During the 1980s, a special set of accounting rules was in effect for the savings and loan industry. These accounting rules allowed companies in that industry to record losses on sales of certain securities over a several-year period. For example, suppose that a savings and loan sold a security for $1 million that had originally cost $3 million. Rather than immediately reporting the loss on this sale, the company could spread the loss over several years in its income statement.
Required:
(a) In the example just given, how much loss would the savings and loan have reported in the year of sale had the special accounting rules not been in effect?
(b) Assume now that the savings and loan spread the loss on the sale of the security over a five-year period, recognizing an equal portion of that loss in each of those years. What portion of the loss did the savings and loan report in the year of sale?
(c) How was this special accounting treatment for losses on the sale of certain securities misleading to financial statement users?