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a. The problem with using current costs is trying to determine what the current cost is. That is, how does
one determine the current cost of a specialized piece of manufacturing equipment or the current cost
of an office building in a slowmoving real estate market? This difficulty in determining current costs
gives managers leeway to manipulate the amounts reported in the financial statements. If managers
are given the opportunity to manipulate the financial statements through subjective current costs, then
financial statement users will be wary of placing any reliance on the financial statements. Thus,
current costs could potentially lead to the demise of financial statements. b. Historical costs are sunk costs in that they represent the cost of an asset at the time the asset was
acquired; historical costs do not indicate the magnitude of cash or net assets that an asset will
generate in the future. Since sunk costs are irrelevant for decisionmaking purposes, historical costs
are not relevant for decisionmaking purposes. Alternatively, current costs provide a measure of the
value of an asset today. For example, the amount reported for Cost of Goods Sold and Depreciation
Expense under current cost represents the current values of the inventory sold during the period and of
the fixed assets "consumed" during the accounting period, respectively. These values essentially
represent what it would cost the company to replace the inventory it sold and the fixed assets it
"consumed." In addition, the amounts reported on the balance sheet for inventory and fixed assets
essentially represent what it would cost the company to replace its inventory and fixed assets, which
is essentially the same value as what the company would realize if it sold the inventory and fixed
assets. Thus, current cost information would be very relevant for decisionmaking purposes because it
provides information about cash inflows the company could generate and about cash outflows the
company is likely to make. In short, current cost information is very relevant for decisionmaking
purposes. c. The argument comes down to reliability versus relevancy. Current cost information is more relevant
than historical cost information, but it is considerably more difficult to objectively determine current
costs than it is to determine historical costs. If individual financial statement users were able to dictate
the valuation basis to be used in preparing financial statements, each individual would be able to
determine his or her personal decision on the tradeoff between reliability and relevancy. However,
financial statements are intended for general use, which means that the same financial statements will
be used by a variety of people. Historically, reliability has been given more importance than relevancy
because (1) relevant information is not very useful if you are not sure you can rely on the information
and (2) managers and auditors are legally liable to financial statement users. That is, they are uneasy
about providing information that might be subjective because it could greatly increase their legal
41 Asset writedowns allow Kellogg to manage earnings by reducing depreciation expenses in future
periods. If Kellogg has a good quarter and decides to write down an asset this lowers the book value of the asset and thereby reduces the amount of depreciation expense that will be incurred in future
b. The accounting profession in general tends to prefer conservative accounting practices. By carrying
the value of assets at a lower value, the auditors reduce their risk that if something goes wrong with
the company that they will be sued. So if management makes estimates that reduce the value of
assets, the auditors will be less likely to object. c. The FASB has come out against this policy of “taking a bath” by companies when they have had a
really bad quarter to begin with. Some companies will then go ahead and write down assets so that in
future periods the amount of depreciation will be reduced thereby improving reported net income.
While the write down of assets may be conservative, this approach violates the matching principle.
The appropriate costs are not being matched with the related revenues in future periods. ID9–11
a. The writeoff of an outdated technology system would reduce assets and equity; equity is reduced
because of the writeoff expense, which reduces Retained Earnings through lower profits. b. The most likely factor in determining that a system is overvalued is the introduction of new
technology products in the market that better meet the company’s needs. The old system, still
carried on the balance sheet, is no longer as valuable because of the technological updates of the
new systems. c. Management could decide to take the writeoff 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 the writeoff chargein the current period. ID9–12
According to U.S. GAAP, longlived assets are recorded at original cost less accumulated depreciation. If
the market value of the asset permanently falls below the balance sheet carrying value, an impairment
charge must be recorded, and cannot be reversed in later periods, even if the value of the asset recovers.
Under IFRS, companies can either follow the U.S. GAAP method, or they can periodically revalue their
longlived assets to fair market value, recognizing not only impairments but also recoveries of previously
impaired assets and increases in asset values. Effectively, U.S. GAAP follows the more conservative
“lowerofcostor market” principle, where asset values may be marked down but may never be marked up.
IFRS, on the other hand, gives companies the option to value assets according to everchanging market
values, where both market value increases and decreases are recorded.
Under U.S. GAAP, development costs must be expensed, while IFRS gives companies the ability, in
certain circumstances, to capitalized development costs and amortize those costs over future accounting
periods. U.S. GAAP requires immediate expensing, while IFRS can allow costs to be allocated to future
Property, plant and equipment make up 14.8% ($1,957.7/$13,249.6) of total assets. Other
longlived assets make up 11.8% ($1,557.9/$13,249.6) of total assets.
b. According to Note 3, Machinery and Equipment is the largest category within property, plant and
c. Depreciation expense (from the Statement of Cash Flow) is 1.7% ($335.0/$19,176.1) of Net Revenue.
Because depreciation is a noncash expense, it is added back in the Statement of Cash Flow in the
calculation of cash from operating activities. d. According to Note 1, Nike depreciates its assets using the straightline method. The company uses 2
to 40 years for buildings and leasehold improvements, 2 to 15 years for machinery and equipment, and
3 to 10 years for computer software. e. The company’s largest intangible asset is Trademarks. f. According to Note 1, Nike evaluates assets for impairment whenever business circumstances or
events indicate the carrying value of assets might not be recoverable. If the evaluation determines
impairment, the asset is written down to its estimated fair value. g. The acquisition of Umbro and the subsequent determination that the carrying value of the acquisition
was greater than the fair value of the acquired company led to the large impairment charge.
Impairment expenses appear on both the income statement and the statement of cash flow because
they are noncash expenses (and therefore are added back to earnings in the calculation of cash from
operating activities). h. Nike spent $455.7 milliion for capital expenditures. The same year the company received $32 million
in cash from the disposal of property, plant and equipment. 43...
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