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Case 5-5 Revenue Recognition Revenue is usually recognized at the point of sale. Under special circumstances, however, bases other than the point of sale are used for the timing of revenue recognition. Required: 1. Why is the point of sale generally used as the basis for the timing of revenue recognition? 2. Disregarding the special circumstances when bases other than the point of sale are used, discuss the merits of each of the following objections to the sales basis of revenue recognition: 1. It is too conservative, because revenue is earned throughout the entire process of production. 2. It is not conservative enough, because accounts receivable do not represent disposable funds, sales returns and allowances may be made, and collection and bad debt expenses may be incurred in a later period. 2. Revenue may also be recognized (1) during production and (2) when cash is received. For each of these two bases of timing revenue recognition, give an example of the circumstances in which it is properly used and discuss the accounting merits of its use in lieu of the sales basis. Case 5-7 Matching Concept The accounting profession has employed the matching concept to determine what to report in the income statement and to determine how to measure items reported in the income statement. This concept implies that expenses should be measured directly, and thus balance sheet measures are residuals. The matching concept is therefore an income statement approach to the measurement and reporting of revenues and expenses. SFAC No. 5 defined earnings as the change in net assets exclusive of investments by owners and distributions to owners, a capital maintenance concept of earnings measurement. Under this concept, assets and liabilities would be measured directly, and changes to them would flow through the income statement. Thus the SFAC No. 5 definition of earnings represents a balance sheet approach to the measurement and report of revenues and expenses. Required: 1. Describe and discuss the matching concept and its importance to income reporting. 2. Give specific examples of how the matching concept is used in practice. 3. Describe and discuss the balance sheet approach and its importance to income reporting. 4. Give specific examples of how balance sheet measurements affect the measurement and reporting of earnings. Case 5-8 The Concept of Conservatism The concept of conservatism has been influential in the development of accounting theory and practice. A major effect of conservatism is that accountants tend to recognize losses, but not gains. For example, when the value of an asset is impaired, it is written down to fair value and an unrealized loss is recognized in the income statement. However, when the asset's value appreciates, its value is not written up to fair value. (An exception is current accounting for investments in securities having readily determinable fair values.) Stated differently, accountants tend to recognize holding losses, but not holding gains. Required: 1. Define conservatism. 2. Why do you believe conservatism has affected financial reporting? Explain. 3. Do you believe that financial statements that recognize losses but not gains provide information that is relevant and representationally faithful? Explain. 4. Do you believe that the concept of conservatism is consistent with the physical capital maintenance concept? Explain. 5. Do you believe that the concept of conservatism is consistent with the financial capital maintenance concept? Explain. Case 6-3 Income Statement Format Accountants have advocated two types of income statements based on differing views of the concept of income: the current operating performance and all-inclusive concepts of income. Required: 1. Discuss the general nature of these two concepts of income. 2. How would the following items be handled under each concept? 1. Cost of goods sold 2. Selling expenses 3. Extraordinary items 4. Prior period adjustments Case 6-4 Accounting Changes It is important in accounting theory to be able to distinguish the types of accounting changes. Required: 1. If a public company desires to change from the sum-ofyear's-digits depreciation method to the straight-line method for its fixed assets, what type of accounting change will this be? How would it be treated? Discuss the permissibility of this change. 2. If a public company obtained additional information about the service lives of some of its fixed assets that showed that the service lives previously used should be shortened, what type of accounting change would this be? Include in your discussion how the change should be reported in the income statement of the year of the change and what disclosures should be made in the financial statements or notes. 3. Changing specific subsidiaries comprising the group of companies for which consolidated financial statements are presented is an example of what type of accounting change? What effect does it have on the consolidated income statements? Case 6-7 Identifying Accounting Changes Sometimes a business entity changes its method of accounting for certain items. The change may be classified as a change in accounting principle, a change in accounting estimate, or a change in reporting entity. Listed below are three independent, unrelated sets of facts relating to accounting changes. Situation 1 A company determined that the depreciable lives of its fixed assets were currently too long to fairly match the cost of the fixed assets with the revenue produced. The company decided at the beginning of the current year to reduce the depreciable lives of all its existing fixed assets by five years. Situation 2 On December 31, 2013, Gary Company owned 51 percent of Allen Company, at which time Gary reported its investment using the cost method owing to political uncertainties in the country in which Allen was located. On January 2, 2014, the management of Gary Company was satisfied that the political uncertainties were resolved and that the assets of the company were in no danger of nationalization. Accordingly, Gary will prepare consolidated financial statements for Gary and Allen for the year ended December 31, 2014. Situation 3 A company decides in January 2014 to adopt the straight-line method of depreciation for plant equipment. This method will be used for new acquisitions as well as for previously acquired plant equipment for which depreciation had been provided on an accelerated basis. Required: For each of the preceding situations, provide the information indicated below. Complete your discussion of each situation before going on to the next situation. 1. Type of accounting change 2. Manner of reporting the change under current GAAP, including a discussion, where applicable, of how amounts are computed 3. Effects of the change on the statement of financial position and earnings statement 4. Required e disclosures