Chapter 1 - Solution Manual

Team 1 this question should prompt the student to

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Debate 1-2 Should the scope of accounting standards be narrowed further? : Team 1. This question should prompt the student to investigate how management might benefit from alternative accounting choices. They can go to the web and find out that accounting choices provide managerial incentives that are either income increasing or income decreasing. They may also find instances that management can choose methods of presenting financial information that make the company appear less risky. Income-increasing choices afford management the ability to paint a better picture of company performance. Management may be inclinedto select income increasing policies because they believe the stock market will react favorably and their own personal wealth and position in the firm may be more secure. their bonus may be tied to the bottom line. The company may appear better able to pay suppliers and thus may be in a better position to negotiate favorable terms with suppliers The company may appear better able to repay debt and thus look good to a lender. Students can cite real-world examples, eg., World Com capitalized expenses Income-decreasing choices may be selected by companies that Are highly regulated, such as utility companies. Poor performance can support the notion that the company deserves a rate increase If a company is having a bad year, it may choose to load up the income statement with expenses and losses so that it will appear better off in future years. Have labor unions hope to fare better in negotiations for labor contracts Companies have used off-balance sheet financing to improve the perception of a company’s riskiness. Enron is a prime example. Enron used special purpose entities to hide debt from investors. The student can also argue that accounting choice can be used to provide more relevant financial statements. For example, SFAS 115 provides choices that are intended to result in financials that better disclose the results of management investment choices. Team 2. All of the above can be used as arguments against the proliferation of accounting choices. Narrowing accounting choices has been a goal of accounting professionals for many years. For example, one of the objectives of the APB was to narrow areas of difference in GAAP. Critics maintain that management is allowed too much leeway in the selection of the accounting procedures used in corporate financial reports. These criticisms revolve around two issues (1) Executive compensation is frequently tied to reported earnings, so management is inclined to adopt accounting principles that increase current revenues and decrease current expenses and (2) the value of a firm in the marketplace is determined by its stock price. This value is highly influenced by financial analysts’ quarterly earnings estimates. Managers are fearful that failing to meet these earnings estimates will trigger a sell-off of the company’s stock and a resultant decline in the market value of the firm.
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