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Chapter 2: 10CA (page 71)

ETHICS (Expense Recognition Principle) Anderson Nuclear Power Plant will be "mothballed" at the end of its useful life (approximately 20 years) at great expense. The expense recognition principle requires that expenses be recognized as assets are used up or liabilities are incurred. Accountants Ana Alicia and Ed Bradley argue whether it is better to allocate the expense of mothballing over the next 20 years or ignore it until mothballing occurs.

Instructions

Answer the following questions.

(a) What stakeholders should be considered?

(b) What ethical issue, if any, underlies the dispute?

(c) What alternatives should be considered?

(d) Assess the consequences of the alternatives.

(e) What decision would you recommend?

Short Answer

Expert verified

Users of financial statement are the stakeholders. Maintaining honesty and integrity in the reporting of financial statement is the ethical issue. Applying expense recognition principle is the alternative method.

Step by step solution

01

Accounting information

Accounting information is a diverse term and includes budgets, production worksheets, income statements, balance sheet, cash flow statements, and the pro forma reports of a company. In simple words, it is the compiled data of all the business transactions of a company.

Users of the accounting information: The various groups such as the creditors, or the stakeholders, or the internal management need the accounting information to analyze the business performance. These groups are the users of the accounting information.

02

Who are the stakeholders

(a) The current and the future users of the financial statements, such as the investors, creditors, are the stakeholders to be considered.

03

Ethical issue

(b) The ethical issues that underlines the dispute are to maintain the integrity and honesty while reporting the financial statements to correctly estimating the cost of the mothballing, the profits manipulation and to assure that the stakeholders have the useful information, and whether the costs involved will cost the job security of the individuals involved.

04

Alternative available

(c) The alternatives available are whether to apply the expense recognition principle and allocate the expense over the useful life of the plant, or to not apply the expense recognition principle and expensing the mothballing later when it occurs.

05

Consequence of the alternatives

(d) The main concern is to correctly estimate the cost of the mothballing. By applying the expense recognition principle and allocating the expense over the useful life of the plant results in lower profits and higher rate for consumers, On the other hand, non-application of the expense recognition principle and expensing the mothballing later when it occurs generates higher profits, lower rates for consumers and a greater potential job security.

06

Recommendation

(e) The company should estimate the expense of the mothballing and accrue the expense over years. This method will state the earnings accurately. Also, the effect on the consumer should be considered. Deferring the expense allocation will benefit the consumers today at the expense of the consumers in future.

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Most popular questions from this chapter

Question: William Murray achieved one of his life-long dreams by opening his own business, The Caddie Shack Driving Range, on May 1, 2017. He invested \(20,000 of his own savings in the business. He paid \)6,000 cash to have a small building constructed to house the operations and spent \(800 on golf clubs, golf balls, and yardage signs. Murray leased 4 acres of land for \)1,000 per month. (He paid the first month鈥檚 rent in cash.) During the first month, advertising costs totaled \(750, of which \)150 was unpaid at the end of the month. Murray paid his three nephews \(400 for retrieving golf balls. He deposited in the company鈥檚 bank account all revenues from customers (\)4,700). On May 15, Murray withdrew \(800 in cash for personal use. On May 31, the company received a utility bill for \)100 but did not immediately pay it. On May 31, the balance in the company bank account was \(15,100.

Murray is feeling pretty good about results for the first month, but his estimate of profitability ranges from a loss of \)4,900 to a profit of \(1,650.

Accounting

Prepare a balance sheet at May 31, 2017. Murray appropriately records any depreciation expense on a quarterly basis. How could Murray have determined that the business operated at a profit of \)1,650? How could Murray conclude that the business operated at a loss of \(4,900?

Analysis

Assume Murray has asked you to become a partner in his business. Under the partnership agreement, after paying him \)10,000, you would share equally in all future profits. Which of the two income measures above would be more useful in deciding whether to become a partner? Explain.

Principles

What is income according to GAAP? What concepts do the differences in the three income measures for The Caddie Shack Driving Range illustrate?

The Financial Accounting Standards Board (FASB) has developed a conceptual framework for financial accounting and reporting. The FASB has issued eight Statements of Financial Accounting Concepts. These statements are intended to set forth the objective and fundamentals that will be the basis for developing financial accounting and reporting standards. The objective identifies the goals and purposes of financial reporting. The fundamentals are the underlying concepts of financial accounting that guide the selection of transactions, events, and circumstances to be accounted for; their recognition and measurement; and the means of summarizing and communicating them to interested parties.

The purpose of the statement on qualitative characteristics is to examine the characteristics that make accounting information useful. These characteristics or qualities of information are the ingredients that make information useful and the qualities to be sought when accounting choices are made.

Instructions

(a) Identify and discuss the benefits that can be expected to be derived from the FASB鈥檚 conceptual framework.

(b) What is the most important quality for accounting information as identified in the conceptual framework? Explain why it is the most important.

(c) Statement of Financial Accounting Concepts No.8 describes a number of key characteristics or qualities for accounting information. Briefly discuss the importance of any three of these qualities for financial reporting purposes.

Question: What are some of the costs of providing accounting information? What are some of the benefits of accounting information? Describe the cost-benefit factors that should be considered when new accounting standards are being proposed.

According to the FASB conceptual framework, the objective of financial reporting for business enterprises is based on the needs of the users of financial statements. Explain the level of sophistication that the Board assumes about the users of financial statements.

Revenues, gains, and investments by owners are all increasing in net assets. What are the distinctions among them?
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