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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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MacAdams Company had engaged in large amounts of R&D to develop a new product that would put the company ahead of its Japanese competition. As a result, the company’s profits were severely reduced, and the president was concerned about the possibility of a takeover by a European competitor. The president was discussing the situation with the controller and said, “Your accounting principles make me so mad. Here we are working hard to develop a product to beat the rest of the world, and you won’t let me treat any of those costs as an asset.”

The controller replied, “I understand your frustration. And please remember they are not ‘my’ principles.”

“I know,” responded the president. “Do you have any suggestions?”

“Well,” the controller replied, “we can’t adjust R&D expense, but we can reduce our pension expense. One easy way to increase our profits would be for the board of directors to vote to increase the discount rate used for computing the present values and to increase the expected rate of return on plan assets. Both of those would have the effect of reducing the pension expense.”

“Great idea, I will have to remember that when it is time for the year-end bonuses.”

Required:

Write a short report evaluating the controller’s suggestion.

To determine

Prepare a report evaluating the suggestion of the controller.

Explanation

Pension plan: Pension plan is the plan devised by corporations to pay the employees an income after their retirement, in the form of pension.

In this case, the company has spent a huge amount in research and development cost and as a result, the profits of the company were reduced. Hence the controller suggests reducing the pension expense as it would increase the profits of the company. However, under GAAP, the management judgment is required for all the aspects and moreover all companies do not operate in the same environment, or follow the same philosophy towards risk, hence the flexibility is appropriate. However, this flexibility can be abused if it becomes manipulation.

Instinctively, the controller is also correct. Because when the discount rate increases it will reduce the service cost and reduce the projected benefit obligation, as a result it would reduce the interest cost...

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