Case 1-4 a. The term "accounting principles" in the auditor's report includes not only accounting principles but also\practices and the methods of applying them. Although the term quite naturally emphasizes the primary or fundamental character of some principles, it includes general rules adopted or professed as guides to action in practice. The term does not however, mean rules from which there can be no deviation. In some cases the question is which of several partially relevant principles has determining applicability. Neither is the term "accounting principles" necessarily synonymous with accounting theory. Accounting theory is the broad area of inquiry devoted to the definition of objectives to be served by accounting, the development and elaboration of relevant concepts, the promotion of consistency through logic, the elimination of faulty reasoning, and the evaluation of accounting practice. b. Generally accepted accounting principles are those principles (whether or not they have only limited usage) that have substantial authoritative support. Whether a given principle has authoritative support is a question of fact and a matter of judgment. Since September 15, 2009 the primary source of GAAP has been the FASB’s accounting standards codification. However, if the guidance for a transaction or event is not specified within a source of authoritative GAAP for that entity, an entity shall first consider accounting principles for similar transactions or events within a source of authoritative GAAP for that entity and then consider nonauthoritative guidance from other sources (FASB ASC 10510-5-2).. The CPA is responsible for collecting the available evidence of authoritative support and judging whether it is sufficient to bring the practice within bounds of generally accepted accounting principle. c. The auditor’s report states that a company’s financial statements present “fairly,” in all material respects, its financial position, based on his or her judgment as to whether the accounting principles selected and applied have general acceptance and that the accounting principles selected are appropriate given the circumstances. This statement is necessary because there are many areas where companies make choices among and between accounting principles (Depreciation method, inventory cost flow assumptions, etc). Therefore,, it is expected that financial reports are prepared in a manner that reflects the underlying economic events and activities of the reporting entity. This expectation was stressed in SAS No. 90 which stated, "In each SEC engagement, the auditor should discuss with the audit committee the auditor's judgments about the quality, not just the acceptability, of the entity's accounting principles applied in its financial reporting. The discussion should also include items that have a significant impact on the representational faithfulness, verifiability, and neutrality of the accounting information included in the financial statements. “ As a consequence, the choices of accounting principles made by one company are often different than those made by another company. Case 1-6 a. Historically, accounting has been considered a highly trustworthy profession. Public accounting firms trained new accountants in the audit function with oversight from senior partners who believed that their firm’s integrity rode on every engagement. That is, new auditors were assigned client responsibility after minimal formal audit training. Most of the training of new accountants took place on-site, and the effectiveness of the new auditor depended on the effectiveness of the instructor. CPA firms have always called their customers “clients” and have worked hard to cultivate them. Partners routinely entertained clients at sporting events, country clubs, and restaurants, and many CPA firm employees later moved on to work in their clients’ firms. Any conflicts in these relationships were, at least partially, offset by the CPA firm’s commitment to professional ethics. These relationships changed as information technology advisory services grew in the late 1970s and early ’80s. Also in the mid-1980s, the AICPA lifted its ban on advertising. As a result, revenue generation became more critical to partners’ compensation. Thereafter, the profit structure of CPA firms changed dramatically and in 1999, revenues for management consulting accounted for more than 50 percent of the then Big Five’s revenue. As a result, the audit function evolved into a loss leader that public accounting firms offered in conjunction with vastly more lucrative consulting engagements. But as pubic accounting firms competed more aggressively on price for audit engagements, they were forced by cost considerations to reduce the number of procedures performed for each client engagement. This resulted in increased test of controls and statistical models, and fewer of the basic, time-consuming tests of transactions that increase the likelihood of detecting fraud. In addition, junior auditors were frequently assigned the crucial oversight roles usually filled by senior partners, who were otherwise engaged in marketing activities to prospective clients. This reduced the effectiveness of the instructor–new accountant training process. b. 1. Arthur Andersen, formerly one the Big Five audit firms, has gone out of business. 2. In July 2002, President George W. Bush signed into law the Sarbanes-Oxley Bill, which imposes a number of corporate governance rules on publicly traded companies 3. Establishment of PCAOB. FASB ASC 1-3 Accounting for the Investment Tax Credit Search investment tax credit Found at 740-10-25- 45 7 46 740-10-47-27 & 28 Case 2-2: a. i. The FASB was motivated to create the CFP because it saw how many difficulties that the APB had faced. The FASB wants the CFP to be viewed as a common basis for identifying and discussing issues, for asking relevant questions, and for suggesting avenues for research. The concepts in the CFP are used to establish standards and to provide reference to resolve accounting issues. The CFP does not provide every single answer, but it does help by giving alternatives. The most direct beneficiary of the CFP is the FASB. Because the CFP reduces personal bias influence on standard setting, members of the board cannot influence standard setting with personal frameworks. ii. In 1984, the FASB established the Emerging Issues Task Force because there was criticism that the FASB was failing at giving timely guidance on issues. The EITF’s objectives and goals are to help the FASB out by giving timely guidance on financial accounting issues. The guidance given by the EITF is intended to follow the framework of the Accounting Standards Codification to keep practice similar in a timely manner. The FASB uses the term standards overload to describe their concern for the amount of difficult accounting standards there are. The board agreed to look at being able to issue standards for basic principles, rather than detailed rules. This problem is especially bad for small businesses because small businesses usually do not have the resources to be able to research and apply all of the standards. The FASB and other organizations have studied the problem, but no solution has been reached. Case 2-7: a. The bonds are usually distinguished based on the uncertainty of future cash flows. Because both bonds are due in ten years, there are many factors that might make the bond market value of company A’s bond a greater amount than company B’s bond. The factors include the estimation of future cash flows such as investment with higher cash inflow will have a higher bond market, differences in the timing of above stated cash inflows, the time value of money as characterized by the risk-free percentage of interest and the amount for bearing such uncertainty in the future, and liquidity and imperfection of market. The company that yields a lower market rate has the better credit rating. In this case, if both companies have the same stated or nominal rate of interest, company A bonds will be more valuable if its credit rating is better than company B’s. b. If both companies have the same credit rating, then company A’s shorter bond term would make its market worth greater than company B’s bonds. However, if the credit ratings and bond terms were both the same, then company A’s bonds will be sold for a lrger amount than company B’s bonds only if company A is proposing a greater specified interest rate than company B. FASB ASC 2‐8 Using Present Value: 325-40-35-7: If the present value of the original estimate at the initial transaction date (or the last date previously revised) of cash flows expected to be collected is less than the present value of the current estimate of cash flows expected to be collected, the change is considered favorable. 325-4035-8: If the present value of the original estimate at the initial transaction date (or the last date previously revised) of cash flows expected to be collected is greater than the present value of the current estimate of cash flows expected to be collected, the change is considered adverse. 958-60555-22: The present value of the future cash flows is one valuation technique for measuring the fair value of contributions arising from unconditional promises to give cash; other valuation techniques also are available, as described in Topic 820.
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