CHAPTER 3
1.What are rules-based and principles-based standards and how do they differ in
application across four characteristics shown in Exhibit 3-1?
Rules-based standards, perceived to be the dominant approach of the FASB, attempt to
anticipate all or most of the application issues and prescribes solutions. As a result, U.S.
GAAP as codified by the FASB runs into approximately 17,000 pages. Principles-based
2. Why do some critics use the Lehman case as a critique of the U.S. GAAP
approach to standard setting?
Before collapsing and precipitating the financial crisis of 2008, the company used a
refinancing device called a repurchasing agreement or a repo at the end of each
quarter that allowed it to reduce its debt and thus meet the regulatory debt-to-equity
3. Why do some critics use the reliance on judgment as a critique of the IFRS
approach to standard setting?
There is no doubt that principles-based standards place more reliance on professional
4. How do U.S. GAAP and IFRS differ in their implementation of accrual
accounting?
The FASB and IASB implement accrual accounting very differently. U.S. GAAP
emphasizes measurement of items on the income statement (often referred to as
5. Why is the characterization of U.S. GAAP, based on historical cost not valid?
Give examples.
6. Why is fair value critical to U.S. GAAP and IFRS and how do they differ in
the application of fair value?
The objective of a fair value measurement is to determine the price that would be
7. Why is revenue recognition a good example of the contrasting approaches of
IFRS and U.S. GAAP to level of detail? Why might this situation change?
A major goal of the IASB/FASB Convergence Project is agreement on a single definition
of revenue recognition. Such an agreement would eliminate the complex differences in
8. How does the IFRS balance sheet approach to revenue recognition differ for the
U.S. GAAP approach?
U.S. GAAP defines revenue from an income statement point of view without respect to
9. How are the criteria for revenue recognition similar under U.S. GAAP and IFRS
and what is the most significant difference?
A major goal of the IASB/FASB Convergence Project is agreement on a single definition
10. Do U.S. GAAP or IFRS give more industry guidance? Give two examples to
support your answer.
In general, GAAP give more industry guidance in order to fulfill its rules-based
characteristic. For instance, IFRS typically record service revenue using the percentage–
11. How is revenue recognition defined under the proposed converged revenue
recognition standard? Why is it significant?
In an attempt to resolve the differences in revenue recognition that currently exist
12. What is a performance obligation, why is it important, and what are some
indications that a performance obligation has been satisfied?
The exposure draft boils revenue recognition down to a single, contract-based model in
which an entity would recognize revenue from contracts with customers when it transfers
13.What are the steps in applying the proposed revenue recognition model?
1. Identify the contract with the customer.
14.How has the reporting of comprehensive income changed under U.S. GAAP to
converge with IFRS?
15. What is recycling and what are some examples of when it is allowed and not
allowed?
Recycling occurs if an item is first recorded as an unrealized gain and loss and reported
as OCI, as when there is a change in fair value, and then is subsequently realized when
16. Discussion or group question: In the principles versus rules debate on the
approach to standard setting, which approach will produce the most truthful
financial statements? Use revenue recognition as an example and give key points on
each side of the argument.
Rule-based standards, perceived to be the dominant approach of the FASB, attempt to
anticipate all or most of the application issues and prescribe solutions. As a result, U.S.
GAAP as codified by the FASB runs into approximately 17,000 pages.
17. Discussion or group question: The concepts of probable and more likely than not
arise frequently in exercising judgment in applying accounting standards under
both U.S. GAAP and IFRS. In your mind, if an event is probable as opposed to more
likely than not, what would be your assessment of the difference in the two terms?
Can you assign a probability to each?
18. Exercise-Revenue recognition: Assume that after graduation you have the
opportunity to join a professional organization related to your work. The
organization requires a one-time, nonrefundable $250 initiation fee and a
membership agreement cancelable with 30 days notice to pay $25 dollars per
quarter to use the club for the next six quarters. How are the $250 and the $25 per
month accounted for under current U.S. GAAP and the proposed new IFRS? In
completing your answer follow the following steps:
1. Identify the contract with the customer.
2. Identify the separate performance obligations in the contract.
3. Determine the transaction price for the entire contract.
4. Allocate the transaction price to the separate performance obligations.
5. Recognize revenue when each separate performance obligation is satisfied.
Under U.S. GAAP, the $ 250 payment is recorded as unearned revenue and
allocated over a reasonable future period (based on the estimated average