
$100,000
100,000
$200,000
0
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Year 3
Preferred
Year 3 dividend
[See computation in (a)]
Common
80,000 shares x $5 = $400,000
x 10% = 40,000
2% to preferred
(2% x $1,000,000)
$100,000
$ 40,000
20,000
2% to common
(2% x $400,000)
Remaining dividend to common
Total
8,000
$120,000
52,000
$ 100,000
Year 1
Preferred
0
Common
0
Year 2
Preferred
Arrears [See computation in (a)]
$100,000
c.
Year 2 Dividend
[See computation in (a)]
Total
Year 3
Preferred
Year 3 dividend
[See computation in (a)]
Common
80,000 shares x $5 = $400,000
x 10% = 40,000
100,000
$200,000
0
$100,000
$ 40,000
Fully participating; therefore, the
remaining dividend will be split
between preferred and common in
proportion to their outstanding
stock at total par value.
48
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Total par value of preferred
$1,000,000 71.43%
Total par value of common
$ 400,000 28.57%
Total
$1,400,000 100.00%
Preferred 71.43% x $80,000 =
Common 28.57% x $80,000 =
Total
d.
Year 1
Year 2
Preferred
Year 2 dividend
[See computation in (a)]
Common
Remainder to common
Total
Year 3
Preferred
Year 3 dividend
[See computation in (a)]
Common
Remainder to common
Total
57,144
$157,144
22,856
$ 62,856
Preferred
0
Common
0
$100,000
$100,000
$ 100,000
$ 100,000
$100,000
$100,000
$ 120,000
$ 120,000
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PROBLEM 3-4
a.
“Balance sheet” should be in the heading.
b.
$10,000 cash should be classified under “other assets” (restricted for payment of long-term note).
c.
Disclose accumulated depreciation related to building.
d.
Patent should be classified under intangibles.
e.
Organizational costs should be disclosed under intangibles.
f.
Prepaid insurance should be under current assets.
g.
Dividends payable should be classified as a current liability.
h.
Notes payable and bonds payable due in the years 2014 and 2018,
respectively, should not be classified as a current liability.
PROBLEM 3-5
a.
Year 1
Preferred
5,000 x $100 x 9% = $45,000
Year 2
Preferred
Cumulative
5,000 x $100 x 9% = $45,000
Common
10,000 x $10 x 9% = 9,000
Preferred
Common
$ 40,000
0
$
5,000
45,000
$
9,000
Fully participating; therefore, the
remaining dividend will be split
between preferred and common in
proportion to their outstanding
stock at total par value.
50
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Total par value of preferred
$500,000
83.3%
Total par value of common
$ 100,000
16.7%
Total
$ 600,000 100.00%
$65,000 - $5,000 - $45,000 - $9,000
= $6,000
b.
Year 1
Preferred
5,000 x $100 x 9% = $45,000
Year 2
Preferred
5,000 x $100 x 9% = $45,000
Common
Remaining divided to common
($65,000 - $45,000)
c.
Year 1
Preferred
5,000 x $100 x 9% = $45,000
Year 2
Preferred
Cumulative
5,000 x $100 x 9% = $45,000
Common
$10,000 x $10 x 9% =
5,000
$ 55,000
1,000
$ 10,000
Preferred
Common
$ 40,000
0
$ 45,000
$ 45,000
$ 20,000
$ 20,000
Preferred
Common
$ 40,000
0
$ 5,000
$ 45,000
$
9,000
Additional % to preferred and common:
Preferred: 5,000 x $100 x 1%
Common: 10,000 x $10 x 1%
5,000
$ 55,000
1,000
$ 10,000
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d.
Year 1
Preferred
5,000 x $100 x 9% = $45,000
Year 2
Preferred
Cumulative
5,000 x $100 x 9% = $45,000
Remaining to common
Preferred
Common
$ 40,000
0
$ 5,000
$ 45,000
$ 50,000
$ 15,000
$ 15,000
PROBLEM 3-6
a.
Heading date is wrong. It should read December 31, 2012.
b.
Preferable to disclose allowance for doubtful accounts on face of
statement. Some firms disclose this account in a note.
c.
Treasury stock should be deducted from stockholders' equity.
d.
Land and building are disclosed net. Accumulated depreciation should be
disclosed.
e.
Short-term U.S. Notes should be classified under current assets.
f.
Supplies should be classified under current assets.
g.
For most industries, liabilities should be classified as current and longterm. Short-term bonds should be under current liabilities. Long-term
bonds payable should be under long-term liabilities.
h.
Redeemable preferred stock should be presented before stockholders'
equity.
52
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PROBLEM 3-7
a.
Straight-line method = $100,000 - $10,000 = $9,000
10 per year
b.
Declining-balance method
Year 1
1/10 x 2 x $100,000 =
$20,000
Year 2
1/10 x 2 x $ 80,000 =
$16,000
Year 3
1/10 x 2 x $ 64,000 =
$12,800
c.
Sum-of-the-years’-digits method
Year 1
10/55 x $90,000 =
$16,363.63
Year 2
9/55 x $90,000 =
$14,727.27
Year 3
8/55 x $90,000 =
$13,090.91
53
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PROBLEM 3-8
a.
Restricted cash in sinking fund should be classified as long-term
investment.
b.
Investment in Subsidiary Company is long-term.
c.
Measurement basis of marketable securities should be disclosed.
d.
Preferable to show land and buildings separately, since land is not
depreciable.
e.
Treasury stock should be deducted from stockholders' equity.
f.
Discount on bonds payable is a contra liability and should be classified as
a deduction from bonds payable.
g.
Prepaid expenses should be classified as a current asset.
h.
For most industries, liabilities should be classified as current and long-term.
i.
Preferred and common stock should be separated, as should capital in
excess of par.
PROBLEM 3-9
$60,000 - $10,000 = $2.00 per hour
25,000 hrs.
Year 1
5,000 x $2.00
=
$10,000
Year 2
6,000 x $2.00
=
$12,000
Year 3
4,000 x $2.00
=
$ 8,000
54
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PROBLEM 3-10
Alleg, Inc.
Balance SheetDecember 31, 2012
ASSETS
Current assets:
Cash
Marketable securities
Accounts receivable
Inventories
Total current assets
Plant and equipment:
Land and buildings
Machinery and equipment
Less: Accumulated depreciation
$ 13,000
17,000
26,000
30,000
86,000
57,000
125,000
182,000
61,000
121,000
Total plant and equipment
Intangibles:
Goodwill
Patents
8,000
10,000
18,000
50,000
$275,000
Other assets
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Current maturities of long-term debt
Total current liabilities
$ 15,000
11,000
26,000
Long-term liabilities:
Mortgages payable
Bonds payable
Deferred income taxes
Total long-term liabilities
80,000
70,000
18,000
168,000
Shareholders’ equity:
Common stock
21,000 shares authorized at $1 par value,
10,000 shares issued and outstanding
Additional paid-in capital
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders’ equity
10,000
38,000
33,000
81,000
$275,000
55
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PROBLEM 3-11
a.
The straight line method will result in the lowest depreciation in the first year.
With the depreciation being the lowest for straight-line, the income will be the
highest using the straight-line method. The straight-line method should be
used for the financial statements. The declining-balance method will result in
the maximum depreciation in the first year. With the depreciation being the
highest, the income will be the lowest. The declining-balance method should
be used for taxes.
Straight-line ($50,000 - $10,000)/5 = $8,000
Double-declining-balance method = 1/5 x 2 x $50,000
= $20,000
Sum-of-the-years’-digits = 5/15 x ($50,000 - $10,000)
= $13,333
b.
It is permissible to use different depreciation methods in financial statements
than in tax returns.
56
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PROBLEM 3-12
Lukes, Inc.
Balance Sheet
December 31, 2012
ASETS
Current assets:
Cash
Receivables, less allowance of $3,000
Inventories
Prepaid expenses
Total current assets
Plant and equipment:
Buildings
Machinery and equipment
Less: accumulated depreciation
Land
Other assets
Total assets
$
3,000
58,000
54,000
2,000
$ 117,000
$ 75,000
300,000
375,000
200,000
175,000
11,000
7,000
$ 310,000
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable
Accrued income taxes
Other accrued expenses
Current portion of long-term debt
Total current liabilities:
Long-term liabilities:
Long-term debt, less current portion
Deferred income tax liability
Total long-term liabilities
Stockholders’ equity:
Common stock, no par value 10,000 shares
authorized, 5,724 shares issued
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
$ 35,000
3,000
8,000
7,000
$ 53,000
99,870
24,000
$ 123,870
3,180
129,950
$ 133,130
$ 310,000
57
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PROBLEM 3-13
a.
4
Gain from the sale of land would be on the statement of income.
b.
1
Cash restricted for the retirement of bonds would be under other assets.
c.
3
Accounts payable is usually one of the larger current liabilities.
d.
5
Construction in process is part of plant and equipment.
e.
4
Bonds payable is usually long term.
f.
4
Redeemable preferred stock is shown above shareholders’ equity.
g.
3
Accounts receivable is a current asset.
h.
1
Research and development is expensed.
i.
2
Assets $100,000 = Liabilities $60,000 + Stockholders’ Equity j.
1
Inventory is a current asset.
k.
4
Pension liabilities are usually long-term.
l.
1
Unearned rent income is a current liability.
?
m. 3
Treasury stock represents a reduction of stockholders’ equity.
n.
5
Statements 1, 2, 3, and 4 are true.
o.
3
IFRS model balance sheet does not put an emphasis on liquidity.
.
58
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PROBLEM 3-14
Airlines International
Balance Sheet
December 31, 2012
ASSETS
Current assets:
Cash
Marketable securities
Accounts receivable
Less: Allowance for doubtful accounts
Inventory
Prepaid expenses
Total current assets
Investment and special funds
Property, plant, and equipment:
Property, plant and equipment
$ 28,837
10,042
$ 67,551
248
67,303
16,643
3,963
$ 126,788
11,901
$809,980
Less: Accumulated depreciation
220,541
Other assets
Total assets
589,439
727
$ 728,855
LIABILITIES AND STOCKHOLDERS’ EQUITY:
Current Liabilities:
Accounts payable
Accrued expenses
Unearned transportation revenue
Current installments of long-term debt
$ 77,916
23,952
6,808
36,875
Total current liabilities
$ 145,551
Long-term debt, less current portion
Deferred income taxes
Stockholders’ equity:
Common stock (par $0.50, authorized 20,000
shares, issued and authorized 14,304)
Capital in excess of par
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
393,808
42,070
$
7,152
72,913
67,361
147,426
$ 728,855
59
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CASES
CASE 3-1 CONVENIENCE FOODS
(This case provides an opportunity to review a moderately complicated balance
sheet.)
a.
b.
c.
d.
e.
f.
1.
The financial statements of the parent and the subsidiary are
consolidated. A subsidiary is a company controlled by another company.
2.
No. There is noncontrolling interest presented.
1.
No. Only the net accounts receivable is disclosed.
2.
$1,190,000,000
1.
$1,056,000,000
2.
Inventories are valued at the lower of cost or market.
3.
A moderate increase in inventory balance.
1.
$3,128,000,000
2.
Straight-line methods for financial reporting and accelerated methods,
where permitted, for tax reporting. The company wants to defer the
payment of taxes.
3.
$0. Depreciation of land is not recorded.
1.
Treasury stock is company stock that has been sold and has been bought
back.
2.
Kellogg is using the cost method.
3.
Treasury stock represents stock that has been sold and bought back and
not retired.
1.
The company’s fiscal year normally ends on the Saturday closest to December 31 and as a result, a 53rd week is added approximately every
sixth year.
2.
Most fiscal years will be 52 weeks. A 53rd week is added approximately
every sixth year.
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g.
Management makes estimates and assumptions that affect the reported
amounts of assets and liabilities.
h.
Yes. Highly liquid investments with original maturities of three months or less
are considered to be cash equivalents.
i.
1.
Goodwill is the difference between the purchase price of the acquired
company and the fair value of the reported identifiable net assets.
2.
They must be reviewed for impairment at least annually.
j.
The costs of research and development are expenses as incurred.
k.
There are uncertain tax positions.
CASE 3-2 THE ENTERTAINMENT COMPANY
(This case provides an opportunity to review the balance sheet).
a.
b.
c.
d.
1.
The financial statements of the parent and the subsidiary are
consolidated.
2.
The majority-owned and controlled subsidiaries were consolidated.
1.
$5,784,000,000
326,000,000
$6,110,000,000
2.
The receivables have increased materially.
1.
Yes.
2.
No. Land will never be depreciated. Projects in progress will be
depreciated when completed.
1.
$69,206,000,000
2.
$12,225,000,000
3.
$1,442,000,000
2,180
1,350
=
61% increase
Somewhat conservative on a moving average cost basis and are stated
at the lower of cost or market.
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e.
Management makes estimates and assumption that affect the amounts
reported in the financial statements and footnotes thereto.
f.
Advertising expenses are expenses as incurred. It would be too subjective to
determine the period or periods of benefit.
g.
Yes. Original maturities of three months or less.
h.
Revenue Recognition
1. Broadcast advertising revenues
Revenues are recognized when commercials are aired
2. Revenues from advance theme park ticket sales
Recognized when the tickets are used
3. Revenues from theatrical distribution of motion pictures
Recognized when motion pictures are exhibited
4. Merchandise licensing advances and guarantee royalty payments
Recognized based on the contractual royalty rate when the licensed
product is sold by the licensee
5. Revenues from internet and mobile operations
Recognized when advertisements are viewed online
6. Different business situations call for different revenue recognitions.
7. In some cases, they are industry-specific, but many recognition methods
go across industries.
i.
Treasury stock – A firm creates treasury stock when it repurchases its own
stock and does not retire it. Reported as a reduction to equity.
j.
Noncontrolling interest reflects the ownership of noncontrolling shareholders in
the equity of consolidated subsidiaries less than wholly owned.
k.
1.
The Company’s fiscal year ends on the Saturday closest to September 20 and consists of fifty-two weeks with the exception that approximately every
six years we have a fifty-three week year.
2.
Yes. Fiscal 2010 had a fifty-two week year. Fiscal 2009 had a fifty-three
week year.
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CASE 3-3 HEALTH CARE PRODUCTS
(This case provides an opportunity to review liabilities and shareholders’ investment).
a.
The financial statements of the parent and the subsidiary are consolidated
when the subsidiary is controlled by another company.
b.
1.
Obligation in connection with the conclusion of the TAP Pharmaceutical
Products Inc. joint venture.
2.
Short-term borrowings.
c.
1.
$1,619,689,876
2.
72,705,928
3.
4.
d.
1,619,689,876
(72,705,928)
1,546,983,948
Cost method
Retained earnings.
CASE 3-4 BEST
(This case represents an opportunity to review assets.)
a.
1.
2.
Receivables
February 26, 2011
February 27, 2010
Gross Receivable:
February 26, 2011
Allowances
February 27, 2010
Allowances
$2,348,000,000
$2,020,000,00
$2,348,000,000
107,000,000
$2,455,000,000
$2,020,000,000
$101,000,000
$2,121,000,000
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b.
Merchandise inventories
“Physical inventory counts are taken on a regular basis.”
They were not taken at the end of the year; therefore, they are adjusting for
anticipated physical inventory losses that have occurred since the last physical
inventory.
c.
1.
Consolidated balance sheet
Consolidation occurs when the investor controls the investee through an
investment in equity securities
2.
“We consolidate the financial results of our Europe, China and Mexico operations on a two-month lag.” d.
Estimates and assumptions are made. They affect the reported results. These
estimates and assumptions are necessary to prepare the financial statements.
e.
“Our fiscal year ends on the Saturday nearest the end of February. Fiscal 2011, 2010 and 2009 each included 52 weeks.”
.
f.
g.
Yes. “Cash equivalents consist of money market funds, U.S. Treasury bills,
commercial paper and time deposits such as certificates of deposit with an
original maturity of three months or less when purchased.”
1.
“Accelerated depreciation methods are generally used for income tax
purposes.”
2.
“We compute depreciation using the straight-line method over the
estimated useful lives of the assets.”
3.
They are trying to achieve higher reported income and lower cash outlays
for taxes.
CASE 3-5 OUR PRINCIPAL ASSET IS OUR PEOPLE
a.
It would be very subjective to identify which payments relating to people would
be considered an asset and which would be considered an expense. Also, if
considered an asset, the subsequent deterioration would be difficult to
determine. The legal implications likely also have a bearing on not considering
people as an asset; but it should be noted that accountants use an economic
definition of an asset.
b.
They are using a broad definition of an asset, recognizing the importance of
people to the firm.
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CASE 3-6 BRAND VALUE
a.
SFAC No. 6:
"Assets are probable future economic benefits obtained or controlled by a
particular entity as a result of past transactions or events."
b.
As a practical matter, brands would represent a valuable asset. Brands also
appear to fall within the definition of an asset presented in SFAC No. 6.
c.
Brands appear to fall within the definition of an asset presented in SFAC No. 6.
In practice, however, generally accepted accounting principles in the United
States do not recognize brands as an asset when internally generated. This
apparent inconsistent position is likely rationalized by conservatism.
d.
A brand purchased would be recognized as an asset. This would be
considered to be objective for valuation purposes.
CASE 3-7 ADVERTISING - ASSET?
a.
SFAC No. 6:
"Assets are probable future economic benefits obtained or controlled by a
particular entity as a result of past transactions or events."
b.
To be conservative, advertising is not usually recognized as an asset in the
United States. Identifying the future benefits of advertising is usually
considered to be too subjective. Examples of advertising being presented as
an asset can be found in U.S. accounting. When it is recognized as an asset, it
may be presented under other assets and possibly disclosed in a note.
CASE 3-8 TELECOMMUNICATIONS PART 1
(This case presents an opportunity to review the financial report of a Chinese
company as filed on Form 20-F to the SEC.)
a.
1.
Prepared in accordance with International Financial Reporting Standards
(IFRS)
2.
No, they are not required to reconcile to U.S. GAAP.
3.
No. “As applied to our company, HKFRS is consistent with IFRS in all
material respects.”
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b.
Audit Report
1.
Three (December 31, 2010, 2009, and 2008)
2.
IFRS standards
3. “The Group maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria
established in Internal Control – Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(“COSO”).
4. “The Group’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting.”
5. “We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
6. Proper internal controls will not prevent or detect misstatements. They
prevent or detect material misstatements.
c.
Consolidated Balance Sheet
1. Since this report is being presented to the SEC, it is helpful that it be
translated to U.S.
2. The presentation follows the usual IFRS presentation. Emphasis is on
noncurrent assets and not on current assets.
3. Equity is presented before liabilities. This is a usual IFRS presentation.
4. As indicated in (3) above, liabilities usually come after equity with a IFRS
presentation.
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CASE 3-9 GLOBAL HEALTH CARE
(This case presents an opportunity to review fair value measurements.)
a.
This maximizes the use of observable inputs and minimizes the use of
unobservable inputs when measuring fair value.
b.
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Observable inputs other than Level 1 prices, such as quoted prices
for similar assets and liabilities, or other inputs that are observable or can be
corroborated by observable market data for substantially the full term of the
assets or liabilities.
Level 3 – Unobservable inputs that are supported by little or no market activity
and that are financial instruments whose values are determined using pricing
models discounted cash flow methodologies, or similar techniques, as well as
instruments for which the determination of fair value requires significant
judgment or estimation.
c.
Level 1 – The Company’s Level 1 assets include equity securities that are traded in an active exchange market.
Level 2 – The Company’s Level 2 assets and liabilities primarily include debt
securities with quoted prices that are traded less frequently than exchangetraded instruments, corporate notes and bonds, U.S. foreign government and
agency securities, certain mortgage-backed and asset-backed securities,
municipal securities, commercial paper and derivative contracts whose values
are determined using pricing models with inputs that are observable in the
market or can be derives principally from or corroborated by observable market
data.
Level 3 – The Company’s Level 3 assets include certain mortgage-backed
securities with limited market activity. At December 31, 2010, $13 million, or
approximately 0.4%, of the Company’s investment.
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