Financial Accounting Theory Essay

The article GM to Take Charge of $20. 8-Billion here reproduced from The Globe and Mail (February 2, 1993) describes the authority impact of SFAS 106, chronicle for Postretirement Benefits Other Than Pensions, on General Motors and Ford. For example, it appears that General Motors allow be required to record a liability of $20. 8 billion, reducing its sh areholders equity from $27. 8 billion to $7 billion, slightly a 75% reduction. Describe and explain how you would expect the efficient securities commercialise to react to this information.SFAS 106, Accounting for Postretirement Benefits Other Than Pensions This Statement establishes news report system standards for employers accounting for postretirement benefits other than pensions. It forget importantly change the prevalent current practice of accounting for postretirement benefits on a pay-as-you-go (cash) basis by requiring accrual, during the years that the employee renders the necessary religious service, of the ex pected cost of providing those benefits to an employee and the employees beneficiaries and covered dependents.In exchange for the current services provided by the employee, the employer promises to provide, in addition to current wages and other benefits, health and other well-being benefits after the employee retires. It follows from that view that postretirement benefits are not gratuities but are break up of an employees compensation for services rendered. This Statement relies on a staple fibre premise of generally accepted accounting commandments that accrual accounting provides to a greater accomplishment than relevant and serviceable information than does cash basis accounting.Accrual accounting goes beyond cash legal proceeding and attempts to recognize the financial effects of noncash transactions and events as they occur. Recognition and measurement of the accrued obligation to provide postretirement benefits will provide users of financial statements with the oppo rtunity to assess the financial consequences of employers compensation decisions. In applying accrual accounting to postretirement benefits, this Statement adopts three fundamental aspects of pension accounting delayed perception of trustworthy events, reporting boodle cost, and offsetting liabilities and related assets. (FASB, 2012) I would expect the efficient securities market to find this practice acceptable. Accrual-based accounting is more effective than cash-based accounting.A few arguments to support this theory are certain cash usefulness and disbursements are lumpy, within run cash flows receipts and payments can be lumpy, accrual-based accounting is a better predictor of a companys long-term financial performance. Also all form- still(prenominal) statements collect to be set up using accrual-based accounting, and publicly traded companies need to use accrual-based accounting to conform to GAAP standards (Keener, 2012). 2. Chapter 4 Problem 12 (Imax) a. To what exte nt can tax revenue growth substitute for net income as a predictor of forthcoming earning power? Explain. Use efficient securities market concepts in your answer, and consider the requirement under GAAP for immediate writeoff of look and startup cost. Both revenue growth and net income are useful in determining the financial strength of a company, but they are not interchangeable. Net income describes how efficient a company is with its spending and operating costs and how effectively it has been controlling total costs.Revenue, on the other hand, only indicates how effective a company is at generating sales and does not emergence into consideration operating efficiencies which could have a dramatic impact on net income (Investopedia, 2012). Start-up costs are defined as those unusual one-time costs incurred in putting a new plant into operation, opening a new sales outlet, initiating a new process in an animate plant, or otherwise commencing some new operation (FASB, 2012). Costs of start-up activities, including government costs, should be expensed as incurred (FASB, 2012). Definition of Revenue Recognition An accounting principle under generally accepted accounting principles (GAAP) that determines the specific conditions under which income becomes cognise as revenue. Generally, revenue is know only when a specific diminutive event has occurred and the amount of revenue is measurable. Revenue Recognition explained For most businesses, income is recognized as revenue whenever the company delivers or performs its product or service and receives payment for it. However, there are several situations in which exceptions may apply.For example, if a companys business has a very high set of product expires, revenue should only be recognized after the return period expires. Companies can sometimes play around with revenue credit rating to make their financial figures look better. For example, if XYZ Corp. wants to hide the fact that it is having a ba neful year in sales, it may choose to recognize income that has not hitherto been collected as revenue in order to boost its sales revenue for the year (Investopedia, 2012). b. Use the concept of relevance to defend the revenue recognition policies outlined above. Relevant financial statements give information to investors about the unbendables future economic prospects (Scott, 2009). c. Use the concept of dependability to criticize the revenue recognition policies outlined above. To be reliable, information must have representational faithfulness and it must be verifiable and deaf(p) (Scott, 2009). d. To the extent that investors are aware of the possible use of revenue recognition policies that overstate revenues (even though, for a specific firm, they may not know the extent to which that firm is using such policies), what is the effect on the operation of the peachy market?Explain. Investors have prior beliefs about a firms future performance. These prior beliefs will b e based on all available information. If net income is high, or higher than expected, this may be skillful news. If so, investors would revise upward their beliefs about future performance. Other investors, who perhaps had too high expectations for what current net income should be, might interpret the same net income number as bad news.Investors who have revise their beliefs about future performance upward will be inclined to buy the firms shares at their current market price, and vice versa for those who have revised their beliefs downward. We would expect to observe the script of shares traded to increase when the firm reports its net income. Furthermore, this volume should be greater the greater are the differences in investors prior beliefs and in their interpretations of the current financial information (Scott, 2009).