0Fourth_EditionSkills_for_Accounting_ResearchFASB_Codification

/'0 Fourth Edition

Skills for Accounting Research

FASB Codification and eIFRS Text and Cases

Shelby Collins, CPA Accounting Research Solutions

With Tax Research Chapter By Martha L. Salzman

University at Buffalo

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Foreword

For 16 years, I taught the graduate accounting policy and research class at the University of Georgia's J.M. Tull School of Accounting. And then , I worked closely with my successor to help him develop materials to teach the course. These experiences have taught me firsthand what a challenging, albeit rewarding, topic accounting research is for students, and what a challenging course it can be to develop. Prior to this position, my 26 years with Ernst & Young and 10 years as Chairman of the Financial Accounting Standards Board (FASB) have shown me that despite this challenge, research and communication skills are what set graduates apart in practice.

My class required students to prepare reports on real-world case studies and to participate actively in class discussions of research and current events. However, these research and com- munication skills did not always come naturally to students. I'll never forget the time when, after assigning students a case involving revenue recognition at CBS Sports , a student approached me and said that he could not find "NFL Football" anywhere in the accounting Literature. I hinted to him that terms such as "revenue recognition" or "licensing fees" were more likely to result in relevant information for this particular case. Frequently, even identifying the right keywords to search can involve practice and finesse.

While the introduction of the FASB Codification has done a lot to facilitate guidance search- es, accounting research remains a daunting challenge for many students. In part that's simply because of the sheer volume of guidance included within U.S. GAAP, and in part it is because accounting policy issues often don't have black or white answers.

It's therefore imperative that students are well trained in the resources that can help them make informed judgments. These include not only the authoritative literature, but also guid- ance for similar issues that may be relevant "by analogy" and nonauthoritative sources, such as examples from practice and interpretive guidance.

Shelby Collins is one of my former students, and a standout whom I had the privilege of nominating for a position at the FASB. When she approached me with the idea for this book, I was immediately supportive. After all, throughout my 16 years of teaching, I was unable to find a resource that met the challenge of teaching accounting students the skills necessary to perform great research, let alone prepare instructors for the challenge of teaching this course.

This book does just that. Shelby and I worked closely on the initial draft of this book, and this edition builds upon that strong foundation to incorporate even more feedback from the community of accounting research instructors. I am pleased to say that the result is a useful, and necessary resource that will enhance the quality of accounting research education-for students, instructors, and professional users alike.

With the help of this book, we can make this challenging, yet important, skill more attain- able for students.

Dennis R. Beresford Executive in Residence, University of Georgia

Former Chairman of the Financial Accounting Standards Board

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About the Authors

Shelby Collins, CPA, loves accounting research. Her current consulting position, assisting companies with implementation of the new GAAP and IFRS lease and revenue accounting stan- dards, brings a fresh and relevant perspective to this text. Prior to this position, Shelby taught the accounting research course at the University at Buffalo for six years. Her career has been dedicated entirely to this field: first at the Financial Accounting Standards Board (FASB) as a postgraduate technical assistant, then in KPMG's Accounting Advisory Services group, and then in the accounting policy and research group at Exelon Corporation in Chicago.

Shelby has seen firsthand the doors that can open for professionals who excel in research and communication. She is eager to bring practical, real-world insights to students in a way that promotes hands-on, active learning. It's her hope that this book, and the exercises herein, will prepare students to shine when they encounter accounting research opportunities as professionals.

Martha L. Salzman authored the tax research chapter of this book. Martha is a clinical assistant professor at the University at Buffalo School of Management, where she teaches the Masters- level professional tax research course and business law courses. Martha is a graduate of the University of Rochester (B.A., Political Science) and the University of Pennsylvania Law School (J.D.), and is licensed to practice law in the State of New York. Martha spent 18 years at the law firm of Phillips Lytle LLP, where her practice focused primarily on taxation, including advising clients regarding tax planning, compliance, audits and disputes. Martha enjoys using her real-world tax experience to better prepare students for their futures as tax and accounting professionals.

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Preface

Increasingly, accounting research and communication skills are being regarded as fundamental to success in our profession. Professionals who excel in these areas will likely experience a dis- tinct competitive advantage relative to their peers. At the same time, in today's highly regulated business climate, the consequences of inadequately researching and documenting accounting judgments can be severe (e.g., PCAOB or SEC enforcement actions). Recognizing the impor- tance of research skills, research simulations are now a key component of the national CPA exam. This hands-on textbook aims to teach students these important skills.

In this book, students will learn to confidently address and communicate accounting research issues, from start to finish. Students will not only take away the ability to identify the accounting problem (the "researchable question"), but will gain experience locating and applying guidance within key research tools (including the FASB Codification and eIFRS), in a variety of accounting environments. In learning to use these research tools, students will have the opportunity to apply guidance to a variety of actual accounting topics.

Recognizing that students cannot learn to research simply by reading about research, the textbook offers students numerous opportunities to actively apply chapter lessons, throughout each chapter. Students will come away from this book armed with the research and critical think- ing skills necessary for success as accounting professionals.

TARGET AUDIENCE This book is intended to serve as the primary teaching materials for graduate and undergraduate courses in accounting research. The book may also be used to supplement materials used in an intermediate or advanced accounting course, given the many opportunities provided within the text to apply Codification guidance to related accounting topics (including, for example, leases, revenue recognition, and fair value measurements). Practitioners and staff training programs can also benefit from the research and communication strategies covered in this book, while gaining exposure to actual excerpts and topics covered in the Codification and other research databases.

Colleges and universities are increasingly including accounting research as a curriculum requirement for undergraduate and/or graduate-level accounting students. Often, students reach- ing this stage of their accounting program will have just completed their first accounting intern- ship. Interns, as with new staff accountants, will quickly discover that they are expected to learn on the job (accounting can be a sink-or-swim environment). These students will likely have had just enough exposure to the challenges of research that they will crave more formal instruction on this critical skill. This book will offer that to students, in a format that is understandable and engaging.

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Prerequisites for Users of this Book To get the most value from this textbook, students studying this material should have already taken introductory-level accounting courses and-to the extent that the chapters on tax and auditing research will be covered-introductory tax and introductory auditing courses.

Users of this book will need access to the FASB Codification research tool. The American Accounting Association (AAA) provides academic access to the FASB Accounting Standards Codification and the Governmental Accounting Standards Board's GARS Online database for a low annual fee of $250 per year, per institution.

Instructors may also choose to require students to obtain a $30 annual subscription to eIFRS through the IAAER; alternatively, students can register on www.ifrs.org to obtain free access to individual standards.

To complete the exercises and case studies within the tax chapter of this book, it is suggested that users have access to an online tax research service, such as Thomson Reuters Checkpoint or CCH IntelliConnect. Access to these services is often available at reduced rates (or free-of-charge) for students enrolled in a tax or tax research course. Information on Thomson Reuters Checkpoint is available at: https://tax.thomsonreuters.corn/en/checkpoint. Information on CCH IntelliConnect is available at https://taxna.wolterskluwer.corn/research/intelliconnect.

OUTSTANDING FEATURES OF THIS BOOK This book unites research techniques with actual technical accounting issues. Students will move their understanding of accounting issues and research techniques forward along the knowledge continuum, from simply understanding to having the ability to critically think about and apply accounting issues. The practical examples and exercises in this book will challenge students to actively learn while they read.

Instructors will value that this book allows students to independently read and practice the baseline skills necessary to become accounting researchers, leaving instructors free to expand lectures into discussions of accounting judgments, student presentations, current events, and classroom discussions of ( or hands-on group practice with) case studies. In short, instructors will be able to actively engage students in classroom debates and discussions, because they can spend less of their valuable classroom time lecturing on basic research and communication skills.

Overview of the Book Chapters 1-5 of this book provide baseline knowledge that is necessary for understanding the rest of the book; the remaining chapters are written independently of one other, allowing instruc- tors to choose to utilize only those chapters that fit their individual course needs.

Chapter 1 offers an overview of accounting research, including discussion of who performs accounting research and in what circumstances, and introducing key standard setters.

Chapter 2 provides an in-depth introduction to the FASB Codification, and emphasizes that students should perform Browse (as opposed to keyword searches) when possible.

Chapter 3 introduces the research process, and Chapter 4 introduces the fundamentals of effective technical writing, including the format of an accounting issues memorandum, tech- niques for effective email communication of research, and appropriate style for technical accounting writing.

Chapter 5 teaches students how to properly use nonauthoritative resources (e.g., Concepts Statements, firm resources, benchmarking), an essential but often overlooked skill for pro- fessionals learning to perform research.

Chapters 6--8 give students the opportunity to apply guidance to accounting issues following the order of sections in the Codification: first, issues involving scope and recognition (Ch. 6), followed by accounting measurement (Ch . 7), and specifically fair value measurement (Ch. 8).

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Chapters 9-12 introdu ce skills specific to performing research in other environments, including auditing and professional services research (C h. 9), gove rnm ental resea rch (C h. 10), tax research (Ch. 11 ), and intern ati onal research (Ch . 12). Each of these chapters stands on its own, so in structors can choose to cover only the chapters relevant to their own courses.

Finally, Chapters 13 and 14 foc us on softer ski lls. Chapter 13 teaches stu de nts how to prepare and deli ver effecti ve presentations. Chapter 14 emphas izes the need fo r profess ionals to stay current as accounting requirements change and introduces the standard setters' due process for issuing new guidance. This chapter is a mu st-read and encourages students to sign up fo r accounting news alerts.

Engaging Pedagogy Research is a skill that you learn by doing; accordingly, the pedagogy in thi s book is designed to fos ter active learning.

Chapter Opening Vignettes, Learning Objectives, and "Organization of This Chapter" Diagrams Each chapter opens with a brief vignette placin g students in the shoes of a beginning researcher. This opening vignette is fo llowed by a li st of the learnin g obj ectives for the chapter, and then by a diagram illustratin g the organ ization of co nte nt within the chapter. These chapter-openi ng ele- ments are intended to generate reader enthu sias m for chapter co ntent, as well as prov ide stude nts with an overview of the infor mation to co me.

Example Chapter Opening Vignette (from Chapter 6, Scope)

Printout in hand , Julie taps on her boss's door. She is feeling pretty good ; she just

found a paragraph in the guidance that appears to speak directly to the tax accrual

issue her boss asked her to research. As she shows him the guidance , he taps his

pen thoughtfully on the desk.

"Are you sure this guidance applies to our type of transaction?" he asks .

He continues , "I think the guidance for gross receipts taxes (which are based

on revenue measures) may differ from guidance for taxes based on income. You 've

brought me guidance specific to income taxes."

Julie shakes her head ; she realizes that she forgot to review the scope section

of the guidance that she had printed. "Let me double check the scope section for this

guidance ," she says. "I'll stop by again later to let you know what I've found. "

Confirming that a transaction is within the scope of a Codification topic may seem

like an extra step, but much of the guidance within the Codification includes specific

instructions for its use. Don't get caught like Julie, forgetting to do the appropriate dili-

gence work on guidance that may otherwise appear to be on point. A proper review of

the scope section is critical to identifying appropriate recognition , and then measure-

ment, guidance for a transaction .

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Example Learning Objectives (from Chapter 2, regarding the FASS Codification)

After reading this chapter and performing the exercises herein, you will be able to

1. Describe the purpose of the Codification , and the meaning of authoritative.

2. Identify standard setters that have contributed to the current body of authoritative

guidance.

3. Understand the organization of guidance within the Codification.

4. Perform effective Browse searches within the Codification , reviewing all areas of

required reading.

5. Search the Codification using other methods, including keyword searches, the Master

Glossary, and the Cross Reference feature.

6. Differentiate between existing versus pending content, and understand how to inter-

pret transition date guidance.

7. Recognize accounting alternative guidance available for private companies.

Example "Organization of This Chapter" Diagram (from Chapter 3, regarding the research process) Eac h chapter includes a graphic showing the organization of topics within the chapter, along with narrati ve discussion of what the reader can expect key chapter themes to include. Following is one such chapter organization graphic:

Steps in the Research Process

0. Understand the business (i ndustry). Judgment and 1. Understand the transaction. Decision Making

2. Define the research problem . in the Research Next Chapter: 3. Think independently about possible -..... Process -..... Documenting

sol utions. ~ 1. Common biases - accounting 4. Search potentially relevant sou rces of 2. Ove rcoming research

guidance . biases to reach

5. Analyze the alternative treatments. sound decisions

6. Justify and document yo ur conclusion.

Chapter Features Chapters are written in concise, easy to understand language, with boldfaced key terms to call students' attention to certain topics. In addition, chapters include extensive screenshots (from research tools, particularly the Codification) and diagrams illu stra ting key chapter concepts, intended to both engage students and improve their fa miliarity with research tools.

Chapters also include the fo llowing fea tu res , intended to engage students in active learning :

Now You Try Throughout each chapter, students are challenged to practice and apply key skills as they are taught (Now YOU Try questions) . These exercises might involve , fo r example, a student being asked to "draw a picture" of a transaction, "draft an email" describing an issue, "show the search path you would use," or "identify the journal entries" for a scenario, using guidance fro m the Codification as a guide for the appropriate accounting. Instructors can use these questions as a lead-in to acti ve in-class discussions.

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Example Case Study Question (from Chapter 4, regarding effective communication)

Writing a Short Iss ues Memo-In ventory Va luati on You have been asked to draft a brief issues memo ("to the files") analyzing the following issue.

Charles Corp. has leased a mine from which it recently extracted 2,000 kilograms of bauxite (a min- eral used in producing aluminum). Charles Corp. plans to sell the bauxite to aluminum manufacturers. Charles Corp. is analyzing whether its bauxite inventory can be carried at its selling price per ASC 330- I0-35- I 6(b) . Assume that quoted market prices are generally available for bauxite, and that the market for bauxite is active.

Using the standard memo format, analyze whether all necessary conditions are met for the accounting treatment proposed. If assumptions are needed to fully evaluate the guidance, identify those assumptions in your analysis. For this particular memo, you are not required to present alternative treatments; assume for this issue that you have solely been asked to document whetherthe conditions in ASC 330-I0-35-16(b) are met.

NEW TO THIS EDITION

• MyBusinessCourse: New video examples have been added to MBC.

• New Standards: Includes strategies for navigating the revised revenue and lease topics and new assignments requiring students to research and interpret the new standards and to docu- ment and communicate their findings.

• Codification: Presents updated screenshots of the Codification featuring the latest standards.

• Updated Detailed Research Example: The author presents a real research question involving baseball stadium concession sales (Lease? Revenues?) and integrates it throughout Chapters 3 and 4. Students will follow this real-world example through the research, process culmi- nating in a new chapter-end sample memo.

• Case Studies: The text includes new, current, and real-world case studies of varying dif- ficulty level-including cases building upon the stadium example. Cases place increased emphasis upon the use of professional judgment.

SUPPLEMENTS All supplements for this book have been created by the book's authors.

Instructors Manual-Includes resources for instructors of this course, including sample course schedules and grading considerations, teaching tips for each chapter, and links to external resources.

PowerPoint Slides-Available for each chapter, PowerPoint lecture slides highlight key mat- ter from each chapter.

Solutions Manual-Includes solutions to all end-of-chapter review questions, exercises, and case studies.

Now You Try Responses-Available to instructors, solutions to the Now You Try exer- cises are intended to assist instructors in leading class discussions.

~ : A web-based learning and assessment program intended to complement your textbook and classroom instruction. This easy-to-use course management system includes prac- tice quizzes and guided examples videos narrated by the author. MyBusinessCourse provides students with additional help when you are not available. MyBusinessCourse is ideal for online courses or traditional face-to-face courses for which you want to offer students more resources to succeed.

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ACKNOWLEDGEMENTS I would like to first thank Denny Beresford, for his enthusiastic initial, and continuing, support of this book.

We were fortunate to receive review comments on this book from accounting research fac- ulty from across the country, and we are sincerely grateful to these individuals for their time and important contributions to this book. These individuals are

Sheila Ammons, Austin Community College Marie Archambault, Marshall University Salem Boumediene, Montana State University Megan Burke, Texas A&M University-Commerce Kimberly Charland, Kansas State University Yu Chen, Texas A&M International University Mary Christ, University of Northern Iowa Ann Cohen, SUNY-Buffalo Amanda Cromartie, University of North

Carolina-Greensboro John Crowley, Castleton State College Abbie Daly, University of Wisconsin- White Water John DeJoy, Union Graduate College Victoria Dickinson, University of Mississippi Lynn Dikolli, University of North Carolina at Chapel

Hill Tom Downen, University of North

Carolina-Wilmington Emily Doyle, University of South Carolina Robert Elya, Golden Gate University Patricia Fairfield, Georgetown University Tim Firch, California State University-Stanislaus Michael Fischer, St. Bonaventure University Caroline Ford, Baylor University James Fornaro, SUNY at Old Westbury Jim Fuehrmeyer, University of Notre Dame Carl Gabrini, College of Coastal Georgia Catherine Gaharan, Midwestern State University Patricia Galleta, CUNY-College of Staten Island Alan Glazer, Franklin & Marshall College Hubert Glover, Drexel University Rita Grant, Grand Valley State University Mahendra Gujarathi , Bentley University Parveen Gupta, Lehigh University Leslie Hodder, Indiana University Patrick Hopkins, Indiana University Ron Huefner, SUNY-Buffalo Venkataraman Iyer, University of North

Carolina-Greensboro Mark Jackson, University of Nevada-Reno Carol Jessup, University of Illinois-Springfield John Jiang, Michigan State University

Vicki Jobst, Benedictine University Jeff Jones, Auburn Universi ty (Amanda) Bree Josefy, Indiana University Ahmad Jumah, University of Illinois-Springfield Sara Kern, Gonzaga University Katherine Krawczyk, North Carolina State University Sudha Krishnan, California State University-Long

Beach Benjamin Lansford, Penn State University Siyi Li, University of Illinois-Chicago Linda Lovata, Southern Illinois

University-Edwardsville Jason MacGregor, Baylor University Dawn Massey, Fairfield University Dawn McKinley, Harper College Janet Mosebach, University of Toledo Kelly Noe, Stephen F. Austin State University Elizabeth Oliver, Washington & Lee University Kevin Packard, Brigham Young University-Idaho Susan Parker, Santa Clara University Laurel Parrilli, St. John Fisher College Terry Patton , Midwestern State University Suzanne Perry, Texas A & M University-Commerce Marlene Plumlee, University of Utah Richard Price, Utah State University K.K. Raman, University of Texas, San Antonio Paul Recupero, Newbury College Phil Rohrbach, University of Richmond John Rossi , Moravian College Beverly Rowe, University of Houston Downtown Carol Sargent, Middle Georgia State University Lee Schiffel, Valparaiso University Barbara Scofield, Washburn University Debra Sinclair, University of South Florida Kevin Smith, Utah Valley University Chad Stefaniak, University of South Carolina Randall Stone, East Central University Ronald Stunda, Valdosta State University Walter Teets , Gonzaga University Thomas Vogel, Canisius College Robert Walsh, University of Dallas Changjiang Wang, Florida International Uni versity

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Christine Wayne, Harper College Jeannie Welsh, LaSalle University

Philip Woodlief, Vanderbilt University Gail Wright, York College of Pennsylvania Rong Yang, Rochester Institute of Technology Jeff Wilks, Brigham Young University

John Williams, Missouri State University

In particular, thanks to Sheila Ammons, Lynn Dikolli, Tim Firch, Jim Fornaro, Jim Fuehrmeyer, Richard Grueter, Carol Jessup, Sara Kern, Elizabeth Oliver, Debbie Sinclair, Nicholas Stell, Keith Stolzenburg, Jeff Wilks, and Phil Woodlief for their valuable feedback and counsel on the development of this text. Thanks, too, to our colleagues and former colleagues at the University at Buffalo for their support of this text, especially Ron Huefner, Ann Cohen, Arlene Hibschweiler, and Susan Hamlen.

A sincere thanks to the many institutions and corporations that permitted the use of their material in this book, especially the generosity of the Financial Accounting Foundation, PCAOB, and AICPA.

I would also like to thank George Werthman and Marnee Fieldman at Cambridge Business Publishers for their dedication to this book.

Finally, thank you to the instructors, students, and firms using this book. I look forward to your comments and suggestions.

/'0 Brief Table of Contents

Chapter 1 Overview of Accounting Research 2

Chapter 2 The FASB Codification: Introduction and Search Strategies 20

Chapter 3 The Research Process 54

Chapter 4 Creating Effective Documentation 76

Chapter 5 Using Nonauthoritative Sources to Supplement Codification Research 11 O

Chapter 6 Scope and Recognition Guidance: A Brief Introduction 146

Chapter 7 Using the Codification to Research Measurement Issues 184

Chapter 8 Fair Value Measurements in the Codification 208

Chapter 9 Audit and Professional Services Research 236

Chapter 10 Governmental Accounting Research 274

Chapter 11 Fundamentals of Tax Research 308

Chapter 12 The International Research Environment 352

Chapter 13 Delivering Effective Presentations 392

Chapter 14 Staying Current with Emerging Guidance 408

Index 421

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Contents

Target Audience v

Prerequisites for Users of this Book vi

Outstanding Features of this Book vi

Overview of the Book vi

Engaging Pedagogy vii

New To This Edition x

Supplements x

Acknowledgements xi

Chapter 1 Overview of Accounting Research 2

Why Accounting Research Skills Matter 4

What Is Accounting Research, and Why Is It Performed? 4

In What Future Roles Might I Perform Accounting Research? 5

When Is Accounting Research Performed? 6

Researching a Proposed Transaction 7

Researching a Past Transaction 8

Research Performed After Financial Statement Issuance 9

Research for the Purpose of Shaping Future Accounting Standards 10

In What Environments Is Accounting Research Performed? 10

Different Guidance for Each Research Environment 11

Accounting Standard-Setting Bodies 12

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The Securities and Exchange Commission 12

The American Institute of Certified Public Accountants 14

The Financial Accounting Standards Board 14

Chapter Summary 16

Review Questions 16

Exercises 17

Case Study Questions 18

Chapter 2 The FASB Codification: Introduction and Search Strategies 20

What is the FASS Codification? 22

What Sources of Guidance Were Used to Populate the Codification? 23

How is the Codification Updated? 24

Navigating The Codification 24

How is Information Organized Within the Codification? 25

Areas and Topics 26

Subtopics 28

Sections 28

Subsections and Paragraphs 33

Tips for Performing Browse Searches 35

Join All Sections 35

Navigating a Subtopic, Considering All Areas of "Required Reading" 36

Other Search Methods 39

Keyword Searches 39

Search by ASC Reference Number 43

Cross Reference Tab 44

Master Glossary 44

Pending Content and Effective Dates 45

What is "Pending Content"? 45

Understanding Effective Dates 46

Private Company Accounting Alternatives in the Codification 47

Chapter Summary 47

Review Questions 47

Exercises 49

Case Study Questions 50

Chapter 3 The Research Process 54

Why Use A Research Process? 56

The Accounting Research Process 56

Pre-Step: Understand the Business (Industry) 57

Step 1: Understand the Facts/Background of the Transaction 59

Step 2: Define the Problem. That Is, Identify the "Researchable Question ." 61

Step 3: Stop and Think: What Accounting Treatment Will Likely Be Appropriate? 62

Step 4: Search Potentially Relevant Sources of Guidance, Copying Any Relevant Guidance into a Word Document 63

Step 5: Analyze Alternatives, Documenting Your Consideration of Each 65

Step 6: Justify and Document Your Conclusion 67

Judgment And Decision Making- A Brief Introduction 67

Chapter Summary 70

Review Questions 71

Exercises 71

Case Study Questions 73

Additional References 75

Chapter 4 Creating Effective Documentation 76

Documentation Is Integral to Accounting Research 78

Communicating Accounting Research 79

Emailing the Results of Research Questions 79

Drafting an Accounting Issues Memorandum 83

Facts 84

lssue(s) 86

Analysis 86

Conclusion 91

Contents xv

Financial Statement and Disclosure Impacts 93

Reread Your Work Before Submitting (and what to look for) 93

Properly Referencing Accounting Guidance 94

How Do I Reference a Passage from the Codification? 94

Should I Ever Use Footnotes in Professional Memos? 95

When Should I Use Quotation Marks? 96

When Is It Appropriate to Alter an Excerpt from the Guidance? 96

When Is It Appropriate to Use Ellipses? 97

Style Tips for Professional Communication 98

Use Proper Voice in Your Memos 98

Keep Your Language Neutral (Avoid Strong Words) 98

Get the Grammar Right 99

Getting Feedback On Your Writing 100

Chapter 4 Appendix 101

Sample Accounting Issues Memo 101

Chapter Summary 105

Review Questions 105

Exercises 106

Case Study Questions 108

Chapter 5 Using Nonauthoritative Sources to Supplement Codification Research 110

Nonauthoritative Guidance: What Is It, And How Is It Used? 112

Benefits of Nonauthoritative Guidance 113

Sources of Nonauthoritative Guidance 114

FASB's Conceptual Framework 114

Accounting Standards Updates and Pre-Codification Standards 123

Accounting Firm Resources 125

AICPA Resources 130

Peer Benchmarking 132

International Financial Reporting Standards (IFRS) 136

Using Nonauthoritative Sources: There's a Right Way, and a Wrong Way 138

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xvi Contents

Is It Wrong to Cite Nonauthoritative Guidance Only? 140

What's the Right Way to Search Nonauthoritative Guidance? 140

How Do I Reference Nonauthoritative Sources? 141

Chapter Summary 141

Review Questions 142

Exercises 142

Case Study Questions 144

Chapter 6 Scope and Recognition Guidance: A Brief Introduction 146

Scope Guidance: An Area Of Required Reading 148

Applying Scope Guidance: A Few Examples 149

Considering Scope, Glossary, and Interpretive Guidance 149

Evaluating Subsections with Unique Scope Guidance: Nonmonetary Transactions 151

Which Topic Applies?: Navigating Investments Topics 154

Performing A Scope Test: Derivatives 156

Evaluating Whether an Instrument Meets the Definition of a Derivative 156

To Document, or Not to Document My Scope Review? 158

Recognition Guidance: A Brief Introduction 159

Revenue Recognition: Navigating The REVISED MODEL 161

Conceptual Definitions of Revenue 161

Revised Model: Revenue from Contracts with Customers (ASC 606) 162

Research Techniques for Navigating Revenue Guidance 163

Applying Different Recognition Thresholds 171

Uncertain Taxes: Recognize If More Likely Than Not 171

Effective Settlement of a Tax Position 172

Subsequent Events: Recognize If Conditions Existed at the Balance Sheet Date 17 4

Applying Derecognition Guidance: Liability Extinguishments 176

Chapter Summary 179

Review Questions 179

Exercises 180

Case Study Questions 181

Chapter 7 Using the Codification to Research Measurement Issues 184

What is Accounting Measurement? 186

Overview and Conceptual Background 186

Measurement Attributes 186

Where Can I Find Measurement Guidance? 188

Who Performs Accounting Measurement In Practice? 190

Initial Measurements 190

Overview 190

Applying Initial Measurement Guidance 191

Subsequent Measurements 197

Overview 197

Applying Subsequent Measurement Guidance 197

Disclosure Should Accompany Key Measurement Judgments 203

Chapter Summary 203

Review Questions 203

Exercises 204

Case Study Questions 205

Chapter 8 Fair Value Measurements in the Codification 208

Fair Value Overview 210

What Is Measured at Fair Value? 210

How Is Fair Value Measured? 211

The Fair Value Hierarchy 212

The Debits and Credits: How Are Changes in Fair Value Reported? 214

How Do I Navigate Fair Value Guidance? 215

Organization of ASC 820 216

In What Other Circumstances Are Fair Value Measurements Permitted Or Required? 217

Option to Measure at Fair Value 217

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Items Measured at Fair Value for Disclosure Purposes 219

What Is The Relationship Between Fair Value and Present Value? 221

Contributions Payable: Measuring Fair Value Using an Income Approach 222

Valuation Technique Disclosures: An Insight Into How Fair Value Measurements Are Performed 224

Fixed Assets : Testing For Impairment Using Fair Value 225

Chapter Summary 231

Review Questions 231

Exercises 232

Case Study Questions 233

Chapter 9 Audit and Professional Services Research 236

Introduction To Auditing Research 238

When Is Audit Research Required? 238

Types of Services-A High-Level Overview 238

The Standard Setters: The AICPA and the PCAOB 239

Researching Auditing Standards 242

AICPA Auditing Standards 242

PCAOB Rules and Auditing Standards 247

Searching for Auditing Guidance within Firm Research Databases 254

The AICPA's Code Of Conduct 255

The Code Is Organized Into Three Parts 255

The Conceptual Framework Approach 258

How Is Guidance in the Code Organized? 261

How Can I Search for Guidance in the Code? 265

The Code Will Continue to Change 266

Standards For Other Professional Services 266

Attestation Standards 266

Compilation and Review Standards (SSARS) 266

Internal Audit Standards 267

Documentation of Professional Services Research 268

Citing Professional Standards 269

Chapter Summary 270

Review Questions 270

Exercises 271

Case Study Questions 272

Chapter 10 Governmental Accounting Research 27 4

Conten ts xvii

Governmental Accounting Research 276

State and Local Accounting Standards 276

Federal Accounting Standards 286

Referencing Governmental Accounting Guidance 291

Governmental Auditing Standards 291

In What Circumstances Are Government Audits Required? 291

Who Performs Government Audits? 293

Standards for Government Audits 294

Applying Governmental Auditing Standards 297

Appendix 1 OA : Applying the GASB Codification , An Extended Example 300

Recognition of Tax Revenues , Using Fund Accounting 300

Chapter Summary 304

Review Questions 304

Exercises 305

Case Study Questions 306

Chapter 11 Fundamentals of Tax Research 308

Who Performs Tax Research , and When? 310

The Tax Research Process 31 O

Step 1: Understand the Relevant Facts 311

Step 2: Identify the Tax Issues Involved 312

Step 3: Analyze Tax Research Findings 314

Step 4: Document and Communicate Tax Research Results 315

Sources of Federal Tax Law 318

Primary Sources of U.S. Federal Tax Law 318

Secondary Sources of U.S. Federal Tax Law 334

Using an Online Tax Research Service to Find Tax Law 336

Table of Contents and Index Searches on Thomson Reuters Checkpoint 337

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Keyword Searching 338

Citation Searches 340

Additional Guidance for Using Thomson Reuters Checkpoint 340

Updating Tax Research Results 341

Citators 342

Standards of Professional Tax Practice 344

Circular 230 344

AICPA Statements on Standards for Tax Services 345

Chapter Summary 346

Review Questions 346

Exercises 347

Case Study Questions 349

Chapter 12 The International Research Environment 352

Introduction 354

IFRS: The Predominant Global Financial Reporting Framework 354

A Brief History of International Standards 354

When Are Financial Statements Required Internationally? 355

The IFRS Foundation and Its Standard-Setting Bodies 357

Standard-Setting Bodies of the IFRS Foundation 358

Governance and Oversight of the IFRS Foundation 359

Advisory Bodies of the IFRS Foundation 360

Funding for the IFRS Foundation 361

International Financial Reporting Standards (IFRS) 361

Applicability of IFRS 361

Understanding "Full IFRS" 364

Performing IFRS Research 368

Statement of Compliance with IFRS 372

IFRS for Small and Medium-Sized Entities 373

How Do I Know Whether IFRS Applies to a Particular Country? 375

When Are International Standards Relevant to U.S. Accountants? 376

Foreign Private Issuers 377

U.S. Nonpublic Companies 378

Other Areas Relevant to U.S. Accountants 378

Citing International Accounting Standards 379

Nonauthoritative Resources 380

Deloitte's IAS Plus Website 380

Comparison Guides 380

Other Resources 380

Appendix 12A: International Auditing Standards 381

When Do International Auditing Standards Apply? 381

The International Federation of Accountants (IFAC) and Its Standards Boards 382

Comparing International Audit Reports 385

Chapter Summary 387

Review Questions 387

Exercises 388

Case Study Questions 389

Additional References 390

Chapter 13 Delivering Effective Presentations 392

When Will I Use Presentation Skills in Practice , and What Is the Format? 394

Presentation Formats 395

What Are the Qualities of a Great Presentation? 395

Creating Effective Content 396

Find Ways to Make the Information Resonate 397

How Much Detail Should I Include in My Slides? 398

Does Font Choice Matter? 400

Use Consistent Bullet Style 400

Edit Your Presentation 401

Delivering a High-Quality Presentation 401

Tips for Powerful Body Language 401

What If You Have a Fear of Presenting? 403

Think beyond the Case Facts 403

What Should You Wear? 404

Considerations for Those Working in a Group 404

Chapter Summary 406

Review Questions 406

Exercises 407

Case Study Questions 407

Chapter 14 Staying Current with Emerging Guidance 408

The Professional Advantages of Staying Current 410

The Standard-Setting Process 411

Why Do Accounting Standards Change? 411

Contents xix

The Standard-Setting "Due Process" 412

Identifying Resources for Staying Current 413

First, Identify the Standard Setters You Want to Monitor 413

Next, Identify Resources for Monitoring These Standard Setters 414

Chapter Summary 418

Review Questions 418

Exercises 419

Case Study Questions 420

Index 421

Overview of Accounting Research Each chapter in this book begins with an opening scenario , involving a beginning researcher

who has been challenged to perform research. The opening scenario for this chapter is

about you.

You are a senior or graduate-level accounting student, or you are an associate in an

accounting firm . Your coursework and experiences to date have given you a strong account-

ing foundation ; however, now you are being asked to perform accounting research. As an

accounting student, you are told that you'll need research skills for your upper-level course-

work and for the CPA exam. Or, as a professional , your supervisor is already asking for your

help researching client issues.

To perform this research , you will need the following :

• An understanding of which research tools apply in each research environment,

• Confidence applying a step-by-step research process to open-ended questions, and

• Strong written communication skills , to effectively communicate your research

results.

Continued

After reading this chapter and performing the exercises herein, you will be able to

1. Identify parties who perform accounting research , and circumstances in which

accounting research is required .

2. Describe the ideal timing for performing accounting research , and understand circum-

stances in which this timing may not be feasible .

3. Understand that different standards apply to different research environments (e.g. ,

financial , governmental , audit, tax, and international research).

4. Identify key standard setters involved in establishing U.S. accounting guidance.

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Continued from previous page

You've come to the right place to obtain these skills. By actively participating in the les-

sons in this book, and by practicing your skills through research exercises and case stud-

ies, you can become an effective researcher. Get ready to roll up your sleeves-the ability

to perform accounting research can pay dividends for your career, but mastering this skill

requires practice.

Why Do Sources of Guidance Brief Introduction to Accounting Research Applicable to Different Accounting Standard

Skills Matter? Research Environments Setters

1. Why is accounting 1. Accounting (public vs . 1. SEC research performed? private companies) 2. AICPA

2. In what future roles 2. International 3. FASB might I perform 3. Governmental research ?

4. Tax, and 3. When is research

5. Auditing research. performed?

Organization of This Chapter This chapter provides essential background for researchers about to engage in their first

experiences with the FASB Codification (in Chapter 2). In particular, the chapter emphasizes

the importance of research skills and circumstances in which these skills may be required .

Additionally, the chapter emphasizes the benefits of researching transactions before they

take place.

Next, the chapter highlights that accounting research doesn't just come from one source ;

rather, each accounting environment (U.S. , international , tax, governmental , and auditing)

is governed by its own unique standards. Finally, the chapter introduces the key standard

setters responsible for establishing U.S. generally accepted accounting principles (GAAP).

The preceding graphic illustrates the organization of this chapter.

Following the introduction presented in this chapter, Chapters 2-8 of this book focus on

various aspects of financial accounting research , primarily related to U.S. public and non-

public companies. Discussion of other research environments , including guidance on audit-

ing, governmental , tax, and international research , is provided in Chapters 9-12 . Chapter 13

offers techniques for delivering effective research presentations. Finally, Chapter 14 teaches

readers the importance of staying current as accounting standards continually change.

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4 Chapter l I Overview of Accounting Research © Cambridge Business Publishers

Lo 1 Identify parties who perform accounting research, and cir- cumstances in which account- ing research is required.

WHY ACCOUNTING RESEARCH SKILLS MATTER

Ever heard the one, where you tell someone you're an accounting major, and they say: "Oh, you must be good at math!"?

Numbers certainly have a place in our profession. But I'll let you in on a little secret ... research and communication will also be a key part of your career as an accountant. In fact, excelling in these areas can have a profound effect on your advance- ment. Consider this very rough sketch of research and your career:

Entry-level accountant or

auditor

Some research

Manager/ Sr. Manager/

Partner

More research

From this illustration, here are three takeaways:

Corporate accounting policy team/

Advisory services providers

Research is a major focus of job

• One, there's no way around it. You'll need at least a minimum level of competency in research to do your job as an entry-level accountant or auditor. This book will help.

• Two, the more you advance in your career, the more research you will likely perform. But the inverse is also true; do research well, and you'll be asked to do more of it. Soon, you'll start being viewed as a higher-level professional, and you'll have the ultimate learning expe- rience as you are invited to participate in increasingly important projects.

• Three, if you find that research is something you love, you can actually make a career of it. Most major corporations have accounting policy teams, which focus on reviewing account- ing judgments and implementing new standards. Accounting firms also have teams devoted to assisting clients with accounting policy judgments, like KPMG's Accounting Advisory Services and EY 's Financial Accounting Advisory Services.

You ' ll learn the most about accounting research by actually doing it. So the next chapter jumps right into the FASB Codification . But before we get there, this chapter offers a little back- ground on who performs research in our profession, when, and in what environments. Finally, the standard setters responsible for establishing accounting guidance are also briefly introduced.

What Is Accounting Research, and Why Is It Performed? The term accounting research is used to describe two very different types of research:

• Research done in practice, by accountants and other interested parties, often in conjunction with the preparation or review of financial statements or tax returns; and

• Academic research, primarily done by candidates pursuing-or academics who have obtained-a PhD in accounting.

This book focuses solely on the accounting research that is done in practice, also known as technical accounting research.

The objectives of performing this type of accounting research are generally twofold:

1. To account for transactions or items in a manner that is appropriate and supportable based on authoritative guidance, and

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2. To create do cumentation describing the research performed and supporting the conclusion reached.

That is, accountants often need to consult accounting standards in order to determine the appropriate accounting treatment for a transaction or event, or to locate guidelines for the prepa- ration of financial statements. In particular, accounting research may be necessary for transac- tions that are new or infrequent for a company, highly material, or for which a company does not have an established accounting practice. Ultimately, this accounting research can be necessary to ensure that a company 's accounting complies with authoritative guidance, thus allowing the company to receive an unmodified (aka, unqualified) audit opinion.

Additionally, a key objective of accounting research is to create robust documentation sup- porting the conclusions reached. This documentation should summarize-in one place-all rel- evant background on an issue, the guidance considered, and the basis for the selected accounting position. Documenting the basis for accounting positions is especially critical in circumstances where the accounting for a transaction involves judgment (for example, if two or more alterna- tives are present). Chapter 4 elaborates on why and how to create robust documentation.

As noted earlier, accounting research is generally only performed for transactions and events that are considered material to an entity and that are therefore relevant to users of an entity 's financial statements. Recall that:

Relevance and materiality are defined by what influences or makes a difference to an investor or other decision maker .. . The omission or misstatement of an item in a financial report is material if, in light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item. 1

Materiality can be evaluated based on an item's quantitative or qualitative significance. More resources are generally devoted to researching an entity's most material business issues, and less resources are generally devoted to less material issues.

Recognizing the importance of research skills, the uniform CPA exam tests candidates' research and other critical thinking skills through task-based simulations. Task-based simula- tions account for approximately 50% of candidates' exam scores on each of the regulation (REG), auditing (AUD), and financial accounting (FAR) sections of the exam. 2

Next, let's look at who typically performs accounting research .

In What Future Roles Might I Perform Accounting Research? No matter what accounting career path you pursue, you can expect to perform accounting research. In fact, you will likely be asked to research basic issues during your very first intern- ship, or during your first year in the profession.

As illustrated in Figure 1-1 , here are some circumstances in which the following parties typically perform accounting research:

• Corporate accountants: Also referred to as preparers of financial statements or tax returns, accountants working for a company may perform accounting research in conjunction with the preparation of the company 's financial statements or tax returns, or for purposes of tax planning.

I FASB Concepts Statement No. 8, Conceptual Framework/or Financial Reporting, Chapter I (amended Aug. 201 8). Paragraph QC 11.

2 AICPA , How is the Uniform CPA Examination Scored? Effective April l, 2017. Pages 4, 6.

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Figure 1·1

Particularly for small companies, accounting firm personnel are sometimes engaged to help companies prepare their accounting records or financial statements. This can involve performing accounting research on behalf of the company.

• Auditors: Auditors often must research whether a company's accounting positions are sup- portable based on authoritative guidance, in order to conclude that the company's financial statements are presented fairly in conformity with GAAP.

• Regulators: Regulatory agencies (either governmental or independent) are responsible for overseeing certain corporations and industries. Certain regulators, such as the SEC, routinely review the financial statements of companies they oversee. Regulators may need to perform research to understand positions taken in companies' financial statements.

• Investors : Often referred to as users of financial statements, professional investors monitor accounting positions taken by companies and, in some cases, may raise concerns (or make adjustments to models they maintain) when a company's accounting positions are inconsistent with those of other companies in the same industry.

Parties Performing Accounting Research

Parties performing accounting research

- Before a

transaction occurs

- After company

documentation is prepared

After financial statements are

issued

Regardless of the career path you choose, during the early stages of your career, your research will generally be reviewed by a supervisor before it is relied upon or shared with a client. That said, a well-documented and supportable initial recommendation and research from you can open doors to higher-level projects.

Your Role as a Researcher [

Now

YOU Try 1.1

Based on the preceding descriptions of parties who perform accounting research, in what role(s) do you imagine that you might perform research?

Lo2 Describethe ideal timing for performing accounting research , and understand circumstances in which this timing may not be feasible .

WHEN IS ACCOUNTING RESEARCH PERFORMED?

Accounting research can occur at different stages in the financial reporting process. Ideally, companies with sufficient resources (often, public companies) will research the accounting for a transaction before the transaction takes place . However, the accounting research process may differ for small or nonpublic companies, which may be subject to more resource constraints and which generally have less user demand for financial statements. In these environments, research may only occur as financial statements are being prepared, or it may occur at the request of an auditor seeking further support for a company's accounting methods.

Let's take a closer look at each of these circumstances now.

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Researching a Proposed Transaction Performing accounting research before a transaction occurs is beneficial for a few reasons. This research allows

• Company management to evaluate whether the expected financial statement impacts of the transaction, as drafted, are acceptable.

• Management to adjust forecasted earnings to reflect the expected impacts of the transaction.

• The accounting team to prepare timely documentation of the expected accounting position.

• The audit team to review the proposed accounting treatment before the transaction is recorded.

Corporate management teams are frequently on the lookout for business opportunities that are profitable and aligned with their companies' strategic objectives. While management evalu- ates the merits of a potential transaction, the company's accounting team should be engaged concurrently to evaluate the accounting implications of the transaction. Management will take the expected financial statement impacts of the transaction into consideration when assessing whether the transaction is worth pursuing .

EXAMPLE

For example, assume that a company is closely monitoring its debt-to-equity ratio to remain compliant with its current debt covenants (promises to lenders). Said another way, assume the company has ve1y little remaining debt capacity (ability to issue more debt under its cwTent debt covenants).

If the company needs to raise additional capital, it would likely evaluate potenti al instruments to confirm that they would be accounted for as equity, not debt, before executing a final agreement with a bank. The company's accounting department would be responsible for researching the detail s of the capital issuance to determine whether the issuance would indeed be accounted for as equity instead of debt.

In addition to being responsible for reporting past transactions and events, corporate man- agers are often held equally accountable for providing accurate short- and long-term earnings forecasts. Investors rely on corporate earnings forecasts in setting a reasonable share price for a company's stock, and lenders review forecasts to monitor compliance with debt covenants. Accordingly, once management determines that a proposed transaction is worth pursuing, the company must adjust its future earnings expectations to reflect the anticipated impacts of the transaction. The following Now YOU Tr y depicts an example in which management asks the accounting team to evaluate the financial statement impacts of a proposed transaction.

EXAMPLE

We're considering an investment in a key supplier through a stock-for-stock exchange. How would this transaction affect our financial statements?

Now YOU Try

We're considering

How wou ld this transaction affect our financial statements?

Figure 1-2

Reviewing the financial

statement impacts of a

proposed transaction

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8 Chapter l I Overview of Accounting Research © Cambridge Business Publishers

Now

YOU Try 1.2

Figure 1-3

Researching a past transaction

Fill in the box above by describing a transaction that management might need the accounting team to review in advance , to evaluate potential financial statement impacts.

For their part, the accounting team mu st not only co mmunicate the fi nancial statement impacts of a transaction to management, but they mu st also document the research supporting their accounting conclusions. This doc umentation serves as support for the proposed accounting treatment shared with manage ment and is the preliminary support fo r the acco unting position to be refl ected in the fi nancial statements. This research should be saved in company files for future reference and updated with fi nal contracts if the transacti on is executed.

Certain accoun ti ng elec ti ons must be documented at the time a transaction is executed. For example, so-called contemporaneous doc umentation requirements apply to most entities electing hedge accoun ting fo r their deri vative positio ns (thi s election typically redu ces income statement volatili ty). 3 To comply with thi s requirement, compani es usuall y review draft transaction doc uments to eval uate whether the proposed instrument will meet all req uired criteria fo r hedge accounting, then prepare draft documentati on based on thi s review.

Finall y, researching and documenting the planned accounting fo r a transacti on allows a co m- pany's auditors to offer their tentati ve concurrence with the proposed treatment before a transac- ti on is recorded. While the accountin g remain s the responsibility of management (and auditors mu st take care to maintain thei r independence fro m management), it is often helpful for auditors to rev iew draft agreements- as well as management 's documentati on of an accounting issue-in order to perform their own independent research and offer a preliminary view of manage ment's pos iti on. Seeking thi s auditor "buy in" early in the process can minimi ze last-minute differences of opinion that coul d arise at quarter- or year-end , when financial statements are being fin alized.

Researching a Past Transaction When it is not possible to research a transaction before its execution, accountin g research may be necessary at the time, or after, a transaction occ urs. The purpose of thi s research is simply to determine how to record the event in the fin ancial statements, and to doc ument thi s determina- tion. Figure 1-3 illu strates a sample situ ati on in which accountants must perform research related to a past transacti on.

Bad news . .. a key customer just declared bankruptcy, and our financial statements (for the period just ending) reflect a significant account receivable due from this customer.

Thanks for informing us . We 've already closed the books for this year-end but haven't issued our financial statements. Let me research whether our financial statements should be adjusted for this type of situation. In either event, we 'll need to document the basis for our position .

3 FASB Accountin g Standards Codification 815-20-25-3 (Derivati ves and Hedg ing - Hedg ing).

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Following are examples of circumstances in which research may be required at the time, or after, a transaction is executed:

• The transaction was time-sensitive; there was not sufficient lead time to research its account- ing treatment.

• The transaction was highly confidential; details of the transaction were only released to the accounting team after the transaction was executed.

• The transaction or event could not have been anticipated; for example, the company suf- fered from a building fire or natural disaster.

• Communication broke down between the dealrnakers in the organization and the accounting team; consequently, the accounting team was only informed of the transaction after it was executed.

• The preparer has limited resources and therefore only performs research at the time financial statements are being prepared. For example, the company is a small or nonpublic company, and management is not required to prepare earnings forecasts.

• Finally, documentation (and-as necessary-research) prepared previously, for proposed transactions, should be updated to reflect final contract terms.

Take particular note of the fourth bullet above; a communications failure between a com- pany's operations teams and accounting team should be reviewed to determine what went wrong. To avoid a recurrence of the communications failure, a formal process in which material or unusual contracts are reviewed by the accounting team may need to be established.

As with the process for researching proposed transactions, accounting research performed for past transactions should be documented and shared with the company's audit team. This documentation and review process will support the accounting positions reflected in the finan- cial statements.

Imagine this scenario. You are an accounting manager at ABC Corp, a nonpublic company that prepares GAAP financial statements in order to receive financing from banks.

The operations team at ABC is moving forward quickly on a deal to invest in a key supplier, but has not yet informed the accounting team of this possible deal.

Make your best case: List two reasons why the operations team should involve the account- ing department in reviewing the deal before it is executed.

Research Performed After Financial Statement Issuance After financial statements have been issued, accounting research may be performed by various parties, as follows:

• Investors may research a company's choice of accounting methods and may seek to under- stand alternatives available in the literature. Using this information, investors may choose to adjust their internal models to improve consistency across companies they are evaluating.

• Regulators, such as the SEC or other industry-specific regulatory agencies, periodically review the amounts and disclosures presented in the financial statements of companies they oversee (see example in Figure 1-4). To assess whether companies' accounting judgments and disclosures are appropriate, regulators may perform research to familiarize themselves with accounting requirements.

[

Now ] YOU

Try

1.3

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10 Chapter l I Overview of Accounting Research © Cambridge Business Publishers

Figure 1-4

SEC inquiry regarding valuation disclosures

presented in company

financial statements

Lo3 Understand that different standards apply to different research environments.

• Attorneys may perform accounting research in order to argue (or to defend against claims) that a company's financial reporting has harmed an investor or other interested party. The attorney must support such arguments with citations from accounting guidance.

Questions from these parties may require corporate accountants to perform further research to explain or defend their accounting positions taken. Robust, timely documentation of account- ing positions (ideally, prepared before financial statement issuance) can assist corporate accoun- tants in responding to such inquiries.

Comment letter: For your fair value measurements using unobservable inputs, please tell us what valuation models you used to determine fair values, and provide the assumptions used in those models.

Research for the Purpose of Shaping Future Accounting Standards Accounting standards are dynamic; that is, the current body of accounting guidance is continu- ally being reviewed and revised. Many of the parties who perform accounting research also participate in shaping future accounting standards. For example, the preparer who encounters gray areas in GAAP may request clarification from the Financial Accounting Standards Board (FASB). The investor who observes inconsistent disclosures may lobby the FASB for more transparent disclosures in a given area.

For their part, accounting and auditing standard setters follow a due process that depends heavily on input from their constituents. Chapter 14 introduces readers to the standard-setting process and describes steps researchers can take to stay current.

IN WHAT ENVIRONMENTS IS ACCOUNTING RESEARCH PERFORMED?

Accounting research is performed in a variety of environments, including in public and nonpublic companies (domestic and international), governments, and for purposes of researching tax requirements.

Public companies (e.g., companies that issue publicly traded debt or equity securities) are generally required to file financial statements with the SEC (Securities and Exchange Commission). By contrast, nonpublic, or private, companies are generally not required to

file financial statements with the SEC; however, financial statements may be necessary to satisfy lenders, venture capitalists, or other stakeholders. In both cases, research is frequently necessary to ensure that the financial statements have been prepared in accordance with all applicable account- ing standards.

Outside of the United States, accounting research is performed by public and nonpublic companies, as required by their national laws to issue financial statements. Many non-U.S. coun- tries prepare their financial statements in accordance with IFRS (International Financial Report- ing Standards); other countries continue to follow country-specific financial reporting guidance.

Governmental entities, including state, local, and federal governments and agencies, are frequently required to prepare financial statements to demonstrate how they have used the funds allocated to them. Accountants involved in the preparation of governmental financial statements must be able to research and understand requirements for their preparation.

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Tax research is performed by (and for) corporations and other entities that consider the tax consequences in planning transactions and that are required to report their activities to a govern- ment body (federal, state, and/or local). To understand tax reporting requirements, and to take advantage of all available tax incentive programs, researchers must become familiar with tax research sources ranging from the Internal Revenue Code to court decisions.

Different Guidance for Each Research Environment Each research environment is subject to a different set of standards. Figure 1-5 identifies the rule makers (or "standard setters") for each research environment.

Preparer Type Accounting Standard Setter Audit Type Auditing Standard Setter

Public companies FASB and SEC Audits of public PCAOB companies

Private companies FASB* Audits of private AICPA companies

Governmental entities- GASB (Governmental Audits of state and GAO (Government state and local Accounting Standards Board) local government Accountability Office)

entities

Governmental entities- FASAB (Federal Accounting Audits of federal GAO

federal Standards Advisory Board) government entities

International companies IASB (International Audits of IAASB (International Accounting Standards Board) , international Auditing and Assurance or other local standard setter companies Standards Board), or other

local standard setter

*The Private Company Council advisory body advises the FASB on standard-setting activities affecting private companies.

Tax research, by contrast, requires researchers to consult multiple sources including the Internal Revenue Code, tax regulations, IRS rulings and other guidance, and judicial rulings. Sources of tax research guidance are listed in Figure 1-6; note that this list is not all-inclusive. See Chapter 11 for a more complete discussion of tax sources.

Sources for Tax Research

Statutory Sources

Administrative Sources

Judicial Sources

• Internal Revenue Code • Other statutes with tax-related provisions (e.g., the

Bankruptcy Code)

• Treasury regulations • IRS Revenue Rulings • Written administrative agency determinations

• U.S. Supreme Court • U.S. Court of Appeals • U.S. District Court • U.S. Court of Federal Claims • U.S. Tax Court

This book will introduce you to each of the preceding research environments and standard setters. However, in practice, you will likely specialize in only one or two of these areas. For example, public company accountants and auditors will primarily perform research using FASB guidance for accounting, and PCAOB guidance for auditing.

Figure 1-5

Sources of accounting

and auditing guidance

Figure 1-6

Sources of tax research

guidance

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Now

YOU Try

1.4

In Figures 1-5 and 1-6, put a check mark next to any standard setters whose guidance you have researched, such as in previous accounting or auditing coursework. Then put an open circle next to other standard setters you expect to learn about in this course.

Following is an introduction to key U.S. accounting standard setters, which will set the stage for the accounting research topics discussed in Chapters 2-8. The standard setters responsible for creating auditing, governmental, tax, and international accounting guidance are introduced in Chapters 9-12.

ACCOUNTING STANDARD-SETTING BODIES

Lo4 Identify key standard setters involved in establishing U.S. accounting guidance.

Let's begin our introduction to the standard-setting bodies primarily responsible for estab- lishing U.S. accounting guidance, and their history. Familiarity with these standard setters provides context for understanding the accounting guidance applicable today.

This history follows a chronological order, beginning with the SEC-the first entity given formal authority to establish U.S. accounting standards. Figure 1-7 illustrates a timeline of key U.S. accounting standard setters.

Figure 1-7

Brief timeline of key

U.S. accounting

standard setters

Standard-setting bodies and primary guidance issued

SEC: Given statutory authority to set acoounting standards. Has

elected to delegate this authority,

as follows:

Committee on Accounting

Procedure (CAP)'

t ssued

• A committee formed by the AICPA

Accounting Principles Board (APB)'

t Financial Accounting

Standards Board (FASB)

The Securities and Exchange Commission

FASB Codification established

Following a crisis in investor confidence resulting from the stock market crash of 1929 and sub- sequent Great Depression, the Securities Exchange Act of 1934 (the "1934 Act") created the SEC with the objective of providing investors with reliable financial information about public companies. To accomplish this objective, the SEC not only sets certain disclosure standards but also acts as a law enforcement agency with the authority to enforce securities laws in order to protect the investing public. The SEC describes the work of its Division of Enforcement, in part, as follows:

Each year the SEC brings hundreds of civil enforcement actions against individuals and companies for violation of the securities laws. Typical infractions include insider trading, accounting fraud, and providing false or misleading information about securities and the companies that issue them. 4

A second authority granted to the SEC in the 1934 Act was the authority to establish account- ing standards. The SEC elected to delegate this responsibility-first to the AICPA (American Institute of Certified Public Accountants) and later to the FASB . (Notably, the Sarbanes-Oxley Act of 2002 established criteria-such as funding and independence requirements-related to

4 www.sec.gov, "About" - "W hat We Do." Accessed March 2, 2019 .

0 © Cambridge Business Publishers Chapter 1 I Overview of Accounting Research

the SEC's choice of standard setter.) The FASB website has described its relationship to the SEC as follows:

The SEC has statutory authority to establish financial accounting and reporting standards

for publicly held companies under the Securities Exchange Act of 1934. Throughout its

history, however, the Commission '.s policy has been to rely on the private sector for this function to the extent that the private sector demonstrates ability to fulfill the responsibility

in the public interest. 5

As noted, the SEC relies on the private sector to establish accounting guidance, on condition that the private sector demonstrates its "ability to fulfill" this responsibility. Accordingly, the SEC closely monitors the FASB's agenda and routinely provides input on tentative decisions reached by the FASB .

That said, the SEC does periodically issue accounting guidance applicable primarily to public companies. For example, the SEC establishes public company financial statement and disclosure require- ments through its Regulations S-X and S-K. The

Jay Clayton , Chairman since 2017

SEC also periodically issues interpretive guidance on The SEC chairman is appointed by the topics of key interest to the SEC, in the form of Staff President, with the advice and consent of Accounting Bulletins (SABs) and Financial Report- ing Releases (FRRs).

the senate.

Finally, it is worth noting that the SEC's Division of Corporation Finance reviews, at least every three years, the financial statements and disclosures of all companies with publicly traded securities. 6 These reviews can result in comment letters to corporations requesting additional explanation of a company's financial reporting. In some cases, unsatisfactory responses to comment letters, for material matters, can result in the SEC requesting that a company restate previously issued financial statements. Chapter 5, on nonauthoritative sources, describes how researchers can use the SEC website to search for company filings and SEC correspondence.

The SEC is headed by five commissioners, each appointed by the President of the United States, and each serving a five-year term. The President designates one of the commissioners to serve as Chairman of the SEC. Current SEC Chairman, Jay Clayton, is shown in Figure 1-8.

1. Which of the SEC's roles-as enforcement agency or as accounting standard setter-are

you more familiar with? Give an example of prior exposure you've had to the SEC in one or

both of these capacities.

2. In your own words, explain the SEC's relationship to the FASB .

5 www.fasb.org, "Facts about FASB." Accessed April 22, 2015.

6 Sarbanes-Oxley Act of 2002, Sec. 408(c). Also known as Public Law I 07-204. July 30, 2002. Notably, reviews of certain investment companies' financial statements may instead be performed by the SEC's Division of Investment Management.

Figure 1-8

SEC Chairman, Jay Clayton

Now

YOU Try

1.5

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14 Chapter I I Overview of Accounting Research © Cambridge Business Publishers

[

Now

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1.6

Note to Instructors: You may choose to cover the standard-setters' due process at this point (see Chapter 14).

The American Institute of Certified Public Accountants As noted, the SEC first delegated its accounting standard-setting authority to the AICPA. 7 In 1936, the AICPA formed the Committee on Accounting Procedure (CAP) which, at the urging of the SEC, began actively issuing guidance in 1939. In 1959, facing criticism of the CAP's ad hoc approach to setting standards and the tendency for its standards to allow preparers to choose between two acceptable accounting treatments, the AICPA replaced this committee with the Accounting Principles Board (APB).

The membership of both the CAP and APB consisted of volunteers who also maintained full-time positions with other employers. These early standard setters were criticized for their lack of independence, their slow response time to emerging issues, and for their failure to develop a conceptual framework to guide their decisions. The APB was dissolved in 1973 and was replaced by the FASB. Still today, a portion of the guidance issued by the CAP and the APB continues to be in effect within the FASB's Accounting Standards Codification.

Upon the dissolution of the APB, the AICPA formed an accounting standards committee to continue its participation in, and influence over, standard setting. In the years that followed, this committee issued guidance including AICPA Statements of Position (SOPs), industry-specific Audit and Accounting Guides (A&A Guides), and Practice Bulletins, some of which is still part of the body of authoritative GAAP today.

While the AICPA no longer issues standards that are considered authoritative GAAP, the AICPA continues today to be active in publishing guidance to help entities interpret and apply GAAP. Additionally, in 2013, the AICPA introduced reporting guidelines for entities that are not required to issue GAAP financial statements, in the form of the Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs). This is a non-GAAP reporting frame- work intended to simplify financial statement preparation for smaller entities.

Additionally, today the AICPA remains a key authority in establishing standards for profes- sional services (such as auditing) and for accountants' professional conduct. These standards are discussed further in Chapter 9.

One criticism raised regarding the AICPA's two standard-setting committees is that they were not independent. Based on the preceding discussion, explain the characteristics of these Boards that might have caused this criticism. Why should we care whether an accounting standard setter is independent?

The Financial Accounting Standards Board The FASB was created in 1973, following the dissolution of the APB. The FASB is an indepen- dent organization focused on developing standards that result in decision-useful information for investors and other financial statement users. Both the SEC and the AICPA recognize the FASB as the entity with authority to set accounting standards for nongovernmental entities. To that end, the FASB developed and maintains the FASB Accounting Standards Codification, described in detail in the next chapter.

The FASB's seven full-time board members are required to represent a diversity of back- grounds. Specifically, board members must "collectively have knowledge and experience in invest- ing, accounting, finance, business, accounting education, and research."8 These board members are

7 Founded in 1887, the AI CPA is the professional association for CPAs in the United States.

8 FASB Rules of Procedure, amended and restated through December 11 , 2013. Page 8.

�� /'0 © Cambridge Business Publishers Chapter l I Overview of Accounting Researc h 15

appointed by the FASB 's parent organiza- tion , the Financial Accounting Founda- tion (FAF). The FAF oversees the opera- tions of the FASB; its objective, in part, is to protect the independence and integrity of the standard-setting process. 9 Figure 1-9 depicts the current Chairman of the FASB, Russell G. Golden , who was appointed to his second term as Chairman in 2016.

Russell G. Golden , FASS Chairman (former partner,

Deloitte & Touche LLP)

The FASS Chairman is appointed to a five-year term

by the trustees of the Financial Accounting Foundation.

Image used with permission of the Financial Accounting Foundation.

The FASB's board typically includes representation from the preparer, academic, investor, and auditor communities. That is, board members typically come from a mix of these backgrounds. What perspectives might each of these parties bring to the standard-setting process?

Preparer: ____________________________ _

Academic: ___________________________ _

Investor:-----------------------------

Auditor:-----------------------------

As required by the Sarbanes-Oxley Act, the FASB 's annual operating costs are primarily funded by accounting support fees assessed to public companies. Companies pay a share of this fee based on the size of their market capitalization (that is, the market value of a company's outstanding shares). This funding mechanism is designed to maintain the FASB's independence; that is , rather than rely on donations that could impair the Board's objectivity, public companies are required to participate in supporting the FASB 's operations.

In response to criticism that compliance with GAAP is too burdensome for nonpublic com- panies, in 2012 the FAF created the Private Company Council (PCC). This Council identifies areas within existing and proposed GAAP that can be simplified for private companies, and these efforts have given rise to simplified accounting alternatives being made available to private companies.

The standard setters responsible for establishing auditing, tax, international, and governmental accounting standards will be introduced in Chapters 9-12 of this book. For now, understanding the roles of these three U.S. accounting standard setters will provide the foundation for your next challenge: learning to perform great accounting research.

1. Explain how levying the accounting support fee, as opposed (for example) to relying upon individual corporate donations, helps maintain the FASB's independence.

2. Considering the preceding introduction to accounting standard setters , which entity would you expect to have authority to adopt IFRS as the applicable reporting standards in the United States? Explain.

Continued

9 FASB Rules of Procedure, amended and restated through December 11 , 2013. Page 6.

Figure 1-9

FASS Chairman, Russell

Golden

Now

YOU Try

1.7

Now

YOU Try

1.8

0 16 Chapter l I Overview of Accounting Research © Cambridge Business Publishers

Continued from previous page

3. Contrast the role of the AICPA's FRF for SM Es with the role of the FASB's Private Company Council.

CHAPTER SUMMARY Thi s chapter emphasized that research and communication will play a role in your career as an accountant. Indeed, accounting research is integral to the work of many corporate accountants, auditors , investors, and regulators, as this chapter discussed.

Accounting research is ideally performed before transactions take place; however, this is not always feasible given resoW'ce constraints. Sources of research vary based on the diverse research environments (accounting, governmental , audit, tax, and international) ; it's important for practitioners to understand which standard setter has authority before beginning research.

Finally, this chapter introduced the organizations historically responsible for setting U.S. GAAP, and which contributed to the expansive population of accounting guidance available today. In the next chapter, we'll discuss the FASB Codification, which brings together these many diverse sources of guidance.

REVIEW QUESTIONS

1. What are two key objectives of performing technical accounting research?

2. Identify four parties who typically perform accounting research and explain why they perform research.

3. Name three reasons for which accounting research should ideally be performed before a transaction is executed.

4. Name three circumstances in which it might not be possible to research the accounting for a transaction until after it has occun-ed.

5. What is the meaning of the term contemporaneous? Explain.

6. Differentiate between the requirements for public (versus nonpublic) companies to prepare financial statements, and state why-in both cases-accounting research is frequently necessary.

7. To what research environment do the following standards apply? a. Standards of the GASB b. Standards of the FASB c. Standards of the AICPA d. Standards of the IASB e. Standards of the FASAB

8. List the organizations, in chronological order, that have historically been responsible for setting accounting standards.

9. What legislation gave the SEC the authority to set accounting standards? What was happening at the time that led to this need for accounting standards?

10. What two committees did the AICPA form , which were at one point respon sible for setting accounting stan- dards? And, what were some of the criticisms raised regarding these first two standard-setting bodies?

11. Define accounting support fees and explain why these fees help the FASB maintain its independence.

12. Fill in the blanks: The SEC has authority to establish accounting standards but has histori- cally delegated this authmity to the sector. Then , explain this statement.

13. What two SEC divisions were discussed in the chapter, and what are some of these divisions' responsibilities?

14. What is an SEC comment letter?

15. Why was the PCC formed , and what impact has it had on accounting standards?

/'0 © Cambridge Business Publishers Chapter I I Overview of Accounting Research

EXERCISES

1. Go to marketwatch.com, a Dow Jones & Co. site. Look for the magnifying glass symbol (at top right of blue banner at top of page), click it, then type the stock symbol "AMZN" into the search bar that appears. Next, click on the tab for "Analyst Estimates." a. What is the mean earnings per share estimate for this quarter? (Indicate what date your information is "as

of'-i.e., the date on which you pe1formed this search.) b. What is the mean EPS estimate for the next fiscal year? (Indicate what date your information is "as of.") c. Explain why performing accounting research before a transaction occurs might be important to Amazon's

management.

2. Go to wsj.com and type "Accounting Method" into the search bar (it may help to use the "quotation marks" when doing so). Summarize one of the headlines and issues discussed in the search results. Brainstorm (and explain) why readers of the Wall Street Journal might have an interest in this article.

3. Go to fasb.org and locate (under Latest News on the bottom left side of the homepage) a recent news release. Describe the subject matter of the news release then identify two parties (such as patties depicted in Figure 1-1) who would be interested in this issue. Be as specific as possible, describing why the parties might be monitoring this issue.

4. Go to fasb.org and look up pre-Codification standards (located under the tab Reference Library, then Superseded Standards). Identify and summarize the subject of one standard issued by the CAP and one issued by the APB . What is the current status of these standards?

5. Look up the website for EY's Financial Accounting Advisory Services (FAAS) practice. Explain how experi- ence performing accounting research could prepare you for a career in this practice.

6. Brainstorm an example of: I) a financial accounting issue that would be researched before a transaction is final- ized, 2) an accounting issue that would be researched after a transaction has been executed, and 3) an accounting issue that would be researched following financial statement issuance.

7. The chapter states that a communications fai lure between a company's accounting team and operations teams could result in company accountants evaluating the accounting for a transaction after it has occurred. Brainstorm a process that companies could put in place to encourage the timely communication of proposed transactions.

8. The SEC has five divisions. Using www.sec.gov as a starting point, name these five divisions. Which division would you expect to issue guidance to companies for complying with SEC reporting requirements ?

9. Using sec.gov, go to Regulations then Staff Interpretations . Locate Staff Accounting Bulletin No. 99 ("SAB 99") and summarize the issue addressed by this guidance.

10. Using www.sec.gov, go to Divisions, then Division of Corporate Finance. Under Statutes, Rules , and Fo1ms, go to Rules then to "Regulation S-K." What is the requirement described within Item 308 (Sec. 229.308), and what are 3 of the disclosure elements required to satisfy this requirement?

11. Refer to the previous question. Describe two parties who might perform research to understand the MD&A requirements in Regulation S-K, and the circumstances that might drive them to pe1form this research.

12. Go to sec.gov, then Divisions, then Division of Enforcement. Under Federal Court Actions, locate the March 19, 2018, enforcement action brought against Elizabeth Holmes and Ramesh Balwani. Summarize the charges brought by the SEC against these individuals and the actions of their company, Theranos, Inc. Describe how this enforcement action fits with the SEC's mission.

13. Go to www.fasb.org and look for information from the FASB 's most recent meeting . (Go to Meetings, then Past FASB Meetings). What is one topic the FASB discussed? What is one tentative decision the Board reached?

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18 Chapter I I Overview of Accounting Research © Cambridge Business Publishers

CASE STUDY QUESTIONS

1.1 Purposeful reading: The 3-2-1 Assignment1° Complete the following steps intended to enhance your understand- ing of the chapter reading, and document your responses.

3: Read the chapter, then describe what you feel are the three most important concepts or facts from the reading.

2: Describe two aspects of the reading that you don't fully understand, or which are somewhat confusing. J: Pose one question to the author (this should differ from the areas of confusion described in (2) above),

which goes beyond the reading content, such as inquiring about implications or applications of the reading.

1.2 Relationship Between the FASB and SEC The relationship between the FASB and the SEC has been dynamic over time. Given that the SEC is a government agency, and that it has delegated its standard-setting power to the FASB, the SEC has periodically been lobbied by both lawmakers and corporations who have disagreed with FASB decisions. Using an Internet search engine such as Google, locate one aiticle involving both the FASB and SEC; the article does not have to be cu1Tent. In approximately one page summarize the issue raised in the article and the interplay you observe between these two organizations in the article.

1.3 Researching Original FASB Standards Using the FASB website, locate the original (superseded) standard FASB Statement No. 2, Accounting for Research and Development Costs (as amended). In approximately one paragraph, describe the treatment of research and development costs required by this standard, and cite the FASB standard and paragraph number that provides this guidance. State also which disclosures are required. Finally, considering the background of this project described in Appendix A, was there unifmm guidance for reporting research and develop- ment costs p1ior to this standai·d? Considering the Basis for Conclusions in Appendix B, what alternative accounting methods for recording research and development costs were considered in developing this standard? Explain key factors that led the Board to select the accounting treatment that it did.

1.4 Proposed Accounting Standards Updates and Comment Letters In December 2012, the FASB issued a proposed Accounting Standai·ds Update (i.e., an Exposure Draft), Financial Instruments-Credit Losses (Subtopic 825-15) and solicited constituent feedback. Locate this proposed standard.

1. Read the summary section of this proposed standard. What change in accounting does this exposure draft pro- pose?

2. Look for comment letters related to this exposure draft. From fasb.org, navigate to Projects, then Comment Letters. Under "Accounting for Financial Instrnments," locate this topic, then click on the link to view comment letters. Next: a. Locate a comment letter that looks interesting to you. What company or individual wrote the letter, and

what is their perspective in writing this letter (i.e., are they writing from the perspective of a financial state- ment user, preparer, etc.)?

b. What aspects of the proposed standard does the commenter support? c. What concerns does the commenter raise regai·ding the proposed standard? d. How would you expect a company (preparer) might react to this proposed standard compared to how a

banker (investor) might react? Explain.

1.5 Reviewing a Final Accounting Standards Update Accounting Standards Update No. 2016-13 , Financial Instru- ments-Credit Losses, was issued in June 2016.

a. Read the Summary section of this standard and describe why the standard was issued. What is the issue it is intended to resolve?

b. Look for guidance on when the standard became effective. That is, what is its effective date? c. Look for the Dissenting Opinion written in the standard. What is these Board members' concern about the stan-

dard, and what do they describe as their preferred approach?

1.6 Understanding How FAS 168 Established the Codification as GAAP Using the FASB website, locate the original (superseded standard) FASB Statement No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles (as amended) then respond to the following . Include paragraph numbers to support your responses.

1. Read the Summary of this standard, which begins on page FAS 168-1. Based on this Summary, describe the purpose of this standard and the key changes effected by this standard.

10 Geraldine Van Gyn , PhD. It's The Little Assignment with the Big Impact: Reading, Writing, Critical Reflection, and Meaningful Discussion.. Faculty Focus.com, May 6, 2013.

��

2. Summarize par. 3, Objective. In doing so, also comment on the role of SEC guidance in the Codification (this is also described in par. 3).

3. Describe the "GAAP hierarchy" introduced by Statement 168. Use information within the standard to respond. 4. What are some examples, provided in Statement 168, of nonauthoritative sources of guidance? Use information

within the standard to respond . 5. In Appendix A (Background Information and Basis for Conclusions) of this standard, locate the discussion of

why the FASB Codification was introduced. That is, what was the issue the Codification attempts to resolve? 6. Using Appendix B (Amendments to the FASB Codification) of this standard, describe where in the Codification

a user can find the principles established by FAS 168 . That is, in which topic will the principles of FAS 168 be described?

Networking with a Professional, and Understanding the Role of Research in His or Her Work Conduct a brief 1.7 interview with a professional in your planned or chosen field (auditing, tax, systems, internal audit, etc.). Ask for 5-10 minutes of their time, and be mindful to not exceed this time limit.

Ask the professional what role research plays in their current job responsibilities, and ask what resources they refer to most often in order to perform this research (e.g., the Codification? Finn audit program ? Tax research data- base? Daily news updates?) . Finally, ask what advice they would offer a beginning researcher. Make every effort to have this conversation live (in person or on the phone).

Once you've asked your questions, let the professional do most of the talking; practice your listening skills dur- ing the conversation. Summarize the professional's responses-including his or her name and organization, and the setting for your conversation-in 1-3 paragraphs (less than one page).

/'0

The FASB Codification: Introduction and Search Strategies Jeremy has just been asked to research an issue related to his company's "volatility"

assumption , one of the variables used to estimate the fair value of his company's outstand-

ing stock compensation awards. Jeremy is a staff accountant, with only a limited under-

standing of stock compensation accounting. He doesn 't feel very competent in this area.

Nevertheless, Jeremy gets right to work. First, he asks his supervisor for more back-

ground on the issue then reviews a memo describing how the company has estimated

this assumption in the past. Next, Jeremy logs on to the FASB Accounting Standards

Codification (the "Codification") and begins reading more about this assumption within the

stock compensation topic. Before long, he has a basic understanding of the requirements

for estimating volatility, and he is pleased to have learned something new in the process of

researching this issue. Continued

After reading this chapter and performing the exercises herein, you will be able to

1. Describe the purpose of the Codification, and the meaning of authoritative.

2. Identify standard setters that have contributed to the current body of authoritative

guidance.

3. Understand the organization of guidance within the Codification.

4. Perform effective Browse searches within the Codification , reviewing all areas of

required reading.

5. Search the Codification using other methods, including keyword searches , the Master

Glossary, and the Cross Reference feature .

6. Differentiate between existing versus pending content, and understand how to inter-

pret transition date guidance.

7. Recognize accounting alternative guidance available for private companies.

/'0

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Continued from previous page

As you begin working with the Codification, your experience may be similar. You may

be asked to research topics that you know very little about, and this may initially be uncom-

fortable ; however, users of the Codification quickly learn that research is a skill you learn

by doing.

Understanding the Codification Researching within the Codification

1. Authority of the Codification 1. Tips for performing Browse searches

2. Sources of guidance included within the 2. Strategies for other search methods : Codification Is key to • Keyword searches , and identifying

3. Organization of the Codification "- search terms

•Areas - • The Master Glossary, Go-To , and Cross • Topics Reference features

• Subtopics 3. Pending content and effective dates

• Sections 4. Private company accounting alternatives

• Subsections

• Paragraphs

Organization of This Chapter This chapter introduces the FASS Codification , including (1) the meaning of the term authori-

tative, (2) what sources of guidance were used to populate the Codification , and (3) how

guidance is organized within the Codification. Examples abound in this chapter, as it is critical

for beginning researchers to develop a hands-on feel for th is important research tool.

Following this introduction, the chapter describes several methods for searching the

Codification, including techniques for efficiently performing those searches. The chapter

emphasizes that researchers should Browse to applicable research topics whenever pos-

sible, as this is the method used by research professionals. In our discussion of Browse

searches , readers will learn not only how to find information, but also what other sources of

required reading should be consulted to ensure that a research effort is thorough.

However, there are certainly times when keyword searches are valuable . The chapter

describes how to perform such searches and offers readers the opportunity to practice iden-

tifying possible search terms . The chapter is rich in information , also covering other search

strategies (e.g. , the Master Glossary and Cross Reference feature) , the role of pending

content, and private company alternatives.

As illustrated in the preceding graphic, this chapter emphasizes that understanding how

the Codification is organized is key to performing effective research .

/'0 22 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

WHAT IS THE FASB CODIFICATION?

Lo 1 Describe the purpose of the Codification, and the meaning of authoritative.

The FASB Accounting Standards Cod(fication ("ASC" or the "Codification") is con- sidered the primary source of authoritative, generally accepted accounting principles (GAAP) for nongovernmental entities. (Guidance from the SEC is also authoritative for public companies.) The Codification became effective in 2009, with the objective of sim- plifying research. Prior to the issuance of the Codification, accounting guidance in the form of individual standards had piled up for nearly a century. Accounting practitioners often

had to search several different standards to find guidance on a single topic. This created the risk that practitioners could miss important sources when searching for guidance. The Codification reduces that risk by organizing accounting guidance by topic, within a single research source.

What does it mean for the Codification's guidance to be authoritative? It means that the Codification establishes GAAP. In order to receive an unmodified (aka, unqualified) audit opinion, U.S. nongovernmental entities must prepare their financial statements in accordance with Codification guidance.

The FASB gets its authority to set GAAP primarily from two sources.

• First, the SEC, acting in its authority under the Securities Exchange Act and Sarbanes- Oxley, has identified the FASB as the designated private sector standard setter with author- ity to establish GAAP. 1

• Second, in its Code of Professional Conduct, the AICPA recognizes the FASB as the orga- nization with the authority to establish GAAP for nongovernmental entities. An auditor may not issue an unmodified opinion for financial statements containing a material departure from GAAP. 2• 3

Using this authority, the FASB has designated the Codification as the sole source of its authoritative guidance.

The term nongovernmental entities encompasses both public and nonpublic (private) enti- ties, as well as not-for-profit entities. However, these entities are not always treated as equals within the Codification. That is, due to resource constraints and often lesser demand for nonpub- lic entity financial statements , nonpublic entities are exempt from some requirements (such as segment reporting requirements) and are frequently given longer transition periods for adopting new guidance. As noted in Chapter 1, the Private Company Council (PCC) was created in 2012 and advocates for simplified reporting options for private companies. The PCC's work has led to a growing number of private company alternatives available within the Codification.

Accounting guidance for industries, including not-for-profit entities, also falls within the Cod- ification 's authority. As industries often have unique activities and transactions, industry-specific content must be followed in addition to the other general requirements of the Codification. That said, in limited cases, industry-specific content may indicate that it should be applied in lieu of a specified topic or paragraphs from the Codification's general requirements. Industries addressed in the Codification include airlines, financial services, not-for-profit entities, real estate, and software.

I SEC Relea se No. 33-8221, Policy Statement: Reaffinning the Status of the FASB as a Designated Private -Sector Standard Setter. April 25, 2003 .

2 AICPA Code of Profess ional Conduct, ET 1.320.001 (Accounting Principles Rule) , par. 01: "A member shall not (I) express an opinion or state affirmatively that the financial statements or other financial data of any entity are presented in conformity with [GAAP] or (2) state that he or she is not aware of any material modification s that should be made to such statements or data in order for them to be in conformity with [GAAP], if such statements or data contain any departure from an accounting principle promulgated by bodies de signated by Council to establish such principles th at has a material effect on the statements or data taken as a whole .... "

3 AICPA Code of Profess ional Conduct, Appendix A: " . .. the FASB ... hereby is, designated by this Council as the body to establish accounting principles pursuant to the "Accounting Principles Rule .. .. "

��

Students are often confused by the role of industry guidance in the Codification . Remember: Industry guidance in the Codification generally applies in addition to other general Codification content.

l TIP from the Trenches

Describe what types of entities the Codification applies to. Does it apply equally to these entities? Explain.

Now

YOU Try

2.1

What Sources of Guidance Were Used to Populate the Codification? The Codificati on is an aggregation of many, many accounting standards issued over the course of the past centu ry. These include, for example,4

• FASB Statements and Interpretations,

Lo2 Identify stan-dard setters that have contributed to the current body of authoritative guidance.

• Emergin g Issues Task Force (EITF) Abstracts, and

• AICPA Statements of Position.

Additionally, th e Codification includes all still-effective guidance fro m the two standard- setting bodies that preceded the FASB , namely,

• The Committee on Accounting Procedure (CAP), which issued Accounting Research Bulletins (ARB s) and

• The Accounting Principl es Board (APB ), which issued APB Opinions.

In 2009, when the guidance from these original standard s was moved into the Codification, the original standards were superseded and became nonauthoritative. Today, these so-called pre-Codification standa rds still serve a limited role in research. This role is discussed fu rther in Chapter 5, which describes the use of nonauthoritative guidance.

Figure 2- 1 depicts the many sources of guidance used to populate the Codification. All guid- ance in the Codifica tion tod ay has equ al authority.

Key Standard Setters and Guidance Issued

Committee on Accounting Procedure (1939-1962) - Issued ___________ _

Accounting Principles Board (1962-1973) - Issued APB and related AICPA Accounting

Interpretations (AIN )

Financial Accounting Standards Board (1973-present) - Issued FASS and , as well as Technical

Bulletins, Staff Positions , and Staff Implementation Gu ides

Other Standard-Setting Bodies and Guidance Issued

- Emerging Issues Task Force: Issued EITF ____ _ and D-Topics

- Derivatives Implementation Group: Issued "DIG" issues

- AICPA : Issued , Practice Bulletins , plu s certain

content from Technical Inquiries and Audit & Accounting Guides

These original standards were

_____ when

the Codification became effective. All guidance in the Codification has

authorit .

4 To view the complete list of guid ance used to popu late th e Codification as of its adoption in 2009, consult th e FASB noti ce About the Codification, access ible fro m the homepage of the Codifica ti on.

Figure 2-1

Sources of guidance

used to populate the

Codification

0 24 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

Now

YOU Try

2.2

[ TIP from the Trenches

Lo3 Understand the organiza- tion of guidance within the Codification .

1. Considering the discussion preceding Figure 2-1, fill in the blanks in Figure 2-1 with the types of guidance that were used to populate the Codification .

2. Then, in the blue box in Figure 2-1, fill in the blanks regarding the effects of these standards being moved into the Codification.

Additionally, the Codification includes certain content issued by the Securities and Exchange Commission (SEC), which is authoritative for public companies. Portions of the following SEC guidance have been included within the Codification:

• Regulation S-X (SX)

• Financial Reporting Releases (FRRs)/ Accounting Series Releases (ASRs)

• Interpretive Releases (IRs)

• SEC Staff guidance in • Staff Accounting Bulletins (SABs) • EITF Topic D and SEC Staff Observer comments

However, it's important to understand that not all SEC content has been incorporated within the Codification. Some SEC rules and requirements , such as management's discussion and analysis (MD&A) disclosure requirements, are also authoritative for public companies but are only available at www.sec.gov, and in related accounting research databases.

The role of SEC guidance is further described in the following TIP from the Trenches.

Students are often confused by the role of SEC guidance in the Codification. Here's what you need to know:

• Guidance from the SEC is authoritative for public companies.

• Portions-but not all-of the SEC's guidance have been included in the Codification. Companies can access the full population of SEC guidance at www.sec.gov.

• Nonpublic companies may find it helpful, but are not required, to follow SEC guidance in the Codification.

How is the Codification Updated? The FASB is responsible for maintaining the Codification. As the FASB issues new accounting standards (referred to as Accounting Standards Updates), the FASB amends or adds to the con- tent in the Codification. Accounting Standards Updates are not authoritative in their own right; rather, they serve only to update or amend Codification content. The Codification includes links to proposed and final Accounting Standards Updates; these are also available on the FASB 's website (www.fasb.org).

NAVIGATING THE CODIFICATION

In my time as an accounting research instructor, I've noticed a disconnect between how students are inclined to research versus the method that professionals use to research.

As a beginning researcher who has grown up on Google searches, your tendency may be to perform keyword searches in the Codification. By contrast, professional

0 © Cambridge Business Publishers Chapter 2 I The FASB Codification: Introduction and Search Strategies 25

researchers tend to perform Browse searches, where the researcher directs the search by navigat- ing to topics that might apply. In fact, the FASB actually recommends that researchers should primarily perform Browse searches, as well.5

Browse searches are a user-directed search. This means that you-as the researcher- would navigate to content in the Codification that you believe might apply. In doing so, you'll have context as you perform the search, and will better understand relationships between top- ics in the Codification. You'll also learn more about which paths don 't work , often an equally important lesson . By contrast, keyword searches may dump you off into the middle of guidance that you may not understand, and that may not be relevant. These searches can result in some off-the-wall answers, trust me!

Figure 2-2 illustrates the difference between a Browse and keyword search for guidance on accounts receivable.

In a browse search , the user

navigates to topics that might apply.

In a keyword search , the user enters a

keyword and is directed to a list of search results.

~~e SEARCH: accounts receivable

rro ACC O UN TI NG STANDARDS C ODIFI CAT ION® Professional View • CodifG!ooOClhefSotltes -+ Advance BROWSE

CODIFICATION

lex:740-10-25 I E? General Principles

Presentation

Ui@MMNl;MlfiWIM3Mii@MM,HIMMtifWff,MW- Home> Assets> 310 Receivables> 10 Overall

310 Receivabl es 10 Overall

, •••••••• ---1h..Oin.aLSeo,-.--.S'"""""--"'ol<..l\' NALL SECTIONS. 30 5 • Cash and Cash Equiva lents

Lia bilities

Equity

Revenue

Expenses

Broad Transactio ns

Industry

Master Gl ossary

32X- ln vestments 20 - Nonrefunda ble Fees and Other Costs

330- Inve ntory 30 - l oans and Debt Securities Acq uired with Deteriorated Credit Quality

340 - Other Assets and Deferred 40 - Troubled Debt Restructurings by Creditors

35 0 - Intangibl es-Goodwill and 905-Agriculture

36 0 - Prope rty, Plant, and Equi 910- Contractors-Construction

912 - Contractors-Federal Government

920 - Entertainment-Broadcasters

Reproduced with permission of the Financial Accounting Foundation .

A key goal of this chapter is to improve your confidence in performing Browse searches . In order to do this, though, you must first understand how the Codification is organized. To get the most out of this discussion, please log into the Codification and follow along whi le you read.

How is Information Organized Within the Codification? The Codification is organized into areas, topics, subtopics, sections, subsections, and para- graphs. These categories are relevant not only to users browsing within the Codification, but also are used in referencing the Codification (such as in a memo). References to the Codification are generally presented using the following format:

Topic (XXX) - Subtopic (YY) - Section (ZZ) - Paragraph (PP)6

For example, ASC 842-20-30-1 refers to Topic 842 (Leases), Subtopic 20 (Lessee), Section 30 (Initial Measurement), Paragraph 1.

Figure 2-3 illustrates the location and purpose of these various categories within the Codification.

5 FASB Accounting Standards Codification , About th e Codification (v4. J 0). December 2014. Page 6.

6 Notice that areas and subsections aren ' t included in numerical Codification references.

Figure 2-2

Browse versus keyword searches of the Codification

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26 Chapter 2 I The FASB Codifi cati on: Introducti on and Search Strategies © Cambridge Business Publishers

Figure 2-3

Organization of content in the Codification

Now

YOU Try

2.3

1. Co ntent is organized into nine

broad Areas , plus the Master

Glossary.

Other Presentation Matters

Provides references and links to Accounting Standards Updates that have changed the content of the subtopic.

Provides general overview and background information for subtopics. Describes in general terms what transactions the subtopic is intended to address .

States the high-level objectives of the subtopic.

Answers the question : Does this guidance apply to my transaction? It is assumed that all transactions and entities are subject to guidance unless granted a scope exception .

Defines all glossary terms used in a subtopic. The Codification also includes a Master Glossary, which includes all glossary terms used within the Codification.

Describes what items can be recorded in the financial statements , when an item can be recorded, and how an item should be recorded .

Describes at what value (i.e., how much?) a financial statement item should be initially recorded. Also known as "day 1" measurement.

Provides guidance on how to change the value of an item after it is initially recorded . Also known as "day 2" measurement.

Describes when and how a recorded item should be removed from the financial statements.

Provides additional guidance on how the transaction should be presented in the financial statements.

Continued

Figure 2-5

List of sections available under the Equity Method Investments topic

0 30 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

Continued from previous page

Section Number

(xxx-yy-00) Section Name Description

S-00

Disclosure

Implementation Guidance and Illustrations

Relationships

Transition and Open Effective Date Information

Grandfathered Guidance

XBRL Elements

"S" sections

Provides disclosure requirements for a particular transaction or financial statement item.

Includes (1) interpretive guidance describing how the guidance should be applied to specific scenarios and (2) illustrative examples.

Provides references to other subtopics containing related guidance.

Provides transition guidance for content that has not yet become fully effective.

Not generally relevant, but applies to practices that are no longer acceptable for new transactions but that some practitioners continue to apply to transactions that occurred prior to 2009 (when the Codification became effective).

Contains the XBRL-related elements for this subtopic. XBRL is a reporting format, for the benefit of financial statement users, in which companies "tag" certain financial statement data and information, allowing users to easily compile and compare information across companies.

Provides select SEC guidance, generally organized into sections similar to those described above. S-sections do not contain the full population of SEC guidance; limited guidance is provided for the convenience of Codification users.

' Note that the revi sed revenue topi c (ASC 606) combines the Initial Measurement and Subsequent Measurement section s and refers to thi s combined section as Section 32: Measurement.

Certain of these sections warrant additional discussion . Following is additional background and tips for reviewing these key sections.

Overview and Background (-05 ) The Overview and Background section provides users with general knowledge about a Codification topic and highlights types of transactions covered by the guidance. Read this sec- tion to obtain a basic understanding of guidance that is new to you.

Try to avoid citing the Overview as a source. For example, this section may say: "This topic introduces the requirement that ... " Beware: Quoting this sentence is not as impactful as quoting the requirement itself. You would be better off finding the actual requirement in the guidance, for example under a Recognition or Measurement section.

Objectives (-10 ) The Objectives section answers the question: What were the standard setters hoping to achieve when they created these requirements? Like the Overview section, "Objectives" should not be read as actual requirements; rather, this section provides users with overarching principles to consider when applying guidance requirements.

Scope (-15 ) The Scope section is one of the most critical sections of an accounting topic. It indicates which transactions or entities are subject to guidance within the topic. However, beginning researchers often overlook this section, choosing instead to focus on the more "useful" guidance they expect to find under Recognition or Measurement. Pages and pages of professional literature have been devoted to analyzing nuances of the scope guidance contained within the Codification, as recog- nizing when you are within the scope of a standard is critical to properly applying the guidance.

/'0 © Cambridge Business Publishers Chapter 2 I The FASB Codification: Introduction and Search Strategies

Scope guidance is commonly presented in one of two ways:

• The guidance may list transactions that are not within scope. For example, scope guidance in ASC 350-10 (Intangibles-Goodwill and Other) states

15-3 The guidance in the Intangibles-Goodwill and Other Topic does not apply to the following transactions and activities: a. The accounting at acquisition for goodwill acquired in a business combination ...

• Alternatively, some scope guidance contains tests to determine what transactions should be included within the scope of the topic. For example, scope guidance in ASC 842-10 (Leases) states

15-3 A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.

To account for a transaction as a lease, a researcher would need to confirm that the contract involves 1) an identified asset and that 2) the contract conveys control over the asset.

Recognition (-25 ) Guidance in the Recognition section describes what, when, and how an item should be recorded in the financial statements. Following are examples of each issue:

• What should be recorded? Asset retirement obligation (ARO) guidance tells you that the obligation to pay money upon retirement of an asset must be recognized in the financial statements (ASC 410-20-25).

• When should items be recorded? Revenue recognition guidance tells you when it is appro- priate to recognize revenue in transactions with customers (ASC 606-10-25).

• How should items be recorded? Derivatives guidance states that derivatives should be rec- ognized as assets or liabilities in the balance sheet (ASC 815-10-25).

Initial Measurement (-30) Guidance in the Initial Measurement section describes at what value ( or for how much?) a financial statement item should be recognized. This value is also known as an item's "day l" measurement.

For example, in general,

• Inventory is initially measured at cost (ASC 330-10-30).

• Guarantee liabilities are initially measured at fair value (ASC 460-10-30).

• Property, plant, and equipment is initially measured at historical cost, including interest (ASC 360-10-30).

Subsequent Measurement (-35) Guidance in the Subsequent Measurement section describes how to change the value of an item after it is initially recorded. This value is also known as an item's "day 2" measurement.

For example,

• Inventory obsolescence would be considered in determining its "day 2" value (ASC 330-10-35).

• Collectibility of an account receivable (for risk of uncollectible accounts) would be consid- ered in determining its "day 2" value (ASC 310-10-35).

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• Depreciation of property, plant, and equipment is considered in determining its "day 2" value (ASC 360-10-35).

Other Presentation Matters (-45) The Other Presentation Matters section provides additional guidance on how a transaction should be presented in the financial statements. This goes beyond the presentation guidance provided under the Recognition section.

For example,

• Treasury Stock-Other Presentation Matters addresses where within the Equity section of the balance sheet to classify repurchased shares, when the repurchased shares may not be retired (ASC 505-30-45).

Disclosure (-50) The Disclosure section sets forth required and recommended disclosures for a particular trans- action or financial statement item. This section provides disclosures related only to the specific subtopic being addressed; other general disclosure requirements are addressed in Topic 235 (Notes to Financial Statements).

For example,

• The Inventory topic requires disclosure of "substantial and unusual losses" resulting from the subsequent measurement of inventory (ASC 330-10-50).

Implementation Guidance and Illustrations (-55) The Implementation Guidance and Illustrations section includes the following, as applicable to each topic:

• Interpretive guidance describing how the guidance should be applied to specific scenarios.

• Examples illustrating application of the guidance.

For example, according to the Recognition guidance in the topic "Loss Contingencies," an estimated loss from a loss contingency must be accrued if the loss is probable and reasonably estimable (ASC 450-20-25). The Implementation Guidance section for loss contingencies :

• Identifies additional factors that should be considered in determining whether the "prob- able" threshold has been met (ASC 450-20-55).

• Illustrates appropriate accruals and disclosures for sample loss contingency cases.

SEC Sections (S-00) SEC sections are identified in the Codification by an "S" that precedes the section reference number. These sections include accounting and reporting guidance that is authoritative for public companies. Often, SEC guidance offers further interpretation of general Codification require- ments; for this reason, although the guidance is only required for public companies, public and nonpublic companies alike can benefit from the SEC's interpretations of GAAP.

SEC guidance is generally organized into the same sections as other Codification content. For example, S-25 offers SEC recognition guidance. However, beware: Creators of the Codifica- tion did not want to change content issued by the SEC; therefore, any content not fitting neatly within separate sections (e.g., S-25 for recognition) is available under S-99. Therefore, research- ers searching for recognition guidance should check both sections: S-25 and S-99.

The following Now YOU Try is intended to improve your familiarity with sections in the Codification.

0 ��

Understanding Sections

For this example, we'll use a sample of the guidance from possibly one of the most daunting top- ics in the Codification-Derivatives (ASC 815). Your challenge will be to label each excerpt from the Derivatives topic with the section in which the excerpt is located. Then, identify the likely paragraph number for this excerpt (presented as Section XX - Paragraph YY) .

As you'll notice in this example, the guidance within a topic becomes much more approach- able once you understand how it is organized.

Sections to select from: Scope, Recognition, Initial Measurement, Subsequent Measurement, Other Presentation Matters, Disclosure, or Implementation Guidance. Paragraphs to select from (from ASC 815-10): par. 15-83, 25-1, 30-1, 35-1 and 35-2, 45-4, 50-1, 55-1.

Likely Para. Section?

0 An entity shall recognize all of its derivative instruments in its statement of financial position as either assets or liabilities depending on the rig hts or obligations under the contracts.

0 Definition of a derivative instrument A derivative instrument is a financial instrument or other contract with all of the following characteristics ....

An entity with derivative instruments ... shall disclose information to

0 enable users of the financial statements to understand all of the following: a. How and why an entity uses derivative instruments (or such nonderivative instruments) ...

This section provides guidance on the following implementation matters: a. Determining whether a contract is within the scope of this Subtopic

0 b. Unit of accounting-a transferable option is considered freestanding , not embedded c. Definition of derivative instrument d. Instruments not within scope .

0 All derivative instruments shall be measured initially at fair value.

0 All derivative instruments shall be measured subsequently at fair value. Unless the conditions in paragraph 210-20-45-1 [Balance Sheet >

0 Offsetting] are met, the fair value of derivative instruments in a loss position shall not be offset against the fair value of derivative instruments in a gain position.

Chapters 6, 7, and 8 of thi s book provide additional discussion and examples of applying sec- tion guidance in the Codification, in particular, scope, recognition, and measurement gu idance.

Subsections and Paragraphs Paragraphs are where the actual guidance is found within the Codification. Paragraphs are sometim es organized into groups, called subsections. For example, within the Receivables topic (ASC 310-10), guidance is organized into a General subsection and a subsection for Acquisition, Development, and Construction Arrangements. Each of these subsections has unique scope and recognition guidance. Whenever you find a paragraph with content that appears relevant to your search, be certain that you understand the context. That is, be sure you are reading guidance within a subsection that is relevant to your issue.

For example, assume you word search (ctr! + f) wi thin the Receivables topic for "residual profit" and land in section "a" (bolded below).

Number?

Now

L YOU Try

2.6

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34 Chapter 2 I The FASB Codificati on: Introducti on and Search Strategies © Cambridge Business Publishers

Now

YOU Try J 2.7

Assets > Receivables> Overall > Recognition

General

a. Factoring arrangements

b. Loan syndications and loan participations c. Standby commitments

Acquisition, Development, and Construction Arrangements

a. Expected residual profit

b. Characteristics implying investment in real estate or joint ventures

Before you share this paragraph wi th your supervisor, wait! Consider the context. Did you intend to search within thi s specific subsection of guidance? Is your transaction within the scope of this subsection? To avoid errors, be sure to scroll up and down on the page to understand all related section and subsection headers when you fi nd guidance that appears to be on point.

In addition to understanding what sub section you are in within the guidance, you must also pay attention to paragraph groups, indicated by a header and>> notations. For example, para- graphs could be organized as fo llows:

Issue header >Issue l >>S ubissue A >>Subissue B >Issue 2

Assume that you encounter paragraphs organi zed in thi s fas hi on, and the guidance in Subi s- sue B is relevant to your research. Since Subissues A and B are ex tensions of the guidance in Issue 1, it would not be appropriate to fo ll ow the guidance in Subissue B without also readin g Issue 1. You wo ul d not be requ ired to read Subissue A if it does not appear to be applicabl e.

Subsections and Paragraphs

Following is an example from ASC 820 (Fair Value Measurement) , showing the organization of certain paragraphs within the Subsequent Measurement section. > Definition of Fair Value

» The Asset or Liability » The Transaction » Market Participants » The Price » Application to Nonfinancial Assets

»> Highest and Best Use for Nonfinancial Assets »> Valuation Premise for Nonfinancial Assets

» Application to Liabilities and Instruments Classified in a Reporting Entity's Shareholders' Equity

Questions:

1. If you find guidance you are looking for under the header "Highest and Best Use for Nonfinancial Assets," what two other issues should you also read?

(continued)

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Continued from previous page

2. Explain.

Chapter 2 I The FASB Codification: Introduction and Search Strategies 35

If you lose track of where you are in the Codification, you can hover your mouse over the paragraph number to be reminded of the subtopic and section number for your current location.

I TIP from the Trenches

For example, by hovering your mouse over par. 15-6 (circled in the illustration), you'll see the "Currently Viewing" screen, which describes your location.

> Other Considerations

> > Significant Influence

Ability to exercise significant influence over _::, ..,.__...,ud·ing the following:

Currently Viewing :

323 Investments-Equity Method and Joint Ventures 10 Overall

15 Scope and Scope Exceptions General

> Other Considerations » Significant Influence

Reproduced with permission of the Financial Accounting Foundation (circle and cursor image added).

Let's look now at some tips for performing effective, and efficient, Browse searches.

TIPS FOR PERFORMING BROWSE SEARCHES

Now that you have a basic understanding of how the Codification is organized, you are capable of performing basic searches using the Browse feature. Lo4 Perform effective

As noted previously, the Browse feature is essentially a user-directed search. You, as the user, will click through a series of topics and subtopics that will, with a little experience, take you right to the appropriate guidance for a given transaction. As your understanding of the Codification increases, your efficiency in performing these searches will improve.

Browse searches within the

The starting point in a Browse search is to locate the specific topic and subtopic that

Codification, reviewing all areas of required reading.

you are searching for. See Figure 2-6, illustrating a researcher browsing to the subtopic Revenue from Contracts with Customers-Overall (ASC 606-10) .

Join All Sections Once you're in the appropriate subtopic, I suggest that you click on the Join All Sections button. This button displays all subtopic content on one page and allows you to navigate more easily through the subtopic.

�

36 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

Figure 2-6

Example of a Browse search

BROWSE

CODIFICATION

!ex 740-10-25 ! - ?

General Principles

Presentation

Assets

Liabilities

Equity

Expenses

Broad Transactions

Industry

Master Glossary

OTHER SOURCES

MMN'f¥MdlMl@t+11;;.11;;.;+J;ffil§M,HWMMMIH,tW Home > Revenue > 606 Revenue from Contracts with Customers > 10 Overall

606 Revenue from Contracts with Customers 10 Overall

To join all Sections within this Subtopic, click JOIN ALL SECTIONS.

fHll,.i!i=ti,HMi 1

+ 05 Overview and Background + 10 Objectives + 15 Scope and Scope Exceptions

20 Glossary + 25 Recog nition + 32 Measure ment

Reproduced with permission of the Financial Accounting Foundation.

For example, assume you are looking for the term collectibility , and you know the term is somewhere within this revenue subtopic (ASC 606-10). Selecting "Join All Sections" puts the full content of the subtopic on one page, allowing you to search the full subtopic for this term using "ctrl + F" (find).

Navigating a Subtopic, Considering All Areas of "Required Reading " You are now ready to begin reviewing the subtopic for relevant guidance. As discussed earlier in this chapter, the first section you should read, if you are unfamiliar with a subtopic, is the Overview section (05). Next, consult the Scope section (15) to confirm that your specific trans- action is within the scope of this guidance. Then, think about what question you are asking: Is it about Recognition? Initial Measurement?

Go to the appropriate section, and find guidance applicable to your search question . Let's assume that relevant guidance was available in par. 1 under Recognition. You ' ve found your answer; you're done, right? Not so fast.

There are several important additional steps that you should "check off' before you can be confident that your research effort was thorough. In particular, treat any relevant Implementa- tion Guidance and SEC content (particularly for public companies) as required reading. Often, the interpretive guidance located in these sections can confirm or change your view of how the guidance should be applied. Also, remember that these sections are equally as authoritative as other sections within the topic.

Figure 2-7 illustrates the following steps:

1. Confirm that your transaction (or entity) is within scope.

2. Look for guidance in the section that you anticipate is most relevant. For example, after con- firming that your transaction is within the scope of a topic, head straight to "Recognition" for questions about recognizing an asset.

3. Ensure that you have read any preceding paragraphs that are related. In doing so, pay atten- tion to the hierarchy of paragraphs, indicated by > >.

4. Fully skim the rest of the section you are searching (for example, the full Recognition section), to ensure that you have considered all relevant guidance. Subsequent paragraphs within that section may offer additional detail or situation-specific guidance that you should consider. Pay particular attention to boldfaced headings used to organize paragraphs, as they can assist you in quickly determining whether groups of paragraphs are potentially relevant.

0 © Cambridge Business Publishers Chapter 2 I The FASB Codification: Introduction and Search Strategies

5. Review the list of issues addressed within the Implementation Guidance sec tion (55). In some cases, the first paragraph of the Implementation Guidance section includes a list of issues it addresses; in other cases, you may have to skim through the guidance, reviewing for potentially relevant headings (e.g., headings related to Recognition) .

6. Particularly for public companies, scan the S-sections to check for relevant SEC guidance. Look in particular for guidance related to the section you are searching (e.g., S-25 and S-99 may both offer recognition guidance).

Be patient; it may initially be frustrating to use the Browse feature as your primary means for searching the Codification. However, it is essential that you learn how the guidance is orga- nized . You will become more efficient with practice .

The following example illustrates how Implementation Guidance can assist in interpreting content within the Codification.

EXAMPLE

Understanding Why Implementation Guidance (Section 55) Is Integral to Your Browse Search Assume that a customer slipped and fell in ABC Grocery, but the customer has not yet filed suit. Should ABC Grocery record a loss, due to the poss ibility that the customer will file a lawsuit? If the customer does file suit, the amount of loss is ex pected to be approximately $ 100,000.

ASC 450-20 (Loss Contingencies) states:

25-2 An estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met:

a. Information available before the financial statements are issued or are available to be issued ... indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements ...

b. The amount of loss can be reasonably estimated.

Continued

Figure 2-7

A checklist of required reading

38 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

Now

YOU Try

2.8

Continued from previous page

The preceding guidance states that a loss should be recorded if it is probable that a liability has been incurred; this determination involves judgment. Experienced researchers know that additional guidance, when available, can assist in framing judgmental issues. After finding this guidance under Recognition , look for Recognition guidance in the Implementation Guidance section (55). There, you can find the fo llowing guidance even more specific to this issue:

Assessing Probability of the Incurrence of a Loss (ASC 450-20) 55-14 With respect to unasserted claims and assessments, an entity must deter-

mine the degree of probability that a suit may be filed or a claim or assess- ment may be asserted and the possibility of an unfavorable outcome. If an unfavorable outcome is probable and the amount of loss can be reasonably estimated, accrual of a loss is required by paragraph 450-20-25-2. [Italicized emphasis added].

Armed with thi s guidance, management should consider the probability that a suit will be filed , as well as the probability of an unfavorable outcome. Both gu idance references (par. 25-2 and par. 55-14) should be cited in a memo documenting the position taken. Note: Even if no accrual is made, it is a best practice to document the basis for such a judgment.

Next, let's look at an example illu strating how-particularly for public companies-review in g SEC content is critical to carefully researching an issue.

EXAMPLE

Understanding Why SEC Content (Section "S") Can Be Integral to Your Browse Search A public company applying ASC 480-10 (Distingu ishing Liabilities from Equity) wi ll report equity instruments with certain redemption features differently than would a private company fo ll ow ing the FASB's guidance alone: • A private company applyi ng the guidance in ASC 480-10-25 would conc lude that equity

instruments with certain redemption features shou ld be classified as equity. • A public company would also be required to consult ASC 480-10-899. In doing so, the

public company might conc lude that equity instruments with these same redemption features should be classified as "temporary equity" (a separate category).

A public company's research would be lacking if it did not include consideration of both sources of literature just shown.

Notice how the preceding SEC guidance came from Section S-99? As noted previously, SEC content not clearly fitting within a single section (such as S-25 for recognition) is availab le under S-99. A researcher in this case should check for SEC recognition guidance in both Sections: S-25 and S-99.

1. Describe how, in the preceding contingent liability example, the Implementation Guidance (Section 55) goes beyond the Recognition guidance (Section 25).

2. Which companies are required to consult guidance in the "S" sections? Explain.

Continued

/'0 © Cambridge Business Publishers Chapter 2 I The FASB Codification: Introduction and Search Strategies 39

Continued from previous page

OTHER SEARCH METHODS

In addition to Browse searches, several other methods are available for searching the Codification:

1. Search by keyword, using the Search/ Advanced Search feature.

2. Jump directly to guidance using the ASC reference number (e.g., type in ASC 820-10-30-1 to jump directly to fair value measurement guidance).

Los Search the Codification using other methods, includ- ing keyword searches, the Master Glossary, and the Cross Reference feature .

3. Cross-reference by the "historical" GAAP designation (e.g. , type in FAS 157 to be directed to ASC 820).

4. Search using the Master Glossary, finding a keyword of interest and clicking on that word to be directed to the guidance.

These search methods are discussed further in the sections that follow.

Keyword Searches

A keyword search (i.e., a text search) is most useful when you are looking for a specific term in the guidance, or when you are uncertain where you would begin a browse search. For example, assume you want to find guidance on "involuntary conversions." Unless you have experience with this topic , you would likely not know that this term is addressed primarily in ASC 610-30 (Other Income-Gains and Losses on Involuntary Conversions). In this case, a keyword search would be appropriate.

When a researcher performs a keyword search, the results of the search are listed by topic and include an excerpt from the guidance containing the term. As this type of search allows researchers to see a term in multiple contexts , keyword searches can be a useful brainstorming tool. Researchers can choose to pursue one or several search results, or the results can be used to generate ideas for other search terms that might be effective.

Figure 2-8 illustrates a simple search for the term "involuntary conversion" (see search bar at top right). Notice that sixteen search results were found, in areas including Revenue, Liabili- ties, and Broad Transactions. Researchers seeking to narrow instances of this term to a single area (or multiple areas)-or by related term-can use the "Narrow" option shown on the right- hand side of Figure 2-8.

Home > FASB Search Results

Search Resul ts

CODIF ICATION(U)

These search results come rmm the non-glossary Sections of Codification content

1 • 10 or 16 Resuls for: in voluntary conversion (Reline Search)

61 0 Ot her Income > 30 Ga i ns a nd Lo sse s on Involuntary Convetslons > 60 Relatio nsh i p s

Income Ta xes

(P) December 16 , 2017 ; (N) December 16, 2018 606-10-65·1 For guidance on temporary differences resulting from involuntary conversions, see paragraph 7 40- 10-55-66

610 Ot her Income > 30 Ga ins and Losses on Inv olu nta ry Conversions > 25 Recognit ion

Gene ral

(P) Oecen1:Jer 16 , 2017 ; (N) December 16, 2018 606-10-65-1 An involuntary conversion or a nonmonet ary asse t to mone tary assets and the subsequent reinvestmen t or the monet ary asse l s is no t equivalent to an exchange tr ansaction between an entity and another entity. The conversion of a nonmone tary ...

610 Ot her Income > 1 O Ov e rall > 05 Ov erv ie w and B ackground

Gellt ral

Reproduced with permission of the Financial Accounting Foundation.

Narrow By Related Tenn: ?

• monetaryasset s

• involi.itary conversions

• loss

• excha n ge

• gain or loss

• properties

ByArea: ?

D Liabilities(1) D Revenue(1J) D EKpenses(1) D Broad Transactions (1)

Figure 2-8

Search results for the term "involuntary conversion"

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40 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

Figure 2-9

Advanced search for an exact phrase, limited by area

Users can choose to conduct either simple or advanced searches. A simple search involves a simple empty search bar, similar to Google. Thi s is the type of search illustrated in Figure 2-8. Note the following about the simple keyword search: 7

• Multiple term s: Entering debt restructuring is equivalent to searching for debt and restructuring.

• Phrases : To search for an exact phrase, use quotes. For example, entering "major mainte- nance" returns res ults about Planned Major Maintenance Activities.

• Singular/plural: A search for either intangible or intangibles will yield the same results.

• Wildcard (*): Add an asterisk (*) to the end of a word to find all forms of the word. Example: Deposit* will return deposit, deposited, depositor, depository, and so on.

An advanced search offers additional search options. For example, users can enter a phrase, such as involuntary conversion and can elect to search for

• "any" words (results will display any guidance containing the word involuntary OR conversion ),

• "all" (results will display any guidance containing both involuntary AND conversion),

• "exact phrase," or

• words that occur within "n" words of each other (for example, users can specify that invol- untary and conversion must be within five words of each other).

The advanced search feature also allows users to choose a specific area to search; for exam- ple, a user could specify upfront that search results for involuntary conversion mu st be from the Revenue area. Figure 2-9 illustrates an advanced search for the exact phrase involuntary conversion, limited by area.

Home > Advance d Search

Advanced Search Enter your sea rch crit eri a in one or more of th e fi eld s that foll ow. Narrow your search by se lect in g specific Codification areas or documen t sources.

Text/Keyword: I involuntary conversion O all O any word

Source Type: I Codification • I ? exact phrase O within D words

Content Type: I FASB and SEC • I

Narrow search by: O Codification Referen ce ? Codification Search Scope ? - • AII Areas

Codification Search Scope: (default is all areas)

+ + + + + + ., + + +

Results per page: ! 10 • I

Genera l Principles Presentation Assets Liabilities Equity Revenue Expenses Broad Transactions Industry

Reproduced with permission of the Financial Accounting Foundation .

Identifying Search Terms Keyword searches are based on specific language. Therefore, you mu st use proper search terms (terms that are actually found in the guidance), or you will not find the appropriate guidance.

7 Source: FASB Cod ifi cati on, Search Help. Accessed April 20 15 .

0 © Cambridge Business Publishers Chapter 2 I The FASB Codification: Introduction and Search Strategies

Identifying search terms can be a sort of brainstorming exercise. Write down all possible terms that you think might be useful, including words that may be synonymous with other search terms you have identified. With time, you'll learn the terms used most commonly in the accounting literature.

After entering a search term, a researcher will be directed to a search results page. At this point, a researcher can choose to pursue one or several search results , or the researcher could use the results to generate ideas for other search terms that might be effective.

Following are steps a researcher can take to determine whether a result he or she has pur- sued is relevant (and if not, what to do):

1. If you see a paragraph in the search results that appears to be directly on point, follow your instinct! Read that paragraph and determine whether it is responsive to your question.

2. If, however, the search results just lead you to a topic but no perfect paragraph, begin by reviewing the Overview and Background section of that topic. See whether the guidance appears to be on the right track for your search.

3. Next, review the scope section for the topic. Is your issue within the scope of this guidance? 4. As you perform the preceding steps, take note of other useful terms, or links to other related

guidance. Perhaps these clues will lead to more relevant guidance, if what you' re reading is not already on point.

5. Finally, if you have hit a "dead-end" (the guidance doesn ' t appear to apply, and you have not successfully identified alternate search terms), scroll down to Section 60 of that topic (Relationships). This section includes links to other related topics; reviewing this list might trigger ideas, as well .

Following are two examples illustrating the brainstorming exercise involved in identifying search terms. Note that a "researchable question" has been identified for each situation below. Researchable questions are discussed further in Chapter 3.

EXAMPLE

Situation 1: Company A (your company) has acquired 51 % of the common stock of Company B. • Researchable question: How should Company A account for its investment in Company B? • Possible search terms: equity investment, acquisition, investment, equity method,

consolidation, consolidate, majority owner

Commentary-Situation 1: Very little information is given about this situation; additional facts would be needed before an accounting position could be selected. That said, we have sufficient information to brainstorm some possible initial searches.

Unfortunately, beginning researchers often have to learn through trial and error which search paths are most effective for a given situation. For example, guidance on whether to consolidate an investee is located under the topic "Consolidation" (under the "Broad Transactions" area). A search for the term "acquisition," on the other hand, will generally land you in business combinations guidance, which describes how to consolidate a majority-owned subsidiary. In this case, therefore, a search for "consolidation" would be more effective than guidance on "acquisitions," since you need to decide whether consolidation is required.

A search for the terms "majority" or "majority owner" is likely to lead a researcher to click on the Consolidation topic, so these terms would be effective. However, a search for the term "equity investment" or "equity method" will land researchers in guidance that does not apply, given that this situation involves a purchase of greater than 50% of the outstanding common shares of an entity. Reviewing the Overview or the Scope guidance in these topics will indicate to the researcher that another search term should be tried.

Continued

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42 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

[

Now

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Continued from previous page

With a little experience, you will learn to browse right to the "Consolidation" topic

for this issue. This is appropriate because a purchase of greater than 50% of an entity's

common stock generally results in consolidation (assuming the investee's capital structure

is fairly simple). The Consolidation topic also addresses the accounting for an investor's

involvement in more complex "variable interest entities."

EXAMPLE

Situation 2: Company A (original debtor) has paid $10 million to Company B to assume its liability

to pay off a 10-year loan obligation , payable to Bank. Bank agrees to release Company

A from its payment obligation , but only on the condition that Company B assumes the

obligation and that Company A will still pay if Company B defaults.

• Researchable question: Can Company A remove the loan obligation to Bank from its

financial statements?

• Possible search terms: debt extinguishment, liability extinguishment, liability

derecognition, secondary liability, guarantee, primary obligor, secondarily liable

Commentary-Situation 2: Ultimately, the most relevant guidance for this research question would be found by keying "secondrui ly liable" into the search bar. Reseru·chers would be directed to the derecognition

section of the Liability Extinguishments topic (ASC 405 -20-40), which indicates that the

origina l debtor becomes a guarantor and must recognize a guarantee obligation. Researchers entering "debt extinguishment" into the seru·ch bar will be led to guidance

that includes links to the liabi li ty extinguishments topic; however, reseru·chers unfortunately

might overlook those links and get stuck reading a lot of guidance that does not apply. A search of the term "guarantee" would result in guidance indicating how to value a

guarantee, but such guidance doesn't indicate whether this arrangement should be recorded

as a guarantee. A link to liability extinguishment guidance is available in the Relationships

section of the guarantee topic.

The l esson: Often , even using the wrong search term initially will lead you to the right

answer eventually. Just keep following all " l eads" that appear to be potentially relevant. Do not try to fit a round peg into a square hole; if it seems like the guidance page you

are reading isn't clear in responding to your question, look for links to related content or

try another search term. This is all part of the process; you will become more efficient with

time.

Identifying Search Terms

Read the following practice scenarios, then brainstorm search terms you would use to look for

relevant guidance. Identify at least two possible search terms.

1. A company ships its widgets to a customer on December 31 but has not yet collected pay-

ment from the customer. The customer has promised to pay within 30 days but has never

purchased goods from the company before.

Possible search terms to use in researching the company's accounting for the sales?

Continued

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Continued from previous page

2. A customer is suing the local grocery store for a slip-and-fall incident. The grocery store believes the lawsuit will likely be considered frivolous and rejected by the court.

Possible search terms to use in determining whether the grocery store should record or disclose the matter?

3. A landlord agrees to pay the last two months of a tenant's existing lease with another party as an inducement to have the tenant sign a lease for one of its properties .

Possible search terms to use in determining how the tenant company should record the pay- ment by the landlord to tenant to pay off its existing lease obligation?

Search terms can be useful not only for performing keyword searches, but also for find- ing a term on a page (using ctrl+f). Search terms can also help you maintain focus during Codification searches , as it is easy to get caught up in the guidance and lose sight of your research question . Keep your search terms at top of mind to maintain efficiency and focus during a search for guidance.

1. When is it most appropriate to use the keyword search feature?

2. If you 're working with a search term that leads you to inapplicable guidance, what strategies might you use to identify other possible search terms?

Next, let' s look at another searc h option.

Search by ASC Reference Number Researchers can use the "Go To" featu re to jump directly to specific content, by typing in the content's ASC reference number. This feature can be useful to a researcher who wants to verify a particul ar reference in the guidance, or for experienced resea rchers who have certain search paths memori zed (e.g., many researchers now instincti vely know that entering ASC 606-10 will take them to the revised guidance fo r revenue recognition)!

Fi gure 2-10 illustrates the use of thi s feature. In thi s exampl e, entering 606-10-25-1 in the box at top left takes the researcher direc tl y to revised revenue guidance.

TIP from the Trenches

Now

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2.10

0 44 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

Figure 2-10

Using the Go-To box

Figure 2-11

Using the Cross Reference feature to find the original standard corresponding to ASC 820-10

Presentation

Assets

Liabilities

Equity

Revenue

Expenses

Home> Revenue > 606 - Revenue from Contracts with Customers > 10 Overall

DOCUMENT

606 Revenue from Contracts with Customers 10 Overall

25 Recognition

Table of Contents

Collapse I Expand

- 606 Revenue from Co ntracts with Customers

Reproduced with permission of the Financial Accounting Foundation .

Cross Reference Tab

The Cross Reference feature allows users to link Codification topics with the original standards that were used to populate the Codification. Users can either key in a Codification topic to find the original standard number, or they can key in the number of an original standard and be directed to the corresponding Codification topic. For example, entering ASC Topic No. 820-10 (Fair Value Measurement) into a cross-reference search directs the user to FASB Statement No. 157, Fair Value Measurements (FAS 157), as illustrated in Figure 2-11.

Home > Cro ss Reference

Cross Reference Use this feature to cross reference between the original standards and the Codi fication. Insert information abo ut a stan dard to identify the Codification Sections th at contain the content . Alternatively, insert info rm ation about the Codification to identify the standards that populated that porti on of the Codification . Click here fo r additional information abo ut the Cross Reference feature. NOTE: The report only includes content contained in published Topics. Click here to view the details of the standard type acronyms.

The "Quick Reference Guide : Pre-Codi fication Standards by Topic" PDF is an index of Pre-C odification Stand ards and the Codification Topics where they are used as of June 2012 . Click here to vi ew the "Quick Reference Guide: For a more detailed cross-reference repo rt, use the Cross Reference Feature below.

By Standard ?

Standard Standard Number Type I

~ . 1

@MM¥i,JM4·l;iiWii\il·W#iN

Sort your resu lts by Standard Type or by Topic. PAGES: 1 12 ~

-.- --...... 17standlrd Slandlrd \ Paragraph/

(: N'""blr Label 157 J 1 ~ 157 / 1 FAS 157 1

Sequence

1.1.1.1.1

1.1.1.1.2

1.1.2

Reproduced with permission of the Financial Accounting Foundation.

.Topic SU biopic Section p._.... 820 10 05 05-1

820 10 05 05-1

The FASB continues to make its original pronouncements available on its website, as well as through a link included in the Codification (to "Pre-Codification Standards"). The abbrevia- tions used in referring to original pronouncements are listed under the acronyms link within the Cross Reference page. Chapter 5 discusses circumstances in which it can be valuable to refer- ence pre-Codification standards .

Master Glossary

The Master Glossary is another useful starting point for researchers seeking further information about a specific term. Cljck below any term in the Master Glossary, and you will be directed to where that term is used within the Codification. Certain terms in the Master Glossary may be dupli- cated or simjlar8; be sure you are consulting the definition applicable to the topic you are searching. Individual topics also include Glossaries (Section 20), which define terms specific to that topic.

8 E. g., The term control has different definitions depending upon whi ch Codification topic is bein g referenc ed.

0 © Cambridge Business Publishers Chapter 2 I The FASB Codification: Introduction and Search Strategies 45

Including a defined term in your research paper? If so, it is generally best to reference the definition in the context of the appropriate Codification topic. For example, if you are perform- ing research on a probable loss, cite ASC 450-20-20 (Loss Contingencies-Glossary) as your source for the definition of probable, rather than citing the Master Glossary as your source .

TIP from the Trenches

Now, let's take a moment to discuss another area that can cause confusion for beginning researchers: pending content in the Codification.

PENDING CONTENT AND EFFECTIVE DATES

What is "Pending Content"? When new guidance (that is, an "Accounting Standards Update") is issued by the FASB, it is added to the Codification as pending content.

Pending content shows up in a box, immediately following existing paragraphs in the Codification. Often, pending content has the same paragraph number as the content

Lo6 Differentiate between existing versus pending content, and understand how to interpret transition date guidance.

just above it, meaning that it will replace that guidance once it becomes fully effective. This process can take up to several years, given that companies can have different fiscal year-ends, and given that small or nonpublic entities are sometimes granted delayed effective dates. Once the pending content becomes fully effective, the previous (nonboxed) guidance will be removed from the Codification and the revised content will remain.9

If you see pending content directly under a paragraph that appears to be relevant to your research, click on the "Transition Guidance" link provided next to the pending content para- graph. Carefully read the transition guidance to determine whether the pending content will be effective for the transaction you are accounting for. If so, you should read the pending content in lieu of the identical paragraph number that precedes it. If pending content is in addition to exist- ing content (for example, if there is existing content labeled par. 1-2, and pending content begins at par. 3), then consider whether this guidance should be followed in addition to existing content.

To illustrate the presentation of pending content in the Codification, take a look at Figure 2-12, featuring guidance from ASC 705-1 O (Cost of Sales and Services). This topic was recently amended in conjunction with revised revenue recognition guidance. Using Figure 2-12, respond to the following questions.

25-4 For a discussion of the criteria for the recognition of revenue and the related cost of sales when the right of return exists , see the guidance beginning in paragraph 605-15-25-1 .

See Topic 606 on revenue from contracts with customers , specifically paragraph 606-10-32 -10 and paragraphs 606 -10-55-22 through 55.'29 for the accounting for a sale with a right of return.

~ SUBMITFEEDBACK ? # PERSONAL ANNOTATION ?

> Other Assets and Deferred Costs-Contracts with Customers

25-4A

Pending Content: ? Transition Date : (P) December 16, 2017; (N) December 16, 2018 I Transition Guidance: 606-10-65-1 See Subtopic 340-40 for guidance on the following costs related to a contract with a customer within the scope of Topic 606 on rev- enue from contracts with customers:

a. Incremental costs of obtaining a contract with a customer b. Costs incurred in fulfilling a contract with a customer that are not within the scope of another Topic.

Reproduced with permission of the Financial Accounting Foundation. Continued

9 FASB Accounting Standards Codification, About the Codification (v4. I 0). December 2014. Page 30.

r Now YOU Try

2.11

Figure 2-12

Pending content from ASC 705-1 0

46 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

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YOU Try 2.12

Figure 2-13

Transition guidance for recent changes to ASC 842

Continued from previous page

Questions:

1. Which pending content guidance, paragraph 25-4 or 25-4A, will replace (aka, supersede) existing requirements? Which is adding new guidance? Explain .

2. Where in this screenshot would a researcher click to find out when the boxed content will

become effective?

Understanding Effective Dates

As the FASB issues new guidance, it is common for that guidance to have a delay between its issuance date and its effective date. This gives companies time to review and implement the new guidance. Here are three examples of how effective dates are commonly worded:

a. For fiscal years ending after December 15, 20xl

b. For fiscal years beginning after December 15, 20xl

c. For fiscal quarters beginning after December 15, 20x 1

Each implies quite a different time frame. For example, assume it is the year 20xl.

• A company with a calendar year-end would have to immediately apply any new guidance with the effective date described in (a) above (i.e., to its 12/31/20xl financial statements).

• On the other hand , if new guidance was issued with the effective date described in (b), the company would first reflect the new guidance in its 12/3 l/20x2 financial statements.

To check your understanding of the effective date in (c) above, see the Now YOU Try that follows.

1. Now assume that guidance has been issued with the effective date described in point c above. When would a company with a calendar year-end first have to reflect the new guid-

ance in its financial statements?

Let's look now at the transition guidance provided for ASC 842 (Leases), shown in Figure 2-13.

> Transition Related to Accounting Standards Update No. 2016-02 , Leases {Topic 842) and Accounting Standards Update 2018-01 , Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842

65-1 The following represents the transition and effective date information related to Accounting Standards Update No. 2016-02, Leases (Topic 842) and Account- ing Standards Update No. 2018-01 , Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842: [Note: See paragraph 842-10-565-1 for an SEC Staff Announcemen t on transition related to Update 2016-02.)

a. A public business entity, a not-for-profit entity that has issued or is a conduit bond obligor for securities that are traded , listed, or quoted on an exchange or an over-the-counter market, and an employee benefit plan that files or furnishes financial statements with or to the U.S. Securities and Exchange Commission shall apply the pending content that links to this paragraph for financial statements issued for fiscal years beginning after December 15, 2018 , and interim periods within those fiscal years. Earlier application is pennitted. b. All other entities shall apply the pending content that links to this paragraph for financial statements i.ssued for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Earlier application is permitted.

Reproduced with permission of the Financial Accounting Foundation.

2. First, what section was this screenshot taken from (for example , Section 25-Recognition)?

3. Assume your client is a public company with a calendar year-end . In what quarterly and

annual periods must the company begin applying the pending content for ASC 842?

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PRIVATE COMPANY ACCOUNTING ALTERNATIVES IN THE CODIFICATION

Finally, recall that the Private Company Council (PCC) has been advising the FASB on areas within existing U.S. GAAP, and in the FASB's current projects, that could be simplified for private companies. The work of this council has led to an increasing number of private company alternatives becoming available within the Codification. Figure 2-14 illustrates scope guidance for one such alternative; this particular alternative allows private companies to amortize goodwill, as opposed to performing costly annual impairment tests (ASC 350-20).

Lo7 Recognize accounting alter- native guidance available for private companies.

Accounting Alternative

• COMBINE SUBSECTI ONS ?

154 A Jlr)11at~ .c<?~P.a11v. may make an accounting policy election to apply the accounting alternative in this Subtopic. The~ following transactions or activities:

a . . G.o.<?~W!!! that an entity recognizes in a business combination in accordance with Subtopic 805-30 after it has t

b. Amounts recognized as goodwill in applying the equity method of accounting in accordance with Topic 323 or ir recognized by entities that adopt fresh-start reporting in accordance with Topic 852 on reorganizations.

Reproduced with permission of the Financial Accounting Foundation.

As with other standards, unique transition guidance applies to each newly issued private compa- ny alternative. Private companies can elect to apply one, all, or none of the available alternatives .

Brainstorm : What is one potential downside of a private company electing an accounting alterna- tive? One potential upside?

CHAPTER SUMMARY The FASB Codification is the essential source of authoritative accounting guidance for nongovernmental entities. SEC content is also authoritative for public companies. The Codification brings together many individual standards issued over the years in a single research database where all content has equal author- ity. The FASB continues to update the Codification today, through the issuance of Accounting Standards Updates.

Content within the Codification is organized by topic, and then further segregated into subtopics and sections. For a research effort to be thorough, certain of these sections must be included in every search. Although several methods are available for searching the Codification, users will likely find that user- directed "Browse" searches are most efficient. With practice, you will become increasingly comfortable searching the Codification.

REVIEW QUESTIONS

1. Explain what it means for the Codification's guidance to be "authoritative."

2. Explain why the Codification was developed.

Figure 2-14

Private company accounting alternative from ASC 350-20 (Goodwill)

Now

YOU Try

2.13

3. Aside from the FASB , name three other standard-setting bodies whose guidance is included in the Codification.

4. What two organizations give the FASB the authority to establish "authoritative" accounting guidance? Explain.

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48 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

5. Explain the role of industry-specific guidance in the Codification. Does it apply instead of other general Codi- fication guidance?

6. Which search method does the FASB suggest that researchers use as a starting point when conducting research? Explain.

7. In the following template for a Codification reference, what does each group of letters represent?

XXX-YY-ZZ-PP

8. What entities does guidance in the Codification apply to?

9. Is all SEC guidance contained within the Codification, and is SEC guidance considered authoritative for all entities?

10. In which area of the Codification would a researcher begin a Browse search for the Leases topic?

11. In which area of the Codification would a researcher begin a Browse search for the Inventory topic?

12. Considering the section descriptions provided in the chapter, identify the section that you'd consult to dete1mine: a. Whether lease guidance applies to natural resources, such as land with mineral deposits b. How entities should present basic EPS for continuing operations on the income statement c. What disclosures are required for companies preparing consolidated financial statements d. How to measure the effects of inventory obsolescence.

13. Which section might you read first if you are unfamiliar with a topic and need general information? But, what caution was provided regarding this section? Explain.

14. What are some possible benefits to a researcher reviewing the Implementation Guidance section (55) when conducting research?

15. Explain the numbering for S-sections from the SEC. Why does the chapter recommend that researchers consult S-99 in addition to other S-sections that might apply?

16. When including a defined te1m in your research paper, is it better to cite the source for this term as the Master Glossary, or the glossary located within an individual Codification topic ? Explain.

17. Following is an example from ASC 350-20 (Intangibles-Goodwill), showing the organization of select para- graphs within the Subsequent Measurement section.

If you find guidance you are looking for under the header "Goodwill Impairment Testing and Disposal of All or a Portion of a Repo1ting Unit When the Reporting Unit is Less Than Wholly Owned," which other two headers should you read (at a minimum)? (For convenience, the following headers are numbered.) I. > Assigning Goodwill to Reporting Units 2. > Reorganization of Reporting Structure 3. » Goodwill Impairment Testing by a Subsidiary 4. >> Di sposal of All or a Portion of a Reporting Unit 5. »> Goodwill Impairment Testing and Disposal of all or a Portion of a Reporting Unit When the

Reporting Unit is Less than Wholly Owned 6. >> Equity Method Investments

18. Which additional areas in the guidance are considered "required reading" for a researcher who has found general guidance in the Initial Measurement section, but who needs to be sure his or her search was thorough? (Name three other areas the researcher should consider.)

19. What is the name of the guidance currently issued by the FASB to update the Codification? Is this guidance considered "authoritative" in its own right?

20. When should a researcher rely on guidance shown under "Pending Content" instead of existing content?

21. What is the purpose of the cross-reference feature in the Codification? When might this feature be useful to a researcher?

22. What type of entity is permitted to apply accounting alternatives in the Codification? If a company elects to apply a given accounting alternative, does it mean the company must apply all of the available accounting alter- natives? Explain.

� © Cambridge Business Publishers Chapter 2 I The FASB Codification: Introduction and Search Strategies

EXERCISES

Use the FASB Codification to answer the following questions. There is a specific, correct answer to each of the following questions. Keep looking in the Codification until you find the reference that directly responds to these questions.

1. Suppose you wanted to understand how interest payments on a loan should be presented (classified) in the state- ment of cash flows. a. Show how you would navigate to the appropriate guidance using the "browse topics" feature on the left

side of the screen. (example: liabilities-contingencies-loss contingencies-initial measurement) b. Now provide the nume1ical ASC reference for the relevant guidance, down to the paragraph. c. What search term(s) might I enter, if I wanted to perform a keyword search to locate this guidance? d. What is the Codification reference (ASC xxx-xxx) if I wanted specialized statement of cash flows guidance

for entities in the Real Estate-Timeshare Entities' industry?

2. Describe how you would navigate to the Retirement Benefits topic, Defined Benefit Plans-Pension subtopic within the Codification.

3. In the following reference, label the Topic, Subtopic, Section, and Paragraph. Also, provide the description from the Codification for each of these (e.g., the description for Topic 842 is Leases). Here's the reference: ASC 210-20-45-1.

4. Name three of the topics listed within the Broad Transactions area.

5. a. Go to the tab entitled "cross reference" on the Codification homepage. What is the FASB Statement No. that corresponds to Topic 480-10 (Distinguishing Liabilities from Equity)?

b. Using the "Other Sources" list on the left side of the Codification, go to pre-Codification standards. What is the full name of this FASB Statement that you identified in (a) above?

c. Next, go to the Basis for Conclusions of the standard (as amended) that you identified in step (b ). (To find this, you might start in the standard's Contents list on page 4.) Considering the introduction to the Basis for Conclusions, desc1ibe two reasons for which this standard was issued.

d. Finally, did any FASB Board members dissent to the issuance of this FASB statement? Explain.

6. Use the "advanced search" feature (search by exact phrase) to answer part (a). a. Find the ASC reference (ASC xxx-xx-xx-x) for the following guidance excerpt:

"The acquirer shall recognize separately from goodwill the identifiable intangible assets acquired in a busi- ness combination."

b. Does this guidance (that is, in the ASC subtopic just identified) apply to private companies? Explain why or why not. Cite your sources.

For the next set of questions, identify the ASC reference-down to the paragraph level of detail-that you would look to for guidance on each issue.

7. Guidance on whether equity spinoff transaction guidance in the Codification applies to nonpublic entities.

8. Criteria for determining whether a lease should be classified as a finance lease or an operating lease.

9. Criteria for determining whether information about an operating segment should be reported separately (i.e., as a reportable segment) in the notes to a company's financial statements.

10. SEC guidance describing required disclosures in the event of a LIFO liquidation, an inventory concept.

11. Guidance stating that the issuance of stock after the balance sheet date should be treated as an nonrecognized subsequent event.

12. For number (9) above, describe the browse path you used (or would use) to locate this guidance.

For the next set of questions, answer each question using the FASB Codification and cite your source down to the paragraph[s]. Respond using complete sentences.

13. Provide two examples from the Codification of "nonauthoritative" sources of GAAP.

14. Are residual value guarantees within the scope of derivative accounting guidance?

15. a. Is SEC guidance considered authoritative GAAP? And, b. Is all SEC guidance housed within the Codification?

16. Should prepaid expenses be classified within CUITent assets on the balance sheet?

17. When should an entity record the effects of changes in tax laws and rates in recording its income taxes?

18. What is the initial measurement objective when recording guarantees?

/'0 50 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

19. Within the Codification, navigate to the revised lease accounting standard. a. What paragraph within that topic provides transition guidance for this new topic? Also, in what period does

this guidance first apply to a private company with a calendar year-end? b. Why does all of the content within this topic appear in boxes, as pending content? Explain.

20. Explain the need for a researcher to consider all sections of required reading when performing Codification research.

21. Identify search terms that you might use to research the following issues. Then, identify the browse path (down to the section) you would likely use to navigate to guidance for these issues (example of a browse path: Assets- Inventory-Overall-Initial Measurement). a. A popular website prima1ily generates revenue through ad sales. Ad buyers must pay a specified cost per

click, and this cost is based on agreed-upon terms between the website and ad buyer. The typical term of an adve1tising atTangement is approximately one month with billing generally occuning after the delivery of the advertisement. The website must estimate the revenues it has earned but not yet collected as of the end of the period.

b. An airline has incurred significant cost to update the interior of its aircraft, changing the configuration of seats and overhead storage space (these parts are considered part of the airframe). The airline must deter- mine whether these costs shall be charged to expense or capitalized.

c. A company 's auditor is questioning the appropriateness of the company's healthcare cost growth rate assumption, which it uses to measure its defined benefit post-retirement medical benefits obligation .

d. A company purchases marketable equity securities and holds the securities in a brokerage account. The company must dete1mine how to initially measure this investment.

22. Consider the search terms you identified in the preceding question. In addition to using search terms to perfo1m keyword searches of the Codification, what are some of the other benefits and uses for search terms? Explain.

23. Navigate to the About the Codification document, shown in the middle of the Codification's homepage. Using this document, describe/name: a. The three primary goals of the Codification. b. Two pronouncements of the AI CPA that were considered pa1t of the population of codified standards as of

July I, 2009 (and which are now superseded by the Codification). c. What content is considered essential versus nonessential. Explain.

24. Within the Cost of Sales and Services topic-Accounting for Consideration Received from a Vendor subtopic (ASC 705-20), you can find the following two headers (among others). Describe the relationship between the content that you would find within these headers.

> Accounting for Consideration Received from a Vendor (Supplier)

>> Consideration in Exchange for a Distinct Good or Service

CASE STUDY QUESTIONS

Respond fully to each question, remembering to clearly cite the guidance source for each response.

2.1 Purchase of an Investment An investor has just purchased a 15% share in the equity of a private company and has the right to appoint a member to the private company 's 5-member board. The investor is asse1ting to his auditor that the investment does not qualify for the equity method of accounting since his interest is below 20%. Locate the guidance applicable to this issue and evaluate the strength of the investor's argument. Identify questions you might ask if you are the investor's auditor.

2.2 Investments Held in Company Pension Plan A company's existing defined benefit pension po1tfolio holds cer- tain investments in private companies, which do not have a quoted exchange price. Determine what measurement basis the company must apply to these private company investments within its pension portfolio. Explain.

2.3 Hazardous Chemical Leak A manufacturing plant has leaked hazardous chemicals into a pond on the plant 's prop- erty. The leaking of these chemicals violates state environmental protection regulations. What accounting is required for this leakage? Does the government need to be aware of the leak before the company must account for the cost of remediation?

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Payable to Company Founder Jensen Inc. has a $500,000 note payable due to its founder, Jen Jensen . Ms. Jensen 2.4 is recently deceased and has no heirs that Jensen Inc.'s executive team is aware of. The company has asked for your help to determine whether it is appropriate to derecognize the liability from its financial statements.

Required: l. Respond to Jensen Inc. Describe the applicable guidance requirements, including excerpts as needed to support

yow· response. 2. Next, explain how you located the relevant guidance, including the search method used and which section you

searched within the appropriate topic.

Goodwill Accounting Alternative An "accounting alternative" is available within the Goodwill topic of the Codi- 2.5 fication (ASC 350-20), specifically as it relates to the subsequent measurement of goodwill. Locate this alternative, and explain: l) What measurement approach does the accounting alternative permit?; 2) What types of companies are eligible to apply this accounting alternative, and where did you locate this info1mation?; 3) How does the accounting alternative differ from the measurement requirements for companies that do not (or cannot) elect this treatment? ; 4) What was the effective date for this guidance, and where did you locate this information?

Applying Transition, Effective Date Guidance You are on the audit team for a publicly traded insurance company 2.6 with a calendar year-end . The company needs help understanding the FASB ' s recent standard (ASU 2018-12) on insurance contracts and has asked you the following questions: 1) In what annual period are we fast required to apply the new standard? 2) In what interim period? 3) When we apply the new standard, are we required to recast compara- tive periods to conform to the new requirements? 4) What topic does this ASU update within the Codification? 5) What are some of the key changes brought about by this new standard?

For each question, explain where within the guidance (ASU or Codification) you located the information.

Early Payment Discount Jones Equipment is a private company that sells and in stalls HVAC systems. Jones offers 2.7 payment te1ms of 2/ l 0, n/30, where customers making payment within IO days of installation will receive a discount of 2% off the purchase price or must pay the full balance due within 30 days. Jones has just received payment from a new customer who paid within the I 0-day window and is thus entitled to the 2% discount. The gross sales p1ice of the equipment and installation, before discount, was $10,000. This discount will not result in a loss to Jones on the sale of the product and service. Jones needs your help to determine when the 2% early-payment discount should be recognized and how it should be recorded-for example, as a reduction in revenue or as a cost of sales?

I. Citing from the guidance as suppo1t, show the approximate journal entries that Jones would make upon instal- lation of the equipment and upon receipt of customer payment. 2. Explain how you located the relevant guidance, including the search method used and which section you searched within the appropriate topic.

Determining Inventory Costs Pro Packs, Tnc. manufactures its own backpacks, marketed to customers primarily for 2.8 camping and travel needs. The company is reviewing its policy for capitalizing inventory costs and wants yow· help to determine whether the following costs should be capitalized as part of the cost of inventory: I. Canvas used in the construction of the packs; 2. Zippers purchased from YKK (a supplier), including the cost of freight for the zippers to be shipped; 3. Wages paid to emp loyees operating industrial sewing machines; 4. Electric utility bills related to operation of the plant; and 5. Contract labor paid to update and maintain the company website, through which cus- tomers can directly place backpack orders. For each cost noted, explain your position and the source you consulted.

Purchase of a Vineyard Your client has just purchased land on which it intends to build a vineyard. Tn doing so, the 2.9 client incurs the following costs: I) land surveys; 2) costs of leveling the land; 3) installation of fencing; 4) instal- lation of a sprinkler system. Refer to industry guidance in the Codification to determine whether these costs should be capitalized and whether there are restrictions surrounding the capitalization period. Also, educate your client on how the Codification classifies these different types of costs. Finally, locate one other examp le of a cost that may be capitalized and explain any restrictions on the period during which the cost may be capitalized.

Falling Boxes On January 31, an improperly stacked box fell from the top shelf of a warehouse, injuring an emp loy- 2.10 ee. The employee was hit, fell , and broke his wrist. Your company self-insures for the risk of such incidents rather than paying an insurance company to absorb the risk of such claims. The employee has been treated for his injuries and has retained a lawyer. The lawyer has not yet filed a fo1mal claim with the company. According to your internal 1isk management team , the amount of claim likely to be sought by the employee cou ld range between $50,000 and $300,000. Is your company required to record a liability for this incident? When , and for what amount? What dis- closures are required , if any?

Sale of Custom Merchandise Custom Wares is a public company that sell s custom merchandise, including 2.11 engraved picture frames . On December 15, the company received a pw·chase order and payment from a cu stomer (Jim Burke) for the purchase of 200 custom frames . The frames will be used as a wedding favor and engraved "Jim and Jess, 2020."

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52 Chapter 2 I The FASB Codification: Introduction and Search Strategies © Cambridge Business Publishers

On December 30, Custom Wares shipped the completed order to Mr. Burke, and Mr. Burke received the frames via UPS on January 2. Company policy allows customers to return merchandise within 30 days for a full refund if they are not to the customer's satisfaction. Historically, Custom Wares has experienced product return rates of 2%. The frames sell for $25 each and cost the company approximately $ 10 each.

Custom Wares must determine whether it can recognize the revenue from the sale, when, and in what amount. For example, should Custom Wares wait until the 30-day return window lapses? Citing guidance from the Codification as support, attempt the journal entries that Custom Wares should record at the time of order, at the time of customer receipt, and-if applicable-upon expiration of the return window.

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The Research Process Michael Jones has just joined the accounting policy team at Presto Hospitality (Presto) , a

public company in the business of operating food and beverage concessions. Presto is in the

process of executing a contract related to the following proposed transaction:

Presto has negotiated a 10-year concessions agreement with a major league baseball stadium owner (Stadium Co.) . The agreement would give Presto the right and obligation to operate all of the stadium's fixed concession stands and portable food and beverage carts, to provide food and beverage service to premium seating areas (including suites) , and to have hawkers selling concessions in the aisles of the stadium (Sodas! Peanuts!) , collectively, the "Food and Beverage Facilities." The locations of fixed concession stands within the stadium are designated in architectural drawings included within the draft concessions agreement. The draft contract states that Stadium Co. , at its option and at its cost (such as the cost to rebuild leasehold improvements), can require Presto to move its locations within the stadium.

The concessions agreement will require Presto to remit 50% of its gross food sales and 52% of its gross alcohol sales to Stadium Co. in exchange for the right to operate at the stadium. Presto will also be required to make an upfront payment of $5 million to Stadium Co ., which will be used toward capital improvements, build-outs, and branding of the con- cession facilities. Throughout the operating period of this agreement, Stadium Co. will have the right to approve all of Presto's proposed menu items, pricing, and choices of suppliers, and Stadium Co. has indicated in negotiations that it plans to actively exercise this approval authority. To be chosen as the concession provider for this stadium, Presto submitted a suc- cessful bid and was selected from a group of competing potential concessionaires.

Continued

After reading this chapter and performing the exercises herein, you will be able to

1. List the six steps of the research process .

2. Identify sources for learning about an industry, and for gathering transaction facts.

3. Define the research problem , through the identification of "researchable questions."

4. Search broadly for potentially relevant guidance .

5. Examine alternative viewpoints in an accounting research analysis.

6. Justify and document your conclusion.

7. Identify common decision traps and judgment biases.

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Continued from previous page

Michael has been asked to evaluate the accounting implications of this draft concessions

agreement. As he is new to the company, he wonders where to begin researching this

issue. Should he go right to the Codification for guidance, or are there other steps he

should take first?

This chapter introduces the accounting research process, an approach you can apply

in practice when faced with complex research issues . Notably, our discussion of this

Presto Hospitality transaction continues into the next chapter, which covers effective writ-

ing techniques.

Steps in the Research Process

0. Understand the business (industry). Judgment and 1. Understand the transaction . Decision Making

2. Define the research problem . in the Research

3. Think independently about possible ....... Process

solutions. ..,.... 1. Common biases 4. Search potentially relevant sources of 2. Overcoming

guidance. biases to reach

5. Analyze the alternative treatments. sound decisions

6. Justify and document your conclusion .

Organization of This Chapter This chapter introduces the accounting research process, which is a step-by-step process

that researchers can apply to a wide range of business and accounting issues. As illustrated

in the preceding graphic, this process involves-first-fully understanding a transaction

(within the context of a given industry) , then identifying the issues , thinking through these

issues, locating applicable research, considering alternatives, and-finally-reaching a

thoughtful and defensible conclusion.

In applying the research process, it helps to understand some of the decision traps and

biases that you may be prone to as a researcher and decision maker. Accordingly, judgment

and decision-making concepts are also introduced in this chapter.

Documentation skills, also integral to accounting research, are addressed in the next

chapter of this book.

When faced with research questions in practice, you'll want a plan for how to address

them. You'll also want that approach to feel automatic . Take the time now to understand

and practice applying the research process-this will be a tool you can call upon for years

to come.

Next Chapter: ....... Documenting ..,.... accounting

research

%$��3 56 Chapter 3 I The Research Process © Cambridge Business Publishers

Figure 3-1

Approach 1

Figure 3-2

Approach 2

WHY USE A RESEARCH PROCESS?

As a beginning researcher, your tendency might be to dive right into authoritative guidance when faced with a research question. But your professor-and professionals-would tell you there 's a better way to research. The goal of thi s chapter is to teach you a more thoughtful approach.

Con sider the research approaches illustrated in Figures 3-1 and 3-2. Which research approach would you tru st more?

• e

Beginning researchers often go straight to the guidance when they receive a research question , often necessitating return trips to their supervisor for additional facts.

Take time to fully understand the issue.

Don 't be afraid to ask questions.

Define the research question, then think

through possible alternatives.

SEARCH THE GUIDANCE

Perform research, then use this guidance to analyze alternatives.

Justify and document your conclusions .

The research process introduced in this chapter involves broadly understanding the issues, and their context, plus thinking through the issue yourself, all before looking for guidance in the Codification. This chapter may sound like a lot of theory. But it's not. In practice, accounting researchers actually apply a similar process.

THE ACCOUNTING RESEARCH PROCESS

L01 List the six steps of the research The accounting research process is the step-by-step process that researchers can apply to a wide range of open-ended accounting issues encountered in practice.

process. The research process described in this book consists of the following steps:

1. Understand the facts .

Pre-Step: Understand the Business (Industry).

2. Define the problem.

3. Stop and think.

4. Search for guidance.

5. Analyze and document

alternatives.

6. Justify and document conclusion .

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Note that multiple variations of thjs process exist (for example, in other textbooks, in accounting firm literature, etc.); thjs book describes just one of many possible approaches. The approach described here is particularly geared to the beginrung researcher, who may require a few extra steps in order to fully analyze an issue. Generally speaking, the similarities among the various research approaches tend to outnumber their differences.

To best understand this process, 1) first, read about it; 2) second, practice applying it to case studies. In time, the steps in this process will become second nature to you. Professionals with a mastery of this process may find themselves being asked to participate on increasingly higher- level projects-offering valuable opportunities to grow in knowledge and skills.

Pre-Step: Understand the Business (Industry)

Perform this step upon being assigned to a new client, or before starting work in a new industry. Your first task in the research process, before you even begin understanding a spe- cific research question , is to get to know your company's-or your client's-business. Understanding the business (or industry) gives you the appropriate context for consider-

Lo 2 Identify sources for learning about an industry, and for gathering transaction facts.

ing company-specific accounting issues. In other words, you first need to understand the business before you can understand the transaction. Without preliminary research on the client's business, you risk asking questions about a transaction that are not informed.

Consider thi s comment from a fellow accounting research instructor:

"When I created this course I met with several Partners at Big 4 firms. One thing I heard more than once was they thought new hires Jacked the ability to research and understand their client's business. Therefore, I try to teach that prior to performing accounting research we should research and understand the business itself."

The business environment, supply chain, sources of revenues and expenses, and timing of cash flows can vary greatly for different industries. Just imagine how different the accounting issues faced by an Agriculture company, versus an Airline, rrught be.

To address these unique accounting issues, the Codification includes an Industry area with industry-specific accounting guidance. Figure 3-3 illustrates the topics included in the Industry area, and provides examples of companies.

lndust,y • Ex: American Airlines, Delta Figure 3-3

Master Glossary

,__90_5·A~go_'cul_1""' ___ _...•, ------ 908-Airlines

9tX-ContriCIOfS

915 - Oevelopmenl Slage Entilies ~

OTHER SOURCES 92X-Enterta1nment

93X-ExtractiveAc1ivities ~ ::------_

Halliburton

Caesars Entertainment

Industry-specific topics in the Codification , plus examples of companies in select industries

Accountinn Standards Updates ~ Q)()( f' ·a S ·

Propos~·:ccolXllingS!andards Updates ~ 1--95-2··-Fr~n_::_i~otS_"'_"" __ _...:::, ~ Other Exposure Documents ~ 954- Heal!h Care Enlities Pre-Codification Standards ~ 958. Not-fOJ·Profit Entilies

Concepts Statements 96X - Pl an Accourlling

Main!enance Updates ~ 97X - Real Estate

980 - RegulatedOperations

985-Software

995-U.S. SteamshipEnlities

Reproduced with permission of the Financial Accounting Foundation .

BP, Exxon Mobil

Bank of America

HCA, Kaiser Foundation Hospitals

To become more informed about an industry, your goal during tms pre-step is to understand:

• What are the primary business activities of comparues in tms industry?

• What are key revenue sources, and costs, for companies in this industry?

• What accounting practices are unique to this industry?

• What are some of the peer group companies in thjs industry?

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58 Chapter 3 I The Research Process © Cambridge Business Publishers

Figure 3-4

Snapshot from the A&A Guide Construction Contractors

TIP from the Trenches

How Do I Learn About a New Industry? AICPA Audit and Accounting Guides (A&A Guides) are arguably the best resource for getting to know a new industry. See Figure 3-4. These guides contain general background on the indus- try, including typical operations and ownership structures, guidance on auditing techniques for the industry, and accounting guidance for transactions specific to the industry.

These guides are not available for every industry, as Michael (from our opening scenario) quickly discovered. However, you can see in Figure 3-4 that this would be a valuable resource for an accountant new to the industries for which these are available.

TABLE OF CONTENTS Chap1e,

1 lndustryBoc~round

Porogn:,pl,

0\..52 02-.05 06-.37 07-.08 .09-. 10 . lJ..12 13-. 19 20..2 1 22..30 31-.34

Nohnond Signi/i<:onceol lhe lndustry feo!l.tres oflhe Bu~ne» Environment

ChoroclerislicsCcrnmontoConfrodO'S

Typesol'Conl!och .. . Contract Modifiootion1 and Chcm99s ... BondingondrheSurefyl.11,~i~ngProce» P,ojee10w,,er.hii>cndRightsdllen Finoncin9Con,~m1ion, JointVentvim ... Repor~ng lot Finoncicl and Income To• Pu,po1es ... JS..37

lypicol lndu!lry(}pefa ~ons .38-.50 Prepcr in9Cos1 E16molesond8id1 39-.45 Enlering Into lhe Con~ac, .. 46 Pkinning end ln~icting lhe Project 47-. .50

~riolk:,ns in Size and Nethcxhol Operotion 51 ProjectMonogement ... .52

Acroontinglc,Perlormonceo/Construdion-TypeControcts 01-.37 8(,.icAaoun~ng Policyfor(.on1r(ld, 03,.08

Pe<cen1oge4(ompletion Melhod . 04.06 Comp~d-ConlrOd Melhod 07 .. 08

Oele<mining,heProlitCe!lte< ... .09 Mecm11ingthefaleflto/Prog res,lo,,,cirdComplelion ... 10.. 12 lnc:omeDe1erm ru:ition - Re.eiiue ll-.20

hr~octdChongeOrder1onR-,nue . 14. 18 h,~tdCloim10l'IR9Y8!1..e. . 19-.20

lnc:ome Dete<m inotiOl'I-COI IElements ... 21-.28 AcoountingforCOl'ltrOdCost1 22 Co1tA~ribuloble1oCloim1 .. 23 P,econlrodCo!1 1 24 .25 Co,t Ad ju!l men~ for Bod Chc,rge, 26-.27 E!limoledC01tloComplele .28

Co~otiOl'lofEo ,nedr,come .'29 aev;sed Ei~motes . . . .30 Provilion 1fo rAnlicipoledl.o1sesonControd, 31 Selec~ng o Meornreol Extent of Prog,.,., 32 Cos1101Equipm8!11ond Smo ll Too~ 33-.36 Appendi~ A-ln,:>lemenlotion Guidooce for Accounting

S1oodord1Updot1No. 2014-09, Re,enuefrom Codroci! wi~ CuJlomeo (Topic606/ ... ......... .37

C 2018, AICPA Contents

A&A Guides can be purchased directly from the AICPA, or can be accessed through certain research databases, such as the AICPA's online research system and Deloitte's Accounting Research Tool (DART).

While the auditing guidance in A&A Guides is authoritative, the accounting guidance in A&A Guides is nonauthoritative. Chapters 5 and 9 of this book further describe AICPA guidance.

Suppose that you do not have access to A&A Guides. What then? Your next best option is to consider other sources that can provide you with an overview of

the industry. Your university's online library may provide you access to the Hoovers or IBIS databases, which offer a great introduction to specific industries, including their operations, supply chain, major companies, and more. If these resources are not available, try a Google search for: "Overview of Concession Industry" (or "Overview of Hospitality Industry") for example, and look for reputable industry trade organization websites designed to teach about the industry.

Additionally, you can find the names of other companies in the industry with the Mergent Online database, by inputting a company name then clicking on Competitors.

Finally, another excellent way to learn about an industry is to review the annual report (Form 10-K) of your client, or of another company that is a key player in the industry. To locate a company's 10-K, simply Google search "!OK Halliburton", for example. Or go to the company's website, then look for their Investor Relations page.

Focus on the following sections of the 10-K to broadly learn about the company and its unique accounting issues:

2%$��3 © Cambridge Business Publishers Chapter 3 I The Research Process

• Business (Item 1)

• Critical Accounting Policies and Estimates (a component of Item 7, MD&A)

• Significant Accounting Policies (generally Note l or 2 of the financial statement footnotes)

You'll quickly realize that it would be impossible to adequately perform research without first broadly understanding the business and specific company strategy.

Recall from the opening scenario of this chapter that Michael recently joined the accounting policy team at Presto Hospitality. Imagine that Michael has come to you for advice about how to quickly get up to speed on his new industry. What resources would you recommend that he read , and specifically what sections of these resources?

Why is understanding the business a pre-step? Don 't wait until you're given your first research assignment to start understanding a company 's business model and peer group. By then , the expectation will be that you ' re ready to go on Step I of the research process.

The time to complete thi s step O is when you first get assigned to a client in a new industry, or during the transition pe1iod before you stait as an employee of a new company. You may need to do this reading off the clock-think of it as doing yow· homework on the company.

Step 1: Understand the Facts/Background of the Transaction Let's assume that your involvement in this whole transaction review process began when your supervisor dropped a contract on your desk and said: "Read this and tell me what you think the accounting should be. " What would you do first?

Your first challenge in any accounting research assignment is to fully understand the trans- action and why it is being entered into. Obtaining this understanding often starts with

• Reading transaction documents, including draft or final contracts, and

• Talking to parties within your organization who have knowledge of the transaction. This can help you understand the purpose of the transaction, plus provides context for any unique terms of the transaction.

After considering the two preceding resources , think about whether you understand the big picture for this transaction . Do you have a clear understanding of who the parties are to this transaction, and why they are entering into it? Do you clearly understand the economics (financial costs and benefits) and cash flows of the arrangement? Without realizing it, beginning researchers may go through several rounds of research with incomplete information , gathering additional facts each time they stop to ask ("frequent fliers" to the boss's office). Save yourself time and effort by trying to form a complete picture during this first step of the research process. It might help at this point for you to sketch out-for your own benefit-a picture of the transac- tion. Instructions for doing this are provided in the next chapter.

As discussed in Chapter 1, researching the accounting for a transaction should ideally occur before the transaction takes place (and before contracts are finalized). Be careful, however. An

Now

YOU Try 3.1

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[ Now ]

YOU Try 3.2

accounting position documented based on draft agreements could change as contracts are edited and finalized. Changes to contracts and final drafts should be reviewed to ensure that they do not change the accounting analysis.

Once you have a working understanding of a transaction, consider whether the following resources would shed additional light on the transaction:

• Has my company undertaken any transactions similar to this in the past? If so, try to get your hands on any memos documenting the background and accounting positions taken for those transactions. This will not only save you time and effort in researching the issues, but it may also provide additional understanding of the company's business purpose in entering this transaction.

• Have peers in my industry completed similar transactions? If so, look for discussion of these transactions in

• Peer companies' public filings (Form 10-Ks), press releases, or responses to SEC com- ment letters (where the company may describe to the SEC its rationale for accounting positions taken).

• Industry-specific publications, such as whitepapers or accounting guides.

Take note of the accounting elections or judgments addressed by your peers that may be relevant to your transaction; be aware, however, that differences in terms may exist between the transactions.

See Chapter 5 for further discussion of SEC comment letters and accounting firm resources.

• Should specialists be involved? Certain transactions can be highly nuanced and may require the involvement of individuals with specialized knowledge. Examples of such nuanced transactions include business combinations, securitizations, so-called hybrid debt offerings, or transactions related to a company's pension obligations, to name a few. If such special- ized knowledge is not available within your own company, your auditors may be a good resource. Types of specialists include

• Technical accounting specialists • Actuaries • Valuation specialists, and • Legal counsel.

Any steps that you are able to take to fully understand the purpose and economics of a transaction should be taken.

In some cases, however, you might be given only limited background on an issue (ver- bally, or in writing) and told what to research. This may be especially true early in your career. For example, your supervisor may not want to divulge all relevant transaction facts to you, and may only be asking for your help with one aspect of the research. Even in such cases, it is helpful to go through the preceding list of steps as a sort of checklist; ask yourself: "Can I still perform this step for my limited-scope research question?" Often, even without access to contracts, many of the listed steps will still apply, such as consideration of company past practices and comparison to peer transactions.

Recall the concessions agreement described in the opening scenario of this chapter. In your opinion, what are some of the most critical resources that Michael should consider-and key

questions he should ask-in his effort to understand this proposed transaction?

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A Final Note: Listening Skills during Step 1 Listen up! In this step of the research process, listening skills are key. Being assigned to this research project gives you the oppo1tunity to reach out and learn from others in your organization (or your client's). Your supervisor, and your operations contacts, have a perspective about the company and this transaction that you do not have . This research project is your opportunity to learn from them.

In a 2017 survey of employers, listening skills were ranked as the second most important skill ( out of 25) for new graduate business school hires. (Oral communication was ranked as the most impo1tant skill, with written communication ranked fomthY.

How can you be a better Listener? It's simple: Give the person your full attention, and just Listen. Be patient if the speaker communicates differently from you; focus on what is being said, not how. Don't plan your next comment or question, and don't intenupt. Take notes as necessary. Try to walk away from the conversation having learned from, and understood, what was said.

; 2017 Corporate Recruiters survey by the Graduate Management Admission Council.

Step 2: Define the Problem. That Is, Identify the "Researchable Question." The next step of your research process is to define the problem; that is, identify the researchable question(s). Doing so will help to focus your research efforts. Avoid long or complex questions; if your question has multiple parts, break that issue into two or more questions.

Following are examples of researchable questions that might come to mind during your initial review of a contract:

Lo3 Define the research problem, through the identification of "researchable questions."

• ff my company will receive money under the contract: Will we recognize revenue for this? Will receiving these funds cause us to incur a liability? Have we received any capital con- tributions? Have we entered into a lease arrangement?

• If my company will pay money under the contract: Have we created or purchased an asset? Have we incurred an expense? Have we entered into a lease arrangement?

• If my company purchased an ownership interest in another entity: Will my company have to consolidate the entity? Alternatively, should my company record an investment in the entity?

• If the contract involves the purchase or sale of a commodity ( e.g., oil, gas, gold) or cur- rency: Does this contract contain a derivative that requires mark-to-market accounting?

Notice that each of these question includes a topic that you could navigate to in the Codifi- cation, as a starting point for your research. For example,

• To respond to the question: "Will we recognize revenue for this?", an appropriate starting point for a browse search would be

Revenue > Revenue from Contracts with Customers (Topic 606) > Overall (10) > Recognition (25)

• An appropriate starting point for the question: "Have we entered into a lease arrangement?" would be

Broad Transactions > Leases (Topic 842) > Overall (10) > Scope (15)

• An appropriate starting point for the question: "Does this contract contain a derivative?" would be

Broad Transactions > Derivatives and Hedging (Topic 815) > Overall (10) > Scope (15)

Look again at the questions above. Notice that, in some cases, the research question and related browse path focus on the application of general accounting methods (such as revenue recognition).

In other cases, the research questions focus on the type of transaction being evaluated, and therefore the browse path focuses on whether the arrangement is within the scope of transaction- specific guidance. This search focus is frequently most effective when performing research on topics listed within the Broad Transactions area of the Codification.

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62 Chapter 3 I The Research Process © Cambridge Business Publishers

[ Now ]

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[ Now ]

YOU Try 3.4

The questions just illustrated are prov ided with the intent of helpin g beginn ing researc h- ers draw connec ti ons between co ntract terms and research questi ons. As such, these qu estions have been intentionally kept broad. In prac ti ce, however, it is often appropriate fo r questions to be more specific. For example, the question: "Will Presto accoun t fo r the contract as a lease?" would likely be more effective than the broader wording: "How will Pres to account fo r this arrangement?" As you work through the research process, you will fi nd that you can become more spec ifi c with your questi ons.

Identifying the Researchable Question

Take a moment to practice identifying a single , researchable question for the following issues.

1. A company ships its widgets to a customer on December 31 but has not yet collected pay- ment from the customer. The customer has promised to pay within 30 days but has never purchased goods from the company before .

Researchable question? _____________________ _

2. A customer is suing the local grocery store for a slip-and-fall incident. The grocery store believes the lawsuit will likely be considered frivolous and rejected by the court. The grocery store must decide whether to record or disclose this matter.

Researchable question? _____________________ _

3. A landlord agrees to pay the last two months of a tenant's existing lease with another party as an inducement to have the tenant sign a lease for one of its properties. The tenant needs to understand how to account for this payment.

Researchable question ? _____________________ _

Finall y, additional researchable qu esti ons will often become apparent as you work th rough the research process. For exampl e, assume that Michael has begun to evalu ate whether Presto's arrangement in volves a lease. Next, he mi ght identify these additi onal questions:

• Does the concession agreement qu alify for a scope exception fro m ASC 842 (Leases)?

• Does the concession agreement involve the right to use identified assets?

Once an accounting method has been selected, additional researchable questions might foc us on how to apply the method selected. To illustrate this point, consider the following Now YOU Try.

Assume that Michael and his team conclude that Presto should account for this contract as a lease. Brainstorm some additional research questions that could arise as a result of this conclusion.

Again, word your research questions as specifically as possible, as this provides a good framework for conducting research.

The remaining steps in the research process should be performed for each research question identified.

Step 3: Stop and Think: What Accounting Treatment Will Likely Be Appropriate? The thi rd step of the research process requ ires researchers to "stop and think." That is, before you tu rn to the Codification for guidance, stop and think on your own: What accounting treat- ment do you thi nk would be most appropriate for thi s transaction or event? Coming up with

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your own, independent idea of how a transaction should be accounted for will help you to stay objective as you look for guidance in the Codification and can help you avoid anchoring to the first poss ible solution you find.

Thi s is not your first accounting course-you have the knowledge to think through account- ing issues independently. Use that knowledge now. Think through one or two accounting alterna- tives for thi s transaction that make logical sense to you, and jot down these alternatives.

Finally, it can be helpful at thi s point to jot down poss ible search terms (see Chapter 2) related to your researchable question and the possi ble accounting treatments you just identified. Doing so will help you avoid getting bogged down in Codification guidance once you start your searc h. Keep your research question, and your li st of search term s, at top of mind in order to maintain efficiency and focus as you move to the next step of the research process.

To illustrate the importance of this step, consider the following. I once assigned an ASC 840 lease research case (operating versus capital?) to two teams of students. The teams had to research the case, write an issues memo, then present the case to their peers. l TIP J from the Trenches

The students' peers (assigned to present different cases) were asked to read the lease case then to provide their "gut instinct" as to how they would conclude, without consulting professional literature. Believe it or not, the non-presenting students concluded more cor- rectly on the case than those assigned to present. The presenting students anchored so quickly to the guidance that they failed to stop and think through the issues.

Bottom line: Think through the accounting, and ask your gut what the answer should be, before diving into the guidance.

Step 4: Search Potentially Relevant Sources of Guidance, Copying Any Relevant Guidance into a Word Document Now that you have given some thought to your research question, you are ready to search for applicable guidance.

If you have a sense as to which topic might be most applicable to your research question, begin by browsing to that topic in the Codification.

Lo4 Search broadly for potentially rel- evant guidance.

To save yourself time, always start your research by locating the topic that you expect to be most relevant. If you don't know which topic is appropriate for your search, use the Codifica- tion 's keyword search feature instead. Follow all leads (search results) that appear to be relevant, as the keyword may lead you to several useful sources of guidance. Know that sometimes, research- ing a single accounting issue can involve consideration of multiple Codification topics.

Let's return to our Presto Hospitality example, but let's back up for a moment. Assume that Michael's very first researchable question is: Does this arrangement contain a lease? What Codification topic, subtopic, and section would you expect to be most relevant to this issue?

Accordingly, Michael should begin his research by navigating to this guidance first.

As a beginning researcher, you may end up exploring a lot of places in the Codification before you find guidance that is directly on point. Keep track of potentially relevant guidance that you find by copying sections of the guidance into a Word document. Finding potentially relevant guidance can still be, essentially, a brainstorming exercise. Look for guidance that is either directly on point or, if not available, guidance that may be relevant by analogy (such as guidance applicable to a similar type of transaction) . Be exhaustive in your search; consult all sources of required reading, and attempt to find all potentially relevant guidance that can be used to answer your research question. In this stage of the research process, you may also choose to consult nonauthoritative sources (discussed further in Chapter 5).

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At the end of thi s step, review the guidance you have collected. Ideally, you will have fo und so me th at is relevant to your research questi on, and which you wi ll analyze in the nex t step. Other sources, upon further review, may appear to be less relevant and can now be weeded out (deleted fro m your Word document). This locatin g, then weedin g out, step is particul arl y geared toward beginning researchers. As you gain experi ence with research, you may find it easier to identify-as you go-whether or not a source is releva nt, and whether it's worth pursuing. Eve ntu all y, you will be able to determine in real time whi ch sources are most responsive to your research questi on.

Let's assume that Michael is in step 4 of the research process , searching for guidance on whether Presto's concessions agreement involves use of an identified asset. This is a key step in deter- mining whether an arrangement contains a lease.

Per ASC 842-10:

15-3 A contract is or contai ns a lease if the contract conveys the right to control the use of identified property, plant, or eq ui pment (an identified asset) fo r a peri od of time in exchange for considera ti on . . .

Michael also locates the following guidance on identified assets in the scope section :

»Identified Asset

15-9 An asset typically is identified by being explicitly specified in a contrac t. However, an asset also can be identified by bei ng implicitly specified at the time that the asset is made available for use by the customer.

>>>Portions of Asset

15-16 A capacity portion of an asset is an identified asset if it is physically di stinct (for example, a floor of a building or a segment of a pipeline that connects a si ngle customer to the larger pipeline). A capacity or other portion of an asset that is not physically distinct (for example, a capacity portion of a fi ber optic cable) is not an identified asset, unless it represents substantially all of the capacity of the asset . ..

Walk Michael through the rest of step 4. What other guidance (authoritative or nonauthorita- tive) and what other sections in ASC 842 (e.g ., Recognition , Measurement, or other sources of required reading) should he scan for additional guidance on this issue?

A Final Note: Avoiding Distractions during Step 4 Caution: This step 4 is the pa1t of the research process where you may be most at risk for di stractions.

Reading authoritative literature, such as the Codificatio n, is mentally strenuous. You're going to need a quiet setting , free of distractions.

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Consider this: A study by UC-Irvine professor Gloria Mark showed that each time an office worker was interrupted on a task (such as by responding to an email), it took on average 25 minutes to return to that task. Researchers in other studies have found that 40% of the time, delayed tasks are not resumed right after the interruption.'· 2

In other words, not only will inte1rnptions slow you down, but they may derail you from

the research project altogether. Wouldn ' t you rather just get this research done now ?

Your best bet: Find a quiet place to sit (the upper floors of the library are great). Turn your

phone on airplane mode to avoid beeps and alerts, and close your email browser. Set aside at

least a full hour; you'll need at least this amount of time to conduct really thoughtful research.

If you do stop research to respond to an email, 1) keep your research windows open, and

2) jot down on a Post-it where you left off: Next: Search ASC 842 for "identified asset." Stick the Post-it right in front of your keyboard. These two small actions will improve your chances

of resuming research after an interruption, and will minimize your mental recovery time.

(In the field of "interruption science"-yes, it's a thing!-this is described as helping to

jog your prospective memory. Before dealing with an inte1rnption , remind yourself of the step

you plan to tackle next.)

Step 5: Analyze Alternatives, Documenting Your Consideration of Each Now that you have found guidance that appears to be relevant, the next step is to analyze that guidance, or to evaluate how the guidance applies to your research question. This process can involve judgment; that is, guidance in the Codification may not offer specific answers to your precise issue, or the Codification may allow for alternative accounting treatments. In such circumstances, it is essential for a researcher to clearly identify and analyze the relative merits of the alternatives available.

Los Examine alter-native viewpoints in an accounting research analysis.

Sometimes, "weighing alternatives" can also mean thinking critically about whether a certain treatment is, or is not, met. In other words, don't just assume that an accounting treatment you find in the Codification is applicable. You must fully investigate the guidance before concluding that its use is acceptable. Consider the phrase "You don't know what you don't know."

For example, if a defined term is included within a paragraph you're evaluating, carefully review whether your arrangement meets the definition provided for that term. Or, go back to re-check the scope of the guidance you're reading. Be open to the possibility that the treatment you're considering might not apply.

To illustrate this point, complete the following Now YOU Try exercise, considering the facts presented in the opening scenario of this chapter.

Recall in the previous step (Step 4) that Michael was searching for guidance on whether Presto's concession agreement involved an identified asset. Based on additional research, Michael deter- mined that an identified asset is present if 1) Presto will have the right to use a physically distinct por- tion of an asset and 2) the supplier does not have a substantive right of substitution (see par. 15-10).

>» Substantive Substitution Rights

15-10 Even if an asset is specified, a customer does not have the right to use an identified asset if the supplier has the substantive right to substitute the asset throughout the

Continued

I Mark , G. , Gonzalez, Y. M. , and Hanis, J. No task left behind? Examining the nature of fragmented work. In CHI '05: Proceedings of the SIGCHI Conference on Human Factors in Computing Systems, pages 321 - 330, (New York: ACM Press , 2005). 2 O' Connail, B. and Frohlich, D. Timespace in the wo rkplace: Dealing with interruptions. CHI '95 Conference on Human Factors in Computing Systems, Extended Abstracts, pages 262-263 (New York: ACM Press, 1995 ).

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period of use. A supplier's right to substitute an asset is substantive only if both of the following conditions exist: a. The supplier has the practical ability to substitute alternative assets throughout

the period of use (for example, the customer cannot prevent the supplier from substituting an asset, and alternative assets are readily available to the supplier or could be sourced by the supplier within a reasonable period of time).

b. The supplier would benefit economically from the exercise of its right to sub- stitute the asset (that is, the economic benefits associated with substituting the asset are expected to exceed the costs associated with substituting the asset). [Emphasis added]

Referring to the guidance in par. 15-9, 15-16, and 15-10, analyze the following judgmental issues.

1. Is the portion of an asset that Presto has the right to use physically distinct? Explain.

2. Does the stadium owner (supplier) have a substantive substitution right? Explain.

As we'll discuss further in the next chapter, any reasonable alternative or indicator that you weigh (positively or negatively) in evaluating an issue should be documented. In this case, Michael's documentation should highlight both the reasons for and against his conclusion.

In some cases, two acceptable alternatives may appear to be available, and it may not be clear from the authoritative guidance which should be used. In such cases, you must weigh the relative merits of each alternative, considering the following:

• If authoritative guidance (i.e., the Codification) does not express a preference as to which alternative should be used, do nonauthoritative sources (e.g., accounting firm publications) address this issue?

• Does one alternative appear to better reflect the economics of the transaction (to users of the financial statements)?

• Which alternative is most consistent with the company's prior practices, if the company has entered into similar transactions in the past?

• Is this position consistent with the positions elected by peers in my company's industry?

• Have I vetted this accounting position with the appropriate levels of management?

• Finally, do our auditors agree with this treatment?

Document all factors considered in your analysis of the alternative treatments. Start with the guidance you collected from your search of the Codification, providing discussion (in your own words) of how you considered that guidance relative to your company's fact pattern. After you have presented the authoritative guidance, next you should document all "other" factors considered in your analysis (including any meaningful consideration you gave to the bulleted items just ljsted).

Finally, be wary of selecting an alternative that represents a departure from a past practice of your company, or of companies in your peer group. Such a departure should be addressed in your analysis, as well as discussed with management and your auditors. Your company may risk being questioned by investors or by the SEC if you elect a position (on a material transaction) that is inconsistent with past practices or unique among those in your industry.

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The next chapter describes how the researcher should document key factors considered- both from authoritative and nonauthoritative sources-in his or her written analysis of an accounting issue.

Step 6: Justify and Document Your Conclusion The final step of the research process is to reach a conclusion-that is, determine which accounting treatment is most appropriate given the authoritative guidance and, if appli- L06 cable, other key factors you have analyzed. Next, clearly document this conclusion, sum- conclusion. marizing salient points from your analysis as justification for your position.

The next chapter provides guidelines for documenting conclusions. In addition to fully analyzing the literature and considering alternatives, the SEC's staff

have suggested that preparers should support accounting judgments by considering how the selected treatment reflects the economic substance and business purpose of the transaction.3

At this point of the research process, pause to reflect upon whether your accounting conclusion appropriately reflects the substance of the transaction.

However if, when you reach this step, you have inadequate information to reach a conclu- sion, consider whether you obtained sufficient information in the previous steps. Once a robust analysis has been performed, and sufficient sources have been considered, you should be able to point to key factors from the analysis as support for the conclusion reached.

Refer back to your analysis in the preceding Now YOU Try.

1. What is your preliminary conclusion regarding whether the concessions agreement conveys the right to use an identified assen

2. Alternatively, are there additional questions you need to ask before you feel comfortable concluding on this research question?

Finally, note that Michael will need to monitor any changes that are made to this draft contract, then should carefully review the final, executed agreement to ensure that it is consistent with his previous research.

You now understand how to apply the research process. But one more thing. Every step of this process-every decision you make-could be subject to your own behind-the-scenes deci- sion prejudices. Let's take a look now at a topic that is catching the interest of industries from law, to medicine, to investing, to our own profession.

JUDGMENT AND DECISION MAKING-A BRIEF INTRODUCTION

Justify and document your

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You may not even be aware of it, but in each step of the research process, your judgments may be prone to silent prejudices, or biases.4

These biases are part of our human nature. Each day, we are faced with large vol- umes of information, and it's normal for our minds to apply mental shortcuts in order

Lo 7 Identify common decision traps and judgment biases.

3 Final Report of the Advi sory Committee on Improvements to Financial Reporting to the United States Securities and Exchange Commission, page 95 . August l, 2008. 4 Select resources that were con sulted in developing this di scu ss ion are listed at the end of this chapter, under Additional References.

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to filter and process this information. These shortcuts can greatly influence how we make deci- sions . Yes-we are talking about how psychology actually influences the judgments we make as accountants!

Today, accounting firms and professional organizations alike are realizing that-in order to make sound professional judgments-it's critical that we apply a consistent research process, and we must be aware of common decision traps. This focus is not surprising. A 2008 report from the SEC indicated that our profession needs more guidance in the area of professional judgment, in light of increases in principles-based accounting guidance, subjectivity in measure- ments, and regulatory oversight of the profession. 5

It won't be enough, if a regulator asks your company about a material, highly judgmental position, for you to argue that you applied the guidance that seemed the most on point. Rather, you'll have to be able to demonstrate the quality of your judgment-that your process for evalu- ating the issue was robust, and that you considered an appropriate mix of factors in reaching your ultimate conclusion. To do this , it helps to be aware of some common biases that can impact your professional judgment.

Common Biases

• Confirmation bias: Our inclination to seek (or weight more heavily) information support- ing our existing viewpoint, and to downplay (or minimize) information supporting different options. • Example: After the client offers up his initial thoughts on an accounting judgment, his

auditor inadvertently looks for more guidance that confirms the client view, as opposed to guidance that could oppose the client's position.

• Investors who have a positive feeling about a company tend to focus on information about the company that confirms their prior beliefs.

• Availability bias: The tendency to weight more heavily that information which is readily available (or mentally accessible), and to overlook information which takes more time or effort to gather. Examples: • You generally feel as though the U.S. economy is improving, based in part on the fact

that you recently received a raise. • Asked to come up with reasons for budget variances, managers tend to think of exam-

ples from recent experiences they've had. Also related is recency bias, or tending to give more weight to information that you received most recently.

• Anchoring and Adjustment: The tendency to fixate on initial information received, and failing to adjust adequately for subsequent information. Such as fixating on a number we observe early on, then later comparing this to every other number we consider. • Example : If I asked you whether you thought today's temperature would be hotter or

colder than 65 degrees, your responses might be closer to this number than if I had not provided this initial anchor point.

• Asked in 1983 (when the prime interest rate was 11 % ) if the prime interest rate in 6 months would be above or below 8%, respondents in a study provided responses closer to this anchor point (10.5 %) than respondents who were given an initial estimate of 14% (they guessed 11.2%), or given no initial estimate (they guessed 10.9%). 6

• Group think: Prioritizing the views of the most vocal, most respected, or most senior, member of a group. Or agreeing too readily to a path in the interest of group harmony, with- out independently thinking through an issue or challenging the group's initial path. • Example: An accounting professor assigned a group of students to perform a gross vs.

net revenue analysis using ASC 605. The group came back having analyzed just one

5 Final Report of the Advi sory Committee on Improvements to Financial Reporting to th e United States Securities and Exchange Commi ss ion , August I , 2008. 6 Edward Ru sso, J. and Paul Schoemaker, J.H. Winning Decisions , page 95 (Currency Doubleday, 2002 ).

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weak reporting indicator (credit risk) out of 11 possible indicators that could have been evaluated. How could thjs have happened, if all individuals were independently thinbng through this case, or challenging each other's views? (The group, by the way, reportedly got along very well.)

• Hindsight bias: Thinbng-after the fact , once the outcome is known-that you would have made the right decision, or that you knew the right answer all along. Or viewing an event as more foreseeable after the fact than prior to the event. • Example: An auditor who exhibits professional skepticism when evaluating an incon-

sistency may tend to be rewarded (by the client and his own manager) if a misstatement is found, but penalized for exhibiting skeptical behavior if no misstatement is found. 7

• Escalation of commitment: Staying with a decision even when you suspect or have evi- dence that the decision is wrong. That is, not "cutting your losses" once it's clear a decision is not worbng. • Example: Internal auditors involved in an initial decision related to budgeting were

more inclined to stay the course, making final decisions consistent with their initial decisions but which differed from internal auditors who made only a final decision on the same budget issue.8

• An investor buys a stock expecting its price to rise. Instead, the price falls and the investor ends up pouring more money into the failing stock than irutially planned, in an attempt to justify and recoup the initial investment losses.

Notably, these are just a few of the many possible biases that can influence your decision mak- ing. Just imagine how these biases could impact each step of the research process, from deciding which facts to gather, to identifying alternatives, to reaching a conclusion.

Identifying Biases in Your Own Decision Making

Think of a recent decision you've made, either in a personal or professional context. What is one bias that may have affected your decision-making approach? Describe.

Describe one step of the research process that could be impacted by decision biases. Explain.

How Do You Overcome These Biases? (To Reach a Sound Decision?) To overcome judgment biases, first be aware that such biases exist. Next, obtain information and viewpoints from a variety of sources. Seek information that will challenge your existing views, or which offers a different perspective. Listen and understand when someone disagrees with you. And finally, applying a systematic research process will help you evaluate issues carefully and methodically. Your best evidence of this systematic process is high-quality documentation, as we'll discuss in the next chapter.

Challenge your existing views by asbng disconfirming questions, or questions that explore opposing views. Consider this example, from the book Winning Decisions:

7 Brazel , Jackson, Schaefer, and Stewart. Hindsight Bias and Profess ional Skeptici sm: Does the End Ju stify the Mean s?, (Abstract). A working paper. November 2013 . Retri eved from http://www3 .nd.edu/- carecob/Workshops/13 - 14Workshop s/Brazel %20Paper.pdf 8 Brody, R. and Kaplan, S. "Escalation of Commitment Among Internal Auditors," Auditing: A Journal of Pra ctice & Th eory, 1996, pages 1- 15.

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If [an investment analyst] thinks the disposable diaper business is becoming less price com- petitive, for example, he will ask executives a question that implies the opposite, such as "ls it true that price competition is getting tougher in disposable diapers?" This kind of question makes him more likely than competing analysts to get the real story.9

When it comes time to reach a decision, focus on the issues that are most material. What matters most in this decision, and therefore what information is most important to consider? In many cases, reaching a decision will require the team to discuss and debate reasonable alter- natives. Some decision researchers favor systematic techniques, such as importance-weighted decision matrices, where numerical values are assigned to the importance of each decision cri- terion. Increasingly, accounting firms are issuing decision frameworks which outline their firm policies for applying proper professional judgment (such as the KPMG Professional Judgment Framework).

In short, make sure that you gather sufficient, diverse information to make a high-quality decision. Then, have an attitude of professional skepticism toward even your own judgments.

Learn from Your Mistakes (and Successes!) Finally, much of our ability to make quality professional judgments comes from experience. Let's face it-you won't get every issue right the first time, especially early on in your career. Becoming a great accounting researcher involves a steep learning curve. To fast-track your learning, take the time to reflect-after the fact-on your mistakes and successes.

For example, if you recommend an accounting position that is later rejected or disproven, perform a root cause analysis of sorts, and review your process for coming to this conclusion. Was it flawed in some way? Did you fail to consider enough alternatives, or did you anchor too quickly to a solution?

You can also learn from projects that were successful. What process steps did you take that resulted in a favorable outcome? What lessons can you apply to future projects?

Writing your learnings down can be so simple-I'm a fan of Post-it notes. Simply jot down the key lesson learned and stick it on the wall ("Remember to check Section 55 Implementation Guidance"), until you feel like you've committed the lesson to memory. You might consider maintaining a brief Word document log of successes, as this list can be valuable at performance evaluation time.

Brainstorm, then briefly describe, a "lesson learned" that you 've experienced already, in your brief career-to-date as an accounting researcher.

CHAPTER SUMMARY This chapter introduced you to a step-by-step approach that you can apply to a range of research challenges. Your mission now is to practice using this approach, so that you'll be ready to shine when you have the opportunity to perform research professionally.

As you app ly the research process described in this chapter, keep in the back of your mind some of the common judgment biases we discussed, as these can impact the choices you make in applying the research process. As discussed, your best defense against judgment biases is , first, awareness that these biases exist and next, application of a consistent, high-quality research process. As you gain experience as a researcher, take the time to identify lessons learned.

9 Ru sso and Schoemaker, page 87.

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REVIEW QUESTIONS

1. What is the accounting research process? What steps are involved in this process?

2. Why use a research process?

3. Why is it impo1tant to know a company' s business before pe1forming research on a given transaction?

4. What infotmation should you try to understand, during the pre-step of understanding the business?

5. Name three of the resources recommended for getting to know a company's business or industry.

6. In what sections of a 10-K should a researcher look for background on a company's business and industry accounting issues?

7. What's the ideal timing for completing "step O" of the research process?

8. Identify three resources a researcher might consult when gathe1ing facts and background necessary to under- stand a transaction .

9. Why are listening skills highlighted as important for success during step 1 of the research process?

10. Why is it important to identify the "researchable question(s)" early in the research process?

11. Explain some of the ways that a researcher may revise or refine his or her research questions as he or she works through the research process.

12. What is a benefit of perfotming step 3 of the research process: stop and think?

13. Describe the process recommended in step 4 (search for guidance), for collecting then narrowing down guidance.

14. Complete the following sentence from the chapter's description of step 4. "Know that, sometimes, researching a single accounting issue can involve consideration of ______________ _

15. What strategies does the chapter offer for avoiding distractions when performing research?

16. Name four resources (or questions) a researcher might consider when weighing alternative accounting treatments .

17. What is one example of a judgment encountered by Michael in his consideration of whether Presto's contract involves an identified asset?

18. Explain the final step of the research process. Should additional evidence be gathered at this stage?

19. What caution does the chapter offer about accounting conclusions reached based on draft contracts?

20. What is a bias, and how might biases affect how you apply the research process?

21. Name the six biases described in this chapter, and briefly describe each.

22. Name three strategies for overcoming biases.

EXERCISES

1. You have just been assigned to provide client services to the following entities. For each, identify three resources you could consult in order to better understand the company's business model and industry. a. Pfizer b. Southwest Airlines c. Caesars Ente1tainment

2. For the first company in the preceding question, Pfizer, use a library database to: a. Identify two competitors (aka, major companies in the industry). b. Next, look for an indust1y description page. Quoting verbatim from the database, name one interesting fact

about this indust1y.

3. Look up the AI CPA Audit & Accounting Guide Airlines, then look for the table of contents to this guide. Imagine that you've just been assigned to the audit of an airline. Name two chapters from this book that you might read (or skim) in advance of the engagement, and explain why you chose these.

4. Understanding the facts/background of a transaction: Caesars Ente1tainment is in negotiations to purchase a new hotel. You are an analyst in the accounting policy depa1tment and are in the first step of the research process (understanding the facts/background of the transaction). Identify three resources you could consult to gather additional background/precedent for this issue.

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5. You are once again in the first step of the research process (understanding the facts). Now, your company is look- ing to repurchase some of its outstanding stock. You are about to attend a meeting between representatives of your company 's Treasury department and a bank at a fixed price on a ce1tain future date. Identify three resources you could consult, or questions you might ask of others on your team or in the organization, to gather additional background/precedent for this issue before you attend the meeting.

Identify at least one researchable question for each of the following issues (in questions 6-12).

6. A cable network has just entered into an agreement granting it the right to show reruns of a hit TV series. In exchange for this right, the network must pay the TV show's creators a fee each time the show airs .

7. An on line restaurant booking site sells a $100 meal voucher, good for $100 toward a meal at Randall ' s Steak- house, to a customer for $60. When the customer presents the voucher to Randall 's Steakhouse, the restaurant booking site must remit $50 to Randall 's, retaining $10.

8. A company 's auditor is questioning the appropriateness of the company 's discount rate assumption, which it uses to measure its defined benefit pension obligation.

9. Coal, Inc. has paid $10 million to a waste disposal company to clean a site originally contaminated by Coal, Inc. through its operations and to assume its environmental liability (cmTently recorded as an $10 million liability on Coal 's financial statements). State regulators have signed off on the liability transfer and now look to the waste disposal company as the responsible party for the cleanup.

10. Automotive, Inc . has announced the sale of its Truck Division ' s three plants , along with planned layoffs of the Truck Division's employees. Automotive, Inc . is hoping to segregate the results of the Truck Division 's opera- tions in its financial statements. Identify at least two possible research questions.

11. Your company is planning to issue equity secu,ities with attached call options, where the company can repur- chase the securities at a specified price if future events occur.

12. For the following researchable question, identify two additional questions that might arise as the researcher digs deeper into the research topic. Assume that a company has just sold a portfolio of mortgage loans in exchange for cash and ce1tain retained interests in the loans receivable. The initial question: Can the company record the transfer as a sale?

13. Stop and think. In this example, you'll be asked to stop and think about an issue, then to search the Codification for applicable guidance. a. Stop and think. Your company sells seasons passes to a waterpark that it owns. The passes are good from

June I to September 30 of a given year. The company must determine the approp,iate pattern of recognition for recording this revenue. What does your instinct tell you?

b. Now, pe1form research within the Codification to find guidance on this issue. How does the authoritative guidance describe this issue?

c. Finally, consider: Was your instinct consistent with the guidance for this issue? How did this instinct help you evaluate the guidance you found ?

14. Identifying alternative accounting treatments: A joint venture was just formed , and one of the venturers (com- panies that invested in the JV) contributed a technology patent with a basis of $5 million and an estimated fair value of $9 million . List two accounting measurement alternatives available for the joint venture to recognize the contributed patent. Explain. (Notably, the Codification does not directly provide guidance for this issue, so your goal dming this exercise is just to brainstorm.)

15. What are two types of "Accounting Changes" described in the Codification? Identify these "alternative" types of accounting changes , and cite where you found these listed in the Codification.

For each of the following sample scenarios (in questions 16-19), identify one or more biases that could be at play, then explain.

16. A judge ruling in a securities fraud case found a corporation guilty of misleading investors because the com- pany' s disclosures predicted that a new dmg would likely receive FDA approval years before the actual approval came through . What bias may have been at play for the judge in reaching this ruling?

17. Growth rates in sales had slowed versus the prior year. A task force was convened that consisted of senior vice presidents from across the company, plus one executive vice president (the COO) . The COO came to the meet- ing prepared to offer a solution. When she did, the group agreed it was the appropriate path fo1ward and set in motion a plan to implement her recommendation.

18. Upon adoption of the new revenue standard, a company wrestled with a gross versus net accounting policy judg- ment and ultimately rationalized that it should likely continue its current position unless there was a compelling reason in the guidance to change.

19. Smith Corp. is testing one of its manufacturing plants for impairment following a decline in real estate values for the market in which the plant is located. Smith Corp. has submitted its estimate of undiscounted future cash flows to its auditors to ask whether the company's view of the value appears reasonable.

20. The six decision traps and biases are not an all-inclusive list. Perform an Internet search for one other bias that you believe could be applicable to accounting or auditing, and which was not named in this chapter. In two or three sentences, explain this bias and its potential application to our profession.

CASE STUDY QUESTIONS

Researching Presto's Industry Recall Presto Hospitality, the (fictitious) concessions company introduced in this 3.1 chapter. Assume that you have just been assigned to work on the Presto audit team, but you do not have prior experi- ence in this industry. You need to do a little homework before the engagement begins.

1. Using an online library database that is available to you (such as Hoovers or IBIS), research and respond to the following: • What industry or industties would you describe as most closely related to Presto's business? • What are some key companies (competitors) in this industt·y? • What are key sources of revenue for companies in this industry? • What can you learn about this industt-y's supply chain? • What information can you find on industry growth trends and forecasts? • What is one other industry-specific fact you learned (e .g., industry jargon , analyst call preparation ques-

tions, etc.)? 2. Next, brainstonn: What is one other source you might consult for background on this industry prior to beginning

the audit?

Presto Hospitality-Research Questions 3.2 I. a. List the research questions that Presto would need to evaluate to dete1mine whether its concession agree-

ment is a lease. b. Next, list the research questions that would result if Presto were to determine the airnngement is a lease. c. Finally, list the research questions that would result if Presto were to dete1mine the anangement is not a

lease. 2. Stop and think: What accounting tt·eatment do you think is likely to be most appropriate? 3. What ai·e some of the implications of the different alternatives that you identified (such as in your list of research

questions)?

Presto Hospitality-Scoping Assume that Presto concludes the arrangement is not a lease. Next, in selecting an 3.3 appropriate framework for evaluating the Presto Hospitality concessions agreement, evaluate whether this a1rnnge- ment should be considered a Collaborative Arrangement. What ai·e the implications of an a1rnngement falling within the scope of this guidance? In addition to researching the guidance, stop and think: Does this guidance intuitively make sense for this situation?

Presto Hospitality-Identified Asset Question Recall from the case facts in the Presto Hospitality example that 3.4 the concessions agreement includes architectural drawings noting the location of fixed concession stands within the stadium. Research whether the fixed concession stands would still be considered identified assets if the contt·act did not include these drawings. For example, assume the contt·act states: "Concession Provider has the right to operate concession stands and po1table cmts within the Stadium (the "Food and Beverage Facilities") as well as the right to have hawkers selling food and beverage and the right to serve food and beverages in suites and club seating areas ." Use excerpts from the Codification to evaluate and conclude upon whether the concession stand locations would still be considered identified assets.

As necessmy, identify additional questions you might ask-or facts you might gather-in order to fully research this question .

Presto Hospitality-Lease Scope Research Research this question: Is Presto entitled to substantially all economic 3.5 benefits from use of the identified assets? What is the significance of this question (in other words, what happens if the answer to this question is yes? What if the answer is no?). You may need to review the sample memo at the end of Chapter 4 for additional guidance on Presto's identified assets. In researching this question, in addition to the facts presented previously, consider also that Stadium Co. can require Presto to source supplies from sponsors of the stadium (Stadium Co.'s "official sponsors").

As necessary, identify additional questions you might ask-or facts you might gather-in order to fully research this question.

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74 Chapter 3 I The Research Process © Cambridge Business Publishers

3.6 Presto Hospitality-Upfront Payment The Presto Hospitality case facts note that Presto is required to make a $5 million upfront payment to Stadium Co., and these funds will be used toward capital improvements, build-outs, and branding of the concession facilities. Research: What is the accounting for the $5 million upfront payment? How does this accounting change if this is a lease versus if the :mangement is determined to not be a lease? Do companies in this indust1y desc1ibe similar payments in their 10-K disclosures?

3.7 Industry Research, Lease Adoption In their adoption of ASC 842 (Leases), companies in the travel and hospitality industry debated the question of whether hotel rooms are leases.

Apply the research process to this question as follows: a. Research the industry-what are some companies that own or operate hotels? b. Locate disclosures from one of these companies to get a better understanding for how they describe hotel

room rentals (both from a business and an accounting perspective). Review, for example, the latest l 0-K for one of the companies you identified.

c. Define the research question. d. Stop and think: What answer makes sense to you, and what are the potential implications of this judgment? e. Search for guidance. What guidance does the Codification offer that might address this issue? f Analyze and document the alternatives. g. Conclude and justify your position.

3.8 Identifying Researchable Questions Facts: Imports Inc. is a U.S. public company and has a calendar year-end. Imports purchases auto parts from Korea and sells them to domestic car dealerships around the U.S. On November 1, 20Xl, Imports received a shipment on account of $400,000 worth of shocks and struts from its Korean supplier. Unfortunately, the pa1ts were defective. Faced with commitments to deliver working parts to its own customers, Imports paid $200,000 on l I I I 5/X I to a domestic third paity to fix the defective parts. However, even after the repair effort, the shocks and struts remained defective.

Impo1ts has not yet paid the Korean company for the parts purchased. In early December, Imp01ts requested repayment from the manufacturer for its costs of repair ($200,000).

However, when the manufacturer refused to pay, Imports sued the manufacturer on 12/15/XI for its amount invested ($200,000) plus an additional $100,000 for lost revenues.

On Februaiy 2, 20X2, a U.S. court ruled in favor of Imports, awarding Imports Inc. $300,000, payable ratably in three monthly in stallments to begin on 2/ 15/X2.

Required:

l. Identify Import Inc.'s researchable questions as of 12/31/Xl related to this series of issues. 2. Identify Import Inc.'s researchable questions as of 2/2/X2 related to this series of issues.

3.9 Change in Estimate versus Error Correction Facts: Your company, PlumbAll, provides routine and quick- response plumbing services to a range of corporate customers. Customers ai·e expected to pay on the first of each month, in advance of receiving services . One of your customers is a private school that has been a longtime cus- tomer. The customer has not paid for the last four months of services (September-December 20X I) ; neve1theless, to maintain a positive relationship, your company continued to provide services during that time. Your company ceased providing services in January 20X2 and found out in that same month that the school filed for bankruptcy in August. You now believe that collection of the missed payments is extremely unlikely.

Your company has already issued financial statements to lenders (for the period ending I 2/3 1/X I) that reflected revenue and a corresponding account receivable related to this customer of $11,000 per month for services provided to this customer. Those fi nancial statements also reflected the company's standard allowance (reserve) amount on receivables of 3% of sales. In total, your company's average monthly sa les amount to $300,000.

Required:

l. Evaluate whether receipt of this information indicates you have a change in estimate or whether the customer's bankruptcy results in this event being considered an error in previously issued financial statements.

2. Describe the accounting treatment required by the Codification for each alternative. Suppo1t your explanations with draft journal entries.

3. Briefly state which treatment appears to be more appropriate given the circumstances, describing any assump- tions you made in concluding.

3.10 Hone Your Listening Skills The chapter mentioned that an impo1tant part of the research process is learning to listen to others, so that you can learn from them. Conduct a two-minute interview with a peer or friend who is studying a different field. Ask that person to teach you something that they find interesting about their field. For two minutes, work ve,y hard to li sten attentively. Document the conversation, desc,ibing what you leai·ned. Finally, describe a circumstance in which you think these listening skills could benefit you as an accounting professional.

%$��3 © Cambridge Business Publishers Chapter 3 I The Research Process

You Create the Case (Applying the Accounting Research Process) On your own, create a fictitious fact pattern 3.11 (accounting problem/business issue) to which you can apply the accounting research process. If you can, use a fact pattern based on a real situation that you've encountered professionally. Alternatively, the following sources may help you generate ideas: ( l) The Codification: browse for guidance, then "back into" a fact pattern; (2) recent business news articles (e.g., from the Wall Street Journal); (3) di scussions with small-business owners; or (4) corporate annual repo1ts.

Required:

1. Describe the fact pattern. 2. Identify at least l researchable question for this fact pattern. 3. Brainstorm the likely answer to the question . 4. Locate the applicable Codification reference . Describe the requirements, plus any alternatives available. 5. Briefly describe your conclusion.

ADDITIONAL REFERENCES

l . Kahneman, Daniel. Thinking, Fast and Slow. Fa,rnr, Straus and Giroux , 2013. 2. Russo, J. Edward and Schoemaker, Paul J.H. Winning Decisions: Getting It Right the First Time. Crown

Business, 2001. 3. Fay, Rebecca. "I' m not biased, am I?" Journal of Accountancy, Febrnary l, 2015. 4. Elevating Professional Judgment in Auditing and Accounting: The KPMG Professional Judgment Framework.

2011, KPMG.

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Creating Effective Documentation Recall Michael , the accounting policy analyst at Presto Hospitality who was introduced in the

previous chapter. Now that Michael has learned a step-by-step research process to apply to

Presto's draft concessions agreement, his next challenge is to prepare thoughtful documen-

tation of the accounting issues identified.

Michael's supervisor has asked him to prepare an issues memo that documents the

accounting for this transaction. His documentation should walk through the path he took to

concluding on whether Presto's concessions agreement contains a lease and-if not-what

accounting is most appropriate for the arrangement.

In practice , documenting accounting research is integral to the process of performing

research. So Michael would have prepared much of this documentation while performing

his research. However, this chapter specifically focuses on writing. This chapter covers writ-

ing conventions, style , and tips that are particular to technical accounting research. Read

on , and find out what tips we can offer Michael on preparing a memo that professionally

addresses his company's proposed transaction.

After reading this chapter and performing the exercises herein, you 'll be able to do the

following:

1. Explain the importance of documentation .

2. Draft effective emails to communicate the results of limited-scope research .

3. Formulate an effective Facts section and Issues list in an accounting research memo.

4. Prepare an effective research analysis , including consideration of alternative view-

points , and a well-supported conclusion.

5. Properly reference passages from the Codification.

6. Communicate using professional style .

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Lo 1 Explain the importance of documentation.

DOCUMENTATION IS INTEGRAL TO ACCOUNTING RESEARCH

Recall from previous chapters that the objectives of accounting research are generally twofold:

1. To account for transactions or items in a manner that is appropriate and supportable based on authoritative guidance, and

2. To create documentation describing the research performed and supporting the conclusion reached.

In other words, petforming accounting research is only half the battle. You must also clearly document your research. Accounting research involves professional judgment. The best way to support the judgments you are making is through thoughtful documentation.

Documentation is critical to accounting research because

• The exercise itself of creating documentation can cause you to think through accounting issues more critically than if you simply discuss the issues.

• Creating documentation of the basis for accounting positions creates an audit trail. Not only will the files be useful for historical reference, but current documentation can be shared with the company's auditors, helping the auditors understand and review the company 's account- ing judgments in real time.

• This transaction sets precedent for future transactions. Without proper documentation , com- pany accountants could risk reaching a different conclusion if this type of transaction is later repeated. This could result in inconsistent accounting or, worse, restatement if company accountants conclude that the prior transaction 's accounting is improper and the transaction is material.

• If your company's accounting position on a transaction is ever questioned (for example, through an SEC comment letter, in the event of a lawsuit, or by regulators), ideally, your company's rationale for the accounting would already be neatly summarized into a memo. In theory, that memo could be forwarded straight over to the SEC in response to their inquiry.

• Auditors must also maintain documentation evidencing their reviews of judgmental client accounting positions. This documentation shows that the auditor was diligent in researching and evaluating whether client positions are appropriate.

Furthermore, know that when you create robust documentation, you protect yourself-in a sense-from the sort of "hindsight bias" that we read about in Chapter 3. The following com- ments from the SEC staff, which emphasize the importance of robust, timely documentation to support judgments, further illustrate this point:

"The alternatives considered and the conclusions reached should be documented contem- poraneously. This will ensure that the evaluation of the judgment is based on the same facts that were reasonably available at the time the judgment was made ... "1

By walking your reader through your analysis, in real time as you make accounting judg- ments, you demonstrate to the reader that your process for evaluating the issue was robust and appropriate in light of facts known at the time.

Remember that it's often your end product-your research report-which determines whether your research is seen as high-quality. Understanding the importance of writing skills, this chapter walks you through not only the form and content of professional accounting docu-

I Final Report of the Advisory Committee on Improvements to Financial Reportin g to the United States Securities and Exchange Commission, August l, 2008. Page 96.

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mentation, but also some of the finer points to writing in a style that will impress even the most technical of accountants.

COMMUNICATING ACCOUNTING RESEARCH

Let's take a closer look at how to communicate the results of your research. We will explore two common methods for communicating accounting research:

• Emails

• Accounting issues memoranda

Notably, client letters are another form of communicating accounting research , but are not a focus of this chapter. See Chapter 11 for a sample client letter and guidance for preparing client letters.

One overarching tip, as we move into our discussion of writing: Know your audience. Start out any writing assignment by considering who will read your work, then write at a level that your reader will understand.

For example, the level of detail you provide in your Codification references (ASC 842, versus "the Leases topic") may depend upon whether you are writing to a technical accountant, versus a member of the Finance team at your company.

In his Preface to the SEC 's Plain English Handbook, Warren Buffett offers the following suggestion:

One unoriginal but useful tip: Write with a specific person in mind. When writing Berkshire Hathaway's annual report, I pretend that I'm talking to my sisters. I have no trouble pictur- ing them: Though highly intelligent, they are not experts in accounting or finance. They will understand plain English, but jargon may puzzle them. My goal is simply to give them the information I would wish them to supply me if our positions were reversed. To succeed, I don 't need to be Shakespeare; I must, though, have a sincere desire to inform. 2

In many cases, your audience for accounting research communications will be your supervi- sor, your auditors, and-possibly-regulators who might later scrutinize a transaction. Accord- ingly, much of the accounting research communication that we will cover in this chapter will be written to an audience of fellow accountants. However, it's important in all cases to consider your audience before you begin writing.

Let's look now at how to write professional emails.

EMAILING THE RESULTS OF RESEARCH QUESTIONS

Email is often useful for communicating the results of limited-scope research questions. This is often the case when you are not the "owner" of the issue (i.e., the party responsi- ble for documenting or concluding on the complete issue), but rather are helping provide relevant guidance to some aspect of an issue that a colleague is managing.

Here is an example of a professional email responding to a limited-scope research question. In this example, Jenn, a staff member at Presto Hospitality, has been asked to

LO 2 Draft effective emails to com- municate the results of limited- scope research.

help Michael research whether the stadium owner has a substantive right of substitution with respect to the portable concession spaces that Presto has the right to use in the agreement. As you may recall, understanding whether the supplier has a substantive right of substitution is critical to understanding whether the arrangement involves identified property, plant, or equipment. Jenn's response is as follows:

2 Office of Inves tor Education and Assistance, of the U.S. Securities and Exchange Commission. A Plain English Handb ook: How to create clear SEC disclosure documents. 1998. Preface.

1 80 Chapter 4 I Creating Effective Documentation © Cambridge Business Publishers

Re: Stadium Co.'s substitution rights (po1tables)

Michael,

You asked me to research whether Stadium Co. has a substantive right of substitution with respect to the portables in the draft concessions contract. Based on the following guidance, I have concluded that Stadium Co. does have a substantive right of substitution, and thus the portables would not be considered identified assets (even if their location s are initially specified in the contract).

Per ASC 842-10:

15-10 Even if an asset is specified, a customer does not have the right to use an identi- fied asset if the supplier has the substantive right to substitute the asset throughout the period of use. A supplier 's right to substitute an asset is substantive only if both ... : a. The supplier has the practical ability to substitute alternative assets throughout

Implementation guidance in ASC 842-10 provides an example involving airp01t concession space that is similar to the p01table carts in our a1rnngement:

> > > Example 2-Concession Space

55-52 A coffee company (Customer) enters into a contract with an airport operator (Supplier) to use a space in the airport to se ll its goods for a three-year period. The contract states the amount of space and that the space may be located at any one of several boarding areas within the airport. Supplier has the right to change the location of the space allocated to Customer at any time during the period of use. There are minimal costs to Supplier associated with changing the space for the Cu sto mer: Cu stomer uses a kiosk (that it owns) that can be moved easily to sell its goods. There are many areas in the airport that are available and th at would meet the specifications for the space in the contract.

55-53 The contract does not contain a lease.

55-54 Although the amount of space Customer uses is specified in the contract, there is no identified asset. .. . [T]he contract is for space in the airport, and this space can change at the discretion of Supplier. Supplier has the substantive right to substitute the space Customer uses because: a. Supplier has the practical ability to change the space used by Customer

throughout the period of use. There are many areas in the airport that meet the specifications for the space in the contract, and Supplier has the right to change the location of the space to other space that meets the specifications at any time without Customer's approval.

b. Supplier would benefit economically from substituting the space. There would be minimal cost associated with changing the space used by Customer because the kiosk can be moved easily. Supplier benefits from substituting the space in the airport becau se substitution allows Supplier to make the most effective use of the space at boarding areas in the airport to meet changing circumstances.

Continued

Continued from previous page

In our case, like this airport kiosk example, Stadium Co. : a) has the contractual right to substitute the location of the portables and has access to alternate spaces that could be used; and b) would incur only minimal (if any) cost in substituting the space. Therefore, this substitution right is substantive.

This analysis may be less clear when performed for fixed concession stands, which could involve additional supp li er cost to substitute. Let me know if you'd like me to research that

issue next.

Thanks for letting me assist with this question.

Jenn

The sample email above exhibits qualities that you should generally try to include in your professional email communications. Here are some of the lessons learned from this email:

• Keep it brief. The sample email above is concise, yet complete in its response to the question.

• Include a subject line that briefly describes the accounting issue you've researched, and the client name.

• Re-state the question: "You asked me to research . .. "

• Include an excerpt from authoritative guidance to support your response.

• Use complete sentences.

• If you made any assumptions in researching the issue, state what you assumed. It 's likely that you will have to make assumptions if you have only limited background on an issue.

• Reread, possibly print, the email before you send it. This will help you identify confusing or weak language, as well as grammatical errors.

• Do not say "I think/feel"; this isn't about you. It 's about what guidance is on point. If you are unsure about how guidance should be read, you can say: "It appears ... "

• Avoid exclamation points, in order to keep your tone as professional as possible.

• Include an offer to be of further assistance.

One of my former accounting research colleagues made it a habit to print and reread eve,y substantive email to a client or supervisor before sending it. She wanted to always put her most professional self forward. Her thoughtful approach to research-combined with her attention to detail-has paid dividends for her career; she went on to work in the SEC's Office of the Chief Accountant and currently is a partner in the national office of a major firm.

Drafting a Professional Email

You are a staff auditor reviewing the Statement of Cash Flows for Auto Corp (the client). The senior on your audit team (Robin) has asked you to research whether the client has appropriately classified the proceeds from the sale of its manufacturing facility as cash flows from investing activities.

Draft an email response to Robin's question. Use the Codification guidance in Figure 4-1 to support your response.

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l TIP from the Trenches

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82 Chapter 4 I Creatin g Effecti ve Documentati on © Cambridge Business Publishers

Figure 4·1

Codification excerpt for email exercise (ASC 230-10, Statement of Cash Flows)

TIP from the Trenches

> Classification

45-10 A statement of cash fl ows shall class ify cash receipts and cash payments as res ulting from investing, fin ancing, or operating acti vities.

> > Cash Flows from Investing Activities

45-11 Cash fl ows fro m purchases, sales, and maturities of available-for-sale debt securities shall be classifie d as cash fl ows from investing activities and repo1ted gross in the statement

of cas h flo ws.

45-12 All of the fo llowing are cas h infl ows fro m in ves ting activiti es :

a. Receipts from collections or sales of loans made by the enti ty and of other entities '

debt in struments (oth er than cash equi valents, certain de bt instruments that are acquired

specifica ll y for resale .. . , and ce1tain donated debt in struments received by not-fo r-profi t

entiti es (NFPs) .. . )

b. Receip ts from sales of equ ity in stmments of oth er entiti es . . . and from retw·ns of

investmen t in those in stmments

c. Receipts from sales of property, pl an t, and equipment and oth er prod ucti ve assets . . .

Reproduced with permission of the Financial Accounting Foundation.

A final tip on the subject of emails .. . Ever wonder if sending a higher-ranking colleague a quick '1hank you" email , after they have assisted you , will bother them? As a young profes- sional , I recall wondering the same thing .

But trust me , a quick 'Thanks for your help! " note is never a bother to receive . These emails are a win-win : You 're showing that you 're a grateful, appreciative person , and the note will make your colleague or instructor smile (and can be easily deleted-it's really not a nuisance) .

As a general rule of thumb, if someone assists you , don't second guess it. Send a quick thanks.

, ..

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DRAFTING AN ACCOUNTING ISSUES MEMORANDUM

Documentati on in the form of an accountin g iss ues memorandum is ge nerally warranted when a transacti on is co mplex, judgmental, or highl y materi al. Each co mpany should have poli cies in pl ace fo r when such documentati on is required, and at what point in the transacti on rev iew process. It is considered a best prac ti ce to evalu ate and doc ument the accounting fo r a transac- ti on at or before the time the transaction is executed. In certain cases, such "contemporaneous" doc umentation is required, as di scussed in Chapter 1.

Accounting issues memos are often organized into secti ons similar to those presented in Figure 4-2. Of course, thi s fo rmat is subj ect to some va riation by co mpany; fo r example, some co mpani es prefer to include an Executi ve Summary section at the beg inning of the issues memo. Nevertheless, we' ll refer to the layout presented in Figure 4-2 as the standard memo format.

Facts State the relevant facts surrounding the issue.

Often, drawing a picture is helpful.

..... Issues

List the researchable questions you're trying to answer .

..... Analysis

Include all relevant authoritative guidance, along with analysis in your own words of how the guidance applies to your fact pattern . ....

Conclusion State your conclusion based on your research findings, highlighting key factors considered.

Provide additional discussion for highly judgmental issues . .... Financial Statement and Disclosure Impacts

Summarize financial statement accounts affected and any disclosures required.

Include journal entries when possible.

The issues memorandum should include all of the sec ti ons shown in Figure 4-2. Present these section headers in bold to improve the readability of your memo. A sample accounting issues memo, which addresses the Presto Hospitality concessions agreement, is included in an Appendix at the end of thi s chapter.

Your ultimate goal with the issues memo is to create a "one-stop shop" for knowledge about this transaction and its accounting. A reader, after picking up your memo, should not have to do additional digging to fully understand the background or the support for the accounting conclusion . After reading your memo, if a reader finds it necessary to get additional key facts from the contract, or to read additional guidance from the Codification , then you have failed to make your memo a one-stop shop.

Figure 4-2

Standard memo format

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84 Chapter 4 I Creating Effective Documentation © Cambridge Business Publishers

Facts

L03 Formulate an The Facts (or Background) section of an issues memo should include all relevant back- ground necessary for understanding the transaction and its accounting. This section should be concise, but not sparse. Aim to provide enough detail about the issue that

effective Facts section and Issues list in an accounting research memo.

Figure 4-3

Picture of joint venture arrangement

Figure 4-4

Picture of joint venture with ownership by Entities 1 and 2

a party uninvolved with the matter could pick up the memo-even years later-and understand the issue well enough to form an opinion as to whether or not the accounting treatment is appropriate.

Step 1 of the research process, described in the preceding chapter, outlines the process nec- essary to understand the facts and background of a transaction. Relevant information obtained from this step 1 should be included in the Facts section of an issues memo.

Transactions are often complex. A picture of a transaction, included within the Facts sec- tion of a memo, can greatly enhance a reader's understanding of the relationships and parties involved in the issue. These can be fairly easy to create using the "shapes" feature in Word. In the picture, try to show as much information about the relationships among the parties as you can (parent/subsidiary relationships, what each party gives or gets from the other, etc.).3

For example, here is a simple picture for the following arrangement:

• Two unrelated entities are entering into a joint venture (JV). Entity A contributes $1,000 to the JV for 50% of the equity ownership, and Entity B makes a $2,000 loan to the JV for 50% of the ownership.

$1,000 contribution loan

Notice how, just by looking at the picture in Figure 4-3, you can get a basic understanding of the relationships between the parties. To illustrate a slightly more complex arrangement, let's add new facts to this example. Let's assume that Entity A is owned by Entity 1, and assume that Entity B is owned by Entity 2. Let's also assume that a bank loans the JV $500. Often when drawing a picture, ownership can be implied by a vertical relationship between two entities.

$1,000 contribution

,......a=--.._~~--'--=:a......,

3 The relationship between the parties in the Presto Hospitality transaction is fairly straightforward ; accordingly, the Ch. 4 Appendix sample memo does not include a picture.

�

Noti ce a few thjngs about the pi cture in Figure 4-4. First, even without " 100%" written nex t to the line conn ecting Entity 1 and Enti ty A, the ve rti cal relati onshjp impli es full ow nership. Second , as the bank is not involved as an owner, it is not drawn in a verti cal relati onshjp ; it is show n to the side of the JV to indi cate that it is an outside, tru rd party.

There is no magic to draw in g a pi cture for inclusion in a memo. The idea is just to portray relati onshjps in a way th at readers can easil y understand .

Drawing a Picture

Draw a picture for the following arrangement:

• Entity A owns Entity B and Entity C. Entities B and C enter into a joint venture ('1he JV"). Entity B contributes $20,000 for 99% of the equity ownership. Entity C contributes $500 for 1 % of the equity and will serve as manager of the JV. Bank lends the JV $1 million.

• Hint: Beside the line representing Entity C's contribution of $500, you can also write "man- ager," as this is a type of service that Entity C is contributing to the JV.

Your picture here

The approach for drawing pictures outlined in this chapter came from what I learned in the field , informally. My colleagues at the FASB used to sketch out transaction structure pictures on whiteboards-just to facilitate conversations we had amongst ourselves, and that prac- tice continued in my roles in advisory and corporate accounting. More formal diagramming methods exist but are not covered in this book.3

Finally, it is often helpful at the end of the Facts section to very briefly (1-2 sentences) set up the overall issue to be addressed. That is, you ' re not listing out your research questions yet, but you can set the stage fo r the overall themes that you plan to address in the memo.

For example: Presto must determjne whether thi s arrangement contains a lease within the scope of ASC 842 (Leases) .

Beginning researchers often struggle with wording when setting the stage. Avoid statements such as:

• Presto must choose how to record thi s transacti on. Or,

• Presto has the option to record tru s arrangement as a lease .

Rather th an describing an accounting poli cy detenninati on as a choice or an option, think of Presto's obj ective as to determine wruch accounting meth od is most appropriate. Or, to deter- mjn e whether it should accoun t fo r the transaction as a lease.

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86 Chapter 4 I Creating Effective Documentation © Cambridge Business Publishers

[ TIP from the Trenches

lssue(s) The Issues (or Questions) section of the memo should follow immediately after the Facts sec- tion. Under the header "Issue(s)," list your researchable question(s). Often, there may be multiple questions to address. For example, let's assume that your company (Manufacturer Co.) recently contributed assets to form a joint venture (JV) with another company. To evaluate the accounting for this arrangement, your memo could list the following research questions :

Issues:

1. Is Manufacturer required to consolidate the JV?

2. If consolidation is not required, how should Manufacturer account for its investment in the JV?

3. How will Manufacturer record its asset contribution to the JV?

Notice that each issue is phrased in the form of a question, and these research questions should be listed together at the beginning of the memo (in the Issues section). It's often the case with complex issues (as is the case here) that each research question builds on the previous question. Had this been a simpler topic, a single issue ("Issue l") might suffice to determine the accounting, and a second issue ("Issue 2") might address required disclosures.

There is no magic to picking the perfect research questions. In fact, in this scenario, you might have chosen to break Issue 1 down into several issues, such as:

1. Is the joint venture within the scope of the variable interest entity (VIE) accounting model?

2. If not, how should Manufacturer apply the voting model to this arrangement?

Or, more detailed still: Does Manufacturer have a variable interest in the joint venture? Does the joint venture qualify for a scope exception to the VIE model?, and so on.

In short, the goal in selecting issues is to organize your accounting analysis in a logical way, which clearly walks your reader through the issues you faced and the research you performed. Use your judgment as to how best to organize your issues.

As an accounting research instructor, I often assign case studies that have questions intended to guide the students in addressing all key issues. A common mistake students make is to organize their memo entirely based on these discussion questions, exactly as provided.

But the thing is, you----as writer-are responsible for deciding how to organize your memo in a manner that most clearly introduces the topic and walks readers through the relevant issues. This all starts with how you organize the issues list. Don't assume this list should be an exact match to the discussion questions provided.

Analysis

Lo4 Prepare an effective research analysis, including consideration of alternative viewpoints, and a well-support- ed conclusion.

The Analysis section is arguably the most critical component of a well-written issues memo. In this section, you will address each issue listed, one at a time. In our Presto Hospitality example, Michael might title the first Analysis section, for example, Analysis oflssue 1: Does the Concessions Agreement involve an identified asset ?

Tying Together the Guidance and Case Facts The Analysis section is aptly named because in it you will include excerpts from authori- tative guidance, along with commentary in your own words about how the guidance

applies to your transaction. Nonauthoritative guidance may also be included in this section of your memo, as a supplement to authoritative guidance.

A leading professor in accounting research described a common student struggle with the analysis section, as follows:

��

The Analysis section is really the key and what I often find most lacking in students' reports. That 's because they don ' t do a good job of reasoning from the facts of the case, using

the literature they found , to reach the appropriate conclusion. Rather, their process is more like: here are the facts , here is research, here is a conclusion.

In other words, the analysis section is your chance to bring together the facts of the case, the literature, and your evaluation of judgments or alternatives in the guidance. You must take the time to really relate the guidance to your specific fact pattern. Pull in actual words from your summary of the facts, and describe how they relate to actual words from the guidance.

As an example, consider the following excerpt from Michael's analysis of Presto's con- cessions agreement. In this excerpt, Michael is reviewing ASC 842-10 (Leases) to determine whether a portion of an asset (such as the right to use parts of a stadium) can be the subject of a lease. Notice how Michael's analysis brings together authoritative guidance and the facts of this arrangement.

EXAMPLE

Par. 15-16 provides the following guidance regarding whether a portion of an asset is an identified asset:

> > > Portions of Assets

15-16 A capacity portion of an asset is an identified asset if it is physically dis- tinct (for example, a floor of a building or a segment of a pipeline that connects a single customer to the larger pipeline) . A capacity or other portion of an asset that is not physically distinct (for example, a capacity portion of a fiber optic cable) is not an identified asset, unless it represents substantially all of the capacity of the asset and thereby provides the customer with the right to obtain substantially all of the economic benefits from use of the asset. [Emphasis added]

As the Food and Beverage Facilities represent a portion of a broader asset (the Stadium), these facilities are only considered an identified asset if they are physically distinct.

In this aJTangement, ce1tain of the Food and Beverage Facilities (specifically, fixed concession stands) are specified on architectural drawings and are thus physically distinct. Additionally, the right to serve food and beverages in premium seating areas, including suites, involves physically distinct spaces. These concession stands and premium areas can be used independently from one another. Therefore, these spaces are all considered physically distinct.

By contrast, other rights in the contract, such as the right to operate portables and the right to have food and beverage hawkers operating throughout the stadium, do not involve physically distinct portions of an asset. The location of the portable carts is not specified, and therefore any location within the stadium could be used to locate the carts. Per par. 15-16, if a po1tion of an asset is not physically distinct, it "is not an identified asset, unless it represents substantially all of the capacity of the asset. .. ". This condition is not present, as use of the portables and rights of the hawkers within the broader Stadium do not represent "substantially all" of the Stadium's capacity. Therefore, these rights do not involve identified assets.

Did you notice in Michael's analysis that he discussed how the guidance relates specifically to Presto's fact pattern? See how he says : "In this arrangement, certain of the Food and Bever- age Facilities .. . are specified on architectural drawings and are thus physically distinct." He is walking us through his reasoning, as opposed to simply stating: This arrangement involves identified assets.

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Present Available Alternatives Recall th at the an alys is sec ti on should cl early describe any altern ati ves availabl e in accounting for a given transaction, weighin g their relati ve merits. Remember that accountin g research isn' t always just about the des tin ati on; how you get to a parti cul ar accountin g treatment matters too. I don't accept the argum ent from students that the onl y goal is to get to the ri ght answer. Rather, the analys is secti on is your opportunity to walk the reader thro ugh your thought process. What guidance did you consider? What alternati ves were prese nt? Was appli cati on of the guidance judgmental? Could other guidance have applied?

There is an old say ing among auditors th at "If it wasn't documented, it wasn' t done." Even if you as a researcher consider other alternatives to the co nclu sion reac hed, if these alterna- ti ves are not documented, there is no ev idence that you did so. Should your judgments ever be chall enged, it becomes mu ch more difficult to demonstrate the thoroughn ess of your work if the alternati ves considered were not documented at the time of evaluati on.

Considering Michael's case, it would not have been enough fo r him to assume th at the arrange ment in volves identifi ed assets and to go straight to the nex t step of the lease evaluation. Even though the end result may be the same, Michael must walk hi s readers through hi s evaluati on, demonstrating how he determined which rights in the agreement are considered identified assets.

Furthermore, by presenting avail able alternatives in your memo, you are being upfro nt with your reader. You are show ing the reader that your conclu sion in volved judgment. This is a good thing. To illustrate this point, consider the fo llowing TIP fro m the Trenches.

The only way someone reading your documentation will trust your conclusion is if you have clearly identified the available alternatives in your analysis.

In the past, I have asked students to document the accounting required for a certain transaction, knowing that when they began to explore the guidance, they would be presented with two alternatives.

• The "A" papers are the ones where students say: "Two alternatives exist (method A and method B). Method A appears to be more appropriate for this situation because . .. "

• The "B" or "C" papers are the ones where students say: "Method A should be followed because . .. " without mentioning that an alternative treatment is available.

As an employer, I would place more trust in the work of the "A" students. Even if I disagree with their choice of accounting method, at least I have been made aware that two choices exist. In contrast, the "B" or "C" papers did not give me the full story. When reviewing future submissions from these "employees," I would likely perform the extra step of recheck- ing the guidance they cite for completeness.

Tips for Incorporating Guidance-the Guidance Sandwich Reca ll the "one-stop shop" co ncept described earlier. Your An alys is sec ti on should include enough excerpts fro m th e authoritative guidance th at a reader will not have to go back to the Codifi cation (or other applicable auth ority) in order to understand the support fo r your analys is. Don' t just refer generally to the guidance, or paraphrase the guidance into your ow n word s. Rather, include enough actu al excerpts to clearl y make your case, then analyze this guidance in your ow n words.

As a general rule of thumb , your own co mm entary should precede and fo llow all guidance exce rpts.

Ever heard of the interperso nal communi cation concept of a "complim ent sa ndwich"? It goes so methin g like thi s: If you' re going to criti cize someone, say someth ing nice before and after the criti cism. For exampl e, "Joe, I like your ti e today. I really wish you would do so methin g about your bad breath . By the way, nice job on that report. "

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Think of your analysis section as a series of guidance sandwiches, with your own words introducing, and then analyzing each guidance excerpt.

EXAMPLE Following is a simple guidance sandwich that illustrates Michael's initial consideration of the guidance regarding whether a contract contains an identified asset.

Identified Asset

ASC 842-10 states the following with respect to determining whether a contract involves an identified asset:

15-9 An asset typically is identified by being explicitly specified in a contract. However, an asset also can be identified by being implicitly specified at the time that the asset is made available for use by the customer.

The baseball stadium (an asset) is explicitly specified in the contract. However, Presto only has the 1ight to use specified pmtions of the stadium. Accordingly, two challenges that arise in applying the concept of identified asset to this agreement include evaluating I) when a portion of an asset is an identified asset and 2) whether the supplier has a substantive right to substitute the asset.

Notice how the example provides commentary in Michael's own words before and after the guidance excerpt. The first sentence of the example introduces the guidance and states why it is being considered. The quote from the guidance is inserted next. Finally, the last sentence applies the guidance to the company's own set of facts.

Nonauthoritative sources that you consider would be presented in a similar manner, following the authoritative sources you present. See Chapter 5 for more on citing nonauthoritative sources.

In the commentary that follows guidance excerpts, incorporate key words considered from the guidance. Don't be creative in re-stating guidance requirements. Rather, use the words that were just provided to you, so as to avoid inadvertently changing the meaning of the guidance.

Take a moment now to identify the guidance sandwich you used in the email example earlier in this chapter.

Guidance Sandwiches

Remember the email you drafted to your audit senior (Robin) regarding the Statement of Cash Flows for Auto Corp? Take a moment now to identify the guidance sandwich you used in that email (or, take a moment to create one now). Recall that you are responding to Robin's question about whether the client has appropriately classified the proceeds from the sale of its manufactur- ing facility as cash flows from investing activities.

Hint: Your guidance sandwich could start with, for example:

• ASC xxx states that cash flows from investing activities include ... "(x)."

Your response here _________________________ _

Next, let's focus on how to organize your analysis.

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Organizing Your Analysis Use additional subheaders throughout your analysis, as needed to help guide your reader. For example, in Michael's memo evaluating Presto's concessions agreement, he uses the following subheader to help guide readers through his evaluation of Issue l.

Analysis-Issue 1: Does the Concessions Agreement involve an identified asset? Portion of an Asset Substantive Right to Substitute • Practical Ability to Substitute • Economically would benefit from substitution

Notice how Michael uses subheaders to clearly organize his analysis of the identified asset requirements (namely, portion of an asset, and substantive right to substitute). Use of subheaders can be valuable for organizing your analysis of guidance with multiple conditions. Of course, you might choose to break this single "Issue l" down into multiple issues, or researchable ques- tions. Refer to the Appendix to see how Michael used these subheaders to organize his Issue l analysis.

In some cases, you will encounter guidance with multiple conditions, often shown as "and" or "or" conditions. Generally speaking, "and" conditions must all be met in order for a certain accounting treatment to apply. With "or" conditions, only one condition must be met.

In such cases (both for "and" or "or"), it is a best practice to evaluate each condition pro- vided. Take, for example, the definition of a derivative. For a contract to meet the definition of a derivative, it must: 1) have a notional and an underlying (e.g., a quantity and a price); and 2) require little/no initial net investment; and 3) be capable of net settlement. A researcher in this case might organize his or her analysis as follows:

ASC 815-10 (Derivatives) defines derivative instruments as follows:

[Guidance Excerpt]-Par. 15-83 (Definition of a derivative instrument)

The company has analyzed each characteristic, as follows.

Characteristic 1 - The contract has both an underlying and a notional amount. Analysis:

Characteristic 2 - The contract requires no initial net investment. Analysis:

Characteristic 3 - The contract can be settled net. Analysis:

In this example, the full guidance excerpt is presented, followed by analysis of each required characteristic. Notice how the use of these subheaders improves the readability of the analysis.

Assume you are preparing a memo to evaluate whether a lease should receive operating or finance treatment. Five conditions are provided; if any one condition is met, the lease should be classified as a finance lease. Assume the first condition (transfer of ownership) is met. Should you still evaluate the remaining four conditions? Explain .

Could subheaders be used to organize your analysis of the lease criteria? Explain.

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Consider Including Journal Entries for Each Alternative To the extent you are weighing alternative accounting treatments, consider including (in your Analysis section) the journal entries that would apply to each alternative. Identifying the impact each alternative will have on the financial statements can help you recognize a client's motiva- tion for a particular accounting treatment (e.g., income manipulation). Also, seeing how alterna- tive treatments would play out on the financial statements can help researchers visually connect the substance of a transaction to its possible financial statement impacts.

You won't always find journal entry guidance in the Codification, so you'll often need to think through this part of the analysis on your own, or by considering other sources.

Document Other Factors Considered Finally, in addition to analyzing the requirements of accounting guidance (both from authoritative and nonauthoritative sources), the Analysis section of an issues memo is also the appropriate place for discussion of other key factors considered in determining an appropriate accounting treatment.

For example:

• How are peer companies accounting for this type of transaction?

• How has our company handled this type of transaction historically?

• Did we consult with subject-matter experts in analyzing this issue?

Present your consideration of these other factors, as applicable, following your review of authoritative literature.

Flip back to the par. 15-16 example presented earlier, and respond to the following.

1. First, label the guidance sandwich shown in that example . Use the following labels: 1. Introduction in the author's own words. 2. Guidance excerpt. 3. Commentary in author's own words.

2. Next, in the author's commentary (which follows the guidance excerpt), underline any words that the author repeated from the guidance.

3. What might be a benefit of restating parts of the guidance when performing your analysis?

4. Circle places where the author discusses the case facts, and how they relate to the guidance.

5. Why is it important to discuss case facts in your analysis of guidance excerpts?

Conclusion Complete your discussion of each separate issue with a clearly written conclusion. This section should briefly summarize key points from your analysis that were considered in arriving at the conclusion reached.

Once you reach the point of documenting your conclusion, in many cases it may already be fairly obvious from your analysis which treatment is most appropriate. In such cases, your con- clusion can be fairly brief. For example, following is Michael's conclusion section documenting his determination that the rights to operate fixed concession stands and to serve in premium seating areas involve identified assets.

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Conclusion-Issue 1: Identified Asset

The Food and Beverage Facilities are a portion of an asset, and thus these spaces are considered "identified assets" if they are physically distinct and not subject to substantive substitution rights. We have concluded the following: • Fixed concession stands, suites, and premium areas are physically distinct and are not

subject to a substantive substitution right (given that relocation would be costly and thus unlikely). These locations are considered identified assets.

• With respect to the right for hawkers to operate in the stadium, the hawkers are not limited to a defined space (i.e., the space is not physically distinct), and thus this right does not involve an identified asset.

• With respect to portables, the locations are not physically distinct, and Stadium Co. has a substantive right of substitution. Thus, portables are not considered identified assets.

Therefore, the identified assets in this arrangement are I) fixed concession stands and 2) premium seating areas and suites.

What are some of the factors that Michael pointed to when describing how he reached the conclu- sion that portable concession stands are not identified assets?

Notice that, even in this example of a brief conclusion, the author summarized the most compelling points in the analysis as support for the conclusion. It is not sufficient to say:

In conclusion, portables are not identified assets.

Rather, the following underlined text should be added to such a conclusion, restating the rationale for the conclusion:

In conclusion, because of factors x. y. and z, portables are not considered identified assets.

Don't "jump to" conclusions. Make sure your conclusion includes your rationale (for example, "because of factors x, y, and z"), rather than simply naming the alternative selected.

In cases where the choice between two or more alternatives is highly judgmental, the conclusion should be longer and more detailed. The conclusion should clearly explain which requirements from the guidance, along with other factors considered, were compelling in select- ing an alternative. The researcher might comment on why the alternative selected best reflects the substance and business purpose of the transaction. The rationale articulated in the conclusion could later become a critical part of the audit trail if the accounting for the transaction is ever called into question. That said, do not introduce new arguments in your conclusion. Rather, all relevant factors should be introduced in your Analysis, and then the most key factors should be discussed and referred back to in the conclusion.

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Should you use one Conclusion section, or several, in a memo with multiple issues? It depends on the complexity of the issues you've analyzed. If the issues are straight-

forward and your analysis is fairly brief, one Conclusion section may be sufficient. However, when addressing more complex issues, each issue may require its own Conclusion section.

Financial Statement and Disclosure Impacts When applicable, conclude your memo with a summary of financial statement and disclosure impacts. Journal entries can be useful in describing anticipated financial statement impacts.

Continue to use the same writing process and format, such as citing authoritative guidance as support, in writing this section. In other words, show the journal entries that will be required based on your conclusion. If you are able to find authoritative excerpts that support either side of the entry (debits or credits), then include that guidance as support for the entry. As noted previ- ously, journal entry guidance is often not provided in the Codification; to the extent you refer to other sources for journal entry guidance, you should include a reference to those sources.

For disclosures, include authoritative excerpts describing disclosure requirements, followed by discussion of how the company will comply with these requirements, specifically to address this issue.

Reread Your Work Before Submitting (and what to look for) By now, you've prepared a thoughtful, complete accounting analysis. But is it ready to send to your supervisor?

Always reread your work before submitting. Check for:

• Commas, spelling, and proper grammar (more on this in a moment)

• Consistent font (generally, go with 11-12 point, Times, single spaced but double space between paragraphs)

• Concise, clear sentences

• Active voice

In other words, this reread process is your chance to fine-tune your writing. Doing so will give your paper extra polish, and will add that "wow" factor (what a professional, strong writer!).

Writing an issues memo may require three passes. On your first pass, get your rough draft thoughts down and the technical details in place. On your second pass, reread your work, adjusting the order of sentences and paragraphs as necessary to organize your thoughts in a more logical manner. Also, use this review to strengthen, or beef up, your arguments as needed. On your final pass, review your wording for opportunities to communicate more clearly and directly.

Concise, Clear Sentences Recognizing that technical accounting is challenging to communicate, the SEC released a Plain English Handbook in 1998. In it, the SEC encourages companies to prepare disclosure docu- ments that investors can easily understand , and offers strategies to that effect (Write in active voice! Use clear section headings! Know your audience! Be concise!). The handbook states: "A plain English document uses words economically and at a level the audience can understand. Its sentence structure is tight."4

4 Office of Investor Education and Assistance, of the U.S. Securities and Exchange Commission. A Plain English Handbook: How to create clear SEC disclosure documents. 1998. Page 5.

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In reviewing your own work for clear and concise wording, ask yourself: Can I rephrase any of my sentences to be more concise? Can I eliminate unnecessary words?

Active Voice Your writing will generally be clearer, and more direct, if you write in active voice. Consider the following examples of active vs. passive voice.

The girl was bitten by the dog.

The dog bit the girl.

(Passive voice)

(Active Voice)

In active voice, the subject performs the action described by the verb. For clarity, keep the subject and verb close together.

Change the following sentence to active voice, and see if you can word it more concisely.

The documentation put together by you should be carefully subjected to an editing process.

While the research you submit should always be your own effort, you might consider having a reviewer proofread your writing. Especially if you struggle in this area, a trusted peer, or the school's writing center, can offer comments on your grammar and spelling. Have your reviewers hand-write their comments, so you can input and learn from their edits.

Los Properly refer-ence passages from the Codification.

PROPERLY REFERENCING ACCOUNTING GUIDANCE

How Do I Reference a Passage from the Codification? Excerpts from authoritative guidance are critical to effective accounting research com- munications. Paraphrasing guidance (that is, summarizing it into your own words) is not enough; authoritative guidance is far more impactful in a memo than a summary of guidance in your own words. Additionally, quoting "Codification excerpts" from articles

or textbooks is inappropriate; always get authoritative guidance directly from the Codification. This discussion focuses on how to properly cite guidance excerpts from the Codification.

The first time you refer to the Codification in a memo, give its full title ("FASB Accounting Standards Codification"). Include the numerical reference for the topic you are citing, as well as a parenthetical description of the topic name. For example:

• Per FASB Accounting Standards Codification (AS C) topic 360-10-35-1 (Property, Plant, and Equipment), ...

Remember that not everyone reading your memo was an accounting major and understands the acronym ASC. Therefore, it is important initially to provide the full name of the Codifica- tion, then to use the parenthetical (AS C) to show that you will abbreviate this term in future references within the memo.

After your initial reference to the Codification, it is acceptable to refer to the topic using the abbreviation "ASC ," and omitting the parenthetical topic name (Property, Plant, and Equip- ment). For example,

• Per ASC 360-10-35-2: ...

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Note how these sample numerical references go all the way down to the paragraph level. Always provide as much detail as possible. Your reference would be lacking if you sent readers to Topic 360-10, as that leaves them with pages of guidance to sort through to find what you are trying to reference. Do your readers the favor of getting them directly to the appropriate paragraph within the guidance.

In citing guidance, don't get creative with sentence structure. Following are examples of both strong and weak references . Stick to the strong references, and your memos will have a more professional tone .

• Strong references:

• According to ASC xxx, "Quote"

• ASC xxx states or ASC xxx requires: "Quote"

• Per ASC xxx : "Quote"

• ASC xxx provides the following guidance: "Quote"

• The rate of return shall be based on: "Quote" (ASC xxx).

• The rate of return shall be based on : "Quote" rn 1

(at end of page) Footnote 1: ASC xxx

• Weak references:

• ASC xxx asks readers to .. . "Quote"

• ASC xxx believes ... "Quote"

• The Codification writes ... "Quote" (ASC xxx)

• The FASB says ... "Quote" (ASC xxx)

• I found the following guidance . . . "Quote" (ASC xxx)

Take careful note of the language and punctuation used in the preceding examples. "Per ASC xxx" is followed by a colon (:) . "According to ASC xxx" is followed by a comma (,). All of the lead-ins just listed should be followed by excerpts from the guidance. Additionally, each excerpt includes a reference to the source of the guidance (ASC xxx). Note that these numeri- cal references should get down to the paragraph-level of detail, since each provides a quotation directly from a paragraph of the guidance.

Referencing the Codification

Fill in the blanks using strong reference words.

1. ASC 360-10-35-17, "An impairment loss shall be recognized only if ... "

2. ASC 360-10-35-17 : "An impairment loss shall be recognized only if ... "

3. ASC 360-10-35-17: "An impairment loss shall be recognized only if . . . "

4. Show two ways that the underlined words in this reference could be stated more clearly.

According to ASC 360-10-35-17 it states: "An impairment loss shall be recognized only if ... "

~~~~~~~~~~~~~~~or~~~~~~~~~~~~~~~

Should I Ever Use Footnotes in Professional Memos?

The use of footnotes and endnotes (that is, numerical references leading readers to a "works cited" source at the end of a page or document) should be fairly rare in accounting research memos. That is , you should primarily expect to cite the Codification or other authoritative sources of guidance , and these source references can be included in the body of your memos.

Footnotes or endnotes are appropriate, however, if you are referencing a less-common source of guidance, which requires a lengthier source citation. For example, if you find guidance in an academic paper or in a professional journal, a footnote or endnote citation is appropriate, as

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reference when indenting guidance.

For example, we split this reference between

the introduction (715-30) and

the reference must include not only the author's name, but the article name, date published, title of journal, edition number, and page number. Including all of this detail in the body of a memo would bog down your reader.

When Should I Use Quotation Marks? Any guidance copied directly from the Codification must be enclosed in double quotation marks, and you must cite the source of the guidance down to the paragraph-level of detail (e.g., Per ASC XXX·XX·XX·XX ••• ).

For example, ASC 715-30-35-47 (Compensation-Pension) states : "The expected long- term rate of return on plan assets shall reflect the average rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the projected benefit obligation."

Notice the use of double quotation marks to enclose the quote, and notice the full reference to the Codification source.

There is one (and only one) instance in which quotation marks are not required: If you are including a long excerpt-roughly three lines or more-from the Codification, and you indent the guidance. Indenting long excerpts (as opposed to integrating the quotation within other text) can also improve the readability of your memo.

EXAMPLE

ASC 715-30 (Compensation-Pension) requires that companies consider future expected returns on investments in selecting an expected return on assets assumption:

35-47 The expected long-term rate of return on plan assets shall reflect the average rate of earnings expected on the funds invested or to be invested to provide for the benefits included in the projected benefit obligation. In estimating that rate, appropriate consideration shall be given to the returns being earned by the plan assets in the fund and the rates of return expected to be available for reinvestment .. .

Therefore, an asset return assumption is appropriate if management believes this rate is achievable in the future.

Notice how this example includes both: (l) a reference (ASC xxx) down to the paragraph level of detail and (2) guidance that is indented, indicating that it is a direct quote.

When Is It Appropriate to Alter an Excerpt from the Guidance? It is only appropriate to alter an excerpt from the guidance if (l) in doing so, you do not change the meaning of the guidance, and (2) you clearly tell the reader what you have altered. Use brackets [ ] to identify any words you have changed, or to acknowledge that you have added emphasis to part of a quote.

For example, note the following altered excerpt from ASC 815-10 (De1ivatives and Hedging):

15-83. "A derivative instrument is a financial instrument or other contract with all of the following characteristics . .. " [Emphasis added]

Also note this excerpt from ASC 842-10 (Leases):

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15-3. "A contract is or contains a lease if the contract conveys the right to control the use of identified [PP&E] (an identified asset) for a period of time in exchange for consideration."

In the preceding example, the author omitted the words "property, plant, or equipment" in favor of using the bracketed term " [PP&E]." Additionally, the author added boldface type to the term "all" and acknowledged this change by stating, "[Emphasis added]." As neither change alters the meaning of the guidance, and as both changes were identified with brackets, these changes are appropriate.

When Is It Appropriate to Use Ellipses? Ellipses , or those three dots in a row ( ... ) are used when a writer omits some text in a quote or doesn't quote the full sentence or paragraph. As you begin writing technical emails and memos , you may find that ellipses are useful in trimming fat; that is, eliminating irrelevant sections from a paragraph may improve the readability of your analysis. While sufficient guidance is critical to a strong issues memo , too much guidance can be burdensome.

EXAMPLE

Here is original guidance from ASC 405-20 (Extinguishments of Liabilities) describing how a debtor's secondary liability should be recorded as a guarantee.

40-2 If a creditor releases a debtor from primaiy obligation on the condition that a third paity assumes the obligation and that the original debtor becomes secondai·ily liable, that release extinguishes the original debtor 's liability. However, in those circumstances, whether or not explicit consideration was paid for that guai·antee, the original debtor becomes a guai·antor. As a guarantor, it shall recognize a guarantee obligation in the same manner as would a guai·ai1tor that had never been primai·ily liable to that creditor, with due regard for the likelihood that the third pai·ty will cai1y out its obligations. The guarantee obligation shall be initially measured at fair value, and that amount reduces the gain or increases the loss recognized on extinguishment. See Topic 460 for accounting guidance related to guai·antees.

Here 's an example of the proper use of an ellipsis to abbreviate a sentence from the preced- ing text.

40-2 "However ... , in those eirenmstanees, whether or not exp li cit consideration was paid for that guarantee, the original debtor becomes a guarantor."

Here 's an example illustrating the proper use of an ellipsis when the full paragraph is not being quoted. Here, the ellipsis shows that the paragraph continues on , even beyond this excerpted text.

40-2 "If a creditor releases a debtor from primary obligation on the condition that a third party assumes the obligation and that the original debtor becomes secondarily liable, that release extinguishes the original debtor 's liability. However, in those circum- stances, whether or not explicit consideration was paid for that guarantee, the original debtor becomes a guarantor . .. "

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LO& sional style.

While ellipses may become a great tool in your toolbox, you must always check and double check that the text you are skipping over is not critical to the understanding of a passage, and that using the ellipsis does not change the meaning of the original guidance.

Communicate using profes-

Here's an improper use of an ellipsis . Notice how pertinent guidance has been omitted.

40-2 "If a creditor releases a debtor from primary obligation on the condition that a third party assumes the obligation . . . and that the e,r iginal debte,r beeomes seeondat ily ttabte, that release extinguishes the original debtor 's liability."

STYLE TIPS FOR PROFESSIONAL COMMUNICATION

We'll conclude our chapter on communication by discussing a few points on style. Attention to style will improve the professionalism of your work products.

Use Proper Voice in Your Memos Avoid saying "I" or "we" or "you" in accounting research communications. Technical account- ing memos are not about you; they should not be written in the first person.

• For example, do not say: "We found the guidance in ASC 606."

• Do not say : "I think" or "We have concluded" in a memo.

• Do not say : "You have asked us for the appropriate accounting treatment . .. " in a memo.

When referring to a company, do not say "they" or "their." Rather, call the company by its name initially, and identify (in parenthesis) any abbreviations you plan to use for the company name thereafter.

• For example, Presto Hospitality ("Presto" or "the Company") shall recognize revenue on a net basis. This is appropriate given the Company's role as agent.

Notice how this example initially introduces Presto Hospitality using its full name, and then uses the parenthetical ("Presto" or "the Company") to show how the company will be described in future references within the memo. Finally, note the following additional examples of proper and improper voice:

• Do say: The Company has evaluated its accounting.

• Do not say : The Company has evaluated their accounting.

Keep Your Language Neutral (Avoid Strong Words) To improve the professionalism of your writing, keep your language neutral. I once asked stu- dents to review a company's accounting election and to comment on whether it was supportable based on guidance from the Codification. A few students described the company's position as "wrong," and one may have even called the company's accounting "ridiculous."

The lesson here: Try to leave your emotions out of technical writing. Keep your language neutral. Here are examples of more appropriate ways to comment on an accounting position. The accounting is

• "Appropriate/not appropriate."

• "Consistent/not consistent with" the guidance.

• "Supported/not supported by" the guidance .

Also, try to avoid "absolutes" in your technical writing. It's better to play it safe and use qualify- ing words.

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• Use the word "generally" rather than "always."

• Analysts "generally" (not "always") listen to companies' earnings calls for the purpose of understanding more of the qualitative factors behind a company ' s performance.

• Use the word "could" rather than "will."

• The company "could" (not " will") have to restate later if it chooses an accounting posi- tion that is not supported by the guidance.

• Use the word "specialist" rather than "expert."

As a check of your word choice, reread your work and ask yourself: Would I be comfortable if a quote from this work appeared in the newspaper? This same advice is commonly given to CPA firms by their attorneys, according to a retired "Big Four" partner.

One of the writing conventions that I picked up during my time at the FASB is use of the verbs states, stated, or said in technical writing. The guidance states. The Board members stated. My project manager's red pen frequently came out when my draft board minutes included more creative terms such as "argued," "pointed out," or "asserted." In each case, he sug- gested that I change the word to "stated" or "said." (Board minutes have since changed to focus on decisions reached, as opposed to discussions held.)

Get the Grammar Right Grammatical errors in your writing can undermine the quality of your whole research effort. Before submitting a memo to your supervisor or to a client, carefully reread it for proper gram- mar, spelling, and clarity. Even an offense as seemingly minor as a misplaced comma can tarnish the polish on an otherwise great paper.

Commas Following is a brief refresher on commas. If this is a trouble area for you, please review this section carefully.

• Use commas between "independent clauses"-each with a subject and a verb: • I went to the store, and you went home. • Comparative income statements must be presented for three years, but comparative bal-

ance sheets must be presented for two years. • Note: Each of these clauses could be a sentence all by itself, so a comma is needed

between them.

• Use commas after an introductory phrase: • Although the company's earnings were below expectations, the company's stock price

did not change.

• If two alternatives are available, both should be analyzed in your memo. • Note: Note that each phrase has its own subject and verb; the introductory phrase also

includes a transition (if, although, after, before, etc.). Separate these two phrases with a comma.

• Use commas when you insert a phrase into a sentence that isn't necessary for understanding the sentence.

• He said, with an encouraging nod, that I should read more. • Nonauthoritative guidance, which is available from a number of different sources, can

be useful in supporting authoritative references.

• Note: If the phrases "with an encouraging nod" or "which is available from a number of different sources" were stricken from these sentences, the sentences would still read

[ TIP from the Trenches

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just as clearly. As these phrases are purely descriptive, and not necessary for under- standing the sentence, they are set off in commas.

Criteria versus Criterion Students are frequently uncertain how to form the singular, verus plural, form of the word cri - teria. Here' s the deal:

• Criteria is plural. There are five criteria for evaluating lease classification.

• Criterion is singular. The first criterion involves whether the lease transfers ownership by the end of the lease term.

Getting Feedback On Your Writing I still, to this day, cringe when I get feedback on my work. This may be a natural thing to do . But I've also learned to tell my self: "Wait. I can learn from thi s." And just like that, I go from dreading the feedback to appreciating the learning opportunity it presents .

If your instructor or supervisor takes the time to provide feedback on your writing, under- stand that they do this because they believe in your potential to improve. I can attest that provid- ing detailed feedback to each student takes a ton of time. Take the time to read and learn from any comments you are given.

Consider taking the following steps when getting feedback:

1. Don ' t panic when it 's given to you. Think: l can learn from this.

2. Read it closely, and with an open mind. If you don ' t understand the feedback, ask for clari- fication.

3. Appreciate the feedback-either silently or by thanking the person who provided it.

As you advance in your career, there may be increasing circumstances where you consider, but then reject, feedback you are given. In many cases, however, you aren't there yet! Be open to learning from others.

Common Instructor Notations For reference, here are some notations that I commonly use in providing handwritten feedback to my students. Your in structor may (or may not) use similar notation s.

91 Start a new paragraph.

SJ, CJ, WI Should, could, or would

Sib , C/b, W/b Should be, could be, would be I\ Insert

= dbl underline The first letters should be uppercase.

$trikethrough The first letter should be lowercase.

sp Spelling error

stet Means: "What you had is fine. Di sregard my comment." y Delete

w/r/t with respect to

K contract

...

"·

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CHAPTER 4 APPENDIX

Sample Accounting Issues Memo The following Presto Hospitality memo is only partially complete and is provided for example purposes. Additional issues will need to be evaluated in order to fully conclude on the account- ing for this arrangement.

Draft-For Discussion Purposes Only Memorandum

To: Presto Hospitality Accounting Files

From: Michael Jones, Accounting Policy team

Date: 12/l/20Xl

Use this DRAFT stamp in the

header until final contracts have been reviewed.

Re: Accounting for concessions agreement with Stadium Co . ... -1----------------l.-.r-------, Describe the type

Facts

Presto Hospitality (Presto) is a public company that is in the process of signing a 10-year concessions agreement with a major league baseball stadium owner (Stadium Co.). The agreement would give Presto the right and obligation to operate all of the stadium's fixed concession stands and portable food and beverage carts , to provide food and beverage service to premium seating areas (including suites), and to have hawkers selling concessions in the aisles of the stadium (Sodas! Peanuts!), collectively, the "Food and Beverage Facilities." The locations of fixed concession stands within the stadium are designated in architectural drawings included within the draft concessions agreement. The draft contract states that Stadium Co., at its option and at its cost (such as the cost to rebuild leasehold improvements), can require Presto to move its locations within the stadium.

The concessions agreement will require Presto to remit 50% of its gross food sales and 52% of its gross alcohol sales to Stadium Co. in exchange for the right to operate at the stadium. Presto will also be required to make an upfront payment of $5 million to Stadium Co., which will be used toward capital improvements, build-outs, and branding of the concession facilities. Throughout the operating period of this agreement, Stadium Co. will have the right to approve all of Presto's proposed menu items , pricing, and choices of suppliers, and Stadium Co. has indicated during negotiations that it plans to actively exercise this approval authority. To be chosen as the concession provider for this stadium, Presto submitted a successfu l bid and was selected from a group of competing potential concessionaires.

Presto must detetmine whether this an-angement contains a lease within the scope of ASC 842 (Leases).

Issues

1. Does the Concessions Agreement involve an identified asset? ... c:;-----------.-'--l 2. List additional questions here.

Analysis-Issue 1: Does the Concessions Agreement involve an identified asset? FASB Accounting Standards Codification (ASC) 842- 10 (Leases) provides the fo llowing scope guidance for determining whether an atrnngement is or contains a lease:

15-3 A contract is or contains a lease if the contract conveys the right to control the use of identi- fied property, plant, or equipment (an identified asset) for a period of time in exchange for consideration ...

Continued

of transaction succinctly in the

"Re" line.

If the transaction is complex or

involves multiple parties, include a

picture here.

Phrase issues in the form of a

question.

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Continued from previous page

15-10 Even if an asset is specified, a customer does not have the right to use an identified asset if the supplier has the substantive right to substitute the asset throughout the period of use. A sup- plier's right to substitute an asset is substantive only if both of the following conditions exist: a. The supplier has the practical ability to substitute alternative assets throughout the

period of use (for example, the customer cannot prevent the supplier from substituting an asset, and alternative assets are readily available to the supplier or could be sourced by the supplier within a reasonable period of time).

b. The supplier would benefit economically from the exercise of its right to substitute the asset (that is, the economic benefits associated with substituting the asset are expected to exceed the costs associated with substituting the asset). [Emphasis added)

According to the concessions agreement, Stadium Co. can require Presto to relocate its facilities within

the stadium. Therefore, it is necessary to evaluate whether this substitution right is "substantive" by

evaluating the conditions in par. 15-IO(a) and (b).

Practical Ability to Substitute (par. 15-!0a): Stadium Co. has the practical ability to substitute alternative

assets throughout the period of use, as it has the stated right per the contract to make changes to the

specified facilities. Fmthe1more, alternate locations within the Stadium are available to Stadium Co. that

could be used to substitute Presto's designated spaces in the Stadium. Therefore, par. 15-1 O(a) is met for

all concession spaces in the contract.

Economically would benefit from substitution (par. 15-lOb): It is unclear whether the economic benefits

to Stadium Co. associated with substituting the designated food and beverage spaces would be expected

to exceed the costs associated with substituting these spaces. Stadium Co. would presumably incur

significant relocation costs if it were to require Presto to change the location of a fixed concession stand

in the Stadium, given the kitchen and other equipment involved in such a relocation effmt. On the other

hand, food and beverage kiosks (pmtables) could easily be moved without significant cost.

To assist in our evaluation of this "economic benefit" condition, we considered the following

implementation guidance from ASC 842-10 involving a pmtable concession stand. While we already

concluded that the spaces on which pmtables will be located are not physically distinct pmtions of assets,

we will evaluate this example for the avoidance of doubt.

> > > Example 2---Concession Space

55-52 A coffee company (Customer) enters into a contract with an airport operator (Supplier) to use a space in the airport to sell its goods for a three-year period. The contract states the amount of space and that the space may be located at any one of several boarding areas within the airport. Supplier has the right to change the location of the space allocated to Customer at any time during the period of use. There are minimal costs to Supplier associated with changing the space for the Customer: Customer uses a kiosk (that it owns) that can be moved easily to sell its goods. There are many areas in the airport that are available and that would meet the specifications for the space in the contract.

55-53 The contract does not contain a lease.

55-54 Although the amount of space Customer uses is specified in the contract, there is no identified asset. Customer controls its owned kiosk. However, the contract is for space in the airport, and this space can change at the discretion of Supplier. Supplier has the substantive right to substitute the space Customer uses because: a. Supplier has the practical ability to change the space used by Customer throughout the

period of use. There are many areas in the airport that meet the specifications for the space in the contract, and Supplier has the right to change the location of the space to other space that meets the specifications at any time without Customer's approval .

b. Supplier would benefit economically from substituting the space. There would be mini- mal cost associated with changing the space used by Customer because the kiosk can be moved easily. Supplier benefits from substituting the space in the airport because substitution allows Supplier to make the most effective use of the space at boarding areas in the airport to meet changing circumstances.

Continued

Indent excerpts to improve the

readability of your memo.

104 Chapter 4 I Creating Effective Documentation © Cambridge Business Publishers

Continued from previous page

This par. 55-52 example involves an airport kiosk whose location can be easily changed. This is analogous

to the p01tables involved in Presto's agreement, which can be easily moved. Consistent with this example,

Stadium Co. 's substitution right is substantive with respect to p01table concession spaces.

However, with respect to more "fixed" locations, such as concession stands with kitchen equipment, the

guidance offers an example illustrating that moving such spaces could impose economic cost to the supplier (Stadium Co.):

55-63 Customer enters into a contract with property owner (Supplier) to use Retail Unit A for a five-

year period. Retail Unit A is part of a larger retail space with many retail units.

55-64 Customer is granted the right to use Retail Unit A. Supplier can require Customer to relocate

to another retail unit. In that case, Supplier is required to provide Customer with a retail unit

of similar quality and specifications to Retail Unit A and to pay for Customer's relocation

costs. Supplier would benefit economically from relocating Customer only if a major new

tenant were to decide to occupy a large amount of retail space at a rate sufficiently favorable to

cover the costs of relocating Customer and other tenants in the retail space that the new tenant will occupy. However, although it is possible that those circumstances will arise, at inception

of the contract, it is not likely that those circumstances will arise. For example, whether a

major new tenant will decide to lease a large amount of retail space at a rate that would be

sufficiently favorable to cover the costs of relocating Customer is highly susceptible to factors

outside Supplier's influence .

. . . 55-69 Retail Unit A is an identified asset. It is explicitly specified in the contract. Supplier has the

practical ability to substitute the retail unit, but could benefit economically from substitution only in specific circumstances. Supplier's substitution right is not substantive because, at

inception of the contract, those circumstances are not considered likely to arise.

In this example, it is considered unlikely at inception of an a1rnngement that the supplier would move a

customer using "Retail Unit A." Despite the availability of other retail units that could be substituted for

Retail Unit A, the supplier' s costs in moving the customer would not be expected to exceed the benefits.

Therefore, the supplier's substitution right is not considered substantive. Consistent with this example, in

Presto 's arrangement, fixed concession stands and premium areas would be costly to move and therefore

would not likely be subject to substitution. Per discussions with Presto management, based on its prior

experiences with similar contracts, the food and beverage locations within the stadium are generally unlikely

to be changed by the stadium owner.

Conclusion-Issue 1: Identified Asset The Food and Beverage Facilities are a portion of an asset, and thus these spaces are considered "identified

assets" if they are physically distinct and not subject to substantive substitution rights. We have concluded

the following:

• Fixed concession stands, suites, and premium areas are physically distinct and are not subject to a substantive substitution right (given that relocation would be costly and thus unlikely). These

locations are considered identified assets.

identified asset.

• With respect to po1tables, the locations are not physically distinct, and Stadium Co. has a substantive right of substitution. Thus, portables are not considered identified assets.

Therefore, the identified assets in this an-angement are 1) fixed concession stands and 2) premium seating

areas and suites.

Given that this is not a complete memo, the "Financial Statement and Disclosure Impacts" section of the

memo has been omitted.

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CHAPTER SUMMARY

Effective documentation serves several functions for the company and its auditor. Not only does the process of creating documentation allow the accountant to think critically about the issues at hand, but a complete set of documentation serves as support for key judgments, a valuable histori- cal reference, and-in the case of auditors-evidence of a robust evaluation of client positions.

This chapter introduced a standard format for preparing accounting issues memoranda and professional emails . The chapter also provided style tips for professional communication, including how to cite from the FASB Codification, use neutral language, and use professional voice. Commit these tips to memory, as they will serve you well in your professional career.

REVIEW QUESTIONS

1. Cite two reasons why documentation is a critical part of performing accounting research.

2. Explain how creating clear documentation might provide some protection against hindsight bias.

3. Contrast the circumstances in which an email should be used to communicate research, versus circumstances in which a memo may be warranted.

4. Name three of the tips provided for drafting effective emails.

5. The chapter notes that email communications should be kept fairly brief. In light of this, is it appropriate to include guidance excerpts in an email? Explain.

6. Name the sections included in the standard memo format introduced in this chapter.

7. Explain what is meant by the statement that a memo should be a one-stop shop.

8. How much detail should be included in the Facts section of an issues memo?

9. Should your issues list always be organized around the case study questions, as given to you? Explain.

10. Complete the following sentence. Issues should be phrased in the form of _____ _

11. What is the goal of the Analysis section of the memo? Explain .

12. When alternative accounting methods are available, why is it essential for a researcher to identify these possible alternatives in his or her documentation?

13. In what circumstances might subheaders be useful to help organize your analysis?

14. Explain why researchers should include actual excerpts from the guidance in accounting memoranda, rather than paraphrases of guidance (in the researcher 's own words).

15. Which section of an accounting issues memorandum is often enhanced by a picture (or diagram) of the transaction?

16. Is it acceptable to document other sources considered, such as nonauthoritative sources, in a memo? Explain.

17. What is meant by the advice: Don't jump to conclusions!

18. What does the term "guidance sandwiches" mean? Where would you find these in an accounting issues memorandum?

19. Should new arguments or guidance references be introduced in the Conclusion section of a memo? Explain.

20. Why is a Conclusion section necessary in an issues memo?

21. What is the role of journal entries in an accounting issues memo? Where should these be discussed?

22. What are three things you should check for when reviewing your writing?

23. How should a researcher refer to guidance from the Codification, the first time it is cited in a memo?

24. Which of the fo!Jowing Codification references is stronger? Explain. • Per ASC xxx: "Quote" • ASC xxx asks readers to ... "Quote"

25. Describe what "voice" should be used in accounting research communications . (Feel free to respond by describing what voices "should not" be used.)

26. Explain what it means for the language in an accounting memorandum to be "neutral."

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EXERCISES

1. For each of the following pieces of infonnation, state whether it should be included in, or excluded from, the Facts section of an issues memo, assuming that the objective of the issues memo is to evaluate the accounting by a company for a repurchase of its own stock. Briefly explain your reasoning. a. The fact that the issuer is a public company. b. The market value of the company 's stock on the date the program commences. c. The anticipated size of the repurchase program, in dollars . d. The period over which the repurchase program is expected to occur. e. Background on the company and its primary sources of revenue. f The fact that the company entered into a similar transaction several years ago. g. The name of the investment bank that will facilitate and manage the repw·chase program.

2. As the Presto Hospitality memo in this chapter illustrates, accounting issues are not always straightforward. The following questions are intended to highlight some of the many judgments and alternatives present in that memo. Considering that memo, respond to the following. Use the Presto Hospitality memo, and your own thinking, to respond. (Codification research is not necessary for this exercise.) a. Why is it important for Presto to dete1mine whether the concessions agreement is a lease? What impacts could

this conclusion have on Presto's accounting? b. Describe the steps involved in perf01ming the analysis of which concession locations/rights are considered

identified assets. c. What would have happened if Presto had concluded that the an-angement does not involve identified assets?

What analysis would have been pe1formed next? d. What value did the airport kiosk implementation guidance example contribute to Presto's evaluation of its

identified assets? e. What value did the Retail Unit A implementation guidance example contribute to Presto's evaluation of its

identified assets? f The Conclusion section laid out not only the conclusion for each concession right/location, but also the ratio-

nale. Summmize the rationale described for each conclusion reached.

3. Draw a picture illustrating the following fact pattern:

Trnck Co., a wholly owned subsidiary of Auto Corp., is selling its light-duty truck plant to Company B for $10 million. Company B has taken out a loan for $8 million from Sub Bank in anticipation of the exchange. Sub Bank is a wholly owned subsidiary of Pm·ent Bank.

4. Draw a picture illustrating the following fact pattern involving an interest rate swap:

Company Chas issued bonds that pay LIBOR (a floating rate) to investors (in exchange for cash). Company D has issued bonds with a fixed 6% rate to investors (in exchange for cash), with interest payable semiannually. Company C and Company D enter into an interest rate swap. In this swap, Company C will pay a fixed 6% rate to Bank (a financial inte1mediary); in turn , Bank passes this payment on to Company D. Company D will pay LIBOR to Bank, which in turn passes this payment on to Company C. (Through this derivative u·ansaction , Company Chas essentially converted its payment obligation from a floating to a fixed rate; Company D has converted its obligation from fixed to floating).

(Hint: To begin this picture, draw four boxes in a row horizontally, to depict, respectively, Investors, Company C, Company D, Investors. There should be lines between each company and its investors depicting the consideration they exchange. Above this horizontal row, draw one box for Bank.)

5. a. Draw a picture illusu·ating the following fact pattern involving trust-preferred securities: Bank S sets up a trust (a subsidiary entity) and owns 100% of the common stock in the u·ust. That trust issues preferred securities to investors (in exchange for cash) , and the investors earn pe1iodic fixed dividend payments on their preferred shares. Using the funds from the sale of preferred stock, the uust purchases junior subordinated debt from Bank S, and this debt pays periodic fixed interest payments equal to the divi- dend payments made by the u·ust. The trnst has a call option, allowing it to call back the preferred shares from investors at its option. Additionally, Bank S has a call option, allowing it to call back its debt from the trust at its option . Bank S guarantees to the trust's investors that the trust will use its available cash to make interest payments.

b. Next, imagine that you are writing an issues memo documenting this mrnngement from Bank S's perspective. What are four researchable questions that you might list in the Issues section of the memo?

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6. a. Briefly, desc1ibe whether your base-level understanding of interest rate swaps and tmst-prefe1Ted securities has improved after completing exercises 4-5 above. Explain.

b. Now, describe one other circumstance in which drawing a picture could be useful in perfonning or commu- nicating accounting research.

7. Locate Codification guidance describing how inventory should initially be measured, and present the excerpt in a guidance sandwich. Assume you are answe1ing the question: Should inventory be measured initially at its market value or at cost?

8. Read the following issue. Next, add an ellipsis to par. 15-2 to reflect the removal of any guidance not considered relevant to this issue.

Issue: Presto Hospitality is researching the interaction between ASC 842 (Leases) and ASC 606 (Revenue). Presto wants to know whether it must evaluate ASC 606 for any contracts that it concludes are within the scope of leasing guidance. Presto reviews the following scope guidance in ASC 606-10:

15-2 An entity shall apply the guidance in this Topic to all contracts with customers, except the following: a. Lease contracts within the scope of Topic 842, Leases. b. Contracts within the scope of Topic 944, Financial Services-Insurance. c. Financial instrnments and other contractual rights or obligations within the scope of the following

Topics: l. Topic 310, Receivables 2. Topic 320, Investments-Debt and Equity Securities 2a. Topic 321, Investments-Equity Securities 3. Topic 323, Investments-Equity Method and Joint Ventures 4. Topic 325, Investments-Other 5. Topic 405, Liabilities 6. Topic 470, Debt 7. Topic 815, Derivatives and Hedging 8. Topic 825, Financial Instruments 9. Topic 860, Transfers and Servicing.

d. Guarantees ( other than product or service warranties) within the scope of Topic 460, Guarantees. e. Nonmonetary exchanges between entities in the same line of business to facilitate sales to customers

or potential customers. For example, this Topic would not apply to a contract between two oil compa- nies that agree to an exchange of oil to fulfill demand from their customers in different specified loca- tions on a timely basis. Topic 845 on nonmonetary transactions may apply to nonmonetary exchanges that are not within the scope of this Topic.

9. C01Tect any etTors in the following paragraph, or fix any areas where the professionalism of the writing could be improved. Consider proper voice, language, and punctuation. You do not need to use the Codification to complete this exercise.

In my opinion Beta Corp's ("their") accounting is wrong because they are applying revenue recognition guidance to a lease contract, even though lease transactions are exempted from Code 606. Code Section 606- 15-2 says that "a. Lease contracts within the scope of Topic 842, Leases" are not subject to revenue recognition guidance.

10. Change the following sentences to active voice. a. The inc01Tect accounting applied by the company resulted in a restatement. b. A new standard was issued by the FASB that will result in changes to long-duration insurance contracts.

11. Add commas to the following sentences, and for each sentence briefly justify why the commas were needed. a. Although Apple's sales remained stagnant in Q2 its stock p1ice rose. b. Jones Company which is based in India is privately held. c. We need to audit the company's accounts receivable accounts payable and cash accounts. d. Presto will make an upfront payment and Stadium Co. wi ll use the funds toward capital improvements.

12. Replace the following weak Codification references with stronger language. a. I found the following guidance in ASC 360-10-35-3, "Depreciation expense in financial statements for an

asset shall be dete1mined based on the asset's useful life." b. Per GASB Statement No. 51 , " ... alt intangible assets not specifically excluded by its scope provisions be

classified as capital assets." (Summa1y page). c. In the Codification, ASC 450-20-25-2 says that "An estimated loss from a loss contingency shall be accrned

by a charge to income if both .. . "

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[Hint: This letter (c) example statts with a strong reference, but the reference doesn't flow with the rest of the quote. Find a way to fix this.]

13. Introduce the following guidance using a strong reference, then indent the guidance following your introduction. Split the guidance reference (topic-subtopic), (section-paragraph) in a manner similai· to the example shown on p. 96.

ASC 210-10-45-13 (Balance Sheet)

Asset valuation allowances for losses such as those on receivables and investments shall be deducted from the assets or groups of assets to which the allowances relate.

14. In the following excerpt, explain why brackets [] ai·e present (e.g., what are the two functions of the brackets in this example?). Also, explain why it's necessat-y for the researcher to show any changes to quoted text in brackets.

Per ASC 842-10-15-3: "A contract is or contains a lease if the contract conveys the right to control the use of identified [PP&E] (an identified asset) for a period of time in exchange for consideration." [Emphasis added]

CASE STUDY QUESTIONS

4.1 Presto Hospitality-Lease Scope In Case Study 3.5 , you researched whether Presto has the right to substantially all economic benefits from use of the identified assets. Now, research whether Presto has the right to direct use of the identified assets. In doing so, assume that the stadium owner has the right, per contract, to require Presto to change the "concept" offered at the concession stands at its option. For example, Stadium Owner could require that a hot dog stand be changed out for a pizza concept. However, assume, in practice, that the stadium owner may only exercise this authority once per year, perhaps for one concession stand out of the several stands run by Presto. Also, assume that Presto can recommend p1icing to the Stadium Owner, but ultimate approval authority rests with the Stadium Owner.

As necessai·y, identify additional questions you might ask-or facts you might gather-in order to fully research this question .

Next, benchmai·k against peer disclosures: Do other companies with similar activities report these contracts as leases?

4.2 Presto Hospitality-Lease Scope Describe the decisions in the Presto Hospitality alTangement that are predeter- mined versus decisions that remain to be made throughout the contract term. These are the decisions that comprise right to direct.

4.3 Presto Hospitality-Lease Scope a. Evaluate how Presto's lease scope assessment would be impacted if the anangement were priced differently. For

example, would you conclude that the atTangement is a lease if the contract is called a Management Agreement and the atTangement is priced such that Presto earns a fixed management fee of $100,000 per year? Assume in that case that all operating profit or loss would be borne by Stadium Owner.

b. What if Presto earns a fixed fee of $85,000 per yeai· + 1 % of gross sales+ 10% of profits? How does this pricing affect your analysis of lease scope?

4.4 Presto Hospitality-Lease Scope A colleague in your accounting policy group came across guidance in Deloitte's lease accounting Roadmap publication that describes a concept of functional independence. Your colleague believes Presto could make the case that its concession stands are not "functionally independent" of the stadium, noting for example that Presto cannot independently market its stands to customers unless those customers have a ticket to enter the stadium. Evaluate the strength of this argument, and describe the implications of taking this position on Presto's accounting.

4.5 Presto Hospitality-Revenue Recognition Assume Presto concludes that its concession agreement with Stadium Co. is not a lease. In that case, apply the five-step revenue process in ASC 606 to this atrnngement. Assume you are evaluating appropriate revenue recognition for the contract and for individual transactions that will ai·ise within the scope of the contract (for example, a sale of a hot dog to a customer in the stadium). Assume a hot dog retails for $6, of which Presto retains 50%.

4.6 Baseball Suites-Lease Evaluation The New York Yankees offer multiyeai· luxury suite licenses to customers, including 3-, 5-, and 10-year Licenses . Customers who sign these license agreements have the right to use a specified suite in the stadium (say, suite no. 25) for the dates specified in the license agreement. Alternatively, customers with a more limited interest or budget can sign up for a partial season (a 20- or 41-game plan) where the customer can specify which games it wishes to view from the suite. While the customer is enjoying the suite, a third-patty conces-

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sionaire (similar to Presto's role) will provide premium food and beverage service to guests in the suite. Evaluate-is a suite license a lease? Assume a customer signs a 20-game license for specified games to occur within a single Major League Baseball season.

Sales Commissions, Writing an Email Assume the New York Yankees pay its sales staff a 2% sales commission 4.7 on each luxury suite license contract signed (such as by a corporate customer) . Research whether this commission payment should be repo1ted as an asset or an expense by the New York Yankees. Craft your response in the form of an email, and assume you ' re responding to a question asked to you by the accounting manager for the Yankees.

Why Documentation Matters A company is evaluating a lease to determine whether it should be classified as a 4.8 finance or operating lease and concludes that it should be reported as a finance lease. However, company accountants realize that a similar lease contract, executed just two years ago, has been accounted for as an operating lease. The company is unable to locate documentation explaining the rationale for the earlier lease's operating classification. Think through this issue. What should the company do ? What lessons can the company learn from this ?

Writing an Analysis-Derivatives Facts: You are a corporate accountant for Theta, Inc . Today's date is l 2/3 l/20X5. 4.9 You 've been asked to review a contract in which Theta agrees to purchase 200 shares ofIBM stock from Delta (seller) in 1 year (on 12/3 l/20x6), for $140 per share. Said another way, Theta has entered into a forward contract for the purchase of stock.

Required: Act as though you are writing just the Analysis section of an issues memo, and research the following ques- tion: Does Theta 's contract with Delta meet the definition of a derivative? In your response, include applicable excerpts and guidance sandwiches that relate the guidance to this fact pattern.

In your research, you need only consider the following paragraphs from the guidance: ASC 815-10-05-4 ASC 815-10-10-1 ASC 815-10-15-83, 15-88, 15-92, 15-96 ASC 815-10-15-119 and 120

In your analysis, include only those paragraphs that are most responsive to this issue. Assume that no scope excep- tions apply.

Drafting an Email, Earnings per Share Your audit team is reviewing the third quaiter financial statements of 4.10 Smirks, Inc ., a publicly traded company. The audit manager, Jason , thinks the client may have omitted an important item and has asked you to reseai·ch whether interim financial statements are required to include eai·nings per share amounts. Prepare an email responding to Jason's question. Comment on any other potential ramifications of Smirks, Inc.' s omission that come to mind, which you can offer to research.

Writing a Sho1t Issues Memo- Inventory Valuation You have been asked to draft a brief issues memo ("to the files") 4.11 analyzing the following issue.

Charles Corp. has leased a mine from which it recently extracted 2,000 kilograms of bauxite (a min- eral used in producing aluminum). Charles Corp. plans to sell the bauxite to aluminum manufacturers. Charles Corp. is analyzing whether its bauxite inventory can be carried at its selling p1ice per ASC 330- 10-35-l 6(b). Assume that quoted market prices are generally available for bauxite, and that the market for bauxite is active.

Using the standard memo fo1mat, analyze whether all necessary conditions are met for the accounting treatment proposed. If assumptions are needed to fully evaluate the guidance, identify those assumptions in your analysis. For this pa1ticulai· memo, you are not required to present alternative treatments; assume for this issue that you have solely been asked to document whether the conditions in ASC 330-10-35- I 6(b) are met.

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Using Nonauthoritative Sources to Supplement Codification Research

Increasingly, standard setters are focused on eliminating "bright-line" accounting guidance

and replacing that guidance with principles-based standards. The revenue recognition

standard (ASU 2014-09) is one such example. The challenge as a practitioner applying

principles-based guidance is that significant judgment is involved ; this can result in compa-

rability being sacrificed .

Enter nonauthoritative resources. As a consultant assisting companies with adoption of

the new revenue and lease standards , I utilize firm guide books (described in this chapter) and

AICPA industry task force whitepapers daily. These publications give me specific examples

of how the guidance applies to fact patterns that (hopefully) mirror those I am facing. While

Continued

After reading this chapter and performing the exercises herein, you will be able to

1. Understand what nonauthoritative guidance is , and understand its potential benefits.

2. Become familiar with the FASB's Conceptual Framework, and gain experience apply-

ing this guidance.

3. Locate the FASB's basis for conclusions in pre-Codification standards and Accounting

Standards Updates.

4. Locate guidance within accounting firm publications and AICPA publications.

5. Understand when peer benchmarking is appropriate and how it is performed.

6. Describe circumstances in which analogy to IFRS may be appropriate.

7. Utilize and properly cite nonauthoritative sources.

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companies must comply with the principles in principles-based standards , it is also important

for companies to apply the guidance consistently with their industry peers.

This chapter will introduce you to key nonauthoritative resources that are indispensable to

performing high-quality accounting research .

Using Nonauthoritative Sources of Guidance

1. What is nonauthoritative guidance, and how is it used?

2. What are some useful sources of nonauthoritative guidance?

• FASB's Conceptual Framework

• Accounting Standards Updates (ASUs) and pre-Codification standards

• Accounting firm resources

• AICPA resources

• Peer benchmarking

• International Financial Reporting Standards (IFRS) as a nonauthoritative source

3. How to properly use-and cite- nonauthoritative sources

Organization of This Chapter Nonauthoritative sources can add a great deal of value to a researcher's understanding of

the Codification, and can provide guidance when the Codification falls short. Understanding

how to use these sources is critical to your skill set as a researcher.

This chapter begins by describing when it is appropriate to utilize nonauthoritative

sources, citing guidance from the Codification that permits the use of these sources in cer-

tain circumstances .

Next, the chapter introduces several important sources of nonauthoritative guidance,

indicating when each source may be used and providing examples demonstrating the use

of each source. The chapter concludes with guidance on how to properly use, and cite ,

nonauthoritative sources.

The preceding graphic illustrates the organization of material in this chapter.

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Understand

NONAUTHORITATIVE GUIDANCE: WHAT IS IT, AND HOW IS IT USED?

L01 what nonauthori- Nonauthoritative guidance is any source of accounting guidance or practice not included within the FASB Codification. (An exception is SEC guidance, which is also authoritative for public companies.) Because nonauthoritative sources are not included tative guidance is, and under-

stand its potential benefits. within the Codification, they are not considered part of GAAP and cannot be relied upon exclusively to support an unmodified (aka, unqualified) audit opinion.

Figure 5-1

Browse path for accessing ASC 105, Generally Accepted Accounting Principles

Codification Topic 105 (Generally Accepted Accounting Principles) explains the relation- ship between authoritative and nonauthoritative accounting guidance. Figure 5-1 illustrates the browse path for accessing Topic 105.

BROWSE System Updates Recently Issued Cross Reference Jom Sections

CODIFICATION Home > General Principles > 105 Generally Accepted Accounting Principles > 10 Overall

l ex 740-10-25 I Gia? General Pnnc1ples •

Presentation

Assets

Liabilities

Equity

Revenue

Expenses

Broad Transactions

Industry

Master Glossary

105 Generali Acee ted Accounting Principles 105 - Generally Accepted Accounting Principles ~

To join all Sections within this Subtopic . click JOIN ALL SECTIONS.

il•IUM+i#Nll•!f~i 1 Collapse I Expand

- 105 Generally Accepted Accounting Principles - 1ooverall

+ 00 Status + 05 Overview and Background + 10 Objectives

Reproduced with permission of the Financial Accounting Foundation.

Because this topic is foundational to understanding the authority of the Codification, you should take a moment to read the following key paragraphs from ASC 105-10.

05-1 This Topic establishes the Financial Accounting Standards Board (FASB) Accounting Standards Codification® (Codification) as the source of authoritative generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants . ...

05-2 If the guidance for a transaction or event is not specified within a source of authorita- tive GAAP for that entity, an entity shall first consider accounting principles for simi- lar transactions or events within a source of authoritative GAAP for that entity and then consider nonauthoritative guidance from other sources. An entity shall not follow the accounting treatment specified in accounting guidance for similar transactions or events in cases in which those accounting principles either prohibit the application of the accounting treatment to the particular transaction or event or indicate that the accounting treatment should not be applied by analogy.

05-3 Accounting and financial reporting practices not included in the Codification are non- authoritati ve. Sources of nonauthoritative accounting guidance and literature include, for example, the following: a. Practices that are widely recognized and prevalent either generally or in the

industry b. FASB Concepts Statements

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c. American Institute of Certified Public Accountants (AICPA) Issues Papers d. International Financial Reporting Standards of the International Accounting

Standards Board e. Pronouncements of professional associations or regulatory agencies f. Technical Information Service Inquiries and Replies included rn AICPA

Technical Practice Aids g. Accounting textbooks, handbooks, and articles.

The appropriateness of other sources of accounting guidance depends on its relevance to particular circumstances, the specificity of the guidance, the general recognition of the issuer or author as an authority, and the extent of its use in practice.

Considering the preceding excerpts from ASC 105-10, respond to the following.

1. What two sources are described in par. 05-1 as authoritative? Explain.

2. ASC 105-10 sets out a sort of decision tree for researchers to follow if authoritative GAAP isn't available for a specific transaction. According to this guidance, researchers should:

First,------------------------------ Then, _____________________________ _

Finally, as you can see, par. 05-3 lists many possible sources of nonauthoritative guidance . This chapter introduces just a few of these sources that you may find most useful as a practitioner.

Benefits of Nonauthoritative Guidance You might be wondering whether it's better to just play it safe, and to steer clear of sources that are not authoritative. However, nonauthoritative guidance can be useful for providing:

• Guidance for issues not addressed by the Codification,

• Interpretive guidance to help researchers understand and apply Codification requirements, and

• Additional context for understanding the intent of Codification guidance.

First, although the guidance included within the Codification is extensive, there are a few rea- sons that it may not offer guidance on every possible accounting issue:

• First, the body of guidance making up the Codification was developed over time, in a man- ner that responded to practitioners' needs as they arose-often, for very specific fact sets. The guidance was never methodically created in such a manner that all pos sible accounting topics or financial statement line items would be addressed.

• Second, transactions are often unique, and it would be impossible for guidance to be on point for every unique set of facts.

Nonauthoritative guidance can assist in addressing these items or transactions not covered by the Codification. For example, assets and liabilities are not defined in the Codification, so research- ers must look to the FASB's Conceptual Framework (a nonauthoritative source) for these definition s. Additionally, very little journal entry guidance is in the Codification; sometimes, researchers might look to firm guidance or even textbooks (assuming they are not outdated) for guidance in translating Codification requirements into entries.

Second, nonauthoritative sources can offer interpretive guidance, or additional expla- nations and illustrations, for complex accounting topics. Accounting guidance can be highly nuanced; that is, while the words in the authoritative literature may seem straightforward, there

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are often hidden areas of judgment involved in applying the guidance. Interpretive guidance can help users identify and understand the nuances and areas of complexity within the Codification.

Third, nonauthoritative guidance can offer additional context for understanding the intent of authoritative requirements. In particular, reading a standard setter's basis for conclusions, located within the original standard, can often be useful in applying guidance requirements in the manner intended by the standard setter.

Don't be afraid to use nonauthoritative sources. Experienced researchers would argue that these sources are often indispensable to their understanding of complex guidance. You just have to learn to use these sources the right way.

Without further ado, let's explore some very important (and useful) nonauthoritative sources.

SOURCES OF NONAUTHORITATIVE GUIDANCE

This section of the chapter introduces the following sources of nonauthoritative guidance:

• FASB 's Conceptual Framework,

• Accounting Standards Updates and pre-Codification standards,

• Accounting firm resources,

• AICPA resources,

• Peer benchmarking, and

• IFRS as a nonauthoritative source of U.S. GAAP.

While many other nonauthoritative sources exist, these are the resources that you'll be most likely to use in practice.

FASB's Conceptual Framework

L02 Become familiar with the FASB's The FASB's Conceptual Framework is a set of principles and objectives that are intend- ed to improve the consistency and quality of accounting standards. This Framework is comprised of the FASB Concepts Statements (CON), also known as Statements of Financial Accounting Concepts (SFAC).

Conceptual Framework, and gain experience applying this guidance.

Figure 5·2

FASB Concepts Statement No. 8

Although issued by the FASB, the Conceptual Framework is not considered authori- tative. Rather, the Concepts Statements can be accessed within the Codification's Other Sources links, or on the FASB website (under Standards).

Figure 5-2 illustrates the most recently issued Concepts Statement, CON 8.

1w1 - • This is described as Statement of St;,ll'mMlt olFinandnl N't'Olluh~~·r~l: -

Cooctptunl Fnuurwork for Fimuk'LAI R«!porting - This statement is part of the Conceptual __ Chapter 1, Tho 00,.CtlVO of Generol Purpo,e

Finllncktl Reporting. and Chapter 3. Oualitativ. Chontcteffsties ol Ust,fvl F,nanda/ lnforrnot,or,

It replaces standards known as FASB ___ .a,..,&..- · o1 (I FASIC:.-,.1 ... ~- No. 1 ....t No., -

Financial AccounUng Standatds Boatd d lho rinanc:e1 Aocounting Fouidakln

Reproduced with permission of the Financial Accounting Foundation.

��

To familiarize yourself with the terminology used to describe the Conceptual Framework, fill in the blanks shown next to Figure 5-2.

The Conceptual Framework primarily serves two purposes:

• First, it gives the FASB a common framework, or language, to guide the development of new standards.

• Second, it's intended to provide practitioners with key objectives and principles to consider in the preparation of financial statements.

These two purposes are illustrated in the following Now YOU Try.

The preamble to CON 8 describes how the Board , and practitioners , might use the Conceptual Framework, as follows:

The Board itself is likely to be the most direct beneficiary of the guidance provided by Concepts Statements. They will guide the Board in developing accounting and reporting guidance by providing the Board with a common foundation and basic reasoning on which to consider merits of alternatives .

. . . The objectives and fundamental concepts [of Concepts Statements] also may provide some guidance [to practitioners] in analyzing new or emerging problems of finan- cial accounting and reporting in the absence of applicable authoritative pronouncements. [Explanation added] 1

Questions:

1. In your own words, and considering the excerpt from CON 8, how is the Conceptual Framework expected to assist the FASB Boarcf?

2. In your own words, and considering the excerpt from CON 8, how might practitioners benefit from using the Conceptual Framework?

Key Standards in the Conceptual Framework You may recall that the FASB 's predecessors (the CAP and APB) were criticized for their failure to develop a consistent framework that would guide the issuance of new standard s. Accordingly, creation of the Conceptual Framework was a key objective of the FASB upon its establishment in 1973 .

The Board moved quickly to issue Concepts Statements No. 1-6 between 1978 and 1985 ; Concepts Statement No. 7, on present value measurement, was issued in 2000. The Board has renewed its focus on the Conceptual Framework in recent years, issuing Concepts Statement No. 8 (Ch. 1 and 3) in 2010, then adding Ch. 8 in 2018.

Today, the Conceptual Framework comprises the following key statements , among others:

I FASB Statement of Financial Accou ntin g Concepts No. 8, Conceptual Framework for Financial Reporting, preamble. September 20 10.

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• CON 8, Ch. 1 and 3: Objectives of Financial Reporting, and Qualitative Characteristics of Useful Financial Information

• CON 8, Ch. 8: Notes to Financial Statements

• CON 5: Recognition and Measurement in Financial Statements of Businesses

• CON 6: Elements of Financial Statements

• CON 7: Using Cash Flow Information and Present Value in Accounting Measurements

Once you start working with these statements, you' II recognize some of the concepts you've been taught since your very first accounting courses. The following Now YOU Try gives you the chance to match concepts with the statement they come from.

Match each of the following phrases to the Concepts Statement that the phrase likely came from (CON 5, 6, 7, or 8) .

Excerpt'

1. The primary objective of general purpose financial reporting is to provide information that is useful to users ........................................... .

2. A full set of financial statements should include: end-of-period financial position , earnings and comprehensive income for the period , periodic cash flows , and changes in ownership .................................................... .

3. Accounting measurements that reflect the present value of future cash flows are generally more relevant than measures reflecting the sum of undiscounted cash flows ... . .... . .. . . .. . . .... .... .... . .. . . .. . . .... .... .... . .. . . .. . . ... ... . .

4. To be recognized , an item must meet four recognition criteria :

• An item must meet the definition of an element under CON 6.

• An item must be measurable.

• Information about the item must be relevant to users.

• Information about the item must be reliable ... . .. . ... . ... . ........ . . .... . .. .

5. Assets are defined as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." ................... .

6. For information to be useful, it must be relevant and a faithful representation ......... .

7. Present value is most relevant when it is calculated based on observable , market inputs .. ....... . .... . .. . .... . .... . .. . .... . .. . .... . .... . .. . .... .. . .

8. Expenses are defined as "outflows or other using up of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods , rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations ." ...... .... .... ... . .. ....... .. ...... ...... ....... ... ... .

· sources for this exercise (footnotes omitted, and underlined emphasis added}:

Likely

Concepts Statement

Number?

- Concepts Statement No. 8, Ch . 1 (The Objective of General Purpose Financial Reporting) , par. 082, and Ch . 3

(Qualitative Characteristics of Useful Financial Information) , par. QC4.

- Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises (CON 5),

par. 13 and 63.

- Concepts Statement No. 6, Elements of Financial Statements (CON 6), par. 25 and 80.

- Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements (CON 7), "Highlights."

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I've seen it in my own students . Their eyes kind of glaze over when we start talking about the Conceptual Framework. But pay attention to this lesson! The concepts in this guidance are foundational to our profession . Even today, the FASB is devoting a great deal of resources to reviewing and refreshing these concepts. Plus , there's a really good chance you'll need to use the Concepts Statements to perform research in practice .

When Should You Use Guidance from the Concepts Statements? Before turning to the Concepts Statements fo r guidance, always first look to the Codification to see whether transaction, or item-specific guidance is available.

That said, the Concepts Statements are, in some circumstances, the only place to find cer- tain guidance. Here are some common circumstances in which the Concepts Statements may be utilized.

• To classify elements of financial statements. The broad meanings of the terms asset, liability, equity, expenses, gains, and losses are not defined in the Codification. For these definitions, you will need to consult CON 6. This guidance contains definiti ons and detailed di scussion of characteristics that are essential to meeting these definitions.

CON 6 is commonly used in determining whether a cost should be classified as an asset or as an expense.

• To understand the computation and obj ectives of present value. Prac titi oners may consult CON 7 fo r guid ance on present value meas urements, but are encouraged to do so only afte r considering present value guidance within ASC 820 (Fair Value Measurement), as discussed furth er in Chapter 8.

CON 7 can be used to understand how present value should be computed.

• To determine whether an event or item should rece ive fin ancial statement recog niti on. In the event that the Codificati on does not address a particular cl ass of tran sacti ons or items, it may be necessary to consult CON S's fo ur recognition criteria (illustrated in the previous Now YOU Try).

CON 5 establishes fo ur fu ndamental recognition crite ria; however, it is not used freq uently in practice.

Let's take a moment now to practice perfo rming research using the Concepts Statements. The fo llowing question s fo cus on applying the definit ions of fin ancial statement elements.

Researching with the Conceptual Framework

Scenarios 1-2: Asset versus Expense

Use the following excerpts from CON 6 to respond to Scenarios 1 and 2 that follow. Notice that CON 6 presents general principles in the body of the standard (e.g. , par. 25-28), while guidance in an appendix to CON 6 (e.g., Appendix B) elaborates on these principles. 2

2 Footnotes to CON 6 references inco rporated in thi s chapter have been omitted.

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Assets

25. Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

Characteristics of Assets

26. An asset has three essential characteristics: (a) it embodies a probable future benefit that involves a capacity, singly or in combination with other assets, to contribute directly or indirectly to future net cash inflows, (b) a particular entity can obtain the benefit and control others' access to it, and (c) the transaction or other event giving rise to the entity 's right to or control of the benefit has already occurred ...

. . . 28. The common characteristic possessed by all assets (economic resources) is "service potential" or "future economic benefit," the scarce capacity to provide services or benefits to the entities that use them. In a business enterprise, that service potential or future economic benefit eventually results in net cash inflows to the enterprise ...

Appendix B: CHARACTERISTICS OF ASSETS, LIABILITIES, AND EQUITY OR NET ASSETS AND OF CHANGES IN THEM

Characteristics of Assets

171. Paragraph 25 defines assets as "probable future economic benefits obtained or con- trolled by a particular entity as a result of past transactions or events ." Paragraphs 26-34 amplify that definition. The following discussion further amplifies it and illustrates its meaning under three headings that correspond to the three essential characteristics of assets described in paragraph 26: future economic benefits, control by a particular entity, and occurrence of a past transaction or event.

Future Economic Benefits

172. Future economic benefit is the essence of an asset (paragraphs 27-31) . An asset has the capacity to serve the entity by being exchanged for something else of value to the entity, by being used to produce something of value to the entity, or by being used to settle its liabilities .

173 . The most obvious evidence of future economic benefit is a market price. Anything that is commonly bought and sold has future economic benefit, including the indi- vidual items that a buyer obtains and is willing to pay for in a "basket purchase" of several items or in a business combination . Similarly, anything that creditors or others commonly accept in settlement of liabilities has future economic benefit, and anything that is commonly used to produce goods or services, whether tangible or intangible and whether or not it has a market price or is otherwise exchangeable, also has future economic benefit. Incurrence of costs may be significant evidence of acquisition or enhancement of future economic benefits (paragraphs 178-180).

174. To assess whether a particular item constitutes an asset of a particular entity at a particular time requires at least two considerations in addition to the general kinds of evidence just described: (a) whether the item obtained by the entity embodied future economic benefit in the first place and (b) whether all or any of the future economic benefit to the entity remains at the time of assessment.

175. Uncertainty about business and economic outcomes often clouds whether or not particular items that might be assets have the capacity to provide future economic benefits to the entity (paragraphs 44-48), sometimes precluding their recognition as assets. The kinds of items that may be recognized as expenses or losses rather than as assets because of uncertainty are some in which management's intent in taking certain steps or initiating certain transactions is clearly to acquire or enhance future economic benefits available to the entity. For example, business enterprises engage in research and development activities, advertise, develop markets, open new branches or divi- sions, and the like, and spend significant funds to do so. The uncertainty is not about

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the intent to increase future economic benefits but about whether and, if so, to what extent they succeeded in doing so. Certain expenditures for research and development, advertising, training, start-up and preoperating activities, development stage enter- prises, relocation or rearrangement, and goodwill are examples of the kinds of items for which assessments of future economic benefits may be especially uncertain .. .

Control by a Particular Entity

183. Paragraph 25 defines assets in relation to specific entities. Every asset is an asset of some entity; moreover, no asset can simultaneously be an asset of more than one entity, although a particular physical thing or other agent that provides future eco- nomic benefit may provide separate benefits to two or more entities at the same time (paragraph 185). To have an asset, an entity must control future economic benefit to the extent that it can benefit from the asset and generally can deny or regulate access to that benefit by others, for example, by permitting access only at a price.

184. Thus, an asset of an entity is the future economic benefit that the entity can control and thus can, within limits set by the nature of the benefit or the entity's right to it, use as it pleases. The entity having an asset is the one that can exchange it, use it to produce goods or services, exact a price for others' use of it, use it to settle liabilities, hold it, or perhaps distribute it to owners ...

Occurrence of a Past Transaction or Event

190. The definition of assets in paragraph 25 distinguishes between the future economic benefits of present and future assets of an entity. Only present abilities to obtain future economic benefits are assets under the definition, and they become assets of particular entities as a result of transactions or other events or circumstances affecting the entity. For example, the future economic benefits of a particular building can be an asset of a particular entity only after a transaction or other event-such as a purchase or a lease agreement-has occurred that gives it access to and control of those benefits. Similarly, although an oil deposit may have existed in a certain place for millions of years, it can be an asset of a particular entity only after the entity either has discov- ered it in circumstances that permit the entity to exploit it or has acquired the rights to exploit it from whoever had them.

191. Since the transaction or event giving rise to the entity's right to the future economic benefit must already have occurred, the definition excludes from assets items that may in the future become an entity's assets but have not yet become its assets. An entity has no asset for a particular future economic benefit if the transactions or events that give it access to and control of the benefit are yet in the future. The corollary is that an entity still has an asset if the transactions or events that use up or destroy a particular future economic benefit or remove the entity's access to and control of it are yet in the future. For example, an entity does not acquire an asset merely by budgeting the purchase of a machine and does not lose an asset from fire until a fire destroys or damages some asset.

Scenario 1: A company purchased 50 hole punchers for its office staff. Each hole puncher cost $5 and should be in service for 5 years or more.

Should the cost of these hole punchers be recorded as an asset or as an expense? Support your answer using references to paragraphs from CON 6.

1. Analysis-Should the hole punchers be recorded as an asset or expense?

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In Scenario 1, note that while you could support your position using only the definition of an asset (par. 25), your answer is stronger if you support your conclusion with excerpts from detailed Appendix B implementation guidance, as well. For judgmental issues, reference to this detailed interpretive guidance can be essential.

Scenario 2: Using the definition and characteristics of an asset above, explain why advertising costs are generally recorded as expenses, rather than as assets.

2. Analysis-Why are advertising costs generally recorded as expenses, rather than as assets?

Be aware that while the Codification does not broadly define assets and liabilities, many Codification topics do define specific assets, such as inventory or receivables. A researcher should only turn to the nonauthoritative, Conceptual Framework definition of assets after concluding that more specific guidance is not available within the Codification.

Scenario 3: Revenues, Expenses, and Gains

CON 6 includes the following guidance defining revenues, expenses, and gains.

Revenues

78. Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering ser- vices, or other activities that constitute the entity's ongoing major or central operations.

Characteristics of Revenues

79. Revenues represent actual or expected cash inflows ( or the equivalent) that have occurred or will eventuate as a result of the entity's ongoing major or central operations. The assets increased by revenues may be of various kinds-for example, cash, claims against cus- tomers or clients, other goods or services received, or increased value of a product result- ing from production. Similarly, the transactions and events from which revenues arise and the revenues themselves are in many forms and are called by various names-for example, output, deliveries, sales, fees , interest, dividends, royalties, and rent--<lepend- ing on the kinds of operations involved and the way revenues are recognized.

Expenses

80. Expenses are outflows or other using up of assets or incurrences of liabilities ( or a com- bination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations.

Characteristics of Expenses

81. Expenses represent actual or expected cash outflows (or the equivalent) that have occurred or will eventuate as a result of the entity's ongoing major or central operations. The assets that flow out or are used or the liabilities that are incurred may be of various kinds-for example, units of product delivered or produced, employees' services used, kilowatt hours of electricity used to light an office building, or taxes on current income. Similarly, the transactions and events from which expenses arise and the expenses them- selves are in many forms and are called by various names-for example, cost of goods sold, cost of services provided, depreciation , interest, rent, and salaries and wages- depending on the kinds of operations involved and the way expenses are recognized.

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Gains and Losses

82. Gains are increases in equi ty (net assets) fro m peripheral or incide ntal tra nsactions of an entity and fro m al l other transacti ons and other events and circum stances affectin g the entity except those that result from revenues or in vestments by owners.

Characteristics of Gains and Losses

84. Gains and losses result fro m entities ' peripheral or incidental transactions and from other events and circumstances stemming from the env ironment that may be largely beyond the control of indi vidual entities and their managements. Thus, gain s and losses are not al l alike. There are several ki nds, even in a single entity, and they may be described or classified in a variety of ways that are not necessarily mutu ally exclusive.

Scenario 3: Assume that a manufacturing company usually pays a waste company (by the pound) to haul away manufacturing waste. Recently, a landfill gas company offered to buy a small portion of the waste for cash , saving the manufacturing facility a portion of its disposal costs and providing it with proceeds from the disposal.

The sale of manufacturing waste is not a primary business activity of the manufacturer; how- ever, it will now result in an inflow of cash.

Which is more appropriate-classifying this transaction as an increase in revenue, a decrease in expense, or as a gain?

3. Analysis-Record the transaction as increase in revenue or decrease in expense? Alternatively, should the transaction be recorded as a gain?

Your first source of guidance in applying revenue concepts should be ASC 606 (the revised revenue standard) . But it's worth noting that this CON 6 definition of revenue served as the basis for the revised definition that now exists in ASC 606 .

Scenario 4: Definition of a Liability

CON 6 includes the following guidance defining liabilities.

Liabilities

35 . Li abi li ties are probable future sacri fices of economi c benefi ts aris ing from present ob li gations of a particular entity to transfer assets or prov ide serv ices to other entities in the fut ure as a res ul t of past transactions or events.

Characteristics of Liabilities

36. A liability has th ree essential characteristics: (a) it embodies a present duty or responsibi li ty to one or more other entities that entai ls settlement by probable fu ture transfer or use of assets at a specifi ed or determin able date, on occurrence of a specified event, or on demand, (b) the duty or res ponsibili ty obligates a par- tic ular entity, leaving it li ttle or no discretion to avo id the fu tu re sacrifice, and (c) the transacti on or oth er event obligating the entity has already happened . Liabi liti es comm only have other feat ures that help identify them-for example, most li abiliti es

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122 Chapter 5 I Using Nonauthoritative Sources to Supplement Codification Research © Cambridge Business Publishers

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require the obligated entity to pay cash to one or more identified other entities and

are legally enforceable. However, those features are not essential characteristics of

liabilities. Their absence, by itself, is not sufficient to preclude an item 's qualifying

as a liability. That is, liabilities may not require an entity to pay cash but to convey

other assets , to provide or stand ready to provide services, or to use assets. And the

identity of the recipient need not be known to the obligated entity before the time

of settlement. Similarly, although most liabilities rest generally on a foundation of

legal rights and duties, existence of a legally enforceable claim is not a prerequi-

site for an obligation to qualify as a liability if for other reasons the entity has the

duty or responsibility to pay cash, to transfer other assets, or to provide services to

another entity. [Footnotes omitted]

Scenario 4: Consider the following case excerpt from the FASB's discussion materials related to the existing CON 6 liability definition: 3

Suppose a hospital has carried out a routine operation during which the patient died. If the patient's death was the result of hospital negligence, it is highly probable the hospital will

have to pay compensation to the patient's dependents . The cause of death has not been

established .

. . . Is a present obligation created when:

a. the hospital determines it has been negligent?

b. the executors of the patient's estate assert negligence occurred?

c. a court concludes that negligence has occurred?

Reproduced with permission of the Financial Accounting Foundation.

4. Analyze this issue.

The Conceptual Framework Today Today, the FASB is taking a fresh look at several areas of the Conceptual Framework, including

presentation concepts and measurement, and the Board is revisiting the definitions of financial

statement elements, with a particular emphasis on liabilities and equity definitions.

Eventually, the FASB hopes to replace all of its existing Concepts Statements with a single

document (CON 8), which is expected to read like a chapter book. So far, as you've seen, Chap-

ters 1, 3, and 8 ( Objectives , Qualitative Characteristics, and Notes to Financial Statements) have been completed.

As part of this project, the Board also expects to reconsider the authoritative status of the

Conceptual Framework, and may eventually decide to elevate the Conceptual Framework to

authoritative GAAP. 4

3 FASB, Financial Reporting Issu es Conference Materials (20 16), Case 1 (the Hospital).

4 Proposed Statement of Financial Accounting Concepts, Conceptual Framework-Chapter 8: Notes to Financial Statements. March 4, 2014 . Par. Pl I.

��

Accounting Standards Updates and Pre-Codification Standards

The second nonauthoritative source we will cover is FASB's Accounting Standards Updates and pre-Codification standards. Lo3 Locatethe FASB's basis for • The term Accounting Standards Updates (ASUs) refers to the guidance periodi-

cally issued by the FASB for the purpose of making changes to the Codification. AS Us are not considered authoritative in their own right.

conclusions in pre-Codification standards and Accounting Standards Updates.

• Pre-Codification standards refers to all GAAP that predates the Codification. For exam- ple, all then-effective FASB Statements, EITF Abstracts , APB Opinions, and Accounting Research Bulletins were used to populate the Codification in 2009, then were superseded when the Codification became effective.

It's worth taking a moment to understand these resources. In some cases, these standards contain content relevant to a topic, but which was deemed "nonessential" and not carried forward by creators of the Codification. Following are three circumstances in which these resources can be useful:

• To read a standard setter 's basis for conclusions-In most cases, the Board's basis for reaching its conclusions on each standard has been omitted from content moved into the Codification. Understanding the rationale for Board decisions can often be useful in apply- ing standards in the manner intended by the Board.

• To access grandfathered content-This is guidance which is no longer effective for new transactions, but which companies are allowed to continue following if they were already, as of the Codification's effective date in 2009, accounting for a transaction using this guidance.

• To locate historical guidance-This is guidance that applied in the past, but that has since been superseded. Practitioners may need to read historical guidance when dealing with restat- ed (historical) financial statements, or in order to understand prior guidance requirements .

Accounting Standards Updates Let's take a moment to further discuss ASUs . Each ASU begins with a summary of its key provisions and an explanation of why the Codification is being updated. Next, each ASU details the changes it will make to the Codification, then describes the Board's rationale (its basis for conclusions) .

Figure 5-3 depicts the cover (at left) and an excerpted page (at right) from a sample ASU.

FINANCIAL ACCOUNTING SERIES

This is ASU No. _ ___ .,.,__ ________ N,.,,,,.,, April2016

It amends Topic ____ in ----- RevcnucfromContractswithCustomers

(Topic 606)

the Codification.

The purpose of this ASU is to clarify Topic 606 guidance related to Identifying ...

--- Jdentif}ingPerfonnanceOl>ligationsandLicensing

Financial Accounting Standards Board

Reproduced with permission of the Financial Accounting Foundation .

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Figure 5-3

Sample ASU cover and excerpts

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124 Chapter 5 I Using Nonauthoritative Sources to Supplement Codification Research © Cambridge Business Publishers

Now

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Now

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Group." The FASB issued this ASU in order to clarify and enhance certain provisions originally included in Topic 606.

Notice the following about this ASU:

• On the cover, notice how this guidance is described as "An Amendment of the FASB Accounting Standards Codification."

• On the excerpted page, notice how changes to existing Codification content are marked. Underlined text reflects new Codification requirements; strike-outs reflect deleted content.

To improve your familiarity with ASUs, take a moment to complete the following Now YOU Try.

1. Fill in the blanks beside the ASU cover in Figure 5-3.

2. Broadly, what issue does this guidance clarify in the Codification?

To identify the ASUs that have resulted in changes to a given topic, consult the topic 's Sta- tus section (-00) or use the Cross-Reference feature .

Pre-Codification Standards We will use a Now YOU Try to illustrate the use of a pre-Codification standard.

Using Pre-Codification Standards

ASC 730-10 (Expenses-Research and Development) requires that certain elements of research and development costs shall be expensed as incurred. One such element is described as follows:

25-2(a). " .. . the costs of materials, equipment, or facilities that are acquired or constructed for a particular research and development project and that have no alternative future uses (in other research and development projects or otherwise) and therefore no separate economic values are research and development costs at the time the costs are incurred."

That is, if a physical structure is built as part of a research and development activity, but has no future use, that structure may not be capitalized as an asset.

A researcher wanting more background on this requirement could consult FASB Statement No. 2, Accounting for Research and Development Costs (FAS 2). This is the pre-Codification standard that cross references to ASC 730. Appendix B (Basis for Conclusions) of FAS 2 states:

33. Consideration was given to the alternative that the costs of materials, equipment, or facilities that are acquired or constructed for a particular research and development project and that have no alternative future uses .. . be apportioned over the life of the project rather than treated as research and development costs when incmTed. The Board reasoned, however, that if materials, equipment, or facilities are of such a spe- cialized nature that they have no alternative future uses, even in another research and development project, those materials, equipment, or facilities have no separate eco- nomic values to distinguish them from other types of costs such as salaries and wages incurred in a particular project. Accordingly, all costs of those materials, equipment, and facilities should be treated as research and development costs when incurred.

Continued

Continued from previous page

Questions:

Chapter 5 I Using Nonauthoritative Sources to Supplement Codification Research

1. Explain the Board's rationale for requiring that materials, equipment, and facilities with no

alternative future use be expensed as incurred. Did this add value to your understanding of

par. 25-2 in the Codification? Explain.

2. How would a researcher know that ASC 730 cross references to FAS 2?

Accounting Firm Resources

125

Within major public accounting firms, a handful of employees often act as technical accounting specialists, who specialize in one or several technical topics and work to educate other members of the firm on proper application of the topic. These individuals are often in the firm 's national office or may be part of an accounting advisory group. As illustrated in Figure 5-4, specialists might include, for example, a "securitization special-

Lo4 Locate guidance within account- ing firm publications and AICPA publications.

ist" or a "leasing specialist." In addition to advising peers and clients, technical specialists often write interpretive guid-

ance for their firm and for clients ' use in applying complex topics. This guidance frequently offers plain-English discussion, interpretation, and examples of guidance found in the Codification. In certain cases, firm specialists may "clear" any highly judgmental interpretations with the FASB staff before their issuance, to ensure that Codification requirements are correctly interpreted.

We just had a client restate for

reflecting a secured borrowing as an asset sale. I can help review

Resources commonly issued by firm technical specialists include:

• Firm research databases (clients of the firm must log in to view content)

• Firm-published guide books by topic

• Technical accounting alerts and "hot topics" whitepapers

Additionally, firm auditors may have access to the following useful resources:

• National office consultation databases (certain audit firms maintain records of inquiries submitted to their national office)

• Auditor 's verbal inquiries of his or her peers (how are other clients in this industry handling this issue, or interpreting this new guidance?)

We will discuss each of these resources in turn.

Figure 5-4

Specialists you might find within public accounting firms

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126 Chapter 5 I Using Nonauthoritati ve Sources to Supplement Codification Research © Cambridge Business Publishers

Figure 5-5

Homepage: PwC 's Inform database

Now

YOU Try

5.8

Research Databases Several large pu blic accounting fi rms maintain online accounting and auditing research data- bases for the benefit of their empl oyees, cli ents, and paid public subscribers. These databases are ge nerall y free of charge to firm employees; all other users are charged a subscripti on fee (but free 30-day tri als are often ava il abl e). These research databases prov ide users with access to the FAS B Codifi cation, along with auditing guidance, SEC guidance, and firm-generated interpreti ve guidance.

Firm databases include, for example:

Research databases from other providers

include:

• Deloitte Accounting Research Tool (DART) • AICPA's Online Professional Library • EY Atlas • CCH's Accounting Research Manager • KPMG Accounting Research Online (ARO) • PwC Inform • Grant Thornton 's Client Experience Portal

Many of the research databases just named also contain accounting manuals published by the fi rm sponsoring the database. These manu als ofte n present requi rements directly fro m the Codification, followed by the firm's own interpreti ve guidance. Accounting manuals are ge nerall y organi zed by topic (simil ar to the Codifica ti on's organi zati on) and can be searched li ke the Cod ifi- cati on (i.e., via keyword or browse searc hes). Accounting manuals include, for example:

• EY's Accounting Manua l

• PwC's Accounting and Reporting Manual (ARM)

Many users of firm acco unting manuals become so comfo rtabl e with the pl ain-Engli sh deli very of the content th at they co nsult these manu als even before searching the Codificati on.

Fi gure 5-5 includes an image fro m the homepage of PwC Inform and may be helpful in unders tanding how content within fi rm research databases may be organi zed. In thi s screenshot, notice that researchers can browse (us in g the left-hand nav igati on panel) to the FASB Codifi- cati on, PwC material, AICPA and SEC materi al, and so on. Using the Search tab (see circl e), researchers can search for content within spec ifi ed materi als.

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1. Using the homepage of PwC Inform (illustrated in Figure 5-5) , show how you would search for the phrase debt extinguishment within the "FASB Codification" branch .

2. Next, use Figure 5-5 to show how you would search for PwC interpretive guidance related to this phrase (debt extinguishment) .

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Continued from previous page

3. Where, within the browse options (at left), would you expect to find the FASB Concepts Statements?

Guide Books In addition to maintaining research databases, major public accounting firms also frequently write topic- specific guide books. These guide books are intended to provide interpretive guid- ance and illustrative examples for complex accounting topic s (such as those li sted under "Broad Transactions" in the Codification).

Firm guide books may be nonauthoritative, but they are incredibly useful. Technical accoun- tants-both in the Big 4 and in industry-frequently refer to guide books published by their own firm or auditor, or by other firms, for guidance on complex issues. Put yourself in their shoes-imagine how helpful it must be to find a firm example that is directly on point to your research question!

Examples of guide book topics include

• Lease accounting

• Consolidation

• Revenue recognition

• Fair value measurement

• Stock compensation

• IFRS/U.S. GAAP similarities and differences

Some firms even publish guide books summarizing the recent year's SEC comment letters to public companies , as depicted in Figure 5-6 .

At left: EY 's derivatives Financial Reporting Developments publication , at 575 pages plus appendices, offers extensive interpretive guidance . At right : Deloitte's SEC Comment Letters guide book is published annually, to summarize comments and questions sent by the SEC to financial statement preparers .

rlniJ11Cla1reportlnQcleYelopments

Derivatives and hedging

5 Thi s publication contain s general information onl y and Deloitte is not, by means of this publi catio n, rendering accounting, business, financial , investment, legal, tax , or other professional adv ice or services. This publicati on is not a substitute for such professio nal adv ice or services, nor should it be used as a bas is for any decision or acti on that may affect your business. Before making any dec ision or tak ing any action that may affect yo ur bu siness, you should consult a qualified professional advisor.

• Deloitte shall not be respo nsible for any loss sustained by any pe rso n who relies on this publication.

• As used in thi s document, "Deloitte" means Deloitte & Touche LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/abo ut for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain serv ices may not be avail able to attest clients under the ru les and reg ulations of public accounting.

Figure 5-6

Sample accounting firm guide books

-�1 128 Chapter 5 I Using Nonauthoritative Sources to Supplement Codification Research © Cambridge Business Publishers

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Figure 5-7

Example accounting firm whitepapers-PwC's In Depth and KPMG's Defining Issues series

Firm guide books are often daunting in size. However, they generally include a very detailed table of contents, and are often organized somewhat like the Codification (e.g., scope issues, fol- lowed by recognition, and so on). Start with the table of contents when reviewing a guide book; from there, you can often jump to the exact issue you need to research.

One great thing about accounting firm guide books is that they are frequently availab le for free on the Internet. Search for them by naming the topic, the word "guide," and the firm name. For example, a Google search for "Accounting for income taxes guide Deloitte," will direct you to Deloitte's 781-page guide on this topic.

Google accounting for income taxes guide deloitte

Google and the Google logo are registered trademarks of Google Inc., used with permission.

In some cases, a no-cost login may be required to view these guides (such as for EY materials). These guide books are also usually available within firm research databases.

EY's guides are referred to as Financial Reporting Developments, and Deloitte's guides are referred to as the Roadmap series. When searching Google for these guides, you might want to substitute these terms ("Financial Reporting Developments," or "Roadmap") for the word guide.

Accounting Firm Technical Updates I Whitepapers Guide books and accounting manuals take time to develop. For issues that are emerging, or that deal with newly issued guidance, practitioners often turn to firm whitepapers and technical alerts.

PwC's In Depth and KPMG's Defining Issues series, illustrated in Figure 5-7 , address emerg- ing implementation and standard-setting issues.

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--·--------·----- Image at left:© Pricewaterhouse Coopers LLP ("PwC"). Not for further reproduction or use without the prior written consent

of PwC.

Image at right: Reprinted from "Defining Issues - FASB proposes clarifications and technical corrections to the new leases standard", Copyright:© 2018 KPMG LLP, a Delaware limited liability partnership and a member firm of the KPMG network

of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All

rights reserved.6

Firms frequently distribute these emerging issues whitepapers by email; simply sign up for tech- nical accounting alerts on the accounting firm's website, and you will be alerted as the firm issues new interpretive guidance. Chapter 14 provides additional strategies for selecting email subscriptions.

6 All inform ation provided is of a general nature and is not intended to add ress th e circumstances of any parti cul ar indi vidual or entity. Although we endeavor to provide accurate and timely inform ation, there can be no guara ntee that such infonn ation is acc urate as of the date it is recei ved or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice aft er a thorough exa mination of the fa cts of a parti cul ar situation. For additional news and information , please access KPMG 's global Website on the Internet at http ://www.kpmg.com.

1 © Cambridge Business Publishers Chapter 5 I Using Nonauthoritative Sources to Supplement Codification Research 129

Auditor Inquiry Auditors are often able to avail themselves of additional sources of interpretive guidance, described next.

• Some firms maintain a database of inquiries received by their national offices. In some cases, auditors are able to search this database to determine whether a specific client inquiry has been previously addressed by the national office.

• Auditors are frequently able to make verbal inquiries of their peers, to understand how other clients in an industry are handling a specific issue. For example, if an auditor is addressing a question at Healthcare Company A, he may contact his colleague who performs the audit of Healthcare Company B to ask how the client plans to address the same issue. This practice is generally acceptable as long as the auditors are not sharing confidential or nonpublic information.

When (and How) Should You Use Accounting Firm Resources? Accounting firm guidance can be used either as a starting point for research or as additional sup- port for your reading of the Codification. As noted previously, some researchers routinely begin their searches with firm manuals. Others may tum to firm guidance only as needed to search for examples of application issues or Q&As.

However you use firm guidance, bear in mind these two notes of caution:

1. Your primary support for accounting positions must still always be authoritative guidance. Nonauthoritative sources can play a supporting role, at best, in your accounting issues memos.

2. The firm guidance you are reading could be outdated. The FASB continually issues new ASUs that change the content in the Codification, and accounting firm publications may have a lag in reflecting these changes. Therefore, once you find relevant firm guidance, always go back to the Codification to confirm that the guidance you are relying on is still current, then quote from the Codification when possible.

That is , researchers who start their searches with firm guidance should establish a practice of going back to the Codification to pull authoritative excerpts for their accounting memos. It is not okay to cite firm excerpts where Codification excerpts are available.

Caution-As with other sources of nonauthoritative guidance, firm guidance is helpful for interpreting the Codification, but it should not replace your use of authoritative guidance. Guidance citations in accounting memos should primarily come from authoritative sources.

Imagine that you work for a beverage maker that has just sold its diet soda division, and you are evaluating whether the gain on sale should be reported as related to a discontinued operation. Following is guidance from ASC 205-20 (Presentation of Financial Statements-Discontinued Operations) describing when a disposal shall be reported in discontinued operations:

45-lB A disposal of a component of an entity or a group of components of an entity shall be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity 's operations and financial results when any of the following occur:

... b. The component of an entity or group of components of an entity is disposed of by sale .... 7

You've determined that the division qualifies as a component of an entity. Next, you need to evalu- ate whether the disposal represents a strategic shift that will have (or has had) a major effect on

Continued

7 Notabl y, this excerpt reflects pending content, issued in ASU 2014-08 (Reporting Di scontinued Operations).

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130 Chapter 5 I Using Nonauthoritative Sources to Supplement Codification Research © Cambridge Business Publishers

Figure 5·8

Excerpted Contents page from EY's Discontinued Operations Financial Reporting Developments publication

Continued from previous page

operations or financial results. You wonder: Can the significance of the gain on sale of the division be used to evaluate whether the disposal had a major effect on operations or financial results?

Questions:

1. Use the table of contents from EY's Discontinued Operations (October 2017) Financial Reporting Developments publication in Figure 5-8. Where might you start your search for interpretive guidance on this issue?

Contents

1 Overview and scope .... . . . . . . . . . . . . . .. .. . ... . . . . . . . . . . . . . .. . . .. .. . ... . . . . . . . 1 .1 Overview . . ...... .. ........ . ..... ..... . 1.2 Scope. . . . . . . . . . . . . . .. ......... .

2 Criteria for reporting discontinued operations ....... . .. . . . . .. .. .. . . . . .. . . ... .. . . 2.1 Criterion 1: Component of an entity ............... . ... . .

2.1.1 Measurement of a component of an entity . .

2.2 Criterion 2: Held for sale criteria ....

2 4 5 5 6

2.2 .1 Dispo sed of by sa le or other than by sale . . . .. . . . . . . . . . ... . .. .. . .. . .. . . .... 13

2.3 Criterion 3: Strategic shift. ..14

2.4 Illustrations . . ...................... 15

2.5 Newly acquired businesses and nonprofit activities . . . 17 2.5 .1 Held for sa le criteria for a newly acquired business or nonprofit activity . . . 18

2.6 Changes to a plan of sale. . 19 3 Reporting and disclosure. . .... 21

3.1 Reporting discontinued operations ..................................... ... .... 21 3. 1.1 Income statement presentation for real estate investment trusts (REIT) ............ 24

3.2 Adjustments to amounts previously reported in discontinued operations . . . . 24 3.2.1 Classification and disclosure of contingencies relating to discontinued operations .... 25

2. Describe how you would go about locating this guide book.

3. What cautions would you exercise when relying upon a firm guide book?

AICPA Resources The AICPA offers a number of nonauthoritative resources which can be useful to practitioners. These include (1) a non-GAAP reporting framework for small- and medium-sized nonpublic entities and (2) interpretive guidance to assist practitioners in applying U.S. GAAP. We will disc uss each of these in tum.

The FRF for SMEs Issued in 2013, the AICPA's Financial Reporting Framework for Small- and Medium-Si zed Entities ("FRF for SMEs" or the "Framework") offers an alternative to the use of U.S. GAAP for small- and medium-sized entities and responds to concerns that U.S. GAAP is currently too com- plex for certain private companies to apply. In fact, prior to the issuance of this Framework, certain private companies even elected to receive qualified opinions from their auditors, rather than com- plying in full with current U.S. GAAP. For their part, these companies ' lenders and creditors would often accept these qualified opinions, understanding the high costs of full U.S. GAAP compliance.

The FRF for SMEs is expected to benefit certain preparers by providing a more concise, simple reporting framework with fewer required disclosures. The Framework is considered an other comprehensive basis of accounting (OCBOA), meaning a reporting framework that is not GAAP; use of this framework is entirely optional for preparers.

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Notably, this framework does not replace the work of the FASB 's Private Company Coun- cil, which advocates for including simplified alternatives within authoritative GAAP for private companies.

Unlike other nonauthoritative resources discussed in this chapter, which assist in interpreting GAAP, the FRF for SM Es is an alternative to GAAP, and is expected to be most useful to com- panies whose lenders or other creditors will accept non-GAAP financial statements.

Other AICPA Resources Other nonauthoritative resources from the AICPA include the following:

• AI CPA Audit and Accounting Guides ("A&A Guides")-These guides interpret and provide practical accounting and auditing guidance to practitioners. A&A Guides are available for certain industries (e.g., Healthcare, Airlines) and certain accounting topics (e.g., Revenue Recognition). See Figure 5-9. The AICPA also issues Audit Guides (e.g., Audit Sampling) and Accounting and Valuation Guides.

• U.S. GAAP Financial Statements-Best Practices in Presentation and Disclosure-This publication compiles examples from the disclosures of hundreds of public companies, as well as statistical data summarizing disclosure trends. Formerly known as Accounting Trends and Techniques, this publication is intended to save corporate accountants and auditors the effort of searching for examples of how other preparers are complying with accounting and disclosure requirements.

• Technical Hotline-The AICPA offers this sort of "advice hotline" on matters including the application of accounting and auditing guidance to complex issues. Practitioners can call or email their questions into the Technical Hotline service, but only after doing their own research and involving the highest levels of their own organizations. The AICPA technical staff will provide its views; these views do not represent official positions of the AICPA.

Small businesses and small or regional CPA firms, which may not have a national office to serve as a resource for such complex questions, may find the AICPA Technical Hotline to be a valuable resource when they have exhausted their internal options.

• AICPA Technical Questions and Answers-Developed in large part based on inquiries received through its Technical Hotline service, the AICPA often posts Q&As on its website addressing recent accounting and auditing questions it has received. This publication periodi- cally compiles these Q&As.

A'-' DI T • A(COU'Cf l 'fG

GUIDE

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Figure 5-9

AICPA's Audit and Accounting Guide, Revenue Recognition (2018)

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132 Chapter 5 I Using Nonauthoritati ve Sources to Supplement Codification Research © Cambridge Business Publishers

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5.10

Los Understand when peer benchmarking is appropriate and how it is performed .

Utilizing AICPA Resources

Each AICPA resource described above serves a different function . Identify the AICPA resource that might best fit each scenario described next.

Situation • ' Amy is new to the audit team of a healthcare entity and is seeking a resource that will assist her in understanding industry-specific accounting and auditing matters. Explain. 1.

Doug works in the 10-K reporting group at a mid-sized corporation. For years , his team has "rolled forward" the company's pension disclosure, updating numbers but making few changes to content. The company's Controller has asked his team to revisit and improve upon this disclosure. Doug wants to review other companies' approaches to this disclosure. Explain. 2.

After extensive research , the CFO of a small company has hit a dead-end on determining the appropriate accounting treatment for a complex transaction. His accounting firm does not have specialists in this area. He'd like a sounding board for resolving this issue. Explain. 3.

Peer Benchmarking

Often, it is not enough to simply apply GAAP correctl y; compani es and their auditors also want to be sure that what they' re reporting is consistent with how other compani es are addressing the sa me issues.

Peer benchmarking is a common prac ti ce in whi ch companies (and their auditors) review the reporting an d discl osures of others within the co mpany's industry. Bench- marking is particul arl y relevant fo r compani es interested in seeing how th eir peers or

other early adopters have implemented the latest FASB guidance. It is also useful fo r co mpani es wanting to identify best practi ces, or to ensure consistency with their peers' methods fo r di sclos- in g items or transactions.

As di scussed earlier in this chapter, the AICPA's Best Practices publi cati on summari zes di s- cl os ures from hund reds of companies. However, thi s publication is not customi zed by industry; compani es often need to hand- select the peer group companies that they compare to (e.g., sam e industry, same size).

Search for Company Filings Th rough its Edgar database, the SEC prov ides free access to all public filin gs, including compa- nies' annu al (10-K) and qu arterl y (10-Q) reports. This database is as "real time" as it gets-fil- ings are generally avail able and searchable to the public immediately upon their receipt by the SEC. Individu als can searc h for filings by company or by keyword.

Figure 5-10 illustrates two methods for searching the SEC website (www.sec.gov):

• First, a researcher can search for SEC documents using the keyword search box at top right. However, thi s may not show all co mpany filing res ults. For these, click the "Company Filings" link just below the search box.

• Alternatively, a researcher can navigate to "Filings" then "Company Filings Search" to view additional search options.

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U.S. SECUR ITI ES AND EXCHANGE COMMISSION

The Edgar database is available free of charge; however it allows for only one search at a time, and only includes public companies. Companies desiring additional functionality can pay a fee to subscribe to professional research databases , such as LexisNexis, Mergent Online, or S&P Global Market Intelligence. These databases offer advanced search options, including searches by industry, within a predefined peer group, and searches of private company financial statements .

Corporate annual and quarterly reports are also generally available on companies' websites, often through the link "Investors" or "Investor Relations." Figure 5-11 shows the link on Conoco Phillips' website to its public filings.

Used with permission by ConocoPhillips.

Following is an example illustrating one form of peer benchmarking.

EXAMPLE

Imagine your client is in the banking industry and is evaluating whether the fair value hierarchy f\ 1

levels (1, 2, or 3) it has disclosed, in accordance with ASC 820 (Fair Value Measurements), are consistent with others in its peer group. To provide context to your client's decision , you prepare a brief summary of fair value hierarchy disclosures from the peer group's annual repmts. An excerpt of your analysis is shown next.

Continued

Figure 5-10

Searching company filings on the SEC website

Figure 5-11

Navigating to Conoco Phillips' public filings , through its Investors page

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Equity U.S. Treasury and Corporate Asset-Backed Company Securities U.S. Agency Securities Bonds Securities

Bank A . . .. ... .. .. . 1 1, 2 2 2,3

Bank B . ...... .. ... 1 1, 2 2 2

Bank C .. . .. . .... . . 1 1, 2 2 2

...

Using this summary, your client can more clearly determine whether its disclosures are consistent with its peers'.

Form 10-K filings can be lengthy. To skip directly to the financial statements within these fil- ings, use the link within the table of contents (generally located within the first few pages of the filing) to jump ahead to Item 8-Financial Statements and Supplementary Data.

Review of SEC Comment Letters In addition to searching company filings, a review of SEC correspondence, including company responses to SEC comment letters, is another valuable means for understanding peer companies' rationale in selecting or applying accounting policies.

For example, consider the following response from Alphabet Inc. to an SEC comment let- ter, regarding Alphabet 's level of disaggregated revenues disclosed in accordance with ASC 606 (Revenues).

SEC comment: Please provide us with a more specific and comprehensive discussion of what consideration you gave to presenting your advertising revenues on a more disag- gregated basis [under ASC 606) ...

Alphabet response: In accordance with ASC 606-10-55-90 (b) and (c), we considered the information provided to our Chief Operating Decision Maker ("CODM") for evaluating performance of operat- ing segments and other information used to evaluate our financial performance or make resource allocation decisions when assessing the appropriate categories for disaggregated revenue disclosures .

Our CODM, Alphabet's Chief Executive Officer, Larry Page, is responsible for mak- ing decisions about resources allocated to, and assessing the performance of, our operating segments. The following information is regularly provided to our CODM to evaluate per- formance of operating segments: • Operating results (e.g., revenue and operating income) of Google in total on a weekly

and quarterly basis; • Operating results of Other Bets in total on a weekly basis; and • Operating results for each individual Other Bet on a monthly and quarterly basis.

Additionally, our CODM and Board of Directors receive quarterly revenue information for specific product areas within Google, including Advertising, Google Play, Google Cloud and Hardware. This reporting includes disaggregation of advertising revenues by platform (e.g., desktop), and property (e.g. , YouTube). We note that our CODM does not evaluate performance or allocate resources to the individual product areas within the Google operat- ing segment.

Furthermore, segment managers regularly review operating results by product area for their respective segments. For example, Google's CEO Sundar Pichai , the Google segment

Continued

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manager, receives Google operating results disaggregated by product area (e.g., Ad ve rti sing, Google Play, Google Cloud , Hardware), including disaggregation of Ad vertising (e.g., Search, Di splay, YouTube).

We believe that disaggregation of revenues fo r Google Play, Google Cloud, Hardware and individual Other Bets is not necessary due to the relative significance of such revenues at this time in the context of our overall business. We continually monitor the significance of these revenues for disaggregation.8

Considering the SEC comment, and Alphabet's response , respond to the following.

1. What is the concern (or question) being raised by the SEC?

2. What additional information did you learn about how Alphabet's management evaluates its operating segments? Who is the CODM at Alphabet?

3. Provide your thoughts: In what circumstances might a fellow financial statement preparer or auditor find this type of correspondence between the SEC and Alphabet useful?

To locate public company correspondence with the SEC:

1. Go to Company Filings on www.sec.gov, then search for a compan y. In the fi eld fo r Filing Type, ty pe in CORRESP.

Or, if you are searching for a particular term (e.g., "estim ated selling price*") within SEC/ company correspondence, try a full-text, advanced search on the SEC website. Access the fu ll-text search by clicking "Search for Company Filings" then "full-text" on the left-hand nav igation panel.

Figure 5-1 2 illustrates such a search. Use an asterisk * to allow search results with stemming (price, prices, priced) and quotation marks for exact phrases ("estimated selling price*").

Full-Text Search

This page allows you to search the full text of EDGAR filings from the last four years. The full text of a filing includes all data in the filing as well as all attachments to the filing. To find the information you need and make your search easy and enjoyable, please visit our .EAQ page. We are still developing this feature, and we plan to enhance it based on user feedback. Please email your comments and suggestions for improvement to ~~g~.

Note: Occasionally, some recent filings are not avai lable through the EDGAR Full-Text Search.

Search For Text: ldisagg regat* I Basic Search Pag.e. ;==============~~__J In For m Type : l CORRESP • l Results Per Page: IT£:::::] Sort By: l Date (Latest First) Use Stemming : l!J For (!i' Company Name:

Or , Centra l Index Key (CIK): [ Enter full or parti~l Company N~me '

Or l Standa rd Industrial Cla ssi fi ca tion: ~A_II _SIC_s ______________ ~ Between These Dates:

Start Date: l_m_m_/ _dd-/-yy_y_y ____ l G End Date: lmm/ dd/yyyy I Ii] ~-~~---~

I Search 11 Reset I

8 Alphabet Inc. response to SEC co mment letter, dated October 16, 2017. Written by Josh Paul , Alphabet Inc . Director of Acco unting.

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Figure 5-12

Sample full-te xt search for SEC comment letters

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In the Form Type field, you can select UPLOAD to view SEC comments, or CORRESP to view company responses plus SEC comments.

2. Alternatively, researchers with access to advanced research databases may have more advanced search options . Audit Analytics intelligence service, for example, allows its sub- scribers to search for SEC correspondence by Codification citation, company name, topic, date range, and so on. A researcher could type ASC 606-10 into the database to be directed to this Alphabet comment letter (and other comment letters on this subtopic).

A Few Final Thoughts on Peer Benchmarking Remember, of course, when performing peer benchmarking, that companies should always consider their own individual circumstances when determining what level of reporting and dis- closures are appropriate and meaningful to investors.

Also, a note of caution: Just because your peers are disclosing an item in a certain way, that doesn't mean that their reporting complies with GAAP. There is always a chance that your peers are misinterpreting GAAP. Keep in mind that your responsibility, first and foremost, is to comply with the authoritative requirements of the Codification. Consistency with your peers should be secondary to that responsibility.

International Financial Reporting Standards (IFRS)

Lo& Describe cir-cumstances in which analogy to IFRS may be appropriate.

Recall from our earlier discussion of ASC 105 (Generally Accepted Accounting Principles) that it is acceptable for companies following U.S. GAAP to consult IFRS when authoritative GAAP does not address a particular issue. In such instances, IFRS would be considered a nonauthoritative source of guidance.

When Should You Use IFRS as a Source of Guidance? References to IFRS should be rare for most U.S . preparers. Given that IFRS guidance strives to be principles-based, it is generally rare for IFRS guidance to offer clarity where U.S. GAAP falls short.

When possible, before turning to IFRS, a researcher should try to resolve his or her issue using U.S. GAAP. For example, if a researcher does not find guidance within the Codification, the researcher might next search for guidance within nonauthoritative U.S. sources, which may offer interpretive guidance on how to analogize other U.S. literature to the issue.

When researchers do utilize IFRS guidance, they should cite it as they would cite other nonauthoritative sources. That is, ideally, the guidance should be used in addition to Codification excerpts. This demonstrates to readers of your accounting memo that the IFRS guidance you are relying on is consistent with broad principles presented under U.S . GAAP.

Researchers pointing to IFRS requirements, in the absence of directly applicable U.S. GAAP, are said to be analogizing to IFRS guidance. This means that authoritative guidance for the researcher 's specific transaction is not available or does not address a particular nuance of the transaction . Therefore, the researcher must rely on specifics within IFRS guidance that is based on similar transactions or principles.

EXAMPLE

Referencing IFRS Guidance "By Analogy" When companies build new manufacturing facilities , they often pe1form test production rnns to

test the facility's ability to produce its intended product. You are researching whether the cost of a

test production rnn can be capitalized as part of the prope1ty, plant, and equipment (PP&E) .

U.S. GAAP's guidance is vague on the issue of which costs may be capitalized as PP&E:

... the historical cost of acquiring an asset includes the costs necessarily incu1Ted to bring it to the condition and location necessary for its intended use.9

Continued

9 ASC 360-10-30-1 (Property, Plant, & Equipment).

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Fu1t her, test production runs are not addressed in the Codification's implementation guidance.

Capitali zati on of PP&E under IFRS is based on a similar principle:

The cost of an item of prope1ty, pl ant and equipment compri ses .. . (b) an y costs direc tl y attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management. ... 10

However, IFRS elaborates on thi s principle, li sting "costs of testing whether the asset is functionin g properly" 11 as an example of a directl y attributable cost that should be capitalized.

In this circumstance, given that IFRS guidance offers more spec ifics than U.S. GAAP, but is based on the same principl e, it may be appropriate to analogize to IFRS guidance, in addition to citing the U.S. GAAP broad pri ncipl e, as support fo r the decis ion to capitali ze costs of test production.

Note that there is some weakness inherent in applying guidance by analogy; essentiall y, you are appl ying guidance that was not originall y intended to apply to your situ ation. This strategy should be used sparingly.

IFRS

What is the proper accounting when a for-profit business receives federal government grant funds? U.S. GAAP does not provide guidance directly for this issue, as described in a PwC whitepaper:

US generally accepted accounting principles (GAAP) provides limited guidance on the accounting fo r government grants received by fo r-profit companies. As such, there may be more than one acceptable alternative for the accounting for government grants. Companies should understand the conditions and res trictions (e. g., repayment conditions) of the gov- ernment grant and match accounting decisions with the economi cs and substance of the government grant.

We believe it wo uld be acceptable fo r companies to apply the guidance in the International Accounting Standard IAS 20, Accounting fo r Government Grants and Disclosure of Gove rnment Assistance (IAS 20), by analogy. It should be noted that the AICPA issues paper Accounting for Grants Received from Governments, dated October 16, 1979, currently indicates that it has been superseded by IAS 20. 12• 13

For example, assume that a utility company plans to build a solar power production facility, and was awarded a government grant to proceed with the project. The utility might look to the following guidance in IAS 20, given that U.S. GAAP is not available for this issue.

10 Intern ati ona l Accounting Standard No. 16, Property, Plant and Eq uipment (IAS 16). Par. 16.

11 IAS 16, pa r. 17e.

Continued

12 PwC: / 11 Pursuit of Government Grants . Page 10. Jul y 2009. Etheri dge, Herman, Han lon. © Pri cewaterhouseCoo pers LLP ("PwC"). Not fo r further reprodu ction or use without th e prior writte n consent of PwC.

13 This pos ition, and a simil ar EY pos ition, was referenced in the FASAC Survey dated May 20 13, 2013 Su rvey on the Priorities of the FASB.

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Presentation of grants related to assets

24. Government grants related to assets , including non-monetary grants at fair value, shall be presented in the statement of financial position either by setting up the grant as deferred income or by deducting the grant in arriving at the carrying amount of the asset.

Questions:

1. What are the two alternative treatments presented in IAS 20, for recording the receipt of grant money?

2. Reread the requirements for citing nonauthoritative sources in ASC 105-10-05-2 (excerpted earlier in this chapter). State why this analogy to IFRS guidance is permissible.

Notably-acknowledging that U.S. GAAP in this area is not clear-the FASB is currently under- taking a project that would require additional disclosures of government assistance received.

Now that you've seen the great possibilities associated with nonauthoritative guidance, let's talk about how to use this guidance correctly.

USING NONAUTHORITATIVE SOURCES: THERE'S A RIGHT WAY, AND A WRONG WAY

Lo7 Utiliz~ and prop-erly cite nonau- thoritative sources.

Ideally, nonauthoritative guidance should be cited in addition to Codification refer- ences, to support or further clarify Codification guidance. Recall from Chapter 4 that a researcher should incorporate key authoritative and-as needed-nonauthoritative guidance considered in the Analysis section of an issues memo.

As a general rule of thumb, your documentation should present Codification excerpts first, preceded and followed by commentary in your own words (aka, guidance sand- wiches), then nonauthoritative guidance can be cited if you considered it in understanding the Codification requirements.

EXAMPLE

The opening scenario to this chapter noted that ce1tain nonauthoritative guidance is critical to consistent application of principles-based standards. Following is an example intended to illustrate proper documentation practices for citing nonauthoritative sources.

Assume Lisa's company is a casino operator (in the Gaming industry) . The casino frequently sends free play vouchers to customers as an inducement to customers to visit the casino. Example: "Lisa Jones! You are entitled to $10 of free play this week only, if you visit Winning Resorts casino!"

Lisa 's company is applying the new revenue recognition standard (ASC 606). The AICPA has formed sixteen industry task forces to develop interpretive guidance by industry for consistent application of the revenue standard. To properly determine the accounting for these free play vouchers , Lisa will consult both ASC 606 and the whitepapers developed by the AICPA's Gaming Entities Task Force. Following is an example of her research.

1 © Cambridge Business Publishers Chapter 5 I Using Nonauthoritative Sources to Supplement Codification Research

Issue: How should Winning Resorts account for free play (i.e., promotional allowances) granted to customers under ASC 606 ?

ASC 606-10 (Revenues) states the following with respect to consideration payable to a +-- customer:

32-25. Consideration payable to a customer includes cash amounts that an entity pays, or expects to pay, to the Customer . .. Consideration payable to a customer also

Lisa 's words

139

includes credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to the entity (or to other parties that purchase the entity 's goods or services from the customer) . An entity shall account for consideration payable to a customer as a reduction of the transaction price and, therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service . .. that the

----../ Guidance excerpt, ) ~ \.. Authoritative

customer transfers to the entity . . .

In this case, Winning Resorts has offered players $10 of free play to use at the casino. The question is whether revenue should be reported gross of this $10 (that is, should revenue equal the amount the customer wagers, including the $10?) or net of this amount (where i+---~ isa 's words, analys?) revenue should be limited to the amount wagered by the customer less the $10 provided by the casino). The AICPA's Gaming Entities Task Force addressed this issue in its Issue #6-2: Net Gaming Revenue, dated 12/1/16, concluding: 14

FinREC [the AICPA's Financial Reporting Executive Committee] believes the adjustments for cash sales incentives ... to arrive at Net Gaming Revenue represent consideration payable to a customer and therefore should reduce the transaction price, and be accounted for as contra-revenue, in accordance with FASB ASC 606- 10-32-25 through 32-27. [Explanation added]

Excerpt, ) nonauthoritative

gwdance -

Accordingly, as the $10 of free play credit represents "consideration payable to a customer," ~ isa 's words, analys?) it is appropriate for Winning Resorts to record revenue net of these amounts provided to the customer.

In the preceding example, even though the Codification offered guidance applicable to this question, Lisa included interpretive, nonauthoritative guidance in her memo as a sort of "value add." Readers of her memo will appreciate that Lisa has included guidance specific to her com- pany ' s industry as additional validation that her interpretation is consistent with industry views.

Another thing that Lisa did well is that she only cited the nonauthoritative paragraphs that went above and beyond the authoritative guidance available for this issue. Students frequently make the mistake of over-relying on firm guide books, at the expense of authoritative literature. Consider the following example.

EXAMPLE

Now let's assume that Li sa is researching whether her company can apply the short-term lease exemption to leases involving "non-consecutive" periods of use.

It would be incon-ect for Lisa to cite firm guidance as follows:

• Incorrect: Deloitte defines a short-term lease as "(definition)."

Continued

14 Thi s Issue #6-2 , once finalized by the AICPA task forc e, was included in the AICPA' s Audit & Accounting Guide, Revenue Recognition, Chapter 6 (Gaming).

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140 Chapter 5 I Using Nonauthoritative Sources to Supplement Codification Research © Cambridge Business Publishers

Figure 5-13

Was my search effort exhaustive?

Continued from previous page

However, the following citations would be correct:

• Correct: ASC 842-10-20 (Leases) defines short-term lease as: "(definition)." Deloitte's Roadmap publication, Leases (April 2018), Sec. 5.2.4.5 offers the following additional, interpretive guidance for non-consecutive periods of use:

.. . [T]he lease term comprises the period of use and the period of use comprises the sum of nonconsecutive periods. Therefore, if the aggregate of the nonconsecutive periods (that comprise the period of use) is 12 months or less, the lease term would also be 12 months or less ...

Notice how in the latter example, Lisa got the definition of short-term lease from the Codification, then cited nonauthoritative guidance that went above and beyond Codification requirements.

Is It Wrong to Cite Nonauthoritative Guidance Only? In rare cases, nonauthoritative guidance may be cited (by itself) as support for accounting posi- tions when Codification guidance is not available. However, this is clearly not ideal, as this guidance is not GAAP.

If you find nonauthoritative guidance that is on point, use this guidance to help point you back to the right place within the Codification. Only use nonauthoritative guidance by itself after you have conducted an exhaustive search of the Codification. Figure 5-13 illustrates the steps involved in an exhaustive search.

Perform a Browse search, and review all potentially relevant subtopics.

I Conduct multiple keyword searches, including searches using synonyms (i.e., like words) . Pursue all potentially relevant leads.

I Review the Master Glossary to see whether your search terms are defined. Click on glossary terms and review the subtopics containing the terms.

I Consider guidance available for similar transactions or events.

Remember, if authoritative guidance can be used, you should use it.

What's the Right Way to Search Nonauthoritative Guidance? Nonauthoritative sources are commonly organized into chapters, and they often begin with a detailed table of contents. To optimize your efficiency in searching these sources, consult the table of contents first. From there, you can often advance directly to the content that addresses your issue.

For example, assume you have a question about how to account for a trademark acquired in a business combination. Open an accounting firm guide to business combinations, and scan the table of contents for the topic "Recognition of Intangible Assets." You should generally be able to jump right to the guidance you need.

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Never start a search of nonauthoritative guidance by skimming through the chapters; this search method is inefficient, and you will get lost in detailed guidance!

How Do I Reference Nonauthoritative Sources?

Citing Concepts Statements Following is an example of an appropriate reference to a FASB Concepts Statement. The follow- ing format is also acceptable for citing pre-Codification standards (such as FASB Statements).

• FASB Concepts Statement No. 6, Elements of Financial Statements (CON 6), defines assets as:

" ... probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events" (par. 25).

Note the following required elements included in the preceding citation:

• The type of standard: "FASB Concepts Statement No."

• The title of the standard is fully written out, and italicized

• The paragraph number

• The abbreviation, in parenthesis, that the author intends to use for future references to the standard (i.e., CON 6)

Citing Firm Guide Books The objective in citing an accounting firm resource, such as a guide book, is to create a clear trail to exactly where you found the information you're citing. A supervisor or future reader of your memo should have enough information to personally retrace your steps and find the source. For example,

• Deloitte's publication, A Roadmap to Accounting for Income Taxes (2017), Section 6.01, states: "When disclosing gross DTAs and DTLs, an entity should separately disclose deductible and taxable temporary differences" (page 221).

Notice how this reference includes :

• The title of the guide

• Author or firm publishing the guide (Deloitte)

• Year of publication

• The relevant section and page number

As noted in Chapter 4's style tips for professional communication, sources may be cited in the body of an accounting memo or in a footnote attached to any quotes or guidance used from the source.

CHAPTER SUMMARY Nonauthoritative sources are often indispensable to the research process, both in circumstances where Codification guidance is available and in cases where it is not. The FASB-in Topic 105-permits reference to nonauthoritative sources in cases where U.S. GAAP for a p3.!ticula.r transaction, or simil3.1· transaction, is not available. Sources of this guidance include FASB Concepts Statements, Accounting Standards Updates, accounting furn resources, AICPA literature, and international accounting stand3.1·ds . Rese3.1·chers should exercise caution when citing nonauthoritative sources, as they alone would not support an unmodified audit opinion. However, when used properly, nonauthoritative somces can add ci3.1·ity to a researcher's understand- ing of complex issues and can add value to accounting issues documentation.

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142 Chapter 5 I Using Nonauthoritative Sources to Supplement Codification Research © Cambridge Business Publishers

REVIEW QUESTIONS

1. Explain what it means for guidance to be "nonauthoritative."

2. What is the browse path for accessing Topic 105? In other words, in which area would you start?

3. Briefly, summarize the key points made in the first sentence of par. 05-1, and in par. 05-2, of ASC I 05-10 (Gen- erally Accepted Accounting Principles).

4. List three sources of nonauthoritative guidance that are named in par. 05-3 of ASC 105-10.

5. Identify two benefits of using nonauthoritative sow·ces.

6. Describe a circumstance in which a researcher might refer to the Conceptual Framework.

7. What is one example of information that a researcher can find in an Accounting Standards Update, but which is not available in the Codification?

8. What are two key purposes of the FASB 's Conceptual Framework? What two other names are used to describe this guidance?

9. What future changes is the FASB planning to make to its Conceptual Framework?

10. Considering the guidance from CON 6, what are the three essential characteristics of an asset?

11. Again conside1ing CON 6, what would you say is a key difference between revenues and gains?

12. Describe two circumstances in which reference to a pre-Codification standard may be appropriate.

13. Are Accounting Standards Updates (ASUs) authoritative? Explain.

14. Using the excerpts from the Concepts Statements shown in Now YOU Try 5.4, try to identify the objective of each of FASB Concepts Statements No. 6, 7, and 8. For example: "Concepts Statement No. 5 establishes recognition criteria and describes certain required elements of financial statements."

15. Identify two resources available from the AICPA, and state when each might be useful.

16. What is the AICPA' s FRF for SM Es? Which entities can apply it, and is it considered GAAP?

17. Name two types of accounting firm resources/publications, and generally describe what each resource offers.

18. On the SEC website, what form type is used to describe SEC comment letters and responses?

19. Describe an incorrect way to use fitm guidance.

20. When is it acceptable to quote from only nonauthoritative sources, as support for an accounting position?

21. What does it mean to analogize to IFRS?

22. What are the required elements for a source citation, assuming the researcher is quoting text from a pre-Codifi- cation accounting standard?

EXERCISES

Reminder to students: Include the source reference for each response (such as statement and paragraph number). Please do not cite from a standard's Summary page if the same information can be found in the standard's requirements. If citing from a guide book, remember to cite your source in accordance with the guidelines presented in this chapter.

1. Go to ASC 105 in the Codification, Generally Accepted Accounting Principles, then Join All Sections. Aside from the paragraphs cited in this chapter, summarize each remaining paragraph presented in section -05 (Over- view), -IO (Objectives), and -15 (Scope). Use one bullet point to describe each paragraph from these sections.

Exercises involving the Concepts Statements

2. Describe two ways that a researcher could navigate to the FASB Concepts Statements.

3. Locate FASB Concepts Statement No. 6, Elements of Financial Statements (CON 6).

a. What is the definition of "expenses" in CON 6? Also, cite the paragraph source. b. Describe where you would go within CON 6 to find the definition of liabilities versus where you would

go to find more detailed guidance for applying this definition. How would a beginning researcher know to look for this application guidance? Using CON 6, act as though you are coaching a peer on how to navigate this guidance.

4. Using CON 5, answer the following: What is recognition?

5. Using CON 5, answer the following: What is the purpose of the statements of earnings and comprehensive income? Provide the excerpted guidance that responds to this question, then also summaiize the guidance using your own words.

6. Summarize the four fundamental recognition ctiteria identified in CON 5. Cite the pai·agraph source for this information. Following these four recognition criteria are several paragraphs that elaborate upon the criteria. What ai·e the pai·agraph numbers that elaborate upon these four ctiteria?

7. Using CON 7, answer the following: What is the objective of present value when used in accounting measure- ments at initial recognition ?

8. How is CON 8 cutTently organized? What new chapter was most recently added to CON 8, and what is the purpose of this chapter?

Exercises involving AS Us and pre-Codification standards

9. Identify the pre-Codification standai·d that cross-references to ASC 450-20-25-1 (Loss Contingencies). Next, go to par. 59 of that pre-Codification standard. What was the Board intending to prevent by requiring that losses be "reasonably estimable"?

10. Locate EITF O 1-3. Why is this EITF presented in grey shading? (Look carefully at the bracketed text at the top of the standard.) Also, would you expect this guidance to have been incorporated in the Codification? Explain.

11. Locate EITF 07-5. This EITF is listed on the FASB website as "superseded" but is not presented in grey shading. Why do you think that is ? Where, within the Codification, is this guidance incorporated?

12. Locate ASU 2018-07. What is the title of this standard? What is a key change effected by this standard, and what broader FASB initiative is this guidance reflective of?

13. Now look to the contents page of ASU 2018-07. What are the four sections included within this ASU?

14. Locate ASU 2016-13.

a. What is the title of this standard, and what are the main provisions of this standard? (Use the summary pages at the beginning of the ASU to respond.)

b. Also using the Summai·y, desc1ibe how the provisions of this ASU differ from existing GAAP. c. Now look at the amendments to the Codification that will result from this ASU. What glossary term does

this ASU add to the Codification? In what subtopic will this new term be included? Provide the subtopic number and topic description.

Exercise involving firm guidance

15. Locate EY's latest guide book (refetTed to as the Financial Reporting Developments series) on share-based pay- ment. Using the table of contents, identify one topic that is addressed (listed) within the Scope section. State the year of publication for the guide you used .

AICPA resources

16. Provide the title of two AICPA Audit and Accounting Guides. Describe how you located these guides.

Performing research using company filings

17. Using the SEC website, locate MGM Resorts International's most recent FotTn 10-K. Describe: a. How you went about locating the 10-K. (Describe your search path.) b. When was this form filed? c. In what footnote can investors read about the company's loyalty program obligations? d. Brainstorm: In what circumstances might a peer company (accounting researcher) want to review this

footnote containing information about the company's loyalty program obligations?

Consideration of IFRS

18. Using ifrs.org (under IFRS then Standards): a. Identify the international accounting standard that co1Tesponds to the FASB's ASC 820, Fair Value

Measurement. b. Next, compare the definition of fair value used in that standai·d to the definition of fair value in ASC 820-

10-35-2. (You may have to create a no-cost login to view this file.) c. Explain, broadly, a circumstance in which a researcher might look to the IASB's fair value guidance.

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Properly referencing nonauthoritative guidance

19. Correct the errors in the following source citation. Assume this is the first time this source is being mentioned in an issues memo.

Concept 8 states, with respect to financial statement footnotes: "Notes to financial statements are subject to the same cost constraint that applies to financial repo1ting. "

20. Circle each of the required elements shown in the following source citation. Then describe each of the required elements that was appropriately included in this reference.

Per FASB Statement No. 5, Accounting for Contingencies (FAS 5), par. 8: "An estimated loss from a loss contingency (as defined in paragraph I) shall be accrued by a charge to income if both of the following condi- tions are met ... "

21. Determine what is improper about the following nonauthoritative reference, then explain why.

PwC's guide, Business Combinations and Noncontrolling Interests (2017), Sec. 1.2 defines a business as: " ... an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits directly to investors or other owners, members, or participants."

CASE STUDY QUESTIONS

5.1 Using Firm Guidance to Research a Revenue Question You are an accountant working for Hotel Co. Your supervisor has asked you to research what amount of revenue Hotel Co. should recognize for transactions booked by customers on Expedia.com. Expedia generally collects the full transaction price from the customer, then withholds a small fee (say, $10) from each transaction and remits the balance to Hotel Co. Should Hotel Co. record the gross transaction fee or only the net amount it receives from Expedia.com? Use nonauthoritative film guidance to assist in your response.

5.2 Variable Rents-A Liability? Assume a company pays $10,000 per month plus 2% of sales ("a variable rent charge") to occupy a retail space in a mall. The lease agreement has a 3-year noncancelable term. Based on prior history in that location, the company estimates that its variable rent charge will amount to approximately $1,000 per month.

a. Using the Conceptual Framework, evaluate whether this vaiiable rent change meets the definition of a liability. b. Next, locate discussion in the Basis for Conclusions of ASU 2016-02 (Leases) and desctibe how the FASB con-

sidered this issue of whether variable rents should be included in the lease liability recognized by companies. Describe some of the history of this issue-did the Board al ways hold the view that variable rents should/should not be included in companies' lease obligations?

5.3 Rail Grinding Rail grinding is a maintenance activity conducted on railroad tracks that is designed to remove irregularities and impe1fections from the track in order to allow for faster travel speeds on the track and to increase the lifespan of tracks .

a. Using the Conceptual Framework, evaluate whether the cost of rail grinding activities should be capitalized as an asset or reported as an expense.

b. Using SEC.gov, company filings, full text search, look for disclosures from companies in the industry to bench- mark how the industry treats these costs.

c. Also using SEC.gov, search for CORRESP between the SEC and BNSF railroad. Describe the SEC's position on this issue.

5.4 Conceptual Views on Materiality Using CON 8, describe the role of materiality in understanding the qualitative characteristics of useful financial info1mation. Specifically, assume you are describing materiality to a small-business owner who is trying to determine what information must be reported to his financial statement users. Next, com- ment on what the Board's basis for conclusions says about the issue of materiality and its considerations in recently amending the guidance around this concept.

5.5 Improving Your Familiarity with CON 7 Present Value Techniques As noted within the chapter, CON 7 describes techniques for calculating present value, including the following illustration of the expected cash flow approach , reproduced from CON 7. This example illustrates how the expected cash flow approach can be used to assign prob- ability factors to the likelihood of receiving a $1,000 cash flow in any of three possible future years.

�

Present value of $1 ,000 in 1 year at 5% $952.38

Probability 10.00% $ 95.24

Present value of $1,000 in 2 years at 5.25% $902.73

Probability 60.00% 541.64

Present value of $1 ,000 in 3 years at 5.50% $851.61

Probability 30.00% 255.48

Expected present value $892.36

Source: CON 7, par. 46.

a. Review the guidance in CON 7 and, in your own words, explain in approximately one paragraph the difference between the traditional (best estimate) and expected present value techniques for meas uring fair value.

b. Assume that you are a lender determining the present value of this sample receivable illustrated in CON 7. Under the traditional approach, what would the present value of that receivable be?

c. Show the math that would be necessary to add a fou1th scenario: collection of the $1,000 in 5 years at 6%, with a probability of 10%. (No need for a calculator, just write out how you would compute this scenario).

d. Which approach would you expect users of the lender's financial statements to prefer, and why?

Benchmarking Corporate Disclosures-Intangible Assets J.C. Penney and Macy 's are both public companies in 5.6 the retail industry. Review the most recent 10-K for each company and compare their reporting of intangible assets other than goodwill. In particular, consider:

a. Do the companies have similar items included in this category (Intangible Assets)? That is , what is the nature of each company's recorded intangible assets?

b. Have the companies adopted similar policies with respect to categorizing these assets as finite- versus indefinite- lived?

c. Do the companies desc,ibe their impai1ment testing policy in detail? d. Within which sections of the companies' annual reports is the above-listed information included? Are the com-

panies consistent in where they report this information ? Finally, brainstorm a circumstance in which you, as a professional, might pe1fo1m similar benchmarking of a peer company's annual repo1t.

Reviewing SEC Correspondence Among other activities, Madison Square Garden (Ticker: MSG) is home to the 5.7 New York Knicks and New York Rangers. Locate the June 11, 2015 coffespondence (CORRESP) between the SEC and MSG, then look for MSG's response to comment 3.

a. Briefly, what is the concern/comment being raised by the SEC ? b. What is the company 's response? Carefully read, then summarize the company's position and rationale. c. What info1mation can you gather from this correspondence that may go above and beyond the company's annual

filing disclosure?

Lease Classification, Considering Firm Guidance (Issues Memo) Facts: On l/l/20Xl , Investor, Inc. ("Lessee") 5.8 signed a Lease Agreement with Developer Inc. ("Landlord") to lease Landlord's newly constructed hotel located at 15 Main St. in San Francisco, CA. The lease term is 20 years, and the estimated life of the building is 40 years. Lessee will occupy all 4 floors of the building. The lease includes renewal options, exercisable at the Landlord's option, to extend the contract term for three additional five-year te1ms. No purchase option is present in the contract. Lessee's monthly rental payments are $40,000 per month, plus a monthly supplemental rental cost based on Lessee's sales (I% of sales). From experience, Lessee estimates that I% of its sales should approximate an additional $ I 0,000 per month. As of l/l/20Xl, the appraised value of the building is $15 million. For simplicity, please ignore discount- ing in this example (use of present value calculations, rates implicit in the lease, etc.). There are no residual value guarantees present.

Required: You are a corporate accountant for Lessee and have been asked to prepare an accounting issues memo to address the following issue: Should the lease arrangement be classified as an operating lease or as a finance lease ?

Assume that this a,rnngement is within the scope of lease accounting guidance. As needed to clarify areas of judgment, supp01t your response with guidance from both the Codification and from EY's most recent Lease account- ing guide book.

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Scope and Recognition Guidance: A Brief Introduction Printout in hand, Julie taps on her boss's door. She is feeling pretty good; she just found a

paragraph in the guidance that appears to speak directly to the tax accrual issue her boss

asked her to research . As she shows him the guidance, he taps his pen thoughtfully on the

desk.

"Are you sure this guidance applies to our type of transaction?" he asks.

He continues , "I think the gu idance for gross receipts taxes (which are based on rev-

enue measures) may differ from guidance for taxes based on income. You've brought me

guidance specific to income taxes ."

Julie shakes her head; she realizes that she forgot to review the scope section of the

guidance that she had printed. "Let me double check the scope section for this guidance ,"

she says . "I 'll stop by again later to let you know what I've found ." Continued

After reading this chapter and performing the exercises herein, you will be able to

1. Understand the role that scope guidance plays in professional research.

2. Apply basic scope concepts to income taxes , nonmonetary transactions, and invest-

ments.

3. Perform a simplified scope test for derivatives.

4. Understand the conceptual views underlying recognition guidance.

5. Navigate and apply the revised revenue standard .

6. Identify the recognition threshold applicable to uncertain tax positions and subse-

quent events.

7. Apply derecognition guidance to liabilities.

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Continued from previous page

Confirming that a transaction is within the scope of a Codification topic may seem like an

extra step, but much of the guidance within the Codification includes specific instructions for

its use. Don't get caught like Julie, forgetting to do the appropriate diligence work on guidance

that may otherwise appear to be on point. A proper review of the scope section is critical to

identifying appropriate recognition, and then measurement, guidance for a transaction.

Scope Guidance: An Area of Evaluating scope

Recognition Guidance: A Brief Introduction Required Reading

guidance is key to 1. Conceptual Framework guidance on recognition

1. Role of scope guidance in research correctly applying 2. Revenue recognition:

2. Applying scope guidance: recognition • Concepts behind • Income taxes-ls it a tax based on income? guidance. • Navigating and applying ASC 606 • Nonmonetary transactions-Navigating "- 3. Applying different recognition thresholds

"subsection" scope guidance ~ • Uncertain taxes: Recognize if more likely than not

• Investments-Determining which topic applies • Subsequent events: Recognize if conditions

• Derivatives-ls the definition of derivative met? existed at the balance sheet date

4. Applying derecognition guidance: Liability extinguishments

Organization of This Chapter This chapter introduces two important "sections" in the Codification: Section 15 (Scope)

and Section 25 (Recognition). This is the first of several chapters focusing on section guid-

ance from the Codification; Chapter 7 explores Sections 30 and 35 (Initial and Subsequent

Measurement), and Chapter 8 continues this coverage with an emphasis on fair value

measurement.

As a beginning researcher, scope issues are often not on your radar. You may feel so

relieved just to find guidance that seems on point that you fail to ensure that your transac-

tion falls within the scope of the topic. For this reason, I've chosen to emphasize consider-

ation of scope issues in this chapter. The chapter walks through several examples where

scope guidance can make or break a researcher's use of a given topic . Having exposure

to areas of scope judgment will help you be equipped to handle similar judgments in your

own research.

Next, the chapter covers recognition , starting with conceptual views of recognition and

then exploring the application of this guidance to revenue , income taxes , and subsequent

events. Research techniques related to the revised revenue model are emphasized , given

that entities have now largely transitioned over to this guidance. The chapter concludes with

a derecognition example related to liabilities.

The topics covered in this chapter are illustrated in the preceding diagram . For the prac-

ticing accountant, some of the examples that follow may seem overly simplified . However, to

the beginning accounting researcher, these examples will provide a straightforward introduc-

tion to some basics of technical guidance. You can use these skills to tackle more complex

issues later on.

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148 Chapter 6 I Scope and Recognition Guidance: A Brief Introduction

SCOPE GUIDANCE: AN AREA OF REQUIRED READING

Lo 1 Understand the role that scope guidance plays in professional research.

Recall from previous chapters that scope guidance indicates which transactions, items, or entities are subject to the guidance within a topic. As discussed in Chapter 2, researchers should view the scope section of each topic as required reading. Therefore, before relying upon a topic's recognition or measurement guidance, a researcher

TIP from the Trenches

should first confirm that the guidance applies to his or her transaction. The scope guidance for most topics is within Section 15 ("Scope"), usually within

Subtopic 10 (the "Overall" subtopic). However, scope guidance may also be found within other individual subtopics (e.g., Subtopics 20, 30 , and so on) and , in some circumstances , might be provided for individual paragraphs within the guidance.

Information within the scope section is commonly presented in one of two ways :

• The guidance may list specific transactions that are, or are not, within the scope.

• The guidance may contain tests to determine what transactions should be included within the scope of the guidance.

For example, you may recall that our Presto Hospitality memo (see Chapter 4 Appendix) involved a scope test to determine whether the contract contained a lease.

When reviewing the Scope section of a topic, a researcher should read any lists of trans- actions or entities that are excluded from the guidance's scope. If the guidance contains tests, indicating which transactions are within the topic 's scope, a researcher should determine whether his or her transaction meets the tests. For example, a scope test may be presented as three conditions, one or all of which must be met for a transaction to be within the scope of a topic.

Often, it is only the most technical and complex of topics that include tests identifying transactions that should be within scope (e.g. , derivatives, securitizations, variable interest entities, leases). Notice that many of these topics are within the Broad Transactions area, and therefore are subject to specialized accounting. Given the complexity of some of these topics, bear the following in mind if you find yourself faced with one of these tests:

• Before performing a detailed scope test, read the Overview section of the topic to make sure that use of this topic makes sense.

• If I have to "test into" this guidance, then this guidance may be highly nuanced. I ought to see whether there is implementation guidance (Section 55) or a nonauthoritative source that can offer additional information on this scope test.

If you find that your transaction is outside the scope of a particular topic, look for refer- ences within the Scope section to other topics that might apply. If references are not provided, continue to brainstorm alternative accounting treatments for the transaction you are research- ing. Chapter 2 provides suggestions for brainstorming alternate search terms.

It's required reading, but do I have to read it first?

There is no hard and fast rule about when-during your reading of a Codification topic- you must consult the Scope section. My personal tendency is to consult the Scope section first (or, after reading the Overview) for topics listed in the Broad Transactions area. For other topics, I tend to look for recognition or measurement guidance first and then, before relying upon that guidance, I go back to review the Scope section as a final check.

The only "rule" regarding scope evaluations is just that you must consult this guidance at some point in your research.

Let's take a look now at a few topics where application of scope guidance can involve judgment. Our first group of examples involves guidance listing transactions that are or are not within scope. These examples involve income taxes, nonmonetary transactions, and investments.

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Chapter 6 I Scope and Recognition Guidance: A Brief Introduction 149

These examples are followed by a scope test from the Broad Transactions area: applying the definition of derivative instrument.

Let's begin with our first example, which revisits Julie' s gross receipts tax issue from our opening scenario.

APPL YING SCOPE GUIDANCE: A FEW EXAMPLES

Considering Scope, Glossary, and Interpretive Guidance

Evaluating the Income Taxes Topic Recall from our opening scenario that Julie's boss asked her to revisit whether taxes on gross receipts are within the scope of the Income Taxes topic. We'll explore this issue now.

Lo 2 Apply basic scope concepts to income taxes , nonmonetary transactions, and investments

Located in the Expenses area of the Codification, the Income Taxes topic (ASC 740) provides guidance on the recognition of taxes based on income. This topic identifies the follow- ing primary objectives related to the accounting for income taxes:

a. To recognize the amount of taxes payable or refundable for the current year b. To recognize deferred tax liabilities and assets for the future tax consequences of

events that have been recognized in an entity's financial statements or tax returns. (ASC 740-10-10-1)

Determining whether a tax is based on income may sound straightforward, but in practice it often requires judgment. Following are two examples illustrating the scope of Topic 740. The first example evaluates whether a "gross receipts tax" (e.g. , a tax based on revenue) is within the scope of this topic; the second evaluates a so-called "modified gross receipts tax ."

Determining Whether a "Gross Receipts Tax" Is within the Scope of Income Tax Guidance

Facts: Julie's company operates in New Mexico, where businesses are subject to a state "gross- receipts tax." This tax can range in amount from 5.125% to 9.25%, depending on the business's locale. The tax is imposed on a business's gross receipts, or "the total amount of money or value of other consideration" received from conducting its activities. 1 Julie needs your help determining whether this gross-receipts tax is within the scope of ASC 740.

ASC 740-10 includes the following scope guidance:

Transactions

15-3 The guidance in the Income Taxes Topic applies to: a. Domestic federal (national) income taxes (U.S. federal income taxes for U.S.

entities) and foreign, state, and local (including franchise) taxes based on income b. An entity 's domestic and foreign operations that are consolidated, combined, or

accounted for by the equity method.

The Glossary of Topic 740-10 defines income taxes and taxable income as follows:

Income Taxes

Domestic and foreign federal (national), state, and local (including franchise) taxes based on income.

Continued

I Source: www.tax .newmexico. gov/Businesses/gro ss-receipts.aspx and New Mexico Taxation and Revenue Department publication FYI-105 (May 2018).

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150 Chapter 6 I Scope and Recognition Guidance: A Brief Introduction

Continued from previous page

Taxable Income

The excess of taxable revenues over tax deductible expenses and exemptions for the year as defined by the governmental taxing authority.

Net income is defined in the Codification's Master Glossary as follows :

Net Income

A measure of financial performance resulting from the aggregation of revenues, expenses, gains, and losses that are not item s of other comprehensive income. A variety of other terms such as net earnings or earnings may be used to describe net income.

Finally, PwC's guide book, Income Taxes, states the following with respect to the evaluation of gross-receipts taxes under the scope of Topic 740. 2

A gross receipts tax is generally based upon a jurisdiction's definition of "taxable gross receipts." In devising this tax , many jurisdictions do not take into consideration any expens- es or costs incurred to generate such receipts, except for certain stated cash discounts, bad debts, and returns and allowances. Because the starting point of the computation of a gross receipts tax is not "net" of expenses, we believe that a gross receipts tax is not a tax based on income subject to ASC 740.

Questions:

1. Contrast the definitions of net income and taxable income, against the method used to cal- culate New Mexico's gross-receipts tax.

2. Next, consider the interpretive guidance provided by PwC. How does this impact your evalu- ation?

3. Explain your conclusion: Is this gross-receipts tax considered a tax based on income , and thus within the scope of Topic 740 (Income Taxes)?

Let's change the facts slightly and consider another example now.

2 PwC, Guide to Accounting for Income Taxes. May 2018. Chapter I, page 5. © PricewaterhouseCoopers LLP ("PwC") . Not for further reproduction or use wi thout the prior written consent of PwC.

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Chapter 6 I Scope and Recognition Guidance: A Brief Introduction 151

Evaluating Whether a Modified Gross-Receipts Tax Is within the Scope of Income Tax Guidance

Facts: In Texas, certain businesses must pay an annual franchise tax, a type of modified gross- receipts tax , of roughly 0.33% to 0.75%. The tax base (to which this rate is applied) is the entity's taxable margin and is computed in one of the following ways: (1) total revenue minus cost of goods sold , (2) total revenue minus compensation , (3) total revenue times 70%, or (4) total rev- enue minus $1 million.

You must evaluate whether this is considered a tax based on income and thus within the scope of ASC 740.

In addition to the guidance provided for the previous example, consider the following guid- ance from PwC's Guide to Accounting for Income Taxes. 3

In jurisd ictions in which a tax is calculated on modified gross receipts, consideration should be given as to whether it is a tax based on income. We believe th at a tax based on gross receipts reduced fo r certain costs (e.g., inventory, depreciab le and amortizable assets, materials and supplies, wages) is a tax based on income subject to ASC 740.

Questions:

1. Is Texas's franchise tax within the scope of ASC 7 40? Explain.

2. Explain the significance (as further described in the text following this example) of a tax being within the scope of ASC 740 versus within the scope of other guidance.

As these exampl es illustrate, the scope of Topi c 740 is lim ited to taxes based on income. Other GAAP in cluding, fo r exampl e, Topi c 450 (Contingencies) mu st be applied for taxes not within the scope of Topic 740. Application of other Codifica ti on topics to taxes will not res ult in deferred taxes, as that concept is unique to in come tax accounting.

Evaluating Subsections with Unique Scope Guidance: Nonmonetary Transactions As a researcher, if you ever come across a transaction in which physical assets are being exc hanged, consi der exploring whether the transaction is nonmonetary . According to ASC 845-10:

05-2 Most business transactions involve exchanges of cash or other monetary assets or lia- bilities [for example, cash or accounts receivable] for goods or services. The amount of monetary assets or liabilities exchanged generally provides an obj ecti ve basis fo r measuring the cost of nonm onetary assets or services received by an enti ty as well as for measuring gain or loss on nonmonetary assets transferred fro m an entity. Some transactions, however, in volve either of the fo llowing:

Continued

3 PwC, Guide to Accounting for Income Taxes. May 20 18. Chap ter I, page 6. © PricewaterhouseCoopers LLP ("PwC"). Not fo r furt her reproduction or use without the prior written consent of PwC.

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152 Chapter 6 I Scope and Recognition Guidance: A Brief Introduction

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a. An exchange with another entity (reciprocal transfer) that involves principally nonmonetary assets or liabilities ... [Comments added]

That is, in most transactions, goods or services are exchanged for cash or other monetary assets, and the amount of cash generally provides an objective value for the goods being trans- ferred. Nonmonetary transactions therefore present a unique issue, in that they involve assets whose values are not as objectively determinable. Some monetary consideration (boot) may be involved in a nonmonetary exchange, but this amount cannot be significant (as illustrated in Now YOU Try 6.5).

The basic principle in Topic 845 is that nonmonetary exchanges should be recognized at the fair values of the assets exchanged. 4 Often, this fair value measurement can give rise to gain recognition (e.g., when the fair value of the exchanged asset exceeds its carrying value). Under- standably, the FASB took precautions when developing this guidance to limit this opportunity for gain recognition to circumstances where it was considered most appropriate. Accordingly,

• Scope guidance within Topic 845 precludes the use of this topic for transactions between entities under common control (e.g., parent-subsidiary relationships) .5

• Measurement guidance within Topic 845 requires that only transactions with commercial substance (e.g., a valid business purpose) may be recognized at fair value.

ASC 845 is organized into the following subsections:

• General

• Purchases and sales of inventory with the same counterparty

• Barter transactions

• Exchanges involving monetary consideration

Each of these subsections offers not only unique measurement guidance, but also has unique scope guidance. Therefore, determining whether a transaction is within the scope of ASC 845 is a two-step process. Entities must evaluate both (1) "General" Topic 845 scope guidance and (2) subsection scope guidance. Even if a transaction is not precluded from the "general" scope of Topic 845, subsection scope guidance may indicate that the transaction should not be accounted for under Topic 845.

The following example illustrates application of both the General scope guidance as well as subsection scope guidance.

Exchanges Involving Monetary Consideration

Facts: Company A exchanges printing equipment (fair value : $500,000) for a forklift (fair value: $400,000) and $100,000 cash. Company A must determine whether this transaction is within the scope of ASC 845.

ASC 845-10 includes the following scope guidance. Par. 15-12 (below) of this topic is some- what unusual in that it refers readers to the general subsection guidance in order to evaluate what amount of monetary consideration is considered significant. Accordingly, par. 25-6 has been included to show how "significant" is defined in Topic 845-10. The definition of nonmonetary asset has also been included for reference.

Continued

4 ASC 845-10-30-1 (No nm onetary Transactions): "In ge neral , the accounting for nonmoneta1y transactions shou ld be based on the fair values of the assets (or services) involved, which is the same basis as th at used in monetary transactions."

5 ASC 845 -1 O- I 5-4(b ).

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Chapter 6 I Scope and Recognition Guidance: A Brief Introduction 153

Continued from previous page

General

>Entities

15-2 The guidance in the Nonmonetary Transactions Topic applies to all entities.

> Transactions

15-3 The guidance in the Nonmonetary Transactions Topic applies to all types of nonmon- etary transactions including: a. Nonmonetary exchanges involving boot. Some exchanges of nonmonetary assets

involve a small monetary consideration, referred to as boot, even though the exchange is essentially nonmonetary. (See the Exchanges Involving Monetary Consideration Subsection of Section 845-10-15 for situations outside the scope of this Subtopic.)

Exchanges Involving Monetary Consideration

>Overall Guidance

15-12 The Exchanges Involving Monetary Consideration Subsections follow the same Scope and Scope Exceptions as outlined in the General Subsection of this Subtopic, see paragraph 845-10-15-1 , and address what level of monetary consideration in a nonmonetary exchange causes the transaction to be considered monetary in its entirety and, therefore, outside the scope of the Exchanges Involving Monetary Consideration Subsections and this Topic.

> Transactions

15-13 The guidance m the Exchanges Involving Monetary Consideration Subsections applies to nonmonetary exchanges involving monetary consideration (boot).

25-6 An exchange of nonmonetary assets that would otherwise be based on recorded amounts but that also involves monetary consideration (boot) shall be considered monetary (rather than nonmonetary) if the boot is significant. Significant shall be defined as at least 25 percent of the fair value of the exchange ...

Definition of nonmonetary assets and liabilities (ASC 845-10-20) Nonmonetary assets and liabilities are assets and liabilities other than monetary ones. Examples are inventories ; investments in common stocks; property, plant, and equip- ment; and liabilities for rent collected in advance.

As you can see from these excerpts, while the General section scope guidance applies to all enti- ties, the subsection scope guidance sets forth even more specific requirements that can result in transactions being deemed outside the scope of this topic. Considering this guidance and the facts presented, respond to the following.

Questions:

1. Does this transaction meet the General scope guidance within Topic 845?

2. Does the transaction meet the scope criteria in the subsection "Exchanges Involving Monetary Consideration"? Explain .

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154 Chapter 6 I Scope and Recognition Guidance: A Brief Introduction

Figure 6-1

Browse path to Topic 810 (Consolidation)

Continued from previous page

3. Based on your responses to the above questions, does it appear that use of Topic 845 is appropriate to account for this transaction?

4. If you concluded that this transaction is not within the scope of ASC 845-10, where might you go next for guidance? Explain.

As this example illustrated, nonmonetary transactions guidance in the Codification (ASC 845) can be somewhat challenging for researchers in that they must consult not only general scope guidance for the topic, but must also determine whether a transaction is within the scope of subsection guidance (i.e., groups of paragraphs) within this topic. In many cases , references to other Codification topic s are provided within the Scope section for transactions specifically excluded from the scope of Topic 845 .

Which Topic Applies?: Navigating Investments Topics Here's a challenging scope question. Let's say your company makes an equity investment in another company. What Codification topic applies to this transaction? The answer to this ques- tion can be somewhat complicated.

Your first step is to determine whether your company obtained a controlling financial interest in the investee entity. To do this, review scope guidance within Topic 810-10 (Con- solidation), illustrated in Figure 6- l. This guidance requires entities with a controlling financial interest, based on either the variable or voting model-to consolidate the investee entity.

• Voting Model: The usual condition for a controlling financial interest is ownership of greater than 50% of an investee's equity securities or-if the investee is a limited partner- ship-ownership of greater than 50% of the partnership 's kick-out rights.

• Variable Model: For structured, "variable interest" entities-such as entities with insuf- ficient equity at risk-a controlling financial interest is evidenced through other rights and obligations. For example, your company might be required to consolidate the variable interest investee if your company has the power to direct the investee and has exposure to investee losses and returns.

CODIFICATION

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Chapter 6 I Scope and Recogniti on Guidance: A Brief Introduction 155

After concluding that your company does not have a controlling financial interest, the next step is to consider the topics listed under Investments. These topic s are illustrated in Figure 6-2.

To improve your comfort in navigating these topic s, following is a simplified summary of topics applicable to purchases of noncontrolling interests:

• Investments-Equity Method and Joint Ventures (Topic 323): Applies to purchases of equity securities where an investor has significant influence. Significant influence is often characterized by a 20% or greater ownership stake in an investee, but can also be evidenced through qualitative factors.

• In vestments-Equity Securities (Topic 321): Generally applies to all investments in equity securities except for those accounted for under the equity method . Topic 321 requires equity securities to be measured at fair value, but makes an exception for equity securities without a "readily determinable fair value" (w hich can be measured at cost minu s impairment).

CODIFICA llON

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Archived Standards and Guidance

Considering Figure 9-9, respond to the following Now YOU Try.

1. Refer to Figure 9-9. What are two other types of standards issued (or adopted) by the PCAOB that could apply to public company auditors? Explain.

2. Where in Figure 9-9 would you click for interpretive guidance related to PCAOB standards?

Figure 9-9

Locating rules and standards on the PCAOB 's website

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YOU Try 9.9

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252 Chapter 9 I Audit and Professional Services Research © Cambridge Business Publishers

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Figure 9-10

Within the Guidance page , researchers can access staff releases and other interpretive guidance

Certain PCAOB standards are accompanied by appendices, which often contain illustrative examples and the standard setter's basis for conclusions. Appendices can provide researchers with valuable context for understanding the guidance.

Staff Releases and Interpretive Guidance The PCAOB 's staff issues the following guidance intended to highlight emerging or noteworthy audit practice issue s, and to interpret rules and standards of the Board:

• Staff Audit Practice Alerts

• StaffQ&As

• Other Staff Guidance

Figure 9-10 illustrates the location of staff guidance on the PCAOB website. Also available on this page are:

• Auditing Interpretations (AI)

Auditors should carefully consider guidance set forth in these interpretive publications. Staff Practice Alerts, for example, highlight areas of concern noted during PCAOB inspections and set expectations for future PCAOB inspections. The following Now YOU Try illustrates the application of PCAOB standards and practice alerts.

Recall that the Sarbanes-Oxley Act requires auditors of public companies to express an opinion on both : (1) the financial statements, and (2) management's internal controls over financial report- ing. Together, an audit of these two areas is referred to as an integrated audit.

I Search ... PCAOB AuditorSearch : Find your auditor

Public Company Accounting Oversight Board

1111 Home > Standards

Registration & Reporting

Summary Table of Contents

€! Audit Practice Alerts

Inspections Enforcement International

Staff Audit Practice Alerts highlight new, emerging , or otherwise noteworthy

circumstances that may affect how auditors conduct audits under the existing

requirements of PCAOB standards and relevant laws. The statements contained in Staff

Audit Practice Alerts are not rules of the Board and do not reflect any Board

determination or judgment about the conduct of any particular firm , auditor. or any other

person.

• Alert No. 15: Matters Related to Auditing Revenue from contracts with customers

(Oct. 5, 2017) t:l

• Alert No. 14: Improper Alteration of Audit Documentation (April 21, 2016) tel

• Alert No. 13: Matters Related to the Auditor's Consideration of a company's Ability

to Continue as a Going Concern (Sept. 22, 2014) ftl

Continued

Continued from previous page

PCAOB Auditing Standard (AS) 2201, An Audit of Internal Control Over Financial Reporting

That Is Integrated with an Audit of Financial Statements, establishes requirements for auditors'

assessments of internal controls in integrated audits.

Based on significant audit deficiencies noted during its annual inspections process, the

PCAOB staff issued Staff Audit Practice Alert No. 11, Considerations for Audits of Internal

Control over Financial Reporting.

Auditors must now consider both AS 2201 and Alert No. 11 (among other guidance) when

planning and performing an integrated audit.

AS 2201 includes the following requirement:

21. Th e auditor should use a top-down approach to the audit of internal control over finan cial reporting to select the controls to test. A top-down approach begins at the financial statement level and with the auditor's understanding of the over- all risks to internal control over financial reporting. The auditor then focu ses on entity-level controls and works dow n to signifi cant accounts and di sclosures and th eir relevant assertion s. Thi s approac h directs the auditor's attenti on to accounts, di sclos ures, and asserti ons that present a reason able poss ibility of material mi ss tate- ment to the fin anci al state ments and related di sclosures . Th e auditor then verifi es hi s or her understanding of th e risks in the company's processes and selects for testing those control s that sufficientl y address the assessed ri sk of mi sstatement to each relevant assertion.

Note: The to p-dow n approach describ es the auditor's sequenti al thought pro - cess in ide nti fying ri sks and th e contro ls to test, not necessarily th e order in whi ch th e auditor will perfo rm th e auditing procedu res. [B old emphas is added]

Alert No. 11 states:

One of the potenti al root causes for the defi ciencies in audits of intern al contro l, as cited in the general in specti on report, is impro per appli cati on of the top-down approach set fo rth in PCAOB standards. Fo r exampl e, the general in specti on report notes that, in some in stances, it appears that fi rms, in impl ementin g a top-down approach, pl aced undu e emphas is on testing manage ment revi ew co ntro ls and other detecti ve controls without considering whether they adequ ately addressed the assessed ri sks of materi al mi sstatement of the signifi cant account or di sclosure. In some instances, in specti ons staff observed th at firm s fa il ed to test contro ls for all relevant asserti ons of the signifi cant accounts and di sc los ures. In other in stances, it appeared to the inspec tions staff th at firm s did not suffic ientl y understand the li kely sources of potenti al mi ss tatements related to signifi cant acco unts or di sclosures as part of selectin g co ntrol s to test. [Footn otes omitted] (Page 7).

Considering the preceding guidance , respond to the following.

1. Describe the relationship between AS 2201 and Alert No. 11 . What advice would you give

to an auditor performing an integrated audit and in the process of applying AS 2201?

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2. In your own words, explain the top-down approach.

3. What specific concern does Alert No. 11 raise, with respect to how auditors are performing the top-down approach?

4. Think for a moment: What potential consequences could be associated with an auditor's failure to appropriately apply the top-down approach?

The AICPA and PCAOB's professional standards continually evolve. Chapter 14 of this book describes steps that accountants can take in order to stay current with the changing body of accounting and auditing standards.

SEC Ethics Requirements Finally, in addition to complying with PCAOB rules and standards, auditors of public companies must comply with certain professional standards of the SEC. Among these, the SEC's Regulation S-X sets forth certain requirements for auditors, including

• Auditor qualifications requirements,

• Requirements related to auditor independence,

• Required elements of the audit report, and

• Requirements for audits performed by multiple firms. 12

Regulation S-X is available on the SEC's website, www.sec.gov.

Searching for Auditing Guidance within Firm Research Databases Arguably the most efficient way to search AICPA and PCAOB guidance is through a research database. Individuals with access to firm research databases (such as PwC Inform) can perform keyword searches of, or can browse directly to, auditing standards and interpretations. Trial sub- scriptions are frequently available.

Figure 9-11 illustrates a search for the keyword "documentation" using PwC Inform . Notice how the researcher has clicked on the AICPA Professional Standards category (at left) before entering a search term, then selected the option to search within this highlighted branch.

12 SEC, Regulation S-X, Reg. § 210.2-01 (parts a and b): "Qualifications of Accountants"; Reg. § 210.2-02: "Accountants' Reports"; Reg. § 210.2-05 "Examination of Financial Statements by More than One Accountant."

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THE AICPA'S CODE OF CONDUCT

The AICPA's Code of Professional Conduct (the "Code of Conduct" or the "Code") establishes mandatory ethics requirements applicable to all CPAs. Individuals who violate provisions of the Code can be sanctioned by the AICPA.

As a professional, you should consult the Code whenever you face a potential ethics or independence issue. You ' ve had enough training in previous accounting and auditing courses to know that CPAs are expected to fulfill their professional responsibilities with the utmost integrity. Trust your instincts and consult the Code if a situation or circum- stance seems questionable to you.

Lo4 Perform research using the AICPA's Code of Conduct, understanding the Conceptual Framework approach set forth in the Code.

255

The revised Code is available in .pdf format, and in an online interactive version, by navigat- ing to aicpa.org/research/standards. l TIP from the

Trenches

The Code Is Organized Into Three Parts Guidance in the Code is organized into three parts and a preface (plus appendices), as follows :

• Preface (applies to all CPAs)

• Part I-Applies to CPAs in public practice

• Part 2-Applies to CPAs in business

• Part 3-0thers (applies to retired or unemployed CPAs)

Part l of the Code applies to members (of the AICPA) who are in public practice . That is , CPAs engaged in performing professional services for a client must apply this part of the Code.

Part 2 of the Code applies to members in business. These are CPAs who work (either through employment, on a contractual basis, or as a volunteer) in areas such as industry, the pub- lic sector, education, the not-for-profit sector, or for regulatory or professional bodies. 13 These individuals might work for the business as an executive, a staff member, in governance (such as on the company ' s Board), or in an advisory or administrative capacity.

13 ET 0.400.32 (Definition s)

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Finally, Part 3 of the Code applies to members who are not in public practice, nor in busi- ness. Such members include individuals who are retired or unemployed .

In some cases, an accountant may have multiple roles (for example, working with two orga- nization s) and thu s would be subject to multiple parts of the Code.

Take a moment to complete the following Now YOU Try, on identifying parts of the Code.

Identifying Parts of the Code

John is an auditor who works for a CPA firm. In his spare time, he also serves on the Board of Directors of his community's YMCA. This is an unpaid position .

Which part(s) of the Code apply to John? Explain.

The _______ , because __________________ _

Part _______ , because __________________ ~

Part _______ ,because __________________ ~

When you see references to the Code of Conduct, you'll notice that the first number signifies what Part of the Code was consulted. ET 1.XXX, for example, refers to a reference from Part 1 of the Code. ET O.XXX refers to guidance from the Code's Preface.

Next, let's look at what's included in the Code of Conduct.

The Preface-What's Included? The Code's Preface includes:

• The Principles of Profess ional Conduct

• Definitions

• A list of recent changes to the Code

The Principles of Professional Conduct ("principles") acknowledge the CPA profess ion 's responsibility to serve the public and establi sh a framework for individuals to apply specific rules in the Code. Following are select principles from the Code:

Section Principle

The Public Interest, ET 0.300.030

Objectivity and Independence, ET 0.300.050

Due Care, ET 0.300.060

Members should accept the obligation to act in a way that will serve the public interest, honor the public trust, and demonstrate a commitment to professionalism.

A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.

A member should observe the profession's technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member's ability.

The definitions in the Preface cover key terms used throughout the Code. Defined terms include, for example, member, public practice, direct financial interest, client, and so on. Wher- ever defined terms are used in the Code, they are pre sented in italics.

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Next, given that the AICPA will continue to periodically update the Code, the Preface includes a list of recent Code revisions and additions. 14 This list wiU be updated as changes are made to the Code.

Finally, the Preface includes the stated requirement that AI CPA members must adhere to the rules and interpretations of the Code .

. 02 The AICPA bylaws require that members adhere to the rules of the code . . . Members must be prepared to justify departures from these rules. (ET 0.100.010)

.01 A member who departs from the interpretations shall have the burden of justifying such departure in any disciplinary hearing. (ET 0.100.020) 15

Rules and interpretations are located in parts 1, 2, and 3 of the Code. Let's take a look at these parts of the Code now.

Parts 1 and 2 of the Code-What's Included? Parts 1 and 2 of the Code include:

• Rules and interpretations

• Conceptual Frameworks

• Nonauthoritative guidance

Ethics rules (i.e., the "rules of conduct") and interpretations build upon the Principles of Conduct from the Preface. Rules set forth the Code's requirements. Interpretations provide detailed guidance for applying specific rules. As stated in the Preface, CPAs must adhere to both rules and interpretations.

In circumstances where specific ethics interpretations are not available, CPAs should look to the Code's conceptual frameworks. The Code's three separate conceptual frameworks are as follows :

• Conceptual Framework for Members in Public Practice (ET 1.000.010)

• Conceptual Framework for Independence (ET 1.210.010)

• Conceptual Framework for Members in Business (ET 2.000.010)

It's worth noting that the three frameworks are quite similar in their construct, requiring CPAs to consider threats and safeguards in evaluating ethics issues. However, they ' re written in a way that is tailored to members applying that specific part of the Code.

Finally, grey shaded boxes in parts 1 and 2 of the Code offer links to nonauthoritative guidance. This is guidance that has not been through the AICPA's full due process, and thus should not override or replace use of the Code. However, it can assist researchers in applying the Code. Examples include the standard setter's basis for conclusions and Q&As.

Part 3 of the Code-What's Included? Part 3 of the Code includes just a single rule (the acts discreditable rule : "A member shall not commit an act discreditable to the profession") and related interpretations. Again, this part of the Code applies to CPAs who are not in public practice, nor in business.

Take a moment to attempt the following Now YOU Try, on where to locate the Code's conceptual frameworks.

14 ET 0.600 (Ne w, Revised, and Pending Interpretations and Other Guidance)

15 In these excerpts, the terms members and interpretations are italici zed, indicating that the se terms are defined in the Code's definitions section .

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258 Chapter 9 I Audit and Profess ional Services Research © Cambridge Business Publishers

Now l YOU J Try 9.12

Figure 9-12

The Conceptual Framework Approach

[

Now l YOU

Try 9.13

The Three Conceptual Frameworks

Looking at the ET references for the three Conceptual Frameworks, which two frameworks would you expect to find in Part 1 of the Code? State the full name of each framework.

The Conceptual Framework Approach Recall that in circumstances where a specific ethics interpretation is not available, CPAs should ev aluate a situ ation using one of the Code's three conceptu al frameworks. Thi s is referred to as applying a conceptual framework approach.

Under this approac h, CPA s should :

• First, identify threats to compli ance with th e rul es;

• Nex t, evalu ate the significance of these threats; and

• If the threats are at an unacceptable level, identify and apply safeguards to minimize these threats.

• In the event that safeguard s do not reduce threats to an acceptable level, remove yourself fro m the situation (e.g., by declining an engagement, resigning from your employment, etc.).

Figure 9-1 2 illustrates the conceptual framework approach.

•• •• . .

. . ~ ~ .

So urce: Ell en Gori a, "Revised Al CPA Code of Ethics ... What's the Fuss?" AI CPA Journal of Accountancy, Feb. I , 20 14. © 20 18 AICPA. AII rights reserved. Used by permission.

1. In your own words , explain the four steps in the conceptual framework approach .

Continued

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Continued from previous page

2. In what circumstances should a researcher apply one of the Code's three conceptual frame-

works?

Each of the Code's three conceptual frameworks provides examples of potential threats to com- pliance with the Code, and safeguards that could reduce the risk of these threats. Let 's consider now what is meant by the terms threats and safeg uards.

Threats The Preface defines threats as follows:

In connection with independence, threats are relationships or circumstances that could impair independence. In connection with any rule but the "Independence Rule" [ 1.200.00 I], threats are relation ships or circumstances that could compromise a member's compliance with the rules. (Source: ET 0.400.49)

For example, if your close friend asks you to serve as the auditor for hi s company, this should immediately raise a few red flags in your mind . The Code would describe these red flags as threats.

Threats are generally classified into one (or more) of seven broad categories (i.e., threat types), for members in public practice. The following Now YOU Try defines and provides examples of these categories.

Understanding Types of Threats

1. Considering the definition provided for each threat category, draw a line connecting each

threat category to an example illustrating this type of threat. Draw multiple lines if you

encounter examples that could involve multiple threat categories.

Threat category

i. Adverse interest threat: The threat that a member will not act with objectivity because the member's interests are opposed to the client's interests .

ii. Advocacy threat: The threat that a member will promote a client's interests or position to the point that his or her objectivity or independence is compromised.

iii. Familiarity threat: The threat that, due to a long or close relationship with a dient, a member will beoome too sympathetic to the client's interests or too accepting of the client's work or product.

iv. Management participation threat: The threat that a member will take on the role of client management or otherwise assume management responsibilities.

v. Self-interest threat: The threat that a member could benefit, financially or otherwise, from an interest in, or relationship with, a client or persons associated wi th the client.

vi . Self-review threat: The threat that a member will not appropriately evaluate the results of a previous judgment made or service performed or supervised by the member or an individual in the member's firm and that the member will rely on that service in forming a judgment as part of another service.

vii. Undue influence threat: The threat that a member will subordinate his or her judgment to an individual associated with a client or any relevant third party due to that individual's reputation or expertise, aggressive or dominant personality, or attempts to coerce or exercise excessive influence over the member.

Example

Example situations involving threats

a. The CPA advised management on the proper accounting for judgmental aspects of a merger transaction , and management accepts the CPA's recommendations .

b. A member's close friend is employed by the client.

c. The client is involved in a lawsuit against the CPA's firm.

d. The CPA pertorms bookkeeping services for the client.

e. The client threatens to dismiss the CPA's firm from the engagement.

f. A CPA has a financial interest in the dient, and the outcome of the engagement could affect the value of that interest.

g. The CPA firm endorses a client's services or products.

Source: ET 1. 100.0 10 (Conceptual Framework for Members in Pu bl ic Practice), par . . 10-.16.

Continued

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2. Identify one example from above that could involve multiple types of threats. Explain.

3. The Conceptual Framework for members in business includes six broad categories of threats, which are the same as those shown above but which exclude one . Which threat from the above list do you think is not included in the list for members in business, and why?

Safeguards The Preface defines safeguards as follows:

Actions or other measures that may eliminate a threat or reduce a threat to an acceptable le ve l. (Source: ET 0.400.43)

Recall that if identified threats are at an unacceptable level, the next step in the conceptual framework approach is to apply safeguards to minimize these threats. Three broad categories of safeguards exist for members in public practice :

1. Safeguards created by the profess ion, legislation, or regulation.

2. Safeguards implemented by the client.

3. Safeguards implemented by the firm, including firm policies and procedures.

The following Now YOU Try will familiarize you with these categories of safeguard s.

Understanding Safeguards

Draw lines matching each category of safeguard to two examples illustrating this safeguard.

11 Categories of safeguards Sample safeguard

I i. Safeguards created by profession , I Example a. State Boa rd-req uired continuing education legislation or regulation I and training on independence and ethics rules. I ii. Safeguards implemented by the

I b. Rotation of senior personnel who are part of

client the engagement team .

I iii. Safeguards implemented by the I

c. The tone at th e top emphasizes the client's firm commitment to fair financial reporting and

compliance with the applicable laws, ru les, regulations .

d. The client has a strong gove rnance structure, including an active audit committee , to ensure appropriate decision making, oversight, and communications regarding a firm 's services.

e. Professional standards and th e threat of discipline.

f . Internal policies and procedures relating to independence and eth ics comm un ications with audit committees or others charged with client governance.

Source: ET 1.000.010 (Conceptual Framewo rk fo r Members in Public Practice). par . . 17~.23.

3 © Cambridge Business Publishers Chapter 9 I Audit and Profess ional Services Researc h 261

Notably, only two categories of safeguards apply to members in business (ET 2.000.010):

1. Safeguard s created by the profess ion, legislation, or reg ulation; and

2. Safeguard s implemented by the employing organization.

Safeguards implemented by the empl oy ing organi zati on could include, fo r exampl e, the company's:

• Audit committee charter, including independent audit committee members, and its

• Internal policies and procedures related to purchasing controls

The follow ing Now YOU Try walks th ro ugh eac h step of the conceptual framework approach .

Applying the Conceptual Framework Approach

Assume that Smith & Dunn , LLP has had a long association with an audit client, and the client is significant to the firm . Jeff Smith , founder and CPA, is concerned that this association could pose threats to the firm's compliance with the AICPA's ethics rule on independence.

Considering the preceding discussion of threats, safeguards, and the conceptual framework approach , respond to the following.

1. Assume that Jeff is unable to locate interpretations that relate to his issue. Next, Jeff should apply the:

This framework is located in ET ____________ _

2. Refer to Figure 9-12. Jeff's first step in applying a conceptual framework approach is to:

3. Refer now to the types of threats listed in Now YOU Try 9.14. Which of these threats might be present in this situation?

4. After identifying threats, Jeff must next evaluate :

5. If Jeff is not comfortable that the identified threats are at an acceptable level , he must

6. Safeguards in this case might include (brainstorm):

7. Finally, if these safeguards , new or existing , do not reduce the threat of noncompliance to an acceptable level, Jeff's firm should:

The best way to improve your comfort with the revised Code, and particularly the conceptual framework approach , is to read it. After reading this chapter, take a few minutes to click around the Code. Be sure to scan ET 1.000.010, which describes the conceptual framework approach.

How Is Guidance in the Code Organized? Within the Code, guidance is organized into topics, subtopics, and sections. References to the Code use the follow ing fo rmat:

Now

YOU Try 9.16

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262 Chapter 9 I Audit and Profess ional Services Research © Cambridge Business Publishers

Figure 9-13

Topics included in Part 1 of the Code

ET 1.200.001

Section number

References to the Code begin with "ET"

for ethics.

Part number Topic or subtopic number

In other words, this reference is to Part 1 of the Code, Topic 200 (Independence), Section 001.

Paragraphs are shown as 2-digit numbers, so ET 1.200.001.01 means paragraph .01 of the Independence topic , section 001.

The difference between topics and subtopics in the Code's numbering system is subtle. Top- ics are the first level of subject matter you'll see li sted after you click the plus sign next to Part 1 in the Code. Figure 9-13 shows the li st of topic s included in Part 1 of the Code.

: El Title Page

$·El Preface: Applicable to All Member, I

$·El Part 1 - Members in Pub Ii c Pre dice

1 000 ln!Jodudion

~-El 1100 lnteg,ityandObjedivity

1 .200 Independence

1 .300 General Standards

1.310 Compliance With Standard;

1 .320 Accounting Principle;

1 400 Ads Discreditable

1.500 Fees and othB Types of Remunsation

1.600 Advertising and other FOfms of Solicitation

1.700 Confidenti al Information

1.800 Fo,m of Organization and Name 1

~-El Pert 2 - i'..tEmbm in Busine;;

Notably, the conceptual frameworks for parts 1 and 2 are included in the Introdu ction topics (ET 1.000.010 and 2.000.010, respectively). Looking at Figure 9-13, the Conceptual Framework for part 1 would be located within the branch 1.000 (Introduction).

Subtopics are accessible by clicking the + symbol, down one level further from topics. Figure 9-14 depicts several of the subtopics available under topic 1.200, Independence. Notably, the conceptual framework for independence is loc ated within ET 1.210.

The third set of numbers in a Code reference denotes the section. Specifically:

• Sections numbered .001 are for rules.

• Sections numbered .005 tell you how to apply the Conceptual Framework to the rule.

• The Code's conceptual frameworks are located within section .010 of ET 1.000, 1.210, and 2.000.

• Other section numbers generally refer to ethics interpretations.

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:,--~ 1.200.001 Independence Rule

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:,-- ~ 1.200 .005 Application of the Conceptual F,amewotl: for Independence and Ethical Confiicts

$ ~

~-~

1.210 Conceptual Frameworlt App,oach

1.220 Accounting Firms

$ ·~ 1.224Affiliates, lnduding Governmental llnit.

$ ·~ 1.226 Reissued Reports

~-~ 1.228 Engagement Contractual Terms

The following Now YOU Try walks through the Code's numbering system , and illustrate s the application of an ethics rule, interpretation, and nonauthoritati ve guidance.

Applying Rules and Interpretations from the Code of Conduct

Assume that you are performing an audit and want to engage an external valuation firm to assist in reviewing the fair values of the client's private equity investments. However, you are con- cerned about the risk of disclosing confidential client information to the valuation firm. You've decided to consult the Code of Conduct for guidance on confidential client information.

• The Rule briefly states the ethics requirement. Per ET 1.700.001 (Confidential Client Information):

.01 A member in public practice shall not di sclose an y confidential client information without the specific consent of the client.

• ET 1.700.005 addresses how CPAs should apply the Conceptual Framework to the confi- dential client information rule:

.01 In the absence of an interpretation of the "Confidential Client Information Rule" [1 .700.001] that addresses a particular relationship or circumstance, a member should apply the "Conceptual Framework for Members in Public Practice" [1.000.010].

• Interpretations illustrate the application of the rule to a specific scenario. Per ET 1.700.040 (Disclosing Information to a Third-Party Service Provider) :

.0 1 When a member uses a third-party service pro vider to ass ist the member in providing professional se rvices, threats to compliance with the "Confidenti al Client Information Rule" [1.700.001] may exist.

Continued

Figure 9-14

Several of the subtopics available under Topic 1.200, Independence

Now

YOU Try 9.17

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Continued from pre vious page

.02 Clients may not expect the member to use a third-party service provider to ass ist the member in prov iding the professional services. Therefore, before disclos ing confiden- tial client information to a third-party service provider, the member should do one of the fo ll owing:

a. Enter into a contractual agree ment with the third-party service provider to main- tain the confi dentiali ty of the info rmati on and prov ide reasonabl e assura nce that the third-party service provider has appropri ate proced ures in pl ace to prevent the unauthorized release of confidential information to others ... [Or:]

b. Obtai n spec ific consent from the client before di sclosing confidential client infor- mation to the third-party service provider. [Explanati on added]

• Finally, nonauthoritative guidance can assist researchers in applying and interpreting the Code. The following guidance is located just after ET 1.700.040 in the Code .

A nonauthoritati ve bas is-fo r-conclu sions doc ument that summarizes considerations that were deemed signi fica nt in the development of thi s interp re tati on is avail able at www.aicpa.org/InterestAreas/ProfessionalEthics/Resourcesffools/ DownloadableDocuments/Basisfor ConclusionsOutsourcing.pdf.

In addition, nonauthoritati ve sample client disclosure language that could be used to fu lfill the requirement disc ussed in this interpretation is also available at www.aicpa.org/InterestAreas/ProfessionalEthics/Resourcesffools/ DownloadableDocuments/Sample Disclosure Notification.pdf.

Considering the preceding excerpts, respond to the following.

1. What are two actions a member might take before disclosing confidential client information to a third-party service provider?

2. Could a researcher have answered question 1 using only the guidance in ET 1.700.001 (the ethics rule)? What value did interpretive guidance add to your ability to answer this question?

3. Recall that when a specific ethics interpretation is not available , CPAs should evaluate a situation using one of the Code's three conceptual frameworks .

i. Should a researcher apply a conceptual framework in this case , and which one would apply?

ii. Explain why a researcher should or should not consult the applicable conceptual frame- work for this issue.

4. Describe what each number means for the following reference to the Code: ET 1.700.001.01 .

1 indicates that this guidance is from of the Code .

. 700 refers to the , Confidential Client Information .

. 001 is the section number, which tells me that this is an ethics _______ _

.01 is the number.

Continued

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Continued from previous page

5. What two sources of nonauthoritative guidance are referenced, to assist researchers in apply- ing the authoritative rule and interpretation?

How Can I Search for Guidance in the Code? Researchers can browse to guidance within the Code or can perform keyword searches. This book advocates the use of user-directed, browse searches when possible, as these searches will improve your familiarity with the content and layout of the Code.

To search the Code using a browse approach, first decide which part of the Code applies : Part 1, for accountants in public practice? Part 2, for accountants in business? Or both?

Next, click on the topic and/or subtopic that appears most relevant and read the rule for that topic. Look for interpretations under the rule that relate to your specific issue. If no interpreta- tions are available that are on point, you must then apply the appropriate Conceptual Framework (as identified in section .005 of the topic).

Keyword searches can easily be performed using the search bar (or advanced search option) within the Code.

Figure 9-15 illustrates these steps.

1. First, decide which Part of the code applies.

(Part 1, 2, or both?)

+ 2. Next, look for the Topic that

applies to your issue.

(Such as 1.200, Independence)

t 3. Read the Rule for that topic.

(Shown in Section .001)

+ If no 4. Next, look for Interpretations

interpretations 5. Apply the appropriate Conceptual Framework. are on point ....

under the rule for applicable - (Identified in Section .005 of the Topic-such as guidance. ET 1 .100.005)

(Such as 1.230, Fees)

! 1. Conceptual Framework-Public Practice 2. Conceptual Framework-Members in Business 3. Conceptual Framework for Independence

(Applies only to ET 1.200)

While keyword searches are often useful when navigating the Code, they can sometimes lead researchers to guidance that doesn't apply, or that doesn't make intuitive sense. One professor said that her students-asked to locate continuing education (CPE) requirements in the Code-who used keyword searches consistently responded with guidance from the wrong "Part" of the Code.

The lesson: If you do perform a keyword search, be sure you understand the context (part, topic, section, and related paragraphs) for the guidance you locate.

Figure 9-15

Topics included in Part 1 of the Code

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The Code Will Continue to Change The AICPA's Professional Ethics Executive Committee (PEEC) will continue to update the Code as necessary to clarify its provisions or to reflect new ethics interpretations and rulings. As changes are approved and implemented, AICPA members are notified through updates in the Journal of Accountancy. Additionally, all recent changes to the Code will be listed in ET 0.600 (Preface-New Guidance) . Because the Code will continue to change, beware of sav ing the pdf version of the Code to your computer, as it could become outdated.

Here's a topic to round out our discussion of ethics: personal finance. Part of ensuring your ability to act ethically is confidence in your own finances. At this point in your life, you may be starting to earn your first real income, while at the same time managing student debt. This is a great time to develop a plan for your finances.

Consider looking up Dave Ramsey, who teaches "seven baby steps" to financial free- dom (daveramsey.com), and check out his book The Total Money Makeover. Be aware that the book has religious undertones, but it's hands down my favorite guide to establishing your personal finances .

STANDARDS FOR OTHER PROFESSIONAL SERVICES

Los Identify guid-ance applicable to other professional services engagements , including attesta- tion , compilation , and review standards.

Next, let' s briefly introduce a few other sources of client serv ice guidance iss ued by the AICPA and PCAOB .

Attestation Standards For Nonpublic Companies The AICPA issues Statements on Standards for Attestation Engagements (SSAEs), which are organized into sections referred to as "AT-Cs. " These provide guidance on attestation services provided to nonpublic companies. Attestation standards, notably,

do not apply to certain attest engagements that are covered by other guidance, such as financial statement audits and reviews.

CPAs performing attest engagements are expected to conduct their engagements in accor- dance with these standards. Attestation standards include, for example,

• Guidance for performing agreed-upon procedures engagements (AT-C 215)

• Guidance for performing reviews of pro-forma financial information (AT-C 310)

• Guidance for performing examinations of internal controls (AT-C 320)

Interpretive guidance is available for certain of the attestation standards; this interpretive guidance often applies only narrowly, to specified industries or circumstances. For example, AT-C 215 (Agreed-Upon Procedures Engagements) is interpreted by AT-C 9215, which address- es the application of AT-C 215 to certain due diligence services. Accountants providing attesta- tion services should always check interpretive guidance, when available, to determine whether it applies to their engagement.

For Public Companies The PCAOB relies upon a combination of its own attestation standards (AT No. 1, AT No. 2, and so on) and AI CPA attestation standards adopted on an interim basis (AT l O 1, AT 201, and so on). The attestation standards issued by the PCAOB to date primarily focus on services provided to brokers and dealers of financial securities.

Compilation and Review Standards (SSARS) Accountants may also provide compilation serv ices to nonpublic clients. In a compilation, an accountant prepares financial statements usi ng information obtained from management, but does

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not provide any assurance over the information compiled. Additionally, the accountant must generally prepare a compilation report, describing the accountant's role in preparing the finan- cial statements. Independence is not required for compilation engagements; however, a lack of independence must be disclosed in the compilation report.

Issued by the AICPA's Accounting and Review Services Committee, Statements on Standards for Accounting and Review Services (SSARSs) cover compilation and review services provided to nonissuers. These standards are codified in the professional standards as "AR-C" sections.

AR-C sections include:

• AR-C 60, General Principles for Engagements Performed in Accordance with Statements on Standards for Accounting and Review Services

• AR-C 70, Preparation of Financial Statements

• AR-C 80, Compilation Engagements

• AR-C 90, Review of Financial Statements

In particular, accountants providing compilation and review services should become familiar with the requirements in AR-C Section 60 (General Principles). As its name implies, this standard provides overall guidance for accountants performing compilation or review ser- vices. For example, AR-C 60 describes differences between compilation and review services and sets forth reporting requirements for accountants performing these engagements.

Like it has for auditing engagements, the AI CPA has designated certain interpretive publi- cations as authoritative for compilation and review engagements. These are (1) interpretations of SSARSs, (2) exhjbits to SSARSs, (3) compilation and review guidance included in A&A Guides and especially the AICPA Guide Preparation, Compilation, and Review Engagements, and ( 4) AI CPA Statements of Position applicable to compilation and review engagements. 16

Other Professional Standards In addition to the standards described above, the AICPA's professional standards also include:

• Consulting services standards-Statement on Standards for Consulting Services (SSCS)

• Quality control standards-Statements on Quality Control Standards (SQCSs)

• Peer review standards-Standards for Performing & Reporting on Peer Reviews (PRP)

• Personal financial planning standards-Statements on Standards in Personal Financial Planning (PFP) Services

• Tax standards-Statements on Standards for Tax Services (SSTSs)

• Valuation services standards-Statements on Standards for Valuation Services (SSVS)

As you can see from the above list, these standards cover client services (such as consulting and tax services) as well as guidance on firms' internal quality control procedures. Tax standards (SSTSs) are described in Chapter 11 of this book.

Internal Audit Standards The Institute of Internal Auditors (IIA) is a professional association dedicated to supporting and advancing the internal audit profession. The IIA issues guidance, which is primarily divided into two types: (1) mandatory and (2) recommended. Following are the IIA's "mandatory" sources of guidance:

• Definition of Internal Auditing

• IIA's Code of Ethics

• Core Principles

• International Standards for the Professional Practice of Internal Auditing (Standards)

16 AICPA, AR Section 60, Framework for Performing and Reporting on Compilation and Review Engagements. Definition of interpretive publications and par .. 18 , "Interpretive Publications."

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LO& Understand

These sources receive their authority as "mandatory" through internal audit charters main- tained within business organizations. Internal audit charters give the internal audit department access to business unit information and records , whjle simultaneously establishing expectations for the work and conduct of the internal audit department. For reference, the IIA makes a Model Internal Audit Activity Charter available at its website, www.theiia.org.

The IIA's sources of "recommended" guidance include Implementation Guidance and Practice Guides. Internal auditors are encouraged to comply with these sources of interpretive guidance, as applicable.

The IIA's mandatory standards consist of requirements and interpretive guidance governing the planning, performance, and reporting of internal audit engagements. These standards are contained within a single booklet, accessible on the IIA's website.

DOCUMENTATION OF PROFESSIONAL SERVICES RESEARCH

the role docu- mentation plays in performing audit and professional services

You know from previous chapters that accounting positions must be supported with documentation. Now let's take a moment to discuss why documentation is also important from the service professional 's perspective.

Creating and maintaining sufficient documentation, or working papers, is critical to professional service engagements. Particularly for attestation engagements (such as audits), where the accountant must attest to the validity of an assertion, documentation is necessary to demonstrate the basis for the accountant's conclusions, and to demon-

research.

strate that the engagement complied with relevant professional standards. Audit documentation includes, for example, memoranda, confirmations, correspondence, schedules, audit programs, and letters of representation.

For example, one of the first auditing standards issued by the PCAOB was AS 3, Audit Documentation (now referred to as AS 1215). The PCAOB prioritized the issuance of this stan- dard because it viewed audit documentation as one of the "fundamental building blocks" of the Board's oversight function .17 Shortly thereafter, the AICPA also updated its own guidance on audit documentation.

Within their audit documentation standards, the PCAOB and AICPA set forth requirements for the

• Required elements of audit documentation.

• Retention period for audit documentation.

• Process for making changes to audit documentation after the audit report is issued.

To comply with AICPA and PCAOB documentation requirements, auditors are required to document the procedures performed, evidence obtmned, and conclusions reached with respect to financial statement assertions. Additionally, auditors must document any significant audit findings or issues and how these matters were resolved. Both the PCAOB and AICPA requjre auditors to place particular emphasis, within their documentation, on areas with the greatest risk of material misstatement.

Recall from our discussion of accounting research that research memoranda should include quotations from authoritative literature as support for conclusions reached . Similarly, auditors should support their choice of audit procedures and conclusions with citations from both pro- fessional standards and accounting standards. References to auditing research may be included within audit schedules, or within memoranda documenting significant audit issues, depending on the complexity of the issue. Guidance for citing from audit standards is provided within the next section of this chapter.

17 AS 3, Appendix A: Background and Basis for Conclusions. Par. A4. See also PCAOB Adopting Release No. 2004· 006, which you can link to from AS 1215.

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Whether you are performing services for issuers or for nonissuers, prepare documenta- tion with the expectation that it will be reviewed by an external party. Documentation may be reviewed, for example, in the event of

• Quality control reviews (from other partners in the CPA firm),

• Peer reviews (performed by other CPA firms),

• PCAOB inspections,

• SEC inquiries, or

• Litigation involving the audit client or audit firm.

The threat of a review can be disconcerting to some auditors; in recent years, the SEC and PCAOB have sanctioned numerous accountants who have gone back into their workpapers, just before an inspection was to begin, to add key documents or schedules that supported the audit opinion. Don' t jeopardize your career; before the workpapers for an engagement are finalized, think agai n about whether your documentation is sufficient to support a review.

An auditor's best defense for supporting his or her professional judgments is sufficient, contemporaneous, and complete documentation. In fact , the process alone of documenting an issue can often shed light upon whether the position is supportable . Identify the areas of greatest risk in the audit, then consider whether your documentation of these issues is suf- ficient to withstand review.

Citing Professional Standards Following are examples of appropriate initial and sub sequent references to professional stan- dards. After each citation, notice the list of "required elements" included in the citation.

Initial Reference:

AU-C section 700, Forming an Opinion and Reporting on Financial Statements (par. 27), states that audit reports "should describe management's responsibility for the preparation and fair presentation of the financial statements."

This initial reference includes the following required elements:

• The type of standard is named: "AU-C section XXX."

• The title of the standard is fully written out, and italicized.

• The paragraph number is provided.

• Excerpts from the guidance are enclosed in quotes.

Subsequent References (once the standard has already been named in your documentation):

The auditor's report should be in writing (AU-C 700.22).

This second citation includes the following required elements:

• The type of standard (AU-C) is named.

• The standard number and paragraph are provided (700.22).

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When in doubt, err on the side of providing too much detail about the source of guidance you are citing. Your objective in clearly citing professional standards is to allow readers to retrace your steps and locate the guidance that you are relying on. Remember that a "reader" of your documentation could be anyone ranging from an audit supervisor to a PCAOB inspector.

CHAPTER SUMMARY Compliance with professional standards is more than a "nice to know." As a professional, your career depends on it. Accounting professionals are held accountable for compliance with numerous professional services standards and ethics rules. The two primary standard setters for professional guidance are the AJCPA and the PCAOB. The standards issued by these bodies are numerous and cover a variety of topics, from consulting services, to audits, to everyday ethics. Take the time to understand the standards applicable to the type of client you are serving and type of service that you are performing.

In doing so, remember that in order to fully comply with AJCPA standards, you should consider both standards and interpretive publications. To fully comply with PCAOB requirements, auditors should apply PCAOB auditing standards, rules, interpretations, and staff releases. In all cases, CPAs are also subject to the ethics guidance detailed in the AJCPA's Code of Professional Conduct.

Finally, pay careful attention to documentation requirements, as documentation may be your best defense against professional risk. Documentation should focus in particular on key risk areas, and should adequately support the accountant 's opinions, as well as the sufficiency of procedures performed.

REVIEW QUESTIONS

1. What are some of the differences between attestation and consulting services?

2. In what circumstances is an accountant subject to the rules and standards of the PCAOB?

3. Fill in the blank: If Jason is a public company auditor, then his firm must be a ________ public accounting firm.

4. What source of guidance applies to all CPAs, and relates to a CPA's own ethical conduct?

5. Explain the AICPA's definitions of "must" and "should." In what section of an audit standard would you expect to find these terms?

6. Explain the relationship between a SAS and an AU-C.

7. Describe the "hierarchy" of auditing guidance sources issued by the AICPA .

8. Identify the sources of AICPA audit guidance that are considered "interpretive publications."

9. Aside from issuing audit and ethics standards, what are some of the PCAOB ' s other responsibilities?

10. What Act established the PCAOB? What else did this Act require of the PCAOB?

11. How is the PCAOB funded?

12. Are PCAOB standards referred to as "generally accepted auditing standards"?

13. What are two functions of the PCAOB ' s rules?

14. What are the three levels of responsibility defined in PCAOB Rule 310 I? What are the words that may be used (such as "must" and "should") within the guidance to indicate these types of responsibility?

15. Explain the differences in the applicability of the Code's preface, versus Part 1, versus Part 2, and Part 3.

16. What are the Principles of Professional Conduct, and where are these located within the Code?

17. Describe the role of rules, interpretive guidance, and nonauthoritative guidance within the AICPA's Code of Conduct.

18. Identify the three Conceptual Frameworks that are included within the Code. In what ET sections are these Frameworks located?

19. What are the four steps in the conceptual framework approach, and when should a researcher use such an approach?

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20. Explain the meaning of the terms threats and safeguards and provide two examples of each.

21. Must a CPA always apply safeguards after a threat has been identified? In what circumstance might a researcher not have to identify and apply safeguards?

22. Aside from auditing standards, what are some of the other professional standards issued by the AICPA?

23. Which type of standard should an accountant apply, if he or she is pe1forming a financial statement review for a client? Also , what specific standard number provides a framework for pe1forming review engagements?

24. Explain why documentation is critical to audit research . Then, complete the following sentence: Prepare your auditing documentation with the expectation that _______ _

EXERCISES

Code of Conduct Exercises Instructions: Answer the following in complete sentences using the AICPA's revised Code of Conduct, pro- viding the ET references for each of your responses. For questions with multiple parts, include multiple ET references as appropriate.

1. According to Appendix A of the Code, which body has the AICPA designated as having the authority to set accounting standards under the Accounting Principles Rule (in ET 1.320 and 2.320 of the Code)? Include rel- evant excerpts from Appendix A to support your response .

2. Scan Pait 3 of the Code. To whom is this section applicable, and what is the primary focus of this section?

3. List three examples of individuals who are considered "covered members" in the Code's definitions section .

4. Should a member in business allow pressure from others to result in a breach of the Integrity and Objectivity rnle?

5. What are the two broad categories of safeguards identified in Part 2 of the Code, in the Conceptual Framework for members in business?

6. Provide the Code reference to the rnle that governs "acts discreditable" for "members in public practice."

7. Alex, a retired CPA, neglected to file his tax return this year. What does the Code say about this?

8. Using the definitions section of the Code, locate an example of confidential client information.

9. Jenny is a volunteer Board member for the animal shelter. Which pait of the Code should she apply in perform- ing these volunteer duties?

Auditing Standards (and Related Topics) Exercises

10. Consider AICPA guidance. What are three risk assessment procedures an auditor should unde1take in order to assess an entity 's risks of material misstatement in an audit?

11. Consider AICPA guidance. What steps should an auditor take if an auditor is unable to continue ai1 engagement due to the discove1y of fraud?

12. Does accepting contingent fees impair an auditor 's independence? Use the PCAOB website to respond.

13. According to PCAOB standards, who is responsible for supervising an engagement and responsible for its performance?

14. What PCAOB auditing standard requires auditors to discuss critical audit matters in the audit rep01t?

15. Go to the PCAOB's website and list one proposed audit standard named on the site. Where did you navigate within the site to find this?

16. Locate a PCAOB Staff Audit Practice Ale1t. Briefly, summarize the main issue addressed in this particular alert. Next, describe the role you think these alerts play in establishing auditing requirements for registered public accounting firms.

17. Under "Inspections" on the PCAOB 's website, locate the link to Firm Inspection Reports. Review a firm inspec- tion report and describe some of the findings (or deficiencies) cited by the PCAOB. In pa1ticular, look for firm inspection reports that say: "QC criticisms are now public."

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Exercises Related to Other Professional Services Standards

18. Using the AI CPA website, identify the standard applicable to compilation engagements. What is one requirement for the accountant's compilation report?

19. What SSARS number corresponds to AR-C Sec. 120? What is meant by these terms SSARS versus AR-C?

CASE STUDY QUESTIONS

9.1 Auditing Presto You are performing the year-end audit of Presto's first financial statements reflecting ASC 842 (Leases). Your first challenge is to evaluate the completeness of Presto's lease adoption population assessment, to dete1mine whether all material leases were identified and appropriately capitalized. Describe the audit procedures you intend to follow, and cite sources that you found useful in researching this issue.

9.2 Can I help? ToCo, Inc., a nonpublic audit client of your firm , is requesting that your film provide advisory services to assist in its adoption of CECL accounting requirements. That is, ToCo would like your film's assistance fo1mu- lating an acceptable approach for measuring its accounts receivable allowance account in accordance with the new framework set forth in ASC 326-20 (Financial Instruments--Credit Losses). You are the audit manager on ToCo 's audit. Should your firm assist ToCo?

Now assume ToCo is a public company. Does this change your response?

9.3 Spirit of Giving It 's holiday time, and SpiceCo., a nonpublic company and your audit client of five years, has invited you and a guest to attend the company's holiday pa1ty. The party is a black-tie event complete with cocktails, fine foods, and a live band. Should you attend?

Now reverse the situation-your audit firm is holding the party, and you are considering extending an invitation to Ms . James, the Controller at SpiceCo., and her husband Mr. James. Should you invite her?

9.4 PCAOB Disciplinary Orders Utilize the PCAOB website to respond . PCAOB Release No. I 05-2017-054, dated December 19, 2017, is a PCAOB Order formally sanctioning Grant

Thornton and fining the firm $1.5 million in connection with its audit of The Bancorp, Inc.

Required: Locate the above-referenced PCAOB Order and summarize the salient points of the charges made against Grant Thornton. Evaluate this issue in the form of an accounting issues memorandum. In the Facts section of your memo, describe key issues raised by the PCAOB . Next, list then discuss (analyze) the following issues:

I. What is one rule or standard that the auditors ( or firm) violated? What should the auditors have done differently? 2. What is another rule or standard that the auditors (or firm) violated? What should they have done differently?

In your analysis, present relevant excerpts from the applicable auditing rules and standards alongside your consider- ation of the case facts and details from the PCAOB Order.

Conclude with a recommendation for how these issues might be prevented going forward.

9.5 Emphasis Paragraph The auditor of GymCo., a public company, plans to include an emphasis of matter paragraph in its audit opinion highlighting a material transaction between GymCo. and its subsidiaiy, ShoeCo. Is it approp1iate for the auditor to include an emphasis paragraph in an unqualified audit repmt? Also, is it acceptable for the auditor to refer to the emphasis pai·agraph in its opinion , stating: "Subject to the foregoing di scussion , the financial statements of GymCo . are presented fairly . .. "? Refer both to PCAOB auditing standards and staff guidance on the auditor 's report to respond.

9.6 You Create the Ethics Case Required: Create a hypothetical ethics case (situation), then describe the guidance that applies to this issue. The simplest way to complete this assignment is by "backing into" a case idea by looking up guidance in the AICPA's revised Code of Conduct then inventing a hypothetical situation based on this guidance.

However, you can be creative in how you come up with case ideas . For example, you can generate ideas using news sto1ies , AICPA disciplinary actions, your own experiences, and so on.

After describing a hypothetical ethics situation, locate ethics guidance that addresses this issue. Limit your search for guidance to the AICPA's revised Code of Conduct. Document your case and guidance as follows :

• Situation : • Applicable Guidance (and how it would apply to this issue): • Inspiration for this case idea (how did you come up with this case idea?):

9.7 Pay Up. Collins & Harper, LLC has completed its audit procedures related to December 31, 20Xl year-end of Pha1mEx, Inc. However, per the te1ms of its engagement letter with Pha1mEx, fees are due and payable to Collins & Harper before the audit report will be issued to the client. PharmEx has not yet remitted payment for the audit. Col-

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lins & Harper has refused to release its audit report until fees are paid. Is this refusal by Collins & Harper appropriate under the Code of Conduct? What defined term would the applicable Code section use to describe the audit report, in this circumstance?

Navigating the Revised Code Rachel is a CPA who performs part-time bookkeeping serv ices for local bu sinesses. 9.8 Rachel is not familiar with the revised Code. Explain to her what part(s) of the Code she is subject to, if any. Make your case using definitions and concepts from the Preface, as well as the introduction(s) to the applicable part(s) of the Code.

Payroll Services Jones & Jones, LLC is the independent auditor for Jenna Co. Jenna Co. has requested the firm's 9.9 assistance with its payroll processing function. Jones & Jones is being as ked to perform this service while continuing to serve as Jenna Co.'s auditor.

Can Jones & Jones pe1form this nonattest service? What considerations should the firm's management keep in mind when accepting and performing this service?

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Governmental Accounting Research Jon has just been scheduled to work on the audit of a school district, starting on Monday.

He is a staff auditor at a regional public accounting firm , and this is his first governmental

audit client. He wonders how this engagement will differ from his private-sector experiences.

Jon knows that state and local governments must follow GASB accounting standards but

has otherwise forgotten much of what he learned about governmental accounting (let alone

governmental audits) . Now, Jon is unsure of how to prepare for work on Monday and feels

uncomfortable holding himself out as a "governmental auditor."

As Jon likely knows by now, much of the train ing that auditors receive takes place on

the job. That is , much of his initial audit work will involve reviewing prior year workpapers,

then performing specific steps required by the current year audit program .

But Jon also wants to be able to understand the broader context for the audit steps he will

perform . That's why he decides to take a few simple steps , this weekend , to educate himself

for the week ahead. First, he dusts off his old governmental accounting textbook. Flipping

through the table of contents provides him with a much-needed refresher on issues that are

unique to governmental accounting. Second , Jon looks up the client's comprehensive annual Continued

After reading this chapter and performing the exercises herein, you will be able to

1. Understand the environment of governmental financial reporting , including cir-

cumstances in which state , local , and federal government financial statements are

required.

2. Research and apply guidance applicable to state and local governments, particularly

within the GASB Codification.

3. Become familiar with federal government accounting standards issued by the FASAB.

4. Recognize and apply government auditing standards issued by the GAO.

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financial report (CAFR) from last year, to get a feel for the final product his audit team will be

working toward. Finally, Jon scans the GASB's website to see what's new in the world of state

and local government accounting. There , he reads the headlines then accesses a few short

video clips on GASB activities, which he enjoys from the comfort of his couch.

A little bit of preparation will go a long way in making Jon feel confident when he reports

to the client's site on Monday. This preparation will also allow Jon to better understand each

step he performs in the audit program , allowing him to exercise professional care as an auditor.

Governmental Accounting Standards

Governmental Auditing Standards

1. What guidance applies, and how do I search it?

1. When are governmental

• GASB, for state and ~ audits required , and who

~ performs them? local governments

2. GAO's Yellow Book, and • FASAB, for federal

other sources of guidance government entities

3. Illustrative examples 2. Illustrative examples

Organization of This Chapter As you now know, guidance in the FASB Codification only applies to nongovernmental enti-

ties. So where should preparers of government financial statements go for guidance? And

what professional standards apply to governmental auditors?

This chapter introduces sources of governmental accounting and auditing guidance.

Readers will have the opportunity to apply guidance from each of the governmental account-

ing and auditing sources covered, from GASB, to FASAB, to GAO guidance.

In addition to describing key authoritative sources of guidance, this chapter describes

select nonauthoritative resources used in practice by government accountants and auditors.

The preceding graphic illustrates the organization of topics within this chapter.

Let's begin now with the guidance applicable to governmental accounting .

275

�� 3 276 Chapter 10 I Governmental Accounting Research

GOVERNMENTAL ACCOUNTING RESEARCH

Lo 1 Understand the environment of The first thing to understand about governmental accounting research is that the research process itself is no different from the process performed for nongovernmental entities. Like the accounting research process described in Chapter 3, governmental research starts with obtaining an understanding of the entity and its industry, then understanding the specific transaction, followed by identifying the researchable question then searching

governmental financial report- ing, including circumstances in which state, local, and federal government financial state- ments are required.

[

Now ] YOU

Try

10.1

the literature and documenting conclusions. What is unique about governmental accounting research, however, is the body of

knowledge required to perform it. Governmental accounting differs fundamentally from private-sector accounting for a number of reasons. These include :

• The purposes of these entities differ. Governments exist for the public good, while private- sector companies exist for the benefit of their owners (shareholders).

• Governments generate revenues through taxation ; private-sector companies generate rev- enues through sales of goods or services.

• Governments offer services for which they do not receive reciprocal value, such as social services; private-sector companies sell their goods and services in arm's-length exchanges to obtain profit.

• The community of government financial statement users, and their motivations, differ from those interested in private-sector financial statements.

Governmental financial statements are based on standards that reflect these unique qualities. These standards come in the form of guidance from the Governmental Accounting Standards Board (GASB) for state and local governments, and the Federal Accounting Standards Advisory Board (FASAB) for federal government reporting entities.

As in our opening scenario, it's important when performing governmental accounting research to refamiliarize yourself (if necessary) with the basics of governmental accounting. Governmental accounting textbooks (or governmental chapters in advanced accounting text- books) can be a good resource for this. Once you review some of these basics, you will be ready to research more specific issues in governmental accounting and auditing. To help you along in this process, complete the following Now YOU Try.

Take a moment to brainstorm: What are some issues you can think of that might be unique to

governmental accounting?

The next sections of this chapter introduce, first, the standards for state and local govern- ment financial statements and, next, standards for federal government financial statements.

State and Local Accounting Standards

Lo2 Research and apply guidance applicable to state and local governments, particularly within the GASS Codification.

Financial statements are an important mean s by which state and local governments and agencies can demonstrate their accountability to the public. The laws of many indi- vidual states, in fact, require that audited financial statements be prepared at the state and local government levels. Users of these financial statements range from parties interested in understanding the government's priorities (such as citizens and taxpayer groups) to lawmakers interested in setting future agendas and to parties interested in government bond issuances (such as investors, analysts, rating agencies, and munici-

pal bond insurers).

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Chapter 10 I Governmental Accounting Research 277

The Governmental Accounting Standards Board (GASB) establishes accounting stan- dards for state and local government entities. The AI CPA Audit and Accounting Guide, State and Local Governments , par. 1.01 , defines governmental entities as follows: 1

Public corporations and bodies corporate and politic are governmental organizations. Other organizations are governmental if they have one or more of the following characteristics:

Popular election of officers or appointment (or approval) of a controlling majority of the members of the organization 's governing body by officials of one or more state or local governments; The potential for unilateral dissolution by a government with the net assets reverting to a government; or The power to enact and enforce a tax levy.

Furthermore, organizations are presumed to be governmental if they have the ability to issue directly (rather than through a state or municipal authority) debt that pays interest exempt from federal taxation. However, organizations possessing only that ability (to issue tax-exempt debt) and none of the other governmental characteristics may rebut the presump- tion that they are governmental ... [Footnotes omitted]

Figure 10-1 provides examples of state and local government entities subject to the GASB 's guidance.

General purpose state and local governments

Public benefit corporations and authorities

Public employee retirement systems

Governmental utilities, public hospitals and other

healthcare providers

Public colleges and universities

• State of California • Los Angeles County

• The New York City Transit Authority

• The Teacher Retirement System of Texas

• El Paso Water Utilities, Texas • Health & Hospital Corp of Marion, Indiana

• The Ohio State University

Take a moment now to consider the need for financial statements at the state and local govern- ment levels, in the following Now YOU Try.

1. Why might a state government require that audited financial statements be prepared at its

statewide and local levels? Explain.

Continued

I This definition within the AICPA's guide ha s been cleared by the GASB (A&A guide, Stare and Local Governments , 2018, par. l.07 ).

Figure 10·1

Examples of state and local government entities subject to GASB guidance

Now

YOU Try

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�� %$��3 278 Chapter 10 I Governmental Accounting Research

[

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Continued from previous page

2. What organizations do you interact with or frequent that you expect might apply GASB guidance?

GASB guidance is considered authoritative for state and local government entities. In other words , these entities must apply GASB guidance in order for their financial statements to be "in conformity with generally accepted accounting principles," which is necessary for a government to receive an unmodified audit opinion. Although the GASB cannot force com- pliance with the standards it sets, the audit process and state laws requiring GAAP financial statements compel certain governments to comply. In addition, many state and local govern- ments are required, under borrowing agreements, to provide lenders with audited financial information.

Located just downstairs from the FASB in Norwalk, Connecticut, the GASB is an inde- pendent organization focused on creating and improving standards for state and local govern- ments. The objective of these standards is to facilitate governments ' public accountability, and to provide information that is useful to financial statement users. Like the FASB, the funding and administration of the GASB are overseen by the Financial Accounting Founda- tion (FAF). The GASB is funded primarily through an accounting support fee assessed to municipal bond broker-dealers. 2 Additionally, a portion of the GASB ' s funding comes from sales of its subscriptions and publications.

Considering the GASB ' s funding sources , respond to the following Now YOU Try.

In your own words, explain why it makes sense that an accounting support fee, assessed to participants in the municipal bond trading market, is used to fund the GASB.

Guidance Issued by the GASB The GASB issues the following guidance:

• Standards (Statements of Governmental Accounting Standards, or GASB Statements)

• Interpretations

• Technical Bulletins

• Implementation Guides (Q&As) , issued by GASB staff

• Concepts Statements (Statements of Governmental Accounting Concepts)

The GASB uses the GAAP hierarchy depicted in Figure 10-2 to prioritize authoritative sources of state and local government accounting guidance. 3

2 As required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 20 IO.

3 GASB Statement No. 76, Th e Hi erarchy of Generally Accepted Accounting Principles fo r State and Local Governments, par. 4-8 .

�� %$��3 Chapter IO I Governmental Accounting Research 279

Authoritative

levels included

intheGASB Codification

GASB Statements and Interpretations*

GASB Technical Bulletins, GASB Implementation Guides, and AICPA ltterature cleared by the GASB**

If the accounting treatment for a transaction or other event is not specified within a source of authoritative GAAP (level a orb), next a governmental entity should :

Consider guidance for similar transactions.

Next, consider nonauthoritative sources, as long as: • The source doesn 't conflict wtth authoritative guidance, and • The source is consistent with the GASB Concepts Statements.

Examples: GASB Concepts Statements; Guidance from other standard setters (e.g. , FASB, FASAB, international public- and private-sector standard setters) Practices that are widely recognized and prevalent in state and local government

* Includes standards and interpretations of the National Council on Governmental Accounting (NCGA) , the GASB's predecessor. ** Authoritative only if specifically made applicable to state and local governmental entities.

Within Figure 10-2, level "a" and "b" sources are considered authoritative ; however, the degree of their authority varies . Preparers of government financi al statements should prioritize the use of level "a" sources ; when such guidance is not available, level "b" guidance should be considered.

If authoritative guidance is not available for a transaction, guidance for similar transactions should be considered next, followed by nonauthoritative sources. Considering the GAAP hierar- chy, respond to the following Now YOU Try.

1. In your own words, describe the order in which sources should be considered in applying the state and local government GAAP hierarchy.

2. Now, compare this state and local GAAP hierarchy with the FASB's guidance for using authoritative versus nonauthoritative sources.

3. Finally, in a sense, the GASB gives one nonauthoritative source priority over other sources. Name this source, and explain why you believe it is given priority.

Figure 10-2

GAAP hierarchy for state and local entities

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YOU Try

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280 Chapter l O I Governmental Accounting Research

Figure 10-3

Homepage of GARS Online (blue circles added)

Researching GASB Guidance GASB guidance can generally be accessed (1) using the GASB's Governmental Accounting Research System (GARS Online) database or (2) using original standards on the GASB website.

GARS Online The GARS Online database, depicted in Figure 10-3, includes access to the GASB Codification plus other related resources.

Much like the FASB Codification, the GASB Codification organizes authoritative guid- ance by topic and is the preferred method for accessing state and local government accounting guidance. Researchers can purchase a GARS Online subscription directly from the GASB or can obtain low-cost academic access through the American Accounting Association ($250 per school, per year) . The GASB Codification can also be accessed within certain accounting research databases, such as CCH's Accounting Research Manager and PwC 's Inform database.

GJSB

Table ot Contents »

Orig inal Prooouncements

CodifteaUon Comprehen sive lmplemenlatlon Guide

lmplementauon Guleles- Category D (Superseded)

Topical Ind ex

Finding List

Effective Dates Authoritati ve Documents Issued Since Last Update

Doc uments For Public Comment

I Open Documents

My Content

! Tools & Resources

I Preferences I Help

Governmental Accounting Research System™

j New Search

Table of Contents

Reproduced with pennission of the Financial Accounting Foundation.

Notice in Figure 10-3 that authoritative content (namely, the Original Pronouncements, the Codification, and Implementation Guides) has been circled for emphasis. Unlike the situation for FASB guidance, the GASB's original pronouncements (to the extent not superseded) remain an authoritative source of guidance, despite the existence of the Codification.

To access guidance in the Codification, click the+ signs next to each heading (or else you'll just be directed to the preface of each section, if you click the heading itself). Also circled is the GARS Online "Back" button (use this , rather than your browser's "back" button, which may cause you to be logged off of GARS Online). Figure 10-4 further describes the content included within GARS Online.

%$��3 Chapter 10 I Governmental Accounting Researc h 281

GARS Link Content

Original Pronouncements

Codification

Comprehensive Implementation Guide

Finding List

Effective Dates

Documents for Public Comment

Includes all original sources of governmental accounting guidance, such as: GASB Standards and Interpretations, Technical Bulletins , Concepts Statements, certain AICPA guidance, and Standards and Interpretations of the GASB's predecessor (the NCGA).

Includes the following currently-effective content, organized by topic: • GASB Standards, Interpretations, and Technical Bulletins • References to relevant AICPA Audit & Accounting Guides and Statements

of Position • Links to related Implementation Guides

Includes all currently-effective implementation guidance (primarily in the form of Q&As) , organized into chapters by topic

Cross references each original pronouncement, by paragraph, to its location in the GASB Codification . Also identifies those paragraphs considered "background information" and thus not incorporated into the Codification.

Lists the effective dates for each original pronouncement.

Links to guidance currently being proposed by the GASB.

Take a moment now to complete the following Now YOU Try, intended to improve your famil- iarity with the contents of GARS Online.

Considering the GARS Online screenshot from Figure 10-3 and the content descriptions in Figure 10-4, identify which resource a researcher would use:

1. For Q&As related to a particular Codification topic? _____________ _

2. To find background information or the basis for conclusions in an original GASB standard?

3. If a researcher wants to locate the Codification reference for GASB Statement No. 34, par. 2? _______________ ~

Also, respond to the following :

4. What key sources of guidance were used to populate the GASB Codification? What level(s) in the GAAP hierarchy are these sources?

You may have noticed in Figure 10-3 that the GASB Codification includes five parts (I-V) plus appendices; let 's take a moment now to understand how guidance is organized within these five parts.

The Five Parts of the GASB Codification Figure 10-5 illustrates the five parts of the GASB Codification, describes how guidance from each part should be referenced, and summarizes types of content located within each part. Take a moment to review Figure 10-5, then respond to the question s that follow.

Figure 10-4

Content included within GARS Online

Now

YOU Try

10.5

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282 Chapter 10 I Governmental Accounting Research

Figure 10-5

The five parts of the

GASS Codification, plus

appendices

Now

YOU J Try 10.6

Reference format

Sections 1000-1800

Sections 2100-2900

Section 3100

Sections A10-U50 (Alpha-numeric code)

Sections Bn5-Ut5 (Alpha-alpha-numeric

code)

Includes, for example, standards that are not yet effective (App. A)

and the GASB Concepts Statements (App. B)

Content

Describes overarching principles for applying governmental accounting standards. Example sections include: • The Hierarchy of Generally Accepted

Accounting Principles (Sec. 1000) • Fund Accounting (Sec. 1300) • The Budget and Budgetary

Accounting (Sec. 1700)

Provides guidance on individual financial statements and required financial statement content. For example: • Comprehensive Annual Financial

Report (Sec. 2200) • Notes to Financial Statements (Sec. 2300) • Segment Information (Sec. 2500)

Includes only one topic: Fair Value Measurement (Sec. 3100)

Provides guidance on specific items, for example: • Investments (Sec. 150) • Leases (Sec. L20) • Pension Activities-Employer

Reporting (Sec. P20) • Property Taxes (Sec. P70)

Provides guidance for stand-alone reporting of special purpose governments or activities. For example: • Colleges and Universities (Sec. Co5) • Hospitals and Other Healthcare

Providers (Sec. Ho5) • Pension Plans-Defined Benefit (Sec. Pe5)

Using Figure 10-5, complete the following Now YOU Try.

In what part of the Codification might a researcher find:

1. Sections entitled "Defining the Financial Reporting Entity" and "Cash Flow Statements"?

2. Guidance on differences between the cash and accrual bases of accounting? _____ _

3. Sections entitled "Bankruptcies," "Pension Plans," and "Regulated Operations"?

4. Sections entitled "Inventory" and "Nonmonetary Transactions"? _____ _

Browse Searches within GARS Online As you know from prior chapters, a browse search means little more than attempting to navigate directly to appropriate guidance within a research database. In this case, researchers must first determine which part of the GASB Codification to search, then should look for relevant topics within that part. Browse searches are generally preferable to keyword searches in that they allow a researcher to understand how an issue fits into the broader context of the Codification.

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Chapter 10 I Governmental Accounting Research 283

Because the GASB Codification contains guidance with varying degrees of authority (recall the hierarchy of authoritative guidance), each paragraph within the Codification indi- cates its source material. This is also helpful to researchers looking for background informa- tion that is included within original standard s, but which has not been included within the Codification. Al so, where relevant, topics link to separatel y located content such as Implemen- tation Guides and certain AICPA content. Certain topic s also include paragraphs .901-.999, Nonauthoritative Di sc uss ion .

To illustrate the format of an individual topic, Figure 10-6 depicts the top-of-page matter for Topic AlO (Certain Asset Retirement Obligations). Notice that the page li sts the topic' s source material ("Sources") and provides links to related topics (under "See Al so").

GPSB Governmental Accounting Research System™

GARS

!!I ~ A10--Certain Asset Retirement Obliga~ons

A10-CERTAIN ASSET RETIREMENT OBLIGATIONS

ion P40 19, ~Pollution Remediation ObligationsH

'-M_y_co_" _'""_' __ __,I ~(g] Scope and App licability of Thi s Sect ion Too ls & Resources

Preferences

Help

.101 This section establishes standards of accounting and financial reporting for certa in asset retirement obligations

(ARO) l.9. 1 The requ irements of this section apply to financial statements of all state and local governments. [GASBS 63, 13]

Reproduced with permission of the Financial Accounting Foundation .

Considering Figure 10-6, respond to the following.

1. What are some sources used to generate this Codification topic Po50? Why might a researcher want to review these source materials?

2. What are the two related topics listed next to "See Also"?

A few additional observations regarding Figure 10-6: Notice that the li st of "Open Documents" on the left side of the screen keeps a running li st of any documents a researcher views. Click two of the checkboxes, and you'll have the option to view two documents concurrently. Additionally, researchers can use the "See Also" links for additional direction if an initial search proves fruitless.

When researching an issue that is new to you, chances are pretty good that you won't always end up in the right place the first time . Take advantage of the "See Also" links within each stan- dard to generate ideas about possible other, or related, areas to search for relevant guidance.

Figure 10-6

Sample GASB Codification section , A 10 (Certain Asset Retirement Obligations) , blue circles added

Now

YOU Try

10.7

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� %$��3 284 Chapter 10 I Governmental Accounting Research

Figure 10-7

Advanced keyword search of GARS Online , blue circles added

Keyword Searches within GARS Online Keyword searches within GARS Online are generally most appropriate when a researcher has a search term in mind but is not familiar with how that term fits into the literature.

The keyword search function within GARS Online is fairly straightforward, particu- larly for researchers familiar with FASB Codification searches. This function is depicted in Figure 10-7.

GJSB Governmenta l Accounting Research System™

Help

Advanced Search

AJIWordl .. AllyWordl Exact Phnlu BooltonSM1th

Reproduced with permission of the Financial Accounting Foundation.

As illustrated in Figure 10-7, a researcher can choose to search for all words, any words, an exact phrase, or using a "Boolean operator" search (where the terms "and," "or," or "not" are inserted between two search terms). Additional guidance on conducting Boolean searches is avail- able under the GARS Online help menu (see left-hand link). Also in Figure 10-7, the search field "Publication" allows researchers to specify whether to search just within the Codification or within another area of GARS Online (such as Original Pronouncements only). Your best bet? Stick with the default option, to search the full GARS Online database, and your results will be organized by part anyway (e.g., "2 results in Original Pronouncements," "2 results in GASB Codification").

An extended example applying guidance from the GASB Codification to a local government's sales and property tax revenues is provided in the Appendix to this chapter. Intended to expose beginning researchers to a range of issues, the example touches upon revenue rec- ognition, application of the accrual/modified accrual bases of accounting, and fund accounting.

Now that you have a basic understanding of GARS Online and the GASB Codification, let's discuss another (albeit less desirable) option for accessing GASB guidance.

Accessing Standards on the GASB Website A less ideal way to research GASB literature is by accessing full texts of the GASB 's original standards free of charge on its website, www.gasb.org, under "Pronouncements ." This manner of searching is less than ideal because

• These standards are only available in their original, as issued form on the GASB website and do not reflect revisions that may have occurred since their issuance.

• Guidance is not organized by topic. Therefore, in some cases, researchers must navigate through multiple standards and interpretations in order to understand the guidance appli- cable to a single topic.

• Finally, the GASB website does not include the full population of guidance applicable to government financial statements. For example, certain AICPA literature is considered authoritative for government financial statements but is neither accessible nor clearly refer- enced on the GASB 's website.

%$��3 Chapter 10 I Governmental Accounting Researc h 285

Researc hers using the GASB website therefore risk usi ng outdated, or incomplete, sources. Recognizing the se limitations, the GASB website cautions that its standard s page is intended to serve only as a "general reference."4

To search for original standards on the GASB website, researchers can navigate to the Pronouncements page (under the Standards & Guidance tab). There, researchers can perform keyword searches on the page (using, for example, ctrl + f). Alternatively, researchers can per- form an Advanced Search from the homepage, for any in stances of a term on the GASB website. Figure 10-8 illustrates an advanced search for the term "infrastructure. "

Standards & Guidance Download the original te.xt of all GASB Statements, Concepts Statements, and other pronouncements for free.

Reproduced with permission of the Financial Accounting Foundation .

The current status of standard s listed on the GASB website varies; certain standards are still fully applicable, while others may be fully or partially superseded. Figure 10-9 illustrates the standards list from the GASB website, including links to statu s information. Notice, for example, that Statement No. 22 has been fully superseded. Notice also the link to the Status page for each standard (such as under Statement No. 24).

Statement No . 24 Accounting and Financial Reporting for Certain Grants and Other Financial Assistance Effective date beginning after: June 15, 1995 (Issued 6/94) [Full Text] [Summa<I.filfil!!.fil:=)

Statement No. 23 Accounting and Financial Reporting for Refundings of Debt Reported by Proprietary Activities Effective date beginning after: June 15, 1994 (Issued 12/93) [Full Text] [Summary) [Status)

tatement No. 22 (Superseded Ac · ssed Tax Revenues in Governmental Funds Effective date beginning after: June 15, 1994 (Issued 12/93) [Full Text] [Summary) [Status)

Reproduced with permission of the Financial Accounting Foundation .

When accessing standards on the GASB website, it is essential to review a standard 's Sta- tus page. On thi s page, a researcher can determine how a given standard has been affected by sub sequent guidance issuances, can identify ways thi s standard affects (or has changed) other standards, and can find references to Other Interpretive Literature related to the standard. It is critical to understand how current a standard is before relying upon it.

4 www.GASB.org, Pronouncements.

Figure 10-8

Search of the GASB website. Circled emphasis added.

Figure 10-9

Status information on the GASB website

%$��3 286 Chapter l O I Governmental Accounting Research

[ TIP from the Trenches

Figure 10-10

The GFOA 's "Certificate of Achievement'' seal for excellence in government reporting

The GASB's website can be a useful reference but should not be relied on as a source of

authoritative guidance if you are performing governmental accounting in practice. There is just too much risk involved-you could inadvertently apply outdated guidance or miss an

important interpretive source.

Additional Sources for State and Local Guidance Numerous nonauthoritative resources are available to assist government accountants in the preparation of financial statements. These resources often include practical explanations of authoritative requirements, illustrations, and checklists. For example,

1. GFOA's blue book, Governmental Accounting, Auditing, and Financial Reporting (GAAFR)

r, Certificate °achievement ll·J;IJ3:139!:l:C:¥41:I

Financial Rtporting

Used with permission fromGFOA.

First published in 1934, the Blue Book of the Government Finance Officers Association (GFOA) provides practical guidance and reference materials related to the preparation and audit of government financial statements.

Notably, the GFOA is also responsible for the Certificate of Achievement for Excellence in Financial Reporting Program, awarded to state and local governments for high quality financial reporting. Figure 10-10 illustrates the seal awarded to recipients of this distinction.

2. The AICPA Audit and Accounting Guide, State and Local Governments (limited portions of which have been cleared by the GASB and are authoritative)

3. PPC 's Guide to Preparing Governmental Financial Statements

4. Resources from the Association of Government Accountants (AGA), such as its quarterly magazine, the Journal of Government Financial Management.

5. Interpretive Guidance within Firm Research Databases. CCH's Accounting Research Manager, for example, gives subscribers access to CCH's governmental GAAP practice manual, a governmental GAAP guide, audit tools, and checklists.

Next, we will di scuss the accounting standards applicable to federal government financial statements.

Federal Accounting Standards

Lo3 Become familiar with federal gov- ernment accounting standards issued by the FASAB.

The Federal Accounting Standards Advisory Board (FASAB) establishes accounting standards applicable to U.S. government financial statements. Under the CFO Act of 1990, the U.S. government and its component entities, or federal reporting entities, are required to prepare annual, audited financial statements.

Specifically, the CFO Act required executive branch entities of the U.S. government to prepare audited financial statements; legislative and judicial branch entities are gener-

ally not subject to this requirement and instead report limited cash-basis financial information. 5

Annually, the financial statements of entities from each branch of the U.S. government are aggregated to create the government-wide consolidated financial report (CFR). This report is audited by the Government Accountability Office (GAO).

Figure 10-11 illustrates several of the executive branch entities (depicted as significant reporting entities) that are required to prepare audited financial statements. 6 Note, however, that not all entities required to comply with the CFO Act are shown in this graphic.

5 2017 Financial Report of the U.S. Government, Appendix A: Reporting Entity. Page 211.

6 This illustration was excerpted from the 2017 Financial Report of the U.S. Government, Management' s Discussion and Ana lysis, Exhibit I, page 9. The original illustration (not reproduced in full in this chapter) also li sts several of the "other significant reporting entities" (such as the Securities and Exchange Commission) required to prepare audited financial statements .

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Chapter 10 I Governmental Accounting Researc h 287

( THE UNITED STATES GOVERNMENT

LEGISLATIVE BRANCH THE CONGRESS

SENATE HOUSE Architect of the Capite>

United States Botanic Garden Government Accountability Office

Government Publishing Office Library of Congress

Congressional Budget Office U.S. Capitol Police

DEPARTMENT DEPARTM ENT OF OF

AGR ICU LTURE COMM ERCE

DEPARTM ENT DEPA RTMENT OF HEALTH OF HOM ELAND AND HUMAN SECURITY SERV ICES

DEPARTMENT DEPARTM ENT OF OF

LABOR STATE

THE CONSTITUTION

EXECUTIVE BRANCH THE PRESIDENT

THE VICE PRESIDENT EXECUTIVE OFFICE OF THE PRESIDENT

White House Office Office of the Vice Presiden t

Council of Economic Advisers Council on Environmental Quality

National Security Council Office of Administration

Office of Management and Budget Office of National Drug Control Policy

Office of Policy Development Office of Science and Techne>ogy Policy Office of the U.S. Trade Representative

SIGNIFICANT REPORTING ENTITIES

DEPARTMENT OF

DEFE NS E

DE PARTMENT OF HOUSING AN D URB AN

DEVELOPMENT

DE PARTMENT OF

TR ANSPORTATI ON

JUDICIAL BRANCH THE SUPREME COURT OF THE

UNITED STATES United States Courts of Appeals

United States District Courts Territorial Courts

United States Court of International Trade United States Court of Federal Claims

Admin istrative Office of the United States Courts

Federal Judicial Center United States Sentencing Commission

DE PARTMENT DEPARTMENT OF OF

ED UCATION ENERGY

DE PARTM ENT DEPARTMENT OF THE OF

INTER IOR JUSTI CE

DEPARTMENT DEPARTMENT OF THE OF VETERANS

TREASURY AFFAIRS

The FASAB was established in 1990 in order to create accounting standards for the financial reports required under the CFO Ac t. Federal officials representing the Department of the Trea- sury and the Office of Management and Budget (OMB ), both Executive Branch entities, and the Government Accountability Office (GAO), a legislative branch agency-having the authority to set these standards-created the FAS AB and delegated to it their standard setting responsibilities .

Collectively, the Departm ent of Treasury, the OMB , and the GAO (i. e., the sponsor agen- cies) fund the FAS AB. Of the FASAB 's nine- member board, three members are appointed by the sponsor agencies, and six members are selec ted fro m the public. Two of the FAS AB 's sponsor age ncies, the GAO and OMB, have the right to review and, at their discreti on, obj ec t to, FASAB standards before they are issued as final.

1. Within Figure 10-12, locate the FASAB's three sponsor agencies and circle them.

2. Considering the significant reporting entities depicted in Figure 10-12, which entities' finan- cial statements would you be most interested in reviewing? Why?

3. What perspectives or priorities might you expect members appointed by the GAO and OMB to bring to the FASAB board? Explain.

Figure 10-11

Organization of the U.S. government, including "significant'' executive branch reporting entities required to prepare audited financial statements

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288 Chapter l O I Governmental Accounting Research

Figure 10-12

The FASAB Handbook (cover image)

Figure 10-13

Hierarchy for the use of FASAB guidance7

Guidance Issued by the FASAB Guidance issued by the FASAB is referred to as GAAPfor federal entities. The FASAB 's authori- tative sources of guidance are compiled and codified together in the FASAB Handbook of Federal Accounting Standards and Other Pronouncements (the "FASAB Handbook"), available free of charge at www.fasab.gov, under "Standards." The FASAB Handbook, depicted in Figure 10-12, reflects the current population of FASAB guidance and is generally updated annually. Individual standards issued between updates are also available on the FASAB 's website.

FASAB guidance can also be accessed in certain, but not all, firm research databases. PwC's Inform database, for exa mple, provides its subscribers access to FASAB 's final and proposed guidance.

The FASAB Handbook includes:

• FASAB Standards, also referred to as Statements of Federal Financial Accounting Standards (SFFAS)

• Concepts Statements, or Statements of Federal Financial Accounting Concepts (SFFAC)

• Interpretations, or Interpretations of Federal Financial Accounting Standards • Technical Bulletins (TB) • Technical Releases (TR), or Federal Financial Accounting and Auditing Technical Releases

• Staff Implementation Guidance

The hierarchy depicted in Figure 10-13 applies to the use of FASAB guidance .

......... • FASAB Standards

....,,. • FASAB Interpretations

• FASAB Technical Bulletins • Certain AICPA Industry Audit and

Accounting Guides•

......... • Technical Releases of the FASAB's

....,,.. Accounting and Auditing Policy Committee

• Implementation guides published by the ......... FASABstaff ....,,. • Practices that are widely recognized and

prevalent in the federal government

'If specifically made applicable to federal reporting entities by the AICPA and cleared by the FASAB

7 SFFAS 34, Th e Hierarchy of Generally Accepted Accounting Principles, Including the Application of Standards Issued by the Financial Accounting Standards Board, par. 5.

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Preparers of federal government financial statements should utilize accounting guidance in the order of priority listed. That is, if guidance in level a is unavailable for a transaction, guid- ance in levels b-d may be applied in descending order. If none of these sources (a-d) offers relevant guidance, entities should consider guidance for similar trans actions , then they may consider other sources of guidance such as the FASAB Concepts Statements or FASB , AICPA, GASB , or IASB guidance, articles, or textbooks.

Guidance within the FASAB handbook is organized by standard, and each standard is pre- sented as a separate chapter. The Status page of each standard lists other standards and interpretive guidance that affect, or are affected by, the standard. For example, Figure 10-14 illustrates the Sta- tus page of SFFAS 33 (Pensions, Other Retirement Benefits, and Other Postemployment Benefits).

Statement of Federal Financial Accounting Standards 33: Pensions, Other Retirement Benefits, and Other Postemployment Benefits: Reporting the Gains and Losses from Changes in Assumptions and Selecting Discount Rates and Valuation Dates

Status Issued October 14, 2008

Effecti ve Date For fiscal years beginning after September 30, 2009

Interpretation s and Techntcal Releases None.

Affects • SFFAS 5. pars. 65, 66, 83, 95, and 157, by changing the standard for selecting discount rates.

• SF FAS 7, par. 67 .1 , by replacing the phrase "best estimate• with "reasonable estimate" and "likely" with "reasonably expected"; par. 67.2 by replacing "besr with "reasonable.·

• SFFAS 17, pars. 25, 27(2), and 27(4), by replacing the phrase ' best" with •reasonable" and deleted •best: respectively.

Affected by None.

Source: FASAB Handbook, as of June 30, 2018

To search for guidance within the FASAB Handbook, researchers can (1) perform "ctrl + f' (find) keyword searches within the Handbook or (2) scan the Handbook's table of contents to locate standards relevant to their searches. Within each individual standard is a table of contents, which can help researchers efficiently navigate to relevant guidance.

Applying FASAB Guidance The following example illustrates the accounting for government Medicare obligations (a type of "social insurance"). Readers will have the opportunity to review and apply FASAB guidance applicable to thi s issue.

Accounting for Medicare

Facts about Medicare: Medicare is a national health insurance program for people ages 65 and older, as well as for certain individuals with disabilities. Generally, U.S. citizens and permanent residents meeting the age requirement are eligible for Medicare if they or their spouse worked for at least 10 years in Medicare-covered employment. Medicare is funded , in part, through a payroll tax levied on employees and employers.

Required: Read the following excerpts from SFFAS 17, Accounting for Social Insurance, then respond to the questions that follow.

14. The following programs are designated as social insurance and subject to these standards: • Old-Age, Survivors, and Disability In surance (OASDI or "Social Security"); • Hosp ital In surance (HI) and Supplementary Medical In surance (SMI) , known col-

lectively as "Medicare"; • Railroad Retirement benefits; • Black Lung benefits; and • Unemployment In surance (UI) ... .

Continued

Figure 10-14

Sample "Status" page, showing guidance that affects (or is affected by) SFFAS 33

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Characteristics of Social Insurance Programs

15 . These programs were developed to carry out the responsibilities of the government and generally have characteristics that make them unjque .. .. This statement identi- fies the following five characteristics common among social insurance programs: (l) Financing from participants or their employers, (2) Eligibility from taxes/fees paid and time worked in covered employment, (3) Benefits not directly related to taxes/fees paid, (4) Benefits prescribed in law, and (5) Programs intended for the general public.

Questions:

1. First, recall from the reading: Is SFFAS 17 applicable to state and local governments, or to federal government entities? Explain .

2. Read the "Facts about Medicare" above, then explain how you determined (under both par. 14 and 15) that Medicare is within the scope of this guidance:

Par. 14:

Par. 15:

SFFAS 17 states the following regarding the recognition and measurement of social insurance benefits:

22. The expense recognjzed for the reporting period should be the benefits paid during the reporting period plu s any increase (or less any decrease) in the liability from the end of the prior period to the end of the current period. The liability should be soc ial insurance benefits due and payable to or on behalf of beneficiaries at the end of the reporting period, including claims incurred but not reported (IBNR).

3. How does SFFAS 17 require governments to measure the liability for social insurance benefits?

4. Brainstorm, recalling from previous financial accounting courses: Is this recognition model con- sistent with how nongovernmental entities record employee retirement healthcare obligations? Explain.

5. What level in the FASAB hierarchy is this guidance? Explain.

6. What other resources might you consult for additional interpretation of this SFFAS?

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Chapter IO I Governmental Accounting Research 291

Referencing Governmental Accounting Guidance Citing Standards References to governmental accounting standards follow a simjJar format as references to other, nongovernmental sources . For example, following are sample references to GASB and FASAB standards:

• Per GASB Statement No. 72, Fair Value Measurement and Application (Statement 72 or GASBS 72) par. 28, "Valuation techniques should maximize the use of relevant observable inputs and minimize the use of unobservable inputs ."

• Per Statement of Federal Financial Accounting Standards No. I (SFFAS I), Accounting for Selected Assets and Liabilities, par. 18, "intragovernmental assets and liabilities arise from transactions among federal entities."

Both citations include the following required elements:

• The full name of the standard type (e.g., GASB Statement No ., or Statement of Federal Financial Accounting Standards No.). This full introduction is necessary whenever guidance is first cited in a memo. Without this , a reader might have difficulty understanding how to locate trus guidance.

• Full name of standard is included, in italics.

• Paragraph number is included.

• An indication (in parenthesis) that future references to this source will be abbreviated as "GASBS 72" or "SFFAS l ."

Future references to these standards may simply state: "Per GASBS 72, par. 28" or "Per SFFAS 1, par. 19," for example.

Citing the GASB Codification References to the GASB Codification can be cited as follows:

GASB Cod. Sec. 2300, par. I 02 (Notes to Financial Statements) states: "The notes to the financial statements should communicate information essential for fair presentation of the basic financial statements that is not displayed on the face of the financial statements."

In this example, identification of the "GASB Cod" is provided initially ; future references to the Codification within the same memo can be abbreviated as "Sec. 2300.102."

Next, we'll turn our attention to the standards for performing governmental audits.

GOVERNMENTAL AUDITING STANDARDS

In What Circumstances Are Government Audits Required? Recall from our discussion of governmental accounting standards that many state, local, and federal government entities are required to prepare audited financial statements. These audits may be required by

• The CFO Act, which requires certain federal entities to prepare annual, audited financial statements;

Lo4 Recognize and apply govern- ment auditing standards issued by the GAO.

• The laws of individual states, which may require annual audited state and local government financial statements; or

• Compliance with debt or other covenants, requiring governments (borrowers) to provide audited financial statements.

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292 Chapter IO I Governmental Accounting Research

Figure 10-15

A "single audit" combines required financial statement and performance audits, for recipients of federal funds

[

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In addition to financial statement audits, entities may be required to undergo performance audits in certain circumstances . The objectives of individual performance audits can vary but might focus on, for example,

• The efficiency and effectiveness of a government program (e.g., Are government resources being expended in the manner intended?);

• An entity 's internal controls and governance structure;

• An entity 's information security; or

• An entity's compliance with laws and regulations.

Following are two circumstances in which performance audits are currently required.

"Single Audit" Requirement for Recipients of Federal Funding Entities receiving federal funding in excess of $750,000 are required by the U.S. government's Office of Management and Budget Uniform Guidance to undergo a single audit. 8 Illustrated in Figure 10-15, a single audit is defined as a financial statement audit plus a program (aka, per- formance) audit of programs for which federal funds have been received. Single audits must be conducted in accordance with both federal regulations (specifically, 2 CFR Part 200, subpart F) and governmental auditing standards , and these audit requirements apply to both governmental and nongovernmental entities receiving federal funding.

Financial statement audit , plus one or more of: • Program or performance audit(s) • Review of program internal controls • Review of program compliance with

laws and regulations

Annually, the OMB prepares a Compliance Supplement document that includes specific guidance to assist auditors in complying with the requirements necessary to perform single audits. This Compliance Supplement also includes department-specific guidance for auditing federal award programs.

For example, the Compliance Supplement includes suggested audit procedures for review- ing the effectiveness of Department of Education "Title 1" grants to underperforming schools. These procedures include: "Review program expenditure and other records to verify that educa- tional services that were planned were provided ."9

Considering the requirements of Uniform Guidance and the Compliance Supplement just described, respond to the following.

1. In your own words, explain why a financial statement audit, plus a performance audit, could be beneficial in the case of these local governments that received Department of Education Title 1 grants.

Continued

8 OMB Rule, Uniform Administrative Requirements, Cost Prin ciples, and Audit Requirements for Federal Awards ("Uniform Guidance"), issued 12/26/2013.

9 OMB Compliance Supplement 2018 . Department of Education section, p. 4-84.000-24.

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Continued from previous page

2. Generally speaking, in what circumstances is a local government subject to this single audit requirement?

State-Required Performance Audits Certain states require their municipal governments and agencies to submit to periodic perfor- mance audits, which can range in their objectives and scope. For example,

• In New York, the Office of the State Comptroller (OSC) conducts performance audits of state agencies, public authorities, and local governments (including towns, villages, school districts, and fire districts). The focus of these audits can vary, from a review of internal controls, to a review of the entity's governance structure, to reviews of specific programs' efficiency and effectiveness. The type of audit required is determined based on a risk assess- ment by the OSC.

• The need for regular oversight over school district governance and controls, in particular, was underscored by the $11 million, Roslyn, New York, School District fraud, uncovered in a 2005 audit. 10 Perpetrated primarily by the district's Superintendent and the school dis- trict's chief financial officer, this fraud might have been prevented had effective governance and internal controls been in place. In response to this fraud, the New York OSC initiated a 5-year effort to review the internal controls of all New York school districts, in addition to continuing to require annual, independent financial audits of all school districts in the state. 11

Clearly, government audits can range widely in their objectives and complexity; these examples illustrate just a few of the circumstances in which government audits are required. Next, Jet's discuss the parties who perform government audits.

Who Performs Government Audits? You may be wondering: do all government auditors work for the government? It's true that many auditors of government financial statements work for federal, state, or local governments; however, individuals in public accounting firms also frequently perform government audits. Therefore, even if your future involves working for a public accounting firm, it is possible that you will be assigned to a governmental client.

Often, the governmental entity under audit can engage a firm of its choice; however, in many cases, the federal government may conduct ( or assign responsibility to another agency for conduct- ing) an audit of a state or local government that receives federal government funds. Similarly, state auditors may audit municipalities or appoint another auditor of the state's choice.

Many federal agencies have an Office of the Inspector General whose mission is, in part, to audit the programs and operations of the agency. 12

Figure I 0-16 illustrates a sample of CFO Act agencies and their auditors, as well as their fiscal year 2017 audit opinion.

The next section of this chapter introduces readers to the authoritative guidance applicable to government audits, and describes the minimum training requirements applicable to govern- ment auditors.

IOHuefner, Ronald J. "Local government fraud: the Roslyn School District case." Mana gement Research Review, copyright Emerald Group Publishing Limited. Vol. 33 , No. 3, 2010. Page 199.

11 Division of Local Government and School Accountability, of the Office of the New York State Comptroller. "Making the Grade: Five Years of School Di strict Accountability." 2009 Annual Report. February 20 I 0. Page 2.

12 Inspector General 's Act of 1978, as an1ended.

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In the auditor's (or attestation provider's) report , when stating that an engagement was performed in accordance with GAGAS , it is not necessary to state that the engagement also complied with AICPA standards. Because GAGAS incorporates AICPA standard s by reference, it is understood that an engagement performed in accordance with GAGAS also complies with AICPA standards. 14

Following is a brief Now YOU Try exercise intended to reinforce th e sources of guidance that mu st be followed under GAGAS .

Understanding Compliance with GAGAS

Review the excerpt from par. 4.01 and the preceding discussion, and respond to the following.

1. For an auditor to comply with GAGAS, he or she must also comply with the AICPA's

2. Specifically, an auditor must comply with all sections of the AICPA's SAS, including the intro- duction, objectives, ______________________ _

3. When citing compliance with GAGAS in the auditor's report, it is not necessary to also state that the audit complied with AICPA standards because ___________ _

The Yellow Book is accessible on the GAO's website at www.gao.gov/yellowbook. Figure l 0-17 illustrates the cover page of the Yellow Book.

Within the Yellow Book, guidance is organized by topic. Therefore, when searching for guidance, researchers may find it most efficient to scan the Yellow Book's table of contents. This offers researchers the benefit of getting a feel for available guidance and seeing how it is organized. Alternatively, researchers can perform keyword searches of the entire document, using ctrl + f.

GAO

July2018

GA0 ·1 8-568G

Unl1ed Sl.lltu Gov, mment Aecounl.llblllty Office

By the Comptroller General of the United States

GOVERNMENT AUDITING STANDARDS

2018 Revision

Figure 10-18 li sts th e chapters and summari zes some of the key content included in the Yellow Book.

14 GAO, Government Auditing Standards (i.e. , the "Yellow Book").2018 Revision. Chapter 6, par. 6.37.

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Figure 10-17

GAO's Government Auditing Standards (Yellow Book) cover page

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296 Chapter 10 I Governmental Acco unting Research

Figure 10-18

Yellow Book chapters and content summary

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Chapter Examples of chapter content

Chapter 1, Foundation and Principles for the Use and Application of Gvt. Auditing Standards

Chapter 2, General Requirements for Complying with GAGAS

Chapter 3, Ethics, Independence, and Professional Judgment

Chapter 4, Competence and Continuing Professional Education

Chapter 5, Quality Control and Peer Review

Chapter 6, Standards for Financial Audits

Chapter 7, Standards for Attestation Engagements

Chapter 8, Fieldwork Standards for Performance Audits

Chapter 9, Reporting Standards for Performance Audits

Appendi xes

• Describes the purpose and applicability of GAGAS (identifies entities subject to)

• Role of government auditors • Defines types of GAGAS engagements (financial/performance audits ,

attestation engagements)

• Defines "unconditional" and "presumptively mandatory" requirements • Describes the relationship between GAGAS and other professional

standards (such as AICPA guidance)

• Requires auditors to be independent and to use professional judgment

• Establishes minimum annual training requirements for government auditors

• Audit firms must maintain a system of quality control

• Requires auditors to comply with AICPA audit standards in addition to specific GAGAS field work and reporting standards

• Requires auditors to comply with AICPA attestation standards in addition to specific GAGAS standards

• Provides guidance for performance audits, including audit planning, evidence, and documentation

• Provides guidance on communicating the results of performance audits

• Supplemental guidance • Conceptual Framework for independence

Notably, within Yellow Book Chapter 4, the section on auditor co mpetency includes certain training requirements for government auditors. Specifically, govern ment auditors mu st earn at least 80 hours of co ntinuin g edu cation credits in the field s of audit and attestation every 2 years, and 24 hours of this mu st pertain specifically to the government environment and government auditin g. 15 These edu cation requirements are important when you consider that our profession's audit quality on single audits has bee n fo und to be lacking. In a sample of sin gle audits co nduct- ed by the AICPA 16, successful performance of the audit in confor mity with auditin g standards was largely drive n by the auditor's number of sin gle audi ts performed.

Take a moment now to practice your Yell ow Book research skill s with the fo llowin g Now YOU Try exercise.

Locating Information within the Yellow Book

Provide the chapter number that you would consult for guidance on the following questions.

1. Are GAGAS applicable to nonprofit entities?

Chapter No. __

2. What audit evidence is required for auditors engaged to perform "performance" audits?

Chapter No. __

3. What are the minimum training requirements necessary for a government auditor to demon- strate "competence"?

Chapter No. __

15 GAO, Government Auditing Standards (i. e., the "Yell ow Book").20 18 Revi sion. Sec. 4.1 6.

16 AICPA Go vernmenta l Audit Quality Center (GAQC) Alert No. 340, Au g. 20 17.

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4. Like the AICPA, does GAGAS use the word "must" to indicate an unconditional requirement?

Chapter No. __

5. What additional documentation (beyond AICPA requirements) is required for financial state- ment audits performed under GAGAS?

Chapter No. __

Citing GAO Guidance The following example illustrates an appropriate reference to guidance from the Yellow Book.

• Per Government Auditing Standards, 2018 Revision, Section 3.18 (Independence):

3.18 In all matters relating to the GAGAS engagement, auditors and audit organizations must be independent from an audited entity.

Note that the preceding reference contains the title of the source (Government Auditing Standards) as well as the date of revision. As a researcher, err on the side of caution and assume your reader does not know what a "yellow book" is-only use this term after introducing the full title of the source.

Because the Yellow Book is revised periodically, it is necessary to include the date of the revision you have consulted. Without this complete information, future readers of your memo may have difficulty locating your original source.

Note also that section and paragraph numbers (e.g., 3.18) should be included any time spe- cific guidance is cited.

Other Governmental Audit Resources In addition to the resources previously described, several other sources of authoritative guidance exist for government audits. These include (but are not limited to):

• OMB Bulletin No. 17-03, Audit Requirements for Federal Financial Statements (or a more recent version of this document) , which establishes additional audit requirements for federal government financial statements.

• FASAB Technical Releases, located within the FASAB Handbook, which set forth certain requirements for audits of federal government entities.

• State-specific audit requirements, often included within individual states ' audit manuals. States may require governmental auditors to comply with these requirements in addition to complying with GAGAS.

Nonauthoritative Resources A number of practical, nonauthoritative resources are also available to aid government auditors. These include (but are not limited to):

• GAO Financial Audit Manual (FAM): Presents a methodology for performing financial statement audits of federal entities

• AICPA Audit Guide, Government Auditing Standards and Single Audits

• PPC 's Guide to Single Audits and PPC's Guide to Audits of Local Governments

Finally, the Governmental Audit Quality Center (GAQC) of the AICPA offers practical and cur- rent resources intended to improve the quality of government audits.

Applying Governmental Auditing Standards Following are two examples illustrating the application of governmental audit guidance. The first example illustrates an audit report for a local government performance audit. The

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second example illustrates the GAO ' s audit findings related to its audit of the U.S. federal government.

Audit of Local Government's Receipt of Grant Funds

Facts: In 2012 , the U.S. Department of Justice's Office of the Inspector General (OIG) conducted a program audit of "COPS" grant money received by the City of Newark, New Jersey. The COPS program offers federal grant money to local governments in order to enhance their local policing efforts and to upgrade existing police communication systems.

Following is an excerpt from the Yellow Book describing the reporting requirements for per- formance (including program) audits:

7.08 Auditors should prepare audit reports that contain (1) the objectives, scope, and methodology of the audit; (2) the audit results , including findings, conclusions, and recommendations, as appropriate; (3) a statement about the auditors' compliance with GAGAS; (4) a summary of the views of responsible officials; and (5) if applicable, the nature of any confidential or sensitive information omitted.

Following are excerpts from the OIG's audit report on Newark's use of COPS funds .17

The purpose of this audit was to determine whether reimbursements claimed for costs under the grant were allowable, supported , and in accordance with applicable laws, regulations, guidelines, and terms and conditions of the grant, and to determine program performance and accomplishments. COPS awarded Newark $2,787,00 1 to implement the grant program and required Newark to provide $929,000 in local funds for a total project cost of $3,7 16,001.

We examined Newark's accounting records, financial and progress reports, and oper- ating policies and procedures and found the deficiencies below resulting in net questioned costs totaling $3 ,539,432.

• Newark significantly changed the sco pe of the grant project without prior written approval from COPS.

• Newark did not achieve the performance objectives related to voice communications funded by the grant.

• Newark purchased wireless network equipment and services totaling $2,777,569 that were not procured using a competitive process or approved for purchase under the New Jersey State Cooperative Purchasing program, which is in violation of grant regulations requiring competition ....

We conducted this performance audit in accordance with generally accepted govern- ment auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives.

Using the excerpted GAGAS requirements and the OIG audit report, respond to the questions that follow.

Questions:

1. What law or standard, discussed within the chapter, requires certain recipients of federal grant funds to be audited?

Continued

17 U.S. Department of Justice Office of th e Inspector General Audit Divi sion, Audit Report GR -70-12-007 . Jul y 2012 . Pages i- ii, 17.

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2. Describe how the OIG 's audit report satisfies the GAGAS requirements excerpted in par. 7.08. (Or note any areas not covered in this excerpt).

ii)---------------------------

iii)----------------------------

iv)

v) ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~-

Audit Report-Federal Government-Wide Financial Statements

Facts: One of the GAO's responsibilities is to audit the consolidated U.S. government-wide finan- cial report on an annual basis. However, fiscal year 2017 marked the twentieth consecutive year that the GAO expressed a disclaimer of opinion on this report. 18 The following example focuses on the GAO's reported internal control findings which were, in part, responsible for this disclaimer of opinion.

The following excerpts from the Yellow Book describe auditor reporting requirements related to internal controls:

Reporting on Internal Control; Compliance with Provisions of Laws, Regulations, Contracts, and Grant Agreements

6.40 When providing an opinion or a disclaimer on financial statements , auditors should

report as findings any significant deficiencies or material weaknesses in internal con-

trol over financial reporting that the auditors identified based on the engagement work

performed.

Presenting Findings in the Audit Report

6.50 When presenting findings, auditors should develop the elements of the findings to the

extent necessary to assist management or oversight officials of the audited entity in

understanding the need for corrective action.

The next excerpt is from the GAO's consolidated federal government audit report:

Basis for Disclaimers of Opinion on the Consolidated Financial Statements

The federal government is not able to demonstrate the reliability of significant portions of

[its] financial statements ... principally resulting from limitations related to certain material

weaknesses in internal control over financial reporting and other limitations affecting the

reliability of these financial statements and the scope of our work ... As a result of these

limitations, readers are cautioned that amounts reported in the accrual-based consolidated

financial statements and related notes may not be reliable .

. . . The underlying material weaknesses in internal control, which have existed for

years, contributed to our disclaimer of opinion on the accrual-based consolidated financial

statements. [These include] the federal government's inability to

• satisfactorily determine that property, plant, and equipment and inventories and related

property, primarily held by the Department of Defense (DOD) , were properly reported

in the accrual-based consolidated financial statements;

Continued

18 20 17 Finan cial Report of the U.S. Government. Management 's Discu ss ion & Analysis, page 12.

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• reasonably estimate or adequately support amounts reported for certain liabilities, such as environmental and disposal liabilities, or determine whether commitments and con- tingencies were complete and properly reported;

• support significant portions of the reported total net cost of operations, most notably related to DOD, and adequately reconcile disbursement activity at certain federal entities;

• adequately account for and reconcile intragovernmental activity and balances between federal entities ;

• reasonably assure that the consolidated financial statements are (1) consistent with the underlying audited entities ' financial statements, (2) properly balanced, and (3) in accordance with [GAAP] ; ...

Questions:

1. According to par. 6.40 of the Yellow Book, when must auditors report on internal controls

over financial reporting?

2. What reasons does the GAO give for its disclaimer of opinion?

3. Describe how the GAO's audit report excerpt satisfies the requirements in par. 6.50 of the Yellow Book-and identify any areas not shown in this particular excerpt that are also

required by par. 6.50.

APPENDIX 10A: APPLYING THE GASB CODIFICATION, AN EXTENDED EXAMPLE

Recognition of Tax Revenues, Using Fund Accounting The following example illustrates the recognition of sales and property tax revenues by a local government. In doing so, the example touches on the different bases of accounting applicable to governments (accrual and modified accrual), as well as the use of fund accounting. For teaching purposes , this example has been kept very simple; however, in practice, these issues can be much more nuanced and can require professional judgment and as necessary, additional research.

Facts: Assume that the Town of Hampton imposes two taxes on its residents:

1. A 10 cents per-gallon fuel tax, charged on purchases of gasoline from gas stations located in the town.

2. A 2% property tax, charged annually on the assessed value of residential properties. This tax is billed in January of each year; collections generally occur within 15 to 30 days .

Respond to the questions that follow using the guidance provided.

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Are the Town of Hampton's two taxes considered "nonexchange transactions"? GASB Cod. Sec. NS0.104 (Nonexchange Transactions) defines a "nonexchange transaction" as one where a government "either gives value (benefit) to another party without directly receiving equal value in exchange or receives value (benefit) from another party without directly giving equal value in exchange."

Per Section N50, par. 104, nonexchange transactions are divided into four classes:

• Derived tax revenues, imposed by governments on exchange transactions; examples include taxes on sales of goods or services, and corporate or personal income taxes.

• Imposed nonexchange revenues, based on assessments imposed by a government entity on a nongovernmental entity (excluding assessments on exchange transactions); examples include commercial and residential property taxes, and fines and penalties.

• Government-mandated nonexchange transactions, when a governmental entity provides resources to a lower-level governmental entity and requires the recipient to use the funds for a specific purpose; examples include federal programs that state/local governments must perform (using federal funding), or state programs performed by local governments (using state funding).

• Voluntary nonexchange transactions, resulting from agreements entered into by willing parties; examples include grants and donations.

Questions:

1. First, do the two taxes appear to meet the definition of a "nonexchange transaction"?

2. Next, identify which class of nonexchange transaction each Town of Hampton tax falls under. Explain.

Fuel tax:

Property tax:

In What Circumstances Are the Accrual and the Modified Accrual Bases of Accounting Used? In governmental accounting, revenues may be recognized on an accrual basis, or using a modi- fied accrual basis. Understanding what basis of accounting applies is an important step in deter- mining how the Town of Hampton should recognize its tax revenues.

Section 1600 (Basis of Accounting) of the GASB Codification describes circumstances in which each basis is most appropriate:

Government-wide Financial Statements (Statement of Principle)

The government-wide statement of net assets and the statement of activities should be pre- pared using the economic resources measurement focus and the accrual basis of accounting.

Fund Financial Statements (Statement of Principle)

In fund financial statements, the modified accrual or accrual basis of accounting, as appro- priate, should be used in measuring financial position and operating results. a. Financial statements for governmental funds should be presented using the current

financial resources measurement focus and the modified accrual basis of accounting. Revenues should be recognized in the accounting period in which they become avail- able and measurable ...

b. Proprietary fund statements of net position and revenues, expenses, and changes in fund net position should be presented using the economic resources measurement focus and the accrual basis of accounting.

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c. Financial statements of fiduciary funds should be reported using the economic resources measurement focus and the accrual basis of accounting. [Underlined emphasis added]

3. Based on the guidance above, explain when each basis of accounting (accrual vs. modified accrual) applies. Accrual: ____________________________ _

Modified Accrual: _______________________ _

What Are Some Common Funds Used in Governmental Accounting, and Should the Property and Sales Tax Revenues be Recorded in a Fund? Next, in order to determine which basis of accounting is most appropriate for its sales and prop- erty tax revenues, the Town of Hampton must determine whether the revenues will be recorded within a fund.

Per Section 1300 (Fund Accounting) of the GASB Codification:

Fund Accounting Systems (Statement of Principle)

Governmental accounting systems should be organized and operated on a fund basis. A fund is defined as a fiscal and accounting entity with a self-balancing set of accounts recording cash and other financial resources, together with all related liabilities and residual equities or balanc- es, and changes therein, which are segregated for the purpose of carrying on specific activities or attaining certain objectives in accordance with special regulations, restrictions, or limitations.

Section 1300 requires governments to report governmental, proprietary, and fiduciary funds to the extent that they have activities meeting the criteria for these funds. Following is a list of the three fund categories (shown in bold) from Section 1300, each followed by a description of certain funds that are included within that category.

Governmental Funds

.104 The general fund should be used to account for and report all financial resources not accounted for and reported in another fund .

. 105 Special revenue funds are used to account for and report the proceeds of specific revenue sources that are restricted or committed to expenditure for specified purposes other than debt service or capital projects ...

. 106 Capital projects funds are used to account for and report financial resources that are restricted, committed, or assigned to expenditure for capital outlays ...

. 107 Debt service funds are used to account for and report financial resources that are restricted, committed, or assigned to expenditure for principal and interest ...

Proprietary Funds

.109 Enterprise funds may be used to report any activity for which a fee is charged to external users for goods or services ... [Such as where a government utility passes its operating costs on to its customers]

.110 Internal service funds may be used to report any activity that provides goods or services to other funds, departments, or agencies of the primary government and its component units, or to other governments, on a cost-reimbursement basis ...

Continued

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Chapter IO I Governmental Accounting Researc h 303

Continued from previous page

.. . Fiduciary Funds should be used to report assets held in a tru stee or agency capac ity fo r others and therefore cannot be used to support the government's own programs . . .. [I] ncludes pension (and other empl oyee benefi t) tru st funds, in ves tment tru st fund s, private- purpose tru st fund s, and agency funds. (Par .102(c)). [Emphasis and co mments added]

4. What are the three fund categories used to organize governmental accounting systems?

5. Assume that the Town of Hampton plans to use these tax revenues to fund its general government operations . In this case, which fund appears to be appropriate? How did you ascertain this?

6. Considering your response to the previous question and the guidance provided above from Section 1600 of the GASS Codification , what basis of accounting applies to that fund?

Based on This Fund Type and Basis of Accounting , When Can Hampton Recognize Its Sales and Property Tax Revenues? Broad revenue recog ni tion guidance fo r nonexchange transactions is provided in GASB Cod. Sec. N50 (Nonexchange Transactions). Additi onal guidance on the recognition of property tax revenue is also provided in Section P70 (Property Taxes).

Per Section N50 :

Revenue Recognition in Governmental Fund Statements

.1 27 When the modified accru al basis of accounting is used, reve nu es resulting fro m non- exchange transactions should be recog ni zed as follows: a. Derived tax revenues. Rec ipi ents should recogni ze revenues in the peri od when

the underlying exchange tra nsaction has occurred and the resources are ava ilable. b. Imposed nonexchange revenues-property taxes. Rec ipients should recognize

revenues in accordance with Secti on P70. [Footnotes omitted]

Per Section P70:

Application of the Modified Accrual Basis to Property Tax Revenues

. I 04 When a property tax assess ment is made, it is to fi nance the budget of a particular period , and the reve nue produced fro m any property tax assessment should be recog- nized in the fiscal period for which it was levied, provided the "available" criteria are met. Available means collected within the current period or ex pected to be collected soon enough thereafter to be used to pay liabilities of the current period. Such time thereafter shall not exceed 60 days . Governments should di sclose in their summary of significant accounting policies the length of time used to defi ne available for pur- poses of revenue recognition in the governmental fund fi nancial statements.

7. What is the principle applicable to each tax, for determining when the Town of Hampton can recognize revenues? Cite your source for each response.

Fuel tax:

Continued

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304 Chapter 10 I Governmental Accounting Research

Continued from previous page

Property tax:

CHAPTER SUMMARY Audited financial statements are often required for governmental entities ranging from local governments, to state governments, to individual and consolidated federal agencies . Additionally, ce1tain states require their municipal governments and agencies to undergo periodic compliance audits. While the process for pe1forming governmental accounting and auditing research is no different from the process for pe1forming FASB research , the body of knowledge required to pe1form governmental engagements is fundamentally different. It is therefore imperative for accountants performing such engagements to educate themselves about how governmental accounting and auditing requirements are unique.

The authoritative sources for governmental accounting standards are the GASB (for state and local governments) and the FASAB (for federal government entities) ; governmental auditing standards are established by the GAO and by the OMB 's Uniform Guidance. In addition to these authoritative sources, practitioners may find value in certain nonauthoritative resources, such as practical guides including inter- pretive discussion , model financial statements, and checklists.

REVIEW QUESTIONS

1. Does the FASB Codification apply to governmental entities? Explain.

2. What are a few of the reasons for which governmental accounting differs from private-sector accounting?

3. Describe two circumstances in which state and local governments might be required to issue audited financial statements.

4. What are some steps a beginning accountant might take, when first assigned to a governmental accounting or audit engagement, in order to become more familiar with fundamentals of governmental accounting and auditing?

5. How is the GASB funded? What is the role of the Financial Accounting Foundation (FAF)?

6. Aside from general purpose state and local governments, list three other types of entities that may be subject to GASB's accounting standards.

7. What is meant by the term the GASB "hierarchy"? What are the two authoritative levels in the hierarchy, and what should a researcher do if authoritative guidance is not on point?

8. When searching for GASB guidance, why is it preferable to use the GASB Codification, as opposed to searching for individual standards on the GASB 's website?

9. Are the GASB's original pronouncements (used to populate the Codification) authoritative? Explain.

10. Describe the information available on a standard 's "Status" page, on the GASB website.

11. Is guidance issued by the FASAB referred to as "GAAP"? Explain.

12. Complete the following sentence. The FASAB 's authoritative guidance is compiled and codified in

13. Which entities are required to comply with FASAB guidance? Explain , and name three examples of specific entities that comply with FASAB guidance.

14. Who are the FASAB 's three sponsor agencies? What is their role?

15. Who audits government financial statements?

16. What is the role, in part, of the Office of the Inspector General, within a given federal agency?

17. Are auditors subject to the GAO's Yellow Book also required to comply with AICPA audit standards? Explain the relationship between the Yellow Book and AICPA guidance.

18. Under what circumstances would an entity be required to undergo a single audit? What is a single audit?

19. What is the name of the publication issued annually by the OMB that gives auditors specific guidance (such as current guidance on federal regulations) necessary for petforming single audits?

3 Chapter IO I Governmental Accounting Research 305

20. Assume you have written a memo and included the following citation. How might you abbreviate future refer- ences to guidance from this standard, within the same memo?

Per Statement of Federal Financial Accounting Standards No. I , Accounting for Selected Assets and Liabilities, par. 18, "intragovernmental assets and liabilities arise from transactions among federal entities."

21. Do the GAO's auditing standards apply solely to audits of financial statements? Explain .

EXERCISES

The following exercises require students to access information and guidance using the following websites, as appropriate: GASB standards and GASB Codification (www.i:asb.ori: or www.aaahq.ori:), FASAB (www.fasab.i:ov), GAO (www.i:ao.i:ov/yellowbook).

1. Complete the following chart, identifying the relevant standard setter and type of standards applicable to each preparer or auditor.

Name of applicable Preparer/Auditor Standard setter standards

State Comptroller's Office, auditing the state of New York

The state of Georgia's financial statements

U.S. federal government-wide financial statements

KPMG auditor, auditing the Department of Commerce

The City of Newark's financial statements

U.S. Department of Energy's financial statements

New Jersey Transit Authority's financial statements

Governmental Accounting Research Exercises

2. a. Using the GASB Codification, locate and describe the requirement that each governmental entity should publish an annual comprehensive annual financial report (CAFR). Name two items that should be included in the financial section of the CAFR.

b. Next, describe what "Part" (I, II, III, or IV) of the GASB Codification this requirement is included within, and why.

3. On the GASB website, locate the Status page for GASB Statement No. 13, Accounting for Operating Leases with Scheduled Rent Increases. What GASB Statement superseded this standard?

4. Using the GASB Codification: a. What measurement attribute is generally used to account for inventory? b. Provide both the GASB Codification reference to this guidance, as well as the original GASB standard

number. Describe how you located the original GASB standard number.

5. Using the GASB Codification: Are budgetary comparison schedules required to be included in the CAFR? Explain, and cite your source.

6. Using GARS Online, what is one GASB standard that has been issued recently but not yet incorporated in the GASB Codification? Describe how you navigated to this standard within GARS Online.

7. Locate the Foreword to the FASAB Handbook. Summarize the section that describes the Origins of the Documents.

8. Using the FASAB Handbook, research: a. What is a nonexchange transaction? b. Should a liability be recognized for federal nonexchange transactions?

9. Using FASAB guidance, respond to the following: a. What is "general" PP&E? In your response, cite from the actual requirement and not just the summary

guidance that describes general PP&E. b. How is depreciation expense calculated for general PP&E?

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10.1

10.2

10.3

10. Locate SFFAS 24, Selected Standards for the Consolidated Financial Report of the United States Government. a. Read, then summarize the discussion in par. 8. b. Using SFFAS 24's Basis for Conclusions, describe one reason why the FASAB decided not to require

budgetary information (as required by SFFAS 7) to be repo11ed in the CFR (consolidated financial report of the U.S. government).

11. Using the FASAB Handbook: a. What standard provides guidance for managerial cost accounting? When might these concepts be used? b. Using the standard's table of contents, determine whether (and if applicable, identify) any Interpretations

or Technical Releases related to this standard.

Governmental Auditing Research Exercises

12. Locate the "Yellow Book," Government Auditing Standards, 2018 Revision (or more recent if available). What types of audits does the Yellow Book say the requirements and guidance in GA GAS apply to?

13. Are government auditors required to follow AICPA auditing standards in addition to the Yellow Book's require- ments ? Citing from the Yellow Book, suppo11 your response.

14. What are the minimum training requirements for government auditors?

15. Using the Yellow Book, determine whether auditors are required to consider fraud 1isks in conducting a pe1for- mance audit.

16. Locate the auditor's rep011 included within the 2017 federal government-wide financial statements (Financial Repo11 of the U.S. Government). a. Who performed the audit of the federal government-wide financial statements? b. Name one management responsibility described in the audit report. To respond, look for the document

actually labeled Independent Auditor's Report. c. In this context, who exactly is management? Explain yow· response. d. Identify one of the auditor's summary findings described on the first page of the audit report.

Citing Governmental Accounting Standards

17. Imagine you are writing a memo and including the following excerpt from GASB guidance: "Every govern- mental entity should prepare and publish, as a matter of public record, a comprehensive annual financial report (CAFR) that encompasses all funds of the primary government (including its blended component units)." Locate this quote in GARS Online and write out the full source citation for this quote. Assume this is the first reference to GASB guidance that you are including in your memo.

18. Imagine you are writing a memo and including the following excerpt from FASAB guidance: "A liability for federal accounting purposes is a probable future outflow or other sacrifice of resources as a result of past transac- tions or events." Locate this quote in the FASAB Handbook and write out the full source citation for this quote. Assume this is the fast reference to FASAB guidance that you are including in your memo.

CASE STUDY QUESTIONS

Potholes All along the sides of Route 10, residents displayed signs saying: "County Executive: Fix this Road! " Wanting to minimize the negative publicity associated with this sign campaign, the County Executive authorized a $1.8 million investment in upgrades to the road. How should the county account for these upgrades? Is the cost capital or expense? What other information may be required to evaluate this issue?

CAFR Presentation Laredo County has invested in an upgrade to its sewage facilities ($10 million) , financed by a $10 million sewer bond. How should Laredo present this investment and borrowing in its CAFR?

Glenn Village Facts: Frustrated by high property taxes, residents in the Village of Glenn voted to dissolve their village government, instead agreeing to receive similar services (fo1merly provided by the Village government) from their county government, Broward County. No consideration must be paid by (or to) the county to effect this transfer. The effects of this transfer/dissolution will be that all village assets and liabilities (cash balances, buildings, infrastructure, and accounts payable) will become prope11y and responsibility of the county, five employees will transfer to the Broward County offices, and two employees will be involuntarily terminated and given 3 months of severance pay. The two terminated employees were responsible for Glenn 's parks and recreation department, which will be discontinued .

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Required: You have been asked to write a brief accounting issues memo to the Broward County government files describing the accounting implications of the Village of Glenn dissolution. In your memo, address the appropriate accounting for the transaction: merger, acquisition, or transfer of operations ? Also, address how Broward County should recognize and measure the additional assets and liabilities, and describe-broadly-the accounting implica- tions of the discontinuation of the parks and rec operations and the principle for recognizing the related employee terminations. In doing so, assume that the Village of Glenn has prepared financial statements as of the merger date .

Planning a Performance Audit You have been assigned to a perfo1mance audit of a local government, focused 10.4 on compliance with requirements for state grant funds . Assume that you are just beginning to plan your audit. Con- sidering guidance in the GAO 's Yellow Book, summarize some of the most important steps you should take in this Planning phase of your audit.

Reviewing a CAFR Review the most recent CAFR of a state or local government in your area. Using that repmt, 10.5 identify:

1. The entity's most significant source of revenues and most significant expense 2. The entity 's most significant asset, and its most significant liability 3. Two of the individual funds used by the government (look for separate fund financial statements) 4. Who prepared the report 5. Who audited the report, and using what auditing standards

Finally, note one other interesting difference between this report and the fo1m or content of financial statements prepared by nongovernmental entities.

Outline and Minimum Content of a CAFR Provide an outline for the minimum content of a comprehensive annual 10.6 financial report (CAFR). Include in your outline only the major content categories-no need to drill down to the i, ii level. Provide the source reference for where (using the GASB Codification) you found this information.

Federal Financial Statements Locate the most recent audited financial statements of a CFO Act agency (that is , 10.7 an individual federal reporting entity). Determine who audited the agency. What, if any, audit findings were named? What internal control findings , if any, were described? What other commentary did you identify, in the auditor 's repmt, which was notable to you ?

Role of Your State Comptroller's Office Perform a Web search for your state's Comptroller' s office (or Treasurer, 10.8 or other agency responsible for overseeing local government finances within the state). Identify the agency, then describe one oversight function pe1formed by the agency related to state or local government finances . For example, describe any financial audits , compliance audits, or other repo1ting requirements pe1formed or required by the agency or Comptroller's office. Describe how this oversight function contributes to the state or local government's account- ability to the public.

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Fundamentals of Tax Research

It is income tax preparation season , and CPA Susan Jones is preparing her client Nora

Smith's federal income tax return. Ever since her mother lost her job a year ago, Nora has

been paying the real property taxes and mortgage on her mother's house in order to help

her avoid foreclosure . Now, Susan needs to determine whether Nora can deduct any part

of the payments on her personal federal income tax return. Susan starts her search for the

applicable federal tax law by looking at the most fundamental primary source , the Internal

Revenue Code . She then turns to other primary sources of tax law, such as regulations,

rulings , and cases , as well as explanations in secondary sources, to reach a conclusion.

As a professional performing tax services, it is important to be familiar with the many

different sources of tax law and to know how to locate guidance within these sources . This

chapter will teach you the fundamentals of tax research and the professional standards

applicable to tax services.

After reading this chapter and performing the exercises herein, you will be able to

1. Understand the circumstances in which an accountant would perform tax research

services.

2. Understand and apply the tax research process .

3. Contrast and understand the relative precedential values of the different primary

sources of tax law.

4. Differentiate between primary and secondary sources of tax law.

5. Navigate and use an online tax research service (Thomson Reuters Checkpoint) .

6. Identify the key sources of professional standards for tax services.

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Fundamentals of Tax Research 1. Who performs tax research , and when?

2. The tax research process

3. Sources of tax law

• Primary sources

• Secondary sources

4. Using an online tax research service

• Thomson Reuters Checkpoint

5. Updating tax research

• Citators

6. Professional standards

Organization of This Chapter Previous chapters in this text have focused on accounting and auditing research related to

both governmental and nongovernmental entities. By contrast, this chapter focuses on tax

research , a type of accounting research specifically focused on determining the proper tax

treatment of transactions and events.

After first identifying who generally performs tax research , and when , this chapter

describes the tax research process and notes its similarities and differences with the

accounting research process described in Chapter 3.

The chapter then describes key sources of federal tax law and their relative importance

as precedent. The sources of federal tax law include primary sources, such as the Internal

Revenue Code , Treasury Regulations, Internal Revenue Service rulings , and court deci-

sions; and secondary sources, such as treatises and periodicals.

Next, the chapter demonstrates the use of an online tax research service , followed by a

discussion of how and when to update tax research , focusing on the use of a citator.

Finally, this chapter concludes by discussing the professional standards that govern a

CPA's own conduct for providing tax services .

The preceding graphic illustrates the organization of content within this chapter.

This chapter focuses solely on research related to U.S. federal tax issues and does not

address state tax research . The process for researching state tax issues is very similar, but

the sources involved (e .g. , individual state tax statutes, state tax agencies' regulations and

rulings , and state court decisions) can be quite different.

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WHO PERFORMS TAX RESEARCH, AND WHEN?

Lo 1 Understand the circumstances in which an accountant would per- form tax research services.

Tax research is generally performed by in-house corporate accountants and by public accountants for their clients . In addition, because tax research is essentially a type of legal research focused on tax , it is also common for tax research to be performed by tax lawyers on behalf of their clients. For example, a tax lawyer may advise a client on how to structure a transaction or may represent a client in a litigated tax dispute. Finally, individuals working for government tax agencies may also perform

tax research, such as in the course of auditing tax returns. This chapter primarily refers to the taxpayer as a "c lient," but the lessons in the chapter are intended to apply equally to both in-house accountants and public accountants performing tax research.

Tax research is unique in that it focuses on compliance with tax laws. Accordingly, this research may be performed

• For tax and transactional planning purposes,

• For purposes of tax compliance, and

• During and after tax audits.

Tax professionals are often asked to determine the tax treatment of a proposed transaction or event before it occurs. This is called tax planning. Accountants who are consulted before a trans- action or event occurs may be in a position to not only advise the client as to the tax results of the proposal, but may also be able to suggest other alternative structures that may lower or defer tax.

For example, suppose that a business client has contacted you for advice regarding its plan to sell a warehouse and use the proceeds to purchase a larger warehouse. The client's initial ques- tions might focus on the tax treatment of the sale, such as whether or not the client will have a taxable gain, whether the gain will be ordinary or capital, and ultimately how much tax will be due. Being consulted in advance, however, puts the tax professional in a position of being able to research and suggest an alternative, such as structuring the transaction as a like-kind exchange of real property pursuant to Section 1031 of the Internal Revenue Code, which can produce a better tax result for the client.

Tax research is also performed for tax compliance purposes; that is, the preparation and timely filing of accurate tax returns. Sometimes, a tax professional may not learn about a trans- action or other event that affects the client's tax return until the return is being prepared. In this context, the primary questions for the tax professional (and which may require research) may be "How is the completed transaction treated for tax purposes?" and "How and where should the transaction be reported on the client's tax return?"

Finally, tax research may be necessary even after tax returns have been filed, such as when a client is being audited by a governmental tax agency. During an audit, the government tax auditor may review whether transactions or other events were properly reported and, ultimately, whether the correct amount of tax was paid. The tax professional may be asked to research these issues in anticipation of, or in response to, a position taken by the government auditor. Tax research may also be used to support a dispute of the results of a tax audit (e.g., through the administrative process or litigation).

Lo2 Understand and apply the tax research process.

THE TAX RESEARCH PROCESS

The tax research process is very similar to the accounting research process introduced in Chapter 3. The major differences are the unique (tax) subject matter and the relevant sources of guidance. The steps in the research process described in Chapter 3 are somewhat abbreviated in this chapter, but that does not mean that steps not included here are irrel- evant. For example, the pre-step of understanding the client's business or industry is also

relevant to tax research, but has been incorporated within the first step of understanding the rele- vant facts. Similarly, step 3 in the accounting research process to "stop and think" is also applicable throughout the tax research process. Figure 11-1 depicts the key steps in the tax research process.

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3. Find, 4. Document

1. Understand 2. Identify analyze and

and the relevant the tax

update communicate

facts. issues. applicable

tax research sources of tax

results. law.

To some extent, these four steps are intertwined and often cannot be performed in a straight 1-2-3-4 order. For example, a tax authority (i.e., a source of tax law that provides guidance) found in step 3 of the research process may require the researcher to go back to step 1 and ask more questions, which may lead to the identification of additional tax issues (step 2). As a result, tax researchers have to be flexible and open to following where their research takes them.

Step 1: Understand the Relevant Facts First, you must gather and understand both the relevant tax and nontax facts related to the client' s tax issue(s). When performing tax research for a new client, this step may include gaining an understanding of the client's tax situation generally, including its general tax treatment and tax issues that are relevant to its business or industry. This is similar to the pre-step of the account- ing research process.

Facts may be obtained either directly from the client and/or indirectly from others at the researcher 's firm who have directly communicated with the client. Where applicable, facts may also be obtained from, and/or confirmed with, reliable outside sources.

• For example, if the client's records do not indicate how much the client paid for an asset, it may be necessary to request this information from the seller of the asset or from other records (such as county real estate transfer records) .

• Similarly, it may be necessary or advisable to obtain an appraisal (prepared by a third-party qualified appraiser) of an asset, such as in the case of a donation to a charity.

Consider the following questions when gathering tax facts relevant to an issue:

• How is the client generally treated for tax purposes? • Is the client an individual, a business entity, or another type of taxpayer (such as a trust

or estate)? • Is the client a U.S. domestic taxpayer or a foreign person or entity? • If the client is a corporation, is it a C corporation, or has it elected to be treated as an

S corporation? • If the client is a limited liability company (LLC), is it treated as a disregarded entity, as

a partnership, or as a corporation for tax purposes? • Is the client subject to special income tax rules, such as those applicable to charitable

organizations, real estate investment trusts (REITs), banks or insurance companies ?

• What type of tax is involved? Does the issue involve income tax, estate tax, excise tax, or another type of tax ?

• What are the client's relevant tax attributes? The client's tax year; the amounts, if any, of the client's taxable income, net operating loss (NOL) and tax credit carryovers; and the adjusted tax bases of the client's relevant assets are examples of tax attributes.

• When will the transaction take place? Is this research being performed for a proposed transaction, a completed transaction, or for a tax position that is under audit?

• Are other parties involved? If so, are any other parties considered "related parties" for which loss recognition may be limited under the Internal Revenue Code?

• What tax years are involved? Does the current year, or another year's, tax law apply to this transaction?

Figure 11-1

The tax research process

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Figure 11-2

A few factual questions related to a client's sale of a building

• What are the dollar amounts involved in the transaction? Dollar amounts may include, for example, the tax basis of an asset sold, the amount of depreciation or other expense claimed, or the amount of payments received .

• What is the location of the client and/or the transaction? This question is particularly relevant when researching state, local, and foreign tax issues.

• What documentation is necessary to evidence the transaction for tax purposes? Is con- temporaneous documentation (such as in the form of a store receipt or an acknowledgment from a charity for a gift of $250 or more) necessary to claim a deductible expense or credit on a tax return?

A researcher should also consider the nontax facts related to a transaction; that is, the client's business purpose or other motivations for undertaking the transaction. Such facts are particularly relevant when determining how best to structure a proposed transaction. Researchers should consider, for example,

• Why is the client undertaking this transaction? This may explain why the transaction is being structured in a particular way. • For example, while it may be desirable for tax purposes for a seller to structure the sale

of a corporate business as a stock sale, nontax facts such as environmental liabilities, or a buyer's unwillingness to purchase the corporation's stock, may rule out this option. The tax researcher needs to know these nontax facts to efficiently perform research that is useful to the client.

• What documentation exists that evidences the transaction? The tax researcher should review all documentation related to the transaction, including contracts, written correspon- dence, appraisals, and receipts, to properly research the tax issues and accurately report the transaction on a tax return.

Figure 11-2 lists just a few of the factual questions a researcher might ask in determining the proper income tax treatment of a client's sale of a building.

When did the client buy the building, and for what amount?

How did the client use the building? (e.g., personal residence, rental property, or in a trade or business)

If the client claimed depreciation on the building: What depreciation method was used, and what is the taxpayer's remaining tax basis in the building?

Step 2: Identify the Tax Issues Involved Armed with the facts of your client's transaction, your next step is to identify the tax issues related to the transaction. This is another way of saying "define the problem" (step 2 of the accounting research process described in Chapter 3), but is focused on the relevant tax concerns. As you identify each relevant tax issue, you should also use your substantive tax knowledge to "stop and think," as you would do in step 3 of the accounting research process. Consider what you think would be the most appropriate tax treatment for the transaction or event as well as any relevant sources of tax law with which you are familiar.

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For beginning researchers, identifying the tax issues applicable to a given fact pattern may require some trial and error, and may even require some preliminary research. To assist with this learning curve, the following are a number of common income tax issues to consider as a starting point.

First, ask yourself what type of ta.x is involved: Is it an income tax issue? An estate or gift tax issue? An excise tax issue? A sales or use tax (or other state tax) issue? An employment (e.g., FICA/Social Security tax) and withholding tax issue?

Once you determine the type of tax involved, more specific tax issues can be identified. For example, assume you are researching issues related to a client's income tax return. Specific tax issues related to the client's cash receipts might involve, for example,

• Is the item included in gross income for tax purposes?

• Is the item considered ordinary income or capital gain income?

• If the item is capital gain income, is it short term or long term?

• Is the item considered active or passive income?

• Is the item qualified business income for which a noncorporate taxpayer may be eligible for the pass-through deduction?

On the other hand, tax issues related to cash payments might include, for example,

• Is the item deductible as an expense?

• Does the item qualify for a tax credit?

• Do any limitations (such as the at-risk and passive activity loss limitations) apply?

• What documentation is required to claim the payment as an expense for tax purposes?

• What year (or years) is the item deductible?

• Is a purchased asset depreciable or amortizab le for tax purposes?

The tax issues involved can vary considerably depending upon the facts. Figure 11-3 illus- trates just a few of the tax issues involved when evaluating a client's sale of a building, assuming that the building was being rented to an unrelated tenant.

Is the client's gain or loss on the sale of the building capital gain or loss and, if so, short or long term?

Is the client's gain or loss on the sale of the building active or passive?

What year or years is the gain or loss required to be reported on the client's federal income tax return, and where is it reported on the return?

Next, list the tax issues that you have identified. Decide which issues require more research and which you are comfortable answering with only minimal, confirming research. With experi- ence, you will become better able to organize and prioritize the tax issues involved.

Take a moment to complete the following Now YOU Try exercise, intended to get you thinking about steps 1 and 2 of the research process.

Figure 11-3

A few tax issues involved in a client's sale of a building

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[

Now ] YOU

Try 11.1

Determining Facts and Identifying Tax Issues

Your client, Heather Stark, loves dogs and volunteers for an organization called People for Dogs Inc. ("PFD") . PFD's mission is to temporarily provide foster homes and, ultimately, to find perma- nent homes for stray dogs. Heather volunteers for PFD, by temporarily fostering several dogs each year. Last year, Heather spent a considerable amount of time and money on the dogs that she fostered, including paying for dog food, veterinary services, dog toys, feeding dishes, and other supplies. You have been asked to prepare Heather's federal income tax return for last year.

1. Referring back to the lists of sample questions for determining the facts relevant to an issue, list two tax or nontax facts questions you might ask Heather:

2. Identify a relevant "tax facts" question that you might ask the PFD organization:

3. List two tax issues that you would need to research in order to prepare Heather's federal income tax return:

4. Take a moment to stop and think. What do you think the answers to the two tax issues you identified will be?

Step 3: Analyze Tax Research Findings The third step in the tax research process involves finding, analyzing, and updating tax law that is relevant to the client's issue. This step is similar to step 4 (search for guidance) of the account- ing research process described in Chapter 3, but is focused on using tax law as guidance. Later in this chapter, we will describe the sources of tax law and how to update research results. For now, we will focus on the process of identifying and analyzing how tax law applies to a research issue.

Assume that a researcher has located sources of tax law and now must analyze whether each tax authority found is relevant to the client's issue. In analyzing each tax authority, a researcher should consider the following:

• Does the Internal Revenue Code section or regulation being considered apply to the client's situation?

• Are the facts of the case or ruling analogous to the client's situation?

• What are the key differences between the facts of the case or ruling and the client's situa- tion? Does the Code, a regulation, or another case or ruling indicate that these factual dif- ferences should lead to a different result?

• What is the reasoning or rationale for the conclusions reached in the case or ruling? Does that reasoning or rationale apply to the client's situation ?

Part of analyzing each tax authority found includes considering its relative weight as prec- edent. You will find, as considered later in the discussion of sources of federal tax law, that not all sources of tax law are equal. At times, the conclusions reached by different sources of tax law may be inconsistent; in these cases, the researcher must take into account the relative prec- edential values of the sources found. The precedential value of a tax authority refers to how

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strong the authority is for the client's situation. This takes into account both the relative weights of different sources of tax law and the relevance of each authority to the client's situation.

• For example, as discussed below with respect to court decisions, appellate court decisions (particularly decisions of the U.S. Supreme Court and of the client's applicable Circuit of the U.S. Court of Appeals) have a greater precedential value than trial court decisions.

• Therefore, if a trial court and an appellate court reach different conclusions on a tax issue in cases involving similar facts, the tax researcher would generally give greater weight to the appellate court's decision in his or her analysis.

• However, if one authority ruled on a fact pattern that was more closely aligned with the cli- ent's situation than another, greater weight might be given to that (closely aligned) authority.

At times, a tax researcher may only be able to find sources of tax law that are of relatively low precedential value. For example, if a tax issue has not been litigated in court, the only authority that may exist is an IRS ruling interpreting an Internal Revenue Code provision. The ruling is of lower precedential value than some other sources of tax law (such as a Code provi- sion or regulation). In some circumstances, the client may wish to pursue a tax treatment that conflicts with a lower precedent source, as described in the following TIP from the Trenches.

Not all sources of tax law are irrefutable. If the only relevant tax authority is of limited prece- dential value, the tax researcher may consider recommending taking a contrary position on a tax return. The recommendation should only be made after careful consideration, disclosing the risks (including that it may be necessary to litigate the issue) to the client, and properly disclosing the position taken on the client's tax return to minimize penalties.

The tax professional can make reasoned conclusions for the issues researched only by thoroughly analzying the relevant sources of tax law found. As with identifying tax issues, a researcher's ability to analyze tax research findings should improve as the researcher gains experience.

Step 4: Document and Communicate Tax Research Results As a general rule of thumb, if you find the need to research a tax issue, you should take the time to document your research, including your conclusions and any alternative ways of structuring the transaction for tax purposes, similar to what you would do in steps 5 and 6 of the accounting research process described in Chapter 3.

In documenting research findings, a tax researcher often prepares

• A memorandum to the client's file; and

• A written communication of tax advice to the client.

Part of documenting one's research findings is writing a memorandum to the client's file. A file memorandum should be dated and would usually include a statement of the relevant facts (including from whom the facts were obtained), an identification of the tax issue or issues involved, the researcher's conclusion on each identified issue, a discussion of the authority sup- porting the conclusion(s), and an indication of the next steps to be taken (such as contacting the client or verifying a fact relied on). The discussion of supporting authority should describe and cite the sources of tax law relied on in reaching the conclusion(s), and describe and cite any significant and relevant contrary authority that the researcher ruled out in reaching the conclusion(s ).

TIP from the Trenches

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316 Chapter l l I Fundamentals of Tax Research © Cambridge Business Publishers

(

State the relevant facts

Identify the tax issue(s)

State your conclusion( s)

----Discuss

EXAMPLE

The following is an example of a short memorandum to client Nora Smith's file regarding the tax issue identified in this chapter's opening scenario. The length of a tax memorandum to a cli- ent's file may vary from very short, such as this example, which essentially involves one issue for which the tax Jaw is very clear, to several pages if there are multiple issues or the conclusion needs a longer explanation.

Sample Memorandum to Nora Smith's File

Relevant Facts Nora Smith has been paying the real prope1ty tax and mortgage on her mother's house to avoid foreclosure.

Tax Issue Can Nora deduct the real property tax payments and the interest portion of the m01tgage payments paid on her mother's house?

Conclusion Nora cannot deduct the real property tax or mo1tgage interest paid on her mother's house .

Support

(

the reasons for your conclusion(s); include t---+-• citations for authorities cited in memorandu

Interest paid on a home m01tgage is deductible provided that, it is "qualified residence interest" as defined in IRC Section 163(h)(3). Subject to a $10,000 ($5,000 for a married person filing a separate return) per taxable year limitation on deducting state taxes, real prope1ty tax paid on a home is deductible pursuant to IRC Section 164(a)(l).

to file ---

( Clarify next steps

Court decisions have established that the taxpayer may deduct payments of real prope1ty tax and mo1tgage interest only if the payer is legally obligated to pay them. See, e.g., Tuer, TC Memo 1983-441. In Tuer, the Tax Court denied deductions for the child payer despite that such payments were made to avoid foreclosure on a parent's house. Similarly, because she does not own the house and is not legally obligated to pay the real property taxes and mortgage, Nora Smith cannot deduct the payments she made to save her mother's house.

Subject to the limitation noted above, real prope1ty tax payments would be deductible by Nora if ownership of the house is transferred to her. Future mo1tgage interest payments might also be deductible by Nora if she becomes legally obligated to make them. However, the limitations on "qualified residence interest" as applied to Nora would also have to be considered.

Actions to be Taken Prepare letter and review results with client. Performing additional research if Nora is interested in having ownership of the house and liability on the mortgage transfmed to her.

Preparer: Susan Jones [Date Prepared] Reviewer: Jack Kiefer [Date Reviewed]

Documenting tax research results would also usually include printing (or saving digital) copies of relevant sources of tax law relied on, and of any significant contrary authority that the researcher has ruled out (such as a source with significantly different facts or of lesser prec- edential value). The memorandum and related documentation become part of the client file and should be organized so that the original researcher, or another tax professional, can be quickly reacquainted (or acquainted) with the relevant authority at a later date (such as when it's time to prepare the related tax return or defend the conclusion reached during a tax audit).

Communicating tax research results involves providing the client with tax advice that is based on the conclusions reached through research. Tax advice may be provided orally, such as in person or over the telephone. However, it is always suggested (and sometimes required

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318 Chapter 11 I Fundamentals of Tax Research © Cambridge Business Publishers

- Identifies the )

(

question, states the facts and provides

brief conclusion

( -

Summarizes controlling law

( Notes a possible

alternative

/'Limits conclusion to ~ current law

Contrast and

Sample Letter to Nora Smith

Jones & Associates CPAs Amherst, NY March_, 20_ Ms. Nora Smith 123 Main Street Amherst, New York 14228

Dear Nora:

You asked me whether you can deduct the real property tax and mortgage interest you paid last year with respect to your mother 's house. I understand that you made these payments in order to avoid your mother losing her house to forec losure. You have also indicated that your mother is the sole owner of her house and that you are not legally obligated to pay her mortgage. Unfortunately, you cannot deduct these payments on your federal income tax return.

While the Internal Revenue Code generally provides that, subject to limitations, real property tax and home mortgage interest payments are deductible, court decisions have clarified that they can only be deducted by the payer if she is legally obligated to pay them. You are not legally obligated to pay the real property tax on your mother's house or her mortgage payments. Therefore, you cannot deduct the payments you made for her.

If you are going to continue to make these payments going forward, you and your mother may want to consider transferring ownership of the house and liability on the mortgage to you. Please let me know if you would like to consider that possibility, however, as some additional research, including considering how best to structure such a transfer, will be necessary.

My conclusion is based on the facts you have provided me and on the app li cable income tax laws in effect as of the date of this letter. Thank you for requesting my advice concerning this matter. Please do not hesitate to call me if you have any questions.

Sincerely, Susan Jones Jones & Associates CPAs

The applicable standards of professional tax practice, briefly described at the end of this chapter, must also be considered in communicating tax advice to the client.

The next section of this chapter introduces the sources of U.S. federal tax law, including primary and secondary sources. Being familiar with these sources, and understanding their rela- tive weights and importance, will help enable researchers to perform the third and fourth steps in the tax research process.

SOURCES OF FEDERAL TAX LAW

Primary Sources of U.S. Federal Tax Law

L03 understand the The primary sources of U.S. federal tax law are issued by the U.S. federal government and generally have precedential value, the level of which varies among the primary sources. By contrast, secondary sources of tax law (discussed later in this chapter) are not precedential. In addition, taxpayers may incur a substantial understatement penalty under Section 6662 of the Internal Revenue Code for taking a position on a tax return for

relative precedential values of the different primary sources of tax law.

which there is neither substantial authority nor adequate disclosure. Only some of the primary sources of tax law constitute substantial authority. These are listed in Treasury

Regulation Section l .6662-4(d)(3)(iii).

�� © Cambridge Business Publishers Chapter 11 I Fundamentals of Tax Research 319

The primary source s of U.S. federal tax law are depicted in Figure 11-5 . The sources dis- cussed in this chapter, and that a beginning researcher is most likely to encounter, are noted with an asterisk.

U.S. Constitution

Statutory Law

Regulations

Rulings

Letter Rulings

Other IRS Pronouncements

& Guidance

Court Decisions

Tax Treaties

The Internal Revenue Code

• Gives the federal government the power to impose taxes (e.g. , Sixteenth Amendment) and

• Places limits on this power (e.g., Due Process Clause)

• The Internal Revenue Code* • U.S. Federal Statutes that affect taxes (e .g.,

the Bankruptcy Code's provisions regarding discharging unpaid taxes)

• Issued by the Treasury Department in final , proposed , and temporary forms*

• IRS Revenue Rulings* • IRS Revenue Procedures*

• Private Letter Rulings* • Technical Advice Memoranda* • Determination Letters

• Actions on Decisions* • Announcements and Notices • General Counsel Memoranda • Technical Memoranda • IRS Publications

• Trial Courts* • U.S. Court of Appeals* • U.S. Supreme Court*

• Between the U.S. and certain foreign countries • Can affect the taxation of cross-border transactions

and related matters

The Internal Revenue Code (the "IRC" or the "Code") is a federal statute and an important primary source of federal tax law and a substantial authority. The IRC is codified at Title 26 of the United States Code ("U.S.C."). The IRC is often amended, and the current version of the Code is the "Internal Revenue Code of 1986, as amended." The Code is accessible within online tax research serv ices such as Thomso n Reuters Checkpoint (discussed later in this chapter), or for free through the IRS 's website (www.irs.gov).

Organization of the Internal Revenue Code The Code is organized in the following order: First into subtitles (lettered A through D, followed by chapters (organized by chapter number), then subchapters (lettered A, B, C, etc.), parts (num- bered I, II, III, etc.), and section s (organized by section number).

Figure 11 -5

Primary sources of U.S. tax law

320 Chapter l l I Fundamentals of Tax Research © Cambridge Business Publishers

Each Code section (or§) may be further organized in the following order:

• Subsections lettered (a), (b), (c), and so on;

• Paragraphs numbered (1) , (2), (3), and so on ;

• Subparagraphs lettered (A), (B), (C), and so on;

• Clauses numbered (i), (ii), (iii), and so on; and

• Subclauses numbered (I), (II), (III), and so on.

Figure 11-6 shows part of IRC § 117, "Qualified scholarships." To locate Section 117 within the Code, a researcher would browse to this section as follows:

IRC (Title 26 of the U.S. Code)

> Subtitle A (Income Taxes)

>> Chapter l (Normal Taxes and Surcharges)

>>>Subchapter B (Computation of Taxable Income)

»»Part III (Items Specifically Excluded from Gross Income)

>>>»Section 117

Within Section 117, a researcher will find subsections, paragraphs, and so on. For example, the last arrow shown in Figure 11-6 points to IRC § 117(d)(2)(B). Alternatively, it can be cited, by reference to the United States Code, as 26 U.S.C. § 117(d)(2)(B).

Reading and Interpreting the Internal Revenue Code Interpreting an IRC section requires careful and thorough reading and analysis. When reading a section of the Code, keep the following considerations in mind:

• Definitions. Terms used within a Code section may be defined in that section or elsewhere in the Code. Definitions may apply only for purposes of a particular portion (such as a sub- title, chapter, or section) of the IRC, so the researcher must always consider to which parts of the Code a definition applies. Definitions are not bold or highlighted in the Code but are often shown in "quotation marks," as you'll notice in the case of the term "qualified tuition reduction" shown in IRC § 117(d)(2) in Figure 11-6. • IRC Section 7701 includes a number of definitions that apply to the entire Code, includ-

ing the definitions of person , corporation , partnership, foreign , domestic, and taxpayer.

• General Rules and Exceptions. Many IRC sections begin by stating a general rule, which is followed by exceptions, definitions or other rules limiting its application. For example, the general rule described in IRC § 1 l 7(a) in Figure 11-6 is followed by several definitions and rules that limit its application . A researcher must read the entire Code section to be certain a situation is covered by that Code section and to determine the applicable tax treat- ment. Reading only part of a Code section can result in missing important (and relevant) information, and can lead to providing erroneous tax advice.

• Effective Dates. The IRC is frequently amended, so some provisions of the Code only apply to certain tax periods. The applicable period may be stated in the Code section. If the Code section does not state an effective date (as is the case in Figure 11-6), the researcher may need to refer to amendments to the Code section to determine the effective date of any changes made by the amendment. In this case, a researcher might search for amendments to Section 117 to identify the effective date of applicable amendments.

• Cross References. A Code section often refers to one or more other sections of the IRC. It is necessary for the tax researcher to actually look at the provisions of the cross-referenced Code sections to conclusively determine the proper tax treatment.

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Internal Revenue Code Section 117-Qualified scholarships

(a) General rule. Gross income does not include any amount received as a qualified scholar- ship by an individual who is a candidate for a degree at an educational orga- nization described in section l 70(b )(1 )(A)(ii).

(b) Qualified scholarship. For purposes of this section-

(1) In general. The term "qualified scholarship" means any amount received by an individual as a scholarship or fellowship grant to the extent the indi- vidual establishes that, in accordance with the conditions of the grant, such amount was used for qualified tuition and related expenses. (2) Qualified tuition and related expenses. For purposes of paragraph(!), the term "qualified tuition and related expenses" means-

(A) tuition and fees required for the enrollment or attendance of a student at an educational organization described in section l 70(b) (l)(A)(ii), and (B) fees, books, supplies, and equipment required for courses of instruction at such an educational organization.

(c) Limitation. (1) In general. Except as provided in paragraph (2) , subsections (a) and (d) shall not apply to that portion of any amount received which represents payment for teaching, research, or other services by the student required as a condition for receiving the qualified scholarship or qualified tuition reduction . (2) Exceptions. [omitted].

(d) Qualified tuition reduction. (1) In general.

•

Gross income shall not include any qualified tuition reduction. •~@1!11.jlijlf§jj"-'. •"'ii (2) Qualified tuition reduction.

For purposes of this subsection, the term "qualified tuition reduction" means the amount of any reduction in tuition provided to an employee of an organization described in section l 70(b )(I )(A)(ii) for the edu- cation (below the graduate level) at such organization (or another organization described in section 170(b)(l)(A)(ii)) of-

•

(A) such employee, or li!'l:mW!ll.jl!ll.ijll.jlijlf$1111, l!ll.j'!II! .. (B) any person treated as an employee (or whose use is treated as

an employee use) under the rules of section 132(h).

(3) - (5) [ omitted].

Take a moment to complete the following Now YOU Try exercise, intended to improve your familiarity with the guidance included within Code sections.

Figure 11-6

Internal Revenue Code Section 117

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322 Chapter 11 I Fundamentals of Tax Research © Cambridge Business Publishers

Now ] YOU

Try

11.2

[

Now

YOU Try

11.3

Code Section 117

Refer to Figure 11-6 to answer the following questions:

1. List three terms that are defined in Section 117:

2. To what part of the Code do these definitions apply?

3. What other Code sections are referred to in I RC § 117?

4. Assume that your client owns and operates a chain of retail stores. Your client would like to provide a scholarship to one of its part-time employees who is a student at a nearby college. Your client wants to make the employee agreeing to continue to work for the client for two years as a condition to receiving the scholarship. Will the scholarship be included in the employee's gross income? Why or why not?

• Common Terms. Some word s used in the Code should be interpreted in accordance with their everyday meanings. Such common terms include, for example, references to dollar amounts or time periods and word s such as "and" and "or." • For exampl e, the ph rase "less than $100" includes amounts of $99.99 or less, but not

$100. By co ntrast, "$ 100 or less" and "not more th an $100" do include $100, as we ll as lesser amounts.

• If an IRC section provides that a for m mu st be fi led "within 30 days" after an event occurs, the tax researcher should know th at 30 days is not necessarily the equivalent of one month . The 30-day period would start on the day after the event occ urs and would end on the 30th day thereafter.

• When a list of terms is joined by "and ," all items in the list are required to be tru e or cor- rect. When a list of terms is joined by "or," only one of the items in the list is required to be true or correct.

Take a moment to complete the fo llow ing Now YOU Try exercise, which foc uses on the everyday meanings of a few common terms used in the Code.

Common Terms

Answer the first two questions. The common term is highlighted in each question.

1. The phrase "before September 1, 2019" refers to the period that ends on what date?

2. The phrase "after September 1, 2019" refers to the period that begins on what date?

Refer again to Figure 11-6 to answer the next two questions.

3. A "qualified scholarship" can include amounts used for which of the following?

(a) tuition

(b) books

Continued

Continued from previous page

(d) all of the above

Chapter 11 I Fundamentals of Tax Research

4. "Qualified scholarships" are excluded from gross income under Internal Revenue Code Section 117, but all ''tuition reductions" are included in gross income. Is the previous sentence true or false? Why?

Understanding Legislative History Understanding the legislative history of tax laws can provide researchers with additional background on, including the intent behind, enacted laws. For federal tax legislation, legislative history comprises

• Reports of the House Ways and Means Committee, and reports of the Senate Finance Committee;

• Reports of the Joint Conference Committee; and

• General Explanations of the Joint Committee on Taxation.

As noted, the IRC is frequently amended by federal statute. A legislative bill becomes a fed- eral statute only after it is passed by a majority vote of each house of the U.S. Congress (i.e., the House of Representatives and the Senate) and then signed into law by the President. If the Presi- dent vetoes a bill, Congress can override the veto by a two-thirds vote of both houses of Congress.

Before being considered by the full House of Representatives or the Senate, proposed tax legislation is generally first considered by committees, who issue reports on their findings:

• The House Ways and Means Committee writes and reviews draft tax legislation for the House.

• The Senate Finance Committee writes and reviews draft tax legislation for the Senate.

If a tax bill that is passed by the House of Representatives differs from a tax bill passed by the Senate, it is referred to the Joint Conference Committee (composed of members of the Hou se Ways and Means and the Senate Finance Committees), which must prepare a compromise version of the proposed legislation for vote by both the House and Senate. The Joint Conference Committee may also issue a committee report that becomes part of the legislative history of the ultimately enacted tax legislation .

In addition, the Joint Committee on Taxation, a nonpartisan committee with members from the House Ways and Means and Senate Finance Committees and with a professional staff of economists, attorneys, and accountants, 1 prepares a report that is a general explanation of newly enacted tax legislation.

Collectively, these reports of the House Ways and Means Committee, the Senate Finance Committee, and the Joint Conference Committee become part of the legislative history of a tax law. The legislative history of a statutory change and the Joint Committee on Taxation's general explanation are considered substantial authority, and reviewing them can aid a tax researcher in understanding the reasons for the legislation (i.e., the "legislative intent") as well as the mean- ing of the statutory changes. This can be particularly helpful to a tax researcher when reviewing new tax legislation for which there are no regulations or other guidance. Figure 11-7 reviews the process by which tax legislation is adopted.

I See IRC §8002 and https:llww1v.ict.gov/about-us/o verview.html for additional information regarding The Joint Committee on Taxation.

323

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Figure 11-7

The process of adopting tax legislation

Tax Bill introduced in U.S. Congress and considered by Committees:

House Ways and Means Committee Senate Finance Committee

•@@ti5#iN,MiJ.IG-i:Hl+1bMliii:1¥iiN:W,li·lll·II-I• U.S. House of Representatives U.S. Senate

U.S. House of Representatives U.S. Senate

The President-signs into law or vetoes; veto can be overridden by 2/3 votes in

both houses of Congress

Federal statutes are referred to by Public Law (or "P.L.") number. A Public Law number includes two numbers with a hyphen in the middle (e.g., P.L. 115-97). The first number indicates the 2-year Congressional Session in which it was enacted, and the second number indicates the number of the bill (in sequential order) enacted by that session of Congress. For example, P.L. 115-97 (the "Tax Cuts and Jobs Act of 2017"), was the ninety-seventh bill enacted into law by the 115th Session of Congress (2017-2018). Committee Reports reference the related tax legis- lation by Public Law number.

Federal Tax Regulations The Internal Revenue Service (IRS) is the largest of the U.S. Treasury Department's bureaus and "is responsible for determining, assessing, and collecting internal revenue in the United States."2 As an administrative agency of the U.S. federal government, the IRS issues many dif- ferent administrative sources of federal tax law. Figure 11-8 lists the sources of federal tax law issued by the IRS that are discussed in this chapter.

Federal tax regulations are the Treasury Department's official interpretation of the IRC, are considered substantial authority, and have the greatest precedential value of any of the sources of federal tax law listed in Figure 11-8. While the Treasury Department is the official issuer of tax regulations, it does so with much IRS involvement; accordingly, Figure 11-8 shows lines from both Treasury and the IRS for regulations.

Authority to issue tax regulations is found in IRC § 7805, which provides that the Secretary of the Treasury "shall prescribe all needful rules and regulations for the enforcement of this title, including all rules and regulations as may be necessary by reason of any alteration of Jaw in relation to internal revenue." Tax regulations that are issued to interpret a section of the Code under this general grant of authority to issue regulations are sometimes referred to as "general regulations" or "interpretive regulations."

Other Code sections give the Secretary authority to set (rather than merely interpret) the requirements for a specific area of tax law. For example, IRC Section 385(a) authorizes the Sec- retary "to prescribe such regulations as may be necessary or appropriate to determine whether an interest in a corporation is to be treated for purposes of this title as stock or indebtedness ( or as in part stock and in part indebtedness)." Regulations issued under such a special grant of authority are sometimes referred to as legislative regulations.

2 http://w ww.treasurv. gov!about/ organiwtional-structure!bureaus/ Pa ges!default.aspx.

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U.S. Treasury Department

Federal Tax Regulatlons

Revenue Rulings

Revenue Procedures

PLRs&TAMs

Actions on Decisions

(dltcu- u.-"Cowl Declllonl")

Courts use a deferential standard when reviewing regulations (meaning, they often "defer" to the Treasury Department) and will generally uphold a regulation provided that it is based on a permissible construction (interpretation) of the statute. 3 If there is clearly a conflict between a Code provision and a regulation, however, the Code provision controls, as its authority as a statute is of greater precedential value than a regulation.

Federal tax regulations are issued in final, proposed, and temporary formats.

• Final regulations are the Treasury Department's final, official interpretations of the tax law and are issued by a Treasury Decision (T.D.).

• Proposed regulations are not considered official interpretations of the tax law until they have been through a finalization process. When issuing a proposed regulation, the IRS will generally provide a public comment period (of at least 30 days) and may schedule a pub- lic hearing to discuss a proposed regulation. Following this public outreach, the Treasury Department may finalize the proposed regulation, revise and repropose it, or withdraw it for further study.

• Temporary regulations are official interpretations of the IRC, but are effective for only a temporary period, usually 3 years . A temporary regulation is usually issued with a proposed regulation to provide some immediate, reliable guidance for a temporary period while the IRS requests and receives comments on the proposed regulation and works towards issuing a final regulation.

Final, proposed, and temporary federal tax regulations are published in three places : the Federal Register, the Internal Revenue Bulletin (I.R.B.), and the Cumulative Bul- letin (C.B.). Final and temporary federal tax regulations are also compiled and published in Title 26 of the Code of Federal Regulations (C.F.R.). Figure 11-9 compares the Federal Reg- ister, I.R.B., C.B., and C.F.R.

3 Mayo Foundation f or Medical Ed. & Resea rch v. U.S. , 107 AFrR 2d 2011 -341 , 131 S.Ct. 704 (2011 ).

Figure 11-8

Sources of U.S. federal tax law issued by the IRS

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Figure 11-9

Comparison of the Federal Register, I.R.B., C.B. , and C.F.R.

• Published every weekday (not including federal holidays) by the U.S. Government Printing Office (GPO)

• Includes rules and regulations issued by all agencies of the federal government

• Can be accessed on the GPO website (www.gpo.gov/fdsys/)

• Published weekly by the IRS • Includes Federal Tax Regulations (final, proposed, and

temporary) , IRS Revenue Rulings and Revenue Procedures, and Actions on Decisions

• Recent copies are available on the IRS website (www.irs.gov)

• Published annually by the IRS • Usually published in 2 volumes per calendar year • Compiles all the items included in the year's I.R.B.s

• Published annually by the U.S. GPO • Includes final and temporary rules and regulations of federal

government agencies • Can be accessed on the GPO website (www.gpo.gov/fdsys/)

Federal tax regulations are organized first by a number that designates the type of tax or regulation involved (followed by a period), and then by IRC section number. The numbering system is as follows:

Number Type of Tax or Regulation

1 Income tax 20 Estate tax 25 Gift tax 31 Employment tax

301 Procedural regulation

For example, the citation to Regulation § 1.117-4 indicates that it

• Is an income tax regulation (1),

• Was issued with respect to IRC § 117 ( 117), and

• Is the fourth final regulation that was issued related to IRC Section 117 (-4 ).

Similar to Code sections, regulations are broken down by paragraphs, subparagraphs, and clauses. For example, "Regulation § 1.117-4( c )(2)" refers to subparagraph (2) of paragraph ( c) of Regulation § 1.117-4. Treasury regulations are often cited using the abbreviation "Treas. Reg ." or just "Reg. " before the section number. A final regulation can also be cited by reference to the Code of Federal Regulation s as "26 C.F.R. § 1.117-4." The "26" in this citation refers to Title 26 of the C.F.R., the title within the C.F.R. where federal tax regulations are codified.

Proposed regulations should be cited with either the word "Proposed" or the abbreviation "Prop." at the beginning of the citation. For example, "Prop. Reg. § 1.117-6." informs the reader that the regulation cited has not been finalized. Temporary regulations include a "T" in the cita- tion to clearly indicate that the regulation cited is only temporary. For example, in "Treas. Reg. § l.6012-6T," the "T" indicates that it is a temporary regulation.

��

Final, proposed, and temporary regulations may be accessed using an online tax research service such as Thomson Reuters Checkpoint (introduced below), or for free through the IRS website (www.irs.gov). Final and temporary regulations are also available on the U.S. Govern- ment Printing Office (GPO) website (www.gpo.gov/fdsys/).

Consider the following TIP from the Trenches related to finding tax regulations.

Despite that tax regulations can be accessed for free through the GPO and I RS websites, the search engines on these sites are limited and best used when the researcher already knows the citation for the regulation and just needs to retrieve it. When searching for regulations without a citation, such as by keyword search or by reference only to the related IRC section, it is generally more efficient to use an online tax research service.

Revenue Rulings The IRS issues several primary sources of federal tax guidance. One such source is an IRS Revenue Ruling. Revenue Rulings are issued by the IRS National Office and are published in the I.R.B. A Revenue Ruling is "an official interpretation by the IRS of the internal revenue laws and related statutes, treaties, and regulations"4 and is considered a substantial authority. Revenue Rulings may

• Involve the application of the Code and regulations to a particular factual situation. • As a result, a Revenue Ruling can be an important source of guidance for taxpayers in

the same or a similar situation, because it can be relied on in determining the tax treat- ment of a transaction.

• However, the IRS cautions against reaching the same conclusion reached in a Revenue Ruling in another case unless the facts and circumstances are essentially the same as those described in the Revenue Ruling.

• Contain informational updates, such as inflation-related adjustments to certain provisions of the Code and changes in the applicable federal rates of interest applicable to certain tax calculations.

The IRS sometimes modifies, revokes, or issues guidance that supersedes a Revenue Rul- ing. Therefore, the researcher must be certain that any Revenue Ruling relied on is still "good law." Revenue Rulings are cited by number and by reference to where they appear in the I.R.B. or the C.B. Figure 11-10 illustrates sample Revenue Ruling citations.

Rev. Rul. 2016-15, 2016-26 I.R.B. 1060

What do the numbers mean? • 15th Revenue Ruling issued in 2016 • Can be found beginning on page

1060 of the Internal Revenue Bulletin issued during the 26th week of 2016

Rev. Rul. 99-7, 1999-1 C.B. 361

What do the numbers mean? • 7th Revenue Ruling issued in 1999 • Can be found beginning on page

361 of the 1st volume of the 1999 Cumulative Bulletin

Take a moment to complete the following Now YOU Try exercise, intended to help you practice properly citing Revenue Rulings.

4 Rev. Proc. 89- 14, 1989-1 C.B. 814.

I TIP from the Trenches

Figure11-10

Revenue Ruling citations

3 ��

Now

YOU Try 11.4

Figure 11-11

Comparison of a PLR and a TAM

Citing Revenue Rulings

Provide the citation to the following Revenue Rulings:

1. The 23rd Revenue Ruling issued during 2017 and that can be found beginning on page 546 of the Internal Revenue Bulletin issued during the 49th week of 2017:

2. The 60th Revenue Ruling issued during 1998 and that can be found beginning on page 751 of the second volume of that year's Cumulative Bulletin:

Revenue Procedures A Revenue Procedure is an official statement published in the I.R.B. that affects the rights or duties of taxpayers or others under federal tax law. 5 The topics of Revenue Procedures are var- ied, but generally they involve guidance in the nature of "how to" do something, such as how to request a private letter ruling (discussed below) from the IRS or how to make certain elections under the Code. Revenue Procedures are also considered substantial authority.

Like Revenue Rulings , Revenue Procedures are cited by number and by reference to where they appear in the I.R.B. or the C.B. For example, Revenue Procedure number 2018-26 would be cited as "Rev. Proc. 2018-26, 2018-18 I.R.B. 546," which indicates that

• It is the 26th Revenue Procedure issued in 2018 (20 18-26), and

• It can be found beginning at page 546 of the Internal Revenue Bulletin issued during the 18th week of 2018 (546 and 2018-18).

Private Letter Rulings and Technical Advice Memoranda The IRS National Office issues Private Letter Rulings or PLRs to taxpayers seeking guidance regarding, or to confirm the tax consequences of, proposed or not-yet-reported transactions. In some cases, the IRS may refuse to issue a requested PLR; this refusal may lead the taxpayer to reconsider and/or restructure a proposed transaction .

The IRS National Office also issues Technical Advice Memoranda or TAMs. A TAM may be requested by an IRS agent during a federal tax audit, for which the agent seeks National Office input. The TAM describes the IRS ' s tax analysis and conclusion regarding the audit issue. In some cases, a taxpayer may choose to litigate this decision in court. Figure 11-11 contrasts a Private Letter Ruling and a Technical Advice Memorandum.

Private Letter Ruling (PLR)

• Requested by a taxpayer • Issued by IRS National Office • Generally regarding a proposed or

not-yet-reported transaction • Purpose:

- Guidance -Assurance

Technical Advice Memorandum (TAM)

• Requested by IRS auditor (sometimes at a taxpayer's request)

• Issued by IRS National Office • Completed transaction • Regarding issue(s) raised on IRS

audit of a taxpayer's return • Purpose: IRS analysis &

conclusion(s)

Both PLRs and TAMs provide that they "may not be used or cited as precedent." This means that PLRs and TAMs are not precedent that the IRS is required to follow in other cases. However, a tax adviser should review relevant PLRs and TAMs (involving facts that are similar to the client' s)

5 Id.

�3

3 ��

when researching a tax issue, because they provide guidance as to how the IRS has treated the issue under similar circumstances. PLRs and TAMs are frequently cited when documenting tax research, but with the understanding that they are not binding on the IRS as precedent for the client. For the taxpayer for whom it was requested , however, a PLR or a TAM is substantial authority that can be relied on to avoid certain statutory penalties.6

PLRs and TAMs are cited in a similar format, by number. For example, let's "decode" PLR 200601002:

• The first four digits7 of the PLR refer to the year it was released to the public (2006) ;

• The next two digits indicate the week it was released ("0 l " means the PLR was released during the first week of 2006); and

• The final three digits indicate the order in which the ruling was released during the week ("002" means the PLR was the second one released during the week).

Take a moment to complete the following Now YOU Try exercise regarding PLRs and TAMs.

PLRs and TAMs

Answer the following questions based on the information just provided.

1. List two ways in which PLRs and TAMs differ.

2. What does the citation "PLR 201815005" tell you about this ruling?

PLRs and TAMs are not published in the I.R.B. or the C.B . However, they are made avail- able for public inspection by the IRS and , more practically, can be accessed using an online tax research service (discussed later in the chapter) .

Court Decisions When the IRS and a taxpayer disagree about the proper tax treatment of a transaction, their dispute may end up being litigated in court. This litigation may result in the court issuing a written decision interpreting other sources of tax law, including the Code and regulations. Court decisions are another primary source of tax law and can provide important guidance for the tax researcher. A relevant court decision is considered substantial authority provided that it has not been overru led or reversed on appeal.

There are a number of different federal courts that hear and decide federal tax cases, includ- ing trial courts (where the case is initiated and tried) and appellate courts (which decide appeals of trial or lower appellate court decisions). Understanding each court's jurisdiction (i.e., the types of cases the court has authority to hear and decide) helps the researcher to determine whether a decision is precedent for the client' s situation being researched. Court decisions appear in reporters (volumes in which a number of court decisions are published) and are also accessible using online tax research services .

Trial Courts The trial courts that can hear and decide federal tax cases are the U.S. Tax Court, the U.S. District Court, and the U.S. Court of Federal Claims. Figure 11-12 contrasts these three federal trial courts.

6 Treatment of a PLR or a TAM as substanti al authority is subject to the limitations in Reg. § l .6662-4(d)(3)(iv) .

7 For pre-2000 PLR s and TAMs, onl y the fir st two digits refer to the year iss ued . For example, TAM 9715002 (April 11 , 1997) was the second rulin g issued during the fifteenth week of 1997.

[

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Try 11.5

329

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Figure 11-12

Trial courts that decide federal tax cases

Figure 11-13

Types of U.S. Tax Court decisions

U.S. Tax Court

• Decides only federal tax cases

• Based in Washington , D.C.; trials in many U.S. cities

• Litigate case before paying tax alleged to be due

• No jury

U.S. District Court

• Decides different types of federal cases

• 94 Districts located throughout the U.S.

• Refund claims only •Maybe a jury trial if a

question of fact

U.S. Court of Federal Claims

• Decides only cases involving monetary claims against the U.S. Federal Government

• Based in Washington , D.C.; trials in many U.S. cities

• Refund claims only • No jury

A taxpayer initiates a case in U.S. Tax Court ("Tax Court") by filing a petition, which is generally required to be filed within 90 days of receiving a notice of deficiency from the IRS following a tax audit. The Tax Court is the only court at which the taxpayer may litigate a fed- eral tax deficiency without first paying the tax. The U.S. Tax Court issues three types of deci- sions: regular decisions, memorandum decisions, and summary decisions. Figure 11-13 briefly summarizes the differences between these three types of Tax Court decisions and their relative precedential values.

Tax Court Regular Decisions

• Often involve issues being decided for the first time by the Tax Court • Highest precedential value of all Tax Court decisions • Decisions reported in the Tax Court of the United States Reports (abbreviated ''T.C .") • Can be appealed to an appellate court

Tax Court Memorandum Decisions

• Historically, have involved previously-decided and factual (as opposed to legal) issues • Have precedential value, but less than Tax Court regular decisions • Decisions reported in RIA's Tax Court Memorandum Decisions ("RIA T.C. Memo") and

CCH's Tax Court Memorandum Decisions ("TCM") • Can be appealed to an appellate court

Tax Court Summary Decisions

• Applies to small cases; tax and penalties at issue cannot exceed $50,000 • Cannot be used or cited as precedent per IRC §7463(b) • Decisions not officially published , but available through online tax research services

(e.g., RIA's "TC Summary Opinions") • Cannot be appealed to an appellate court

As shown in Figure 11-13, regular and memorandum Tax Court decisions may be used as precedent, and therefore should be considered when they involve an issue of Jaw relevant to a client's situation. Additionally, despite the prohibition against citing and using summary deci- sions as precedent for other cases, a researcher should review them to see how the Tax Court has decided cases that are similar to the client's.

As an alternative to filing a petition with the U.S. Tax Court, a taxpayer may choose to pay the tax, penalty, and interest alleged to be due and file a lawsuit seeking a refund of the amount paid either in a U.S. District Court or in the U.S. Court of Federal Claims.

• The U.S. District Court with jurisdiction over a taxpayer 's refund claim is generally the district in which the taxpayer resides. The U.S. District Court has jurisdiction over federal tax cases-like the Tax Court-as well as cases involving any federal statute or the U.S. Constitution, cases in which the U.S . government is a party, and cases in which the parties are of diverse citizenship (e.g., citizens of different states) and more than $75,000 is at issue.

• The jurisdiction of the U.S. Court of Federal Claims is limited to cases involving monetary claims against the U.S. federal government (including claims for tax refunds).

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3 ��

Decisions of the U.S. District Courts are reported in the Federal Supplement ("F. Supp.") or "F. Supp. 2d" (the second series of the Federal Supplement) . Decisions of the U.S. Court of Federal Claims are reported in the Federal Claims Reporter ("Fed. Cl.").

To locate tax decisions within online tax research services, see RIA's American Federal Tax Reports ("A.F.T.R." or "A.F.T.R.2d") or CCH's U.S. Tax Cases ("U.S.T.C."), for example.

Appellate Courts The appellate courts that decide appeals of federal tax cases are the U.S. Court of Appeals and the U.S. Supreme Court. Appellate courts do not hold trials of cases. Instead, an appellate court has to decide whether any errors of law (which can include an error in interpreting tax law) were made by the trial court or a lower appellate court. An appellate court is sometimes referred to as a higher court, because appellate court decisions are of greater precedential value than trial court decisions, with the U.S. Supreme Court's decisions being of the highest precedential value. Decisions of an appellate court must be followed by trial courts in cases that can be appealed to that appellate court.

A researcher may find court decisions that reach different conclusions on the same issue of tax law. Assuming the facts are similar to the client's situation, the researcher should give more weight or importance to the decision of the court with greater precedential value, and less or no weight to the decision of the court with less precedential value. Figure 11-14 illustrates the hierarchy of the different courts that decide federal tax cases (and the hierarchy of regular and memorandum U.S . Tax Court decisions). The higher the court is on this hierarchy, the greater the precedential value of the court's decisions .

U.S. Supreme Court

I U.S. Court of Appeals

/ (for the Circuit to which the taxpayer's case can

~ be appealed)

I- I- U.S. Court of U.S. Tax Court U.S. District Court

Federal Claims

Regular Decisions

Memorandum

Decisions

U.S. Court of Appeals The U.S. Court of Appeals hears appeals of decisions of the three federal trial courts described previously. There are 13 Circuit Courts of the U.S. Court of Appeals (11 of the Circuits are referred to by number and there are also a D.C. Circuit and a Federal Circuit). An appeal of a Tax Court decision would be to the Circuit that has jurisdiction over the geographic area within which the taxpayer resided when the Tax Court petition was filed. An appeal of a U.S. District Court decision would be to the Circuit that has jurisdiction over the geographic area where the District Court is located. An appeal of a decision of the U.S . Court of Federal Claims is made to

Figure 11-14

Hierarchy of federal courts

331

Figure 11-15

Geographic boundaries of the U.S. Court of Appeals8

the U.S. Court of Appeals for the Federal Circuit. Figure 11-15 depicts the geographic boundar- ies of the U.S. Court of Appeals.

. NORTHERN MARIANA ISLANDS

GUAM 0

'°' HI ~ {)

Geographic Boundaries of United States Cour ts of Appea ls and United States District Courts

... _. I °u'.s V1Ro1N ISLAND PUERTO RICO 1 ,::,.

For example, considering the map in Figure 11-15, if a taxpayer lived in Jacksonville, Florida, when she filed her petition with the Tax Court, an appeal of the Tax Court's decision would be filed with the U.S . Court of Appeals for the Eleventh Circuit (which includes Alabama, Florida, and Georgia). The Eleventh Circuit also has jurisdiction over appeals of decisions of the U.S. District Courts located in Alabama, Florida, and Georgia.

Decisions of the U.S. Court of Appeals are reported in the Federal Reporter, which is abbre- viated "F.," "F.2d" (for the second series), or "F.3d" (for the third series). Decisions of the U.S. Court of Appeals in tax cases are also available in online tax research services such as RIA's Ameri- can Federal Tax Reports ("A.F.T.R." or "A.F.T.R.2d") and CCH's U.S. Tax Cases ("U.S .T.C.").

The different Circuit Courts of the U.S. Court of Appeals may interpret tax law differently, as long as the issue has not been decided by the U.S. Supreme Court. A trial court must follow the law as interpreted by the Circuit Court to which the case could be appealed. Because decisions of the Tax Court are appealed to different Circuit Courts, the Tax Court may interpret the law differently in different cases based on the taxpayer's residence, creating conflicting precedents.

U.S. Supreme Court The highest appellate court in the U.S. federal court system is the U.S. Supreme Court. A deci- sion of the U.S. Supreme Court in a federal tax case must be followed by all trial and appellate courts in federal tax cases involving the same issue. The only exception to this is if the Code (or, in some cases, a regulation) is changed in a way that makes the Supreme Court's decision no longer applicable. There are nine justices on the U.S. Supreme Court, which is located in Washington, D.C. The Supreme Court is primarily an appellate court and , with respect to federal tax cases, may decide a case after an appellate decision is issued by the U.S. Court of Appeals.

The U.S. Supreme Court has discretion over which cases it will decide and issues a writ of certiorari if it agrees to hear and decide an appeal. More often, however, the Supreme Court decides not to grant certiorari. When the Supreme Court has granted certiorari, but has not yet decided the case, the citation to the case includes "cert. granted." Finding that certiorari has been granted in a relevant case should put the researcher on alert that the U.S . Supreme Court

8 Source of map: http://www. uscourts.govlsites/default/files/u. s.Jederctl_courts_circuit _map _J .pdf

3 ��

will be deciding the issue. If the Supreme Court has refused to grant certiorari in a case, the citation to the case includes "cert. denied." The Supreme Court's denial of certiorari is not an indication that the Court agrees with the Court of Appeals' decision in the case. Instead, it is just an indication that the Supreme Court chose not to decide the case.

U.S . Supreme Court decisions are reported in United States Reports ("U.S.") (its official reporter) , as well as in the Supreme Court Reporter ("S.Ct.") and the United States Supreme Court Reports, Lawyers ' Edition ("L.Ed."). Tax decisions of the U.S. Supreme Court are also published in, and may be cited by reference to , online tax research services such as RIA's Ameri- can Federal Tax Reports ("A.F.T.R." or "A.F.T.R.2d") and CCH's U.S . Tax Cases ("U.S.T.C .").

Citing Court Decisions The citation to a court decision generally includes the following information:

• The names of the parties with a "v." (for versus) in between. Citations of Tax Court deci- sions generally include only the taxpayer 's name and omit "v. Commissioner."

• The volume number of the reporter in which the decision appears, the abbreviation for the reporter, and the first page number on which the decision appears. Alternatively, the para- graph number for the case may be included in lieu of a page number and/or volume number.

• An abbreviation indicating the court that decided the case (if not obvious elsewhere in the citation).

• The year in which the case was decided (if not obvious elsewhere in the citation).

Although citations to court decisions generally refer to volume and page numbers of paper reporters, and some court decisions may also be available on the website of the court that issued the decision, it is generally more efficient and thorough to research court decisions using an online tax research service (discussed later in this chapter) .

Take a moment to complete the following Now YOU Try exercise, intended to acquaint you with case citation format and determining from the citation which court decided the case.

Case Citations For each of the cases cited below, indicate whether it is a U.S. Tax Court Regular Decision, U.S. Tax Court Memorandum Decision, U.S. District Court Decision, U.S. Court of Federal Claims Decision, U.S. Court of Appeals Decision, or a U.S. Supreme Court Decision.

1. U.S. v. Baker, 852 F.3d 97 (1st Cir. 2017) or 119 A.F.T.R.2d 2017-1286 (CA1) or 2017-1 USTC ,J50, 186

2. Phillips, TC Memo 2017-230

3. Quimba Software, Inc. v. U.S., 132 Fed. Cl. 676 (2017) or 120 A.F.T.R.2d 2017-5230 (Ct. Fed . Cl.)

4. DAG Management, LLC v. U.S., 275 F.Supp. 2d 928 (N.D. II. 2017) or 120 A.F.T.R.2d 2017- 5739 (DC IL) or 2017-2 USTC ,J50,347

5. CGG Americas, Inc., 147 T.C. 78 (2016)

6. INOOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992) or 112 S.Ct. 1039 (1992) or 69 A.F.T.R.2d 92-694 (S Ct) or 92-1 USTC ,J50, 113 (S Ct)

[

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Actions on Decisions A federal tax case is generally initiated by a taxpayer who disagrees with an IRS decision regarding the taxpayer 's tax liability. If the IRS disagrees with the court's decision in a federal tax case involving a significant issue decided in the taxpayer's favor, the IRS may indicate whether or not it will continue to litigate the tax issue decided in the case. The IRS does this by means of an Action on Decision (AOD). An IRS acquiescence to a case means that the IRS will no longer litigate the issue decided in the case. An IRS nonacquiescence to a case means that the IRS does not agree with the court's interpretation of the tax law in a case and will continue to litigate the issue in other cases. The IRS publishes A ODs in the I.R.B . AODs are included in the list of substantial authority that can be relied upon to avoid tax penalties. A full citation to a case in which the IRS has acquiesced includes "Acq.," and the full citation to a case in which the IRS has issued a nonacquiescence includes "Nonacq.," followed by the I.R.B. citation where it appears, for example, Norris, TC Memo 2011-161, Nonacq. AOD 2011-005, 2011-52 I.R.B.

Secondary Sources of U.S. Federal Tax Law

Lo4 Differentiate between primary and secondary sources of tax law.

Secondary sources of U.S. federal tax law include editorial content provided by tax services, tax treatises, and tax periodicals. Although secondary sources are not binding on the IRS or the courts, and are not substantial authority for purposes of avoiding tax penalties, they can be very helpful to a tax researcher for a number of reasons .

First, consulting a secondary source may be a good first step in your research pro- cess. When confronting an issue with which you have little or no experience, you may

use a secondary source as background reading to identify and get acquainted with the issue. Second, a secondary source may help you identify the primary sources of law related to the

issue. You can then review the identified primary sources and determine whether they resolve the issue or whether you need to do further research. In either event, you should not rely on the secondary source's discussion of a primary source. It is always necessary to look at the primary source yourself, because the discussion in a secondary source summarizes the primary source. What is left out of the summary may make a difference in the client's case.

Third, you may not be certain of your interpretation of a primary source of tax law. Consult- ing a secondary source can reinforce your interpretation or may lead you to focus on a different interpretation worth considering.

Tax Services Tax services generally include a publisher's annotations to and explanations of primary sources of tax law and are periodically updated for new developments. Although these services origi- nated in paper form, they are now generally accessed via an online tax research service that is available by subscription. The primary online services are Thomson Reuters Checkpoint (which includes RIA tax databases) and CCH's IntelliConnect. In addition, online legal research ser- vices, such as LexisNexis and Westlaw, include access to primary sources of tax law and may also include some secondary sources.

Tax Treatises Tax treatises are published in book form (although some are also accessible via an online tax research service) and provide an in-depth discussion of tax issues. A few examples of tax trea- tises include:

• Bittker & McMahon, Federal Income Taxation of Individuals

• Bittker & Eustice, Federal In come Taxation of Corporations & Shareholders

• Mertens, Law of Federal Income Taxation

• Saltzman, IRS Practice and Procedure

See the following TIP from the Trenches regarding when to consult a treatise.

��

When the researcher has little or no background knowledge related to the tax issue being researched , a treatise may be the best first place for the researcher to start. Treatises can be used for in-depth background reading to get acquainted with the tax topic involved. Reading the relevant part of a treatise may also help the researcher to better define the issues to be further researched . The treatise will point the researcher to many primary sources of tax law cited within the treatise .

Tax Periodicals Tax periodicals include scholarly and practitioner journals dealing with tax matters. Examples of tax periodicals include the following:

• The Tax Adviser (AICPA)

• TAXES-The Tax Magazine (CCH)

• Journal of Taxation (WG&L)

• Tax Notes (Tax Analysts)

• Daily Tax Report (BNA)

Tax periodicals include articles that highlight new developments in tax law. Reading tax periodicals on a timely basis helps the tax professional to stay current. Articles in tax periodicals may also be consulted during the research process and provide the researcher with insight in the fo rm of an author's interpretation of tax law.

Consider the fo llowing TIP from the Trenches regarding using secondary sources for research.

As a beginning researcher, you may find it useful to start your research using a secondary source. When using a secondary source , remember that it is not precedent, but can point you in the right direction (towards primary sources) and is often quite user-friendly. For example , beginning tax researchers using Thomson Reuters Checkpoint (discussed later in the chap- ter) often find that using the Federal Tax Coordinator is a good starting point, and topics can be searched by table of contents, index, or keyword(s).

Take a moment to complete the fo llowing Now YOU Try exercise designed to test your know ledge of primary versus secondary sources of tax law.

Primary versus Secondary Sources

For each listed item , indicate what it is a citation for and whether it is a primary source or second- ary source of tax law.

1. Bittker & Lokken , Federal Taxation of Income, Estates & Gifts

2. IRC §167(c)(2)

3. Rev. Proc. 2017-56 , 2017-441.R.B. 465

4. Andreozzi , R. and Hibschweiler, A. , "FBAR: Handle with Care," 43 The Tax Adviser 330 (AICPA May 2012)

5. RJ Channels, Inc., TC Memo 2018-27

TIP from the Trenches

[ TIP from the Trenches

Now

YOU Try

11.7

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USING AN ONLINE TAX RESEARCH SERVICE TO FIND TAX LAW

Los Navigate and use an online tax research service (Thomson Reuters Checkpoint).

With so many sources of tax Jaw, subscribing to and using an online tax research ser- vice is a necessity for the professional tax researcher. These services include Thomson Reuters Checkpoint and CCH IntelliConnect. LexisNexis and Westlaw-two legal

[ TIP from the Trenches

Figure 11-16

Thomson Reuters Checkpoint Search screen

research services-also include access to tax Jaw sources. These services are available by paid subscription, and often make arrangements with colleges and universities so that

access may be provided free-of-charge to students. While it may require time and effort to become comfortable using these services, the ben-

efits of doing so are numerou s. Researchers can experience efficiency, mobility, and the confi- dence of knowing you are using a dedicated, professional tax research service designed to help you find accurate and relevant results. The following TIP from the Trenches highlights the importance of consulting professional resources in performing tax research.

Researchers should not perform tax research using a general Internet search engine, such as Google or Bing. While some of what the researcher may find will be accurate and authori- tative (such as some of the information on the IRS website [www.irs.gov]), other results of the search will be secondary authorities (at best) and incorrect information (at worst). Relying on those results in taking a position on a tax return can lead to the imposition of tax, penalties, and interest.

The remainder of this discussion of online tax research services focuses on Thomson Reuters Checkpoint, which includes access to primary sources of tax law, as well as secondary source material which it classifies as Editorial Materials and News/Current Awareness. Figure 11-16 shows the Search screen (with the Search button circled) for Thomson Reuters Checkpoint. The Search screen lists the different sources within which the researcher can search on Checkpoint.

~om, T,bro1Con1,nt, Ness Tools Lra rmnq - (1) Search Practice Area:

Keyword Starch O

FindbyCltatlon

Date Range Search

Legislation Seard\

Go To

~orm1uneFinder

t-Tables

ndexes

Tax Watch

JSTRCodeSection

Quick Tax AmounlS

@ Intuitive Search Q Term s& Coru1eacrs (!) Th~urus/OueryTool

Choose Sources from·

- O Editorial Materials

+ (]2017 Tu Reform : Tu Cuts and Jobs A.ct + o c11ator 2nd{RIA)

+ ocompl~te Analysis (New Law): Prior Year

O Federal Tax Coordinator Analysls (RIA)

O FederalTaxCoordinatorCheckllsts(RIA)

O Federal Tax Coordinator Client Letters (RIA)

O FederalTaxHandbook(RIA)

+ OForm/Une Finders (RIA)

O Tables&Rates(RIA)

O TaxPlannlngandPracllceGuJdes(Special Studies)(RIA)

+ D~;~f States Tax Reporter -Annotations O UnitedStatesTaxReporter - Explanations

(RIA)

O Qu lckTaxAmounls

Cl 2019Thomson Reuters/Tax&A=ntlng.All RightsReser,,ed. I PrivacyStatemen1

Find Sources:

- O Primary Source Materials

+ O lnternal Revenue Code (RIA) + o rreasuryRegulallons {RIA)

+ o FederalTuCases(RIA)

+ O IRS Rulings and Releases (RIA)

O IRSPubllcatlons(RIA)

O U.S.TaxTrealles !nForce(RIA) + 0 ~~~~;~;.:gress: Committee Reports I

O Committee Reports (Code Arranged · USTR) (RIA)

- O News/Current Awareness

OF1deralTaxUpdatts

D RIATaxWatch + Q WG&L Journals

+ Archives

©2019 by Thomson Reuters!Tax & Accounting . Reprinted with permission . All rights reserved . This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of Thomson Reuters!Tax & Accounting .

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Sources of tax law can be searched in a variety of ways on Thomson Reuters Checkpoint, as well as on most of the other online tax research services.

Table of Contents and Index Searches on Thomson Reuters Checkpoint One way to search on Checkpoint is to think of each database in its Editorial Materials as a large book (or multi volume set). Books have tables of contents and indices and so do these databases. The table of contents of each database may be viewed by clicking on the "Table of Contents" tab followed by clicking on Federal Library and then Federal Editorial Materials. From there, the researcher can click on a database, such as the "United States Tax Reporter" and see its table of contents by groups of Code sections. The researcher can go further, and ultimately access the material in the United States Tax Reporter, by continuing to click onto more and more specific content headings such as one for a particular Code section or its related annotations and expla- nations. Figure 11-17 illustrates how a table of contents search through the United States Tax Reporter can ultimate! y lead to accessing its listings for Code Section 61, including the Code section itself, regulations , explanations and annotations .

, , THoMsoN REuTrns I CHECKPOINT 0- B· 1•· G o ®· c~ ' ' H,t(r~ enld r~ tllqJ d10) N ti', Opt~,, H,lp <;qn0 t

Home Search N,w, fools Li'Jrnns - G) Tab le of Contents

Jump To

Titles @ Intuitive Search Q Terms&Connectors ® Thesaurus/Query Toot

Fo«n / 1.itle Fil'lder Displaylevel: 11213

USTRCodeSectio<1

Federal Library

Uni~State,TaxReporter

lncome(USTR)

Computaliono1Taxab!elncome§§61·291

Grosslncome,AdjusledGrosslocome,Tmit,1e!r.come.Etc.§§61-68

D §61Gf0ssincome~fined

D lcSi §61Grog.sinc,omedefined.jAmenoodll'jtheTaxCutsand.lobsAd.,P.l.11$-97; seaCodehlstoryfordetails.J

+ D CommitteeRepo!lsforCodeSee.61

+ 0 RegutationsforCodeSec. 61 + 0 Exptanallon•lorCodeSec.61

+ 0 AnnotationsforCodeSec.61('J615.001-11615.120)

+ 0 AnnotatlongforC\ld6Sec. 61('J615.121·-t615 .240)

+ 0 AnnotationsforCodeSec.61('J615.24PJ618.05)

CIZ019ThomSol1 Reuters/Tai&Aa:ount!ng.AIIRlghtsReseM!d. I PrivaqSlatement

©2019 by Thomson Reuters/Tax & Accounting. Reprinted with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of Thomson Reuters/Tax & Accounting.

Editorial materials may also be accessed by an index search. This is akin to performing a Master Glossary search within the FASB Codification. To begin an index search on Checkpoint, a tax researcher would again click on the Table of Contents tab, followed by Federal Library, then Federal Editorial Materials, and then Federal Indexes. From there the researcher can click on a database, such as the Code Arranged Annotations & Explanations ( USTR) Topic Index or the Fed- eral Tax Coordinator 2d Topic Index, to see the alphabetical index for that database.

When searching in Checkpoint's Editorial Materials, it is important to remember that the results of the search (such as in the form of annotations or explanations) are secondary sources. However, they generally provide links to connect to the primary sources that are annotated or explained in the Editorial Material.

Figure 11-17

Sample table of contents search on Thomson Reuters Checkpoint

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Figure 11-18

Thomson Reuters Checkpoint search connectors 10

Keyword Searching An important method for accessing the information on an online tax research service is by searc h- ing for keywords in one or more selected databases. This can include primary source material databases, such as Federal Tax Cases, Internal Revenue Code, or IRS Rulings & Releases, or the databases in Checkpoint's Editorial Materials, or a combination of both. On Checkpoint, a key- word search involves using its Search screen (see Figure 11-16), selecting the databases to be searched and entering words (which can be entered as either an Intuitive Search or by using Terms & Connectors) that one would expect to find in the expected search result documents.

To perform an Intuitive Search, you can enter a sentence, a question, a citation, or terms and connectors. Checkpoint interprets your query using historical usage data and editorial information embedded within the content to determine the most relevant results for the terms entered. 9 In a Terms & Connectors search you would enter spec ific words and phrases (but generally not as a sentence, question, or citation) as well as Checkpoint's relevant search con- nectors. The connectors filter the results of your search by taking into account things such as the proximity of the searched terms within a document. Whether using an Intuitive Searc h or Terms & Connectors keyword search, search results will include documents within the selected database(s) that will need to be reviewed for relevance and analyzed.

Keyword searc h results can be limited by making use of the available connectors or expanded by using the Thesaurus/Query Tool , which can be accessed from the Search screen on Checkpoint. The Search Connectors used in Checkpoint are li sted in Figure 11-18.

Search Connectors

To locate documents: Use: Example:

containing any of my keywords OR , I funding OR deficiency

containing all of my keywords space, &, AND funding & deficiency

that contain one keyword but exclude ", NOT funding " deficiency another

containing my exact phrase "" "funding deficiency"

containing variations of my keywords • (asterisk} deprecia•

disabling automatic retrieval of plurals and # (pound sign) #damage (retrieves only damage , not equivalencies damages)

containing single-character variations ? ( question mark} s????holder (retrieves stockholder, shareholder)

containing compound words - (hyphen) e-mail (retrieves e-mail , e mail , email}

containing terms that occur at least# times atleast#() atleast5( customer)

Note: The# character does not turn off the automatic retrieval of possessives (for example, customer's).

Using Connectors in Intuitive Search

If the Terms & Connectors search method is selected, the AND, SPACE , or & connectors can all be used to require more than one term in each of the documents of your search results. However, if Intuitive Search is left as the default search method, Checkpoint will read the word "AND" and any SPACE as it would any other word used in your query. Although the most relevant documents are likely to have all words used , you may get results that have only most of the words.

Also, when using the Intuitive Search method , the use of quotations to search for a phrase will find the most releva nt documents that include the exact phrase and relevant variations that contain the keywords within 3 words of one another.

To search for a word or phrase: Use: Example:

within n words of another (in any order) /# (where # equals number) "disclosure exception" n negligence

within n words of another (in exact order) pre/# (where # equals number) "disclosure exception" pren negligence

9 Checkpoint User Guide at p. 89 (Thomson Reuters 20 18).

IOCheckpoint User Guide at pp. 101 - 102 (Thomson Reuters 2018).

Continued

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Continued from previous page

To search for a word or phrase: Use: Example:

within the same sentence (20 words) as Is "disclosure exception" /s negligence another (in any order)

within the same sentence (20 words) as pre/s "disclosure exception" pre/s negligence another (in exact order)

within one paragraph (50 words) as another /p "disclosure exception" /p negligence (in any order)

within one paragraph (50 words) as another pre/p "disclosure exception" pre/p negligence (in exact order)

portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of Thomson Reuters/Tax & Accounting.

Consider the following TIP from the Trenches with respect to index/table of contents searc he s versus keyword searches and Intuitive versus Terms & Connectors keyword searches.

Researchers with limited tax knowledge should start their use of an online tax research service by index or table of contents searching. Keyword searching is an "art" that improves as one's knowledge of tax law and its key terms increases. Without sufficient tax knowledge, keyword searches can yield far too many or far too few search results. When first performing keyword searches, a novice tax researcher may find it more helpful to use an Intuitive Search, because it allows the researcher to enter a question (such as is a particular item taxable or deductible) in the query box. After becoming more experienced with tax terminology and using the databases on Checkpoint, the tax researcher may find that performing a Terms & Connectors keyword search can be more efficient and produces fewer, but more relevant and specific, results.

EXAMPLE The following is an example of how one might use keyword searc hes to find guidance regarding the tax issue identified in thi s chapter's opening scenario.

Sample Keyword Searching Regarding Nora Smith's Issue

[ TIP from the Trenches

-Step One: Search in the Internal Revenue Code database for "mortgage interest deduction " and "real property tax deduction" (without quotation marks) to determine that Sections 163 and 164 are the relevant Code sections.

Determine and revie~ .... ~- - ""' applicable Code and

regulations sections

Step Two: Review Code Sections 163 and 164 and the related regulations to determine what, if anything, they say about deducting these items when paid for someone else, such as one 's parent, as well as any other relevant limitations on the deductibility of mortgage interest and real prope1ty tax. You will find that the Code and regulations are not particularly helpful on the issue of the dedu ctibility of payments made for another person and will want to research further.

Step Three: Search in the Federal Tax Coordinator Analysis, USTR-Annotations , USTR- Explanations, Federal Tax Cases, and IRS Rulings and Releases databases (at once or seperately) using relevant terms. For example, an Intuitive Search for "interest prope1ty tax 163 164 and mother or father" retrieved a number of relevant (and some in·e]evant) items, including Ann <J[l645.005 Who can deduct-in general (a secondary source) and Tuer, TC Memo 1983-44 l (a primary source discussed in the Sample Memorandum to Nora Smith's File above). To gain experience keyword searc hing on Checkpoint, you should mod ify your search, adding or eliminati ng terms, and try both the Intuitive Search and the Terms and Connectors search options, to see how your modifications affect the searc h results.

- -

Search using relevan~ - -- terms in secondary and

pnmary source databases -

Figure 11-19

Find a Ruling by Citation screen on Thomson

Reuters Checkpoint

Citation Searches Sometimes the tax researcher has the citation for a specific source of tax law, and just needs to retrieve it. The tax researcher can look up the source by using the Find by Citation ljnk under the Search tab. For example, if you want to retrieve Revenue Ruljng 2001-4 by a citation search, click on RulingsllRB under Find by Citation. This wi ll bring up a Find a Ruling by Citation screen on which the researcher can type 2001-4 in the box under Revenue Rulings, click the Search button and immediately start reading Revenue Ruling 2001 -4 . This search is illustrated in Figure 11-19. Similar citation searches can be used to find court decisions (Find a Case by Citation) and sections of the Code and regulations (Find a Code or IRS Reg Section by Citation) .

:. } THOMSON REUTERS I rHFC , PC NT

I mf' Search Tabl~ o' Con1ent< Ne11< 1~01, ~earn nJ

Search Practice Area ·

Federal

Code & Regs

Cases

E::> IRSPu b5 &0tht:r T,ix Oou

Cl tator 2nd

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Date Range Sea rch

LeglslatlonSearch

Go To

Form/Lir.eFlnder

I-Tables

Indexes

Tax Watch

USTRCode Sectioo

Quicll Tax Amounts

Find a Ruling by Citation

Example: 99-7 or 2000-4 or 00.4

2001-4

RevenueProcedu1es

Exam~e:99-10or2000-4or00-4

Example:99-12 or2000-4or00-4

Announcements

Example:99-11or2000-4or00-4

PLRs/TAMs/FSA$ and other FOIA Oocuments

Exampje:200601001

General Counsel Memo

Uample : 34820

lntemalRevenue Bulletin(1996-present)

Example: 2003- 13(bullebn) Of2003(yi.ar)

SEARCH \

I SEARCH I

SEARCH )

permission. All rights reseNed. This information or any portion thereof may not be copied or disseminated in any form or by any

means or stored in an electronic database or retrieval system without

the express written consent of Thomson Reuters/Tax & Accounting.

Additional Guidance for Using Thomson Reuters Checkpoint In addition to the search options described above, online tax research services offer useful links between related sources of tax law. For example, when viewing a Code section on Checkpoint, a number of buttons that link to related material appear above or within the text of the Code section. These buttons link to the following:

• The regulations (Regs button) issued with respect to that Code section,

• Legislative history material (Com Rpts and Hist buttons),

• RIA explanations and annotations (Exp!, Annos and AdvAnnos buttons),

• Related material in RIA's Federal Tax Coordinator (FTC button), and

• For recently amended Code sections, the New Law Analysis button.

The AdvAnnos button refers to the most recently issued annotations that have not yet been added to the more permanent annotations (Annos) database. To be current when researching

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annotations, both Annos and AdvAnnos should be reviewed. There may also be a New Law Analysis button if the Code section has been recently amended.

Figure 11-20 highlights the buttons that appear on Checkpoint above and within a portion of Code Section 104.

When viewing a regulation, the researcher will see many of the same buttons that appear when viewing the related Code section . In addition, an !RC button gives the researcher quick access to the related Code sec tion.

When viewing a case or ruling, the researcher may see buttons linking to where the case or ruling appears in an annotation (Annos button) or in the Federal Tax Coordinator (FTC). Cases and rulings also include a Tra ck It button, where the researcher can choose to be notifi ed by email when the case or ruling being tracked is cited in sub sequent sources of tax law, and a Cita- tor button (discussed later under Citators).

RIA §104 Compensation for injuries or sickness. Internal Revenue Code (RIA )

Naviga te by: Contents < )

, .. Regs ComRpt5 NewlawAnillysls § 104 Compensation for injuries or sickness .

wi& (a) FTC NewlawAllilt~s [n general,

Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) ror any

prior taxable year, gross income does not include-

amounts received under workmen's compensation acts as compensation for personal injuries or sickness;

the amount of any damages (other than punitive damages) received {whether by suit or agreement and whether as lump sums or as periodic

payments) on account of personal physical injuries or physical sickne ss:

•;• (3) Fl( E:::) amounts received through accident or health insurance (or through an arrangement having the effect of accident or health insurance) for

personal injuries or sickness (other th an amounts received by an employee, to the extent such amounts (A) are attributable to contributions by

the employer which were not includible in the qross income of the employee, or (B) are paid by the employer);

portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or

retrieval system without the express written consent of Thomson Reuters/Tax & Accounting.

UPDATING TAX RESEARCH RESULTS

Tax law changes frequently. The Code can be amended by legislation, the Treasury Department can replace a regulation, a court decision may overrule the decision in a different, prior case or may reverse a lower court's deci sion in the same case, and the IRS may modify or declare obso- lete a Revenue Ruling or Revenue Procedure. For the se reasons, it is necessary for you to know that you are relying on sources of tax law that are current and still good law.

For amendments to the Code and new or amended regulations, it is generally necessary to look at the Code or regulations themselves. For amendments to the Code, Checkpoint helpfully includes aids such as the New Law Analysis button within Code section s that have been recently amended for easy access to information regarding those amendments. The buttons for access to the related Congressional Committee Reports (Com Rpts) and legislative hi story (Hist) are also very helpful.

Checkpoint also provides helpful information when viewing a regulation that has not been amended to reflect relevant amendments to the Code. For example, just above the text of Reg. § 1.162-2 on Checkpoint cautionary information indicates that the regulation has not been amend- ed to reflect changes made by several amendments to Code Section 162. The tax researc her would then look to those Code amendments to determine whether or not IRC § 162 was changed in a way that would make the regulation unreliable in the client's situation.

Figure 11-20

Buttons linking to related sources of tax law on Thomson Reuters Checkpoint

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342

l TIP

from the Trenches

Updating research findings is part of the third step in the research process (finding, analyz- ing, and updating applicable sources of tax law). Each time the researcher finds a relevant tax authority, it is necessary to update it to make sure that it is still reliable and authoritative. Tax advice must be current as of the date it is provided to the client. Consider the following TIP from the Trenches regarding updating the client on subsequent tax law developments.

Absent an agreement to provide updates to a client, once tax advice has been provided to the client, a CPA is generally not required to provide the client with updates for subsequent tax law developments affecting that advice. From a client relations standpoint, however, it may be advisable to at least alert the client if it appears that a new development could put the client in a worse tax position (or could give the client a more positive tax result) than indicated in the predevelopment advice. It is then the client's decision whether to engage the CPA's services for a more thorough analysis of the affects of the new development on the client's situation. By contrast, in-house corporate tax accountants are generally expected to update the tax advice provided to their employers for relevant tax law developments.

Citators Citators are used to update court decisions and IRS Revenue Rulings and Revenue Procedures. For court decisions, a tax researcher can use a citator to learn whether the decision has been affirmed, reversed, modified, or remanded (sent back to the trial court or a lower appellate court) by an appellate court, whether the U.S. Supreme Court has granted or denied certiorari in the case, and whether the IRS has issued an AOD acquiescing or nonacquiescing in the court's decision.

Relying on a case that has already been reversed is relying on a discredited authority and can amount to malpractice. Therefore, the tax researcher must check a citator for the subsequent history of the case.

The citator will also indicate the other subsequent cases in which the case being checked has been cited and, if so, whether a subsequent case approved, criticized, or otherwise commented on the decision. This information may indicate how reliable the case is . For example, it may not be advisable to rely too strongly on a case that has been criticized in several subsequent court decisions. Citators can also be used to learn the prior history of the case checked on and to access the lower court's deci sion in the same case.

Similarly, IRS Revenue Rulings and Revenue Procedures can be updated using a citator. In this case, the citator will indicate whether the ruling or procedure has been cited in a court deci- sion, and whether the IRS has clarified, modified, superseded, revoked, or declared the ruling or procedure obsolete. Again, the tax researcher should use this information to determine whether he or she is relying on current, good law or whether it is necessary to look further, such as at a more recent ruling that may have superseded the prior one found by the researcher.

Online tax research services have citators that make updating the law relatively easy. On Checkpoint, the citator is known as Citator 2nd (RIA) and can be accessed in two ways. One way to use the citator is by pushing the Citator button when viewing a court decision or rul- ing. This gives the researcher access to the citator information related to that case or ruling. For example, you might try finding Revenue Ruling 2001-4 (hint-the quickest way to do this would be through a Citation Search described above) on Checkpoint and clicking on the Citator button. Figure 11-21 shows part of Revenue Ruling 2001-4 with the Citator button circled.

Clicking on the Citator button will bring up a reference to the ruling on the right-hand side of the screen. If you click on this reference, you will see the citator results. A portion of the cita- tor results for Rev. Ru!. 2001-4 is shown in Figure 11-22.

Using the Citator 2nd results , the tax researcher would click on the subsequent rulings and cases listed to review where and how they reference Rev. Ru!. 2001-4.

The other way to access the Citator 2nd (RIA) is by clicking on the Search tab on Checkpoint. This will bring up the option Find by Citation on the left side of the screen. Clicking on Find by

RIA Rev. Ru l.20014,2001-1 CB 295-IRCSec(s).162, 12/22/2000 ReYenueRullngs (l954·Present)(RIA)

~ ~ ~ (E [ill [E ~ [ill~ ~ [ill Navlgateby: COntents < )

"'8 Rev. Rul. 2001-4 , 2001-1 CB 295, 12/22/2000, IRC Sec(s) . 162

Trade and business expenses-aircraft maintenance vs. improvement.

Headnote :

[CAUTION: This Rev Rul has been modified by (;)Notice 2001·23, 2001 ·1 CB 911 .J

IRS analyzed three different factual situatioos involving maintenance and/or upgrade work performed on aircraft airframes, including implementing service bulletins issued by manufacturers and

airworthiness directives issued by FAA. Generally, aircraft heavy maintenance is deductible under Code Sec. 162;, but costs incurred that materially add to value, prolong life of, or adapt airframe to

new or different use must be capitalized under Code Sec. 263; . Examples of costs incurred that should be capitalized are additions of fire protection, air phone. ground proximity warning systems,

and replacing significant number of airtrame's skin panels. {gRev Proc 99-49. 1999-52 IRB 725. is modified arid amplified to indude prospective change in accounting method in its appendix.

Reference(s): 11625.184(60); Code Sec. 162;

Full Text:

Issue

Are costs incurred by a taxpayer to perform work on its aircraft airframe, including the costs of a "heavy maintenance visit ." deductible as ordinary and necessary business expenses under OCsection 162 of the Internal Revenue Code, or must they be capitalized under ~ sections 263 and [ 263A?

©2018 by Thomson Reuters!Tax & Accounting. Reprinted with permission . All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or

retrieval system without the express written consent of Thomson Reuters!Tax & Accounting.

RIA REVR 2001-4, 2001-1 CB 295 Ci tator 2nd (RIA)

Filter thi!i Docu ment by Court{A'LC 3

Rev Rul 2001-4, 2001-1 CB 295

Judicial History

Decision modified: Notice 2001-23, 2001-1 CB 911

Modifying & amplifying: Rev Proc 99-49, 1999-2 CB 725

Cited In

Cited without Comment: FPL Group, Inc. & Subsidiaries , 2008 RIA TC Memo 2008-800 (512812008) [Cited in appendix}

Cases distinguished: Tsakopoulos , George & Drousoula, 2002 RIA TC Memo 2002-36

Cited without Comment: Notice 2004-6, 2004-1 CB 308

Cited favorably: Rev Proc 2002-1, 2002-1 CB 41

Cited favorably: Rev Proc 2002-3, 2002-1 CB 125, 2002 USTR 86 ,164

Naviga te by;

©2018 by Thomson Reuters!Tax & Accounting. Reprinted with permission. All rights reserved. This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of Thomson Reuters!Tax & Accounting.

Citation and then Citator 2nd will bring up the option of finding citations by a Case Name, Case Citation, or Ruling Citation. Each of these options has a box where the researcher can type in either a case name or the citation to a court decision or IRS ruling and access the cases and rulings that cite the case or ruling entered, or a list of the cases and rulings cited within the case or ruling entered. At this screen the researcher will also need to indicate whether he or she wants to check the Citator or Advanced Citator. The Advanced Citator would include only the most recent rulings and cases in which the item searched for is cited. In addition, the researcher can check the Cited box to search for only the cases and rulings in which the searched for item is cited or can check the "Citing" box to also retrieve the cases and rulings cited within the item searched.

Figure 11-21

Citator button and Revenue Ruling 2001-4

Figure 11-22

Citator 2nd (RIA) partial results for Revenue Ruling 2001-4

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Figure 11-23

Citator 2nd (RIA) search on Thomson Reuters Checkpoint

Figure 11-23 illustrates a Citator 2nd search for Revenue Ruling Number 2001-4. The results of this search will include Revenue Rulings , Revenue Procedures, and other IRS docu- ments numbered 2001-4. This is less efficient than finding the ruling and clicking on the Citator button, but may be helpful for finding a document by number when uncertain of its type.

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~ Keyword Sea rch

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Quick Tax Amounts

The "cited" option will retrieve the main entry 0< entries of your search entry. The "clling" option wi ll retrieve al l the cases and/or rulings which were cited by your search entry.

Ru lingSe leclion: (Examplesareforill ustraliononly)

@ Rev Ruis , Rev Procs, IRs, Notices, Announcements

for pre-2000 Rev Ru is. Rev Procs, Notices, alld Announcemen ts, and pre-1999 I Rs, use 98-17 , 94-23, etc.

for post-1999 Rev Ruis, Rev Procs, Notices, and Arlnouncements, and post-1998 !Rs. use 2000-3, 2001-7, etc.

O PLRs. Delegation Orders, and other rulings types not listed fo r pre-1999 PLRs, use 9848001 , etc

fo r pos!-1998 PLRs, use 199913047

for Delegation Orders, use 236 or 97 (Rev 34), etc.

!or other rulings types, use appropriate style

Q GCMs and AODs

for GCMs, use 39891 , for AODs, use 2004-001

O Treasury Decisions fo r TDs, use 8819

Cl 2019 Thomson Reuters/Tax & Accounting. All Rights Rese/'led. I Privacy Statement

This information or any portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of Thomson Reuters/Tax & Accounting.

STANDARDS OF PROFESSIONAL TAX PRACTICE

Lo& Identify the key sources of professional standards for tax

Accountants who practice before the IRS, including preparing tax returns and representing clients during tax audits, are subject to rules of practice designed to help maintain the integ- rity of the federal tax system. The standards for professionals who practice before the IRS are set forth in Circular 230. CPAs are also subject to the American Institute of Certified services. Public Accountants (the AI CPA) Statement on Standards for Tax Services (SSTS). 11 These standards reinforce the need for a tax professional to competently follow the steps of the

tax research process to arrive at reasonable and supportable conclusions. These standards are briefly discussed below. A tax professional should be fully familiar with their requirements.

Circular 230

Circular 230 12 is a set of regulations issued by the U.S. Treasury Department that provides the rules of conduct for practicing before the IRS , including who may practice before the IRS and

11 Attorneys practic in g before the IRS are also subj ect to the rules of profess ion al conduct in effect in the jurisdictions

within wh ic h they practice.

12 Circular 230 is part of Title 31 of the Code of Federal Regu lati ons. It may be accessed on line at htms://www.irs.gov/

publirs-pdf/pcir230.pdf

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the standards for providing tax advice and issuing tax opinions. Circular 230 provides aspiration- al standard s and requirements that should be followed by all professional tax advisers and that are consistent with the tax research process as described in thi s chapter. As set forth in Section 10.33 (a) of Circular 230, the aspirational or "best practices" standards include

• "Communicating clearly with the client regarding the terms of the engagement."

• "Establishing the facts, determining which facts are relevant, evaluating the reasonableness of any assumptions or representations, relating the applicable law (including potentially applicable judicial doctrines) to the relevant facts, and arriving at a conclusion supported by the law and the facts."

• "Advi sing the client regarding the import of the conclusions reached, including, for exam- ple, whether a taxpayer may avoid accuracy-related penalties under the Internal Revenue Code if a taxpayer acts in reliance on the advice."

• "Acting fairly and with integrity in practice before the Internal Revenue Service."

With respect to written advice, Circular 230 sets forth requirements that the tax practitio- ner mu st follow, including basing written advice on reasonable factual and legal assumptions; reasonably considering all relevant facts and circumstances that the practitioner knows or rea- so nably should know ; using reasonable efforts to identify and ascertain the relevant facts; not unreaso nably relying on the taxpayer 's or anyone else's representation s, statements, findings, or agreements; relating the law and authorities to the facts; and not, in evaluating a federal tax matter, taking into account the possibility that a tax return will not be audited or that a matter will not be raised on audit. 13

AICPA Statements on Standards for Tax Services The cover of the AICPA's Statements on Standards for Tax Services is shown in Figure 11-24. 14

The AICPA's Statements on Standards for Tax Services (SSTS) supplement the AICPA's Code of Professional Conduct and Circular 230 and apply to CPAs providing tax services. The SSTS consist of seven Statements, each of which includes an introduction, statement(s), and

13Ci rcu lar 230, Section 10.37.

14 The AICPA' s Statements on Standards for Tax Services apply to members of th e AICPA and may be accessed on line at https:/lwww.aicpa.org/contentldamlaicpalinterestareas/tax/resources/standardsethics !Hate me ntsonst and a rdsfortaxse rv ices/ down loadabledocumen ts!i sts-effecti ve-ianuarv- 1-2010. pdf

Figure 11-24

Cover of the AICPA's Statements on Standards for Tax Services

345

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explanation(s). Many of the statements and explanations are relevant to the tax researcher. For example, paragraph number 4 of SSTS No. 1, regarding taking positions on tax returns, includes the following statement: "A member should determine and comply with the standards, if any, that are imposed by the applicable taxing authority with respect to recommending a tax return position, or preparing or signing a tax return." Determining the applicable standard with which to comply necessarily involves researching the applicable tax law.

SSTS Nos. 2 and 3 primarily relate to obtaining information from the client (the factual investigation portion of tax research). Paragraphs 2 and 3 of SSTS No. 7, regarding the form and content of advice to taxpayers, stresses the need to provide competent tax advice, "comply with relevant taxing authorities, if any, applicable to written tax advice," and to consider "return reporting and disclosure standards applicable to the related return position" and "the potential penalty consequences of the return position." Explanation paragraph 7 of SSTS No. 7 states that the member should consider a number of factors in deciding the form of advice provided to a taxpayer. The decision as to form includes whether the advice should be provided in writing and, if so, the form and level of detail. These factors include the importance of the transaction, the amount involved, the existence of authority and precedent, the tax sophistication of the taxpayer, and the potential penalty consequences.

Providing competent tax advice to a client involves researching the law and the facts and reaching supportable conclusions that are appropriately communicated to the client. This is nec- essary both to provide a professional service to the client as well as to comply with the applicable standards imposed on practitioners by the IRS and on its CPA members by the AICPA.

CHAPTER SUMMARY As a tax professional, you will be expected to provide sound and accurate tax advice to your clients or employer. You will need to ask questions in order to learn the relevant facts, and will need to know how to find and analyze the many sources of tax law to enable you to reach reasoned, suppo1table conclusions. You will also have to communicate the advice to yow· client or employer in a way that can be understood . While doing each of these things, you must always remember to comply with the professional standards applicable to providing tax advice as prescribed by the IRS and the applicable professional organization, such as the AICPA.

By following a professional and systematic approach to tax research, exercising good judgment, and following the applicable professional standards, a tax professional can enjoy a successful and rewarding career while establishing and maintaining an ethical reputation.

REVIEW QUESTIONS

1. What types of accountants pe1form tax research? Who else perfo1ms tax research?

2. At what points in the life of a transaction might it be necessary for an accountant to perform tax research?

3. Identify the four key steps in the tax research process.

4. Identify four "tax facts" questions a researcher might ask during step I of the tax research process.

5. Identify two "nontax facts" questions a researcher might ask during step 1 of the tax research process.

6. List at least five primary sources of tax law and two secondary sources of tax law. How do primary sources and secondary sources differ?

7. Compare and contrast the Internal Revenue Code and Treasury Regulations with respect to the following questions: a. How and by whom are amendments to the Internal Revenue Code adopted? How and by whom are Trea-

sury Regulations promulgated? b. Which of these two sources of tax law has greater precedential value? c. How are each of these two sources of tax law cited?

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8. Compare and contrast Revenue Rulings and Revenue Procedures. Where are they published? How do they dif- fer? How are they cited?

9. Compare and contrast P1ivate Letter Rulings and Technical Advice Memoranda. How do they differ? What does the number of a Private Letter Ruling or Technical Advice Memorandum indicate?

10. List the trial comts that can hear and decide federal tax cases. For each of these courts, indicate the following: a. Is the court's jurisdiction limited to federal tax cases, or can it hear and decide other types of cases? If so,

what other types of cases? b. Does the taxpayer have to pay the tax alleged to be due before initiating litigation in the comt?

11. Which type of U.S . Tax Comt decision has the greatest precedential value? Which type of U.S . Tax Court deci- sion cannot be appealed to an appellate cow·t?

12. What is an appellate court? List the appellate courts that may issue decisions in federal tax cases. Which of these courts is the highest judicial authority on issues of U.S. federal tax law?

13. What must be included in the citation of a court decision in a tax case?

14. List and briefly describe the three methods of searching using an online tax research service.

15. What is a citator? Why is it important to use a citator when conducting tax research?

16. What professional standards apply to CPAs who represent taxpayers in preparing federal tax returns and provid- ing tax advice to clients? Who sets these standards?

EXERCISES

Except as otherwise noted, answer the following using an online tax research service, such as Thomson Reuters Checkpoint.

1. Find IRC Section 132. How many subsections does it have? What are they?

2. Find the regulations issued pursuant to IRC Section 132. How many regulations are there? How many are (a) final regulations? (b) proposed regulations? (c) tempora1y regulations? Properly cite one of each of these types of regulations.

3. Use the Federal Tax Coordinator 2d Topic Index to find all the items in the Federal Tax Coordinator 2d that mention the term "guarantors." a. How many items are listed? b. Click on the link to <j[K-5133. What is the title of this paragraph? c. Which Internal Revenue Code section is discussed in <J[K-5133? d. List two other primary sources of tax law discussed in <J[K-5133 and that can be accessed from it (by cli ck-

ing on the links to those sow·ces).

4. Use the Code Ananged Annotations & Explanations (USTR) Topic Index to find all the items in the United States Tax Repo1ter (USTR)-Annotations (RIA) and USTR-Explanations (RIA) that mention the term "day care services." a. How many items are listed? b. Cli ck on the link to 1280A4. Is this an Annotation or an Explanation paragraph? What is the title of this

paragraph ? Which Internal Revenue Code sections are discussed in this paragraph? List three other differ- ent types of primary sources of tax law that are referred to in this paragraph and that can be accessed from it (by clicking on the links to those sources).

c. Cli ck on the link to 11625.078(20). Is this an Annotation or an Explanation paragraph? What is the title of this paragraph ? List two different types of p1imary sources of tax law that are refe1Ted to in this paragraph and that can be accessed from it (by clicking on the I inks to those sources).

5. Keyword Searches a. Using a Keyword Search in the Federal Tax Cases database search for cases using an "Intuitive Search"

with the phrase "are damages received to settle abuse or harassment claim taxable ." How many cases did this search find?

b. Now change your keyword search to a "Terms & Connectors" search and search for the fo ll owing set of terms "damages settle abuse or harassment claim" (not in quotes and not separated by commas). How many cases did this search find?

c. Now change your "Terms & Connectors" keyword search to the following set of terms "damages Is settle* abuse or harassment /5 claim" (again not in quotes and with no other connectors or commas). How many cases did this search find?

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6. Using a Citation Search or a Keyword Search in the IRS Rulings & Releases database, find Revenue Ruling 2011-29. a. Provide the citation to this ruling. b. What Code sections are discussed in the ruling? c. What are the facts of the ruling? d. What issue is decided in the ruling? e. What did the IRS conclude with respect to this issue? f When viewing the ruling, click on the "FTC" button at the top. What are the paragraph numbers and head-

ings or titles under which this ruling is cited in the Federal Tax Coordinator 2d? g. When viewing the ruling check the citator to see in what cases and rulings Revenue Ruling 2011-29 was cited.

What did you find? Did Revenue Ruling 2011-29 affect any prior ruling(s)? If so, which one(s) and how?

7. Using a Citation Search or a Keyword Search in the IRS Rulings & Releases database, find Revenue Procedure 2013-30. a. Provide the citation to this procedure. b. Which Code section is discussed in this procedure? c. What type of relief can taxpayers request of the IRS pursuant to this procedure? d. When viewing the procedure, click on the "Annas" button at the top. What are the paragraph numbers and

headings or titles under which this procedure is annotated in the USTR Annotations (RIA)? e. When viewing the procedure, check the citator to see its "judicial history" and in what other sources of tax

law Revenue Procedure was cited. What did you find?

8. Using a Citation Search or a Keyword Search in the Federal Tax Cases database, find the 2012 Tax Court memo- randum decision in the Daniel H. O'Connor case. a. Provide a proper citation to the Tax Court's decision in the case. b. Which Code sections are discussed in the case? c. What tax year was involved in the case? d. What are the facts of the case? e. What issues were decided in the case? f What did the Tax Court conclude with respect to these issues?

9. Now check the citator for the 2012 Tax Cou1t decision in the O'Connor case from Exercise 8. (Hint: Click on the "Citator" button when viewing the Tax Court's decision in O'Connor, and then click on the link to the Citator results on the right side of the screen to see the Citator results.) a. What is the subsequent judicial history of the O'Connor case? b. Review the comt 's decision in another case in which the Tax Court's 2012 decision in O'Connor was "cited

favorably." 1. What was the issue in that other case? ii. How do the facts of that case differ from the facts of the O'Connor case?

10. Using a Citation Search or a Keyword Search in the Federal Tax Cases database, find the 2014 decision of the U.S. Court of Appeals (8th Circuit) in the Morehouse case. a. Provide the citation to the case. b. What did the IRS decide after the court decided this case? c. Indicate how you found this IRS decision and cite it.

11. Using a Citation Search, find IRC Section 164. Using the legislative history material available by clicking on the "Hist," "Com Rpts ," and "New Law Analysis" buttons answer the following questions: a. What is the name and Public Law number of the statute that most recently amended Section 164? b. How did that statute amend Section 164? In other words, what changes were made to Section 164 by the

statute refen-ed to in answer to 11.a? c. What Committee's report is available with respect to the statute identified in your answer to 11.a? What

does that Committee report say about this amendment?

12. Using the AICPA's Statements on Standards for Tax Services (SSTS) (available online at https:/!www.aicpa.org/ contentldam!aicpa!interestareas!tax!resources!standardsethics!statementsonstandardsfortaxservices!download- abledocuments!ssts-effective-january-1-2010.pdj), answer the following questions and indicate the Statement number and paragraph number of the SSTS where you found each answer: a. May a CPA rely on information provided by third parties in preparing a client's tax return? When should a

CPA not rely on information provided by the client or a third party in preparing the client's tax return? b. What should a CPA do if he or she discovers an en-or on a client's previously filed tax return? c. What should a CPA do if he or she discovers an error on a client's previously filed tax return during the

course of representing the client in an administrative proceeding before the IRS regarding that retm·n?

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13. Using Circular 230 (available online at h1tps://www.irs.govlpub/irs-pdf!pcir230.pd!J, answer the following ques- tions and properly cite to where in Circular 230 you found each answer: a. When advising a client on a position to take on a federal tax return or written advice, may a practitioner

rely on information provided by the client? When should a practitioner not rely on infotmation provided by the client or third persons in providing return position or written advice to the client?

b. What should a practitioner do if he or she discovers an error or omission on a client's previously filed tax return?

c. What types of tax records must a practitioner return to a client who requests them ? What types of tax records is the practitioner not required to return?

CASE STUDY QUESTIONS

Employee Wages vs. Compensation Paid to an Independent Contractor, Finding and Analyzing the Relevant 11.1 Code Sections and Regulations and a Relevant Case Facts: Your client, Sarasota Management Institute (which will be refetTed to as "SMI"), is a school that is just starting operating. SMI is located in Sarasota, Flotida, and will specialize in teaching its students business management. Carl Brand is a marketing professor. Carl has agreed to teach online marketing courses as an adjunct professor at SMI. SMI and Carl have agreed that Carl will teach approximately 6 to IO online marketing courses for SMI each year and that they will enter into a separate contract for each course. Each course will last 10 weeks, and SMI will pay Carl $7 ,500 for each course. For each course, SMI will provide an outline of the material to be covered , and Carl will use the outline to create his course syllabus. Carl will set his own work hours and will record and upload his online classes for student viewing according to his own schedule, but within cettain timing requirements set by SMI (so that students can view the classes by set days and times). SMI will provide the website used for the course and will register and enroll SMI students in the course. Carl will provide SMI with a copy of his course syllabus and the students' grades at the end of each course. SMI's payroll supervisor has asked you for guidance regarding whether Carl will be SMI's employee and whether the amounts SMI will pay to Carl will be considered "wages" for federal employment tax purposes.

Required: First Step: Identify and properly cite the Code sections and regulations that define the terms "wages" and "employ- ee" for employment tax (i .e., withholding, FICA and FUTA) purposes. Review the definitions . Do they resolve SMI's issue? Why or why not?

Second Step: Find and review a relevant comt decision that involves SMI's issue and similar facts. Provide a proper citation for the case. Btiefly describe the facts of the case and the comt's reasoning and conc lu sion(s). Indicate whether you think the court would reach the same conclusion(s) in the SMI-Carl situation and why or why not.

Can a Swimming Pool Be a Deductible Medical Expense? Finding and Analyzing the Relevant Code Sections 11.2 and Regulations and a Relevant Revenue Ruling Facts: Your clients, Bill and Mona Holder, are a maJTied couple with two daughters, April (age 8) and Erica (age 5). In early 2018, the Holders learned that Erica has a medical con- dition that makes her muscles very weak. In addition to presctibing physical therapy that will include exercises to strengthen Erica's muscles, Etica 's doctor suggested that swimming regularly could greatly improve Erica' s muscle strength. The Holders live in a rural area far from any public swimming pool. They are considering installing a swim- ming pool in the backyard at their house. However, the Holders would like to know whether the cost of installing a swimming pool may be deductible as a medical expense for federa l income tax purposes.

Required: First Step: Identify and properly cite the Code sections and regulations that discuss the deductibility of medical expenses. Indicate whether and, if so, where, they indicate whether the cost of a swimming pool may be deductible as a medical expense.

Second Step: Find and review a relevant Revenue Ruling that involves the issue of whether the cost of a swimming pool may be deductible as a medical expense. Provide a proper citation for the Revenue Ruling . Briefly describe the facts of the ruling and the IRS's reasoning and conclusion(s) . Indicate whether you think the IRS would reach the same conc lusion(s) in the Holders' situ ation and why or why not.

Business Casualty Loss, Writing a Client Letter Facts: Your client, Mr. Brakes Inc. , owns and operates an auto- 11.3 motive repair shop in Cooperstown, New York. Mr. Brakes specializes in replacing and repairing brakes on cars, sport utility vehicles, and pickup ttucks. In November of last year, the roof over two-thirds of Mr. Brakes' building collapsed due to the weight of the snow on the roof. Since then, the portion of the building damaged by the roof collapse has been demolished, an addition was built onto the undamaged (one-third) portion of the building, and Mr.

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Brakes reopened for bu siness on September I st of this year. The fair market value of the building (immediately before the roof collapse) was $1 ,800,000, and Mr. Brakes' adjusted federal tax basis in the building was $300,000. The fair market value of the building immediately after the roof collapse was $600,000. Mr. Brakes received $1,200,000 of insurance proceeds due to the destruction of two-thirds of the building. Mr. Brakes spent $1,500,000 in demolition and construction costs (including $300,000 of its own funds and the $1 ,200,000 of insurance proceeds) . Mr. S. PetTy Tyre, the president of Mr. Brakes Inc ., would like to know the federal income tax consequences of this matter.

Required: First Step: Identify the relevant Code Sections and regulations and find a coutt decision that is relevant to Mr. Brakes' situation. Be sure to check the citator to make sure that the case is current and that subsequent authority has not affected the precedential value of the decision.

Second Step: Based on your findings in the First Step, write a brief letter to Mr. Tyre advising him of Mr. Brakes' federal income tax consequences with respect to this matter.

11.4 Gambling Winnings and Losses. Writing a Client Letter Facts: Your client, Mr. Roy L. Flush , is a full-time professional poker player who lives in Las Vegas , Nevada . Roy has been competing in poker tournaments for many years. For the last several years, Roy has been very successful , and his poker tournament winnings have far exceeded his losses and expenses. Unfo1tunately, last year was not a good one for Roy. Last year, Roy won money at some poker tournaments, amounting to $180,000 in winnings, but he lost $260,000 in other poker tournaments. In addi- tion , Roy incwTed the following expenses last year: (a) Travel to poker tournaments (held other than in Las Vegas): $2,500 and (b) Tournament admission/entry fees: $10,500. Roy also earned $90,000 of investment income last year. Roy recently told you that he assumes that, due to his losses and expenses , he will not owe any federal income tax for last year but has asked you to confirm that for him.

Required: First Step: Identify the relevant Code Sections and regulations and find a court decision that is relevant to Roy's situation . Be sure to check the citator and the Code to make sure that the case is cu1Tent and that subsequent authority has not affected the precedential value of the decision. (Hint: The cou1t decision you find may predate amendments made to the Code; this may affect your conclusion and the advice that you provide to Roy in the next step.)

Second Step: Based on your findings in the First Step, write a brief letter to Roy telling him whether or not his assumption is correct; that is, will Roy's losses and expenses offset all of his income from last year?

11.5 Trust's Payment of Investment Advice Fees, Writing a Memorandum to the Client's File Facts: Your client, Justin Pauly, is employed as a car salesman . Justin's aunt, Marge Simmons, recently died, and her last will and testa- ment provided for the creation of the "Marge Simmons Trust" (the "Trust"). Most of Marge 's assets were sold, and the proceeds (approximately $2 million) were transferred to the Trust. The principal and income of the Trust are pay- able to Marge 's eight nieces and nephews at set intervals. Marge 's will named Justin as the sole trustee of the trnst. Justin wants to invest the assets of the Trnst to earn a fair amount of income, but he has very little personal invest- ment experience. As a result, Justin hired Sally Cookson , a well-respected professional investment adviser, to advise Justin on how to invest the Trust's assets . You will be meeting with Justin next week and know that he will be asking you whether there are any limitations on the deductibility of the investment advice fees the Trnst is paying to Sally.

Required: Is there any authority indicating whether the Trust can deduct the investment advice fees it is paying to Sally? Research this question , considering the relevant Code section(s), regulation(s), cases , and/or rulings, and w1ite a brief memorandum to the client' s file that addresses this question.

11.6 Charitable Gift of Property Subject to a Mortgage, Writing a Memorandum to the Client's File Facts: Your clients are Matt and Lucy Bauer, a married couple. The Bauers owned l 00 acres of land located near Charlotte, North Carolina. The land was located in an area where a great number of new houses and other buildings were being built. The Bauers purchased the land several years ago as an investment. They intended to sell the land at a profit a few years later, when less undeveloped land would be available in this high demand area. In April of last year, the Bau- ers learned that the Charlotte Theatre Company ("CTC") wanted to build a new theatre building and school in the area where their land was located. As lifelong theatre goers, the Bauers wanted to help CTC, which is a 501 (c)(3) chaiitable organization. They agreed to give the 100 acres of land to CTC. The Bauers transfetTed the land to CTC on June 30th of last yeai·. At the time of the transfer, the land had a fair market value of $500,000 and was subject to a $200,000 mortgage, and the Bauers' adjusted basis in the land was $300,000.

Required: Is there any authority indicating what, if any, effect the mortgage has on the deductibility of the Bauers' contribution of the land to CTC? Research this question considering the relevant Code Section(s), regulation(s), cases , and/or rulings , and write a brief memorandum to the clients' file that addres ses this question.

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Reacquired Real Property, Writing a Memorandum to the Client's File Facts: Paul and Penelope Pine owned their 11.7 house in Grosse Point, Michigan, for over 30 years. It was their only residence for all those years, and their adjusted tax basis in the house at the time they sold it in January of last year was $500,000. In January of last year, the Pines sold their Grosse Point house to John and Jackie Juniper for $1 ,200,000. The installment sale contract for the house required the Junipers to pay the Pines $300,000 at the closing and to pay the balance due of $900,000 over 5 years at the rate of $15 ,000 per month plus interest. The house served as collateral for the future installment sale payments under the contract. At the closing in January of last year, the Junipers paid the Pines $300,000 and made a monthly payment of $15,000 plus interest each month from Februaiy through December of last yeai·. The Junipers defaulted on the install- ment sale contract when they failed to make this yeai·'s January payment. After it was clear that the Junipers were unable to make any more payments on the house, the Pines cancelled the contract and took back possession of the Grosse Point house in late May of this year. On their joint federal income tax return for last yeai·, the Pines rep01ted a $700,000 gain on the sale of their Grosse Point house, claimed a $500,000 exclu sion, calculated a gross profit percentage by dividing the remaining gain of $200,000 ($700,000 minus $500,000) by the $1 ,200,000 sale price, and determined and reported their 2017 installment sale gain on the sale of the house by multiplying the gross profit percentage by the portion of the purchase price they received from the Junipers last year. Now that they have reacquired and moved back into their Grosse Point home, the Pines ai·e considering continuing to live there for many more years. They have come to you for advice on the tax consequences of their reacquiring the house from the Junipers.

Required: Is there any authority indicating what, if any, effect the Pines' reacquisition of the house will have on (a) their realized and recognized gain on its sale to the Junipers and (b) their adjusted tax basis in the house? Research this question considering the relevant Code Section(s), regulation(s) , cases, and/or rulings, and write a brief memo- randum to the clients' file that addresses these issues. Hint: You can ignore the interest payments and any interest- related tax issues for purposes of completing this Case Study; focus on the Pines ' gain , the $300,000 initial payment and $15,000 monthly payments they received, and their adjusted tax basis in the house.)

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The International Research Environment I've been where you are . I know you may be skeptical of whether IFRS research is worth

learning-you may be correct in assuming that the majority of the accounting research you

will perform in the United States will involve U.S. GAAP.

But the fact is that international accounting and auditing standards do impact U.S.

accountants. Our economy is becoming increasingly global , and the expectations for profes-

sionals and CPA exam candidates have followed suit. For example , as a professional your

company may engage in cross-border merger activities, which will require you to understand

differences between U.S. GAAP and IFRS. Or perhaps an international subsidiary of your

company is required to prepare statutory financial statements (for its home country) under

IFRS. Or, perhaps you are participating in implementing changes to your firm 's ethics code,

and these changes are driven largely by recent U.S. convergence with international ethics

standards. Continued

After reading this chapter and performing the exercises herein, you will be able to

1. Understand the context in which accounting research is performed internationally,

and the role of IFRS in international accounting research .

2. Understand the structure and mission of the IFRS Foundation, including its standard-

setting bodies the IASB and the IFRS Interpretations Committee.

3. Navigate, apply , and understand the scope of the two prevailing sets of international

accounting guidance: full lFRS, and IFRS for small and medium-sized entities (SMEs).

4. Locate jurisdiction profiles to understand circumstances in which IFRS applies inter-

nationally, and understand circumstances in wh ich IFRS applies to U.S. practitioners.

5. Become familiar with the standards and standard setters applicable to international

auditing.

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Continued from previous page

In all of these cases , having experience navigating I FRS and international auditing stan-

dards, and understanding the global context in which they apply, will be an asset to you as

a professional. This chapter aims to provide you with such a foundation.

International Accounting Standards

1. Introduction-the global standard-setting Appendix: environment International Auditing Standards

2. The IFRS Foundation and its standard setters 1. When do international auditing standards

3. IFRS, and IFRS for SMEs: Applicability,

'" apply?

sources, and tips for navigating 2. The IFAC and its standard setting boards ~

4. Understanding jurisdiction profiles, plus the 3. Researching international auditing relevance of international standards in the standards United States 4. Example: Comparing international and

5. Researching international accounting U.S. audit reports standards

Organization of This Chapter This chapter begins with a discussion of the global standard-setting environment, including

circumstances in which companies prepare financial statements internationally. Next, the

chapter introduces the IFRS Foundation and its standard-setting bodies , the IASB and the

IFRS Interpretations Committee.

Next, the chapter differentiates between the applicability of full IFRS versus the IFRS

for SMEs publication , describing the contents of each reporting framework, along with tips

for navigating the guidance.

The chapter also describes circumstances in which international accounting standards

are relevant to U.S. accountants, and explains how to locate jurisdiction profiles, which detail

the applicability of IFRS to different countries . Finally, the appendix to this chapter introduces

international auditing and ethics standards.

The preceding graphic illustrates the organization of content within this chapter and its

appendix.

This chapter and its appendix focus primarily on IFRS accounting guidance and IAASB

auditing standards , both of which are widely used internationally. It's worth noting that other

country- or region-specific sources of international accounting and auditing guidance exist,

but are not a primary focus of this chapter.

Acknowledging the duplication inherent in this phrasing , for purposes of easy readabil-

ity, this chapter occasionally refers to International Financial Reporting Standards (IFRS) as

IFRS standards or IFRS guidance. Also, the terms country, jurisdiction , and region are at

times referred to collectively as country or jurisdiction.

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L01 Understand the context in INTRODUCTION

IFRS: The Predominant Global Financial Reporting Framework

which accounting research is performed internationally, and the role of IFRS in international

Required for listed companies in 144 countries, and translated into numerous languages, International Financial Reporting Standards (IFRS) are considered the predominant global financial reporting framework. Of the countries that have not adopted IFRS, several major economies, such as China and India, have converged or intend to substantially con-accounting research . verge their standards with IFRS. 1

Just a handful of years ago, the IFRS Foundation's mission was to gain global accep- tance as a single set of high-quality global standards. Today, it's widely believed that the IFRS Foundation has substantially achieved its initial mission of gaining global acceptance and therefore can now turn its attention to improving the quality of its standards and the efficiency of the markets it serves.

There are a few notable exceptions to the global shift toward IFRS adoption; key among these is the United States. It's currently unclear whether the United States will ever adopt IFRS. 2

On the whole, the two sets of standards are very similar, thanks in part to a long-running focus on convergence, which notably included issuance of substantially converged revenue recognition guidance in 2014. However, it's now a widely held belief that the era of convergence has ended. Later in this chapter, we ' ll take a closer look at the relationship between U.S. GAAP and IFRS .

A Brief History of International Standards In the past, the applicable financial reporting framework for each country generally was estab- lished by its national standard setter, each issuing unique accounting standards. For example, Japanese companies relied primarily on standards of the Accounting Standards Board of Japan, and Canadian companies relied primarily on the Canadian Accounting Standards Board.

The slow shift toward global accounting standards began in 1973, with the formation of the International Accounting Standards Committee (IASC). With a goal of harmonizing global accounting standards, the IASC issued standards that were largely viewed as "voluntary adjuncts" to the use of national standards.3

However, the IASC 's standards took on a new momentum in June 2000, when the Euro- pean Commission announced its plans to require listed companies in the European Union (EU) to adopt international accounting standards by 2005 . At that time, "no other country or countries in the developed world had yet announced a commitment to the IASC's standards ."4

In 2001, the IASC was replaced by the International Accounting Standards Board (IASB). In the years since its formation, the IASB has seen the use of its standards go from "Oto (over) 140," and the key catalyst for this global acceptance was the EU's commitment to adopting these standards.

The growth in acceptance of the IASB has not, however, replaced the need for national standard setters. The IASB continues to collaborate with national standard setters, and, in some cases, countries adopting IFRS require their national standard setter to endorse each new IFRS before it is accepted for use in the country. This endorsement process can, at times, result in country-specific variations of IFRS-referred to as jurisdictional IFRS (such as "IFRS as

1 2017 Annual Report of the IFRS Foundation. "[T]he total number of juri sdictions requiring the use of IFRS Standards is now 144." Page 4. Also on page 4: " . . . China and India have standards that are substantially ali gned with our Standards."

2 Some might argue that adoption by the United States is unlikely, but thi s position can change with changes in SEC leadership. in a Jan. 5, 2017 public statement, then-SEC Chairman Mary Jo White stated: "While U.S. con stituents have advised us that they do not support a move to , or an option to use, IFRS for financial reportin g by U.S. companies at thi s time, thi s does not lessen the importance of their engagement on IFRS or in the broader work to further enhance globall y accepted standard s." Chairman White encouraged the FASB and IASB to continue their "intense collaboration ."

3 Zeff, Stephen A. "The Evolution of the IASC into the IASB , and the Challenges it Faces." Publi shed in The Accounting Review of the American Accounting Association . Vol. 87, No. 3, 2012. Page 834.

4 Zeff, Page 824.

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adopted by the EU") or in carve-outs of guidance that a country chooses not to adopt. Such variations can be minor or can result in significant differences across standards. The endorse- ment process also can result in delays in a country's implementation of newly is sued IFRS guidance. Jurisdictional variations of IFRS run counter to the IASB 's prior mission of creating a single set of high-quality global accounting standards.

Considering this brief history, complete the following Now YOU Try.

Fill in the blanks in the following timeline.

1973-2000

Each country's accounting standards were generally set by

2000

The European Commission

2001 2005

The EU

Present

The IASC IFRS are now considered

The role of the IASC at this time could be described as

When Are Financial Statements Required Internationally? For many listed (or public) companies around the world, the issuance of audited financial statements is required by securities regulators (such as agencies that are the equivalent of our SEC).

For nonlisted (or nonpublic) companies, financial statements are often required by the laws and regulations of individual countries ( or jurisdictions). Each jurisdiction sets its own criteria for determining which companies must issue such statutory (or government-required) financial statements, and determines the applicable financial reporting framework. In some cases, these statutory financial statements are also designed to fulfill tax reporting require- ments . Companies may also issue financial statements to satisfy the needs of their current or prospective investors and lenders.

These bodies that require financial statements (regulators, governments, and the like) are the same bodies that generally can determine which financial reporting framework should be used to prepare the financial statements. Increasingly, countries have moved to require or permit the use of IFRS in place of their jurisdiction-specific models.

Let's look now at an example of a corporation that has benefited from the move toward global accounting standards.

EXAMPLE

HSBC-A Beneficiary of Global Standards As one of the world's largest banks , HSBC Holdings plc (" HSBC") has been a vocal suppo1ter

of the global move toward IFRS. Based in London, and with subsidiaries located around the

globe, HSBC 's support not only reflects its responsibility to prepare consolidated, global financial statements, but also its role as a major institutional investor (i.e. , a user of global financial statements). Figure 12-1 illustrates the global nature of HSBC 's organization, with

offices in 67 countries and territories across the globe. 5

5 HSBC Holdings pie, Annual Repo rt and Accounts 2017, page 2.

Now

L YOU Try 12.1

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Figure 12-1

HSBC's simplified organizational chart

Figure 12-2

Select markets in which HSBC Holdings pie shares are listed

Now

YOU Try

12.2

Simplified structure chart Principal entitiest as of 1 October 2018

North America and LatAm Asia

- Holdng oompany

- lnterrnedate hok:ling OOTipany

• o perating oomp"1y

• Associate

Europe and MENA

t Showing entities in Priorit y markets , wholl y-owned unl ess shown otherw ise. Excludes other Associates , Insurance

companies and Special Purpose Ent ities.

Image used with permi ssio n from HSBC Holdings Plc. 6

The fo llowing fig ure, Figure 12-2, illus trates several of the in te rnational stock exchanges on whi ch shares of the parent company, HSBC Holdings pie are li sted. HSBC's shares are held by approx imately 200,000 share holders in 13 l coun tri es and ten-i tori es around the world. 5

Listed on multiple exchanges, includ ing:

London Stock Exchange

I Symbol : HSBA Hong Kong Stock Exchange

Symbol: 0005

New York Stock Exchange

I Symbol: HSBC Bermuda Stock Exchange

Symbol: HSBC .SH

Considering the preceding discuss ion of HSBC Holdings Pie, complete the fo llowing Now YOU Try.

1. Describe how HSBC and its subsidiaries might have prepared their individual country finan- cial statements before the widespread acceptance/adoption of IFRS.

Continued

6The HSBC Group, Simplified Structure Chart: Principal entities . As of October I, 20 18.

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Continued from previous page

2. Considering the profile of HSBC provided in the preceding pages, in your own words explain why you would expect this company to be an advocate for a single set of global financial reporting standards.

As you might imagine, during the period when the U.S. SEC was actively considering whether

to adopt IFRS , HSBC was vocal in its support for a move to a single set of global accounting

standards. Writing to the SEC to voice support for this position, HSBC stated: 'The costs of

maintaining separate ledgers and processes for IFRS and U.S. GAAP are very significant in

North America. " Allowing U.S. issuers to use IFRS, HSBC wrote, would "eventually eliminate

the need to maintain two complete sets of financial records and the need to analyze every

transaction under both IFRSs and U.S. GAAP."7

This example illustrates the clear benefits afforded to HSBC of the global shift toward

IFRS. However, it is important to understand this example in context. As a London-based

corporation , HSBC already reports under IFRS in certain jurisdictions and expects to see

additional benefits from the continued expansion of IFRS globally. Not all multinational

corporations share this view. For example, U.S.-based multinationals Citigroup and Wal-Mart

have expressed concern to the SEC that the benefits of an outright adoption of IFRS would

not exceed its costs, instead expressing a preference for continued convergence between U.S.

GAAP and international standards.8

Let's take a closer look now at the IFRS Foundation and its standard-setting bodies.

THE IFRS FOUNDATION AND ITS STANDARD-SETTING BODIES

Headquartered in London, England, and with a regional office in Tokyo, Japan, the IFRS Foundation oversees two independent standard-setting bodies, the IASB and the IFRS Interpretations Committee (IFRIC) .

The IFRS Foundation, both directly and through its standard-setting bodies, has a challenging mission as illustrated in Figure 12-3.

Lo 2 Understand the structure and mission of the IFRS Foundation, including its stan- dard-setting bodies the IASB and the IFRS Interpretations Committee.

7 Iain Mackay, Senior Executive VP and CFO, HSBC North America Holdings Inc. "Comment letter to the SEC." In reference to SEC File Number: S?-27-08 . April 20, 2009. Page 2.

8 Per comment letters in response to SEC File Reference No. S?-27-08, authored by: Robert Traficanti, Citigroup Vice President and Deputy Controller, April 20, 2009 . Page 2. Steven P. Whaley, Senior Vice President & Controller, Wal - Mart Stores, Inc ., April 20, 2009. Page 2.

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Figure 12-3

The challenging mission

of the IFRS Foundation

and its standard-setting

bodies

Figure 12-4

Structure of the IFRS

Foundation

Develop standards that bring transparency, accountability and

efficiency to financial markets around the

world.

Promote the use of IFRS around the world.

Encourage consistency in the

enforcement by global securities regulators of compliance with IFRS.

Receive input on proposed standards from its worldwide

constituent base of standard setters , regulators ,

corporations, accounting firms , and investors.

Ensure that standards are translated into languages

understood by the IFRS Foundation's many

constituents.

Post-issuance, review the effectiveness and

implementation process of IFRS guidance.

Offer education and training , to ensure consistent global

application of IFRS.

Image of world used with permission from Microsoft.

Let's briefly look at how the IFRS Foundation is organized and funded.

The IFRS Foundation has a three-tier structure, as illustrated in Figure 12-4.

Three-tier structure

IFRS Foundation Monitoring Board

IFRS Foundation Trustees

I International Accounting

Standards Board I

IFRS Interpretations Committee

SME Implementation Group

Public accountability

Governance and oversight

Independent standard-setting and related activities

Source: IFRS Foundation, Pocket Guide to IFRS Standards (2017). Page 20.

Standard-Setting Bodies of the IFRS Foundation The International Accounting Standards Board (IASB) The IASB is an independent standard-setting organization whose current 14 full-time board members represent a diversity of countries and constituencies (including, for example, financial statement users, preparers, auditors, and academics).

9 Reproduced by Cambridge Busin ess Publishers with the permi ss ion of the International Financial Reporting Standards Foundation®. Reproduction and use ri ghts are strictly limited®. No permi ssion granted to third parties to reproduce or di stribute.

The IASB 's responsibilities include

• Developing.fit// IFRS,

• Issuing guidance for small- and medium-sized entities ([FRS for SMEs), and

• Approving the issuance of IFRS interpretive guidance.

The IASB cannot perform these responsibilities in isolation , however. For the IASB to maintain its authority as global standard setter, it must collaborate extensively with the national and regional standard-setting bodies representing its constituents.

The IASB is hopeful that this collaboration (in particular with the ASAF, discussed further below) will reduce instances of nonendorsement of its final standards.

The IFRS Interpretations Committee (IFRIC) The IFRS Interpretations Committee (IFRIC) issues authoritative guidance on emergent issues that are "likely to receive divergent or unacceptable treatment, in the absence of such guidance." 10

That is, this committee is intended to respond, in a timely manner, to issues that arise regarding the clarity or application of IFRS guidance. The IASB must approve all interpretive guidance before it is issued as final. Take a moment now to read and react to the following Now YOU Try .

The IFRS Interpretations Committee has been criticized for not issuing enough interpretive guidance, and for not responding in a timely manner to areas of diversity in practice. 11 This has recently begun to change, as the IFRS Interpretations Committee has become more active in issuing interpretive guidance in recent years. Yet, IFRS was initially heralded as being a more principles-based reporting framework. Do you think the recent increase in interpretive guidance is a positive development for IFRS? Explain.

Governance and Oversight of the IFRS Foundation

The Monitoring Board The IFRS Foundation's Monitoring Board provides for the formal interaction between the IFRS Foundation and individuals representing the capital markets authorities (i.e., securities regulators) it serves. These include

• The U.S. SEC

• The European Commission

• Korea 's Financial Services Commission (FSC)

• The Brazilian Securities Commission (CVM)

• The Financial Services Agency of Japan (JFSA)

• The Growth and Emerging Markets Committee of the International Organization of Securities Commissions (IOSCO)

Members of this board represent capital markets authorities responsible for setting the form and content of financial reporting in their respective jurisdictions.

10 IFRS Foundation , 2018 Blue Book. Preface to Internati onal Financial Reporting Standards , par. 14.

II For example, the SEC discusses this concern in its Final Staff Report: Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System/or U.S. Issuers. Sec. I(C)(2), page 4. July 13 , 2012.

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Recall that under the Securities Exchange Act of 1934, the U.S. SEC was given authority to set U.S. accounting standards , but it chose to delegate this authority to the FASB. In a similar fashion , many international capital markets authorities have chosen to entrust standard setting for listed (e.g ., public) companies to the IASB , but still desire oversight over the process in which standards are set. Accordingly, members of this board participate in the appointment of IFRS Foundation Trustees, provide input into the IASB 's processes, and-as its name implies- generally monitor the activities of the IFRS Foundation.

Trustees The IFRS Foundation's Trustees provide governance and oversight over the Foundation. Representing a diversity of geographic and professional backgrounds, the Trustees are respon- sible for

• Appointing members to the IASB , the IFRS Interpretations Committee, and the IFRS Advisory Council;

• Providing governance over the independence, funding , and processes of the IASB ; and

• Promoting and supporting the use of IFRS globally.

In fulfilling these duties, the Trustees are held publicly accountable to the Monitoring Board, to whom the trustees must report at least annually. 12

Advisory Bodies of the IFRS Foundation The IASB regularly receives input from various advisory groups, including the IFRS Advisory Council and the Accounting Standards Advisory Forum (ASAF). Comprised of individuals representing a diversity of geographic and professional backgrounds, the Advisory Council pro- vides a forum for representatives of constituent organizations to provide input into the IASB 's standard setting. The Advisory Council meets with members of the IASB at least two times per year in order to :

• Advise the IASB on its agenda decisions and priority of projects, and

• Provide views on existing standard-setting projects or application issues associated with existing standards.

Members of the IFRS Advisory Council are appointed by the Trustees. 13

The ASAP formalizes the process through which the IASB receives input from regional and national standard setters. Comprised of representatives from member standard setters, the ASAP advises the IASB on its technical projects , which should reduce the risk of nonendorsement by various jurisdictions once a standard has been issued.

Other formal advisory bodies to the IASB include, for example, the Emerging Economies Group and the Capital Markets Advisory Committee .

Considering the preceding discussion, respond to the following Now YOU Try.

1. During 2017, one of the groups just described commissioned an independent survey evaluat- ing how stakeholders perceive the work of the IFRS Foundation and the IASB. Among the findings: The Foundation earned high marks on independence and transparency but identi- fied areas of improvement, including the complexity and timeliness of its standards. 14 Which of the groups just described would you expect to have initiated this survey process? Explain .

12 IFRS Foundation Constitution, updated December 2016. Par. 13 , 15 , 19b, 24 .

13 IFRS Foundation Constitution, updated December 2016. Par. 43-45.

14 Ebiquity. Perceptions of the IFRS Foundation: Reputation Research Findings. July 2017. Page 6.

Continued

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Continued from previous page

2. Given the IFRS Foundation's mission, explain what value you would expect the Foundation's advisory bodies to bring to its standard-setting activities.

Funding for the IFRS Foundation The IFRS Foundation is funded through a combination of

• Mandatory levies, imposed by certain countries' governments and regulatory bodies on list- ed and/or nonlisted companies, similar to the accounting support fee that funds the FASB;

• Contributions from national standard setters and/or governments;

• Contributions from accounting firms and certain U.S. companies (such as Bank of America and Citigroup); 15 and

• Sales of IASB publications and subscriptions.

While the IFRS Foundation has established "target contributions" from its member coun- tries (based in part on each country's GDP), it lacks the authority to impose funding require- ments and thus must rely on this mixed-attribute funding system. 16

Next, Jet's discuss the sources of guidance issued by the IFRS Foundation.

INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)

Applicability of IFRS The IASB issues two types of international financial reporting standards: full IFRS and IFRS for SMEs. Full IFRS applies to profit-oriented entities with public account- ability, and IFRS for SMEs applies to entities that do not have public accountability, as illustrated in Figure 12-5.

Notably, the IASB also publishes a subset of the IFRS for SMEs publication that applies specifically to micro-sized entities, such as those with just a few employees.

Lo3 Navigate, apply , and understand the scope of the two prevailing sets of international accounting guidance: full lFRS, and IFRS for small and medium-sized entities (SMEs).

Applies to entities that: • Prepare general-purpose

financial statements, and • Have public accountability

Applies to entities that: • Prepare general-purpose

financial statements , and • Do not have public

accountability

Not-for-profit entities, while not the intended users of IFRS and IFRS for SMEs, are permit- ted to apply this guidance to the extent they believe application is appropriate. 17

15 2017 Annual Report of the IFRS Foundation. Page 32.

16 IFRS Foundation Annual Report 2016, p. 38.

17 IFRS Foundation , 2018 Blue Book. Preface to International Financial Reporting Standards, par. 9.

Figure 12-5

Applicability of full IFRS versus IFRS for SMEs

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General-Purpose Financial Statements The IFRS for SMEs glossary defines general-purpose financial statements as

Financial statements directed to the general financial information needs of a wide range of users who are not in a position to demand reports tailored to meet their particular information needs.18

That is, many financial statement users (e.g., shareholders, creditors, and employees) can- not individually request financial information from a reporting entity; rather, they must rely on general-purpose financial statements-either presented separately or within an annual report. Such financial statements differ, for example, from financial statements prepared for a specific purpose, such as for tax reporting.

Take a moment to apply your understanding of the term general-purpose financial state- ments in the following Now YOU Try exercise.

General-Purpose Financial Statements

Assume that a company uses IFRS for SMEs as the starting point for its financial statements, then adjusts these statements to comply with requirements specific to its national taxing authority. The entity sends the financial statements to the taxing authority only.

Using the definition of general-purpose financial statements, consider whether these financial statements would be considered general-purpose or special-purpose financial statements. Explain.

Example based on IFRS Foundation's ''Training Material for the /FR~ for SMEs (version 2013-1 )," Module 1, Page 8, Ex4.

Public Accountability The IFRS for SMEs publication defines public accountability as follows:

1.3 An entity has public accountability if: (a) its debt or equity in struments are traded in a public market or it is in the process of

issuing such in struments for trading in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and region al markets), or

(b) it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesse (most banks, credit union s, insurance companies, securi- ties brokers/dealers, mutual funds and investment banks would meet thi s second criterion). 19 [Emphasis added]

Considering this definition, take a moment to complete the following Now YOU Try.

Considering the preceding definition, but in your own words, describe what it means for an entity to have public accountability.

18 IFRS for SMEs (20 15 ), Glossary.

19 IFRSfor SM Es (20 15 ). Par. 1.3.

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The IASB has concluded th at any entity with public accountability, rega rdless of its size, should fo ll ow full IFRS .20 Scope guidance fro m the lFRS fo r SMEs publication emphasizes thi s point:

If a publicly accountable entity uses thi s Standard, its fi nancial statements shall not be descri bed as conforming to the IFRS for SM Es- even if law or reg ul ati on in its jurisdiction permits or req uires thi s Standard to be used by publicly accoun tabl e entiti es.2 1

That is, even if directed by a government authority to issue fin ancial statements using lFRS fo r SMEs, entities with public accountability cannot assert that their financial statements comply with lFRS fo r SM Es . Rather, these entities should apply full IFRS or other acceptable stand ards.

Individual Jurisdiction Considerations So this is all pretty simple, right?

• Not publicly accountable?-Check.

• Issues general-purpose financial statements?-Check.

• Apply lFRS for SMEs.

But wait ... there's ju st one more consideration. See, this is just th e intended scope of the lFRS for SMEs publication. Ultimately, the determin ation of which entities may utili ze thi s guidance rests with authoriti es in individu al countries. To th at end, many indi vidu al jurisdi c- tions have es tablished additional criteria fo r determinin g which entities may report usin g l FRS for SMEs including, for exampl e, cri teria based on reve nue, assets, employees, or other fac tors. Certain countries may dec ide, for exampl e, that entities that are economically significa nt in th at country should be required to use full IFRSs ra ther than the lFRS for SMEs.

Take a moment to appl y your understanding of SMEs in the fo ll ow ing Now YOU Try exe rcise.

Understanding the Scope of IFRS for SMEs

Respond to the following , referring back to the preceding discussion as necessary.

1. A publicly accountable entity has been required by its national taxing authority to issue finan- cial statements following the guidance in IFRS tor SMEs.

Can the entity describe its financial statements as prepared in conformity with IFRS tor SMEs? Explain .

2. An entity meets the IASB's intended scope of entities that should apply IFRS tor SMEs. What other consideration should enter into the entity's decision about whether use of IFRS tor SMEs is appropriate for its statutorily required financial statements?

The IASB's issuance of different guidance for entities with and without public accountability dif- fers from U.S. GAAP, where the Codification applies to all nongovernmental entities. That said , the number of private company alternatives available within the Codification has increased in recent years as a result of collaboration between the FASS and the Private Company Council.

20 IFRS for SM Es (2009), Basis for Conclusions. Par. BC76.

21 IFRS for SM Es (20 15), Par. l.5.

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Figure 12-6

Standards comprise IFRSs and IASs

[

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Figure 12-7

Interpretations comprise IFRICs and SICs

The next section of this chapter offers a closer look at full IF RS.

Understanding "Full lFRS" To comply with full IFRS, entities must comply with standards, interpretations, and the Conceptual Framework. Following is discussion of each of these sources, followed by discus- sion of the priority in which these sources should be considered.

Standards IFRS standards comprise IFRSs and IASs, as illustrated in Figure 12-6.

Standards

International Financial Reporting Standards (IFRS), issued since 2001

International Accounting Standards (IAS), issued from 1973-2001

Each standard within IFRS is intended to address a specific accounting topic . For example, observe the following standard titles.

• IFRS 3, Business Combinations

• IFRS 15, Revenue from Contracts with Customers

• IAS 7, Statement of Cash Flows

• IAS 16, Property, Plant and Equipment

When changes are required to an existing standard, the IASB ' s policy is to amend or replace existing IFRS when appropriate, but to not change how the standards are numbered. New stan- dards are created as necessary to address comprehensive emerging issues. Chapter 14 of this book provides further discussion of the IASB 's standard-setting process.

Considering the IASB's history discussed earlier in the chapter, explain which standard setter likely issues/issued each type of standard: IFRSs and IASs. Explain.

Content within IFRS standards is generally organized into sections similar to those used in the Codification (e.g. , Objective, Scope, Recognition, and so on). That said, section headers are not as standardized as those in the Codification and may be unique to a given topic.

Interpretations Interpretations offer guidance on narrow-scope issues that could otherwise result in the inconsis- tent application ofIFRS. Interpretations comprise IFRICs and SICs, as illustrated in Figure 12-7.

Interpretations

IFRS Interpretations Committee interpretations (IFRICs) , issued since 2001

Standards Interpretations Committee interpretations (SICs), issued from 1997-2001

When researching an issue, be sure to scan the list of available interpretations to identify any guidance relevant to your research topic. The following Now YOU Try illustrates the limited- scope nature of an IFRIC.

��

Reading and Understanding an IFRIC IFRIC 10, Interim Financial Reporting and Impairment, resolves a conflict between the require- ments of IAS 34 (Interim Financial Reporting) and IAS 36 (Impairment of Assets) . Specifically, this IFRIC answers the question : Should an entity reverse an impairment charge recorded for goodwill, if the value of the entity's goodwill recovers in a subsequent interim period?

Per IAS 36, par. 124, "An impairment loss recognised for goodwill shall not be reversed in a subsequent period ." However, "IAS 34 requires year-to-date measures in interim financial state- ments. This requirement might suggest that an entity should reverse in a subsequent interim period an impairment loss it recognised in a prior interim period" (IFRIC 10, BC3) .

Here's what the IFRIC decided: "An entity shall not reverse an impairment loss recognised in a previous interim period in respect of goodwill." (IFRIC 10, par. 8) .

The rationale for this decision is described in IFRIC 1 O's Basis for Conclusions : ''The IFRIC concluded that the prohibitions on reversals of recognised impairment losses on

goodwill in IAS 36 ... should take precedence over the more general statement in IAS 34 regard- ing the frequency of an entity's reporting not affecting the measurement of its annual results. " (BC9) . [Footnotes omitted]

Questions: 1. Explain the conflicting requirements in IAS 36 and IAS 34 that this Interpretation sets out to

clarify.

2. Explain the conclusion reached in IFRIC 10 and the rationale for this conclusion.

3. Why do you suppose the IFRIC addressed this issue , as opposed to the IASB? Explain.

Conceptual Framework The IASB 's Conceptual Framewo rk for Finan cial Reporting (the "Framework") sets fo rth the conceptual underpinnings for the more specific require ments of IFRS Standard s and Interpretations. The purpose of the Framework is generally twofold : fi rst, to assist the IASB in the development of new standards, and second, to assist practitioners in applying judgment in the preparation of financial statements, in the absence of more specific guidance. 22

As you' ll see in the IAS 8 hierarchy in Figure 12-8, the Framework in IFRS is considered authoritative, bu t it has less authority than standard s and interpretations of the IASB . Contrast thi s with U.S. GAAP, where the Conceptual Framework is nonauthoritati ve.

To improve your fa miliarity with the IASB 's Framework, complete the fo llowing Now YOU Try.

1. Match the following concepts from the IASB's Framework with its likely chapter in the Framework. The first line has been drawn for you as an example.

Continued

22 Conceptual Framework (M arc h 20 18), par. SP I. I.

Now

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365

Figure 12-8

The IAS 8 Hierarchy23

Continued from previous page

Excerpt from the Framework

A reporting entity is an entity that is required, or chooses, to prepare financial statements. A reporting entity can be a single entity or a portion of an enmy or can comprise more than one entity. A reporting entity is not necessarily a legal entity.

An asset is a present economic resource controlled by the entity as a result of past events.

Because the statement of profit or loss is the primary source of infom,ation about an entity's financial pertormance for the period , all income and expenses are, in principle, included in that statement .

If financial information is to be useful, it must be relevant and faithfully represent what it purports to represent. The usefulness of financial information is enhanced if it is comparable , verifiable, timely and understandable.

When selecting a measurement basis, it is important to consider the nature of the information that the measurement basis will produce in both the statement of financial position and the statement(s) of financial pertormance.

The objective of general purpose financial reporting is to provide financial infom,ation about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions relating to providing resources to the entity.

An asset or liability is recognised only if recognition of that asset or liability and of any resulting income , expenses or changes in equity provides users of financial statements with information that is useful . .

A financial concept of capital is adopted by most entities in prepanng their financial statements. Under a financial concept of capital, such as invested money or invested purchasing power, capital is synonymous with the net assets or equity of the entity. Under a physical concept of capital, such as operating capability, capital is regarded as the productive capacity of the entity based on, for example , units of output per day.

*Excerpts , chapter titles, and paragraph references are based on the 2018 Conceptual Frameworic:. Footnotes omitted. Sources: par 1.2, 2.4, 3.10 , 4.3, 5.7, 6.23, 7.17, 8.1.

Chapters in Framework

Chapter 1: The Objective of General Purpose Financial Reporting

Chapter 2: Qualitative Characteristics of Useful Financial Information

Chapter 3: Financial Statements and the Reporting Entity

Chapter 4: The Elements of Financial Statements

Chapter 5: Recognition and Derecognition

I Chapter 6: Measurement Chapter 7: Presentation and Disclosure

Chapter 8: Concepts of Capital and Capital Maintenance

2. Contrast the IASB's Framework to the FASB's Conceptual Framework. Refer back to Chapter 5, on nonauthoritative sources of U.S. GAAP, as necessary to respond. Comment on any aspects of the Framework that strike you.

The sources of guidance comprising full IFRS should be considered in the order of priority set forth in IAS 8, as discussed next.

The IAS 8 Hierarchy The IAS 8 hierarchy prioritizes the sources of guidance that entities should consider when devel- oping accounting policies for items or transactions. This hierarchy is illustrated in Figure 12-8.

23 IAS 8, par. 7- 12.

Apply specific IF RS (Standards and Interpretations) 1f avail able All guidance considered "integral" to the IFRS should be applied

If specific IFR S are not available or applicable, management must use judgment to select an accounting policy that results in relevant and reliable information. Management should consider the following sources, in descending order.

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If a researcher locates a specific IFRS that is on point, or directly relevant to a transaction, management should apply that IFRS (source 1 in Figure 12-8). If such guidance is not available, management will have to use its judgment in selecting an appropriate policy; the guidance listed in sources 2-4 should be considered in descending order.

Considering Figure 12-8, complete the following Now YOU Try.

In your own words, describe the steps management should take (and sources a researcher

should consider) if a specific IFRS is not available for a particular issue.

Differentiating between Integral versus Not Integral Content As noted in the first box of the IAS 8 hierarchy, guidance that is considered integral to a standard should be given priority. IFRS distinguishes between guidance that is considered integral to a standard (i.e., mandatory) and guidance that is not integral to the standard (i.e., nonmandatory), as follows:

IFRSs are accompanied by guidance to assist entities in applying their requirements. All such guidance states whether it is an integral part of IFRSs. Guidance that is an integral part of the IFRSs is mandatory. Guidance that is not an integral part of the IFRSs does not contain requirements for financial statements. 24 [Emphasis added]

That is, researchers are required to apply all guidance that is considered "integral" to a standard. The application of non-mandatory guidance is not required per se; however, consid- eration of this guidance may be useful in helping researchers apply the guidance in the manner intended by the Board.

To identify the content that is integral to each standard, researchers can look to (1) the authority paragraph at the bottom of each standard 's "Contents" page (see Figure 12-9) and (2) information in the header of each appendix that indicates its authority (see Figure 12-10).

International Financial Repo1ting Standard 2 Share-based Payment (IFRS 2) is set out in paragraphs 1-64 and Appendices A-C. All the paragraphs have equal authority. Paragraphs in bold type state the main principles. Terms defined in Appendix A are in italics the first time they appear in the Standard. Definitions of other terms are given in the Glossary for International Financial Repo1ting Standards. IFRS 2 should be read in the context of its objective and the Basis for Conclusions, the Prefa ce to International Financial Reporting Standards and the Conceptual Framework for Financial Reporting. IAS 8 Accounting Policies , Changes in Accounting Estimates and Errors provides a basis for selecting and applying accounting policies in the absence of explicit guidance. (Source: 2018 Red Book, IFRS 2 Contents)

24 IFRS Foundation , 201 8 Blue Book. IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors. Par. 9.

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12.11

Figure 12-9

Authority paragraph for IFRS 2, located within the standard's "Contents" page

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Figure 12-10

Header indicating authority of IFRS 2's Implementation Guidance (circl e added for emphasis)

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Guidance on implementing

IFRS 2 Share-based Payment

Definition of grant date

IG1 IFRS 2 defines grant date as the date at whic h the entity

Considering Figures 12-9 and 12-10, complete the fo llowing Now YOU Try.

1. Refer to the authority paragraph for IFRS 2. Which appendices to this standard are consid- ered mandatory?

2. According to the authority paragraph , do all paragraphs in the standard have equal authority? What is the significance of paragraphs that are presented in bold?

3. The Basis for Conclusions to IFRS 2 is not considered integral to the standard . What do you think it means for the standard to be read "in the context of" this guidance?

Performing IFRS Research

Accessing IFRS Guidance To access IFRS guidance, researchers can (1) sub scribe to eIFRS (searchable), or (2) register at www.ifrs.org fo r free (but limited) access to indi vidu al standards (not searchabl e).

Subscriptions to eIFRS can be purchased

• Directly from the IFRS Founda ti on, or

• For students and academi cs, th rough a di scounted (approx im ately $30) annual sub scripti on fro m IAAER, the Intern ati onal Associati on fo r Accountin g Educati on & Research.

Certain researc h databases (such as Deloitte's Accounting Research Too[) also include searchabl e access to IFRS guid ance.

Understanding the Bound Editions IFRS guidance is organized into two bound editions, each avai lable for purchase in printed form or accessible to e-IFRS subscribers. Before beginning a search of IFRS guidance, researchers are often prompted to select fro m among these bound editions.

The Red Book includes all IFRS standards and interpretations, including those not yet effec- tive, and related appendices (s uch as the standard setter's basis fo r conclu sions).

The Blue Book includes only the standards, interpretations, and related appendices that are mandatory fo r the cu rrent fi nancial reporting year. For example, introdu ctory material within the 2018 Blue Book states :

�

This volume does not contain Standards or changes to Standards with an effective date after 1 January 2018. Readers seeking the text of Standards issued at 1 January 2018 (including Standards with an effective date after 1 January 2018) should refer to IFRS Standards-Issued 1 January 2018 (Red Book) ... 25

Think of the Red Book as the book that will help you be prepaRED for future transactions.

Annotated versions of the Red Book and Blue Book are also available in eIFRS and include extensive links and explanatory material. For your reference, the contents of the 2018 Blue Book are illustrated in Figure 12-11, along with commentary pointing out some of the content included in each bound edition.

i 2018 Blue Book 8 Introduction - Introduction to this edition - Changes In this Edition - Preface to IFRS

The Conceptual

- Framewori< for Financial Reporting

• IFRS • IAS • IFRIC • SIC 8 Other IFRS Practice Statement 1 Management Commentary

- A framework for presentation (issued Mar

8. 2011)

IFRS Practice Statement 2 Making Materiality Judgements (issued Sep

14, 2017)

Approvals by the Board of Annual Improvements to IFRS Standards (issued Dec 12, 2008)

Chani This section is a

Volume oi /FREf! Each bound edition includes:

troducti, A preface, setting forth the scope ~--... - and authority of IFRS s volume inch

'"'"-"81'Pf--- The Conceptual Framework

This volume doe

eking the text

ould refer to Ii

~~~~-- Standards and Interpretations anges

e following ar,

ihe Blue f two new~

anamenc

amendme one set a·

an IFRIC~

an IFRS®

The following tat

IFRIC lnterpretat

Standard/lnlerp,

AmendmenV Pr

Statement

IFRS 9 Financi,1,

Considering the preceding discussion of bound editions, complete the following Now YOU Try .

Which bound edition would be most helpful to a researcher whose company is reviewing the accounting for a proposed transaction, which will likely be executed in 1 year's time? Briefly explain.

25 IFRS Foundation, 2018 Blue Book. " Changes in thi s Edition" section.

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Figure 12-11

Blue Book contents, shown in elFRS

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Figure 12-12

Contents of IFRS 2

Even if you are just preparing current-year financial statements and are most interested in standards with current applicability (such as the standards included in the current-year Blue Book) , do not overlook standards with future applicability.

Per IAS 8 (par. 30), entities must disclose any possible impacts that newly issued IFRS guidance will have, when adopted. Additionally, standards with future applicability could impact management's earnings forecasts .

Next, let's discuss how to perform searches within eIFRS.

Browsing Directly to Standards in elFRS Within eIFRS , researchers can browse directly to specific guidance (by clicking on a bound edi- tion), can access the IFRS fo r SMEs publication, or can perform keyword searches within the bound editions. If you have a general idea of the topic you are researching, your best bet may be to browse directly to the applicable standard within eIFRS.

First, select the Bound Edition (Red or Blue Book) most relevant to your situ ation. Nex t, scan the list of stand ards, or search on the page (for example, usin g ctrl + f) fo r keywords in the title of standards.

Next, if you are reviewin g a standard fo r the first time, read the standard's Objective para- graph. This paragraph provides a good overview of the purpose of the standard and its obj ec- tives. Once you determin e that the standard is relevant, be sure to review all guidance considered "integral" to the standard , and look fo r any releva nt interpretations of the standard . Specifically, within eIFRS , the link to the main body of a standard is shown in bold . This is illustrated in Figure 12-1 2, which shows in bold the link to IFRS 2, Share-Based Payment.

In the wrong pl ace? Look for references to other related standards. The Related Documents link provided fo r each standard lists other standards th at significantl y refere nce, or whi ch are signifi ca ntl y referenced by, a given standard.

English .... seareh IFRS ORG , SHCfJ , 'CA£Yl (i) ..,,

IFRS 1: Firs t-time Adoprion o f lntern3tional

Financial Reporting

5tand3f'ds

IFRS 2: Sh:1re-b:JSed

P;Jyment

I Related documen!s I Con:ents

I Sha<a-based-t (ISSC<ld Feb I , 2004)

I Appendix A Defined ,erms

I Appendix 3 Applica:ion

guidance

I Appemfoc C Amendments to

otherlFRSs

Approval by the Board of I IFRS 2 is sued 1n February

200<!

Ap proval by the Board of

201 8 Red Book IFRS IFRS 2: Share-based Payment Share-based Payment Q Print

IFRS 2

Share-based Payment

International Financial Reporting Standard 2 Share-based Payment Objective

Scope

The objective of !his IFRS is to specify the financial re-po rti ng by an entity \.\'hen it undetta'<es a ~ f2s.!vmenl trons,icriqn. In paroc ar, it requ:res an en tity to reflect in its profit or loss and financial position i he effects of share-based payment transactions, r'lclu ding expenses associated with transactions 1n which shc1re gRJm_ are gramed to employees.

An entity s apply this IFRS in accounting for all ~~nt [email protected]!'ons, wheth er or net the entity

can identify speclTi cally some or a~ of the goods or services received. in cl uding:

(a) gsµ.J_rry_-settled share-based ~yment rrnnsactions,

tb) ec1sh-sffllsdshare-bc1S?d.®l::'fflffit rransacoons, and

(c) transacuons in which the entity rece-ives or acquires goods or se 1V1Ces and th e term s of the arrangeme n;: pro\llde either the entity or the suppli er of those goods or services with a choice of

wh eth er the entity sett:es the transaction in cash (or other asse1s) or by issuing ~~.

except as noted in ~g_m~. In the absence of specifical ly identi"fiab!e goods or services, ether

Considering this info rmation, complete the fo llowing Now YOU Try, intended to fa miliar- ize you with the layo ut of material within eIFRS.

Considering the screenshot in Figure 12-12, identify the link you'd click, on the left-hand naviga-

tion panel, for information on each of the following.

1. If you are in the process of preparing 2018 financial statements and want guidance that

applies to the current reporting period only?

2. To access the Spanish-language version of standards?

3. To find links to newly issued standards?

With respect to IFRS 2, where on this page would you:

4. Begin when reading this standard for the first time?

5. Expect to find links to other standards that significantly reference IFRS 2?

6. Click to view the standard itself, IFRS 2?

Performing a Keyword Search in elFRS If you are looking for a specific term in the guidance or are unsure where to begin a browse search, try a Keyword search instead.

Let 's assume that you are searching for the term "self-constructed" within the Blue Book. This search is illustrated in Figure 12-13.

self-constructed ®

RESET ALTERS@

.··~ 2011 mo

mo + Show detailed year list

2018 Annotated Re.. . ID O

w 2018 Annotated Is... Ill O

SORTEDBYRElfVA.'K:E S(JITBYST.:.NOAAD

F2Sl.liS1-100=!0 FF.E\'OJS 010203CJ l\:Xi

Ii 2018 Annotated Issued Standards (Red Book) ifrsl 2018

First-time Adoption of International Financial Reporting Standards ... it applies IFRIC 23. Withdrawal of IFRS 1 -Ossued 2003) <O This IFRS supersedes IFRS 1 (issued in

2003 and amended at May 2008). Footnotes Educational Footnotes E1 [IFRIC Updaie- May 201 O:

Accounting for costs included in sett-constructed assets on transition The Committee received two requests concerning the application of IFRSs for an entity that capitalises cenain costs, including ...

Ii 2018 Annotated Red Book ias16 2018 ~

IAS 16 Property, Plant and Equipment ... of abnormal amounts of wasted material, labour, or other resources incurred in sett-constructilg an asset is not included in the cost of the asset. !AS 23 Borrowing Costs estabTi shes c · eria for the

recognition of interest as a component of the carrying amount of a sett-constructed item of property. plant

and equipment. 22A Bearer plants are accounted for in the same way as sett-constructed ...

Ii 2018 Annotated Red Book ias16 2018 ~

IAS 16 Property, Plant and Equipment ... of abnormal amounts of wasted material, labour, or other resources incurred in self·constructilg an

asset is not included in the cost of the asset. IAS 23 Borrovling Costs estabfishes criteria for the

m O recognition of interest as a component of the carrying amount of a self-constructed Item of property, plant

As illustrated in Figure 12-13 you can choose to search for an additional term within your searc h results ("Search within"). You also have the option to narrow your search results by year, by bound edition, or by standard. The se options are circled in Figure 12-13.

Now

YOU Try

12.14

Figure 12-13

Search for the term "self-

constructed" within the

Blue Book

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Figure 12-14

Anheuser-Busch InBev, Statement of Compliance (from 2017 Annual Report, p. 72)

Additional search tips are available under the Help and the FAQs links at the bottom of your eIFRS page. I'll summarize a few:

• To search for an exact phrase, enclose the search phrase in "double quotes."

• Interestingly, a search for the term self-constructed without quotation marks returned O results. A search for this term without the hyphen returned 170 results. The moral of this story? Try performing your search multiple ways if at first you strike out.

• Once you cJjck on a search result, you can use ctr! + f to search for specific terms on that page.

Accessing Individual Standards on the IFRS Website ("Registered Users Only") By completing a brief, free onJjne registration, "registered users" of the IFRS website can access current-year unaccompanied individual IFRS standards, interpretations, and technical summa- ries of standards. (This is also known as Basic access.)

Access to unaccompanied guidance means that the standards are not accompanied by imple- mentation guidance or the IASB 's basis for conclusions, and prior year (superseded) guidance is not included . Another major downside of this Jimjted access is that you cannot perform keyword searches of the full population of IFRS guidance (such as within bound editions).

Statement of Compliance with IFRS Now that you understand what it takes to research and apply IFRS, Jet 's discuss the requirements for representing compliance with IFRS.

Per IAS 1 (Presentation of Financial Statements), entities whose financial statements com- ply fully with IFRS must make an explicit and unreserved statement of compliance in the finan- cial statement footnotes. 26 As a researcher, you might find it useful to look for this compliance statement (generally located in note l or 2 of companies' financial statement footnotes) when determjning whether an entity has prepared its financial statements in accordance with IFRS.

Figure 12-14 illustrates the statement of compliance footnote from an annual report of Anheuser-Busch InBev ("AB InBev"), which is based in Belgium.

2. Statement of Compliance The consolidated financial statements are prepared in accordance with International Financial Reporting Standards as issued by the International Accounting Stand ard s Board ("IASB") and in conformity with IFRS as adopted by the European Union up to 31 December 2017 (collectively "IFRS") . AB InBev did not early appl y any new IFRS requirements that were not yet effective in 2017 and did not apply any European carve-outs from IFRS.

In Figure 12-14, notice not only the "unreserved" statement of compliance with IFRS , but also a statement that the financial statements are in conformjty with "IFRS as adopted by the European Union." AB InBev also makes a point of stating that it did not apply any EU-specific exceptions to IFRS. But, why all of this explanation?

As noted previously, certfiln countries (or regions) require their local authorities to endorse IFRS before they are adopted for use in the country. In the EU, the Accounting Regulatory Com- mjttee (i.e., representatives from member state governments), as advised by the European Financial Reporting Advisory Group (EFRAG), mu st endorse new IFRSs before they are approved for use in the EU. In the past, this review process resulted in a temporary carve out of key financial instru- ments guidance (the "IAS 39 carve out"). However, at any given time , if differences exist between IFRS and "EU IFRS," and these differences are relevant to an entity's financial statements, the entity cannot represent compliance with IFRS.

The following Now YOU Try looks at HSBC ' s IFRS compliance footnote.

26 IAS I, Presentation of Financial Statements. Par. 16.

�

The IFRS Compliance Footnote

Read the following excerpt from HSBC Holdings pie's IFRS compliance footnote, then respond to the questions that follow.

1 Basis of preparation

(a) Compliance with International Financial Reporting Standards The consolidated financial statements of HSBC and the separate financial statements of HSBC Holdings have been prepared in accordance with IFRSs as issued by the IASB, including interpretations issued by the IFRS Interpretations Committee, and as endorsed by the European Union ('EU '). At 31 December 2017, there were no unendorsed stan- dards effective for the year ended 31 December 2017 affecting these consolidated and separate financial statements, and HSBC's application of IFRSs results in no differences between IFRSs as issued by the IASB and IFRSs as endorsed by the EU. (Source: HSBC Holdings Pie, Annual Report and Accounts 2017, Note la, page 186.)

Questions:

1. Does HSBC comply in full with IFRS, and does it also comply with "IFRS as endorsed by the EU"?

2. What is one potential factor that could give rise to differences between IFRS and IFRS as endorsed by the EU?

Let's now turn our attention to the IFRS for SM Es publication.

IFRS for Small and Medium-Sized Entities

Overview of IFRS for SMEs Recognizing the complexity of applying full IFRS, the IASB created the 250-page IFRS for SMEs publication as a simplified set of guidance for entities without public accountability. In doing so, the IASB acknowledged differences (versus listed companies) in the users and uses of SME financial statements, and the more limited resources generally available to SMEs in preparing financial statements.

The IFRS for SMEs publication is depicted in Figure 12-15. Increasingly, individual juris- dictions (and particularly taxing authorities) are turning to this guidance in establishing their statutory reporting requirements.

201 5

International Ftnanctal Reportmg Standard :.> (IFRS ' ) fo1 Small and Med1un1-S1zed Enuues (SMEs)

IFRS for SMEs® Thi ~ ronouncemen t incorporates 2015 Amendments to the IFRS ~effective 1 Janua ry 2017 wi th early application permi

Now

YOU Try

12.15

Figure 12-15

Accessing the IFRS for SMEs publication within elFRS

TIP from the Trenches

Figure 12-16

Judgment hierarchy under IFRS for SMEs28

To create the IFRS for SM Es publication, the IASB started with full IFRS then made certain modifications , including the following :

• Topics not relevant to typical SMEs were omitted, such as earnings per share, interim finan- cial reporting, and segment reporting.

• Many principles for recognizing and measuring assets, liabilities, income, and expenses have been simplified. For example, goodwill is amortized, rather than tested for impairment; also, all borrowing and research and development costs are expensed, rather than capitalized in certain circumstances.

• Substantially fewer disclosures are required.27

Furthermore, revisions to the IFRS for SM Es publication will be limited to once every three years. Notably, a group known as the SME Implementation Group (SMEIG) periodically devel- ops nonmandatory Q&As designed to assist practitioners in applying the IFRS for SMEs. These Q&As are accessible on www.ifrs.org, under "IFRS for SMEs."

Refer to Figure 12-15. In some cases, you may open a document within elFRS that shows up in pdf format on your screen. If this happens, you may be unable to perform a keyword search (ctrl + f) on the page.

If this happens to you, simply click on the Open PDF (Acrobat) icon (circled in the pre- ceding image) to access a keyword-searchable version of the document.

Judgment Hierarchy and Statement of Compliance The judgment hierarchy shown in Figure 12-16 applies to an entity 's selection of accounting policies under IFRS for SMEs.

l If not available, management must use judgment to select an accounting l l policy that results in relevant and reliable information. Management shall l \ ... consider _the following. sources •. in _descending. order ... .. ...... .. ................................. !

Similar to full IFRS, the authority paragraph in the IFRS for SMEs makes clear which parts of the standard and its appendices are mandatory. This guidance is as follows:

27 IFRS.org, "The IFRS for SMEs Standard."

28 !FRSfor SM Es (2015 ). Par. 10.3- 10.6.

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The International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SM Es) is set out in Sections l-35 and Appendices A-B. Term s defined in the Glossary are in bold type the first time they appear in each section , as appropriate. The IFRS for SM Es is accompanied by a Preface, a Derivation Table, a Basis for Conclusions and Implementation Guidance consisting of illustrative financial statements and a table that collates the presentation and di sc losure requirements in the IFRSfor SM Es. (Source: IFRSfor SM Es 2015, Contents page)

Also si milar to full IFRS , entities whose financial statements comply with all require- ments of the IFRS for SMEs mu st "make an explicit and unreserved statement of such compli- ance" in their financial statement footnotes, 29 like this illustrative example from the IFRS for SMEs publication :

Note 2 Basis of preparation and accounting policies These consolidated financial statements have been prepared in accordance with the

International Financial Reporting Standard for Small and Medium-sized Entities issued by the International Accounting Standards Board . .. 30

Considering the preceding discussion, respond to the following .

1. Why did the IASB create the IFRS for SMEs guidance? Now

YOU Try

12.16

2. According to the IFRS for SMEs authority paragraph , which sections of the IFRS for SMEs are considered "mandatory"?

How Do I Know Whether IFRS Applies to a Particular Country? To find out whether-and to what extent-IFRS applies in a particular country, go to Around the World, then Use by Jurisdiction on the IFRS website.

Additionally, Deloitte 's IAS Plus website (www.iasplus.com) is a great resource for jursidictional profiles. Under the Jurisdictions tab , researchers can select a country, then read about that country's unique financial reporting requirements and access links to more information. For example, Figure 12-17 illustrates a search for the reporting requirements in Nigeria.

29 IFRSforSMEs(20 15). Par. 3.3.

30 IFRS for SM Es (20 15). Illustrative Financial Statements, illustrative note 2, "Basis of Preparation and Account in g Policies."

Lo4 Locate jurisdic-tion profiles to understand circumstances in which IFRS applies internation- ally, and understand circum- stances in which IFRS applies to U.S. practitioners.

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Figure 12-17

Financial reporting requirements in Nigeria, courtesy of Deloitte's IAS Plus website (page excerpted)

Now

[ YOU J Try

12.17

Deloitte. I AS P/us Login or Register v Global (English) v

Home News Publications Meetings Standards Projects Jurisdictions Resources

Nigeria

II National Professional Organisation Websites:

Institute of Chartered Accountants of Nigeria

Association of National Accountants of Nigeria

Standard-Setter Website: Financial Reporting Council of Nigeria

Regulator Website: Securities and Exchange Commission, Nigeria

Financial Re porting Framework In Nigeria

Adoption of International Financial Reporting Standards from 2012

r Search site.. . J Q

El D Cl ml D

On 28 July 2010, the Nigerian Federal Executive Council approved 1 January 2012 as the effective date for con-

vergence of accounting standards in Nigeria with International Financial Reporting Standards (IF RS). The r-- -·--;1 ...i;M-'-'"' H-- "'';--~;-- "--:ountin Standards Board NASB under the su rvision of the Ni erian

firm of Deloitte Touche Tohmatsu Limited, or one of their related entities. 31

In addition to jurisdictional profiles , Deloitte's IAS Plus site offers additional discussion and histori- cal information for every single IFRS standard . Using the screenshot in Figure 12-17, circle where on the page you would click to access a detailed discussion of each IFRS standard.

Using these resources as a starting point, researchers should take care to understand whether IFRS applies as issued by the IASB , and/or whether other jurisdiction-specific requirements apply.

When Are International Standards Relevant to U.S. Accountants?

As you know, the SEC requires U.S. public companies to prepare their financial statements in accordance with U.S. GAAP. It remains unclear whether the SEC will ever move to broadly require or permit the use of IFRS in the United States and-if so-how such a change would be accomplished.

In years past, the SEC gave serious consideration to a possible move to IFRS but noted the following concerns, including

• Is the IASB 's funding mec hani sm suffici ently developed? Or does the IASB 's funding expose it to potential independence concerns?

• Are IFRS being applied consistently globally?

• Is the IASB sufficiently involving (and relying on) regional and national standard-setting bodies in the development of new standard s?

• How much cost and effort would be required (by U. S. companies) to adopt IFRS ?

• Is the interpretive and industry- specific guidance in IFRS suffici ently developed ?32

31 Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited , a UK private company limited by guara ntee, and its network of member firms, each of whi ch is a lega ll y separate and independent entity. Please see www.de loitte.com/ about for a detailed descriptio n of the lega l stru cture of Deloitte Touche Tohm ats u Limited and its member fi rm s.

32 U.S. Securities and Exchange Commission , Final Staff Report: Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers. Jul y 13, 20 12. ("SEC Staff Report, July 2012"). Pages 4--{5.

�

Some speculate that the SEC's (and the U.S. Congress's) greatest concern is the fear of ceding standard-setting authority to an organization outside of the United States. 33 One pos- sible solution to that concern, raised by the SEC , would be the required endorsement by the FASB of IFRS guidance prior to its adoption in the United States.34 Others speculate that the move to IFRS could ultimately be like the U.S.'s consideration of the "metric system" (a lot of talk about adopting, but ultimately no decision to change).

For now, the SEC has left open the possibility that it will reach a decision on this matter; however, the timing of this decision is not clear. In recent years , much of the SEC's attention has been focused elsewhere, in particular on rulemaking related to financial reform legislation (e.g., the Dodd-Frank Act of 2010), however the SEC's draft strategic plan for 2014-2018 also indicated that it intended to consider the use of global standards.

This all being said, international standards are already relevant in the United States in certain circumstances. These include

• Foreign private issuers ' filings in the United States;

• For U.S. nonpublic companies, who have the option to apply IFRS ; and

• Other areas relevant to U.S. accountants.

Foreign Private Issuers Foreign private issuers, listed in the United States, have the option to present financial state- ments in accordance with U.S. GAAP, IFRS , or their home-country accounting standards (with a reconciliation to U.S GAAP). In 2007 , the SEC eliminated the requirement that foreign private issuers must reconcile their IFRS financial statements to U.S. GAAP. The U.S. Exchange Act Rule 3b-4(c) defines "foreign private issuer" as follows:

Any foreign issuer other than a foreign government except an issuer that meets the follow- ing conditions:

(1) More than 50 percent of the issuer 's outstanding voting securities are directly or indi- rectly held of record by residents of the United States; and

(2) any of the following: (i) The majority of the executive officers or directors are United States citizens or

residents; (ii) more than 50 percent of the assets of the issuer are located in the United States ; or

(iii) the business of the issuer is administered principally in the United States. 35

[Emphasis added]

While U.S . public companies are required to file a Form 10-K annual report with the SEC, foreign private issuers generally file their annual reports in the United States using Form 20-F .

Considering this definition of foreign private issuer, take a moment to complete the follow- ing Now YOU Try exercise.

33 PwC video perspective, Th e Quarter Close, Third quarter 2012. Posted on 9/17 /2012 by PwC Ass urance Servi ces. From 3:46 to 4: 30 (minutes: second s).

34 SEC Staff Report, July 2012 , page 35. "As it relates to considering the needs of U.S. investors and the U.S. capital markets, the Staff believes that it may be necessary to put in place mechani sms specifically to con sider and to protect the U.S. capital markets- for example, maintaining an active FASB to endorse IFRSs."

35 U.S . Code of Federal Regulation s, definition of "foreign private iss uer." 17 CFR 240. 3b--4(c). Last updated October 6, 2008.

377

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r Now YOU L Try

12.18

Figure 12-18

Example circumstances in which U.S. accountants would use IFRS skills

Foreign Private Issuers

Based on our earlier discussion of HSBC Holdings pie (the HSBC parent company), would you generally expect this company to meet the definition of a 'foreign private issuer" in the United States? Explain, identifying any assumptions you made in reaching this conclusion.

U.S. Nonpublic Companies Technically, U.S. nonpublic companies have the option to apply the simplified IFRS for SMEs accounting framework and still receive an unmodified audit opinion. Unlike the AICPA's FRF for SMEs, which is a non-GAAP framework, IFRS for SMEs is considered generally accepted accounting principles for companies within its scope.

Recall that U.S. nonpublic companies are not required by the SEC to issue financial state- ments, but often do so to satisfy the needs of their investors and lenders. In order for these financial statements to receive an unmodified audit opinion, they must be prepared in accordance with generally accepted accounting principles.

Since 2008 , the AICPA has recognized the IASB as a designated standard setter with the authority to establish international accounting principles, effectively giving AICPA members the option to use IFRS as an alternative to U.S. GAAP. 36

However, although no public information is available on this matter, it is believed that very few, if any, entities will choose to exercise this option. Lenders would have to be willing to accept financial statements prepared under IFRS; such a change would likely be market-driven.37

Furthermore, recent private company simplification efforts by the FASB (in coordination with the Private Company Council) will likely reduce nonpublic companies ' interest in using IFRS.

Other Areas Relevant to U.S. Accountants U.S. accountants may face a variety of situations involving the use of IFRS, as illustrated in Figure 12-18.

In addition, IFRS skills are relevant to U.S. accountants:

36 AICPA Code of Professional Conduct , Appendix A.

37 AI CPA website: www.ifrs.com , "IFRS FAQs," developed by the American Institute of Certified Public Accountants. Questions No . 14 and 15 . Accessed November 2018.

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• On the CPA exam. In particular, candidates are expected to know differences between IFRS and U.S. GAAP. accounting requirements. 38

• As a nonauthoritative source of guidance. Recall that U.S . accountants may look to IFRS by analogy as a nonauthoritative source of guidance if GAAP is not responsive to a specific issue.

• To monitor emerging accounting guidance. Accountants may be asked to monitor emerging changes in U.S. accounting standards . Decisions reached by the IASB could in some cases influence future U.S. GAAP requirements.

Finally, consider another benefit of IFRS experience, described in this TIP from the Trenches.

Another key benefit of having lFRS experience? It enhances your marketability as a profes- sional. Employers (ranging from accounting firms to corporations with international business to institutional investors) seek out individuals with IFRS experience in order to comply with cross-border accounting requirements impacting their business or their clients' businesses.

The moral of this story? International standards are already relevant, today, to U.S. accountants .

Compare and contrast the reporting frameworks available to nonpublic companies considering the use of IFRS for SMEs, the Codification, and the AlCPA's FRF for SMEs.

Citing International Accounting Standards Following are examples of acceptable references to IFRS guidance.

• Per International Accounting Standard No. 16, Property Plant and Equipment (IAS 16), par. 29:

An entity shall choose either the cost model in paragraph 30 or the revaluation model in paragraph 31 as its accounting policy and shall apply that policy to an entire class of prop- erty, plant and equipment.

• Later references might describe this source as follows: Per IAS 16, par. 29 . ..

Also , following is an acceptable method for citing guidance from the IFRS for SMEs publication:

• Per IFRS for SMEs (2015 revision) , Section 1.1 (Scope): "The IFRS for SMEs is intended for use by small and medium-sized entities (SMEs)."

It is necessary to include the revision date when citing from the IFRS for SMEs publication. It is also helpful to show (in parentheses) a description of the section from which guidance is

38 AI CPA , Uniform CPA Exa mination Blueprints. Effecti ve Jan . I , 2019.

l TIP from the Trenches

Now

YOU Try

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being cited. For example, saying "Section 1.1 " by itself is not descriptive, so it is helpful to also describe this section as relating to Scope.

NONAUTHORITATIVE RESOURCES

Extensive nonauthoritative resources are available to assist practitioners in understanding and applying international accounting standards. The following discussion highlights a sample of available resources.

Deloitte's IAS Plus Website A great starting point for researchers applying, or looking for additional information on, IFRS , Deloitte's IAS Plus website (www.iasplus.com) includes news, detailed histories and summaries for each IFRS standard, information about each jurisdiction where IFRS is used, and extensive interpretive guidance (such as guide books for individual IFRS standards) and training resources (such as e-Iearning modules for each standard) .

Comparison Guides Comparison guides, generally available free of charge from major accounting firms, summa- rize key provisions of U.S. GAAP and IFRS and highlight areas of difference. As a beginning researcher, if you were to look at two standards (a U.S. GAAP standard and an IFRS standard) side by side, you may not pick up on nuances implied by different choices of words. Or you may struggle to efficiently identify differences in requirements. These guides can efficiently point out such differences.

Before you even log on to eIFRS, you might consider consulting a comparison guide. Used as a starting point, the guide will (1) identify the names of applicable IFRS (standards and inter- pretations) that are relevant to a topic and (2) highlight key areas of difference in IFRS versus U.S . GAAP requirements. Both sets of standards frequently change, so be sure that you are using the most current available guide, and always use these guides in addition to authoritative sources.

To locate comparison guides, try a Web search for "IFRS vs GAAP," or some variation of this (such as adding the word "comparison" or "guide").

Other Resources Extensive resources are available that can assist in a researcher's understanding of IFRS; the following discussion names just a few. Caution: When searching for nonauthoritative guidance, be thoughtful about consulting reputable sources . Avoid unknown websites, and avoid textbooks which could be outdated.

For plain-English summaries of IFRS guidance, researchers can consult

• Pocket Guides to IFRS , published by the major accounting firms , which summarize IFRS requirements by standard (e.g. , PwC's IFRS Pocket Guide or Deloitte's IFRSs in your pocket) .

For in-depth analysis of IFRS requirements, researchers can consult

• IFRS accounting manuals, available for purchase from major accounting firms or available through subscriptions to firm research databases. For example, PwC's Manual of account- ing-IFRS offers in-depth guidance on IFRS.

• IFRS guide books by topic. For example, you can search Google for "IFRS 15 Guide" to be directed to firm guidance on the revised IFRS revenue standard.

For "model " IFRS financial statements, researchers can consult, for example,

• BOO Global's website, which annually publishes model IFRS financial statements.

• The EY "Core Tools Library," accessible online, which offers industry-specific illustrative IFRS financial statements (e.g. , Oil & Gas, Real Estate).

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Several firms offer IFRS training modules by topic, including

• The IFRS Foundation's training modules explaining and illustrating the application of IFRS forSMEs.

• Firm-produced IFRS learning modules by topic (Web search: "IFRS e-learning" or "learn- ing modules") .

The above-named resources are generally accessible via Web search, and most are free of charge. Consider now the following TIP from the Trenches.

381

Asked what nonauthoritative resources she would recommend to beginning researchers, a former IASB project manager was quick to name the following, which she herself frequently consults: (1) Deloitte's "IAS Plus" website; (2) accounting firm IFRS vs. U.S. GAAP compari- son guides; and (3) the IASB's own educational resources.

[ TIP from the Trenches

Sustainability Reporting As a result of a 2014 EU directive, large public-interest entities in the EU will begin reporting diversity and other nonfinancial information, including environmental, social, and personnel matters, in 2018. In complying with these required sustainability disclosures, companies will be encouraged to rely upon frameworks such as the Global Reporting Initiative (GRI)'s and guidance of the International Integrated Reporting Council (IIRC), among others.

APPENDIX 12A: INTERNATIONAL AUDITING STANDARDS

When Do International Auditing Standards Apply? LOS Become famil-iar with the As a private standard-setting organization, the IASB lacks the authority to enforce (i.e., ensure that entities are properly applying) its accounting standards. Rather, enforcement is generally left up to national laws, securities regulators, and the audit process. This section of the text focuses on international auditing standards, focusing in particular on their relevance to U.S. accounting professionals.

standards and standard set- ters applicable to international auditing .

Globally, external audits are frequently required for entities with public accountability, as well as for certain statutory financial statements. Governments and securities regulators in indi- vidual countries or regions determine the applicable auditing standards for their jurisdictions. Often, these auditing standards are based on the International Standards on Auditing (ISAs) issued by the International Auditing and Assurance Standards Board.

In the United States, recall that two organizations are primarily responsible for establishing auditing standards: the PCAOB for public company audits and the AICPA for nonpublic com- pany audits . Notably, the PCAOB 's auditing standards also apply to foreign private issuers, as these entities are still considered issuers of securities in the United States-no exception was made under Sarbanes-Oxley for "foreign" issuers.39 Also notable , the AICPA's auditing stan- dards would apply to any U.S. nonpublic companies that choose to prepare financial statements in accordance with IFRS.

As U.S. accounting firms increasingly perform multinational audits, U.S. auditors are expected to become familiar with international auditing and ethics standards. For example,

• When auditing a U.S. subsidiary of a foreign parent, a U.S. auditor may be expected by the parent company to perform the audit in accordance with international standards.

• The "reverse" is also true-when auditing a U.S. parent with a foreign subsidiary, the audit of the foreign subsidiary may be required by statutory laws to comply with international auditing standards.

39 Sarbanes-Oxley Act of 2002, Sections 10 I (c)(2) and I 03(a)(I ).

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Figure 12-19

Sample audit scenarios

and applicable source of standards

Figure 12·20

The IFAC and its standard-setting boards

The graphic in Figure 12-19 summarizes several scenarios for U.S. auditors, and the appli- cable auditing standards.

) Use ISAs for statutory reporting•

•ro the extent the audit is performed by U.S. auditors, the auditors must also adhere to U.S. auditing and ethical standards.

In circumstances where U.S. auditors must comply with international auditing standards, the U.S. auditor is expected to also comply with U.S. auditing and ethical standards.40

Next, let's look at the organizations responsible for establishing global auditing and ethics standards.

The International Federation of Accountants (IFAC) and Its Standards Boards Through its four independent standard-setting boards, the International Federation of Accountants (IFAC) establishes international standards on ethics, auditing and assurance, accounting education, and governmental (public sector) accounting. The IFAC 's mission is, in part, to serve the public interest by "contribut[ing] to the development, adoption, and implemen- tation of high-quality international auditing and assurance standards ... "41

The IFAC and its standard-setting boards are illustrated in Figure 12-20. Like the use of IFRS, standards of the IFAC's various boards are progressively gaining worldwide acceptance; IFAC members represent approximately 130 countries and jurisdictions globally.42

International Federation of Accountants (IFAC)

International Public Sector Accounting Standards Board

(IPSASB)

International Ethics Standards Board for Accountants (IESBA)

International Auditing and Assurance Standards Board

(IAASB)

International Accounting Education Standards Board (IAESB)

40 Consider, in particular, AU -C 700, Forming an Opinion and Reporting on Financial Statements , and AU -C 910, Financial Statements Prepared in Accordance with a Financial Reporting Framework Generally Accepted in Another Country.

41 International Auditing and Assurance Standards Board (IAASB), Handbook of International Quality Control, Auditing Review, Other Assurance, and Related Services Pronouncements, 2016-17 Edition . Page 5.

42 IFAC.org, "Membership." "IFAC is compri sed of over 175 members and associates in over 130 countries and jurisdi ction s* , representing almost 3 million accountants in public practice, education , government service, industry, and commerce." *As of November 2016 . Accessed November 201 8.

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Take a moment to improve your familiarity with the IFAC's standard-setting bodies by completing the following simple Now YOU Try exercise.

Matching Guidance to Standard Setters

The standard setters illustrated in Figure 12-20 issue guidance that is organized into the following handbooks. Match each handbook to the standard setter that issues it.

Handbook of International Quality Control, Auditing, Review, Other Assurance, and Related Services Pronouncements: ____________________ _

Handbook of International Education Pronouncements:

Handbook of the International Code of Ethics for Professional Accountants:

Handbook of International Public Sector Accounting Pronouncements:

The IFAC 's "member bodies ," comprised of global professional accountancy organiza- tions, agree as a condition of membership to adopt or substantially converge with certain of the IFAC's standards, including International Standards on Auditing (ISAs) and the international Code of Ethics. 43 To the extent differences exist between these and national ethics standards, member bodies agree to promote standards that are not less stringent than those of IFAC. The AICPA is a member body of the IFAC and thus has agreed to these requirements. As another example, the Financial Reporting Council (of the U.K. and Ireland) uses IS As as the basis for its own auditing standards.

Following is further discussion regarding each of these standards boards.

International Auditing and Assurance Standards Board (IAASB) The International Auditing and Assurance Standards Board (IAASB) establishes standards for a range of services, applicable to entities of all sizes, including small and medium-sized entities. The IAASB 's "Handbook" includes the following standards:

• International Standards on Auditing (ISAs) for audits

• ISREs for review engagements

• ISAEs for assurance engagements

• ISQCs for quality control

• ISRS for "related services" (e.g., agreed-upon procedures, compilations)

The IAASB Handbook can be downloaded from www.ifac.org. Researchers can search for guidance within the handbook by perusing the table of contents or by performing keyword searches (using ctr] + f).

While not included within the IAASB Handbook, accountants should also consider the IESBA Code of Ethics, which applies broadly to all professional accountants, regardless of the service being provided. For audit and assurance engagements, accountants should also consider the IAASB's "International Framework for Assurance Engagements" (the "Framework"), which describes the objectives of assurance engagements and identifies engagements to which the IAASB's auditing and assurance standards apply. While the Framework by itself is not authorita- tive, accountants are expected to read standards-level guidance for audit and assurance engage- ments in the context of the Framework.

International Standards on Auditing {ISAs) For auditors just starting out with international auditing standards, a good starting point is ISA 200 (Objectives of the Independent Auditor, Conduct of an Audit in Accordance with ISAs). ISA 200 sets forth guidance on the proper use and application of ISAs in an audit, for example:

43 Per IFAC Statements of Membership Obligations (20 12), Ch. 3 par. I 2(a) and Ch. 4 par. I 2(a).

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• An auditor should consider all parts of an ISA in order to properly apply it. This includes con- sideration of the standard's Objectives section, as well as the Requirements and Application and Explanatory Material sections. If necessary to achieve a standard's Objectives, auditors may need to perform procedures beyond those required within a given standard.

• Requirements within ISAs are described using the word shall.

• Similar to the notion of the IFRS "compliance statement," accountants cannot represent com- pliance with ISAs in their audit reports unless they comply fully with all ISA requirements. Therefore, to the extent jurisdictional variations exist of ISAs, entities may not be able to represent compliance with ISAs unless they still comply fully with ISA standards.44

One notable difference between U.S. and international auditing standards is that ISA stan- dards do not require auditors to report on the effectiveness of internal controls. However, thi s requirement may be imposed on a jurisdiction-specific basis (e.g., individual countries may require such reporting). 45

Reporting of Key Audit Matters and Partner Name The IAASB recently made significant changes to the audit report, requiring (among other changes) that the engagement partner be named on the audit report and requiring discussion of key audit matters (KAMs). These changes apply to audits of listed entities conducted under ISAs.

as: The requirement to report on KAMs is set forth in ISA 701. Par. 8 ofISA 701 defines KAMs

Key audit matters-Those matters that, in the auditor 's professional judgment, were of most significance in the audit of the financial statements of the current period. Key audit matters are selected from matters communicated with those charged with governance.

In identifying KAMs to report on, auditors would consider matters discussed with the audit committee (or others charged with governance) that required significant auditor attention. Within the report, auditors are required to: (1) describe each KAM, (2) explain why it was considered to be of significance to the audit, and (3) desc1ibe how the matter was addressed in the audit.

International Ethics Standards Board for Accountants The International Ethics Standards Board for Accountants (IESBA) issues and maintains a model Code of Ethics for Professional Accountants to be followed by-or to serve as a minimum standard for jurisdiction-specific ethics codes for-professional accountants throughout the world. As noted previously, this Code of Ethics applies broadly : professional accountants must comply with the Code of Ethics in all circumstances, regardless of the functional role, or type of engage- ment, being performed by the accountant.

U.S. accountants are generally expected to abide by the IESBA's Code of Ethics when per- forming an audit in accordance with ISA auditing standards .

The Code of Ethics is organized in a manner similar to the AICPA's revised Code, including, for example, parts for members in business and parts for members in public practice.

Other IFAC Standards Boards The IFAC 's International Public Sector Accounting Standards Board (IPSASB) establishes mini- mum standards (International Public Sector Accounting Standards, or IPSAS) for governments and other public sector entities and strives to promote the use, globally, of an accrual-based approach for the preparation of government financial statements. IPSAS are formulated using IFRS as a start- ing point, then are revised as necessary to address issues unique to public sector accounting. 46

44 ISA 200, Ove rall Objecti ves of the Independent Auditor and th e Conduct of an Audit in Accordance with International Standards on.Auditing. Par. 18-20, A58 , A60.

45 ISA 200, Par. A I (Scope of the Audit)

46 Internati onal Public Sector Accounting Standards Board, Handb ook of International Public Sector Accounting Pronouncements , 2018 , page I.

The IFAC 's International Accounting Education Standards Board (IAESB) develops educational standards applicable to member bodies' accountants. For example, the IAESB has established a guideline educational syllabus, outlining educational standards to be achieved by its members. IFAC member bodies are required to consider these educational standards while formulating their own educational programs for accountants.

Comparing International Audit Reports Let's now review excerpts from audit reports illustrating the use of different accounting and auditing frameworks. For this, we'll return to our example of HSBC.

Figure 12-21 depicts the relationship among the London-based holding company HSBC Holdings pie and a few of its subsidiaries. The illustration also notes which of these entities issue public securities.

Comparing International Audit Reports

Using the information in Figure 12-21 and the following audit report excerpts, respond to the

questions that follow. The excerpts below are taken from filings with the U.S. SEC and filings in

the U.K.

I. Report of Independent Registered Public Accounting Firm ... In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America ....

We conducted our audits of these consolidated financial statements in accordance with the standards of the PCAOB. [From annual report Form 10-K filed with U.S. SEC]

Questions:

1. In audit report excerpt I, which financial reporting (accounting) framework are the auditors

opining on?

2. What audit standards did the auditors follow, in conducting the audit? ______ _

3. Which entity (or possible entities) do you think this opinion relates to? Explain. ___ _

Continued

Figure 12-21

Partial depiction of HSBC Holdings Pie's organizational structure. This illustration is not a complete depiction of HSBC's subsidiary relationships; not all intermediate subsidiaries and holding companies have been reflected in this illustration.

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Continued from previous page

II. Report of the Independent Auditors to the Members of [Company]

Opinion

In our opinion [the Group's] financial statements and parent company financial statements:

• give a true and fair view of the state of the Group's and parent company's affairs at 31 December 2017 and of the Group's and parent company's profit and cash flows for the year then ended;

• have been properly prepared in accordance with IFRSs as adopted by the European Union; and

• have been prepared in accordance with the requirements of the Companies Act 2006, and as regards the Group financial statements, Article 4 of the IAS Regulation.

Basis of these opinions

In expressing these opinions, I believe that the audit evidence I have obtained is sufficient and appropriate. My work has been undertaken , and my opinions expressed, in accordance with applicable law and the International Standards on Auditing (U K) as issued by the Financial Reporting Council (FRC) of the United Kingdom. My responsibilities and those of the Directors are explained later in this report.

[From annual report filed in UK]

4. In excerpt II , which financial reporting (accounting) frameworks are the auditors opining on?

5. What audit standards did the auditors follow, in conducting the audit?

6. Which entity do you think this opinion relates to? Explain. ___________ _

III. Report of Independent Registered Public Accounting Firm to the Board of Directors and Shareholders of [Company]

Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of 31 December 2017 and 31 December 2016, and the results of their operations and their cash flow s for each of the three years in the period ended 31 December 2017 in conformity with International Financial Reporting Standards as iss ued by the International Accounting Standards Board and in conformity with International Financial Reporting Standards as adopted by the European Union. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of 31 December 2017, based on criteria established in Internal Control-Integrated Framework (2013) issued by the COSO .. . .

Basis for Opinion

... We conducted our audits in accordance with the standards of the PCAOB. [Form 20-F Annual Report, filed with the U.S. SEC]

7. Recall from earlier in the chapter-when does report Form 20-F apply? ______ _

8. In excerpt Ill, what two financial reporting (accounting) frameworks are the auditors opining on? and ___________ _

Continued

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Continued from previous page

9. What audit standards did the auditors follow, in conducting the audit? _______ _

10. Which entity do you think this opinion relates to? Explain. ___________ _

·company names have been replaced by bracketed text ("[Company]") for purposes of this exercise.

" References for these excerpts are located immediately following the case studies at the end of this chapter.

CHAPTER SUMMARY The IFRS Foundation, through its standard-setting bodies the IASB and the IFRS Interpretations Committee, is considered the predominant global accounting standard setter. Full TFRS is required for many publicly accountable entities internationally, and IF RS for SM Es guidance is required or permitted for many entities without public accountability. The increased (although not total) use of a single set of global standards has streamlined what were once diverse reporting requirements for multinational entities. The guidance comprising full TFRS is organized into bound editions , and guidance within these bound editions should be prioritized using the IAS 8 hierarchy.

International auditing, ethics, and public-sector standards are also increasingly being converged with standards of the IFAC and its four standard-setting bodies. As we've discussed in this chapter, several circumstances exist in which U.S . accountants may be called upon to apply these international standards. The global context, as well as the research skills, you ' ve acquired from this chapter, should help prepare you for the challenges ahead.

REVIEW QUESTIONS

1. Describe the global standard-setting environment prior to 2001, and describe what the role of the IASC was in the years prior to 200 I.

2. What occurred in 2000 that began the shift toward use of the IASC's guidance? Explain.

3. Describe the relationship between the IASC and the IASB.

4. What is meant by the te1ms jurisdictional IFRS and carve-outs?

5. Who establishes the requirement that listed companies issue audited financial statements? Who establishes this requirement for nonlisted companies?

6. Briefly explain why a large multinational corporation, such as HSBC, might be supportive of increasing the global use of IFRS .

7. Describe the relationship between the TFRS Foundation and the IASB.

8. What is the role of the IFRS Foundation's Monitoring Board? Its Trustees?

9. Does the IASB have the authority to impose funding requirements on its member countries? Contrast the TASB 's funding regime with the FASB's funding mechanism.

10. In what circumstances does the TFRS Interpretations Committee handle an issue, and what is the name of the guidance they is sue?

11. Are U.S. public companies allowed to issue financial statements in accordance with IFRS? What about U.S. nonpublic companies? Explain.

12. Which U.S. organization has the authority to determine whether IFRS is permitted in the U.S.?

13. In your own words, how is a "foreign private issuer" defined ? What is the significance of this designation ?

14. Identify the sources of guidance comprising full TFRS .

15. Explain the difference between integral and not integral guidance. What does it mean for a standard to be read in the context of other guidance?

16. Name two differences between the content of full TFRS and the guidance in IFRS for SM Es.

17. Why was the IFRSforSMEs created?

18. Are public (listed) companies permitted to apply TFRS for SMEs? Explain .

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19. Differentiate between the Red and Blue Books.

20. Describe the purpose and authority of the IASB's Conceptual Framework.

21. When should a researcher tum to the IAS 8 hierarchy? In other words, what is a situation in which that hierarchy might be relevant?

22. Once you have located relevant IFRS or IAS guidance, what interpretive guidance should you also look for?

23. Where can a researcher find guidance regarding which countries around the world apply IFRS? Name two sow-ces.

24. (From Appendix) What is one implication of the U.S. AICPA being a member body of the IFAC?

25. (From Appendix) Name the four standard-setting bodies of the IFAC.

EXERCISES

Exercises requiring basic (free) access to ifrs.org. (Become a registered user for free to access individual standards.)

These questions involve IFRS, as well as firm resources. Cite the source for each of your responses.

1. Has South Africa adopted IFRS? Describe your process for locating this information .

2. Locate an IFRS/U.S. GAAP comparison guide. Name one difference between the U.S. GAAP and IFRS require- ments related to contingent liabilities.

3. Locate IAS 7, and identify the guidance considered integral to this standard. Explain how you located this information.

4. Locate the most recent Form 20-F of Toyota Motor Corporation. a. First, determine whether the financial statements were prepared in accordance with IFRS or another report-

ing framework, and describe where you located this basis of preparation information. b. Considering what you learned in this chapter, why might Toyota be permitted to prepare financial state-

ments for the U.S. SEC in accordance with a repotting framework other than GAAP? c. Finally, identify Toyota's auditor and describe the auditing standards applied by the company's auditors.

5. Assume that an entity complied with IFRS guidance in all respects, except that the entity has never included an IFRS compliance statement in its financial statement footnote disclosures . Is the entity subject to the guidance for first-time adopters of IFRS? Use authoritative guidance to respond.

6. Locate the IFRIC related to service concession atTangements, then respond to the following. a. What is a service concession arrangement? b. Should the operator in a service concession arrangement recognize infrastructure within the scope of this

guidance on its statement of financial position?

7. Navigate to Deloitte's iasplus.com website. Look under Standards, then IFRS 8. What is one section on this page you might find useful if researching this standard for the first time?

8. Can a subsidiary-whose parent uses full IFRS-use IFRS for SMEs if the subsidiary itself is not publicly accountable?

9. How frequently must an entity present a complete set of financial statements when reporting under IFRS for SM Es?

10. Correct the following source citation, improving it in any way appropriate. IASB standard 3 tells us that "An entity shall account for each business combination by applying the acquisition method."

11. (Relates to Appendix topics) Connor & Jones, LLC is in the planning phase for its initial audit of Savvy Sisters, Inc. It will petform this audit under ISAs. Is Connor & Jones, LLC required to contact Savvy Sisters predecessor auditor as patt of its engagement planning?

12. (Relates to Appendix topics) Within the handbook of international ethics standards, what are two examples of safeguards (against threats such as client involvement in illegal activities) that an auditor should consider apply- ing during its client acceptance (or "professional appointment") procedures?

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Exercises Requiring Access to eIFRS Note: You may have to log out of your ''free" e!FRS Basic access in order to use your more advanced IAAER- sponsored e!FRS access.

13. What are the three criteria for recognition of a provision?

14. Refer to the Blue Book's introductory material. What are two objectives of the IASB? Can this same information be found in the introductory material to the Red Book as well?

15. Locate discussion of how the IASB considered differences between the terms exit price and an exchange amount in establishing principles for fair value measurement. Are these concepts considered to be similar? Consider discussion in the IASB's basis for conclusions.

16. How should exploration and evaluation assets be measured? What are these?

17. How should cash repayments of amounts borrowed be classified in the statement of cash flows?

18. What are the two recognition criteria for an Investment Property ?

CASE STUDY QUESTIONS

Presto's Subsidiaries Presto Hospitality is based in the United States and has subsidiaries in Brazil and Australia. 12.1 As a nonpublic company with a calendar year-end, Presto is required to comply with ASC 842 for its consolidated financial statements starting with the year ending 12/31 /20 .

1. Research the reporting framework applicable to the Brazil- and Australia-based subsidiaries. Assume they fol- low the same reporting framework that listed (or public) companies in their jurisdictions would apply.

2. What is the effective date for these subsidiaries to apply revised lease accounting requirements ? What standard must each apply?

3. What are key areas of reconciliation that will be required to consolidate the Brazilian and Australian financial statements into the U.S. consolidated report?

Remediation Required A Brazilian listed entity, Company B, violated environmental regulations by seeping haz- 12.2 ardous chemicals from its production plant into a nearby pond . As of 12/31/Xl , government regulators are aware of the pollution and plan to take action against the company. Company B anticipates that this action will include fines, plus a requirement to remediate the pollution. What disclosure or accruals are required by Company B? How would this accounting differ if Company B were subject to U.S. GAAP?

Boom Town Presto 's Brazilian Subsidiary, Brazi!Co, owns a corporate office in a desirable location in downtown 12.3 Brasilia. The property was purchased on 1/l/20Xl for the equivalent of $10 million USD and is being depreciated straight-line over a 30-year life. An appraisal on 12/31/X4 indicated that the building is now worth $14 million . Brazi!Co is asking whether it can remeasure the property to show this increased value on its statement of financial position and, if so, what the offsetting (credit) entry should be. Brazi!Co is also asking whether this remeasurement would have any effect on its existing policy to depreciate the building straight-Line over 30 years. Finally, Presto is wondering whether this increased value is appropriate to carry into its U.S. consolidated financial statements.

IFRS for SMEs Assume that BrazilCo's Controller (from the previous case study) has asked whether revaluation 12.4 of the building is appropriate assuming BrazilCo had applied IFRS for SM Es (assuming the company was permitted to apply this guidance). Draft a brief email to the company's Controller explaining the different accounting, and cite your source.

BraziICo's Restaurant Lease On 1/1/Xl, Presto's Brazilian subsidiary, BrazilCo, leases a vacant restaurant in 12.5 Brasilia for a 5-year term with fixed payments amounting to the equivalent of $100,000 USD per year in year 1, $150,000 in years 2 and 3, and $200,000 in years 4 and 5. Brazi!Co's incremental borrowing rate is 6%. Assume the restaurant's useful life is 20 years .

a. Describe the classification of this lease on BrazilCo's subsidiary-level financial statements. b. Show how this lease would be initially reported on the balance sheet, and show how the lease would flow

through the income statement on 12/31/Xl and 12/3 l/X2 in BrazilCo's subsidiary-level financial statements. c. Next, identify differences in this reporting compared to U.S. GAAP, as Presto will need to reconcile this report-

ing to GAAP for its consolidated financial statements.

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12.6 IFRS for SMEs Dissenting Opinion Within the Basis for Conclusions to the IFRS for SM Es (available in the 2015 revision, but the dissent was originally issued in 2009) a Board member challenged the choice of steps in the IFRS for SM Es judgment hierarchy. Recall that this judgment hierarchy is illustrated in Figure 12-16 of this chapter. Locate this Board member's dissenting opinion, and describe the concerns he raised regarding the judgment hierarchy. Addi- tionally, describe one other concern he raised with respect to issuance of the IFRS for SM Es publication.

12.7 Navigating the IFRS Bound Editions Using the most recent Blue Book, summarize (in 1 paragraph per bullet) the information presented in the following sections of the Blue Book:

• Introduction to this edition

• Changes in this edition

• Preface to IFRS

• The Conceptual Framework (summarize the chapters included and any current developments noted in the Foreword)

12.8 (Relates to Appendix) Carillion Liquidation In early 2018, one of the UK's largest companies, Carillion, announced its insolvency and began the process of liquidating and shutting down the company. This news sent shockwaves through the UK and had many pointing fingers at Caiillion 's auditors, KPMG. Research and summa- rize: 1) Key reasons for Carillion 's failure; 2) Steps the auditors could have taken-and auditing standards the audi- tors should have followed more closely-to prevent the audit failures that occurred . Finally: 3) Comment on what changes are being proposed in the UK audit market in response to these events.

ADDITIONAL REFERENCES

Now YOU Try 12.22 ** Excerpt No. I: HSBC USA Inc, 2017 Form 10-K. Page 121; Excerpt No. 2: HSBC Holdings Pie, 2017 Annual Report. Page 166. Excerpt No. 3: HSBC Holdings Pie, 2017 Form 20-F, Page 210.

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Delivering Effective Presentations

Jess is a senior in the accounting advisory practice of a firm. The partner she reports to has

asked her to prepare a presentation introducing the revised lease accounting standard to

clients of their practice. The presentation will be offered as a "lunch and learn" for several

key clients. The objectives of the presentation will be to generate goodwill (the team plans

to give the presentation at no charge) , to help their clients understand the new standard and

begin formulating an implementation strategy, and-of course-to offer her team's assis-

tance and resources for helping make the client's adoption a success.

Jess has been asked to pull from existing firm resources as a starting point for her

slides , but to consider the specific types of transactions , and industries, of the team 's clients.

Eventually, Jess will submit her preliminary draft of the slides to the partner, who will

review and suggest changes. Come presentation day, Jess will assume a prominent role in

presenting to the client.

Now, imagine for a moment that you are Jess. Would you be ready to take this project

on? How confident are you that your slide deck would be effective, and that you would be

engaging as a presenter? Read on; this chapter should help.

After reading this chapter and performing the exercises herein, you will be able to

1. Understand circumstances in which you will use presentation skills in practice.

2. Create effective content.

3. Know what it takes to deliver a high-quality presentation.

4. Work effectively in a team to create and deliver presentations.

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Creating and Delivering Effective Presentations

1. When might I use presentation skills in practice?

2. How do I create effective content?

3. How do I deliver a high-quality presentation?

4. How can I best work with a group to create and deliver presentations?

Organization of This Chapter So far in this book, you 've learned to communicate accounting issues in written form. But

it's important that you also be prepared to verbally describe and defend your research.

This chapter covers expectations and strategies for creating and delivering effective oral

presentations . These skills can be applied to accounting research presentations , as well as

broadly to other professional presentations you make. The preceding graphic illustrates the

organization of content within this chapter.

Knowing that you have a presentation to prepare , this chapter is kept intentionally

brief. It offers broad strategies for preparing and delivering content, with an emphasis on

PowerPoint, but that can be applied to a range of presentation formats and visual aids.

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WHEN WILL I USE PRESENTATION SKILLS IN PRACTICE, AND WHAT IS THE FORMAT?

Lo 1 Understand circumstances in which you will use presentation skills in practice.

In practice, you could be asked to make presentations to your peers, to colleagues in other departments, to your company's management, or to clients. The objectives of these presentations can vary; the goal may be one or more of the following:

• To convey, or teach information (such as explaining the requirements of a new accounting standard)

• To share a judgment you've made (such as by corporate accountants, in the process of preparing financial statements; or by auditors, describing their positions on key judgments taken by clients)

• To convince the audience of your point of view (for example, the need to invest in updated accounting system s infrastructure, or the need to improve a company's existing controls)

• To sell service s to an existing or potential client To illustrate the role of presentations in practice, assume for a moment that the FASB has

just issued a new accounting standard that has wide-ranging impacts on a corporation with multiple busine ss units. Accountants may make the following presentations related to the new standard, just to name a few:

Auditors

Prior to issuance of the standard, the company's auditors might offer a training course to corporate and business unit accountants , explaining the expected requirements of the standard and offering the services of their advisory practice .

In addition,

Corporate q 1 ______

1 o

[lJ;,& 1ltafrl1 OpCo's

The accounting policy group , which manages the project rollout, might arrange conference calls with business unit accountants to ask for their assistance: (1) identifying areas of impact and (2) assisting with implementation.

I I Next, the Controller's group might present and explain the new standard to company management, describing areas of expected impact and laying out the timeline for adoption .

• The company's accounting policy group might present (and discuss) implications of the standard with other potentially affected functions , such as: information technology, risk, strategy, operations, finance, and investor relations.

• As implementation progresses, the project manager, along with corporate accountants man- aging aspects of the implementation, might present key accounting judgments to company management, including the chief financial officer (CFO).

As you can see, presentations can be given in a range of settings and to a variety of audiences. Given this , it is very likely that you will be involved-at some point-in giving or preparing a presentation.

Presentation Formats By now, I'm sure you're used to the standard classroom format for presentations: A group of three to five students stands in the front of the class, presenting a case with the help of PowerPoint slides.

This format is used for good reason. It helps you become accustomed to standing and pre- senting in front of a group, which is one presentation format that you will likely use in practice. This format can be useful for teaching something to a group, proposing changes to existing practices, or selling a service.

Other formats that you may encounter in practice include presenting in a boardroom setting, where the discussion takes place around a table. This format might be used if you are discussing preliminary accounting judgments with management, your auditors, or your peers.

Or, the presentation could occur via phone or online conference call (like a WebEx or Skype meeting). This format is often used to communicate with team members or clients who work at different locations.

No matter the format, the key ingredients for a great presentation are relatively constant- you must have great content and a great delivery.

In what professional (or, if not, academic) circumstances have you delivered a presentation, or presented the results of your research informally? What was the format, and who was your audi- ence?

As a professional, it may feel like you're being punished when you're asked to present in front of others. However, you are actually being given an opportunity. Succeed at this pre- sentation, and you'll create a strong impression on your supervisors and peers that can open doors to future opportunities.

What Are the Qualities of a Great Presentation? Broadly speaking, a great presentation includes the following elements:

1. Content that is well-researched, useful, and presented in a logical order

2. Speakers who engage the audience, and who are well-rehearsed

3. Speakers who have thought beyond the case facts

4. When applicable, team members who challenge and support each other

For purposes of this chapter, we'll bucket these qualities into three main sections: (1) creat- ing effective content, (2) delivering a high-quality presentation, and (3) considerations for those working in groups.

One other key element, which applies to every item on this list, is preparation, preparation, preparation. The more completely you prepare for your presentation, the more successful it will likely be.

Now

YOU Try 13.1

I TIP from the Trenches

CREATING EFFECTIVE CONTENT

L02 Create effective content. Generally speaki ng, your presentation should be accompanied by materi als (v isual aids or handouts) that reinforce key points fo r your audi ence. The process for creating effec- ti ve content and fo r creating visual aids often goes hand in hand. To th at end, the follow- ing di scussion encompasses both how to pl an content as well as how to prepare effecti ve

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visual aids. We' ll foc us on PowerPoint; however, the concepts described herein can also extend to other presentation medi a.

The first step in creating effective content is to picture your audience. Are you prese nting to a cl ass of your peers, who share your base level of accounting knowledge? Or are you co m- mun icating accounting sys tems needs to your company's IT direc tor? Keep thi s image of your audience in mind as you create your co ntent; these are the people you mu st reach.

Next, work to fully understand the case facts, the questions at hand, available alterna- tives, and your position. If your prese ntati on involves an accounting issue, one of the bes t ways to gain this understanding is to fi rst prepare an accounting issues memo. The writing process alone can cause you to consider the issue more carefull y. However, if a full memo is not requi red (s uch as by your superv isor or instructor) prior to your presentation, you mi ght still create an outline of how you would document the issue in order to stimulate thi s thinking process.

You ' re now ready to start drafting your slides. Your first lesson: Don 't re-create the wheel. If you can, start wi th an existing slide deck used for a past or related presentation in your company, then work fro m there. In doing so, take note of the level of detail on the slides, how the slides are organized, and any bullet, fo nt, or numbering conventions. (More on bullets and fo nt later. )

Next, create a title slide and agenda slide for your prese ntation, which will serve as a rough draft outline for yo ur presentation, then in sert placeholders for indiv idua l slides th at fo ll ow the order of thi s outline. The following TIP emphasizes the importance of age nda slides.

Early in my career, I was counseled to never call a meeting without having an agenda. Having an agenda shows that your meeting has a valid purpose, and that the meeting is organized. In short, an agenda shows respect for your participants' time.

The same principle holds true for leading a presentation: Always share your agenda with attendees. This brief step shows respect for your colleagues, clearly prepares them for what's to come , and demonstrates to them that you 've been thoughtful in organizing the presentation .

As you develop the outline (agend a) fo r your presentation, don' t feel that you mu st stick absolutely to the research questions you were assigned. Rather, take a step back and ask yourself:

How can I organize this information so that it is most clear to my audience?

Consider fo r a moment the foll ow ing TIP regardi ng organizi ng your presentation.

A common pitfall I see with my students is organizing their entire case presentation around the set of case study questions they were given. The case study questions aren't, in all cases, the most logical order for a presentation. Perhaps your audience requires addi- tional context, or background understanding, of the case facts or accounting principles to be applied. Or perhaps the steps you took to analyze the issue offer a more logical path than the questions you were given.

Think outside the box. Organize your presentation in a way that will be most understand- able to your audience.

Once you've outlined the topics that you plan to cover (that is, you now have a title slide, agend a slide, and placeholder slides that fo llow the agenda), you can begin drafting content for

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each slide. This content could be, for example, four bulleted speaking points per slide, or alter- natively could be just a single image that you can speak about.

Next, begin writing the speaking notes that will accompany each slide, refining your draft slide content as you go.

There is some debate in practice about how much detail should be included on each slide. Inspirational talks-such as TED Talks videos-often include only a single image or phrase on each slide. Accounting research slides presented to a CFO, on the other hand, might include detailed bullets and key excerpts from the applicable guidance.

Ultimately, the amount of information you include on each slide will likely be driven by your organization (company or accounting firm), and by the setting in which you will deliver the presen- tation. So it's critical that your first step in laying out your slides is to look for examples of other presentations given by peers or leadership in your organization. More on slide detail in a moment.

If you do include images (pictures) in your presentation, use high-quality images (e.g., jpg file types), rather than hokey cartoon clip art. Check out istockphoto.com for ideas. Don't include images if doing so is inconsistent with your firm's style.

1. Recap the step-by-step process described for drafting slides and speaking notes, starting with the first lesson: Don 't re-create the wheel.

2. Now think: Have you ever been in the audience when a presenter is talking, but you're having trouble deciding whether to listen or whether to read what is on the presenter's slides? As an audience member, you might have bounced between listening and reading, concerned that you could miss out on important information. What suggestions would you make to the presenter in this scenario?

Find Ways to Make the Information Resonate As you create content and speaking notes for your slides, be creative in finding ways to make the information resonate with your audience. Ask yourself:

• Can I draw a transaction structure picture (see Chapter 4), or a timeline, to enhance the facts/background information that I present in my slides?

• If numbers are being presented, can I include a graph or other visual depiction of the numbers?

• When presenting my accounting analysis, would key excerpts from the guidance help my audience have a clearer understanding of the issues?

• Can I share a personal anecdote that will help my audience connect with this information?

• Can I involve my audience by asking them a question during the presentation?

• Can I bring in an example from practice that illustrates the concepts related to my case?

One of the preceding bullets suggests working in a personal anecdote when possible. Audi- ences engage with the speaker more, and get emotionally invested, when listening to a story. Ask yourself: Can I tell a personal story that relates to this topic, and that will help deliver my message?

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Figure 13·1

Sample level of detail appropriate when slides are distributed and discussed in a small- group setting

Tell only true stories that come from your own experience or from reliable sources (such as a trusted news source). Don't tell a story that could jeopardize your credibility with your audience!

Another aspect of making content resonate is that it should be tailored to your audience . Don't present the broad, boilerplate requirements of a new accounting standard to a client whose adoption of the guidance is already well under way. Rather, perhaps a presentation on "common implementation issues our national office has consulted on" wou ld be more meaningful.

Finally, if you are presenting to a classroom of your peers, a key goal of your presentation shou ld always be to teach your peers. Act as though your peers will be tested on the information you are presenting, and make the concepts as understandable as you can. According to one field test, students' test results improved once their peers focused on teaching as a key goal of their presentations. 1 With this goal in mind, you should take creative li cense to present in a way that reaches your peers.

1. In what circumstances would you imagine that a picture or timeline could assist in presenting the facts or background of a transaction?

2. Where (or how) might you look for examples from practice that illustrate the concepts involved in your case?

How Much Detail Should I Include in My Slides?

The amount of detail you include in your slides will be driven primarily by the size of your audi- ence, and by your firm's existing practices.

Picture yourself sitting in an audit committee meeting, around a table. Your audience is somewhere between 6 and 25 people. Each person at the table has a copy of the slide deck, and critical accounting judgments are being discussed. The people at the table need enough detail that they can choose to agree or disagree with the accounting judgments at hand.

In this case, the level of detail depicted in the sample slide in Figure 13-1 might be appro- priate. In this slide, the presenter is sharing a key excerpt from the guidance that will help the audit committee members assess the reasonableness of the judgment regarding whether conces- sion licenses involve identified assets. The presenter has highlighted in bold the words from the excerpt that he believes are most critical to the analysis.

Are Concession Facilities "Identified Assets"? > > > Portions of Assets 15-16 A capacity portion of an asset is an identified asset if it is physically distinct

(for example, a floor of a building or a segment of a pipeline that connects a single customer to the larger pipe line). A capacity or other portion of an asset that is not physica lly distinct (for example, a capacity portion of a fiber optic cable) is not an identified asset, unless it represents substantially all of the capacity of the asset and thereby provides the customer with the right to obtain substantially all of the economic benefits from use of the asset. [Emphasis added]

Our Analysis : Fi xed-location concession stands are identified assets; however, portable carts and the rights for vendors to hawk are not.

Source:ASC 606-1 0

I Alford, Di Mattia, Hill , & Steven s.2011. A Series of Revenue Recognition Re search Cases Using the Codification. Issues in Accounting Education 26 (3): 618.

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On the other hand , im agin e that you are presentin g a case to your peers, who do not have a copy of your slide deck. There are 40 students in your class. In thi s case, your slides will need to include less detail , because your peers will otherw ise struggle to read along on your slides whil e you speak. These students need to learn from your presentation, but they will not be held accountabl e fo r the reasonabl eness of your judgments. Here, you need to foc us more on teach- ing concepts, and less on reading excerpts. Too mu ch detail in this settin g will detract from yo ur prese ntati on.

In thi s case, the slide shown in Fi gure 13-2 would be appropriate.

Identified Assets

./ Fixed concession stands

./ Standalone bars and restaurants

X Portable carts

X Right to hawk throughout stadium

Considerin g these examples, take a shot at the followin g Now YOU Try .

Take a look at the two preceding figures . In your own words, explain why you think a difference in the level of detail is warranted for these slides.

To the ex tent that you do incorporate guidance excerpts in your presentation, remember the fo llowing tips:

• Only include Codificati on excerpts to the extent they will add value to the audience's under- standing of the accoun ting analysis you performed.

• Be highl y selecti ve in choosi ng onl y the most relevant guidance, and limit the amount of text included in excerpts. (Consi der using ellipses . .. to cut out less relevant parts of a paragraph .)

• Bold key passages to help your audience understand your areas of focus in reviewing the guidance. Remember to add "[Emphas is Added]" to the end of any paragraphs where you add bold emphasis.

All of thi s bein g sa id, never put so much in for mati on on the slides that your role as a pre- se nter is moot. No one in the audience wants to hear yo u read fro m a slide word for word!

If the slides you've prepared are so detailed that your audience will be tempted to read while you speak, take this as a sign that you should distribute your slide deck to audience mem- bers in advance of the meeting. This allows your audience to come to the meeting prepared to listen and offer constructive feedback on or questions about your presentation.

Let's look next at a few style points related to your slides.

Figure 13-2

Sample slide that could

be shown to a larger

audience

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Figure 13·3

Sample serif and sans serif fonts

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Does Font Choice Matter?

The font chosen for your presentation should more or less be consistent across all slides. That said, there are different schools of thought on which font to choose; some argue that slide decks should use only sans serif fonts, which have cleaner breaks between letters and thus are more visible to audience members in the back of the room.

Figure 13-3 depicts a serif font, Times New Roman (at left). Notice the small lines ("serifs") extending off of each letter. Arial (at right) is a sans serif font, which lacks these small connec- tor lines.

Sample Serif font Sam pie Sans Serif font

AaBbCc AaBbCc On the other hand , visiting Big Four professionals often come in and present to our students

using standard firm templates that feature serif fonts! The bottom line is to follow the conven- tions expected for your classroom or firm.

It is, however, important to consider font size. If your slides will be shown on a projector, aim for a font size large enough that people in the back of the room can read the slide.

Use Consistent Bullet Style Bullet style should be consistent from slide to slide. Have a rule that you follow across slides, for example:

• Level l bullets are black circles. Text at this level is generally 26 pt.

O Level 2 bullets are open circles. Text at this level is generally 22 pt.

- Level 3 bullets are dashes. Text at this level is generally 18 pt.

The above is not a strict rule. The point here is that you should utilize a uniform style across slides within your presentation. If you've started with an existing slide deck from your firm, stay consistent with the firm's style for presenting bullets.

Additionally, the sentence structure used within bullets should be consistent, as illustrated in the following Now YOU Try.

Explain what's wrong with the following set of bullets. Jack is happy because

O His new car is more fuel efficient than his last car, O The Red Sox won the World Series, and O Ice cream sundaes.

This example is a bit goofy, but I think you get the point.

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Edit Your Presentation Finally, before delivering your presentation (or sending it oft), print and re-read your slides. Check for:

• Spelling and grammar (verbs should flow with nouns)

• Punctuation-consistent within each list; in other words, all bullets should either have peri- ods at the end or not.

• Consistent bullet style within and across slides (e.g., dot, dash , open circle), and consistent sentence structure for same-level bullets

• Consistent font used for all slides

• Type size-consistent (within each slide) for bullets of the same level

Typos are unprofessional. Don ' t undermine all of your effort and preparation by having noticeable errors or inconsistencies in your slides.

Now that your slides and content are all set, let's talk about how to deliver a great presentation.

DELIVERING A HIGH-QUALITY PRESENTATION

Let's assume that a high-quality presentation is characterized by being accurate, infor- mative, and engaging. The previous section of this chapter discussed how to create engaging content. Now, let's discuss how you can be an engaging speaker.

Lo3 Knowwhatit takes to deliver a high-quality presentation.

First and foremost, it's important as a presenter that you care about the topic you are presenting. Passionate speakers are more likely to engage the audience than speakers who lack enthusiasm about their topic.

But what if the information you are presenting is not interesting ? Chances are, if you think the content is boring, your audience will agree. Find ways to bring the topic alive. Think and think about ways to make the topic resonate-is it through telling related stories? Through visual aids? Through questions to your audience? Your job as the speaker is to make this content mean- ingful for your audience, so think carefully about how to make this happen. If needed, go back and revise your slides to incorporate content that will engage the audience.

Tips for Powerful Body Language Let's talk about your body language when presenting. Here are a few do 's and don ' ts , as illus- trated in Figure 13-4.

Figure 13-4

Using body language to engage the audience

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Do:

• Make eye contact with your audience.

• Speak loudly enough that people in the back row can hear you .

• Speak with inflection, changing your voice and tone to emphasize key points.

• Incorporate hand gestures, also to emphasize key points.

• Move. Periodically change where you are speaking from.

Don't:

• Read your presentation (either from note cards, or from your PowerPoint slides).

• Let the audience see that you are scared. Prepare, prepare, prepare, and then if you are still nervous, fake confidence.

• Lean on walls or the podium. (Do: Stand up tall.)

• Chew gum while presenting.

To deliver a great presentation, prepare for the presentation by practicing. Practice not only your spoken words, but also your use of eye contact, movement, and tone of voice.

Then, as you present, watch to see how the audience reacts to the information you ' re shar- ing. Look for cues from them that they are able to follow along. If the audience appears lost, this may indicate that you should slow down and take more time to explain your topic. If the audi- ence seems disinterested, try to engage them by ramping up your own enthusiasm for the topic . At a minimum, if you ' ve lost your audience , consider stepping out from behind the podium to engage them with your body language.

Want to see a speaker really engage his or her audience? Watch a TED Talks video (Google: "best TED Talks"). Notice the subtle ways these speakers connect with the audience: through voice inflection, pauses, hand gestures, and a genuine interest in the topic. Most of all, notice the level of preparation. One highly successful TED speaker (Dr. Bolte-Taylor: "My Stroke of Insight'') reportedly rehearsed her talk 200 times before delivering it.

1. Think of a presentation you've observed that has really impressed you. Describe the presen- tation, and explain what the speaker did to engage you in the topic.

2. Now, think about a presentation you've given that didn't go so well. What were some of the things you might have done differently, if you could do it over?

3. Finally, think about the best presentation you've ever given. What did you do well?

Are Note Cards Okay to Use? Yes, but don't read from them . When rehearsing your presen- tation , practice referring quickly to your notes so they are familiar to you when it's show time.

On the other side of the coin , I've had students attempt to memorize their presentations then freeze in the moment. Sometimes holding note cards gives you confidence, even if you've rehearsed enough that you don't end up using them.

What If You Have a Fear of Presenting? There's a great TED Talk that speaks to this issue, too. Look up Amy Cuddy's talk on body language. She suggests striking a power pose (think: hands on hips) for two minutes before the situation that intimidates you, arguing that this pose can improve your confidence, as well as how you are perceived by the audience.

Think beyond the Case Facts

Like it or not, as a presenter you are holding yourself out as an expert on your particular case or topic. So it's not enough to limit your research to understanding the case questions. Rather, if your issue relates to recognition, as a presenter you should be prepared to speak about measurement, disclosure, SEC reporting, and any other issues that could relate to your topic. Arm yourself with knowledge, so that you are prepared to defend or further elaborate upon your research and conclusions.

In other words, even if your case focuses on two narrow questions, as a presenter you should be prepared to speak about issues beyond those two questions. Figure 13-5 illustrates this point.

Research questions

Also, seek to understand the underlying concepts related to your issue. Take an accounting example: If your topic relates to nonmonetary excha nges, consider:

• What does commercial substance really mean? What are the implications of this concept?

• Do I understand (and am I prepared to explain) the difference between monetary and non- monetary transactions?

• Why might an investor care about the disclosures that are req uired for this topic?

• What additional examples can I share with my peers to further illustrate these concepts?

As an example of the last bullet, I once had a presenting team bring two different candies (Sn ickers and Skittles) to class to demonstrate that exchanging these candy varieties has com- mercial substance because individuals might value them differently (someone might like one candy more than the other). It was clear that the team thought outside of the box in considering what this term means.

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Figure 13-5

Be prepared to discuss issues and concepts beyond your limited- scope research questions

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Anticipate questions that might stem from the accounting concepts, or the facts, in your case. Be prepared for "what if' questions, for example:

• What if the amount of boot (cash exchanged) was changed slightly? • What if the assets exchanged were different? • What if, instead of swapping assets, one company received equity in the other company?

As you think through possible questions, consider going back to your slide deck to incor- porate basket slides that could assist in responding to anticipated Q&As. The term basket slides refers to slides at the end of your deck that anticipate possible audience questions, but that are not part of the prepared remarks that you deliver.

What Should You Wear? I know the expectations for attire can vary by presentation, by firm, and by audience. But in all cases, I'd ask you to keep in mind something that my mom always told me: When in doubt, over-dress. You generally can't go wrong, when delivering a presentation, by showing up in professional attire.

A former supervisor of mine was truly on the fast-track, moving from a corporate manager position, to director, to vice president within only a handful of years. Her work ethic certainly played a major role in this, but I'll focus on another habit for purposes of this discussion: Nearly every day, she wore professional attire to work. She wanted to project herself as a professional, no matter with whom she met that day. (Plus, working in accounting policy is a great way to have face time with management.) With this attire, she was prepared to step into the C-suite at a moment's notice.

CONSIDERATIONS FOR THOSE WORKING IN A GROUP

Lo4 Work effectively in a team to ere- Imagine for a moment that you and four other members from your advisory services practice have 30 minutes on the calendar with a potential client. You're trying to sell them on your firm's mergers and acquisitions support services, and the potential fees from this engagement could be significant.

ate and deliver presentations.

( With your group

Would you work together to develop a presentation, or each take one slide and go your separate ways? Would you each focus on your own notes only, or would you help

one another develop the strongest presentation possible? The truth is that, in practice, you have to be sure your entire team is strong before delivering

a presentation. If one member of your team is weak, it's your job as a team to help him or her improve. You can't risk turning off the client by having a member of your team be underpre- pared. Some other firm will come along and offer a more cohesive product that impresses the client more.

The most effective group presentations are ones where each group member believes that he or she is responsible for the quality of the whole presentation, not just his or her own part.

Ideally, your team will have the time and resources to follow these steps (or a variation thereof) to create a successful group presentation:

1. First, decide on an overall path/outline for the presentation, then divide the content among speakers. Discuss what each speaker should cover in his or her section now, before speaking notes are drafted. In doing so, engage in healthy debates about content; diverse opinions will make the presentation stronger. (See discussion of group think in Chapter 3; group ha1mony is your enemy!)

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2. Indi vi duall y, prepare a draft of the slides and notes that you will present.

3. Next, come together agai n as a group to review the full draft slide deck. Work to develop a consistent message, and offer constructi ve feedback to one another to improve the cohesiveness of the group produ ct.

4. With this feed back in mind , once again you' ll need to indi viduall y refin e your slides and polish yo ur planned speaking notes.

5. Come together agai n as a gro up to practice the presentation. Idea ll y, you should do thi s wi th a day or two to spare before the presentation, so that yo u can free ly suggest improve ments to each other's parts wi thout unnerving each other.

Practice tra nsitio ning to and fro m each speaker. After yo u are introduced, say "Thanks, [prev ious presenter]." When yo ur pa1t is complete, tra nsition to the next speaker: "Next, Jason wi ll describe our proposed solution."

Finall y, work together to brai nstorm poss ibl e Q&As and practice res ponding to them.

6. Once aga in at home, practice yo ur indi vidual part and pract ice responding to Q&As.

7. Deli ver a high-quality presentatio n.

On presentation day, plan to be "on" at all times while your team is presenting. Nod your head to show ag reement with key points that members of your team make . Alternate your gaze between acknowledging your fe llow speakers and connecting with the audience . Among other benefit s, staying engaged will allow you to j ump in as needed to help a team member who stumbles or needs support.

In a group presentation , it's very common for team members to develop an outline then to divvy up slides to the person who will present that section . Doing so is fine, but it's also critical for eve,y group member to review the full presentation to improve the presentation's consistency and to add value to each other's parts. Remember: You are responsible for the quality of the whole presentation, not just your own part.

What If a Member of My Group Is a Non-native English Speaker? If a member of your group speaks English as a second language, and if you think he or she could benefit fro m some coaching (on pro nunciation, word choice, or voi ce proj ection), ask if he or she is open to some fee dback. It could be a win-win .

On your own )

With your group )

On your own )

With your group )

On your own )

With your group )

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Imagine that you have just delivered a group presentation and received constructive criticism from your instructor that your group could have performed better. What specific aspect of your presentation do you think your instructor might have commented on? How could you have improved this?

(In this exercise, you 're being asked to think ahead to the potential weaknesses your group is at risk of exhibiting .)

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Don't be afraid to create healthy friction within your team. Some of the worst presentations I've observed are those where the teams got along the best. Respectfully challenge each other's ideas, content, and presentation styles , in order to create the best possible presenta- tion. Don't settle for mediocre work just because you 're in a group.

CHAPTER SUMMARY Thi s chapter described strategies for creating and delivering effective oral presentations, including tips fo r creating effective conte nt, fo r engaging your audience, fo r deli ve ring yo ur message, and fo r workin g with a team. Practice and refi ne these skills, and you can add yet another talent to yo ur resume: su·ong presentation skill s.

REVIEW QUESTIONS

1. Describe three poss ibl e reasons fo r whi ch a presentation might be give n in prac ti ce.

2. What are three possible form ats, or settings, for delivery of a presentation ?

3. What is the first step in vo lved in creating effecti ve content?

4. Is it necessary to write an accounting memo before deli vering a presentation on an accounting issue? Explain.

5. Ex plain what is meant by the advice: Don't recreate the wheel.

6. Why does the author suggest including an agenda slide each time you deli ver a presentati on?

7. True or fa lse: Your presentation should generall y be organi zed aro und the case questions as they were gi ven to you.

8. To make yo ur content resonate with the audience, what might yo u consider including in your slides to enhance your delivery of each of the fo llowing: a. Bac kground/Facts b. Numbers c. Dates d. Accounting guidance

9. Diffe rentiate between the amount of detai l yo ur slides might include if yo u are presenting to an audit committee (in a boardroom setting with 15 peopl e) versus if you are standing and presenting to a group of 40 of yo ur peers. Why might a difference in detail be appropriate?

10. Complete the follo wing sentenc e: If your slides are so detailed that yo ur audience will be tempted to read them while yo u speak , consider ___________ _

11. Which font style tends to be easier for an audience to read from far away : serif, or sans seri f? Explai n.

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12. What are two things you should check for when reviewing your slides for possible editing en-ors?

13. Is it acceptable to use notecards when delivering a presentation? Explain.

14. In what circumstances might a power pose be useful to strike before a presentation?

15. Name two suggestions described for thinking beyond the case facts.

16. Complete the following sentence: The most effective group presentations are ones where each group member

believes----------------

EXERCISES

1. You are delivering a presentation, and the subject matter concerns whether a company should report revenues on a gross or net basis. Thinking beyond the case facts, list four other considerations you should be prepared to address (such as during Q&A) or background understanding you should gain before presenting.

2. You are delivering a presentation, and the subject matter concerns whether a company should report convert- ible debt simply as a liability, or whether embedded features (like the conversion option) in the debt should be separately accounted for as derivatives. Thinking beyond the case facts, list four other considerations you should be prepared to address (such as during Q&A) or background understanding you should gain before presenting.

3. Describe your personal biggest challenge when delivering presentations. Did this chapter address that challenge, and what tips did it offer?

4. A company is contemplating raising additional capital through the issuance of bonds. Brainstorm four possible presentations that might occur with stakeholders within or outside of the company. Describe the possible setting and purpose of each meeting.

5. Imagine you are presenting an accounting issue to a class of your peers. The issue is when a company should recognize revenue for the sale of a computer with a 2-year wa1rnnty. Prepare a draft agenda (using bullet points) for this hypothetical presentation.

6. Now imagine that you are presenting the same issue to students in an MBA program, who do not have a deep accounting background. Name three ways in which the focus, delivery, or content of your presentation might change in light of this audience.

7. Strike a power pose for two minutes . Describe how you feel after doing this.

8. Brainstorm two ways that you can improve the quality of yow· group's final product and delivery, in circum- stances where you are assigned to present with a team.

9. Now brainstorm how (and when) you will communicate these suggested improvements to your group.

CASE STUDY QUESTIONS

Create a Team Contract Work with your team to develop a one-page outline ( or a contract, of so1ts) detailing how 13.1 you plan to work together on this project. Comment on your expectations for giving each other constmctive feedback. Discuss how you will communicate as a group if a team member is not pulling his or her weight.

Watching and Learning from Great Presenters Watch a TED Talks video of your choice-pick any topic that 13.2 you find interesting. Prepare a half-page written summary describing: ( 1) The topic (what was the talk about?), and (2) Was the presenter effective? Give specific feedback on what made the presentation engaging.

Practice Delivering the Facts Videotape yourself walking through the facts of the Presto Hospitality scenario 13.3 introduced in Chapters 3 and 4. Prepare a list of four areas where your delivery could be improved . Then videotape yourself trying it again. Alternatively, work with a peer to practice delivering the facts, and provide each other with written constructive feedback.

Presto's Lease Evaluation Assume you are in the accounting policy group for Presto Hospitality. Prepare a Power- 13.4 Point presentation to present Presto's lease evaluation to management. Describe key factors considered in the scope analysis, as well as implications of accounting for the concessions agreement with Stadium Co. as a lease.

Discussion Outline Assume similar facts as in the prior case, but this time you have requested a meeting with 13.5 Presto's external auditors, specifically to discuss Presto 's lease scope evaluation. Prepare a written agenda for the meeting, outlining key judgments that you wish to discuss with the auditors. The agenda should be 1 page or less, prepared in Microsoft Word .

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Staying Current with Emerging Guidance Good news: An effort as simple as staying current can help to fast-track your career.

Imagine for a moment Jen , a staff auditor, who is sitting at a picnic table in a cramped

room at her client's site . Today, for the first time , Jen will meet the engagement partner, who

is dropping in to meet with the client. He will be in town for only a few hours, then he's off

to meet with another client.

While the partner is there , Jen receives an email alert: "FASS issues long-awaited credit

losses standard ."

Jen turns to the partner and says: "Oh , did you see? The FASB's new credit losses

standard was just issued. This will affect our client's method for computing their receivables

allowance . Maybe you can mention this during your meeting today."

Suddenly, the partner notices a few th ings about Jen:

First: Jen is not just any staff auditor. She is a staff auditor who takes the initiative to

stay current.

Second: Jen has the client's interests in mind , and she is thoughtful in considering how

emerging guidance will affect this client specifically.

Continued

After reading this chapter and performing the exercises herein, you will be able to

1. Understand the professional advantages of staying current.

2. Describe, generally, the standard setters' "due process" for issuing new guidance.

3. Identify-and subscribe to-useful resources for staying current.

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Continued from previous page

Third: Jen has effective communication skills. Rather than spending the partner's time

on small talk, she provided him with information that was clear, succinct, and useful to his

meeting with the client.

Jen may not realize it yet, but this simple action will have a lasting impact on the partner's

impression of her. Before long, he will begin to request her services on other engagements and

will trust her with increasing amounts of responsibility. This is how successful careers begin.

The Professional Advantages of Staying Current

Why stay current?

__ ...., The Standard-Setting Process 1. Why do standards change?

2. The standard-setting "due process"

Organization of This Chapter

Identifying Resources for Staying Current

How do I stay current?

Accounting research is dynamic. This chapter is designed to teach you the importance of

staying informed as the rules for our profession continually change. This chapter will also

explain why standards change , standard setters' processes for revising standards, and what

you can do to stay current.

The chapter does not provide an exhaustive explanation of standard setting; rather, it is

intended to introduce the process and provide you with a general feel for how new guidance

is established.

Additionally, this chapter does not present "current events" in standard setting , given

how rapidly our profession can change. However, it will provide you with the tools necessary

to take on this challenge yourself.

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THE PROFESSIONAL ADVANTAGES OF STAYING CURRENT

Lo 1 Understand the professional advantages of staying current.

What does it mean to stay current? It mean s recognizing that accounting standards are continually changing and making a conscious effort to keep up. This phenomenon of changing standards is not limited to just accounting, however; auditing and ethical stan-

Figure 14-1

Examples of professionals who monitor emerging guidance

dards, regulatory requirements, and international requirements are equally dynamic. By the time you enter the workforce, many of the textbooks that you learned from in school

will already be outdated. Staying current involves monitoring not only final changes to existing rules, but also being aware of emerging guidance that is under development.

Professionals in a variety of roles have the responsibility to stay current, as illustrated in Figure 14-1.

• I need to ensure that my clients comply with all newly effective guidance.

• It's also important to inform my clients about emerging changes in standards.

• Finally, my firm may choose to comment on standards being developed.

Why I Monitor Emerging Guidance

• I am expected to inform management about possible effects of emerging guidance, including changes to:

- Budgets and forecasts , - Systems requirements, - Current transaction accounting.

• Periodically, my company submits comment letters to the FASB.

• We must disclose impacts of issued, but not yet effective, guidance.

• I actively communicate to the FASB information that is most useful to my analysis of financial statements.

• As new requirements become effective, I may need to adjust my model for analyzing financial statements.

Of course, the professionals depicted in Figure 14-1 are not the only individuals who moni- tor emerging guidance. Parties ranging from regulators to attorneys to academics-to the extent they are involved in applying or interpreting accounting standards-have an interest in staying current.

At what level of your career should you be expected to monitor emerging guidance? The opening scenario of this chapter says it all. While some view "emerging accounting" as a partner- or director-level matter, the truth is that professionals at all levels will see significant advantages in their careers from staying current.

The flip side is also true: Imagine the loss of trust that could occur if you, an auditor onsite daily with a client, let an important emerging guidance topic (with relevance to that client) slip by without informing your client that it is out there. As an auditor, there is a professional expectation that you will help the client stay informed about changes in accounting requirements. Having con- versations with your client, early on, about the impacts of emerging guidance can also minimize differences of opinion later regarding the need to apply, or method of applying, new standards.

Of course, financial statement preparers understand that complying with guidance require- ments and monitoring changes is their own responsibility; however, preparers appreciate when their auditors can leverage firm resources to share news and insights on emerging issues.

You'll have to weigh the advantages of staying current "on work time" versus the advan- tages of printing articles to read on your train ride home, or while waiting at the dentist's office. Judge this based on your firm's culture; if reading on the clock is acceptable and expected, go for it. If not, invest in this professional development time after hours.

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During my career, I was given the advice: "Act like the level you want to be." If a staff accountant starts to perform at a senior level, pretty soon supervisors will notice this, and the individual will be promoted .

Your engagement manager, senior manager, and partner stay informed about emerg- ing issues in the profession; there's no reason you as a first-year associate cannot also be informed. Doing so will actually lighten their load, as they will be able to request your help in monitoring changes to standards and summarizing possible impacts to your clients. Soon, you'll be invited to meetings where these topics are discussed with the client. This can be a great opportunity.

Think for a moment: From your current vantage point (as a student or professional), what advan- tages might you expect to receive from making an effort to stay current?

THE STANDARD-SETTING PROCESS

Why Do Accounting Standards Change?

l TIP from the Trenches

Now

YOU Try 14.1

An accounting standard setter 's decision to revise existing guidance, or to issue new guidance, may be driven by a number of considerations. These include, for example,

• Practitioners, such as preparers or auditors, may express concern that existing requirements are unclear, and may request clarification from the standard setter.

Lo2 Describe, gener-ally, the standard setters' "due process" for issu- ing new guidance.

• This can result in changes to, or interpretations of, existing guidance.

Simplification of complex requirements-to reduce the cost and complexity of financial reporting-is a current area of focus for the FASB.

• Investors and analysts might drive the request for changes, concerned that existing reporting or disclosure requirements do not provide sufficient, useful information for decision making.

• As new types of transactions emerge, standard setters must keep pace, issuing guidance that appropriately reflects the economics of these activities. For example, mortgage securitiza- tions, repurchase financing transactions, and hedge transactions were all-at one point- viewed as "new" transactions that required standard setters' consideration.

• Standard setters are also trying to move away from so-called "bright lines" and toward "objectives-based" guidance that places increased emphasis on professional judgment. Certain standards have become infamous for their use of bright lines, such as the prior "75 % and 90%" tests for lease classification, and the now-superseded rules for Qualifying Special Purpose Entity (QSPE) accounting. In both cases, companies have been known to structure transactions around these rules to achieve a desired accounting result.

• Convergence with international standard setters has historically been another objective of standard-setting projects. For example, standard setters in India and China are currently working to converge their standards with IFRS . In the United States, however, convergence is no longer a primary focus of current standard-setting projects.

Often, standard-setting projects are intended to achieve several of these objectives at the same time, such as issuing objectives-based guidance that provides useful information to analysts.

As global businesses continually evolve, and as the needs of financial statement users fol- low suit, expect changing standards to be a constant.

Now

YOU Try 14.2

Figure 14-2

Typical standard-setting due process

Of the preceding reasons described for why standards change, which of these reasons do you think were relevant to the FASB's decision to revise its revenue recognition model? Explain.

The Standard-Setting "Due Process" Within this book, we have discussed an alphabet soup of standard setters, including the FASB, GASB, IASB, PCAOB, SEC, and so on. Each of these organizations follows an establi shed process when seeking to make changes to its standards. This process is often referred to as the standard setter's due process .

While eac h standard setter's due process may differ slightly, these processes tend to share some common themes, as illustrated in Figure 14-2.

1. Interested parties submit agenda topics to the Board for consideration .

2. The Board votes on and approves items for inclusion on its agenda , considering pre-agenda research performed by the staff. The Board explains its rationale for topics not added .

3. The Board has initial deliberations on the issue, in some cases releasing a Preliminary Views document or a Discussion Paper to solicit constituent feedback on the Board's direction .

4. The Board meets with its working groups, advisory bodies, and other constituents through public roundtables, as necessary, to gather additional input on the project.

5. After reaching tentative decisions on an issue, the Board then issues an Exposure Draft (i.e. , a proposed standard) . This is the formal vehicle for soliciting public comments on proposed guidance.*

6. The Board reviews feedback, redeliberates , then issues a final standard.

7. For major standards , a transition resource group of individuals such as preparers, auditors , and users meets to discuss questions related to implementation of the new standard. This can result in the issuance of additional interpretive guidance to support or clarify the standard.

8. Post-implementation review activities are conducted to assess whether the standard 's objectives were achieved, and to understand costs and benefits associated with adoption and ongoing compliance with the new standard.

* A second, and sometimes even a third, exposure draft may be necessary if significant

changes are proposed following the first exposure draft.

Again, slight variations of this process exist for individual standard setters.

For example, in contrast to its "standards level" projects, the IASB also has an annual improvements process for making narrow-scope amendments to existing standards. Such amendments may include, for example, minor wording changes, clarifications, or the resolution of minor conflicts between standards, which do not introduce new principles or change existing principles. Annually, these collective improvements are exposed for public comment in a single exposure draft, and become effective in the following year.

Now let's consider for a moment the form that final guidance takes at the IASB and FASB. IASB projects generally result in the direct amendment or replacement of existing standards or, as necessary to address new topics, the issuance of a new standard. In contrast, FASB projects culminate in the issuance of a nonauthoritative Accounting Standards Update (ASU), a docu- ment that explains the reason for the project, the decisions reached, the Board's rationale, and that marks the changes-resulting from this guidance-to be made within the authoritative Codification.

For additional discussion of individual standard setters' processes, visit their websites and look for the "standard setting process" page, or a variation of this. This page is located, for example, on www.fasb.org and www.ifrs.org under "About Us" or on www.pcaobus.org, under "Standards."

1. Why do you suppose that accounting standard setters refer to their process as "due process"?

2. Contrast the process required to issue a proposed standard versus a final standard. Explain how these differ.

What does the SEC do when the FASB issues a new standard? Consider the case of the revised revenue recognition standard . For this standard, the SEC staff

• Observed activities of the Transition Resource Group as it worked through implementation concerns;

• Reviewed drafts of industry guidance being prepared by the AICPA; and • Reached out to firms to review draft.firm guidance related to the revised standard.

The SEC indicated that its goal in these outreach eff01ts was to steer practice toward consistent interpretations.

IDENTIFYING RESOURCES FOR STAYING CURRENT

Now

L YOU Try

14.3

Now that you understand why and how standards change, let's discuss the steps you can take to stay current.

First, Identify the Standard Setters You Want to Monitor

Lo3 Identify-and subscribe to- usefut resources for staying current.

Take a moment to consider which standard setters you will likely need to monitor as a professional. This will greatly depend upon what accounting environment you are work- ing in and what your functional role is, as illustrated in Figure 14-3. The examples in Figure 14-3 are not all-inclusive.

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Figure 14-3

Identifying standard setters to monitor

Corporate accountant

Monitor: FASB Accounting Standards

+ Is your company public?

Also monitor SEC accounting and regulatory requirements

Preparing government financial statements?

Monitor GASB or FASAB accounting standards in lieu of

FASB guidance.

Monitor same sources as corporate accountant, plus:

+-----------~i Monitor:

Auditors of public companies, plus:

Auditors of governmental entities, plus:

AICPA Professional Standards

PCAOB auditing standards I I I

-1 I -....__ 1 _ G_A_o_ a_ud_it_in_g_s_ta_n_da_r_ds _ __.

The illustration in Figure 14-3 is meant to serve as a brainstorming tool; in reality, there is no "one size fits all" solution to the set of guidance that each professional should monitor.

Also noteworthy:

• All professionals can benefit from monitoring broad business news. Newspapers such as the Wall Street Journal can be a useful resource for this.

• Industry-specific publications or trade journals are another important reference for both auditors and preparers working in a specific industry.

• Professionals applying IFRS or international auditing standards ( ISAs) should monitor changes to those standards.

• Tax professionals should monitor tax law changes and developments. One way to do this is to sign up for periodic update emails through tax research services, such as RIA Checkpoint or CCH IntelliConnect. Tax professionals can also subscribe to paper or online versions of tax periodicals , such as the AICPA's The Tax Adviser or Tax Analysts' Tax Notes.

Now that you have an idea of which standards to monitor, let's look at some resources that can assist with this effort.

Next, Identify Resources for Monitoring These Standard Setters The following discussion introduces just a few of the many resources available for monitoring changes in accounting standards. The key is to find the sources of information that are most interesting, and useful, to your needs as a professional.

Subscribe to Weekly Email Updates If you're looking for a one-stop shop for standard-setter updates, consider subscribing to weekly emails from a big 4 or other accounting firm, or from a research provider (like CCH) . Subscribers can generally choose from a menu of email options (e.g., Interested in international standards? Governmental? Webcast updates?), then will generally receive a once-per-week email summarizing key standard-setting developments. Notably, the AICPA also offers a free, daily email service (CPA Letter Daily), which summarizes key business and professional news with relevance to accounting professionals.

Often, these email subscriptions offer updates on a broad range of standard setters, includ- ing the FASB , PCAOB, SEC , IASB , and so on. These emails also generally include links to related publications and invitations to educational webcasts. The PwC and EY email subscrip- tions illustrated in the following figures, for example, generally include this content.

First, PwC's CFO Direct website offers updates and insights on standard-setting activities. The link to subscribe to its newsletter service is circled within Figure 14-4. To locate this page, perform a Web search for "PwC CFO Direct."

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Sco1Urlnoopl,lorhlholate,;1CECl.d<r,elc,pm<,n:S

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Issues and featured topics

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Financial reporting blog ¢ SWJ up fo r our newsletter

Similarly, EY's AccountingLink website, shown in Figure 14-5, offers standard-setter updates and other educational resources. Subscribers to this website's email alerts (see link circled) can receive EY's weekly US Week in Review emails. Locate this page by performing a Web search for "EY Accounting Link."

What's new

I US Week in Review -1 5 Nove mber 2018 6 November 2018

To the Point . FASB clarifies the guidance on collaborative arrangements~

6 November 2018

other insights

Note : If you're having trouble printin g a publication, use the publications library drop-down menu to fi nd a pdf you can downk> ad o en and then rinl

Webeasts, podcasts and events

• Podcast - The new credit impairment model for AFS debt securities

• Podcast - Seeking relief from the SEC staff under Rule 3-13

• Accounting overview of ASC 606 for private companies - on-demand video

• Year-end issues for audit committees (17 December)

• EY 04 2018 financial reporting update (20 December)

Access on-demand archives and podcasts.

Figure 14·4

PwC's CFO Direct website (circle added)

Figure 14·5

EY's Accountinglink website (circle added)

Now

YOU Try 14.4

Figure 14-6

Deloitte's Quarterly Accounting Roundup webcast

EY's AccountingLink Website

Identify one resource from EY's website (Figure 14-5) that might be of interest to an auditor whose client is preparing their 04 2018 financial statements.

Register for Free Firm Webcasts Quarterly, the big 4 accounting firms also offer free webcasts on current accounting develop- ments. Locate upcoming webcasts by performing a Web search for : "Deloitte Ql webcast," for example. These webcasts are often CPE-eligible, meaning that attendees can receive educational credits (necessary to maintain CPA licensure) for participating. Figure 14-6 depicts Deloitte's Quarterly Accounting Roundup webcast.

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f'j Roadmap to SEC Reporting Considerations

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Speaker 810 - D

Deloitte.

Quarterly account ing roundup: An update on Q2 2018 important developments

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Dbriefs

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In addition to quarterly updates, the big 4 also offer webcasts as new standards are issued. These webcasts generally provide in-depth discussion of the standard's requirements, as well as implications and implementation issues associated with the new standard. Additionally, on- demand, CPE-eligible webcasts are available anytime on PwC's CFODirect.

Visit the FASB's Website, Subscribe to "Action Alerts" If you haven't already done so, take a moment to visit the FASB's website now (www.fasb.org) . From there, you can

• View current news and activities of the Board.

• Review the Technical Agenda page, where the FASB lists its current projects and project milestones.

• Sign up to receive FASB Action Alert (aka, eNewsletter) emails, which summarize deci- sions reached at FASB Board meetings. To sign up, go to Meetings, then Subscribe to Action Alert on the FASB website, as illustrated in Figure 14-7.

• Access live and archived webcasts of FASB meetings.

In addition, researchers can access final and proposed Accounting Standards Updates on the FASB 's website, or can access the Codification (free subscriptions are available).

I See Ch. 5, fn 5.

··" FASB , iii a • 1n (j

~ ACCOUNTING ~ira.68 FINANCIAL CONTACTUS I HELP L-----SEARCH;;...;.._,

~ STANDARDS BOARD ADVANCED SEARQI

HOME STANDARDS PROJECTS

Upcoming Meetings

Subscri be to Action Ale rt

Past FASB Meetings

Directions, Transportation, Area Hotels

REFERENCE LIBRARY NEWS & MEDIA ABOUT US

T entativa Board Decisions

Meeting Minutes

The Private Company C.Ouncil improves the process of setting acrounting standards for private companies. The PCC is the primary advisory body to the FASB on private company matters.

Used with permission of the Financial Accounting Foundation .

Visit the IFRS Website, Subscribe to Email Alerts

STORE

Like the FASB website, the IFRS website offers extensive news and updates on its standard- setting activities, plus extensive educational re sources.

From www.ifrs.org, scroll to the bottom of the homepage and click the link "Regi ster for News Alerts."

You can then select from a menu of email alert options, choosing for example to be noti- fied whenever new standards are iss ued , or choosing to be notified of changes to specific IASB projects.

Read the Journal of Accountancy The AICPA's Journal of Accountancy, sent monthly to the homes of AICPA members, or available online at www.joumalofaccountancy.com, provides updates and practical guidance on a wide range of services including accounting, auditing, taxation , ethics, valuations, and more. Figure 14-8 depicts a Journal of Accountancy magazine. If this arrives in your mailbox, take the time to browse it!

JOURNAL OF XCCOUNTANCY.

Fraud speaks a new language

~·--·-....,..

Figure 14-7

Subscribing to FASB Action Alerts

Figure 14-8

AICPA Journal of Accountancy

417

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[ TIP

from the Trenches

Finally, consider the follow ing TIP from the Trenches regarding nex t steps in your effort to stay current.

Hopefully, this chapter has inspired you to stay informed about changes in our profession. But don't count on always having the enthusiasm to actively look up information on your own. Sign up today for one or two weekly email updates-these provide a more passive way to stay informed on an ongoing basis (the updates will come to you)! Challenge yourself to read at least one of these update emails every week.

CHAPTER SUMMARY Many of the acco unting principles that you know today will, over time, evolve and change in favor of new require- ments. Ex pect thi s change, and resolve to keep pace with it.

Thi s chapter rev iewed the reasons fo r, and the process fo r, effecting changes to ex isting standards. Now that yo u generally understand this process , it's time to foc us on the real takeaway of th is chapter-Even if it is not expected of you early in your career, stay current.

Taking the ini tiati ve to moni tor emerging gui dance-and espec iall y being thoughtfu l about how proposed changes will affect yo ur company or your client's bu siness- will pu t yo u at a tremendous profess ional advantage vers us peers who do no t make this eff01t.

Take a few minutes today to sign up for one or two emai l subscripti ons, or subscribe to a professional journal, or resolve to use other resou rces-reg ul arl y- to stay abreast of changes in our profession.

REVIEW QUESTIONS

1. What are some of the reasons that a fi nancial statement preparer would need to stay current with emerging and recentl y-issued guidance?

2. What are some reasons that an auditor mi ght need to stay current?

3. At what level should you, as a professional, begin to moni tor emerging guidance? Why?

4. Li st three reasons why accounting standards might require change over time.

5. Describe two ways the SEC res ponded to the FASB 's issuance of revised revenue guidance.

6. Briefl y, describe a typica l standard-setting "due process ."

7. Name fo ur organizations who regu larl y engage in standard setti ng, and who apply some variation of the due process described in this chapter.

8. Di ffe rentiate between a preliminary views document and an exposure draft. What is another name for (or varia- tion of) each?

9. As a publi c company auditor, describe some of the resources you might monitor to stay current.

10. Name two sources that provide comprehensive weekly updates on standard setters.

11. Contrast the U.S. FAS B's process of issuing new guidance (i.e., in volving "ASUs" to update the Codifica ti on) to the IASB 's process fo r up da ting its guidance.

12. Name an example of a free firm webcast that you might view in order to receive CPE and stay current.

EXERCISES

1. Describe what steps you currently take to stay current. Include, for example, newspapers you regularly consult, as well as accounting resources.

FASB/EITF

2. Look at the FASB's current technical agenda. a. Are any final standards set to be issued this quarter? b. Are any exposure drafts ("proposed ASUs") cuITently out for comment, or expected this quarter?

3. Select one of the FASB 's current projects, and describe some of the considerations that led the Board to address this issue.

4. Using the FASB website, locate guidance on the FASB 's standard setting process (under the About Us tab) . a. First, briefly describe the significance of due process in standard setting. b. Next, identify two ways in which the FASB's standard setting process differs just slightly (or offers more

specificity) from the general process description in Figure 14-2 of this chapter.

5. An accountant has been asked by her firm to monitor an upcoming FASB meeting. Walk her through where to find the upcoming meeting materials and what steps she should take to prepare to listen to/view that meeting.

6. What is one of the topics currently being addressed by the EITF? Why do you suppose that the EITF, and not the FASB, is addressing this issue?

7. Locate the most recently issued Accounting Standards Update (ASU). Starting with the ASU's Summary pages, respond to the following: a. What was the Board's reason for addressing this issue? b. What are some of the key changes this standard will make? c. What Codification topics will this "ASU" amend? d. Locate the section of the ASU where it shows changes to the Codification. Does this ASU add to, or

replace, existing Codification content? Explain.

IASB

8. Select one of the IASB's cmTent projects, and describe some of the considerations which led the Board to address this issue.

9. Locate an agenda from an upcoming IASB meeting and list two or three of the topics they plan to cover. Which of these topics do you think may be the most closely watched by the IASB's constituents? Explain.

PCAOB/AICPA

10. Using the PCAOB 's website, locate the most recently issued standard that has been approved by the SEC. Describe the main purpose of this standard.

11. Navigate to the AICPA website. Locate information regarding activities of the Auditing Standards Board (per- form a keyword search for Auditing Standards Board from the homepage). What is one issue that this Board is currently addressing or plans to address at an upcoming meeting?

12. Using the AICPA website, locate a recent edition of the AICPA's Journal of Accountancy, and provide the title and date of a recent article. Summarize (in one or two sentences) what the article is about.

GASB

13. Locate the GASB's technical project agenda and describe two current projects being undertaken. What is the purpose of these projects, and what changes might result from them?

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14.1

14.2

14.3

14.3 Alt.

14.4

14.5

CASE STUDY QUESTIONS

Quarterly Financial Reporting Update Webcasts Register to view (or view via PwC CFODirect's on-demand video library) a big 4 qua1terly financial reporting update webcast. These webcasts generally run approximately 1 .5 hours . (Alternatively, at your instructor's direction, read EY's most recent qua1terly Financial Reporting Briefs pub- lication .) While watching, assume that you are a corporate accountant for a publicly traded construction equipment manufacturer that operates in the United States. Assume that your supervisor asked you to view this webcast and to report back on any issues of relevance to your company. Identify two or three issues with potential applicability to your company.

Selecting and Subscribing to a Resource This chapter covered numerous resources which offer email subscrip- tions . Research a few options, then select one subscription for yourself. Actually subscribe to it. In an email to your professor, approximately two paragraphs, explain the resources you considered and why you selected this particular subscription.

Getting up to Speed on a Current FASB Project Required: Choose an emerging guidance topic from the FASB's project page. (Instructor: You may choose to expand this to include current PCAOB, IFRS, AICPA projects, and so on.) In one page, summarize what the project is (how will it change GAAP?), why it's being undertaken, and the tim- ing of completion or next steps in the project. Try to really capture the essence of this project and include information that gets to the heait of the issues. To be successful in this assignment, you need to really understand the project; don't just reiterate the summary from the project page. Firm resources (such as on PwC's CFO Direct page) , and "FASB In Focus" summaries can be helpful in explaining projects in plain English. Finally, be prepared to present your summary in class.

PowerPoint Summary Alternatively, prepare a slide deck in PowerPoint summarizing a current FASB project. Include a summary of the project, changes anticipated, industries likely to be affected, and possible effective date.

Current Events (Newspaper) Locate a newspaper atticle describing a cmTent event in the accounting or auditing profession. Topics might include, for example, atticles describing recent SEC enforcement actions, ai·ticles about new accounting or regulatory rules, and the like. In one page, summarize the issue addressed, companies that could be affected by this issue, and identify the search term you used to locate this aiticle.

Project Planning Your company has a U.S. corporate office, plus 3 international subsidiaries, each with 10 indi- vidual business units (or operating locations). Assume you are applying new revenue guidance for the first time across the company, and assume both IFRS and U.S. GAAP requirements have changed. You have I year before the standard goes live. Lay out the steps you might take in the first phase of your project as you prepare to comply with new guidance requirements .

Ch 1

Ch 2

Ch 3

Ch 4

Ch 5

Ch 6

Ch 7

Ch 8

Ch 9

Ch 10

Ch 11

Ch 12

Ch 13

Ch 14

Poetry

Directions: After reading the poem The Bean Eaters, analyze it through the SOAPS method.

SOAPS is an acronym to remind you to ask yourself several questions about a poem to establish some background for understanding

S: SUBJECT OF THE POEM-What is the poem about?

O: OCCASION-What is the time and place of the poem and what might have prompted the poet to write it?

A: AUDIENCE-To whom is the poet writing?

P: Purpose-What is the poet’s purpose? Is it to express an emotion, or tell a story, or convince someone of something?

S: SPEAKER-What do you know about the speaker based on the poem?

Complete a SOAPS analysis for The Bean Eaters by Gwendolyn Brooks.

Fair Value Measurements in

the Codification

NYT 8.5

Contrast the roles of ASC 320 and ASC 820 in describing how entities should account for investments

in debt securities. What function did each topic play in providing guidance for this issue?

NYT 8.10

Testing Property, Plant, and Equipment for Impairment: Step 1

Facts: Recall NewTech Corp, the hardware manufacturing company introduced in our opening

scenario to this chapter. Let's revisit the valuation of NewTech's equipment, considering the following

facts.

Recall that NewTech owns specialized equipment used to produce a hardware component

for desktop computers. This equipment, having a carrying value of $10 million at 12/31/20X1 ,

represents NewTech's only major investment in its PC hardware line, and cash flows from the

equipment are largely independent of cash flows from NewTech's other assets. Therefore,

New Tech has concluded that the equipment, by itself, is the appropriate unit of accounting for this

asset. The equipment's estimated useful life is 3 years, and the equipment is expected to have a

residual value of $0.5 million at that time.

As noted previously, changes in the business climate for personal computers have caused

NewTech to reassess its future cash flow projections associated with the equipment. Specifically,

the increasing market share occupied by the tablet computer market has decreased the demand

for NewTech's hardware, and has caused NewTech to lower its earnings projections related

to sales of its hardware. Given this change in business climate and projected earnings, plant

accountants believe it is necessary to test the equipment for impairment.

Questions:

1. Before we continue further into this example, take a moment to brainstorm the browse path

you would use to locate guidance on impairments of PP&E.

Assets> (ASC __ )>Overall (-10) > (-__ )

2. Also, identify the '1riggering event" that caused NewTech to perform this impairment test.

Exercise

2. Refer back to the list of "required reading" areas identified in Chapter 2 of this book. Applying this list to ASC

820, list all areas of "required reading" a researcher should consider when researching fair value measurement

questions.

3. B1iefly summarize, then explain the significance of par. 15-1 (scope) of ASC 820-10 (Fair Value Measurement).

4. Are entities required to disclose fair value hierarchy levels for both recun-ing and nonrecurring fair value measurements?

Explain.

5. B1iefly summarize par. 30-3 (initial measurement) of ASC 820-10 and provide one example listed in par. 30-3A

of an instance when transaction price may not be reflective of fair value.

Case Study 8-1

Spoiled Cheese? Recall Frankie's Homemade Cheese Shop from the Chapter 7 cases. Assume now that Frankie's has finished construction of the new cheese superstore along Route 5 and capitalized $1.9 million related to the project

as of the store's opening on l/l/20Xl. As of 12/31/Xl , the current carrying value of the shop is $1.805 million (assuming a 20-year life for the store and straight-line depreciation). As of 12/31/Xl, Frankie's notices that a few negative factors are at play and asks you whether it is required to test the superstore for impairment:

1. A key stock market index (the Dow) has slid 1,500 points, or 6% since the store was opened.

2. Monthly sales have slid by 10% since the store was opened, partially due to a construction project on Route 5 that has reduced traffic flow to the area.

3. As a result of the slide in monthly sales, the store operated at a deficit in October, November, and December of 20Xl.

Assume the fair value of the store at 12/31/Xl is $1.7 million. As of 12/31/Xl , Frankie's estimates the store will produce net cash inflows of $50,000 in year 2, $100,000 each in years 3-5, $150,000 each in years 6-10, $175,000 each in years 11-15, and $200,000 each in years 16-20. Note that Frankie's incremental borrowing rate is 6%.

Is the store required to be tested for impairment? Should Frankie's impair the current ca1Tying value of the store

at 12/31/Xl?

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