Financial Accounting Theory Essay

The article GM to Take guide of $20. 8-Billion here reproduced from The Globe and Mail (February 2, 1993) describes the potential impact of SFAS 106, Accounting for Postretirement Benefits early(a) Than Pensions, on General Motors and Ford. For example, it appears that General Motors depart be required to demonstrate a liability of $20. 8 jillion, reducing its sh beholders equity from $27. 8 billion to $7 billion, most a 75% reduction. Describe and explain how you would post the cost-effective securities foodstuff to react to this tuition.SFAS 106, Accounting for Postretirement Benefits Other Than Pensions This controversy establishes be system standards for employers accounting for postretirement benefits other than pensions. It leave significantly change the prevalent incumbent practice of accounting for postretirement benefits on a pay-as-you-go (cash) basis by requiring accrual, during the old age that the employee renders the necessary service, of the expected co st of providing those benefits to an employee and the employees beneficiaries and covered dependents.In counterchange for the afoot(predicate) service provided by the employee, the employer promises to provide, in addition to current takings and other benefits, health and other welfargon benefits after the employee retires. It follows from that view that postretirement benefits be not gratuities but argon part of an employees compensation for services rendered. This Statement relies on a basic premise of generally recognize accounting principles that accrual accounting provides more relevant and useful education than does cash basis accounting.Accrual accounting goes beyond cash transactions and attempts to recognize the mo illuminateary effects of noncash transactions and events as they occur. Recognition and bar of the accrued obligation to provide postretirement benefits will provide users of financial statements with the chance to assess the financial consequences of employers compensation decisions. In applying accrual accounting to postretirement benefits, this Statement adopts three fundamental aspects of pension accounting delayed cognition of veritable events, reporting net cost, and off passelting liabilities and related assets. (FASB, 2012) I would expect the efficient securities market to find this practice acceptable. Accrual-based accounting is more effective than cash-based accounting.A fewer arguments to support this theory are certain cash receipts and disbursements are lumpy, within operating cash flows receipts and payments can be lumpy, accrual-based accounting is a better predictor of a keep communitys semipermanent financial performance. Also all formal statements need to be set up using accrual-based accounting, and publicly traded companies need to use accrual-based accounting to correct to GAAP standards (Keener, 2012). 2. Chapter 4 Problem 12 (Imax) a. To what extent can tax taxation enhancement growth substitute f or net income as a predictor of coming(prenominal) earning power? Explain. engage efficient securities market concepts in your answer, and consider the requirement under GAAP for immediate writeoff of research and startup costs. Both tax growth and net income are useful in determining the financial strength of a company, but they are not interchangeable. Net income describes how efficient a company is with its spending and operating costs and how effectively it has been dictatorial total costs.Revenue, on the other hand, alone indicates how effective a company is at generating sales and does not take into consideration operating efficiencies which could bring on a dramatic impact on net income (Investopedia, 2012). Start-up costs are defined as those unusual one-time costs incurred in putting a new plant into operation, opening a new sales outlet, initiating a new process in an existing plant, or otherwise commencing nigh new operation (FASB, 2012). Costs of start-up activ ities, including organization costs, should be expensed as incurred (FASB, 2012). commentary of Revenue Recognition An accounting principle under generally recognised accounting principles (GAAP) that determines the particular conditions under which income becomes realized as revenue. Generally, revenue is recognized only when a specific critical event has occurred and the amount of revenue is measurable. Revenue Recognition explained For most concernes, income is recognized as revenue whenever the company delivers or performs its product or service and receives payment for it. However, there are several situations in which exceptions whitethorn apply.For example, if a companys business has a very high rate of product returns, revenue should only be recognized after the return period expires. Companies can sometimes play around with revenue recognition to make their financial figures control better. For example, if XYZ Corp. wants to hide the fact that it is having a naughty ye ar in sales, it may choose to recognize income that has not yet been collected as revenue in order to boost its sales revenue for the year (Investopedia, 2012). b. Use the concept of relevance to defend the revenue recognition policies outlined above. relevant financial statements give information to investors about the firms afterlife economic prospects (Scott, 2009). c. Use the concept of reliability to criticize the revenue recognition policies outlined above. To be reliable, information must have representational loyalty and it must be verifiable and neutral (Scott, 2009). d. To the extent that investors are cognisant of the possible use of revenue recognition policies that overstate revenues (even though, for a specific firm, they may not know the extent to which that firm is using such(prenominal) policies), what is the effect on the operation of the capital market?Explain. Investors have precedent beliefs about a firms future performance. These prior beliefs will be ba sed on all available information. If net income is high, or higher than expected, this may be good news. If so, investors would revise upward their beliefs about future performance. Other investors, who perhaps had overly high expectations for what current net income should be, might interpret the same net income number as bad news.Investors who have revised their beliefs about future performance upward will be inclined to buy the firms shares at their current market price, and vice versa for those who have revised their beliefs downward. We would expect to observe the brashness of shares traded to increase when the firm reports its net income. Furthermore, this volume should be greater the greater are the differences in investors prior beliefs and in their interpretations of the current financial information (Scott, 2009).