Practical Lessons in Applying Accounting Standards: A Case Study in Applying Accounting Standards Carries Practical Lessons for Accountants

By Pounder, Bruce | Strategic Finance, March 2013 | Go to article overview
Save to active project

Practical Lessons in Applying Accounting Standards: A Case Study in Applying Accounting Standards Carries Practical Lessons for Accountants


Pounder, Bruce, Strategic Finance


Recently I participated in an online discussion with colleagues about how U.S. Generally Accepted Accounting Principles (GAAP) should be applied to a specific real-world situation. We researched the issue and reached a conclusion that we believed to be correct. But we could have easily reached an incorrect conclusion if we hadn't done three particular things in the course of our research. In this month's column, I'll describe the situation we addressed, identify the three key things we did to arrive at our conclusion, and explain why each was critical to the correctness of our conclusion. The practical lessons you'll learn from this case study will help you correctly apply U.S. GAAP--or other accounting standards--to many other situations.

The Situation

In the United States, accounting for income tax purposes differs significantly from financial accounting. Yet income taxes represent an economic reality that must be reflected in a company's financial accounting. Earlier this year, my colleagues and I sought to answer a question regarding the application of financial accounting standards--specifically, U.S. GAAP--to an actual situation involving corporate income taxes, which I'll now summarize.

A reporting entity, "Company X," prepares financial statements and files income tax returns on a calendar-year basis. During 2012, the company incurred research and development (R&D) costs for which no special treatment was required or allowed under enacted tax laws. At year-end, those costs were properly reflected in the company's estimate of its taxable income for 2012. For financial accounting purposes, the company estimated its liability for income taxes at year-end based on its estimated taxable income for the year.

In January 2013, a new tax law was enacted. The law, which was retroactively effective for 2012, allows Company X to claim a tax credit on its 2012 tax return for the R&D costs that it incurred in 2012. At the time the new law was enacted, the company hadn't filed its 2012 tax return nor had it issued its 2012 financial statements.

Company X intends to claim the tax credit on its 2012 tax return. As a result, the actual amount of the company's tax liability would be lower than the amount it had estimated at the end of 2012. The financial accounting question that arose from this situation was "Should the tax liability to be reported in Company X's 2012 financial statements reflect the tax credit or not?"

Initial Analysis

What first came to mind for my colleagues and me was the accounting concept of "subsequent events." Under U.S. GAAP, subsequent events are events that occur after the end of a fiscal year but before financial statements for that year are issued (or are available to be issued). In some cases, subsequent events provide the reporting entity with additional information about the existence and/or amounts of its assets and liabilities as of year-end. In such cases, U.S. GAAP generally requires the reporting entity to use that information in reporting its year-end assets and liabilities (see my April 2010 column, "The Benefit of Hindsight").

The main subsequent events provisions of U.S. GAAP are documented in Topic 855, Subsequent Events, of the Financial Accounting Standards Board's (FASB's) Accounting Standards Codification[R] (ASC). My colleagues and I perceived the retroactively effective tax law to be the kind of subsequent event that ASC Topic 855 would require Company X to consider when measuring its 2012 year-end tax liability. As such, it seemed correct to conclude that the tax liability to be reported in Company X's 2012 financial statements should reflect the new R&D tax credit because the company's reported liability would then match its actual liability more closely.

We had arrived at a simple, obvious answer to our question. But you may have heard an old saying often attributed to Mark Twain, Albert Einstein, and others: "For every problem there is always a solution that is simple, obvious, and wrong.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Practical Lessons in Applying Accounting Standards: A Case Study in Applying Accounting Standards Carries Practical Lessons for Accountants
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.