1. Human Genome Sciences, Inc., a biopharmaceutical company, discovers, develops, and markets new gene and protein-based drugs. Its 1998 annual report showed property, plant, and equipment net of accumulated depreciation of $20,965,000 with total net assets of $244,247,000. A note on operating leases revealed the following: Operating Leases The Company leases office and laboratory premises and equipment pursuant to operating leases expiring at various dates through 2017. The leases contain various renewal options. Minimum annual rentals are as follows: Required: a. Assume that the company’s cost of capital is 10 percent and that operating lease payments between 2004 and 2017 are equal amounts per year. By how much would Human Genome Sciences’ property, plant, and equipment and its total net assets increase by on December 31, 1998 if these leases were capitalized? b. Assume that the company’s net income for 1998 was $20 million. What was its return on assets (ROA) (a) before and (b) after capitalizing the operating leases? Use straight-line depreciation over 14 years for the capitalized leases. Operating lease expense for 1998 is $5,900,000. 2. Wright Company leases an asset for five years on December 31, 2000. Annual lease cost of $10,000 is payable on each December 31 beginning with the year 2001. In addition to the annual lease cost, the lease contract calls for a guaranteed residual value of $3,000. The asset has an economic life of seven years. Wright’s incremental borrowing rate is 8 percent. The asset has an acquisition cost of $45,000. There are no purchase options. Required: a. As things now stand, is this a capital lease or an operating lease? Show figures. b. What can Wright do to convert this lease to an operating lease? Explain and show figures. c. Will lessee and lessor’s accounting for this lease be symmetrical (capital lease for both lessor and lessee or operating lease for both lessor and lessee)? Explain. d. Do you think that Wright’s action in (b) represents a loophole to avoid capitalization or is it a useful part of the present leasing rules? Explain. 3. One of the four capitalization tests of SFAS No. 13 is that the lease term is 75 percent or more of the asset’s remaining economic life. Lease term is defined as follows in SFAS No. 13 (as amended by SFAS No. 98, para. 22a): The fixed noncancellable term of the lease plus (i) all periods, if any, covered by bargain renewal options, (ii) all periods, if any, for which failure to renew the lease imposes a penalty on the lessee in an amount such that renewal appears, at the inception of the lease, to be reasonably assured, (iii) all periods, if any, covered by ordinary renewal options during which a guarantee by the lessee of the lessor’s debt related to the leased property is expected to be in effect, (iv) all periods, if any, covered by ordinary renewal options preceding the date as of which a bargain purchase option is exercisable, and (v) all periods, if any, representing renewals or extensions of the lease at the lessor’s option; however, in no case shall the lease term extend beyond the date a bargain purchase option becomes exercisable. A lease which is cancellable (i) only upon the occurrence of some remote contingency, (ii) only with the permission of the lessor, (iii) only if the lessee enters into a new lease with the same lessor, or (iv) only upon payment by the lessee of a penalty in an amount such that continuation of the lease appears, at inception, reasonably assured shall be considered “noncancellable” for purposes of this definition. Required: How can this test be circumvented through either the structuring of the lease contract or interpretation of the test? What are other ways in which lease capitalization could be avoided through the structuring of lease terms or interpretation of the tests? What problem does this exercise illustrate? 4. This problem shows the importance of considering the importance of converting operating leases to capital leases for the purpose of financial statement analysis. It is based upon the techniques developed and illustrated in Imhoff, Lipe, and Wright (1991 and 1997) though it is much simplified from their presentation. See the text for details related to McAdoo Restaurants. Required: a. Convert the operating lease to a capital lease which is 1-year-old (Hint: Use the present value of a 10-year ordinary annuity). Assume that straight-line depreciation is used for both book and tax purposes. There would be a zero salvage value. b. Determine the net income after taxes if the leases are treated as capital leases. c. Determine the return on assets under the (a) operating lease assumption and (b) capital lease assumption. d. Determine the debt-equity ratio under the (a) operating lease assumption and (b)capital lease assumption. e. Do you think it is useful to convert operating leases to capital leases for financial statement analysis purposes? Discuss. 5. SFAS No. 98, which contained some amendments to SFAS No. 13, passed by a 4 to 3 vote. The following dissent to the opinion was made: Please refer to the text for the details of this lengthy question. Required: Using the perspective on uniformity developed in Chapter 9, analyze the rigid versus finite uniformity approach to the distinction between the two positions.
> Describe the difference between inductive and deductive reasoning and give an example of each.
> Describe how the concept of participant reactivity might explain why a person’s behavior during a job interview is very different from a person's behavior with friends.
> A researcher wants to describe how fine motor skills change as a group of infants age from 18 to 24 months. Describe how this study could be done as a cross-sectional design. Next, describe how this study could be done as a longitudinal study.
> Outline the major advantages and disadvantages of administering a survey by mail.
> In addition to the key words, you should also be able to define each of the following terms: Descriptive research strategy Behavioral observation Habituation Behavior categories Inter-rater reliability Frequency method Duration method Interval method Ti
> Describe how the third-variable problem and the directionality problem limit the interpretation of results from correlational research designs.
> For a two-factor research study with two levels for factor A and four levels for factor B, how many participants are needed to obtain five scores in each treatment condition for each of the following situations? a. Both factors are between-subjects. b. B
> In Figure 11.5, we show three combinations of main effects and interactions for a 2 × 2 factorial design. Using the same 2 × 2 structure, with factor A defining the rows and factor B defining the columns, create a set of means that produce each of the fo
> Define the three types of survey questions (open-ended, restricted, and rating-scale) and identify the relative strengths and weaknesses of each.
> In addition to the key words, you should also be able to define each of the following terms: Publication Manual of the American Psychological Association Plagiarism Author note Subjects subsection Participants subsection Procedure subsection Apparatus su
> What are some reasons why consolidated reports are thought to be relevant?
> What is meant by the term one-line consolidation? What differences occur in financial statements when a one-line consolidation rather than full consolidation is used?
> Is the treatment of unrecognized prior service cost and actuarial gains/ losses in SFAS No. 87 an example of the asset-liability or revenue-expense orientation?
> What prompted FASB Accounting Standards Update 2009-09?
> What does the term functional currency mean?
> While ERISA has been helpful, how well are employees protected in situations where overfunded pension plans exist?
> Current discussions by the Boards leave room open for two Accounting for Leases Standards; one for lessee and another one for lessor. Should two Accounting for Leases Standards be issued? Support your response?
> Why is the G4+1 like the Big Ten (a.k.a. Western Athletic Conference)?
> Compare the present system involving consolidation, equity method, and fair value accounting for intercorporate equity investments with finite uniformity as it exists in lease accounting.
> Should valuable lease options of lessees be capitalized?
> What issues of qualitative characteristics of accounting information (SFAC No. 2) are important relative to accrual accounting for OPEBs?
> What is the danger, particularly to older employees of restructuring pension plans into “cash benefit plans?”
> Why does the elimination of poolings improve representational faithfulness and comparability.
> Why does the elimination of poolings (SFAS No. 141) and the indefinite life of goodwill subject to impairment (SFAS No. 142) represent a possible “quid pro quo?”
> Why is the IASB standard (IAS 7) substantially shorter than the FASB’s standard (SFAS No. 13)?
> What is an equity carve-out?
> How are minority interests handled in consolidations?
> Is SFAS No. 87’s argument favoring recognition of a pension liability for accumulated benefits consistent with the conceptual framework project?
> Describe the implicit assumption made in SFAS No. 94 about the reporting entity.
> Does it matter if capital leases are reported in a footnote or in the body of the balance sheet? What research evidence exists to help evaluate this question?
> Why was there reason to expect some negative economic consequences arising from lease capitalization? What is the role of neutrality in such a situation? What is the response based on research findings to date?
> Why did APB Opinion No. 8 only minimally improve uniformity between companies?
> What economic consequences of SFAS No. 87 were suggested in the chapter?
> Given the evidence from the research in the stock market, does it matter whether pension information is disclosed in the formal financial statements or as supplemental disclosure?
> Why is the aspect of conveyance of leases emphasized in capital leases and the contractual element emphasized in operating leases?
> The equity method reports neither the investor’s cost nor the market value of the investment. Do you believe the equity method provides useful information? Why or why not?
> Compare proportionate consolidation with capitalizing of all leases extending beyond a year, another example of rigid uniformity.
> Why would proportionate consolidation result in rigid uniformity for intercorporate equity investment accounting?
> Why is there a pension accounting problem with defined benefit pension plans, but not with defined contribution plans?
> The logic of pooling rests heavily on the assumption that no substantive economic transaction occurs between the combinor and stockholders of the combinee. Evaluate this assumption.
> Review the evolution of capitalization criteria in lease accounting standards. Why did APB Opinion No. 5 have little impact? What impact has SFAS No. 13 had? Has there been an underlying theme in the development of lease accounting?
> Are there relevant circumstance differences between purchase and pooling of interests? Explain
> ”All leases beyond a year be capitalized!” Evaluate this position.
> How might standards setters address the concerns that Gordon and Gallery (2012) highlight related to pension accounting comparability?
> To qualify as a liability, a past transaction must exist. Is this the case with pensions and OPEBs? How does the use of financial statements for predicting future cash flows as opposed to evaluating management performance enter the picture?
> Novy-Marx and Rauh (2011) estimate state employee pension liabilities in the United States. What thoughts do you have on their findings?
> Zechman (2010) studies firms using synthetic leases. How might her findings influence the setting of lease accounting standards?
> Biggs (2010) presents a bleak picture for future generations attempting to meet the obligations related to public pension plans (e.g., State of New York; Jefferson County, Alabama)). How does his logic hold up when reviewing U.S. public corporations?
> If you had to choose among the current method of consolidation for combinees where the combinor owns at least 50 percent, the new entity approach, or proportionate consolidation, which would you choose? Explain.
> 1. Refer to Appendix 15-A. Assume that the firm is using projected accrued benefit cost funding. Suppose that a plan amendment was introduced during 2002 granting one year of prior service (for the year 2000) to each employee. Required: Determine the con
> Is the executory nature of lease contracts important in assessing lease accounting? How have leases been interpreted? Why might noncancellability override the executory nature?
> 1. Examine the 2001 and 2002 annual reports for a corporation having a financial subsidiary. (Your instructor may suggest a corporation on the EDGAR Website. http://www.sec.gov/edgarhp.htm). Determine the effect of SFAS No. 94 on operating ratios, profit
> Is there a measurement reliability (verifiability) problem with lease capitalization?
> How is representational faithfulness achieved in the capitalization requirements of SFAS No. 13?
> Does symmetry exist between lessors and lessees under SFAS No. 13? Should symmetry be a goal of lease accounting?
> What are the similarities and differences between leases and other means of property acquisition? How can these similarities and differences be reported in the financial statements?
> How has ERISA affected pension accounting?
> Why is there a “double counting” problem if the accumulated benefit obligation is used to measure the pension liability and what can be done about it?
> Explain how previous pension accounting standards were based on a revenue-expense approach to the financial statements.
> Is it inconsistent to use future salaries for service cost calculations and current salaries for minimum liability calculation purposes?
> What differences exist, relative to the use of future costs and future salaries, in the case of OPEBs (SFAS No. 106) and pensions (SFAS No. 87)?
> Why may companies not be indifferent to purchase and pooling accounting, and what do we know about this issue from research studies?
> How did the “give-and-take” differ between the FASB and its constituents in the drafting of SFAS No. 87 on pensions versus SFAS No. 106?
> What types of economic consequences may arise from accrual accounting for OPEBs in SFAS No. 106?
> What considerations may have motivated the FASB to grant a four-year transitional period in capitalizing pre-1977 leases meeting the capitalization tests of SFAS No. 13? What other political behavior is evident in the evolution of lease accounting?
> Research has shown that discount rates used by firms are generally above rates suggested by the FASB. Will this make the interest cost portion of pension expense higher or lower than if discount rates were lower? Why do you think firms favor using a high
> Evaluate the manner in which initial direct lease costs are accounted for under SFAS No. 13.
> What is the disappearing asset problem?
> Why does SFAS No. 52 provide an example of finite uniformity in terms of the use of remeasurement?
> Why would balance sheets prepared under SFAS No. 8 lack additivity?
> How do accounting exposure and economic exposure differ?
> What are the differences between a foreign currency orientation and a U.S. dollar orientation regarding the translation of foreign currency operations?
> What do the following actuarial terms mean: accumulated benefits, actuarial liability, vested benefits, service cost, and unfunded accumulated benefits? How are they measured? How are projected benefit obligations, accumulated benefit obligations, and ve
> What are the main issues surrounding the special purpose entity and its successor, the variable interest entity.
> Current discussions by the Boards point to a possibility that a converged standard on leases will not be achieved. How will lack of converged standard on leases affect the Boards’ Joint Project?
> According to The Wall Street Journal article on February 1, 1996 (“Intrinsic Value” by Roger Lowenstein, p. C1), pension fund assets in the United States grew dramatically—by approximately 29 percent—during 1995, an excellent year in the stock market. Ho
> Distinguish among sell-offs, spin-offs, split-offs, and split-ups.
> If actuarial gains and losses and prior service costs, in line with SFAS No. 158, are to be recognized in the period when incurred, is there a double counting effect when these elements are recognized as part of net pension expense?
> Voluntary pension plan terminations have been increasing [see Stone (1987)] in which surplus plan assets are recaptured by sponsoring companies after deferred annuities (of equivalent value to accrued benefits) are purchased for plan participants. Why do
> What is push-down accounting? What problems would arise in connection with the implementation?
> Does the reporting of capital leases appear to have value to users of financial statements? Why are there costs of reporting capital leases?
> Why does the FASB’s reporting entity project logically precede any conclusion regarding consolidated financial reporting?
> Discuss the limitations of consolidated financial statements and why dual reporting (consolidated and separate entity statements) as well as other forms of disaggregated reporting, such as SFAS No. 131, make sense.
> What is the argument for finite uniformity in accounting for leases? Why is finite uniformity difficult to achieve? Explain what the relevant circumstances are in accounting for different types of leases.
> What is the difference between owners’ equity accounts representing shareholders’ claims as equity holders versus shareholders’ interests as owners?
> Is there a similarity between the codificational approach (Gaa) to standard setting and the jurisprudential approach?
> How does feedback value relate to predictive ability and accountability?
> Of what importance in a conceptual framework or metatheory are definitions of such basic terms as assets, liabilities, revenues, and expenses?
> Does the entity theory or the proprietary theory provide a better description of the relationship existing between the large modern corporation and its owners?
> How does agency theory (Chapters 2 and 4) differ from the equity theories discussed in this chapter?
> Who pays for accounting regulation and who benefits?
> Why do you think the equity theories are less important today than they were, say, 50 years ago?
> In 1936 the United States was still suffering from the Great Depression. During the presidential election campaign, an extensive survey of voter attitudes was undertaken to find out whether the public preferred the incumbent, Franklin Delano Roosevelt, o
> Why is the residual equity theory more in line with recent research in finance than entity and proprietary theory?
> “Assuming all other things equal, it is possible that the lower-of-cost-or-market method can result in any given year in higher income than would be the case under the same inventory costing method without the use of lower-of-cost-or-market. If so, then
> “Since the FASB is independent from the AICPA, the latter is no longer concerned with standard setting and related issues.” Evaluate this statement.
> What is Pareto optimality? Why would adherence to it minimize accounting standard setting?
> What benefit is the conceptual framework project to the FASB if (a) there is no way of determining optimal accounting regulation and (b) regulatory decision making is a political process?
> Of the nine so-called principles shown in Exhibit 5-1, which do you think are the most important in terms of establishing a historical costing system?
> Why has the entity theory fragmented into two separate conceptions?
