Chapter 17 - Solution Manual

The obligation to make lease payments constitutes

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agreement. The obligation to make lease payments constitutes probably future sacrifices, a present obligation to pay cash in the future, resulting from a prior transaction, the initiation of the lease agreement. The asset and liability should be reported as such so that the financial statements will be representionally faithful and will display amounts with predictive value are evaluating the future cash flows. b. & c. are part of the same question. According to the efficient market hypothesis investors would not be fooled by the Mason strategy if they are aware of the net assets of the financing subsidiary. If not, the published financial statement of Mason would contain no details of the lease either in the balance sheet or in the notes. If so, the existence of the asset and associated liability, or knowledge that these are Mason’s asset and liability may not be publicly available. In this case the market may be fooled. d. Mason’s management is clearly attempting to make the financial statements appear as though there is less debt than there really is. The leasing subsidiary arrangement is a sham perpetrated to bias the accounting information. Agency theory predicts that management may be motivated to choose accounting strategies which are aimed at reducing the debt-to-equity ratio. This is particularly true for Mason’s management because of the existence of debt covenants. In my opinion it is unethical for Mason to bias their financial statement to present a more favorable picture, one that does not represent what it purports to represent. It is unethical to try to fool investors or creditors and to make what are in effect false representations of the economic facts e. No the financing strategy does not provide financial statements that are representationally faithful and unbiased. The strategy is designed to “get around’ debt covenants and bonus agreements. The strategy being employed is similar to what Enron used when it created special purpose entities. The resulting financial statements are not transparent in that they fail to disclose the company’s true financial picture. Case 17-10 a. It is unethical for Fillups to select an accounting approach because it produces a positive effect on the firm’s financial statements. Financial statements should be reliable. They should be neutral and free from bias. Clearly the Fillups financial statements are not neutral. Neutrality means that in either formulating or implementing accounting standards, the primary concern should be the relevance and reliability of the information being provided, not the effect that the accounting standards will have on a particular interested party. That is, accounting information should be free from bias toward a predetermined result. Neutrality implies that accounting information reports economic activity and financial position as faithfully as possible without attempting to influence behavior in some particular direction. Accounting information that is not neutral loses credibility.
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