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Chapter 9 - Solution Manual

Case 9 11 178 a the stewardship role of accounting

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178 a. The stewardship role of accounting implies that accountants should report on how moneys were invested in assets and the performance resulting from making those investments. This notion is consistent with reporting assets at historical cost. Long-term assets provide benefits for a number of time periods. Investments are made in fixed assets so that over the long-run revenues will be generated. Fixed asset investments thus generate revenues over multiple accounting periods. The matching principle implies that these revenues should be matched with the cost of generating them. Because an element of this cost is the cost of long-term fixed assets these costs should be matched with the revenues they generate, implying that the cost should be allocated to those periods in which the revenues (benefits) are expected to occur. b. Accountants believe that cost allocation provides relevant information because it attempts to match cost with revenue and thus provides measures of performance. On the other hand, all allocation schemes are by their very nature arbitrary. As such, they are not objective. Also, one could argue that cash flow is all that matters with regard to fixed assets. In other words, purchasing a fixed asset is an investing activity, a cash outflows. It is not an operating activity. It provides physical assets to generate revenue, but it is a sunk cost and does not recur on an annual basis. c. If the purpose of the balance sheet is to disclose resources and claims to resources, historical cost once the asset has been purchased may no longer be relevant. Historical cost does not provide a measure of the current value of the asset in use. Each period the company in effect makes a conscious decision to keep the asset. These decisions imply that the company is, in effect, reinvesting in the asset. Reinvestment decisions are made based on replacement cost. Hence, replacement cost would provide relevant measures of fixed assets. d. Yes, a current value approach to the valuation of fixed assets would be consistent with the physical capital maintenance concept. The concept of physical capital maintenance is concerned with maintaining productive capacity, the operating assets of the entity. Assets must eventually be replaced in order to maintain the current level of productive capacity. Hence, measurement of assets at their replacement cost, a current cost measure, is consistent with the physical capital maintenance concept. e. The major problems associated with use of replacement cost relate to determining the amount of replacement cost. Once purchased, the replacement cost of fixed assets may be difficult if not practically impossible to determine. Replacement cost is the cost to replace the assets with similar assets in similar condition. But, there may be no ready market for the assets. In these cases it may be necessary to obtain appraisal values in order to approximate replacement cost. In some cases specific price indexes may be used, but these measures provide reasonably
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Case 9 11 178 a The stewardship role of accounting implies...

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