Solution Manual for Contemporary Issues in Accounting, 2nd Edition

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Solutions manualto accompanyContemporary issues inaccounting2ndeditionbyRankin, Ferlauto, McGowan and StantonPrepared bySue McGowan

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Chapter 1:Contemporary issues in accounting1.1Chapter 1:Contemporary issues in accountingContemporary issue 1.1Dick Smith hearings reveal questionable accounting of rebatesQuestions1.This article states ‘accounting standards are currently unclear’ with regard to howto account for rebates. Given these rebates seem to be quite common, can you thinkof any reasons the accounting for these could be unclear and why there may not bean accounting standard that specifies exactly how to account for these particulartransactions?2.This article claims that profits were overstated by Tesco ‘because it had bookedrebates from suppliers before receiving them’. Do accounting principles requirecash to be received before recognising items in the accounting? If not, why shouldaccounting be implicated in these profit overstatements?3.A note prepared by PricewaterhouseCoopers claims that supplier rebates arecomplex and as accounting requirements are unclear.Ultimately, getting rebate accounting correct relies on a culture and leadership thatencourages accounting for the commercial substance of rebate arrangements anddiscourages short‐term profit maximisation.What do you think is meant by ‘getting the accounting correct’? Can you identify anyfactors that would influence the exercise of professional judgement in this context?1.Thekey reason would be that rebates vary significantly and are often complex. These caninvolve for example:•Rebates related to inventory (e.g. retrospective volume rebates)•Other rebates (e.g.involving contributions to marketing and promotional costs oractivities).These rebates will be tailored to the particular circumstances (as the PWC notes states thesevary widely“reflectingthe different elements of the goods and services exchanged betweensuppliers and retailers”.)Given the complexities and variations in these rebates, it would not be feasible for theaccounting standards to specify exactly how to account for every possible rebate in everyparticular context/circumstance.The principles in the standards should be applied to reflectthe substance of the particular rebate contract/arrangement. For example, if the rebate relatedto volume rebates would need to apply the principles relating to cost of inventory in IAS2/AASB 102Inventories.Students should also consider if the accounting standards were to specify exactly how suchrebates were to be accounted for:•Is it likely such prescriptions would take a conservative approach (e.g. not allowthese rebates to be recognised/factored into costing of inventory until virtuallycertain)? If this occurred would necessarily result in faithful representation.

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.2•This would amount to a ‘rules’ based approach. If this were to occur, could thecontracts be drawn so that did not fall within the types of rebate contracts specifiedin thestandards?2.A key accounting principle isthe accrual basis: that the effects of transactions and eventsare recognised in accounting records when they occur, not when the cash is received or paid.Therefore accounting principles do not require cash to be received before recognising anitem. For example, we do not defer recognition of revenue when sales are made on credit.However, the accounting standards do specify recognition criteria. For example:•For assets it must be probable that future economic benefits will bereceived.•For revenue, the amount of any variable consideration can only be recognised to theextent that highly probable will not reverse.Given that these rebates oftenare contingent on/linked tofuture events/circumstances–suchas the sale of a particular volume/amount of inventory–this requires estimation andjudgment. For example, in the article it states that “Dick Smith breached accountingstandards by booking its rebates as profit before these were actually sold”.The argumenthere is based on the circumstances of Dick Smith where the inventory was not able to be sold.However, if a company has a history of easily selling and forecasts indicate that it will sell atleast the amount of inventory required to receive the rebate, then it would be expected to beentitled to this rebate (and thus would reduce the cost of inventory by the rebate expected tobe received).It could be argued that accounting is implicated as:•It does not require certainty (or is not conservative enough), and./or•In these cases there were inappropriate estimations/judgments made.3.‘Getting the accounting correct’ would mean that the accounting reflects the substance ofthe arrangements and applies the principles of the standards to reflect a true and fair view.Remember that the objective of financial accounting is to provide useful information to users,that is relevant and faithfully represent what it purports to represent.Factors that couldinfluence professional judgment in this context would be:•Complexity and variation in arrangements, which leads to more possible alternativeaccounting treatments•The continent nature of these rebates involves uncertainties which need to be assessedand evaluated and this can make these more problematic and ambiguous.•Given the above, pressure from clients/companies to exercise professional judgment‘favourably’ for the company.•In addition, the apparent widespread ‘early’ booking of such rebates would seeminglyfurther justify that this may be ‘acceptable practice’.

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Chapter 1:Contemporary issues in accounting1.3Contemporary issue 1.2Blockchain technology: everything you need to knowQuestions1.This article explains that blockchain is both transparent and secure. Would theadoption of a technology such as blockchain mean that accountants would no longerneed to use professional judgement in determining how to account for or reporttransactions and events?2.Identify any technologies or programs that are currently used in accounting firms orfor undertaking accounting tasks in businesses. Using the internet to research, arethere any developments or available alternatives for these technologies?1.The simple answer is no; the introduction of blockchain does not mean that professionaljudgment would no longer be required. This is because:•The nature ofblockchain is that it is essentially a database that is an alternative to thetraditional ledger. The advantage is in processing and also verification.However atransaction would still need to be added to the database and determining how torecord the transaction would still require professional judgment.Further, financialreporting requires the determination of what information to present (e.g. applicationofmateriality)andhow,andsuchdecisionswouldstillrequireprofessionaljudgement.2.A simple internet search reveals that a range of programs and technologies are used inaccounting firms or to undertake accounting tasks. These range from:•general programs (such as excel, word, email)•accounting packages (such as MYOB)which are also now cloud based•audit software(such as eAudit: IDEA Data Analysis)•tax preparation software•document management software for client files•project management programs.Answers re developments or alternatives will vary depending on what students find in theirsearches. Howeverpredictions are that:•There will be development of intelligent automated (smart) software that will replaceroutine tasks and automate complex and multifaceted processes.•Cloud based programs will increase.

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.4Contemporary issue 1.3Some answers, more questions over Dick Smith failureQuestions1.Thisarticleexplicitlyreferstoearningsmanagementresearch.Howhasthisresearch been used in this article to assist in explaining the Dick Smith failure?2.The article states ‘If one subscribes to the conclusions within accounting research’.This proviso implies that others may question the conclusions of the research used inthis article. Can you think of reasons why particular theories or research would notbe accepted?3.This article states that the auditors, Deloitte, questioned the rebates, realised thatinventory values were too high, yet certified that the company was a going concern.A review of the 2015 annual report indicates that inventory represented almost 60%of total assets and was twice the net asset amount. However, in this report there is nomention of these rebates or their impact on profit and the audit report does notsuggest any issues of concern. Referring to the previous definition of professionaljudgement in this chapter, in your opinion what elements in that definition may nothave adequately been practiced?1.Earnings management is defined there as “a manger’s use of accounting discretion throughaccounting policy choices to portray a desired level of earnings in a particular reportingperiod”. However as the article discusses, earnings can also be managed by not simplymanipulating accounting but by manipulating actual transactions or activities. This article hasused the research relating to ‘real activities management’ to analyse the actions of Dick Smithto determine if the transactions (activities) entered into by the company have been chosen,not on the basis of the ‘good business’, but because these transactions enabled the companyto improve their reported financial position. Further the research has been used to explain:•Why Dick Smith used such earnings management strategies (as needed to ‘support’expectation of growing business).•That such earnings management strategies assist in short term and ultimately have anegative effect in longer term (and so exacerbate issues for companies in financialdistress).2.The conclusions referred to in the article areessentially that incentives for managers tomake decisions, not on basis of sustaining business but rather on managing earnings figures,wouldincreaseandtherefore,giventhatdecisionsnotmadetopromotelongtermprofitability it was dangerous (in terms of the company’s survival).However, the article notes research that indicates that 80% of CFOs surveyed indicated thatthey would undertake some form of earnings management. Yet there is no indication thatsuch earnings management would result in such companies necessarily failing.There may also be other theories that could explain the demise of Dick Smith or the actionsthat were taken. For example, in the Enron scandal the corporate culture was implicated.

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Chapter 1:Contemporary issues in accounting1.53.The definition in the textfrom the American Accounting Association defines professionaljudgment as:Professional judgment is a process used to reach a well‐reasoned conclusion that isbased on the relevant facts and circumstances available at the time of the conclusion.A fundamental part of the process is the involvement of individuals with sufficientknowledge and experience. Professional judgment involves the [clarification of issuesand objectives, and the] identification, without bias, of reasonable alternatives;therefore, careful and [unbiased] consideration of information that may seemcontradictory to a conclusion is key to its application. In addition, both professionalscepticismand objectivity are essential to the process and to reaching an appropriateconclusion.Professional judgment would have been required to make decisions regarding:•The disclosure and accounting for the rebates•The (over) valuation of inventory•Assessment of whether the company was a going concern.The article states Deloittes questioned (or was aware of some of these issues), but ultimatelydid not exercise their professional judgment to, for example, require disclosure or changes inaccounting for the rebates (or indicate going concern basis dubious).In relation to definition could be argued that:•Given relevant facts and circumstances at the timeconclusion reached was not ‘well-reasoned”.•Failure to consider information carefully or in unbiased way•Did not exercise professionalscepticismor objectivity.

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.6Review questions1.1‘Accounting is merely a technical exercise and all accountants need to do is followthe rules’. Drawing on your understanding of accounting, discuss whether thisstatement is correct.(LO1)Students should disagree with this statement and note the following:•The nature of accounting is that it is not like a ‘hard science’ where there is onecorrect answer.•Although there are accounting standards that prescribe the accounting treatment forspecific transactions/events these often do not include ‘black and white’ rules. Thestandards are primarily principles based requiringconsideration of substance overform andthe exercise of judgement in applying these. The text notes that even simplyapplications, such as choosing a depreciation method requiresjudgement. Furthersome accounting standards allow a choice.As the text states:The shift to principles‐based standards acknowledges that the mechanisticcompliance to a set of rules may not result in the accurate portrayal of theeconomic substance events and transactions. Although guidance is provided inthe standards, the application of the principles requires the exercise ofjudgement.•As the text notes it is unlikely that the standards (‘rules’) will cover even possibletransaction/ event or directions for the application of the principles in even potentialscenario. Therefore judgment (and choices) will be required.•The text notes that the standards often lag behind events and transactions in the realworld. Therefore even if the standards contained simple rules to follow, there may notyet be standards aboutemerging new transactions.1.2What is meant by ‘professional judgement’? Consider the Pathways Vision Modelin figure 1.1 and explain the role of professional judgement in accounting.(LO1)The definition in the text from the American Accounting Association defines professionaljudgment as:•Professional judgment is a process used to reach a well‐reasoned conclusion that isbased on the relevantfacts and circumstances available at the time of the conclusion.Students may consider common definitions such as:•Judgment is the ability to makeconsidered decisions.•Professional is one engaged/qualified in a particular profession.The American Accounting Association further states in relation toprofessional judgmentthat:•A fundamental part of the process is theinvolvement of individuals with sufficientknowledge and experience. Professional judgment involvesthe [clarification of issuesand objectives, and the] identification, withoutbias, of reasonable alternatives;therefore, careful and [unbiased] consideration of information that may seemcontradictory to a conclusionis key to its application. In addition, both professionalscepticismand objectivity are essential to theprocess and to reaching an appropriateconclusion.

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Chapter 1:Contemporary issues in accounting1.7Thus the first requirement for professional judgment is a person who has the requisiteknowledge and skill setgiven the particular context.If we consider the pathways model (figure 1.1) this clarifies that:•There are no ‘black and white’ choices but what the model calls ‘shades of grey’•Thus judgments are required by accountants to determine the appropriate accountingtreatment and the resulting information to be provided.•Critical thinking underpins accounting (i.e. professional) judgment. This wouldinclude the need to:-clarify the issues-identify appropriate alternatives-analysecarefully information.All of these would require an understanding of objectives and evaluation of potential impacts.From the Pathways model students should see that the role of professional judgment isfundamental in accounting. This is evidenced by the fact that the American AccountingAssociation have identified this as the defining attribute of the accountingprofession.Students may want to consider the alterative. If there was no need for judgment inaccounting, what role would an accounting professional have? If accounting was simply theapplication of a set of specified and immutable rules-a mechanical exercise–surely asoftware program could largely replace accountants.1.3Define what is meant by ‘theory’ and explain how theory is useful. Do you thinktheory needs to be considered in accounting?(LO2)As the text notesthere isno simple definition of ‘theory’ andit can mean different things indifferent contexts.The following are dictionary definitions of what a theory is:•a belief or principle that guides actions or behaviour (such as behavioural theories ofpositive reinforcement or theories in management about motivating employees)•an idea or set of ideas that is intended to explain something (such as Darwin’s theoryof evolution)•the set of principles on which a subject is based or of ideas that are suggested toexplain a fact or event (such as economic theory or the theory of relativity)•more generally, a conjecture or an opinion.Accountants are required to exercise professional judgment and underpinning this is criticalthinking. Critical thinking requires a considered analysis of information and, identificationand evaluation of alternatives. Professional judgment will also require (as outlined in thePathways model) accountants to decide, given their analysis, what information should beprovided to optimise decision making by users. Thus, students should see that theory (andrelated research) will be required in the exercises of professional judgment.For example,howcouldalternativeaccountingtreatmentsordisclosuresbeconsideredwithoutanunderstanding of how information is used, or impacts on investment decisions?So for example, theory needs to be considered in financial accounting to reflect the decision-makingbehaviourofmanagersandinvestors,companypolicies,politicalactivityorprofessionalism of accountants.

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.8Accounting theory definition means as stated by Henderson et al. 2004 p.4‘a description,explanation or a prediction [of accounting practice based] on observations and/or logicalreasoning’…‘Logical reasons in the form of a set of broad principles that (1) provide ageneral framework of reference by which practice can be evaluated and (2) guide thedevelopment of new practice and procedures’Students should discuss how theory can help in accounting. Theories can:•describing andexplaining current accounting practices•predicting accounting practice•providing principles to take into account when taking action or making decisions•help to identify problems and deficiencies with current accounting practice andimprove accounting practice.Examples are that a theory of accounting can:a.provide a basis for action: for example, a theory of capital budgeting helps us withchoosing among investments; a theory of revenue recognition helps to determinewhen and how revenue should be recognised; a theory of lease accounting helps withaccounting for leasesb.revealdeficienciesinpractice:atheoryofprofitdeterminationmightrevealdeficiencies in the way we presently measure profitc.improve practice: understanding deficiencies may promote change; understanding thebehaviour of decision makers may help us to supply better informationd.help with accounting standard setting; the conceptual framework is used as a basis fordrafting accounting standards.1.4It has been stated that ‘many people accept theories without justification’. Identifyreasons people may accept theories. Provide examples of theories that you accept orbelieve although you may not have direct knowledge in the area.(LO3)Students may identify various theories that they accept but have no expert or directknowledge of: e.g. theories re global warming, theories on punishment (e.g. that deterscrime), theories on black holes in space; theories on causes of diseases (such as geneticdepositions).For many theories that a person considers, that particular individual may not have an in-depthknowledge of the area relating to the theory. For example, I believe that the world is not flatand that in fact the theory that the world is round is true. However, I am not a scientist; I havenot studied detailed evidence about this theory in any scientific or systematic manner, sowhat makes me accept this theory, or other theories that are not in my area of expertise.People accept theoriesevery daythat they may not fully understand (such as theories ofglobal warming; the theory of relativity; theories about how certain diseases are spread).There are a number of reasons why we may accept theories without ‘first–hand’ or directknowledge, these include:1.The authority of the source of the theory.If the theory comes from a source perceived as having specific knowledge and expertise thenwe may defer to their superior experience and wisdom. If the ‘experts’ in the area say it is

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Chapter 1:Contemporary issues in accounting1.9true then we are more likely to believe it is true, particularly when the expert providesevidence to support the theory. Statements and theories from eminent scientists or researchersin an area, by teachers (such as university lecturers), from textbooks, even from mediasources (such as television and newspapers) are often viewed as authoritative. We are willingto often accept a theory as correct due towhomor where the information about the theorycomes from (they wouldn’t say it if it isn’t true would they?).2.It ‘fits’ with our own experience.We are also more willing to accept a theory if the theory matches our own experiences andobservations. The theory that the earth is not flat and is in fact round agrees with my ownobservations of the slightly curved horizon, and the sun setting so I am willing to accept thistheory.3.It makes sense.If a theory seems reasonable and sensible we will often accept it.‘If a man is offered a fact that goes against his instincts, he will scrutinize it closely, andunless the evidence is overwhelming, he will refuse to believe it. If, on the other hand, he isoffered something which affords a reason for acting in accordance to his instincts, he willaccept it even on the slightest evidence. (Bertrand Russell).For example, there are various debates about how much alcohol is safe to drink and that oneor two drinks a day may actually be of benefit to aperson’shealth. Many people wouldbelieve this is reasonable and further it may fit with their own preference to drink alcohol sowould accept this.4.Perceived level of general acceptance.A key influence on many people’s beliefs is what other people believe. If a theory appears tobe accepted by many people, particularly if it is repeated. For example, if a poll shows that82% of people believe that introducing gun controls will reduce violent crime, you may bemore likely to accept this. This appeal to general acceptance is often used in advertising andpolitical campaigns, such as ‘3 million Frenchmen can’t be wrong. Buy a Renault’. Ofcourse, just because most people believe something does not make it true. As we notedearlier, many people believed the world was flat but this did not mean that the world was infact flat.These approaches to accepting theories are intuitive ratherthan scientific or systematic andgiven that any individual’s expertise is necessarily limited, provide a practical and rationalway of determining whether an individual accepts a specific theory.

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.101.5Identify a theorythat you have heard about(this can be about any area; e.g. globalwarming). Consider how you would test whether this theory was true. Do you thinkyou could prove it?(LO4)Think of a theory thatdescribes what is happening or explains what is happening. The firststep in testing the theory would be to evaluate its logic.Is the theory logical andgivesa validconclusion given its premises?Sofor example, there may be a theory about global warmingthat measures the hole in the ozone layer and links this to changes in average temperatures.The next consideration would be to consider the evidence. Does the evidence ‘fit’ with, orperhaps contradict, the theory?For example, if the theory regarding temperature changerelated to global warming simply predicted that the temperature may change whateverhappened, would fit with the theory and this could not really be tested. However if it made aclear prediction—for example, that in 2008 temperatures in a particular region wouldincrease by 1% then we could test this by observing the temperatures in that region. If theobservations are not consistent with the predictions of the theory we have established then thetheory is incorrect. If the observations ‘fit’ with the theory then we can claim that theevidence supports thetheory(i.e. that it has not been contradicted or falsified). It is generallyaccepted that theories cannot be ‘proved’ correct because of the problem of determining howmany ‘correct’ observations are enough to establish the truth of a theory.Students should recognise that even well accepted theories (such as Einstein’s theory of theBig Bang) have been later proven wrong when better observations have been able to be made.1.6What is your understanding of the term ‘research’?(LO4)The Macquarie dictionary states that‘research’ is:•‘diligent and systematic enquiry or investigation into a subject in order to discoverfacts or principles’.A view of research taken from FASB’s research and development is:•Research is planned search or criticalinvestigation aimed at discovery of newknowledge with the hope that such knowledge will be useful in developing a newproduct or service or new process or technique or in bringing about a significantimprovement in an existing product or for a significant improvement to an existingproduct or process whether intended for sale or use. It includes the conceptualformulation, design and testing of product alternatives, construction of prototypes,and operation of pilot plants. It does not include routine or periodic alterations toexisting products, production lines, manufacturing processes, and other ongoingoperations even though these alternations may represent improvements and it does notinclude market research or market testing activities.11Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 2 ‘Accounting forResearch and Development Costs’. Stamford, C.T: FASB, 1974) par 8.

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Chapter 1:Contemporary issues in accounting1.111.7Explain the role of research and how this relates to theory.(LO4)Students should firstly understand that research is activity. The relationship to theory dependsonthereasonfortheresearchbeingundertaken,thetypeofresearchand/ortheresults/findings of the research. Research can be undertaken before any theory has beenformed or considered. The findings of such research could lead to the formation of a theory(either positive or normative). Research can also be used to test theories. For example, youcould test the hypothesis of a positive theory and see if the findings match the predictions ofthe theory.Below some types of research are listed–these are not discussed in the text but may beuseful to provide examples to students of research. It may also be useful to have studentsexamine abstracts of academic articles and consider how the research in these relates totheory.Research may beexploratory, descriptive, investigative, causalor some combination of these(Kent, 2001).Exploratoryresearch aims at finding out whether or not something exists(Dane, 1990, p. 8). As such it is about generating ideas, insights or hypotheses rather thanmeasuring, testing or evaluating those ideas, insights or hypotheses. For example, earlyresearch in environmental accounting was aimed at finding outifcompanies were providingenvironmental information in their annual reports.Descriptiveresearch is concerned withproviding more detail (a more complete picture) about something, and so may involvemeasuring the sizes, quantities or frequencies of characteristics, but not investigating therelationshipsbetweenthem.Forexample,researchinenvironmentalaccountinghasinvestigated the exact nature of the environmental disclosures made by companies byrecording the quantities of words included in reports about the environment and the natureand type of environmental information provided. When the research focuses on the extent ofassociation or correlation between two or more variables, the research isinvestigative. Thismay often involve predictions (i.e. if one event occurs can predict that another event willoccur) although it may not explain the cause of this link or correlation. For example,researchers have investigated the question of what factors are associated with companies thatreport environmental information and others that do not. Findings in this area have indicatedthat there appears to be a correlation between the size of a company and the type of industry,and whether it reports environmental information (e.g. that larger companies or companies inmore environmentally sensitive industries, such as mining, are more likely to include thistype of information in their annual reports).Causalresearchextendstheinvestigationbydistinguishingbetweendependentandindependent variables, and examines the degree of, and reasons for, the influence of one ormore independent variables upon the one or more dependent variables. For example, this mayinvestigatethequestionastowhy(whatcauses)companiesthatarelargeincludeenvironmental information in their annual reports more often? Researchers have consideredthat one reason could be to manage the relationships and expectations with stakeholders.

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.121.8Research can be classified in several ways. Outline them.(LO5)The answer to1.7 providestypes/classifications of research in general. In accountingresearch, there are 2 broad classifications. These are:•research of or about accounting. This considers the broader role of accounting•research in accounting which focuses more on the actual practice of accounting.In addition research in accounting can be classified into particular areas (although theseoverlap). The text identifies:•Capital markets research.Capital-market research was undertaken by Ball & Brown(1968) and Beaver (1968) that began the positive research stream. Their studiesinvestigated the use and impact of accounting information by capital markets.•Accounting Policy choice research.Accounting policy choice research is commonlyknown as positive accounting theory for its domination of research which began withWatts & Zimmerman (1978). This research attempted to explain the motivation.•Accounting Information Processing Research.Accounting information processingresearch investigates the use and users of information in the decision-making processand uses theories and models from psychology.•Critical Accounting Research.Critical accounting research considers the role ofaccounting in society and the social content.•International Accounting Research.International accounting research considers thecallforuniformaccountingstandardsworldwideandtoharmonisefinancialaccounting.1.9Explain why case studies are used and outline the suggested steps in answering casestudies.(LO6)Case studies are trying to portray a ‘real life’ problem but often in simplified form. Thisallows students to:•be exposed to some of the complexities of ‘real life’ problems•practice integrating and applying discipline knowledge and theory•develops analytical and critical thinking skills•develops communication skills•practice decision making and judgement, especially where alterative solutions arepossible.The suggested steps in answering a case study are outlined infigure 1.2 of the chapter (on thenext page).

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Chapter 1:Contemporary issues in accounting1.13

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.14Application question1.10(a) Search (either on the internet or via your library database) for academicjournals that publish research in accounting. Some examples of journals are:•The International Journal of Accountinghttps://www.journals.elsevier.com/the-international-journal-of-accounting/•Accounting, Auditing & Accountability Journalhttp://www.emeraldgrouppublishing.com/products/journals/journals.htm?id=aaaj•Journal of Accounting Researchhttp://onlinelibrary.wiley.com/journal/10.1111/(ISSN)1475-679X•Abacushttp://onlinelibrary.wiley.com/journal/10.1111/(ISSN)1467-6281(b) Read the abstracts for three articles in the latest issue of two of the journalsyou have located and for each abstract:•identify the purpose of the research undertaken•explain how this research could assist in improving accounting.(LO4 and LO5)(a)The answers here will depend onthe articles chosen.To illustrate one example is includedbelow:•Xingqiang Du, Wei Jian, Shaojuan Lai (2017)Do Foreign Directors MitigateEarnings Management? Evidence from China, TheInternationalJournal ofAccounting, Vol 52, Issue 2, pp. 142-177.Abstract:•In this study, we use a sample of Chinese companies to examine the monitoring roleof foreign directors in deterring earnings management. Our findings show thatearnings management is significantly negatively associated with the presence andratio of foreign directors on corporate boards. We further find that, under theseconditions, earnings management is less pronounced in state-owned enterprises ascompared to others. These findings are robust to various specifications of earningsmanagement as well as to the approach used in matching the treatment and controlsamples. Interestingly, the negative impact of board membership of foreign directorson earnings management varies with audit quality, IFRS convergence, investorprotection and the similarity or difference of the time zones of the foreign directorsand China.(b)(i)The aim of this research is to determine whether the inclusion of foreign directors impacton earnings management (Earnings management is defined there as “a manger’s use ofaccounting discretion through accounting policy choices to portray a desired level ofearnings in a particular reporting period”).

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Chapter 1:Contemporary issues in accounting1.15(b)(ii)Earnings management is undesirable as this undermines the core aim for financialreporting to faithfully represent the performance of a company. As this research has foundthat the presence where there are foreign board members there is less earnings management.Prima facie students could argue that this could improve accounting by, for example, leadingto corporate governance requirements for foreign board members to reduce earningsmanagement. However care needs to be taken in interpreting any research findings. Anassociation foundbetween 2factorsdoes not necessarilyimply a causal link (Think of therooster crowing in the morning just before the sun rising). For example, in this instance itmay be that the culture of the companieswith foreigndirectors mitigates earningsmanagement overall, rather than simply the presence of foreign directors.

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.16Case study questionsCase study 1.1Economic theories that have changed us: efficient markets and behavioural financeQuestions1.Briefly outline the two theories that are explained in this article.2.The article statesthat these theories prescribe opposite actions for investors. If youwere considering investing in the share market, which theory would you follow?How did you decide?3.Discusswhetheryoubelievethatthesetheorieshaveanyrelevanceto,orimplications for, accounting or accountants?4.The article states ‘there are two things that never makes any sense: investing in astock because you think it’s a good company . . . or picking an industry that youthink is going to do well’. Does this mean that you should invest in bad companies,or if the industry is doing poorly? Explain your answer.5.Discuss how this article may illustrate the overall limitations of theories.(LO2, LO3 and LO6)1.The first theory is the efficient market. This essentially argues that stock (share) pricesreflect all available information.The second theory is behavioural science. Thisessentiallyargues thatdecision makers (in thisinstance investors) do not act in rational or unbiased fashion but base investment decisionsoften on cognitive biases.2.As the article states:•If accept efficient market hypothesis, then investors cannot ‘pick’ or identify goodorbadbuysbyanalysinginformationandassuchshoulddiversifytheirinvestments.•If accept behavioural science view then you can potentially (although as articlestates this is difficult) identify mispriced stocks (these are mispriced due tocognitive biases) and therefore earn profit (above overall market returns).In deciding which theory to follow students should consider:•Evidence for each theory. The article argues that evidence confirms behaviouralscience view, but that in long run stock prices conform to efficient market hypothesis.Further evidence supports the ‘random walk’ of stock prices.•Personal factors such as:oare you investing for short or long term?odoyou have the requisite knowledge or skills to take advantage of thepotential profits to be made accepting behavioural scienceview?owhat level of risk are you willing to accept?

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Chapter 1:Contemporary issues in accounting1.173.These theories are used in capital market research which is an important research area inaccounting. Given that a key role for financial reporting is that accounting information shouldbe useful to investors there is an assumption that accounting informs investment decisions,including those relating to stock/share transactions. Cleary these 2 theories have implicationsfor accounting as these propose different ways investors use information in their decisionmaking..4.The statement in the article is not suggesting that you should invest in a bad company or anindustry that is doing poorly.What it is saying is that the fact that a company is ‘good’ (orindustry doing well)–by this we assume for example, profitable or has high returns–is noton its own a valid reason for purchasing shares in that company or industry. The decision toinvest in a stock/share should be based on the expected return and risk (this will be byconsidering such issues as dividends and changes in share prices) given the investmenttimeframe. For example:•Evidence suggests that a company’s stock price may be temporarily higher followinga unexpectedly good earnings announcement. Further, according to the efficientmarket hypothesis the fact that a company is ‘good’ would already be factored intothe stock price.•Thestockpricesofcompaniesinanindustrydoingpoorlymayoffermoreopportunity forhigherexpected returns, especially if prices have fallen and, ifacceptingthebehaviouralscienceview,investorsmayhaveoverreactedtounexpectedbad news.5.Students could discuss:•These two theories providecontradictoryprescriptions ofhow to invest in stocks yetthere is evidence to support each of these. How thencan someone decide what actionshould be taken?•Both theories make general predictions. This means these may be of limited use to anindividual investor or a specific investment decision.

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.18Case study 1.2Accounting for power: the history of an industry that shaped the worldQuestions1.Do you think the claims made in this article about the impact of accounting on theworld are consistent with the role of accounting as depicted in the Pathways VisionModel infigure 1.1? Explain your answer.2.The article infers that accounting has privileged corporate interests over broadersocial interests. Identify an example of this from the article. Do you believe thataccounting has a role in balancing the interests of corporations and society?3.The article claims that ‘complexity brought creativity’ and that accountants‘exploited loopholes’. Can you suggest any ways to reign in ‘creativity’ byaccountants? Do you believe that more exact accounting rules (rather thanprinciples‐based rules) would help solve the problem of creative accounting?(LO1 and LO6)1.The Pathways vision model shows a clear link between the information provided via theaccounting process and the prosperity of society–it explicitly recognises the impactaccounting information has on decision making which subsequently has economic (andsocial) impacts.The article claims also recognises this by arguing that accounting‘has become a key socialtechnologyof a capitalist society’ and ‘is a set of practices that affects the social reality weinhabit’.Thus in this sense the article is consistent with the Pathways vision model as itrecognises the key impacts (and affects) that accounting can have on society.2.The article argues that accounting:•Enabled growth via allowing separation of ownership and management andultimately stock markets.•Underpinned imperial expansion and advance of global capitalism.•As its key role was to control and protect investments accounting privileged thewealthy (those with capital) and determines income distribution and thus is complicitin the concentration (uneven distribution) of wealth in society.•Creative accounting has allowed corporations to minimise taxes.One example from the article relates to the British Empire and the fact that any part of theBritish Empire was subject to the British accounting models (which were based on theaccounting system,largely drawn from theindustrial revolution) and that protected corporateinterests.Whether or not students believe that accounting has a role in balancing the interests ofcorporations and society,or how far this role should extend,will depend at least in part onpersonal beliefs and this is subjective.For example, those who believe that free market forces will result in growth and overallincreases in prosperity would probablyargue that the accounting profession’s (in particularfinancial reporting) role is limited, and that social interests should bedetermined bygovernments.

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Chapter 1:Contemporary issues in accounting1.19Others would argue thatsince accounting information is used so pervasively in decisions,particularly about allocation of resources, that the accounting has a duty to consider the widerimpacts on society. The call for environmental accounting and triple bottom line reporting isan example of this.The Pathways vison model suggests that accounting has consequences and if professionaljudgment results in optimal information this will lead to ‘good’ decisions and a ‘prosperous’society.However what a particular individual considers ‘good’ or ‘prosperous’ will dependon their individual beliefs and philosophies.Students may also note the issue of accountability of accountants. Is this to their client (whopays them and who they have a legal duty to service within legal restraints) or is theiraccountability wider?3.Creativity in accounting is essentially wherebut accounting choices are made tomanageordistort the information in the financial reports (usually resulting in these being biased and notproviding a true and fair view). In most cases, the rules (accounting standards) are followedbut the way these are applied deviates from the spirit of principles embodied in theaccounting standards. Creativity can also be via the manipulation or creation ofevents/transactions (for example, sham sales or selling assets at a profit just prior to end ofyear to offset losses, or structuring a contract so that it falls outside the ambit of a particularaccounting requirement–i.e. exploiting a loophole). Complexityis usually associated withsuch creativity, as it would be more difficult to justify or obscure ‘creative’ choices for moresimple and transparent transactions.Students could identify various possibilities to reign in creativity by accountants (see below)but should also consider how effective these would be.Possible means to reign in are:•legal sanctions (but if following letter or law then these would not be effective)•ensuring independence of accountants (There are for example requirements forindependence of auditors).•requiring disclosure where choices or assumptions have been made. This would makejudgments more transparent. However given complexity would this be effective.•placing ethical duties/obligations on accountants. (Professional bodies do haveethicalstandards that they expect/require members to comply with).More exact accounting rules it could be argued could reign insomecreative accountingtechniques. Prima facie if there are specific rules then accountants cannot usejudgment/discretion to manipulate financial results.However, even if rules based standards were to replace principles based standards:•These would need to beveryspecific, extensive and complex to cover ever potentialsituation/event/transaction. It is therefore unlikely that judgment/discretion would becompletely replaced (the judgment may relate to deciding which rule applies in theparticular situation).•The move to principles based standards was, at least in part, driven by history thatshowed specific rules could be manipulated and could lead to the structuring oftransactions to avoid certain rules. For example, in the US lease contracts weredevised specifically to avoid the requirements to account for finance leases (as a

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.20previous leasing standard contained ‘exact’ rules). Financial scandals including Enronand Worldcom also involved structuring transactions around certain ‘rules’.•Rules based standards would usurp higher ethical standards. The focus would be oncomplying with the rules, rather than providing the ‘best’ information and a true andfair view..

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Chapter 1:Contemporary issues in accounting1.21Case study 1.3Abstracts from critical accounting researchQuestions1.In each of theseabstracts the notion of true or fair accounting for financialstatements is considered. Identify any requirements in accounting standards orcorporations legislation that relate to the truth or fairness of financial statements orreports.2.Can you think of reasons why there could be claims that financial statements thatare prepared in accordance with accounting standards are not true or fair?3.The first abstract states that current accounting ‘may disenfranchise those partiesto the dispute whose issues are not readily expressed in the common vocabulary ofbusiness’. What do you think the author means by ‘the common vocabulary ofbusiness’? Given this, what type of issues may not be included in accounting reportsor statements and how could their exclusion impact on decision making?(LO1 and LO6)1.The accounting standards require that the financial statements provide a fair presentationand state:•Financial statements shall present fairly the financial position, financial performanceand cash flows of an entity. Fair presentation requires the faithful representation of theeffects of transactions, other events and conditions in accordance with the definitionsand recognition criteria for assets, liabilities, income and expenses set out in theFramework. The application of IFRSs, with additional disclosure when necessary, ispresumed to result in financial statements that achieve a fair presentation.(IAS1/AASB 101, para 15).It should be noted that the concept of faithful presentation and whether there can be a trueand fair view is contested.In Australia corporationslaw, S297, requires that:•Thefinancial statementsand notes for afinancial yearmust give a true and fair viewof:(a)the financial position and performance of thecompany,registeredscheme ordisclosing entity; and(b)if consolidatedfinancialstatementsare required--the financial position andperformance of theconsolidated entity.This section does not affect the obligation undersection296for afinancial reportto complywithaccounting standards.Note:If thefinancial statementsand notes prepared in compliance with theaccountingstandardswould not give a true and fair view, additionalinformationmust beincludedin thenotes to thefinancial statementsunder paragraph 295(3)(c).There is similar legislation in many countries.

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.1.222.The assumption made in the standards is that compliance with accounting standards will,expect in rare cases, result in a true and fair view.Reasons for considering that financialstatements prepared inaccordance with accounting standards may not present a true and fairview could include:•Some accounting standards do not allow professional judgment and have set rules,regardless of whether these rules reflect the substance. For example, internallygenerated intangible assets (such as goodwill, brands) are not permitted to berecognised under current standards, yet these may be valuable assets to an entity.Another example is that in the previous leasing standards no assets or liabilities arerecognised for operating leases despite the fact that most of these leases would meetthe definition and recognition criteria for such elements under the conceptualframework(Note: this deficiency was acknowledged and thisstandard has nowbeen revised).•From a critical perspective, the limitations of information provided by accountingrender these statements incomplete and biased, toward financially measurableelements, and so would not be considered true and fair (see answer to 3 below).Students may identify further reasons.3.•The common vocabulary of business here would refer to monetary or dollars values(so financially measurable elements). This is also normally restricted to ‘direct’ andmeasurable costs and benefits (so other factors,e.g.externalities such as pollutionor employee satisfaction/morale are not included unless directs costs associatedwith these). Further, the prime objective of business is ‘profit’ and this profitorientation is reflected in what is included and how measured and gives primacy toeconomic factors/issues and often short term outcomes.•A few of the issues not included would be social justice, environmental concerns,and socialequity issues. Typically decisionmaking frameworks suggestthatdecision makers should take into account both qualitative and quantitative factors.However if the variable /factors considered are restricted to those in the financialstatements this will effectively exclude most qualitative factors. A quote by John FKennedy (although this is in the context of gross national product, this illustrates thelimitations of quantitative information and hence can be extrapolated to accountingissues).-Gross National Productcounts air pollution and cigarette advertising, andambulances to clear our highways of carnage. It counts special locks for ourdoors and the jails for the people who break them. It counts the destructionof the redwood and the loss of our natural wonder in chaotic sprawl. Itcounts napalm and counts nuclear warheads andarmouredcars for thepolice to fight the riots in our cities. It counts Whitman's rifle and Speck'sknife, and the television programs which glorify violence in order to selltoys to our children. Yet the gross national product does not allow for thehealth of our children, the quality of their education or the joy of their play.It does not include the beauty of our poetry or the strength of our marriages,the intelligence of our public debate or the integrity of our public officials. Itmeasures neither our wit nor our courage, neither our wisdom nor ourlearning,neitherourcompassionnorourdevotiontoourcountry,itmeasures everything in short, except that which makes life worthwhile.(Robert F. Kennedy, University of Kansas, March 18, 1968).

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Chapter 2:TheConceptual Framework of FinancialReporting2.1Chapter 2: TheConceptualFramework of Financial ReportingContemporary issue 2.1No need for prudenceQuestions1.Do you agree or disagree that re‐including prudence in theConceptual Frameworkisa bad idea? Give reasons for your answers.2.How would you choose to measure theliability in the example if:(a)the framework did include the definition of prudence (as defined in theProposed Framework)(b)no reference to prudence was included in the conceptual framework(c)prudence was included but was defined as asymmetrical prudence?3.Reflecting on your answers in question 2, what impact would these alternatives haveon the quality and usefulness of financial reports?

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.2.21.For background:the definition of prudence in theProposed Frameworkis ‘the exercise ofcaution when making judgements under conditions of uncertainty’(2.18). This is interpretedas ‘cautious prudence—being equally cautious when making judgements about any items,‘without needing to be more cautious in judgements relating to gains and assets than thoserelating to losses and liabilities’ rather than asymmetric prudence. The IASB argues that thisisconsistent withneutrality;‘A neutraldepiction iswithoutbias in the selection orpresentation of financial information (2.17).’It will be a personal position as to whether or not students agree with re-including prudence.Some arguments for/against would be:•Unnecessary to include as professional judgment would require care/caution to beapplied where there is uncertainty even if prudence was not explicitly included in theframework.•Inclusion causes more confusion as there can be different interpretations, especially ifguidance lacking.•Is useful to include as emphasises need (and therefore an obligation/duty) toespecially take care in conditions of uncertainty.•Could argue that unnecessary for application, however as many constituents arguedfor its reintroduction, a compromise made to assist in acceptance of changes to theframework (so political reason).2.Students should recall that relevance and faithful representation are thetwo fundamentalcharacteristics that information needs to have to be useful for users. So these need to beconsidered.Asnotedaboveprudencesupportsneutralitywhichispartofafaithfulrepresentation.A faithful representation requires representation to faithfully what it purportsto represent and to be complete, neutral and free from error.This also requires a descriptionof what the number represents.There are no correct answers to (a) to (c) below as this is open to interpretation (andbalancing the fundamental qualitative characteristics) but possible choices are provided.2. (a)Could argue $250. Thistakes into account all of the information known, but is not thelowestamount (so a cautious approach).2. (b)Could argue either $100, as this the most likely amount, or the expectedvalue of $250,as this factors in all the known information objectively.However it could be argued I would argue that the same measures would be used for both (a)and (b) as prudence in theProposed Frameworkis supporting neutrality.2. (c)As focus is on ensuring liabilities not understated then could argue $500, as with anyother measure there is the possibility that liability isunderstated.3.With these small numbers in the example, it probably would not impact on quality orusefulness.However if these were in millions and larger variations, then they could bematerial.If for example, included ‘additional’ $400 million in expenses and provisions, whenthis is unlikelytooccur, this could be argued to be distorting the financialpositon/performance.

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Chapter 2:TheConceptual Framework of FinancialReporting2.3Contemporaryissue 2.2New lease accounting to have big impactQuestions1.Consider the definitions of an asset and liability in theProposedFramework. Woulda 5-year lease for land meet these definitions?2.The extract discusses the fact that these changes reflect the way in which accountingis moving—that is, towards putting all assets and liabilities on the balance sheet.What reasons could there be for this move?Is this consistent with the approach intheProposed Framework?Given the identified impact on key company ratios, doyou believe this approach is justified?

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.2.41.Student should apply the definitions of an asset and a liability from theProposedFramework:In theProposed Frameworkan asset is:•An asset is a present economic resource controlled by the entity as a result ofpastevents (para 4.5). Further an economic resource is defined in para 4.6 as ‘a right thathas the potential to produce economic benefits’.Therefore would meet definition as:it is an economic resource. The use of the land can resultin benefits/cash flows and constitutes via the lease contract a right. Paragraph 4.8 states:•4.8 Rights that constitute economic resources may take the following forms:(a)rights established by contract, legislation or similar means, such as:(ii) rights over physical objects, such as property, plant andequipment orinventories. Such rights may include ownership of a physical object, the right touse a physical object or the right to the residual value of a leased object.Control would be established as given the contract the lessee can obtain the benefits fromusing the asset.Past event:would be lease contract that gave rise to lessee having right of use of asset andcontrolling and accessing benefits.In theProposed Frameworka liability is:•A liability is a present obligation of the entity to transfer an economic resource as aresult of past events (4.24).Thetransfer or economicresources would be the meeting of lease payments).Present obligation:under leasing contractwould assume have legal obligation to makepayments.Past event:would be lease contract that gave rise to obligation.Note: thepreviousaccounting standard on leases, AASB117Leases,overrodethe generalrecognition criteria for liabilities and requires liabilities in relation to finance leases to berecognised. A finance lease is a lease in which substantially all of the risks and rewardsincidental to ownership have been transferred from the lessor (legal owner of the property) tothe lessee (one who is using the property) (AASB 117 para 4).Given that land has anindefinite lifea 5year lease of land would be classified as an operating lease and would notgive rise to an asset or liability. Under thenewleasing standard, AASB 16,these changesandan asset and a liability would be recognised.

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Chapter 2:TheConceptual Framework of FinancialReporting2.52.Reasons towards the move towards putting all assets and liabilities on the balance sheetwould be:•Based on principles & objectives of financial reporting: To be consistent with theconceptual framework all items that meet the definition and recognition criteria ofassets and liabilities should be included on the balance sheet. Also to be complete andso representationally faithful would argue that need to include all elements. Surelyinformation about the assets and liabilities of an entity would be relevant to users.•Improves comparability as does not distinguish on form or arbitrary rules but reflectseconomic substance. For example, underthe previouslease accounting 2 entitiescould have identical items of land–one entity owns and one leases (as operatinglease). The different accounting treatment would result in one entity including anasset but the leasing one not. This would distort ratios such as return on assetsetc.andmake comparison difficult.•Reducesopportunitiestostructuretransactionsonordertoreflectaparticularfinancial position (this could include maintaining certain ratios).If all assets andliabilities meeting the recognition criteria are required to be included on the balancesheet then this limits the ability of entities to choose or plan transactions to avoidincludingtheseontheirbalancesheetorinparticularto‘hide’obligations//commitments. Under the current leasing arrangements company may decide to leaseland rather than purchase (even those costs and commitments may be relatively equal)as leasing will avoid the recognition of the lease liability and asset. It could be arguedthat the use of special purpose entities by Enron which were not required to beincluded on the balance sheet andwere usedto hide debt is an example of structuringtransactions to reflect a particular financial position.Cleary including all assets and liabilities on the balance sheet would impact on key financialratios. Whilst it could be argued that this could disadvantage some companies (for example,if theyare now required to include such assets and liabilities this could mean that they maybreachdebtcovenantratios and incur costsunless they areable to renegotiate debtterms/covenants).However an alternative argument is that if all assets and liabilities areincluded then this provides a more complete and representationallyfaithful viewof thefinancial position and hence the ratios are more ‘accurate’and useful.

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Solution manual to accompany:Contemporaryissues inaccounting2e by Rankin et al.2.6Contemporary issue 2.3Intangible assets hold real valueQuestions1.The extract discusses the ban from including most intangible assets in the balancesheet unless acquired. Consider whether some, or all of such ‘banned’ intangibleswould meet the definition of an asset and criteria for recognition in either theConceptual Frameworkor theProposed Framework.2.Do you believe the inconsistent treatment between purchased versus internallygenerated items is justified?3.If the financial statements are ‘leaving out’ most of the important assets, what doesthis imply for theusefulness of financial statements for users?

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Chapter 2:TheConceptual Framework of FinancialReporting2.71.In theProposed Frameworkan asset is:•An asset is a present economic resource controlled by the entity as a result ofpastevents (para 4.5). Further an economic resource is defined in para 4.6 as ‘a right thathas the potential to produce economic benefits’.Therefore such a banned intangible (e.g.an internally created brand, orcustomerlist) wouldnormally meet definition as:•It is an economic resource. The useof the brand can result in benefits/cash flows andthe entity would haveright.Paragraph 4.8 states:•4.8 Rights that constitute economic resources may take the following forms:(a) rights established by contract, legislation or similar means, such as:(vi) intellectual propertyrights, for example, registered patents.(c) other rights that give the entity the potential to receive future economic benefitsthat are not available to all other parties, for example, rights to the economic benefitsthat may be produced by itemssuch as know-how not in the public domain or bycustomer or supplier relationships. (see paragraph 4.20).Control would be established. This could be via contract or legislation (e.g. registration ofbrand name) or as access to benefits determined by the entity.TheProposed Frameworkstates:•4.19 An entity has the ability to direct the use of an economic resource if it has theright to deploy that economic resource in its activities, or to allow another party todeploy the economic resource in that other party’s activities.•4.20 Although control of an economic resource usually arises from legal rights, it canalso arise if an entity has the present ability to prevent all other parties from directingthe use of it and obtaining the benefits from the economic resource. For example, anentity may control know-how obtained from a development activity by having thepresent ability to keep that know-how secret.Past event:would beactivities of the entitythatcreated the brand (or customer list).Recognition criteria:In theProposed Frameworkrecognition is specified in para 5.9. An item meeting thedefinition is recognised if such recognition provides users of financial statements with:(a)Relevant information about the asset or the liability and about any income, expensesor changes in equity.-Cleary information about such intangibles would be relevant to users. Where thereis some uncertainty about obtaining the benefits, then this would normally bereflected in the measurement (unless such lowprobability that may not berelevant).(b) Afaithful representation of the asset or the liability and of any income, expenses orchanges in equity (extracts from para 5.9).•Given that to include in the statements (recognise) we need to place a $ amountagainst the item this could be more problematic.

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