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Unformatted text preview: the income statement this year but will in future years. The
predictability of the future value of software is higher than for advertising and research and development
Management, separate from any desires to influence the stock price, will generally want to match its
expenses with the revenues that these expenses produce. Management wants to be able to evaluate
the impact of both its advertising and research & development costs. Shareholders may want to
see a system of charging marketing expenses that will have the best impact on stock performance. In
the early years of a company this may mean capitalizing heavy marketing from the early years and
defering the expense until the company has higher levels of revenue to absorb these expenses.
Management may also have an incentive to report higher net income, which could cause some
managers to want to change accounting policies to work to their benefit. This speaks for the benefit of
consistently applying accounting policies from year to year. 39 ID9–6
a. The effect on profits from increased capital spending will come from increased depreciation charges.
Capitalized expenditures for fixed assets will eventually hit the income statement as depreciation
expense. b. The balance sheet will reflect growth in the property, plant and equipment, as well future growth in the
contra asset accumulated depreciation account. The income statement will show increased
depreciation expense. And finally, the statement of cash flow will show greater uses of cash in the
investing activities section. c. The justification of management for the increased capital expenditures will be to remain competitive in
the marketplace. If businesses do not reinvest in the longterm assets of their operations, they will not
be able to remain competitive. Spending the additional money for fixed assets will affect the financial
statements today, but that spending will also keep the business viable into the future. The
stockholders have to allow funds to be allocated for investing activities if they want to continue to
receive a return on their investment in the company. ID9–7
a. The most likely scenario causing a restaurant’s value to be impaired is a loss in the desirability of
the location. If a McDonald’s restaurant was located at a certain intersection and traffic patterns in the
city changed (due to a new interstate highway, for example), the restaurant will no longer be as
attractive a location. McDonald’s therefore would have to adjust downward the carrying value for that
b. McDonald’s will record the impairment by first determining the fair value of the asset. Then, the
company will record an impairment expense and reduce the asset from its current carrying value down
to the (new) fair value.
c. As with other expenses that are somewhat at management’s discretion, shareholders are
vulnerable if management decides to take an impairment expense in a year where earnings are
otherwise very healthy, eliminating the need to take the expense in future years when earnings are
less robust. A management team could lower current earnings (and thus future earnings
expectations) by taking impairment charges in current periods. ID9–8
a. It seems GE is engaging in incomesmoothing. Whenever GE has a onetime reporting gain due to
any unusual events, it also tries to book a related expense or a charge to offset that gain. This
ensures that earnings do not rise so high that they cannot be topped the following year. b. Discretionary restructuring charges are used by GE to offset the onetime gains in order to avoid an
abnormal peak in the company’s earnings for the year. It seems that GE’s management strongly
believes in modest but consistent earnings growth. Therefore, they engage in belowtheline activities
and generate gains for themselves, which they try to offset to a somewhat lesser extent by recording a
restructuring charge. GE wants to pursue this strategy because capital markets reward a net increase
in earnings with a higher stock price. Therefore, GE hopes to increase the price of its stock. c. Since the proliferation of total quality movement, restructuring is usually perceived by the investors and
the market as a costcutting exercise by the company. If the market believes that a company is
becoming leaner and meaner in its operations, it expects the company’s profits to rise in the future. 40 Therefore, in anticipation it rewards the company by increasing its stock prices.
FASB is rightfully concerned in limiting such behavior of various companies. The reason is that several
times in practice, restructuring charges have had nothing to do with downsizing or rightsizing. No
costs are reduced in the future and no real benefits may accrue to the company in the coming years.
Since there are no guidelines, all kinds of expenses incurred by the companies are being classified
under this broad category of “restructuring charges,” which the market has come to perceive as a
favorable charge. ID9–...
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