Ifamcdonaldsrestaurant was located at a certain

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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 costs. 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 restaurant. 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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