Chapter 4 - Solution Manual

D mainstream accounting proponents would argue that

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d. Mainstream accounting proponents would argue that the role of accounting is to report unbiased information. Accounting should report economic circumstances and events as they are and should not present information to achieve a particular result. They would argue that not to report the information required because of potential social costs would be to present financial information that was biased and thus not neutral, thereby violating the neutrality concept. They would also argue that the user needs to know the potential cost of these benefits and therefore reporting them in accordance with the new pronouncements is relevant to user decision making. Case 4-8 a. Liabilities are defined as probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. Capital leases meet this definition, hence they
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70 represent claims to resources. According to SFAC No. 1 claims to resources are relevant for user decision making. Liabilities are to be measured at the present value of future cash flows discounted at the effective rate of interest. This measurement requirement is consistent with the accounting of capital leases. Investors, creditors and other users recognize liabilities as requiring the use of cash in the future, hence, reporting liabilities at the present value of future cash flows provides information for user predictions of future cash outflows. While it is true that reporting the anticipated future cash flows in footnotes would also provide users with information to predict future cash flows, simultaneous reporting of the present value of those future cash flows as a liability on the balance sheet underscores the fact that there is a present claim to company resources. Also, lease capitalization reports an asset that was essentially purchased. This treatment is consistent with that of other purchased assets. The leased asset provides the same services as a purchased asset. It will provide future benefit over its useful life or the lease term and hence meets the definition of an asset. Reporting its value as an asset meets the conceptual framework’s objective of providing information regarding a company’s resources. Simply listing the expected future lease payments in a footnote tends to obscure the fact that there is an asset and that the asset provides future benefit which presumably will be associated with future cash inflows. b. The semi-strong form of the EMH implies that all publicly available information is impounded in security prices. Since the cash flows are the same whether the lease is capitalized or not, and those cash flows would be public information regardless of whether the lease were capitalized or described in the footnotes, the market would instantaneously impound the information into the stock prices in the same way under either accounting approach as soon as the information became public.
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