Chapter 12 - Solution Manual

The decrease in net income would result in a decline

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The decrease in net income would result in a decline in EPS. Ignoring depreciation expense on the acquired asset, the following differences in EPS would occur: EPS - Postpone purchase:($200,000 - 80,000)/55,500 = $ 2.16 EPS - purchase in 2006: ($200,000 -100,000)/55,500 1.80 Decline in EPS $ 0.36 Not only would EPS decline if the purchase were made, but it would fall below the prior year EPS, $1.95. The company would no longer display the historic steadily increasing EPS. d. The company would continue to project a steadily increasing EPS if the purchase were postponed. Although the EPS would be historically correct, i.e., representationally faithful, the projections implied by it may mislead potential investors, particularly, if next year is no better, or is even worse than 2010. The ethical dilemma is that a company should not base economic decisions on financial statement effects. Rather, the financial statements should portray economic reality regardless of what that reality is. Case 12-2 a. There is no clear solution to this exercise, it can be used to generate class discussion about the qualitative criteria. The following represents the opinion of the authors. Nondiscounting Discounting Neither (1) (2) (3) 1. Relevance X a. Timeliness X b. Predictive &
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256 feedback value X 2. Reliability X a. Representational Faithfulness X b. Verifiability & neutrality X 3. Understandability X 4. Comparability X b.i. Relevance. Because the objective of financial statements is to provide decision relevant information, discounted deferred taxes may be more relevant than nondiscounted deferred taxes. The FASB has determined that the asset liability approach measures future tax consequences. It follows that deferred tax liabilities measure future cash outflows. Consistent with liability measurements of other future expected cash outflows the present value of the expected future tax consequences has decision usefulness and is therefore relevant. a. Timeliness. The concept of timeliness, as a qualitative criterion, means that the information provided in financial statements is presented within a time frame to be decision relevant. The measurement method (discounting vs nondiscounting) does not affect the timeliness of either approach. b. Predictive and feedback value. If we believe that deferred taxes are future tax consequences, and that they should be measured in a manner that is consistent with other liabilities in order to be decision relevant, then it follows that discounting provides better predictive and feedback value because it provides an appropriate measure of actions taken and as such should improve decision maker abilities to predict the results of future actions. ii. Reliability. When assessing the reliability of accounting representations, the degree of representational faithfulness must be weighed against verifiability and neutrality. Again, if future cash outflows (liabilities) are better represented by their present value, then discounting deferred taxes has representational faithfulness.
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