Solutions to Supplementary Problems from Scott Textbook 6th Edition Essay Example for Free

Solutions to Supplementary Problems from Scott Textbook 6th Edition EssaySeveral reasons can be suggested why oil company managers ready reservations about RRA The discount rate of 10% might non reflect the solids follow of capital. Low reliability. RRA involves making a large number of assumptions and estimates. period SFAS 69 deals with low reliability in part by requiring end-of-period oil and gas prices to be use (rather than prices anticipated when the reserves are expected to be sold), management may feel that end-of-year prices bear puny relationship to the actual net tax income the company will receive in the future day. Furthermore, management may be concerned about low reliability of other estimates, such as reserve quantities. shop at changes in estimates. Conditions in the oil and gas market can change rapidly, making it necessary for the firm to make frequent changes in estimates. Investors may ignore. Investors may non understand the RRA information. Even if they do, management may believe the RRA information is so unreliable that investors will ignore it. If so, why prepare it? Legal liability. precaution may be concerned that if the RRA estimates are not realized, the firm will be subject to lawsuits from investors. anxietys reservations may be an attempt to limit or avoid liability. 12. a. Most industrial and retail firms regard tax income as earned at the point of sale. Since sale implies a contract with the vendee and change of ownership, this is usually the earliest point at which satisfying risks and rewards of ownership pass to the buyer, the seller loses control condition of the items sold (e. g.. , title passes to buyer) and at which the amount of revenue enhancement to be received can be set(p) with reasonable reliability. b. Under RRA, revenue is recognized when oil and gas reserves are proven.This point in the operating cycle does not meet the IAS 18 criteria for revenue recognition. Since the oil and gas are mollify in the ground and the reserves are not sold, the significant risks and rewards of ownership have not been passed on and control remains with the producer. Also, the large number of revisions to estimates under RRA casts doubt on the reliability of the amount of revenue recognized. Presumably, this is why RRA is presented as supplementary information only. Presumably, however, collection is reasonably assured since oil and gas have ready markets.Note This question illustrates that the tradeoff between relevance and reliability can be equivalently border in terms of revenue recognition as well as balance canvas valuation. In effect, balance sheet valuation is in terms of the debit side of asset valuation whereas criteria for revenue recognition are in terms of the credit side. The basic tradeoff is the same, however. In particular, it should be storied that early revenue recognition increases relevance, even though it may lose reliability. 13. a. From a balance sheet p erspective under exaltation conditions, line of descent is entertaind at new shelter.This could be the present value of expected future cash receipts from sale, that is, value-in-use. Alternatively, if market value of the schedule is available, it could be valued at its market value, that is, its fair value (the 2 values would be the same if markets work reasonably well, as is the case under ideal conditions). From a revenue recognition perspective, revenue is recognized as the inventory is manufactured or acquired. b. Cost basis accounting for inventory is due to lack of ideal conditions. Then, inventory markets may not work well. If so, Samuelsons (1965) demonstration does not apply.As a result, market value requires estimation, orifice up inventory valuation to error and possible manager bias. Accountants must feel that this step-down in reliability outweighs the greater relevance of current inventory value. Historical cost accounting for inventories is not completely rel iable, since firm managers still have some room to manage (i. e. , bias) their reported profitability by dint of their choice of cost methods (FIFO, LIFO, etc. ). Also, historical cost accounting for inventories is accompanied by the lower-of-cost-or-market rule.Then, reliability issues of current valuation re-arise. Furthermore, even the cost of inventories is not always reliable. For example, overhead costs are usually allocated to the cost of manufactured inventory. These costs are affected by manager decisions about allocation rates and turnout volumes. 14. 25. a. Relevant information is information that enables the prediction of future firm performance, such as future cash flows. Early revenue recognition anticipates these future cash flows, hence it is relevant. Thus, Qwests revenue recognition indemnity provided relevant information.b. Reliable information is information that faithfully represents the firms financial position and results of operations. When significant ris ks and rewards of ownership are transferred to the buyer and the seller loses control over the items transferred, the amount of future cash flows is resolute with reasonable representational faithfulness and verifiability, since the purchaser has an obligation to pay. Also, if the amount of cash to be received is firm in an arms-length transaction, the amount of sale is reliable due to lack of possible manager bias.It seems that Qwests revenue recognition policy met none of these reliability criteria. The future cash flows were not representationally faithful since there appeared to be no provision for returns, obsolescence, or unforeseen service costs. Furthermore, as evidenced by the later arcsecond settlements, substantial manager bias is apparent. Obviously, amounts ultimately collectible were not reasonably assured, since the SEC came up with materially different valuations. c. Under ideal conditions, revenue is recognized as production capacity is acquired, since future rev enues, or expected revenues, are inputs into the present value calculations.For an oil and gas company, revenue recognition is analogousrevenue is recognized as reserves are discovered or purchased. The reason is that under ideal conditions, future cash flows, or expected future cash flows, are perfectly reliable. There is thus no sacrifice of usefulness in recognizing revenue as early as possible. Note A tiptop answer will point out that under ideal conditions net income consists of interest on opening present value (i. e. , accretion of discount), plus or minus abnormal earnings under ideal conditions of uncertainty). These are not operating revenues, however, but simply an effect of the passing of time.