Case 1.10 and 2.7 answers
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Case 1.10 and 2.7 answers

Course Number: ACCOUNTING 4500, Spring 2012

College/University: Lake City CC

Word Count: 1485

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Case 1.10 Gemstar-TV Guide International, Inc. 1. What fundamental principles dictate when a company should recognize or record revenue in its accounting records? Revenue recognition issues can be particularly complex for companies that sell software and/or license technology. Identify specific rules or concepts in the professional standards that accountants and auditors can rely on to make proper revenue...

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1.10 Case Gemstar-TV Guide International, Inc. 1. What fundamental principles dictate when a company should recognize or record revenue in its accounting records? Revenue recognition issues can be particularly complex for companies that sell software and/or license technology. Identify specific rules or concepts in the professional standards that accountants and auditors can rely on to make proper revenue recognition decisions for such companies. Revenues are recognized when realized or realizable and earned. Revenues are not recognized until realized or realizable and not recognized until earned. Revenues are realized when products are exchanged for cash or claims to cash. Revenues are realizable when related assets received are readily convertible to cash to claims to cash. Revenues are earned when the products are delivered or services are performed. Recognition is the process of recording an item in the financial statements. Realization is the process of converting non-cash resources into cash. Revenues are inflows of assets or settlements of liabilities (or both). Also, revenues are from activities of the entitys central operations. Gains are increases in net assets and from peripheral or incidental transactions of an entity. In keeping with accrual basis bookkeeping, the Revenue Recognition Principle dictates that revenue must be recorded at the time it has been fully earned, not when it is received. With Accrual Accounting revenue is recorded when it is earned and costs and expense are recorded when they are incurred. Accrual accounting requires the use of payable and receivable accounts and is also used in payroll accounting for recording payroll liabilities. This method of accounting can also track sales tax liabilities that are reported on an accrual basis. AICPA Statement of Position (SOP) 97-2 applies to all entities that license, sell, lease, or market computer software. It also applies to hosting arrangements in which the customer has the option to take possession of the software. Hosting arrangements occur when end users do not take possession of the software but rather the software resides on the vendors or a third partys hardware, and the customer accesses and uses the software on an as-needed basis over the Internet or some other connection. It does not, however, apply to revenue earned on products containing software incidental to the product as a whole or to hosting arrangements that do not give the customer the option of taking possession of the software. SOP 97-2 provides that revenue should be recognized in accordance with contract accounting when the arrangement requires significant production, modification, or customization of the software. When the arrangement does not entail such requirements, revenue should be recognized when persuasive evidence of an agreement exists, delivery has occurred, the vendors price is fixed or determinable, and collectability is probable. In the software industry, the largest part of revenues stems from vendors license fees associated with software. Companies such as Microsoft and Computer Associates have recognized revenue from license fees when the software was shipped to the customer. The amount and timing of revenue recognition is complicated, however, by multiple-element arrangements that provide for multiple software deliverables [e.g., software products, upgrades or enhancements, postcontract customer support (PCS), or other services]. In hosting arrangements that are within the scope of SOP 97-2, multiple elements might include specified or unspecified upgrade rights, in addition to the software product and the hosting service. The software provider often charges a single fee that must be allocated to the products delivered in the present and in the future. If contract accounting is not required, SOP 97-2 requires that the vendors fee be allocated to the various elements based on vendor-specific objective evidence (VSOE) of fair value for each element. VSOE is limited to the price charged by the vendor for each element when it is sold separately. This requires the deferral of revenue until VSOE can be established for all elements in the arrangement or until all elements have been delivered. If PCS is the only undelivered element in the arrangement, however, the entire fee can be recognized ratably over the term of the PCS contract. In addition, recognition of revenue must be deferred if undelivered elements are essential to the functionality of any delivered elements. 4. Do you agree with Henry Yuens assertion that a businessperson who is complying with all applicable laws and regulations is, by definition, behaving ethically? Defend your answer. Knowing that a businessperson or a corporate comply with all applicable laws and regulations is an excellent thing. It is assuring that the laws and regulations are followed you by someone are working for or corporations that you are involved with. Overall, it is very comforting to know that the laws and regulations are not being manipulated by the people with power in various organizations. As for behaving ethically, that depends on what exactly they are doing. If they are knowingly falsifying the financial statements then obviously they are not behaving ethically. It all depends on their actions; I think everybody should act with integrity. If what they are doing is going to hurt or damage ones reputation then they should know better to not do it. It is understandable that not everyone has the same level of integrity; however, when you are a businessperson you should have a higher level of integrity and you should be honest about the real situation that you are in regardless of the good or bad of the situations. Failures are not something anyone would like to experience though everyone can learn from their mistakes and move on to do better from the lessons learned. Case 2.7 Campbell Soup Company 2. Suppose that a company uses one or more of the practices that you identified in responding to the previous question. What implications, if any, do those practices have for the companys independent auditors? Generally Accepted Accounting Principles, GAAP, allow earnings management where the goal is to maximize earnings that benefit the organization as opposed to earnings manipulation provoked to commit fraud than the control group by pressures tied to economic cycles, equity issuance, and achievement. Manipulating earnings is usually unfavorable for the organization and for the auditors as well. Incentives and/or pressures for earnings manipulation are unrealistic economic goals, bonus and incentives that trigger greed and unethical issues. The implications for independent auditors are: 1) Companies pose a higher risk 2) More testing would be required 3) Auditors may be allowed to charge a premium fee 4) Auditors' reputation could be at stake 5) Adjustments required reflecting real earnings may become more complex and subjecting to further discussion with management. 3. What auditing standard, of any, requires auditors to determine whether their clients have properly classified key amounts in their periodic income statements? Identify three methods that audit clients can use to put a favorable spin on their reported operating results without changing their bottom line or net income. AU 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles: 411.04 says, "The auditor's opinion that financial statements present fairly an entity's financial position, results of operations ... as to whether (a) the accounting principles selected and applied have general acceptance ... (d) the information presented in the financial statements is classified and summarized in a reasonable manner, that is, neither too detailed nor too condensed (see section 431) ... AU 508, Reports on Audited Financial Statements: 508.04 says, "... The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed ... 508.05 says, "... Reference in the fourth reporting standard to the financial statements "taken as a whole" applies equally to a complete set of financial statements and to an individual financial statement (for example, to a balance sheet) for one or more periods presented." AU 420, Consistency of Application of Generally Accepted Accounting Principles: 420.17 says, "... Although changes in classification are usually not of sufficient importance to necessitate disclosure, material changes in classification should be indicated and explained in the financial statements or notes. ..." AU 431, Adequacy of Disclosure in Financial Statements: 431.02 says, "The presentation of financial statements in conformity with generally accepted accounting principles includes adequate disclosure of material matters. ... including, for example, the terminology used, the amount of detail given, the classification of items in the statements, and the bases of amounts set forth." Obviously, changing the numbers or manipulating the financial statements is illegal. However, the entity may be able to influence how numbers are interpreted. Two ways that an entity can utilize are: 1) By disclosing comments or explanations that address unfavorable numbers - something that lets the reader know that the numbers are (were) an anomaly and not representative of normal operating conditions. In other words, the users should not expect similar performance under other circumstances. 2) By making forward looking statements that are optimistic so as to lead the users to expecting much better performance in the future.

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