Reference no: EM13315858

Cadenhead presented an approach to uniformity referred to as circumstantial variables.

Circumstantial variables are environmental conditions (conditions beyond the control of the individual firm that are applicable to the particular industry that the firm is in).

Circumstantial variables lead to problems relative to either (1) costliness of the prescribed method in the particular event situation or (2) a low degree of verifiability because estimates vary widely relative to the prescribed method. For example, Cadenhead notes that the existence of a ready market with regularly quoted prices would facilitate inventory valuation if realizable value were not used relative to inventories, but the absence of such a market would allow a firm to use another type of inventory/cost of goods sold measurement.

In the four situations discussed here, classify each situation according to whether it involves finite uniformity, rigid uniformity, flexibility, or circumstantial variables.

a. Research and development costs: SFAS No. 2 requires that all research and development costs (some of which will have future cash flow benefits and others will not) be written off to expense as incurred. Are there any other accounting principles that are present here? Discuss.

b. Unusual right of return by customers: SFAS No. 48 covers those industries (of which there are not many) where buyers have an unusual right of return due to industry practices that cannot be avoided by the individual firm. The “unusual right of return” arises where buyers have an unusually long time period during which purchase returns can be made. From the seller’s standpoint, revenue is recognized at time of sale, provided that the future returns can be reasonably estimated (there are five other conditions that must also be met but they are of no concern here). If sales returns cannot be reasonably estimated, then sales revenues are not recognized until returns can be reasonably estimated or (more likely) the return privilege has substantially expired. Hence, it is not cash flow differences that are at issue but rather the ability to estimate the expected returns that is the key point.

c. Investment tax credit (assume no investment tax credit carryforward problem): All of the cash benefits in the form of lower taxes are received in the year of asset acquisition. The enterprise may recognize benefit (in the form of lower tax expense) in the year of acquisition or the benefits may be spread over the life of the asset in the form of lower annual depreciation.

d. Oil and gas accounting: SFAS No. 19 tried to allow only “successful efforts.” In successful efforts, the costs of dry holes must be written off once it is known that the holes are dry. If (and only if) a well were successful, drilling costs would be capitalized and amortized over future years.