SOLUTION MANUAL
Modern Advanced Accounting In Canada,
10th Edition By Darrell Herauf, Chima Mbagwu,
Chapters 1 - 12, Complete
,
, Chapter 1
Conceptual & Case Analysis
Frameworks for Financial Reporting
A brief description of the major points covered in each case and problem.
CASES
Case 1-1
In this case, students are introduced to the difference in accounting for R&D costs between
IFRS and ASPE and asked to provide arguments to support the different standards.
Case 1-2 (adapted from a case prepared by Peter Secord, Saint Mary’s University)
In this real life case, students are asked to discuss the merits of historical costs vs. replacement costs.
Actual note disclosure from a company’s financial statements is provided as background material.
Case 1-3 (adapted from a case prepared by Peter Secord, Saint Mary’s University)
,A Canadian company has just acquired a non-controlling interest in a U.S. public company. It must
decide whether to use IFRS or U.S. GAAP for the U.S. subsidiary. Financial statement information
is provided under IFRS and U.S. GAAP. The reasons for some of the differences in numbers must
be explained and an opinion provided as to which method best reflects economic reality.
Case 1-4
This case is adapted from a CPA Canada case. A private company is planning to go public. Analysis
and recommendations are required for accounting issues related to purchase and installation of new
information system, revenue recognition, convertible debentures and doubtfulaccounts receivable.
Case 1-5
This case is adapted from a CPA Canada case. A private company is planning to transition from
ASPE to IFRS. Analysis and recommendations are required for accounting issues related to
convertible debentures, unusual item, revenue recognition, contingency and impairment.
,PROBLEMS
Problem 1-1 (40 min.)
A single asset is acquired. Students are asked to prepare and compare financial statement numbers
during the life of the asset using both a historical cost and a current value model.
Problem 1-2 (40 min.)
Details of a European company that reports using IFRS are given along with specific details relating
to certain account balances. Students are asked to show how these balances should be reported
under 1) ASPE and 2) IFRS using the facts provided. Students are also asked to reconcile Net
Income and Shareholders` Equity from IFRS to ASPE.
Problem 1-3 (50 min.)
A private company plans to convert to IFRS go public within 5 years. It wants to know the
impact on net income and shareholders’ equity if it converts from ASPE to IFRS for impaired loans,
interest costs, actuarial gains, compound financial instrument and income taxes.
Problem 1-4 (50 min.)
While taking the role of a financial analyst, the student uses vertical and horizontal analysis and
ratios to analyse and interpret the profitability, solvency and liquidity of a private company.
Problem 1-5 (25 min.)
A private company plans to convert to IFRS. It wants to know the impact on three key ratios if it
converts from ASPE to IFRS for impaired loans, capitalization of interest and actuarial gains/losses.
Problem 1-6 (50 min.)
A private company plans to convert from ASPE to IFRS and wants to know the impact on three key
ratios if it converts from ASPE to IFRS for impairment losses, convertible bonds and income taxes.
,SOLUTIONS TO REVIEW QUESTIONS
1. There are times when external users may want financial reports that do not follow GAAP. For
example, users may need financial statements using non-GAAP accounting policies required for
legislative or regulatory purposes, or for contract compliance. A prospective lender may want to
receive a balance sheet with assets reported at fair value rather than historical cost. Accountants
have the skills and abilities to provide financial information in a variety of formats or using a
variety of accounting policies. When the financial statements use non-GAAP accounting
policies, the accounting policies must be disclosed in the notes to the financial statements. The
accountant’s report would make reference to these accounting policies.
2. The three main areas where judgment needs to be applied are as follows:
- Choosing accounting policies that are appropriate for the company’s situation
- Making estimates to accurately reflect the company’s financial position and results of
operations
- Deciding what to disclose and how to disclose it in the notes to the financial statements.
3. The GAAP-based financial statements are prepared primarily for the benefit of external users.
The financial statements provide a summary of the financial position and results of operations
for the company. Management has access to the detailed information available within the
company. Therefore, the formal financial statements should give priority to the needs of the
external users.
4. The main reason the Accounting Standards Board decided to create a separate section of the
CPA Canada Handbook for private enterprises was to address the cost/benefit discrepancy with
respect to smaller private companies’ ability to comply with GAAP. GAAP has become
increasingly complex and for smaller private enterprises this often means that the cost of
complying with such requirements outweighs the benefit received from compliance. In 2002, the
AcSB adopted differential reporting, which allowed private enterprises choices with the respect
to certain complex accounting standards (e.g. the option to use the cost method for investments
that would otherwise require the equity method). In 2009, the AcSB decided to create a self-
contained set of standards for private enterprises. These standards were effective for fiscal
periods beginning on or after January 1, 2011.
5. There are a few reasons why a private company would want to comply with IFRS even
though it is not required to do so. It may have plans to become publicly listed at some point
, in the future and will then be required to comply with IFRS. In this case it would make sense to
prepare IFRS compliant statements in anticipation of the public transaction since the company
would have to provide multiple years of comparative financial statements that comply with
IFRS. A private company may have users of their financial statements that find IFRS statements
more useful for their purposes (e.g. creditors, customers, partners, and other stakeholders that
may receive the company’s financial statements). Given the global economy and the increased
number of countries that have converted to IFRS, this is more likely than it once might have
been.
6. The following financial statement items could have different account balances under ASPE as
compared to IFRS: impaired loans, property, plant, & equipment, development costs, post-
employment benefits, income taxes, compound financial instruments, preferred shares and
convertible bonds
7. For the item listed in Exhibit 1.1, all items except for disclosure would likely change when a
company switched from ASPE to IFRS.
8. The return on assets or return on equity is typically used to assess profitability. The current ratio
is typically used to assess liquidity. The debt-to-equity ratio is typically used to assess solvency.
9. If XZY Co. had capitalized rather than expenses the development costs in Year 1, the
company’s key ratios would change as follows:
- the current ratio would increase if the development costs were classified as a current asset
because current assets would increase and current liabilities would remain the same; the
current ratio would not change if the development costs were classified as a non-current asset
because both current assets and current liabilities would remain the same;
- the debt-to-equity ratio would decrease because debt would remain the same and equity
would increase
- the return on equity change would increase because net income and equity would increase
by the same dollar amount but net income would be a higher percentage of equity after the
change
10. The six steps of the case framework are as follows:
- Determine Your Role and Requirements
- Identify Users & Their Needs
- Identify & Rank Issues
- Identify Viable Alternatives for Each Major Issue
, - Analyze Alternatives Using Criteria for Resolving
- Communicate Practical Recommendations/Conclusions
11. The report recipient is the direct recipient of your report or memo e.g. the partner who asked you
to prepare the memo. The primary users are the users who will be affected by the actions taken
as a result of your recommendations e.g. bankers and shareholders who will receive the financial
statements. The primary users should be given priority in financial reporting because they are
primary recipients of the financial statements; they are directly affected by the financial
statements. If they did not want to receive the financial statements, we would not be preparing
them and would not have to write a memo to the partner with respect to the financial
statements.
12. The biggest factor to be used when ranking the importance of issues to be resolved is the
materiality of the item. If one problem involves a $10,000 item and another problem involves a
$10 million item, then the $10 million item likely is the most important item. After that, issues
are typically ranked in the following order of priority:
- controversial or highly contentious items
- items with errors
- complex items
13. The final case report should contain your recommendations along with the analysis and
arguments supporting your recommendations. It does not need to discuss the alternatives for
each issue unless the issue was very contentious. If in the analysis stage, you determined that
there was clearly a right answer for a problem, then your report would provide only the
recommendation with the supporting arguments. If two or more alternatives were nearly equal
in benefits, then your final report could present the arguments for both alternatives along with
your recommendation as to the best option in this contentious situation.
SOLUTIONS TO CASES
Case 1-1 [IFRS: The conceptual framework for financial reporting: chapter 3]
Students may assume that IFRS is superior and that all reporting issues can (or should) be resolved
by following IFRS. However, the reporting of research and development costs is a good example of
a requirement where many different approaches can be justified when one considers the cost and
benefits involved.
,IFRS requires capitalization of development costs when certain criteria are met. ASPE allows a
policy choice between expensing all development costs without assessing whether they will provide
future benefits or capitalizing those developments costs that are expected to provide future benefits.
The issue is not whether costs that will have future benefits should be capitalized. Most accountants
around the world would recommend capitalizing a cost that leads to future revenues that are in
excess of that cost. The real issue is whether criteria can be developed for identifying projects that
will lead to the recovery of those costs. One could argue that it is too subjective to determine
whether future benefits will be realized and the assessment could be open to manipulation. History
has shown that the amount of research and development costs capitalized tended to vary as a
company experienced good years and bad. Conversely, under IFRS, development costs must be
recognized as an intangible asset when an enterprise can show that the six criteria mentioned in the
question can be met.
How easy is it for an accountant to determine whether the development project will result in an
intangible asset, such as a patent, that will generate future economic benefits?
Do the benefits of making a determination of future benefits outweigh the cost of making this
determination? No definitive answer exists for that question. Therefore, the option to simply expense
all development costs under ASPE may be a good approach especially when there islots of judgment
involved in determining whether there will be future benefits.
Case 1-2 [IFRS: The conceptual framework for financial reporting: chapter 3]
(a) Can any alternative to historical cost provide for fair presentation in financialreports or
are the risks too great? Discuss.
When we refer to ―present fairly‖ in the preparation of financial statements, we generally qualifythe
statement (as the auditors here have): ―in accordance with generally accepted accounting
principles.‖ That is, fair presentation has a contextual, rather than an absolute, meaning. In order
for any presentation to be fair to the user, the basis of presentation must be known and understood,
but does not necessarily have to follow any one particular model.
, Financial statements may be considered to ―present fairly‖ whether prepared in accordance withthe
historical cost convention, replacement cost, general price level adjusted model, or net realized
value. The important issue is that the model employed is known, understood, and consistently
followed.
Arguably, fair value accounting is the model most likely to provide fair presentation, especially
where asset values are volatile, as historical costs become rapidly out of date. For many long-
established companies, historical costs for some assets are significantly out of date and of no value
in support of managerial decisions. In managerial accounting, we have long recognized that the
relevant costs are the current costs. In some European countries, an approach to financial
reporting has developed that adopts more of a managerial approach and seeks to provide the most
relevant information for decision-making. As a result, many companies followalternatives to
historical cost, generally fair values, in the financial statements.
There are risks, however, that arise from the adoption of alternatives to historical cost. Some of these
are the same risks that arise from the historical cost model in that the recorded amount may soon be
out of date. Prices may go up or down, and even ―fair values‖ of prior periods may display no
relationship to fair values at the present date. Cost is always cost in a particular context and a cost
determined for a particular context or decision may not be valid for a differentcontext or decision
and the user should be aware of this.
The question of objective determination also arises. The reported values in fair value based financial
statements are not directly supportable by arms’ length transactions. This introduces the risk of an
important (and potentially deliberate) misstatement. This is the principal risk arising from fair value
accounting, and leads many countries to have highly detailed rules for thepreparation, audit, and
publication of financial statement asset values under fair values.
(b) Discuss the relative merits of historical cost accounting and fair value accounting. Consider the question
of the achievement of a balance between relevance and reliabilitywhen trying to ―present fairly‖ the
financial position of the reporting entity.
Students will provide a wide range of responses to this question; at this stage (unless they have been
provided with supplementary material or have background from other courses) responses will just
scratch the surface. The following note may be helpful:
