Applied Research in Financial Reporting: Text and Cases

1
Applied Research in Financial Reporting Text and
Cases

• Chapter 3
• The Case Research Approach

2
Chapter Issues

• Definition of a Case Study
• Case Based Research
• Case Development Research
• Sources for case development
• Case Analysis Research
• Differences with problem/exercise approach
• Simple vs. complex cases

3
Case Study Definition

• A case study is a documentation of a real world
  situation
• It focuses on problem situations in need of
  research and resolution
• Can be very detailed covering various functional
  areas (e.g., accounting, marketing)
• Can be short covering only one functional area
  (e.g., accounting)

4
Case Development Research

• Requires field work
• Researcher must have the requisite knowledge and
  experience of the field
• Researcher must be a careful and unbiased
  listener as well as a good evidence collector
• Researchers must consult multiple sources, also
  called triangulation, for evidence
• A need for a detailed plan of action, or protocol
• Staff must be trained to conduct evidence
  gathering

5
Sources for Case Development

• Archives of accounting firms
• Supplanted with field research
• Archives of the SEC
• Supplanted with field research
• Other sources (e.g., the Wall Street Journal
  reports on companies)

6
Cases vs. Problems/Exercises

• (Exhibit 3-2)
• 1. Information Setup
• 2. Source of Information
• 3. Nature of Questions
• 4. Solution
• 5. Assumptions
• 6. Authoritative Source

7
Cases vs. Problems/Exercises

• 7. Synthesis
• 8. Discussion
• 9. Cognitive Demand
• 10. Justification
• 11. Report
• 12. Documentation

8
Models of Case Analysis

• Analysis of Simple Cases
• These cases have specific requirements similar to
  problems and exercises
• The specific requirements are designed to reduce
  the complexity of the case
• Woodside Recreation, Inc. Is an example

9
Woodside Recreation, Inc. Facts

• Campground, cabins and recreational facilities
  within 3-hours of major cities
• Membership cost of 6,000 plus 30/year
• Use as many times as you want up to three weeks
  each time, but dont make it a year-round home
• Average campsites 300 to be sold to 3000 members

10
Woodside Recreation, Inc. Facts

• Average per site in operation over 3 years 6.8
  members
• Average for all operating sites 5.6 members
• Woodside opens campground when 25-30 membership
  is sold
• Sales during first 3-years average 24, after
  that 2 additional annually
• You can buy with 10 down and pay the rest over
  72 months

11
Woodside Recreation, Inc. Facts

• During the last 3 years, 23 of new members fees
  were received in cash
• Woodside books the entire membership amount as
  revenue
• 85 of revenues are from new sales
• Marketing costs are 45 of membership sales

12
Woodside Recreation, Inc. Facts

• Land acquisition is capitalized and amortized by
  the ratio of membership sold/maximum sites per
  campground
• Land acquisition is reported as Operating Real
  Estate net of an Allowance for Costs of
  Membership Sales
• Installment Contracts Receivables are used as
  collateral for debt.
• Current debt to equity ratio 3.5 to 1.0

13
Woodside Recreation, Inc. Discussion

• Requirement 1 Earnings quality
• defined as correlation of earnings to cash flows
• at issue is whether the reported earnings can be
  sustained over the longer period of time
• Books sales with only 10 down
• Over three years, only 23 have paid cash for
  purchases

14
Woodside Recreation, Inc. Discussion

• Requirement 1 Earnings quality
• This can be fine per APB No. 10 if appropriate
  provision for uncollectible accounts exists
• But aggressive marketing and liberal credit
  granting makes collection questionable
• Allocating cost of land acquisition on the basis
  of expected members/maximum membership
  underestimates amortization cost due to slow
  sales
• Installment sale (SFAS 66) may be appropriate
  (used by analogy to make a point)

15
Woodside Recreation, Inc. Discussion

• Requirement 2 What financials should be changed?
• Use installment sales
• Defer revenue until a certain percentage of the
  contract is collected
• Increase provision for doubtful account
• Increase write-off for land and improvement costs

16
Woodside Recreation, Inc. Discussion

• Requirement 2 What financials should be changed?
• (Dollars in thousands)
• As
  Reported As Revised
• Membership sales 28,000 28,000
• Dues and miscellaneous 5,000 5,000
• Provision for doubtful accounts (5,600)
  (7,000)
• Net operating revenues 27,400 26,000
• Marketing expenses (45) 12,600 12,600
• Land and improvement costs 12,000
  15,000
• 24,600 27,600
• Income (loss) 2,800 (1,600)

17
Woodside Recreation, Inc. Discussion

• Requirement 3 Cash flows
• Signs of trouble
• Installment sales, but 45 marketing expense
• Debt/equity ratio is high at 3.5
• Almost all installment contracts receivable are
  used as collateral for debt

18
Woodside Recreation, Inc. Discussion

• Requirement 3 Cash flows
• (Dollars in thousands)
• 20X3 Cash Collected
• Installment contracts receivable 1/1/X3
  35,300
• 20X3 Membership sales 28,000
• Total to collect 63,300
• Accounts written-off ( 1,500)
• 
  61,800
• Less Installment contracts receivable 12/31/X3
  (45,600)
• Cash collected
  16,200
• Dues and miscellaneous (assumed collected)
  5,000
• 
  21,200
• Beginning allowance 4,200 plus provision 5,600
  less ending allowance 8,300.
• 21.6 million is needed just to cover marketing
  costs (12.6) and land acquisition (9.0)
• Woodside has a cash flow problem!

19
Woodside Recreation, Inc. Discussion

• Requirement 4 Other issues
• Marketing costs are too high
• Lifetime campground sales may be a fad
• The membership fee (6,000) is too high in
  comparison to public campgrounds
• Needs additional members to grow

20
Models of Case Analysis

• Analysis of Complex Cases
• A general model is needed (Exhibit 3-3)
• Identify the Objectives of the Case
• Begin with a set of key words to search the
  literature
• Discuss the literature
• List Alternative Solutions
• Suggested Solution
• Provide supplements, if any
• Provide addendum, if any

21
Cullen Provision Corp.

• Analysis
• Using the Case Analysis Model (Exhibit 3-3)

22
Cullen Provision Corp. Facts

• Returned ham from the Army of 880,000 was
  written off against 20X1 income
• The ham was rejected by the Army, but was not
  returned in time, resulting in spoilage
• Cullen filed a claim against the the Army in
  20X1, but did not disclose it in its 20X1 report

23
Cullen Provision Corp. Facts

• Early in 20X3 (before issuing its annual report
  to public), Cullen settled for 475,000, a
  material amount compared to Cullens income
• Management does not want to report it in its 20X2
  income, because
• it occurred in 20X3,
• has not been received
• IRS will want its share in 20X2
• 600,000 will have to be paid to previous owner

24
Cullen Provision Corp.Identify Case Objectives

• Timing of recognition of the contingent gain
• What if the settlement involves a contingent gain
  or loss?

25
Cullen Provision Corp.Professional Literature

• SAS No. 1, Section 560, Subsequent Events
• SFAS No. 5, Accounting for Contingencies
• ARB No. 50, Contingencies for gain
  contingencies
• SFAS No. 16, Prior Period Adjustments
• CON No. 5, Recognition and Measurement in
  Financial Statements of Business Enterprises

26
Cullen Provision Corp.Discussion

• Objective 1 Timing of recognition
• Per SAS 1, Section 560, recognize in the period
  if subsequent discovery of the fact that the
  condition existed at the balance sheet date
• Otherwise SAS 1 does not require recognition at
  the previous balance sheet date

27
Cullen Provision Corp.Discussion

• Objective 1 Timing of recognition
• Contingency situation per SFAS No. 5
• Gain contingency per ARB No. 50
• OK per CON No. 5 to postpone to 20X3
• OK per SFAS 16 to postpone to 20X3
• But what about the previous owner?

28
Cullen Provision Corp.Discussion

• Objective 2 What if it was a loss contingency?
• Conservatism would have changed the picture.

29
Cullen Provision Corp.Alternative Solutions

• Were discussed in relation to case requirements
• To realize gain in 20X2
• What if it was a contingent loss?

30
Cullen Provision Corp.Suggested Solution

• See Discussion of Objectives 1 2

31
Cullen Provision Corp.Supplements

• None

32
Cullen Provision Corp.Addendum

• None