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Cost Benefit Analysis Memorandum Essay history assignment ideas: history assignment ideas

Benefit Analysis Memorandum

Cost-Benefit Analysis

Cost-benefit analyses are routinely conducted for federal programs and proposed federal programs. The researchers propose a cost-benefit analysis for homeland security expenditures designed to address conventional threats to national security. An evaluation of catastrophic threats is specifically excluded from this analysis as only 14% of the federal homeland security budget is directed at the prevention of catastrophic threats to national security. The recommendation from the authors is to employ a risk-informed framework to the proposed cost-benefit analysis is. A risk-informed approach has as its basis consideration of the likelihood of occurrence, the life/safety effectiveness, and the economic cost of proposed security and protective measures, and it includes any “consequence of terrorist attacks on such infrastructure” (Stewart & Mueller, 2009, p.2). Thus, the metrics associated with the proposed cost/benefit research are: 1) Cost per life saved, and 2) Net benefit as measured by lives saved and economic costs.

A report from 9/11 Commission admonished the federal government to develop and implement a national security plan which will “reflect assessment of risks and cost-effectiveness” (p. 2 in NC 2004). The authors argue that a comprehensive assessment to inform policy making and policy implementation has not been conducted, making the cost-benefit analysis policy-relevant. A comprehensive assessment of the anti-terrorism components of the national security plan is of interest to policy makers, policy implementers, and to the general citizenry.

Unit of analysis. Best practices in program evaluation require clarity about what is being measured and investigation into the appropriateness of what is being measured. The proposed cost-benefit analysis for homeland security is poised to use the Value of a Statistical Life (VSL) as the economic measure of as its key unit of analysis — a human life saved by terrorism. The authors examine an historical list of federally-funded projects and their associated VSLs to identify a mid-point value of $7.5 million that represents “a reasonably accurate reflection of societal considerations of risk acceptability and willingness to pay to save a life” (Stewart & Mueller, 2009, p. 5). Here, too, the authors concede that “non-quantifiable criteria may be important also in judging the overall acceptability of risks” (Stewart & Mueller, 2009, p.5), thereby acknowledging a potential weakness in the goodness of fit of latter day mainstream cost-benefit analysis, which presumes an absence of values in the equation and thereby implies the appropriateness of taking issue with the application of cost-benefit analysis to decisions of moral import.

Costs and benefits. The authors clearly identify the costs to be assessed as the VSL of the homeland security expenditures. The benefit to be measured is the effectiveness of increased expenditures for federal homeland security measures since 9/11. The increased cost for six homeland security measures identified by the authors is $31.2 billion in the period from 2001 through 2008 (Stewart & Mueller, 2009, p. 6). The authors delineate costs that are not included in this figure and emphasize that the figure is considered to be a conservative estimate of the increase in homeland expenditures since 9/11.

Cost-benefit analysis by the numbers. The authors examine the parameters of numbers of lives lost and number of potential lives lost to terrorism within several frameworks. Domestic and global numbers of lives lost, both forward and backward looking, are fit together by the authors to create a sort of mosaic of possible scenarios. Top and bottom parameters are calculated and declared by the authors, and a range of 50 to 500 lives is established.

Given the $7.5 million per life established by the authors, the number of American lives that would need to be saved on U.S. soil for the increase in homeland security expenditures from 2001-2008 to be cost effective is 4000. When actual costs for the estimated range of lives that could be saved are calculated, the expenditures could potentially span $63 million for 500 lives saved to $630 million for 50 lives saved. The estimated cost increase for homeland security since 2011 is between 8 to 80 times higher than generally accepted by society as appropriate for risk reduction” (Stewart & Mueller, 2009, p. 11). From this analysis, the authors conclude that, even given the most optimistic equation, the increased expenditures for homeland security as defined fail a cost-benefit analysis.

A second analysis that looked specifically at the economic costs of terrorism was compiled by the authors by examining secondary research and data. Three studies using independent bases were offered for comparison: A RAND study of a moderate case scenario, an Australian study commissioned to explore a scenario similar to the July 2005 London bombings, and a study by the International Monetary Fund (IMF) that focused on U.S. GDP after 9/11 and in the three years subsequent to that event. The RAND study indicated that two to three terrorist attacks would result in cost-effective expenditures. The Australian study on cost-effectiveness would require prevention of seven terrorist attacks similar in scope to the London bombings. And the IMF analysis would have to prevent an attack on the scale of 9/11 every several years in order to be cost effective. As a side note, the RAND corporation conducts just less than half of its research on issues of national security, and they are rated “fifth in the latest survey of think tank media citations by FAIR (Fairness & Accuracy in Reporting) which categorizes RAND as Centrist,” (Source Watch, 2011) all of which lends credibility to their estimates.

A third analysis examines collateral costs and existential threats to the U.S. In an effort by the authors to include less obvious but compelling issues. In this analysis, the authors provide evidence that the reactions that people have to the threat of terrorism cause them to make choices that can have subsequent serious impact. Three primary examples of reaction costs are offered. The first is the rate of increased vehicular accidents following 9/11 as a result of more people choosing what they perceived to be safer travel options than flying. The second example alludes to the theory of existential threat, that is a result of deterioration of society as disoriented and deluded citizens strongly react in substantively damaging ways to perceived threat to the country and life as they know it. The third example of reaction cost is the lamentable loss of lives due to wars for which 9/11 served as a catalyst.

Taken together, the several analyses presented by the authors suggest that — as finite threat and not an existential threat, which is the apparent assertion of the authors — the expenditures of the homeland security programs have been excessive in light of the actual parameters of the terrorist threat. The further conclude that the opportunity costs compound the effects of the inexcusable economic decisions made by homeland security policy makers and policy implementers.


Strengths of proposal. Overall, the evidence, as presented supports the authors’ conclusions. However, one can argue that the authored primarily used only a single policy tool to evaluate the effectiveness of the homeland security fund expenditures, when there are other policy evaluation frames and policy tools available. The evidence, although-based strongly on estimation and scenario-building, is a good match to the policy analysis research questions asked by the authors. The analysis is comprehensive and thorough. However, the authors do not extend their analysis to address several of the issues they present as secondary concerns in the last section of their article, Other Decision-Making Considerations. This issue is discussed in more detail in the following section.

Weaknesses and limitations of proposal. Taken at face value, the evidence provided by the authors strongly supports their conclusions. Further, the analysis was comprehensive, considering several discrete frameworks for considering the data and making estimates. Regardless, the analysis was, at its core, an economic evaluation of federal policy designed to protect much more than economic interests. “An important claim by critics is that CBA [cost — benefit analysis] is a mechanical algorithm that is used to answer questions about what people want — the result of what Ted Porter describes as ‘lust after mechanical objectivity’ (Porter, 1995, p. 187)” (Zerbe, 2007, p.7 ).

That the cost-benefit analysis was suggested for an assessment of the effectiveness of the homeland security measures and programs is not surprising, given its historical basis in the evolution of federal program evaluation. It should be noted that policy analysis, a field that includes the study of the implementation of policy, extends far beyond cost-benefit analysis, and often takes a very different tack than what the authors have presented in their article. A discussion of the evolution the cost-benefit analysis tool follows.

Evolution and application of cost-benefit analysis. In order to consider the appropriateness of the application of cost-benefit analysis, it is important to understand the evolution of the construct and the application of the construct. Early application of cost-benefit analysis took place in programmatic environments in which substantive variables were measurable. In fact, it was a French engineer named Jules Dupuit who first wrote about economic accounting in 1848. But the domestic origin of cost-benefit analysis is with the U.S. Army Corps of Engineers for the Rivers and Harbors Act of 1902, and then with the Federal Navigation Act of 1936. Both were engineering-oriented laws, which, interestingly fits with the professional orientation of one of the authors of the article, whose academic affiliation is with the Center for Infrastructure Performance and Reliability at the University of Newcastle.

Cost-benefit analysis is seen as a way to diminish and, hopefully, resolve collective action problems and conflicts. Commonly, conflicts “arise when individuals or groups pursing narrow self-interest without coordination arrive at outcomes inferior to those that could be achieved by coordination” (Porter, 1995). In the context of those early days, cost-benefit analysis was considered to be a “coordinating decision rulethat could solve collective action problems and lead to outcomes that were both fair and efficient” (Porter, 1995). In the 1950s, cost-benefit analysis entered the purview of economists, and various tests were applied to the concept. For example, the Kaldor-Hicks criterion was applied to cost-benefit analysis in an attempt to separate equity form efficiency. This construct, proposed by Kaldor (1936) in the 1930s, argued that “decision makers [should] address sentiments regarding equity outside the purview of CBA” (2006, p. 6). The problem with this separation of equity and efficiency was that it left “unaddressed matters of equities for identifiable peoples or groups, or sentiments attached to particular projects that cannot be handled by macro policy; equity and justice are particular as well as general” (Weimer & Vining, 1992, p.111). The evolution of the construct of cost-benefit analysis brought about a mainstream view regarding its application — taken to its reasonable extension — which was assumed to be characterized by “the omission of values represented by moral sentiments[and as] a mechanism to provide the answer rather than an approach proving information as part of an ongoing discussion” (Zerbe, 2007, p. 10).

Separate from this summary of the evolution of cost-benefit analysis, is the consideration of its adoption by mainstream policy makers and policy analysts. Cost-benefit analysis was officially endorsed by President Reagan’s Executive Order in 1981 that required all major federal initiatives to undergo Regulatory Impact Analyses (Zerbe, 2007, p. 2). Then in 1994, President Clinton issued an Executive Order that “confirming the government’s commitment to CBA [cost-benefit analysis] and highlighting the partisan support for CBA in federal regulatory decision-making” (Zerbe, 2007, p. 3). It is important to note that Congress has not issued comprehensive legislation requiring formal and broad use of cost-benefit analysis, yet its use by the government is nonetheless apparent in many levels of decision-making (Zerbe, 2007, p.3).

Proposal improvements. That the authors consider and present their argument through a single approach to policy implementation evaluation is the most glaring of the proposal’s weaknesses. Robust policy analysis often requires an evaluation of the goodness of fit between the policy being evaluated and the tools by which one carries out the evaluation. By way of example, consider here the three disparate approaches to contemporary public administration are managerial, political, and legal. The managerial approach emphasizes “economics, effectiveness, and efficiency” (Bemelmans-Videc, 2003). The political approach underscores “accountability of elected officials, representativeness, and political responsiveness” (Bemelmans-Videc, 2003). And the legal approach stresses “equity, substantive individual rights, and procedural norms of due process” (Bemelmans-Videc, 2003). By extension, these public administration approaches can be used to frame policy implementation, and the evaluation of policy implementation.

Cost-benefit analysis is one of many policy tools, and as such, it falls cleanly into the managerial approach to administration with an emphasis on measuring effectiveness and the associated economic factors of implementing the homeland security programs. However, several of the most substantive drivers of the homeland security and protection policies are those found in a political approach to policy implementation.

Field and academic use of proposal. The study seems to hold greatest value as a tool for future evaluation of the political will of stakeholders in the homeland security / national protection arenas. The emphasis on economic variables will be of interest to the current administration and particularly to the Office of Management and Budget (OMB). The present administration under President Obama has exhibited interest in federal programs that show promise of a high degree of net social benefit, not all of which can or should be measured in economic terms. The article helps to create a forum in which discussion about threats to the existence of national security are addressed in a balanced way that includes matters of ethics, morality, and the many other value-laden attributes that cost-benefit analysis was developed to screen out. Zerbe addresses the perceived deficiencies of cost-benefit analysis by making a distinction between old and new versions of cost-benefit analysis. In his words,

“new benefit cost-analysis” (new CBA) as distinguished from mainstream CBA. Such a foundation rests on legal rights and also amends the failure of CBA to include moral sentiments, which arose in the attempt to avoid interpersonal comparisons. This amended legal foundation largely vitiates the extreme positions that have come to dominate thinking about CBA’ (Zerbe, 2007, p. 6).

The potential for misuse or misunderstanding about both the analytical processes and framework, and the data produced through their application, is enormous. The dynamics surrounding 9/11 continue to churn, nearly ten years after the catastrophe, and the ramifications are still globally experienced. The magnitude of the event on the fears and quotidian concerns of the populace is perhaps greater and more enduring than any American event short of outright war. Numbers alone, financial equations alone, cannot address what continues to be a collective and visceral response. As Zerbe puts it, “There are two issues raised here. One is the value of the use of benefit-cost analysis (CBA) and the other is to what extent to which its use can be protected from destructive effects of the political process” (2007, p.4).


Bemelmans-Videc, M., Rist, R.C., and Vedung, E. (2003). Carrots, sticks, and sermons: Policy instruments and their evaluation. Piscataway, NJ: Transaction Publishers. Retrieved, Nicholas (1939). Welfare propositions in economics and interpersonal comparisons of utility. Economic Journal, 49 (195), 549 — 552. doi:10.2307/2224835.

Porter, T.M. (1995). Trust in Numbers: The pursuit of objectivity in science and public life. Princeton, NJ: Princeton University Press. Retrieved / philosophy/articles/sayers/porter.pdf

Source Watch (2011). [Website] Retrieved

Watkins, T. (n.d.). An introduction to cost-benefit analysis. San Jose State University, Department of Economics. [Lecture notes]. Retrieved / faculty/watkins/cba.htm

Weimer, D.L. And Vining, A.R. (1999). Policy analysis: Concepts and practice. Upper Saddle River, NJ: Prentice Hall. Retrieved,+1992&dq=Weimer++Vining,+1992&hl=en&ei=5rbATd63MoSisQPP48ngBw&sa=X&oi=book_result&ct=result&resnum=1&ved=0CCoQ6AEwAA

Zerbe, R.O., (2007, September). An ethical benefit-cost analysis: Cost-benefit analysis of regulations. The Evans School of Public Affairs and The Law School, University of Washington. [Paper presented at Cost-Benefit Conference, Lessons Learned, Future Challenges, at The Searle Center, Northwestern University School of Law].

Conservatism in Accounting Valuation Paper help me with my history homework

Conservatism in Accounting Valuation

Accounting is used to determine the financial health of a business or individual. As such, it is carefully regulated and those who practice it for compensation are required to have education and certification. There are various rules, laws, and principles that govern the business of accounting and that are commonly used in order to ensure that those who work as accountants are handling others’ money and financial information correctly. Because there are only a few accepted methods of accounting, it is possible to learn them all and determine which one of them would be best for a client. That way, an accountant can help his or her client save the most money on taxes and create an accounting system that can be more easily used and dealt with by accountants for the company in the future. Among the principles that are often seen in the accounting profession is the conservatism principle, which will be the focus of the information presented in the following pages.

1.1 Conservatism Principle

In short, the conservatism principle says that, when an accountant has the opportunity to choose between two specific solutions, he or she should select the choice that will be the least likely to overstate the individual or company’s income and assets (Ball, Kothari, & Robin, 1999). Furthermore, the principle indicates that expected gains should not be counted as gains, but expected losses should be counted as losses. Based on this, when stock closes it is valued at the market price or the cost price, whichever is less (Ball, Kothari, & Robin, 1999). Doubtful or bad debts have their own provisions, but each debt that is expected to occur is counted in order to underestimate how much money the company may have earned or will see as its bottom line. When the recognition of gains is delayed and expected losses are acknowledged promptly, it is much easier for the company or individual to see where there are problems – and that will often allow the company to realize a final number better than what was anticipated by the accounting system they have in place and by the accountants who work for that company.

1.2 Widely used

Conservatism has been adopted in accounting because of the benefits it provides to agents that use, prepare, and/or regulate financial reporting (American, 1939). When a financial manager or accountant provides information to a client, and then the client sees later that his or her company or portfolio has actually performed better than expected, that is obviously good news. By using conservatism, it is easy to be realistic about the debts that are being incurred and the income that is coming in without overestimating income and ending up with figures that paint an inaccurate picture of the company’s or individual’s actual financial concerns. Accountants must be open and honest with their methods, and must follow accepted practices. Despite that, however, there are ways in which they can use those practices to underestimate or overestimate the income and assets of a client (Chadwick, 2000).

Overestimating can be troublesome and can lead to problems with the bottom line (Ahmed, et al., 2001). Underestimating is a better option, because it requires clients to operate in a more conservative financial manner and that means they will usually have more savings to enjoy instead of having more debt and less money than they anticipated. All of the approved and commonly-used ways of handling accounting are legal and acceptable, but that does not mean that they are all as valuable or that they all work as well as some of their counterparts. When accountants debate with their clients which method to use, conservatism is the most commonly suggested method because of the benefits that it is able to provide to the client (Ahmed, et al., 2001). A good accountant can discuss those benefits and show his or her client the value behind the method he or she proposes, so that everyone is on the same page financially.

The use of conservatism is long and highly significant, with evidence of the practice dating back over 500 years (Ahmed, et al., 2001). It has also been rated as the most significant and influential practice in accounting. Recent research has provided insight into the fact that accounting valuation has actually become even more conservative recently, which is surprising since there are so many who are very vocal in their opposition of the practice. Because the practice is resilient to criticism and has been widely used for such a long period of time, there are indications that critics are missing many of the benefits that others are seeing when it comes to this style of accountancy.

In order to determine why this is the case, however, what those benefits actually are must be determined. If conservatism is simply avoided, the concern is that doing so could have a detrimental effect on accounting in general, and that it would be problematic for anyone who was used to conservatism in their accounting practices.

2. Overview of Conservatism

In order to clearly understand conservatism, it is important to address the four perspectives that are included within it. That way, it is easier to see the issues that are being faced by the accountants who choose to use conservatism and one can better determine the merits of that option. As such, there will be four perspectives of conservatism discussed here, encompassing contracting, litigation, income tax, and regulatory issues. By addressing them all, a more complete picture of how conservatism works in accounting and how it is able to include all aspects of the accounting profession can be seen. If only some of the principles are addressed, that can make it more difficult to show the value of conservatism when it comes to accountancy and can also make it more difficult for accountants to justify the use of that particular style when they provide services to others.

2.1 Four Conservatism Perspectives

As has been mentioned, there are four perspectives included in conservatism. Each one of them will be addressed here and discussed thoroughly, to form a better and more complete picture of the principle.

A. Contracting perspective

The majority of contracts that are seen between parties to an accounting firm use numbers that help to reduce the agency costs that are specifically associated with that firm (Brooks & Buckmaster, 1976). That can include contracts that are seen between the firm and the holders of debt, employment contracts, contracts for management compensation, and cost plus sales contracts. Any of the parties to a contract generally expect (and often demand) the measures of performance as well as net asset values are provided in a manner that is timely. Being timely helps to avoid outcomes that can otherwise be dysfunctional.

In contracts, earnings are used in order to restrict the dividend payments to the shareholders and keep a minimum level of assets within the firm so that there is backing for the level of outstanding debt that firm has (Bliss, 1924). Whether earnings decrease or increase, reporting that information in a manner that is timely helps to ensure that shareholders are provided with the right information. It can also help the firm manage its debt correctly, because creditors will be more aware of the level of debt the firm has based on its earning power and assets – which can affect issues such as credit ratings and the percentage of interest the firm will be asked to pay on any new or refinanced debt.

When a company estimates what its earnings will be in the future, there is no way to verify that information. It may end up being correct, or it may be far off in either direction due to something unexpected that takes place in the future. Since that is the case, it is highly possible for a company that is not using conservatism in accounting valuation to end up in financial trouble. By making sure conservatism is used, no verification is necessary because there is no speculation. Everything that is claimed as income and assets has already been acquired, and anyone wanting to verify that can easily do so.

B. Litigation Perspective

The idea of litigation under the Securities Act generally encourages the idea of conservatism (Antle & Lambert, 1988). The reason behind that statement is that litigation is far more likely to be seen by the overstatement of assets and earnings instead of the understatement of that information. Since the costs of litigation are expected to be much higher with overstatement than with understatement, it is wise for firms to err on the side of caution and significantly lower their litigation risk and the costs which are associated with that risk. The lowering of that risk is a good incentive for auditors and management to understate both the net assets and the earnings that are held by the company.

Unlike the contracting perspective, which dates back hundreds of years, the litigation perspective only goes back to 1966 in the United States (Antle & Lambert, 1988). That was the year that significant changes were made in the Securities Act and the rules for bringing class action lawsuits were adjusted and modified. Because of those changes, it became more important from a litigation standpoint to ensure that conservatism was used in accounting valuation. Because there are empirical differences between the contracting and litigation perspectives, there have been many discussions regarding them in the past and that will likely continue well into the future. Each accounting firm must do what it feels is in the best interest of both itself and its clients, but the avoidance of lawsuits is a highly significant issue to consider when a company is planning to focus on a particular accountancy option.

C. Income Tax Perspective

Because income taxes are so closely tied to earnings, it only stands to reason that there would be an accounting valuation issue as it relates to conservatism where income tax is concerned (Ball & Watts, 1972). Income taxes often influence how earnings are calculated. Depreciation, for example, must be recorded as an expense now, due to changes requested by the U.S. Treasury. If it is recorded that way in any and all reported financial statements, that makes it possible for it to also qualify as tax deductible. Now that the depreciation laws are so well established they no longer influence taxable income – but the accounting laws still have a strong effect on how the taxable income of any company or individual is reported (Ball & Watts, 1972).

There have been many court decisions over the years that have also served as precedents for the ways in which income reporting and other accounting issues have been handled. As long as a firm is showing a profit and has taxable income and positive interest rates, there is an incentive to defer income so that the present value of taxes can be reduced. This leads to the understatement of assets in many cases, so that taxes will be lower and the company will not have to pay out as much to the IRS. This may sound illegal, but it is not. The income will be properly reported when it is received and is not hidden. It is simply not reported on anything as a speculation and is kept off of the books until it is actually acquired. In this sense, the income tax perspective shares much with the contracting perspective, as both are interested in minimizing current assets for various reasons.

D. Regulatory Perspective

Regulators and those who set standards have reason to be conservative, because they know that overvalued assets and overstated income (and the losses that those things frequently produce) are more easily seen by others than foregone gains due to the fact that everything was understated and undervalued (Beaver, 1993). That does not mean that understating things will never be noticed, but only that it is less observable – and viewed as far less of a problem. It is one thing for a company to make more than the market was expecting, but it is quite another thing entirely for that company to make less than the market had planned.

Making more indicates that the company was actually doing better than anyone would expect. Making less indicates that the company was not performing well, but that it was trying to convey a good performance until it was no longer able to do so (Beaver, 1993). There have been several cases of companies doing this illegally in the past, but there are more legal ways for something like that to occur, also. Avoiding that is by far the best choice for companies, all of which should be focused on handling their earnings in a conservative manner.

Accounting overvaluation was even blamed for what took place in the Stock Market in 1929 (Beaver, 1993). Since history has shown how badly that turned out, there are more and more regulatory bodies that are leaning toward the idea of remaining conservative with virtually any and all accounting practices.

2.2 Empirical Approach

In order to address the empirical approach to this issue, it is very important to understand that there are two different types of conservatism: unconditional (balance sheet) conservatism, and conditional (earnings) conservatism. These are very different in how they are used, and those who work in accounting must be clear on the differences so that both approaches can be used properly. Without using a specific kind of accounting approach correctly, a company can easily have a problem where its assets are concerned.

In unconditional conservatism, there is a greater focus on the expense of the costs of most intangibles (Benston, 1969; Carhart, et al., 2002). For example, this could include the costs for research and development, intellectual property, and other things that are generally not seen and are not part (in a sense) of the finished product or service. Intangibles are not things that the company can touch, but they are certainly very real and they have to be clearly and properly addressed in order to be used by the company as a savings device where accountancy is concerned.

When looking at the balance sheet, is the company really including all of the costs? Are intangible costs being included, and are they being priced fairly and equitably? If they are not, they certainly need to be. Research and development, as well as other intangibles, are expenses that are seen by the vast majority of companies – and those companies will want and need to show those as real expenses when and as they occur (Basu, 1995; Basu, 1997). If they have paid money out for something, or if they have acquired a debt in relation to something intangible, showing that right away is vital to proper conservatism in accounting.

With conditional conservatism, there is less of a focus on the balance sheet and the costs, and more of a focus on the earnings side of the issue (Basu, 1997). Conditional conservatism can help to balance out the asymmetry that is often seen in recognition of earnings and that is also often present with unrealized gains and losses. Impairment of assets would be one example of this. If assets are not functioning correctly and cannot be used (i.e. broken, malfunctioning, or obsolete equipment), they can quickly change from providing gains to providing losses for the company who must repair or replace them.

By having timeliness in both gains and losses, a company is better able to show how its financial bottom line really looks to Wall Street and to potential investors and creditors (Ball, Kothari, & Robin, 2000). The goal is to be honest about finances, but also to paint the company in the best possible, legal light. There are ways to do that, and conservatism is one of those ways. By keeping accounting both timely and conservative, any company can have a bottom line that speaks to what it really has to offer to others and that will not decrease significantly because of unexpected losses or gains that are not realized.

It is never a good practice to show income or assets that have not actually been acquired, or to show ownership of something on which the company still has a debt load. To do so fails to provide an accurate portrayal of the company’s financial strength.

2.3 Theoretical Approaches

There are several theoretical approaches that are seen with conservatism in accounting valuation. One of those is the signaling model. In that model, investors in the market use the signals that are picked up based on the decisions that the manager makes (Ball, Kothari, & Robin, 2000). From those decisions, the investors are able to infer more private information about the firm. That can lead them to predict the future value of the firm more easily. There are still no real easy ways to make predictions about how a firm will perform, however, because there may be other influences that are not seen or noticed by investors.

Still, the signaling model is relatively reliable and is one of the best ways to gain information and make decisions when one does not work in the inner circles of a company or have any kind of inside information as to what the company might do in the future. The signals that are given off by the managers in the decisions they make can be very telling for someone who is good at deducing those kinds of things, but it takes practice and analysis in order to discover what the managers are really doing based on the decisions that they are making.

Sometimes, they appear to make decisions that do not seem to be in the best interests of the company. When that is the case, investors may need to sit back and wait to see what the manager will do next. It is possible that the decision was part of a greater (and often very effective) plan that the investors cannot see from their viewpoint, so speculation may have to wait until more information is available.

2.4 Measuring conservatism

There are several different ways in which conservatism can be measured, and they all have value to the accounting profession. Five of those different measures will be addressed here, so differences in them can be seen.

A. asymmetric timeliness of earnings

Earning asymmetrically is part of measuring conservatism (Ball, Kothari, & Robin, 2000). In some accounting models, earnings become overstated because the earnings are placed on the company’s balance sheet as an estimate, before they are actually earned. That is a relatively common practice, especially with large companies on Wall Street. Still, if the earnings that are actually seen when they are acquired are significantly lower than what the company projected, that can spell real trouble for that company y. Failing to meet earnings is one of the biggest problems that companies can have, and one of the best ways to overcome that problem is to focus only on the earnings that have actually been received and not use the estimated earnings as a measure of how much money a company has made. The earnings are not factual until they have been collected by the company, so keeping them symmetrical based on when they are received is the best way to avoid overestimation of earnings.

B. asymmetric accruals-to-cash-flow measure

The income that has been accrued is not necessarily equal to the cash flow. Conservatism reduces the earnings that are reported cumulatively over time, so it has been suggested by some researchers that the magnitude of these accumulated accruals – or even signs of them – are among the ways in which conservatism can be measured (Dechow, Hutton, & Sloan, 1999). For example, if the company was in a completely steady state where no growth was being seen, and there was no conservatism taking place, earnings would converge into cash flows and the periodic accruals would converge all the way to zero. Negative accruals over a long period of time shows a pattern of conservatism, while the rate of those accruals shows how conservatism has shifted in degrees over time. Of course, there are other ways to show conservatism, and it does not have to be a method that involves accruals and cash flow.

C. market-to-book ratio measure

Some researchers use market to book (or book to market) ratios in which to measure conservatism (Dechow, Hutton, & Sloan, 1999). These researchers look at cross sectional data and pooled time series. Using that information, they can regress the market to book ratios for each year individually and look at dummy variables and stock returns for the current year and the five years previous to the current one. The differences between the firm’s market value and book value of equity are considered, and the lower the coefficient the more the firm is thought to be conservative. Of course, the coefficient measures only the relative conservatism and cannot be used to measure aggregate conservatism (Beneish & Press, 1993). It can, however, show the extent to which the conservatism across firms actually varies. Conservatism can be varied, because some firms are more conservative than others, but market to book ratio is a good way to measure that level of conservatism and see how one firm compares to another.

D. hidden reserve measure

Do companies hide their reserves? Legally, they must declare all of their income and assets (Beneish & Press, 1993). However, that does not mean that there are not any ways in which reserves can be built up or protected. One of the ways to do that is through conservatism, because the accounting firm can use this method in order to make sure the company is not showing income and assets that they have not yet acquired. When companies avoid listing anticipated earnings, they set their expected earnings much lower. That means that Wall Street and investors also set that company’s expected earnings lower. Since that is the case, the company may end up with a higher level of earnings than what it was actually showing. That can allow it to “hide” its reserves, or surplus income and assets, because they were not expected of it in the first place – and that can mean that the company has more to its name than most people think, even though it is not hiding anything for tax purposes.

E. negative accruals measure

Negative accruals are another way that conservatism can be spotted in a company or an accounting firm (Beneish & Press, 1993). When the company does not appear to be accruing anything, and instead appears to be losing money or going backward financially, it is possible that the company is actually being too conservative with its accounting. The odds are high that it is actually making some money, or it would not still be in business, but its balance sheet or income tax statements may show that it is not making money because there are too many expenses and debts being recorded and not enough areas of income (Beneish & Press, 1993). The company may look that way on paper because it does not want to overestimate its earnings, but may have enough income to survive and may beat investor estimates of its earnings.

3. Effects of conservatism

How does conservatism affect accountancy and the assets and debts that are seen by companies and firms? There are three ways in which conservatism affects accounting – earning quality, capital markets, and contracting efficiency (Ahmed, Morton, & Schaefer, 2000). All three of these issues will be addressed here, because it is important to realize how far-reaching the effects of conservatism may actually be when it comes to accountancy and what accountants can provide to companies who wish to use conservatism as the method of accounting that is right for their company. Not all companies choose that method, but it has been proven to be effective and to have mostly positive effects on a company’s bottom line.

3.1 Earning quality

The earning quality of a company is significant when it comes to investors and how they feel about the value of the company in which they are considering investing their funds (Ahmed, Morton, & Schaefer, 2000). If a company is meeting or exceeding its Wall Street expected earnings, then it would appear that the company is doing well. The cash flow is good, the number of assets is high, and the company is performing as well as to be expected. Sometimes, companies actually perform better than Wall Street expects, which can allow that company to enjoy a higher number of investors as well as a lower interest rate when it borrows money. There are other perks, as well, and they mostly depend on the company and what that company wants to do with its income, assets, and debt levels.

If a company is not meeting Wall Street expectations, that company can have trouble getting credit at a lower rate and can also struggle with getting investors for new projects and advancements. Companies in that predicament may actually be doing quite well, but if they set their estimated earnings too high and then fail to meet them, they can appear as though they are performing poorly (Ahmed, Morton, & Schaefer, 2000). Certainly, that is not a good thing for any company to have to deal with, so the best thing that a company can do is try to avoid allowing that to happen. One of the best ways to avoid that is to make sure that the company underestimates its earnings. Then the company will not fall short of the estimate – and that underestimation of earnings can be done through conservatism in accounting. There are other ways to help a company appear better on paper, but conservatism in one of the easiest and most common ways to do so – and it is often also very effective.

3.2 Capital markets

Capital markets are also affected by the conservatism seen in accounting valuation (Beaver & Ryan, 2000). When a company underestimates its earnings and shows lower asset levels, it is not valued as highly because it does not appear to have as much capital. However, when it then exceeds its reporting, it is seen to be more valuable because it looks as though it performed better than expected. This is a game, but it is legal, accepted, and done quite often. Unfortunately, there are some problems with using it that the advocates of conservatism fail to realize. One of these is the damage that is being done to the information environment. Although conservatism in accounting is completely legal, it is also deceitful in that it does not portray information about the company in a light that is completely realistic and honest. Companies are made to look bad so that they can then be made to look good by doing “more” than what was expected of them – except it is not actually more, it is just made to appear that way.

Another concern about the effects of conservatism on accounting is that the forecasts that are given by analysts are called into question when companies use accounting methods that hide some of what they expect to earn. In many cases, these companies are very good at estimating their actual earnings, but they end up underestimating those earnings because they want to exceed the expectations of others so that they can be viewed more favorably in the marketplace. This also lowers the cost of capital for them, because they are able to get better deals and lower interest rates based on the strength that they have in their financial information (Beaver & Ryan, 2000). Giving credit where credit is due makes perfect sense, but only in the context of that credit really being due – and not just looking as though it is due based on practices that make businesses appear to be doing better than they are in fact.

3.3 Contracting efficiency

It can be more difficult for companies to reach outcomes that are mutually beneficial if both companies are not able to put all of their cards on the table (Beatty, Ramesh, & Weber, 2002). That is true no matter who the contracting parties are, and is often seen when it comes to company negotiations where one company vastly outweighs the other one in financial issues, income, clout, or anything else. When one company uses conservatism and the other does not where accounting practices are concerned, it can be highly difficult to determine the true value of both of those companies and what they can bring to the table where negotiations are considered (Beatty, Ramesh, & Weber, 2002). In other words, how can companies really tell how equal they are when their accounting practices are completely different? It is not an easy thing to determine the quality of both of the companies as they relate to one another, and that can be frustrating for any company that is negotiating with another company.

4. Conservatism in U.S.. GAAP vs. IFRS

There are some differences in conservatism rules and regulations that have to be considered, as well. Mostly, however, the main difference is that GAAP has been seen getting more conservative over time, where IFRS has not (Ball, Robin, & Wu, 2002). Evidence of conservatism is much stronger in GAAP, and over the last thirty years or so that has been more obvious. The IFRS is not as conservative and has never been, so that is something that is very important to consider when companies look at working with other companies that may not be required to follow the same kinds of accounting rules (Ball, Robin, & Wu, 2002). There is nothing wrong with doing business with these companies, but understanding how they handle their accounting and if there are any specific issues that should be considered is important.

5. Conclusion and Implication

As can be seen, there is a lot of information to take in when it comes to conservatism in accounting valuation. This paper mostly touched on the surface because there was not space to go into detail on each one of the issues that are being seen in accounting today where conservatism is concerned. However, enough information has been provided to show that conservatism has been changing over time, and that it is getting more pronounced – especially within the United States. International standards are not as strict or conservative, so companies doing business across countries, cultures, and borders should be aware of that before they make decisions about whether to buy out or merge with a company that is located (and pays taxes) in another country.

One of the main implications for conservatism in accounting valuation is the way in which that type of accounting practice focuses on the underestimation of earnings and assets. The method behind that is quite legal, in that it simply shows all of the debts and expected debts, while showing only earned income and not expected income. By doing that, the accounting firm is underestimating the level of income the company will probably have, but that is good in some ways because it makes the company exceed expectations overall. Still, there are valid concerns about making things seem less than they are where expected earnings are addressed. Companies that do not appear to have good earnings may not be able to get credit easily, and they may have to pay more for interest and other debt markers. When they exceed their earnings, they can then more easily get better interest rates and more credit more easily. That is one of the big factors where conservatism is concerned.

Overall, conservatism is becoming more common in the United States, and that is a trend that has been seen for approximately the last thirty years. Conservatism in accounting has been around for much longer, but has not been as obviously used until recently. Some of the regulations that changed in the last thirty years have made things more secure for companies, and have also made it easier for them to consider conservatism in order to avoid some financial problems. Litigation was a particularly problematic issue for companies that were focused on overstating or overestimating their earnings, and companies that do not want to have to worry about that are much more likely to practice being conservative so that they do not need to have as many worries about whether they can be sued because they failed to meet the expectations that they had set forth.

In the future, it remains likely that there will be further conservatism measures taken for companies in the U.S., but unlikely that will transfer to the rest of the world. United States companies must be aware of what they can and cannot do when it comes to accounting rules and regulations, and they rely on their accountants to handle that for them. Still, the more they understand about accounting rules the better off they will be, because even the best accountants can make mistakes. As the rules change and conservatism becomes more the norm despite its critics, individuals and companies that use accounting firms should learn about the changes in the rules and how they will be affected by those changes, so that they are better able to handle any issues or concerns that come their way. Overall, conservatism in accounting makes sense for the majority of companies in the largest number of cases. However, there are always exceptions to the rule and it is a good idea to check with an accounting firm to determine the best type of accounting method for a business.


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Ahmed, A.S., R.M. Morton and T.F. Schaefer. 2000. Accounting conservatism and the valuation of accounting numbers: Evidence on the Feltham-Ohlson (1996) model. Journal of Accounting, Auditing & Finance 15 (Summer): 271-292.

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Ball, R., A. Robin and J.S. Wu. 2002. Incentives vs. standards: Properties of accounting income in four Asian countries. Working paper, University of Chicago.

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Netflix Implementing Activity-Based Costing history homework help: history homework help


ABC at Netflix

To; CEO Netflix

From; XXXX

Re; Move to Activity-Based Costing (ABC)

Activity-based costing has the potential to increase transparency in accounts, compared to absorption costing. Activity-based costing breaks down of the different tasks into the different elements, determining the costs of each activity to create a product or service. This breakdown of costs can them be used to allocate costs for the production process and give an accurate picture of the costs associated with producing each item or serving each customer (Innes & Mitchell, 1998).

Variable costs are easy to allocate to the different products or customers, the greatest value from activity-based costing is the way that fixed, or indirect costs, can be assessed and allocated based on the actual usage. Netflix may benefit from this approach due to the high level of fixed costs and low level of variable costs that are associated with providing the media streaming services. The ability of the firm to assess costs for the service provided, such as serving each customer each month, may allow for better quality input information to the pricing decisions (Innes & Mitchell, 1998).

There are a number of fixed costs, or indirect costs, that need to be assessed. By looking at some of these costs and how they may be allocated in line with activity-based costing the value of the system may be realized. The breaking down of the costs will then allow the firm to assess the cost associated with each customer. These five examples utilized maybe argued some of the most critical to the company’s success, as they deal with the main operational aspects of providing content, delivering it to the customers, collecting payments, looking after customers as well as ensuring the company’s reputation is maintained for security. If any of these elements failed, it could have a significant impact on the company’s sales, as customers would potentially even go elsewhere.

Content Licenses

The firm sells monthly subscription for the users to access televise programs and films. The provide access the firm has to buy the content. These licenses are usually purchased for a fixed amount for several years (Netflix, 2013). The cost is high, but could be allocated based on the number of downloads. The company will project how many times the program or film is expected to be streamed. The total cost of the license, including all the costs associated with the acquisition as well as the license cost itself, may then be divided by the total number of expected downloads or streaming occurrences. For example, if a license costs $500,000 and it is expected that the TV program of film will be streamed 5 million time, the allocated cost will be $0.10 per download.

Internet Access Costs

The firm will have costs associated with access the internet and providing the content. The costs are an overhead, but as the number of users increases and more content is streamed the firm needs more bandwidth. As the costs are incurred on the streaming, the costs may be calculated as a total and then divided by the megabit that is streamed, and then allocated by the megabit that is streamed.

Banking Fees

The firm has to pay fees for the operational banking services, including the collection of the direct debits. The cost of these banking services may be divided by the number of transaction. So, the cost of collected the direct debits should be divided by the number of direct debits which are

The Solutions to Accounting, Finance Problems history assignment help online

Accounting and Finance

Determine the costs that should be capitalized in the machinery account

Capitalization is the act of recognizing costs that provide a future economic benefit by setting up an asset account (Power Point). The costs that should be capitalized include:

Cost of raw materials used during trial runs of machinery $1,000

Additional materials, lumber, steel, and other supplies needed in installation $35,400

Wages paid to company employees to help unload and install the machinery during regular working hours $10,500

Trucking expenses related to the rigging company, which disassembled the machinery in Kentucky and transported it to Pawtucket $104,783

Legal bill related to writing the contract for the equipment $3,000

For any cost that was not capitalized, explain your reasoning

Cost to repair damage from machinery dropped from truck during unloading — This cost is not included because it is self-inflicting by the company, or rather internally generated cost

ii. Cost of advertising the company’s new manufacturing capability in national trade magazines. This cost will only be of benefit for a designated period and not for the economic life of the machinery iii. Casualty insurance policy on new machinery. This cost will only be of benefit for that period and not for the economic life of the machinery

iv. Interest paid on note to bank used to finance the purchase of machinery. This cost will only be of benefit for that period and not for the economic life of the machinery

c. Determine the depreciable cost of the machinery

The depreciable cost of the machinery includes the cost of purchase and also set up and expenses linked to the machinery

200,000 + 3,000 + 104,783 + 10,500 + 6,000 + 35,400 + 5,540 + 3,000 + 1,000 + 30,000 = $399,223

d. Compute the depreciation expense for 2001 and 2002 using straight-line depreciation

Depreciation = Depreciable Cost / Number of Useful asset years

= (399,223 — 30,000) / 20 years

i. Annual expense for 2001 is $18,461.15 x 3/12 = $4,615.29

ii. Annual expense for 2002 is $18,461.15

e. Compute the depreciation expense for 2001 and 2002 using double-declining balance depreciation

The depreciation under double declining method is calculated as:

Depreciable Cost / Asset’s useful life in years x 2

Depreciable Cost = (original cost – accumulated depreciation)

i. Depreciation expense for 2001

Accumulated depreciation for 2001 = 0

= ((399,223 -0) / 20) x 2

= $39,922.3

ii. Depreciation expense for 2002

((399,223 -39,922.3) / 20) x 2

= $35,930.07

f. Assume that, during 2004, a large oven used to dry decorated prices needed a major repair costing $20,000. Should the cost of the repair be capitalized? Why or why not?

The cost of the large oven repair should be capitalized. This is because the repair can be classified to be an extraordinary repair, which implies that it is nonrecurring. Therefore, the cost should be added to the cost of the machine because the benefit that will arise will be more than just that particular period or year.

Chapter 13

Problem 13-5

a. What was the average issue price of the preferred stock as of December 31, 2004?

4,000 + 480 = 4,480

4,480,000 / 40,000 = $112

b. How many shares of common stock are outstanding?

Outstanding common shares = 1,000,000 (authorized) — 600,000 (issued) — 50, 000 (held at treasury)

= 350,000 shares of common stock

c. What journal entry was made when the common stock was issued?

Dr: Cash 600,000

Cr: Common Stock 600,000

d. If all of the treasury stock was reissued for $400,000, what journal entry would the company make?

Dr: Cash 400,000

Cr: Common Stock 50,000

Cr: Additional Paid in Capital 350,000

e. What is the amount of the total dividend requirement on preferred stock annually?

Total dividend required = 7%

= 7 / 100 x 40,000

= 280,000

f. Assuming that there are no dividends in arrears, if the company declared a total cash dividend of $580,000, what would be the dividend per share for the preferred and common stock?

i. Preferred Stock

280,000 / 40,000

= $7 per share

ii. Common Stock

580,000 — 280,000 = 300,000

300,000 / 600,000

= $0.5 per share

g. Assume the company’s common stock is selling for $80 per share. What journal entry would be made if the company issues a 10% common stock dividend?

600,000 x 80 = 48,000,000

10% of 48,000,000 = 4,800,000

Dr: Cash 48,000,000

Cr: Common Stock 600,000

Cr: Dividend 4,800,000

Cr: Additional Paid In Capital 42,600,000

h. Compute basic earnings per share if the company’s net income was $1,560,000 during 2004. Assume no new shares were issued during the year

Earnings per share = (Net Income — Preferred Dividends) / Weighted Average Common Shares Outstanding

= (1,560,000 — 280,000) / 650,000

= 1,280,000 / 350,000

= $3.68 per share

i. Refer to the original data. Assume the company declares a 3-for-2 stock split. How many shares of common stock would be outstanding after the split?

3/2 x 1,000,000 = 1,500,000

3/2 x 600,000 = 900,000

3/2 x 50,000 = 75,000

Shares outstanding would be 1,500,000 — 900,000 — 75,000

= 525,000 shares outstanding

j. Refer to the previous requirement. What effect would the stock split have on the company’s income statement, balance sheet, and statement of cash flows?

The stock split would have an effect on the income statement because the earning per share of the shares decreases in figures but not in value. This is because of the increase in the number of shares outstanding. On the other hand, the balance sheet is affected simply because after the stock split the market capitalization of the company changes as well and this has to reflect on the balance sheet. Lastly, the statement of cash flows is affected by the stock split because the company has to show the flow of money in the investment aspect of the company and it has to reflect in the financial statatements.

k. If the stock market reacts rationally to the stock split, what would you expect the stock to be selling for after the split? Assume the stock was selling for $80 per share before the split

2/3 x 80 = 53.33

Every Share after the stock split would sell for $53.33 per share

Chapter 14

Problem 14-4

a. Compute income tax expense for 2004 under GAAP

Income tax expense for 2004 = 40% x 800,000 = 320,000

b. Determine the amount of income taxes payable that would appear in the balance sheet at 31-31, 2004.

Balance b/f 11,000

Tax payments (340,000)

Tax payable 2014 320,000

Tax payable as at 31 Dec 2004 (9,000)

c. Identify the amount of net income after taxes that the PF Company will report in its 2004 income statement

The company made tax payments of 340,000 in 2014

800,000 — 340,000 = 460,000

d. Prepare the entry at December 31, 2004, to recognize income taxes

Income Tax Expense 340,000

Deferred Taxes 9,000

Income Tax Payable 331,000

e. Identify the amounts of deferred tax assets and deferred tax liabilities that will be presented on PF’s December 31, 2004 balance sheet. Will these deferred tax assets and liabilities be presented as current or long-term?

Deferred tax asset of $9,000 will be presented on the balance sheet of PF as at December 31, 2004 and will be presented as current. On the other hand, deferred tax liability of $200,000 contingent loss will be presented as long-term on the balance sheet of PF