ch01 SM Rankin
ch01 SM Rankin
Solution Manual
to accompany
Contemporary Issues in
Accounting
Michaela Rankin, Patricia Stanton,
Susan McGowan, Kimberly Ferlauto
& Matt Tilling
PREPARED BY:
Sue McGowan
CHAPTER 1
CONTEMPORARY ISSUES IN ACCOUNTING
1. In each of these abstracts the notion of true or fair accounting or financial statements
is considered. Identify any requirements in accounting standards or corporations
legislation that relate to the truth or fairness of financial statements or reports. (K)
The accounting standards require that the financial statements provide a fair presentation and
state:
Financial statements shall present fairly the financial position, financial performance and cash flows of
an entity. Fair presentation requires the faithful representation of the effects of transactions, other
events and conditions in accordance with the definitions and recognition criteria for assets, liabilities,
income and expenses set out in the Framework. The application of IFRSs, with additional disclosure
when necessary, is presumed to result in financial statements that achieve a fair presentation. (IAS
1/AASB 101, para 15).
(It should be noted that the concept of faithful presentation and whether there can be a true and fair
view is contested and this is discussed in Chapter 2).
The financial statements and notes for a financial year must give a true and fair view of:
(a) the financial position and performance of the company, registered scheme or disclosing entity;
and
(b) if consolidated financial statements are required--the financial position and performance of the
consolidated entity.
This section does not affect the obligation under section 296 for a financial report to comply with
accounting standards.
Note: If the financial statements and notes prepared in compliance with the accounting standards would
not give a true and fair view, additional information must be included in the notes to the financial
statements under paragraph 295(3)(c).
2. Can you think of reasons why there could be claims that financial statements that are
prepared in accordance with accounting standards are not true or fair? (J, K, SM)
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 financial
statements prepared in accordance with accounting standards may not present a true and fair
view could include:
Some accounting standards do not allow professional judgment and have set rules,
regardless of whether these rules reflect the substance. For example, in current leasing
standards treat no assets or liabilities are disclosed for operating leases despite the fact
that most of these leases would meet the definition and recognition criteria for such
elements under the conceptual framework (Note: this deficiency is acknowledged and
it is intended that this standard be revised). Another example is that internally generated
intangible assets (such as goodwill, brands) are not permitted to be recognised under
current standards, yet these may be valuable assets to an entity.
From a critical perspective, the limitations of information provided by accounting
render these statements incomplete and biased, toward financially measurable
elements, and so would not be considered true and fair (see answer to 3 below)
Students may identify further reasons.
3. The first extract states that current accounting “may disenfranchise those parties to
the dispute whose issues are not readily expressed in the common vocabulary of
business’. What do you think the author means by ‘the common vocabulary of
business’? Given this, what type of issues may not be included in accounting
reports/statements and how could their exclusion impact on decision making? (J, AS)
The common vocabulary of business here would refer to monetary or dollars values (so
financially measurable elements). This is also normally restricted to ‘direct’ and
measurable costs and benefits (so other factors, eg: externalities such as pollution or
employee satisfaction/morale are not included unless directs costs associated with
these). Further, the prime objective of business is ‘profit’ and this profit orientation is
reflected in what is included and how measured and gives primacy to economic
factors/issues and often short term outcomes.
A few of the issues not included would be social justice, environmental concerns, and
social equity issues. Typically decision making frameworks suggest that decision
makers should take into account both qualitative and quantitative factors. However if
the variable /factors considered are restricted to those in the financial statements this
will effectively exclude most qualitative factors. A quote by John F Kennedy (although
this is in the context of gross national product, this illustrates the limitations of
quantitative information and hence can be extrapolated to accounting issues)
Gross National Product counts air pollution and cigarette advertising, and ambulances to clear
our highways of carnage. It counts special locks for our doors and the jails for the people who
break them. It counts the destruction of the redwood and the loss of our natural wonder in
chaotic sprawl. It counts napalm and counts nuclear warheads and armoured cars for the police
to fight the riots in our cities. It counts Whitman's rifle and Speck's knife, and the television
programs which glorify violence in order to sell toys to our children. Yet the gross national
product does not allow for the health 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. It measures neither our
wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our
devotion to our country, it measures everything in short, except that which makes life
worthwhile. (Robert F. Kennedy, University of Kansas, March 18, 1968)
Review questions
1. Define what is meant by ‘theory’ and explain how theory is useful. Do you think
theory needs to be considered in financial accounting?
A theory may well be born in the human mind, and for it to be useful it must relate to the
‘real’ world. Theory needs to be considered in financial accounting to reflect the decision-
making behaviour of managers and investors, company policies, political activity or
professionalism of accountants.
Students should discuss how theory can help in accounting. Theories can:
a. provide a basis for action: for example, a theory of capital budgeting helps us with
choosing among investments; a theory of revenue recognition helps to determine when
and how revenue should be recognised; a theory of lease accounting helps with
accounting for leases
d help with accounting standard setting; the conceptual framework is used as a basis for
drafting accounting standards.
Positive theories are concerned with ‘what is’ and should relate to the facts or the real world
through hypotheses. For example, there may be a theory about how individuals or groups
actually use accounting information and this would result in predictions (hypothesis) about
how we would expect information to be used by particular individuals/groups. The
hypothesis is usually to test the theory. Many positive theories are generally concerned with
predicting how accounting information is used in economic decision-making and often
referred to as ‘empirical’ theories. In the main positive theories are developed from
observation through the process of induction and deduction.
Normative accounting theory is concerned with ‘what should’ be done or ‘what ought to be’
as they prescribe. Prescriptions or recommendations of these theories aim to achieve some
goal or objective. The normative theories deal essentially with measurement and are based on
classic economic concepts, especially those of income, wealth and rational decision-making.
The conceptual framework is a normative theory. It prescribes the basic principles that are to
be followed in preparing financial statements. Hence an accounting conceptual framework
can be described as ‘A coherent system of concepts that underlie financial reporting’.
Please note that normative does not mean devoid of any empirical base — normative theories
will use empirical theories/observations as assumptions from which prescriptions are
deduced.
Induction is the process of inferring general principles from particular instances; it is the
process of moving from the specific observations (particular instances) to a general theory or
conclusion.
Deduction is from the general to specific statement; it is the process of reaching a conclusion
about particular instances from general principles.
The inductive–deductive cycle is a common way in which researchers work and in which
positive theories emerge. This is often referred to as the scientific method and is the common
way in which positive theories emerge.
An example of the inductive-deductive cycle is below:
Theory development
2. Develop theoretical framework to resolve the problem (deduction).
3. Specific hypothesis to be tested
4. Construct the research design
Use of Observation
Observe via sampling and gathering data
5. Analyse the observations
6. Evaluate the results — are these consistent with the hypothesis of the theoretical
framework that has been developed
7. Assess any limitations
1. Identify
(induction)
2. Develop
(deduction)
3. State
Hypothesis
4. Research
design
5. Observe
6. Analyse
7. Evaluate
8. Limitations
5. It has been stated that ‘many people accept theories without justification’. Identify
reasons people may accept theories. Provide examples of theories that you accept or
believe although you may not have direct knowledge in the area.
Students may identify various theories that they accept but have no expert or direct
knowledge of: e.g. theories re global warming, theories on punishment (e.g. that deters
crime), theories on black holes in space; theories on causes of diseases (such as genetic
depositions).
For many theories that a person considers, that particular individual may not have an in-depth
knowledge of the area relating to the theory. For example, I believe that the world is not flat
and that in fact the theory that the world is round is true. However, I am not a scientist; I have
not studied detailed evidence about this theory in any scientific or systematic manner, so
what makes me accept this theory, or other theories that are not in my area of expertise.
People accept theories everyday that they may not fully understand (such as theories of global
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 direct knowledge,
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
then we may defer to their superior experience and wisdom. If the ‘experts’ in the area
say it is true then we are more likely to believe it is true, particularly when the expert
provides evidence to support the theory. Statements and theories from eminent scientists
or researchers in an area, by teachers (such as university lecturers), from textbooks, even
from media sources (such as television and newspapers) are often viewed as
authoritative. We are willing to often accept a theory as correct due to who or where the
information about the theory comes from (they wouldn’t say it if it isn’t true would
they?).
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,
and unless the evidence is overwhelming, he will refuse to believe it. If, on the other
hand, he is offered something which affords a reason for acting in accordance to his
instincts, he will accept it even on the slightest evidence. (Bertrand Russell).
For example, there are various debates about how much alcohol is safe to drink and that
one or two drinks a day may actually be of benefit to a persons health. Many people
would believe this is reasonable and further it may fit with their own preference to drink
alcohol so would accept this.
These approaches to accepting theories are intuitive rather than scientific or systematic and
given that any individual’s expertise is necessarily limited, provide a practical and rational
way of determining whether an individual accepts a specific theory.
6. Identify a positive theory (this can be about any area; e.g. global warming). Consider
how you would test whether this theory was true. Do you think you could prove it?
Recall that a positive theory describes what is happening or explains what is happening. The
first step in testing the theory would be to evaluate its logic. Is the theory logical and a valid
conclusion given its premises. So for example, there may be a theory about global warming
that measures the hole in the ozone layer and links this to changes in average temperatures.
For a positive theory to be able to be tested by observation it must then make a predication
that can be tested. For example, if the theory regarding temperature change related to global
warming simply predicted that the temperature may change whatever happened, would fit
with the theory and this could not really be tested. However if it made a clear prediction —
for example, that in 2008 temperatures in a particular region would increase by 1% then we
could test this by observing the temperatures in that region. If the observations are not
consistent with the predictions of the theory we have established then the theory is incorrect.
If the observations ‘fit’ with the theory then we can claim that the theory has not been
falsified. It is generally accepted that theories cannot be ‘proved’ correct because of the
problem of determining how many ‘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 the
Big Bang) have been later proven wrong when better observations have been able to be made.
Research is planned search or critical investigation aimed at discovery of new knowledge with the hope
that such knowledge will be useful in developing a new product or service or new process or technique
or in bringing about a significant improvement in an existing product or for a significant improvement
to an existing product or process whether intended for sale or use. It includes the conceptual
formulation, design and testing of product alternatives, construction of prototypes, and operation of
pilot plants. It does not include routine or periodic alterations to existing products, production lines,
manufacturing processes, and other ongoing operations even though these alternations may represent
improvements and it does not include market research or market testing activities. 1
Students should firstly understand that research is activity. The relationship to theory depends
on the reason for the research being undertaken, the type of research and/or the
results/findings of the research. Research can be undertaken before any theory has been
formed 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, you
1
Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 2 ‘Accounting for
Research and Development Costs’. Stamford, C.T: FASB, 1974).par 8.
could test the hypothesis of a positive theory and see if the findings match the predictions of
the theory.
Below some types of research are listed – these are not discussed in the text but may be
useful to provide examples to students of research. It may also be useful to have students
examine abstracts of academic articles and consider how the research in these relates to
theory.
environmental information in their annual reports more often? Researchers have considered
that one reason could be to manage the relationships and expectations with stakeholders.
This statement is incorrect. Recall that ‘empirical research’ is defined as ‘research based on
observation and experience’. As the text states, this can also be associated with normative
theories. As normative theories do not make predictions about what is happening we cannot
use observations of the real world (what is happening) to test these theories — normative
theories are making recommendations and stating what should happen, not what is
happening. However empirical research is often a catalyst for normative theories. For
examples, empirical research that identifies the impact that companies have on the
environment may lead to a normative theory about requirements for companies to include
information about their environmental performance in their annual reports.
In addition research in accounting can be classified into particular areas (although these
overlap). 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 studies
investigated the use and impact of accounting information by capital markets.