Class 1 - The Bigger Picture

2010 CLASS NOTES: THE BIGGER PICTURE
CLASS NOTES: THE BIGGER PICTURE
SIMPLIFIED OUTLINE OF CONTENT OF AN ANNUAL FINANCIAL

REPORT
• INFORMATION ABOUT COMPANY

• MANAGEMENT DISCUSSION & ANALYSIS (MD&A)
• AUDITOR'S REPORT ON FINANCIAL STATEMENTS
• COMPARATIVE FINANCIAL STATEMENTS
INCOME STATEMENT
BALANCE SHEET
STATEMENT OF STOCKHOLDERS’ EQUITY
STATEMENT OF CASH FLOWS
• NOTES TO THE FINANCIAL STATEMENTS
• MANAGEMENT’S EVALUATION AND REPORT OF CONTROLS OVER
FINANCIAL REPORTING
• AUDITORS’ REPORT ON CONTROLS
• CFO AND CEO CERTIFICATIONS
Many players in financial reporting:

Management of the company
Auditors
Sophisticated investors (e.g., buy side analysts)
Unsophisticated investors
Sell-side analysts
Creditors
Regulators (e.g., SEC, Congress)
Standard Setters (e.g., FASB, IASB)
Your textbook (like virtually all of them on the market these days)
largely takes an FASB approach. That is, it mostly evaluates
issues/topics/accounting in light of the FASB’s conceptual
framework.
But that is TOO NARROW, even for

accountants.
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LET’S THINK BIGGER THAN THAT.
 Financial reporting exists to facilitate DECISION

MAKING.
 Financial reporting exists to facilitate CONTRACTING.
THE FASB’s PERSPECTIVE: Those Who Write
the “Rules”
SFAC 1 -- OBJECTIVES OF FINANCIAL REPORTING BY BUSINESS
ENTERPRISES
SFAC = Statement of Financial Accounting Concepts
• There are many potential users of financial reporting. Most of these

users lack the authority to ask for the information they want. Thus,
general-purpose financial reporting is employed.
Comment: Keep this in mind throughout the course
and determine if
financial reporting is, in fact, “general purpose.”
• The focus of the general-purpose financial reporting is external users.

Even though there are a lot of external users, general-purpose
financial reporting is aimed primarily at two user groups: INVESTORS
AND CREDITORS.
• Financial reporting should provide information that is useful to

present and potential investors and creditors in making rational
investment, credit and other decisions.
Specifically, ... information that will enable them to assess the

AMOUNTS,
TIMING, AND UNCERTAINTY OF FUTURE CASH FLOWS -- BOTH
INFLOWS AND OUTFLOWS.
Comment: Keep this in mind throughout the course
and determine
how well financial reporting does this.
And ... to assess economic resources, the claims to those

resources, and the changes in them.
SFAC 2 -- QUALITATIVE CHARACTERISTICS: CRITERIA FOR

SELECTING AND EVALUATING FINANCIAL ACCOUNTING AND
REPORTING POLICIES
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What makes accounting information useful?

PRIMARY QUALITIES
Relevance Reliability
1. Be timely 1. Be verifiable
2. Have predictive value 2. Have representatioinal faithfulness
3. Have feedback value 3. Be neutral or free from bias
SECONDARY QUALITIES
Comparability -- be comparable between enterprises
Consistency -- be consistent across time
CONSTRAINTS
Materiality
Cost/Benefit
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Users of Financial Reporting

What is it that users want when they read financial reports? Who are the
big users? What’s difference between sell-side and buy-side analyst?
The CFA Institute put out a report in late 2005, arguing for the following in
financial reports (see Appendix A for more details on this):
The company must be viewed from the perspective of a current investor in

the company’s common equity.
Fair value information is the only information relevant for financial

decision making.
Recognition and disclosure must be determined by the relevance of the

information to investment decision making and not based upon
measurement reliability alone.
All economic transactions and events should be completely and

accurately recognized as they occur in the financial statements.
Investors’ wealth assessments must determine the materiality threshold.
Financial reporting must be neutral.
All changes in net assets must be recorded in a single financial

statement, the Statement of Changes in Net Assets Available to Common
Shareowners.
The Statement of Changes in Net Assets Available to Common

Shareowners should include timely recognition of all changes in fair
values of assets and liabilities.
The Cash Flow Statement provides information essential to the analysis

of a company and should be prepared using the direct method only.
Changes affecting each of the financial statements must be reported and

explained on a disaggregated basis.
Individual line items should be reported based upon the nature of the
items rather than the function for which they are used.
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Disclosures must provide all the additional information investors require

to understand the items recognized in the financial statements, their
measurement properties, and risk exposures.
Since fraudulent financial reporting disasters (Enron, WorldCom,

HealthSouth, AIG, and others) and since the recent mortgage
meltdown, users have demanded greater transparency and
simplicity in financial reporting.
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Preparers of Financial Reports: Management

What is it that management thinks about when they prepare their financial
reports?
Regulators (and GAAP) …

Question: Can companies get away with murder on their financial
reporting? Apparently Enron did not! Do they have to follow GAAP? On
black and white accounting issues, there’s not much leeway. However,
there are MANY judgmental areas in accounting. What are the forces
toward more “truthful financial reporting?
Financial markets ...

Implicit contracts with owners. Companies constantly worry about
whether their securities are mispriced (specifically, underpriced securities
is the concern). What do companies do when they think their securities
are underpriced? (Good analogy to think about: used car “lemon”
problem)
Effects of debt covenants...

Typical covenants or contracts call for the maintenance of acceptable
levels of working capital, interest coverage, current period earnings, and
net worth. There is a big “cost” when debt covenants are violated.
Thus, managers often are motivated to do their accounting in such a
way as to minimize the likelihood that covenants are violated.
Effects of bonus plan ...

Contracts often exist between the owners and managers of the firm
whereby the managers are compensated for how well they manage the
firm. Thus, managers choose particular accounting methods so that
they can maximize their bonus.
Effects of size (or political cost) ...

Firms under scrutiny often have incentives to choose accounting
methods that will show lower profits so as to lower political risk to them.
Example: GE (big company) is very conservative. Westinghouse (less
big) is very aggressive.
Big oil & gas companies are very conservative. Smaller oil &
gas are more aggressive.
CONSTRAINTS ….
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Managers know that users would like more, rather than less, information
in their financial reports, as doing so reduces information asymmetry.
However, managers often have incentives not to fully reveal their superior
information. For example, revealing proprietary information harms firms’
competitive positions. As another example, low-quality firms don’t want
to reveal too much information so that the users can see that it is low
quality.
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Auditors of Financial Reports

What is it that the auditor thinks about when they audit the company
financial reports?
GAAP
Their own reputation (and, of course, Arthur Andersen) ....
Sarbanes – Oxley Act of 2002 – This Act also created the Pubic
Company Accounting Oversight Board (PCAOB), which assumed
responsibility for overseeing the auditors of public companies.
What management wants ...
What the users want ...
What the users think... What is the earnings expectation?
Board of Directors
What is it that the Board of Directors thinks about when govern the
corporation?
What about the audit committee?
For each topic that we cover in this course, we will:
Consider the economics of the transaction/situation
Address current accounting / does the accounting capture

the economics?
Address any possible, upcoming FASB changes
Address IASB differences (you will be shocked at how
similar IASB is to US GAAP)
Consider the cash flow impact of the transaction (SCF)
Consider the deferred taxes impact (DIT)
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Consider the valuation implications of the accounting /

analyst behavior – do analysts adjust to get to the
economics?
Consider the transparency of current financial reporting

rules
Consider the credibility of management’s disclosures
APPENDIX A – CFA Society report
1. Principle: The company must be viewed from the perspective of

a current investor in the company’s common equity.
Current Practice: Financial reporting standard setters have made

significant improvements in financial reporting since the early 1990s.
These advances include rules requiring that all derivatives be
reported at fair value and that all stock options granted to employees
(compensation) be expensed at fair value. But much remains to be
done. Many major claims against the company’s resources (for
example, pension obligations and contingencies) currently escape
the balance sheet and income statement and are not fully reported
in the notes. Similarly, many revenue-generating assets (for
example, receivables, intangibles, and leased assets) are allowed
under current rules to escape complete and clear recognition in the
financial statements. (See Principle 2)
Reasons for Importance: The current common shareowner (CCS) is

the last to receive a share of the company’s net assets (that is,
assets in excess of liabilities) and earnings. This means that the
claims of all others must be fully satisfied before those of the CCS.
Consequently, a CCS must have complete, accurate information
about all other claims—including potential risk exposures and
possible returns—to value his or her own investment. Similarly, a CCS
must understand what assets are controlled and used by the
company and the implications of these assets for the company’s
future growth and financial health.
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2. Principle: Fair value information is the only information relevant

for financial decision making.
Current Practice: Since the early 1980s, financial reporting standard

setters have tended to base new standards on fair value
measurement. The FASB, working on its own behalf and that of the
IASB, has developed a new standard for fair value reporting for
assets and liabilities and expects to release the final standard in the
fourth quarter of 2005. The CFA Centre strongly supports this effort,
but the majority of standards comprising the bulk of current GAAP
are not based on fair value principles. Much work remains to be done
to bring these rules into compliance with the FASB’s fair value
standard.
Reasons for Importance: Decisions about whether to purchase, sell, or

hold investments are based upon the fair values of the investments
and expectations about future changes in their fair values. Financial
statements based on outdated historical costs are less useful for
making such assessments. Fair values, by definition, impound all of
the most current assessments about the value of an investment and
any future changes in that value.
3. Principle: Recognition and disclosure must be determined by the

relevance of the information to investment decision making and
not based upon measurement reliability alone.
Current Practice: Although recently developed reporting standards

have tended to be designed to provide information relevant to
financial decision making, many older standards, which form the bulk
of current GAAP, were structured more from a concern for
practicability (what was easiest to do and most easily verified) rather
than from a consideration of what would constitute the most useful
information. Indeed, many companies have now instituted financial
analysis divisions responsible for developing the sorts of information
investors require but are only used by internal managers. The role of
the financial analysis team is to develop timely, fair value
information so that managers will have the information they require
to make their own investment decisions, for example, to acquire
assets, expand or reduce operations, or divest portions of the
operating activities. Although company managers may be reluctant
to provide such information to investors, they recognize that the
information is critical for the investment decisions that investors
must make.
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The CFA Centre believes that most standard setters subscribe to the
idea that GAAP accounting methods must produce decision-relevant
information, but much work remains to achieve this objective.
Reasons for Importance: Financial information may be completely

reliable if it is easily verifiable according to one or more criteria. But
the information may not be relevant for financial decision making. An
example is the purchase by a company of a major manufacturing
facility 30 years ago for which the bill of sale is available to support
the recorded cost. The recorded cost may, therefore, be considered
reliable in the conventional sense. Financial decision makers today,
however, would find little that is useful or relevant in that number for
the decisions they must make today.
4. Principle: All economic transactions and events should be

completely and accurately recognized as they occur in the
financial statements.
Current Practice: Because companies seek to portray themselves in

the best light, they sometimes engage in transactions that do not
require immediate recognition (such as offbalance- sheet financing).
For example, despite amendments of the lease accounting rules by
the FASB, many leased assets remain off balance sheet even when
the company effectively owns or controls the leased assets.
Reasons for Importance: The purpose of financial reporting is to

convey the economic position of the company and changes in that
position to investors. Reporting methods that omit or fail to reflect
the economic essence of events and transactions as they occur do
not achieve the purpose of financial reporting.
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5. Principle: Investors’ wealth assessments must determine the

materiality threshold.
Current Practice: Despite statements of regulators, including the U.S.

SEC, company managers and their auditors tend to apply ad hoc
“rules of thumb” when deciding (1) whether certain items are of
sufficient size or importance (materiality) to warrant clear, separate
reporting and (2) the reporting method to be applied. For example,
some managers and auditors may use as their benchmark 5 percent
of a line item, such as net income or total assets or sales. In contrast,
we believe that materiality assessments should use the standard of
whether the item would make a difference to an informed investor.
For example, a relatively small amount might change the trend of an
expense category. Moreover, related items should be considered in
total, rather than individually, to determine materiality.
Reasons for Importance: Financial statements are prepared for those

outside the company who need the information and who base their
financial decisions upon it (e.g., investors). Consequently, the
materiality threshold should be based upon what will affect investors’
decisions and not upon preparers’ arbitrary assessments. These
decisions should be based both on quantitative as well as qualitative
factors. For example, even a small amount of fraud committed by
company managers would likely be considered to be highly material
to investors, who need to assess the integrity of those to whom they
have entrusted their assets.
6. Principle: Financial reporting must be neutral.
Current Practice: Reporting standards issued recently tend to honor

this principle more faithfully than before. Examples include the
recently issued FASB and IASB rules on the expensing of stock
options. Many older standards, however, still exist and are applied to
major categories of transactions that were heavily influenced by
concern about outcomes rather than the imperative to fully report
the economic essence of the items.
Reasons for Importance: Reporting of economic transactions and

events should not be influenced by the outcomes of the financial
reporting or the effects that the reporting may have on one or more
interests. For example, in the recent stock options expensing debate,
those opposed to expensing argued that expensing stock options as
compensation would reduce net income, causing companies that
issue stock options to reduce the number of options granted to
employees, making it harder to attract talented employees. The
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argument was misplaced. All costs of production, including employee

compensation, must be reported fairly, completely, and accurately.
In the past, concern for outcomes has caused preparers to bring
considerable pressure, both directly and indirectly through other
political forces, against standard setters to scale back, slow, alter, or
abandon standardsetting attempts altogether. One example is the
reporting of defined-benefit pension obligations and the cost
associated with such plans. The rule as it was initially drafted for
reporting such obligations was broadly consistent with fair value
recognition. But under the intense pressure of preparers, successive
drafts gradually purged all remnants of fair value reporting. Under
the final rule, neither the balance sheet nor the income statement
reflects the economic position of the plan and changes in that
position.
7. Principle: All changes in net assets must be recorded in a single

financial statement, the Statement of Changes in Net Assets
Available to Common Shareowners.
Current Practice: Changes in net assets are not reported in a single

place but are scattered throughout the financial statements, the
income statement, cash flow statement, balance sheet, and
statement of changes in shareholders’ equity. Moreover, the
extensive aggregation and netting in the financial statements make
analyses to generate many of these numbers all but impossible.
Reasons for Importance: We believe that all such changes should be

reported clearly and understandably and in a single statement.
Investors must now expend great effort to locate these changes and
make use of them. Indeed, because of the high levels of aggregation
and the lack of consistency, investors must resort to a great deal of
analysis to try to determine the source and magnitude of many
changes, if they are able to do so at all.
8. Principle: The Statement of Changes in Net Assets Available to

Common Shareowners should include timely recognition of all
changes in fair values of assets and liabilities.
Current Practice: Relatively few statement items are required to be

recorded at fair value with changes recognized currently in net
income. Derivative instruments and securities held for trading are
notable examples that meet this test. The rules, however, permit
gains and losses for some items that currently are recorded at fair
value in the balance sheet (for example, available-for-sale securities
and cash flow hedges) to be deferred outside of income.
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Reasons for Importance: If investors are to be able to evaluate how

the value of their investment in a company is increasing or
decreasing, they must be able to fully understand how the
company’s operations and activities are increasing or decreasing the
values of the assets they hold and the obligations they have
incurred. The clearest measures of a company’s wealth-generating or
wealth-consuming patterns are changes in the fair values of these
assets and obligations.
9. Principle: The Cash Flow Statement provides information

essential to the analysis of a company and should be prepared
using the direct method only.
Current Practice: Only a handful of the thousands of public companies

worldwide report cash flows using the direct method.
Reasons for Importance: Ultimately, investors value their investments

by forecasting the company’s future cash flows and cash flow
generating ability. A clear picture of the company’s current means of
generating cash flows, the patterns of inflows and outflows, and its
effectiveness in producing cash is essential to this analysis. The
current cash flow statements of most companies do not provide this
information.
10.Principle: Changes affecting each of the financial statements

must be reported and explained on a disaggregated basis.
Current Practice: The financial statements issued by most companies

today, from the largest with extensive cross-border operations to
very small, narrowly focused startups, tend to be highly summarized
and condensed. This is achieved by adding together unlike items to
report relatively few line items in the statements, despite the
disparate economic attributes of their operations. A good example is
the line item “miscellaneous assets,” which is sometimes the largest
amount in the balance sheet.
Reasons for Importance: Aggregation of information with different

economic attributes, different measurement bases, different trends,
and from very different operations results in substantial loss of
information. Indeed, the information lost is essential to investors’
understanding of a company’s financial position, changes in that
position, and the implications for valuation of investments.
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11.Principle: Individual line items should be reported based upon

the nature of the items rather than the function for which they
are used.
Current Practice: Information in financial statements, particularly in

the income statement but also to a lesser degree in the balance
sheet, is aggregated in major functional categories, such as cost of
goods sold and selling, general, and administrative activities. This
practice began long ago when companies tended to be focused in a
single industry or activity and the items aggregated were more
nearly homogeneous. Such is not the case today.
Reasons for Importance: The forecasting of individual line items for

use in valuation and other decisions requires that they be relatively
homogeneous—that is, represent a single economic attribute or an
aggregation of very similar attributes. For example, rather than
following the current practice of aggregating labor cost, pension
costs, raw materials, energy costs, overhead allocations, and the like
into cost of goods sold, which mixes items of very different economic
characteristics, trends, and measurement bases, the individual
categories should be reported. Indeed, investors currently expend
much effort to disaggregate such numbers. Because of the limited
information available, the calculations require much estimation and
result in considerable error, thus affecting the usefulness of the
information.
Companies reporting under International Accounting Standards are

permitted to report expenses based on either function or nature. So,
this is not a new concept.
12.Principle: Disclosures must provide all the additional information

investors require to understand the items recognized in the
financial statements, their measurement properties, and risk
exposures.
Current Practice: Disclosures vary widely in quality and quantity. Older

standards frequently provide for scant required disclosures. Some
disclosures, for example, those for definedbenefit pension plans (and
for stock option expensing prior to the enactment of new standards
in this area) have been crafted to make up for inadequate financial
reporting in those areas.
Reasons for Importance: If investors are to understand the numbers

reported in the financial statements, they must have sufficient
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supplementary disclosures to evaluate the numbers. Such disclosures

can include, for example:
• financial reporting methods used,

• models used for estimation and measurement,
• assumptions used,
• sensitivity analyses of point estimates,
• information about risk exposures,
• information explaining why changes in important items have
occurred, and
a host of other important items. In short, the statements are not

interpretable without them. Disclosures should be regarded as being
as important to investors’ assessments as the recognition and
measurement in the statements.
REVIEW PROBLEM A
BAD DEBTS (You’ll need to deal with this topic when we do
Statement of Cash Flows and also Factoring/Securitization)
Assume that the beginning 2009 balance in Britton Corporation’s

Allowance for Doubtful Accounts account is $2,400 credit.
(1) Assume Britton Corporation estimates that 1% of their 2009

credit sales (which were $732,000 during the year) will not be
collectible. Assume further that in May of 2010, Britton decides to
write off a specific account in the amount of $1,350. Further
assume that in December of 2010, that previously written off
account of $1,350 paid their debt to Britton in full. Provide all
necessary journal entries for this set of facts.
(2) Ignore what you did in part (1). Assume instead that Britton
Corporation estimates that 1½% of ending accounts receivable
(which was $148,000) will not be collected. Assume further that
in May of 2010, Britton decides to write off a specific account in
the amount of $1,350. Further assume that in December of 2010,
that previously written off account of $1,350 paid their debt to
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Britton in full. Provide all necessary journal entries for this set of
facts.
(3) Ignore what you did in parts (1) and (2). Now assume that
Britton uses the direct write-off method to estimate bad debts.
Assume further that in May of 2010, Britton decides to write off a
specific account in the amount of $1,350. Provide the journal
entry for that write off. Further assume that in December of 2010,
that previously written off account of $1,350 paid their debt to
Britton in full. Provide all necessary journal entries for this set of
facts.
This is a bad debt expense problem, which should be review for

you. The Kieso, Weygandt & Warfield textbook is a bit below
average on this topic (see pages 321-326 for their coverage), so
you may need to consult your introductory financial accounting
text for additional assistance if necessary.
REVIEW PROBLEM B
ADJUSTING ENTRIES (This is just a general review of
adjusting entries to get you back into the mindset of
journal entries).
The following transactions and events for Snidemark

Manufacturing Corporation are under consideration for adjusting
entries at December 31, 2009 (the end of the accounting period).
Give the adjusting entry (or entries) that should be made on
December 31, 2009, for each item. If an adjusting entry is not
required, explain why.
a. Machine A in the factory cost $450,000; it was purchased on

July 1, 2005. It has an estimated useful life of 12 years and a
residual value of $30,000. Straight-line depreciation is used.
b. Sales for 2009 amounted to $4,000,000, including $600,000

credit sales. It is estimated, based on experience of the
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company, that bad debt losses will be .25 percent of credit

sales (that is .0025 and not .25).
c. At the beginning of 2009, office supplies inventory amounted

to $600. During 2009, office supplies amounting to $8,800
were purchased; this amount was debited to office supplies
expenses. An inventory of office supplies at the end of 2009
showed $400 on the shelves. The January 1 balance of $600
is still reflected in the office supplies inventory account.
d. On July 1, 2009, the company paid a three-year insurance

premium amounting to $2,160; this amount was debited to
prepaid insurance.
e. On October 1, 2009, the company paid rent on some leased

office space. The payment of $7,200 cash was for the
following six months. At the time of payment, rent expense
was debited for the $7,200.
f. On August 1, 2009, the company borrowed $120,000 from

Sharpstown Bank. The loan was for 12 months at 9 percent
interest payable at maturity date.
g. Finished goods inventory on January 1, 2009, was $200,000,

and on December 31, 2009, it was $260,000. The perpetual
inventory record provided the cost of goods sold amount of
$2,400,000.
h. The company owned some property (land) that was rented to

B.R. Speir on April 1, 2009, for 12 months for $8,400. On
April 1, the entire annual rental of $8,400 was credited to
rent collected in advance, and cash was debited.
i. On December 31, 2009, wages earned by employees but not

yet paid (or recorded in the accounts) amounted to $18,000.
Disregard payroll taxes.
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j. On September 1, 2009, the company loaned $60,000 to an

outside party. The loan was at 10 percent per annum and
was due in six months; interest is payable at maturity. Cash
was credited for $60,000, and notes receivable debited on
September 1 for the same amount.
k. On January 1, 2009, factory supplies on hand amounted to

$200. During 2009, factory supplies that cost $4,000 were
purchased and debited to factory supplies inventory. At the
end of 2009, a physical inventory count revealed that factory
supplies on hand amounted to $800.
l. The company purchased a gravel pit on January 1, 2006, at a

cost of $60,000; it was estimated that approximately 60,000
tons of gravel could be removed prior to exhaustion. It was
also estimated that the company would take five years to
exploit this natural resource. Tons of gravel removed and
sold were: 2006-3,000, 2007-7,000; and 2009-5,000. Hint:
deplete on output basis; no residual value.
m. At the end of 2009, it was found that postage stamps that

cost $120 were on hand (in a “postage” box in the office).
When the stamps were purchased, miscellaneous expense
was debited and cash was credited.
n. At the end of 2009, property taxes for 2009 amounting to

$59,000 were assessed on property owned by the company.
The taxes are due no later than February 1, 2010. The taxes
have not been recorded on the books because payment has
not been made.
o. The company borrowed $120,000 from the bank on

December 1, 2009. A 60-day note payable was signed at 9-
1/2 percent interest payable on maturity date. On December
1, 2009, cash was debited and notes payable credited for
$120,000.
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p. On July 1, 2009, the company paid the city a $1,000 license

fee for the next 12 months. On that date, cash was credited
and license expense debited for $1,000.
q. On March 1, 2009, the company made a loan to the company

president and received a $30,000 note receivable. The loan
was due in one year and called for 6 percent annual interest
payable at maturity date.
r. The company owns three cars used by the executives. A six-

month maintenance contract on them was signed on October 1,
2009, whereby a local garage agreed to do “all the required
maintenance.” The payment was made for the following six
months in advance. On October 1, 2009, cash was credited and
maintenance expense was debited for $9,600.
2010 CLASS NOTES: WRITING CASES AND DATABASE SEARCHES
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CLASS NOTES: SEARCHING THE FASB CODIFICATION,

ACCOUNTING RESEARCH MANAGER, EDGAR, LEXIS / NEXIS, FACTIVA
and ANALYZING / WRITING CASES
1. HOW TO USE THOSE DATABASES?

See booklet on ACCOUNTING RESEARCH USING THE FASB CODIFICATION,
ARM, EDGAR, LEXIS/NEXIS AND FACTIVA that is download-able from my
blackboard course page for detail on how to use these databases.
2. WHAT TO DO WHEN FACED WITH AN ACCOUNTING CASE

SITUATION FOR WHICH YOU DON’T ALREADY KNOW THE ANSWER?
 Determine the problems or issues.
In doing this, it is often helpful to draw a picture or event timeline.

In addition, you’ll more likely get to a “good” solution if you
consider the bigger picture (see bigger picture class notes).
Another way to say this is: THINK BIG PICTURE BEFORE YOU
THINK ACCOUNTING.
Helpful hint: Groups often fail to come up with “good” solutions

to cases because they spend an inadequate amount of time on
defining the problem. That is, they move too quickly from the
problem definition stage to the solution stage.
 Determine possible solutions to the problems / issues. To do

this, you can:
USE ACCOUNTING STANDARDS. If you already know the

relevant standard(s), look through them for the possible solutions.
If you don’t already know the relevant standard(s), you must

search for them. To identify search terms, you can rely on actual
words in the case as a starting point. Another way to determine
search terms is think about what the case is really about. What’s
the substance of the situation or transaction in the case? What
does the case remind you of? Much of this thinking should have
occurred from the problem / issue identification stage, so you
should already have most of your search terms. Also, sometimes
it helps to look through your textbook; it’s a good reference tool
that might give you some ideas.
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These search terms can be used to perform searches of accounting

standards (mostly easily searched via the FASB Codification). The
more-specific your search word or phrase, the more likely you are
to find a relevant standard. For example, if you search with the
word “asset,” you’re likely to come up with a lot of irrelevant
standards.
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FIND PRECEDENTS. These search terms also can be used to

search for precedents (similar situations already encountered by
other companies). These types of searches would have to be
searched via LEXIS/NEXIS, as the FASB Codification does not
contain company data. These searches are useful in that they give
you an indication of how others handled a similar situation.
However, they are probably not helpful in understanding that
company’s logic for choosing a particular accounting treatment, as
such logic is not often described in the financial statements.
Searches can also be performed of companies directly—companies

that you think might have encountered a similar situation to that
you’re faced with. Again, these types of searches would have to
be searched via LEXIS/NEXIS, as the FASB Codification does not
contain company data.
REASON BY ANALOGY. This approach can be used when the

accounting standards or the precedents (see above) do not
address the problem at hand. Instead of throwing your hands up
in disgust, you should think about whether your problem situation
is similar to a problem situation in another, seemingly unrelated
area. If it is, you might think about following the gist of the
accounting prescribed for the latter area.
USE CONCEPTUAL FRAMEWORK. Using ideas and definitions

expressed in the concept statements is often very helpful.
EDUCATED GUESSING. Your educated guessing is probably

heavily influenced by your exposure to the FASB’s conceptual
framework. Be sure to support any educated guessing you do.
That is, say more than just “I think we should do X.”
 Decide what to do.
Following the approaches above should lead you to several

alternative accounting treatments. If you don’t have more than
one alternative, then either your case situation has an obviously
correct solution or you’ve failed to think broadly enough.
Assuming you have several alternatives, one way to choose
among them is list out the alternatives and for each, list out the
reasons that support and do not support the alternative. After
considering the importance of the pros and cons for each
alternative, then you can decide on a proposed solution.
4
5
3. HOW TO WRITE UP AN ANALYSIS OF AN ACCOUNTING CASE?
First paragraph should state the problems or issues that a particular

company faces. Get right to the problems / issues; don’t spend time
reiterating a lot of case facts.
NOTE: After this first paragraph, the exact format to follow is

case-specific. Thus, what works well in one situation may not
work well in another. Use your judgment as to the exact
format / approach to use.
Describe the possible alternative accounting treatments that the

company could follow for each problem you identified. For each
alternative, explain why it could be considered a viable alternative
(i.e., what is its support?). For those alternatives that you don’t
select, explain why they weren’t chosen. Your support can include:
accounting standards, concept statements, analogies, precedents,
consideration of bigger picture factors, etc. It may be that for some
parts of the case, you won’t have to (or won’t have enough space to)
go through all of the alternatives as they are only minor parts of the
case.
If it helps, show journal entries, supporting calculations, etc.
For most of the cases we will do in this class, there won’t be an

obvious solution. So your overall goal when writing up these cases is
to convince me, the reader, why your position has merit.
Cases that render entirely opposite conclusions can still get
the same grade, as long as they are both convincing. Keep in
mind that these cases are graded on a relative basis—relative to the
other groups in the two classes I teach. So, when your case is read,
you want the grader to say “wow, this write-up is much better than
the 40 other ones I’ve just read!” So the easier it is to follow your
arguments, the more your arguments will be understood and the
better chance that you’ll get a better grade. If it is too difficult to
follow your thoughts, you’ll be marked down.
6
(You can turn in these pages for this homework assignment …

Alternatively, this assignment is available in WORD on my
blackboard web page if you want to cut & paste and type in
responses.)
.
ACCOUNTING RESEARCH PROBLEM A
This first exercise involves EDGAR, the SEC’s database. Once you have linked to
the EDGAR homepage, you need to access the section entitled “Descriptions of SEC
Forms” which is under FILINGS AND FORMS. For a more detailed description and
timelines for filing, click on FILINGS AND FORMS, then “Information for EDGAR
filers”, then “Form ID and other EDGAR Forms.”
a. FORM 10-K:
b. FORM 10-Q:
The next two forms to investigate depend on the last two digits of your social
security number (i.e., everybody in the class won’t be reporting on the same forms
for this part of the exercise). Using the table below, determine which two forms
you are responsible for. Example: If your last two digits of your social security
number are 41, then you would be responsible for Forms 8-K and S-20.
Next to last digit / form Last digit / form
0 8-K 0 S-20
1 11-K 1 S-8
2 13G 2 S-6
3 F-1 3 S-3
4 8-K 4 S-20
5 F-3 5 S-1
6 F-4 6 N-4
7 18-K 7 N-3
8 10-QSB 8 N-2
9 12b-25 9 N-1A
For each form, provide a brief description of the form.
c. FORM _______:
7
d. FORM _______:
ACCOUNTING RESEARCH PROBLEM B
For this assignment, you will use EDGAR to find out information about one
company. Your company is based on the first letter of your last name. Using the
table below, determine which company you are responsible for. At the EDGAR
home page, go to “Search company filings” under Filings & Forms. Then go to
Company or fund name …. Enter the company that you are responsible for
researching. (If for some reason, you cannot find your company or it has no
reports, go to the next letter of the alphabet and work with that company. Answer
the questions below.*
First First Firs
lette lette t
r of Company r of Company lett Company
last last er
nam nam of
e e last
nam
e
A Maytag J Dell T Hewlett Packard
B PepsiCo K Meristar U Motorola
Hospitality
C Snap On L Black and V Revlon
Tools Decker
D Riser Foods M Stride Rite W Aetna
E Amazon.com N American X Southwest
Airlines Airlines
F Wells Fargo O Cobblestone Y Westinghouse
Golf Group Electric
G Delta P Procter and Z eBAY
Airlines Gamble
H Family Q or
R
Intel
Dollar
I Talbots S Harmon
Industries
Company:___________________________________________________________________
________
8
Company Headquarters
Location:________________________________________________________
Most recent form (any type)

filed:_________________________________________________________
Date of filing (i.e., date it was submitted to

SEC):_____________________________________________
Did the corporation file a 10-K for the most recent year?
________________________________________
If so, when?
___________________________________________________________________________
What is the date of the most recent 10-Q filing?

_______________________________________________
What is the balance sheet date associated with the most recent 10-Q
filing:________________________
What is the amount of the total assets?

_____________________________________________________
What is the amount of the total revenues?

___________________________________________________
What is their cash flow from operations?

____________________________________________________
* HELPFUL HINT: Often, something like the following will occur: You type in American Airlines and you
get nine matches, none of which are American Airlines. SUGGESTION: Before typing in the company, go
to the Central Index Key Lookup in the Edgar Database. There, type in American Airlines and get its
Central Index Key (CIK). This long string of numbers can then be used as input into the Edgar database.
So, for example, the CIK for American Airlines is 0000004515. Once that is typed in, you’ll get many
matches, all of which are American Airlines’ filings.
ACCOUNTING RESEARCH PROBLEM C

Use LEXIS-NEXIS (BUSINESS database) to perform following searches. HINT:
You should look at the The FASB Codification, etc. booklet that I have
available on my blackboard page for how to “fake out” LEXIS-NEXIS when
looking for words/phrases and you do not know the name of the
company(ies.).
9
1. Using the SEC filings database, determine the number of reports that
mentioned SFAS 121 and whose reports are dated before 6/30/96.
Your search phrase was:
The number of cites was:
2. Using the SEC filings database, find the number of reports that
mentioned the phrase mandatorily redeemable preferred stock in
reports after January 1, 1997.
3. Using the SEC filings database, find the number of reports that
mentioned the phrase mandatorily redeemable preferred stock in
reports after June 1, 2008.
4. Go to SEC filings database and determine the number of reports that

describe a company that has bonds (or debentures, as they are
typically called) with non-detachable warrants.

10
ACCOUNTING RESEARCH PROBLEM D

1. Go to The FASB Codification and to Advanced Search. Type in the term
sales. How many results did you find? (See booklet for assistance with
this exercise.)
2. List the first four headers of the results you found in 1 above.
3. Now go back to the search and type in the term revenue. How many
results did you find?
4. List the first four headers of the results you found in 3 above.
5. If the words sales and revenue generally have the same meaning in
accounting, why are your search results different for these two terms?
6. Go back to the home page in the Codification. Browse through the

Revenue and the Expense category headers. Which of the two appears to
have more industry guidance?
7. Think about searching for information about dividends. In advanced

search, which “area type” would you probably want to limit your search to?
11
12
ACCOUNTING RESEARCH PROBLEM E

Go the FASB Codification and the Advanced Search option. Type in the following
search phrases and report the number of results you get.
1. Intangible
2. Asset
3. Intangible and Asset
4. Intangible Asset (within 10 words of each other)
5. Intangible Asset (within 100 words of each other)
Now redo the searches #1 and #2 above, but go into the Industry area type
within the advanced search. How many hits do you get?
6. Intangible
7. Asset
8. What industry is the first result from for your search in #6 above? And
from #7?
13
ACCOUNTING RESEARCH PROBLEM F
Go to FACTIVA on the Libraries Databases site (same general location as

LEXIS-NEXIS). FACTIVA is DOW JONES & Reuters (what a great place to find
articles!!)
1. Go to NewsPages (at top). List out the publications you have access to
here. You can abbreviate (i.e., Wall Street Journal is WSJ).
2. Now to go Search and then Search Builder. Type in the term derivatives.
How many hits?
_____________________________________________________________________________
______
3. Now limit the search in #2 to only the New York Times publication. How
many hits?
_____________________________________________________________________________
______
4. Now limit the search in #2 to only the Wall Street Journal. How many
hits?
_____________________________________________________________________________
______
5. Now limit the search in #2 to the Banking industry. How many hits?
_____________________________________________________________________________
______

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2010 CLASS NOTES: THE BIGGER PICTURE

CLASS NOTES: THE BIGGER PICTURE

SIMPLIFIED OUTLINE OF CONTENT OF AN ANNUAL FINANCIAL

• INFORMATION ABOUT COMPANY

Many players in financial reporting:

But that is TOO NARROW, even for

LET’S THINK BIGGER THAN THAT.

 Financial reporting exists to facilitate DECISION

• There are many potential users of financial reporting. Most of these

• The focus of the general-purpose financial reporting is external users.

• Financial reporting should provide information that is useful to

Specifically, ... information that will enable them to assess the

And ... to assess economic resources, the claims to those

SFAC 2 -- QUALITATIVE CHARACTERISTICS: CRITERIA FOR

What makes accounting information useful?

Users of Financial Reporting

The company must be viewed from the perspective of a current investor in

Fair value information is the only information relevant for financial

Recognition and disclosure must be determined by the relevance of the

All economic transactions and events should be completely and

Investors’ wealth assessments must determine the materiality threshold.

Financial reporting must be neutral.

All changes in net assets must be recorded in a single financial

The Statement of Changes in Net Assets Available to Common

The Cash Flow Statement provides information essential to the analysis

Changes affecting each of the financial statements must be reported and

Disclosures must provide all the additional information investors require

Since fraudulent financial reporting disasters (Enron, WorldCom,

Preparers of Financial Reports: Management

Regulators (and GAAP) …

Financial markets ...

Effects of debt covenants...

Effects of bonus plan ...

Effects of size (or political cost) ...

Auditors of Financial Reports

What about the audit committee?

For each topic that we cover in this course, we will:

Consider the economics of the transaction/situation

Address current accounting / does the accounting capture

Consider the valuation implications of the accounting /

Consider the transparency of current financial reporting

APPENDIX A – CFA Society report

1. Principle: The company must be viewed from the perspective of

Current Practice: Financial reporting standard setters have made

Reasons for Importance: The current common shareowner (CCS) is

2. Principle: Fair value information is the only information relevant

Current Practice: Since the early 1980s, financial reporting standard

Reasons for Importance: Decisions about whether to purchase, sell, or

3. Principle: Recognition and disclosure must be determined by the

Current Practice: Although recently developed reporting standards

Reasons for Importance: Financial information may be completely

4. Principle: All economic transactions and events should be

Current Practice: Because companies seek to portray themselves in

Reasons for Importance: The purpose of financial reporting is to

5. Principle: Investors’ wealth assessments must determine the

Current Practice: Despite statements of regulators, including the U.S.

Reasons for Importance: Financial statements are prepared for those

6. Principle: Financial reporting must be neutral.

Current Practice: Reporting standards issued recently tend to honor

Reasons for Importance: Reporting of economic transactions and

argument was misplaced. All costs of production, including employee

7. Principle: All changes in net assets must be recorded in a single

Current Practice: Changes in net assets are not reported in a single