Discuss the effect, if any, each of the following should have on the recognition of future events: a. The probabilistic nature of future events b. Management intent c. Conservatism d. Future economic conditions e. Future legal requirements
What will be an ideal response?
ANSWER:
a. The probabilistic nature of future events is the major problem underlying future events and their impact on event recognition. An example occurs in SFAS No. 5 relative to loss contingencies, which should be recognized when the loss becomes “probable” as opposed to being merely “reasonably possible” or “remote.” It is not clear what probability percentage should be attached to the concept of “probable.”
b. Management intent should not be a basis of event recognition. Not only can management intent change, but its interpretation can be subject to agency theory considerations. Considering management intent could result in lower comparability.
c. Beaver stated that there may be a comparative advantage to reporting “bad news” (conservatism) through financial reporting as opposed to other sources for dissemination of financial information. There could be an overall favorable bias built into the reports of the financial analyst. Hence, accounting conservatism could be adding a balance to the totality of financial information flowing to users.
d. Changes in future economic conditions should not be predicted unless compelling evidence is present relative to future changes. For example, unless future tax rate changes have been enacted into law, future tax rates are assumed to be the same as current tax rates.
e. Future economic conditions should not be predicted unless they have already been enacted.
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