Solutions to Supplementary Problems from Scott Textbook 6th Edition
CHAPTER 2 SOLUTIONS TO SUPPLEMENTARY PROBLEMS
FROM SCOTT TEXTBOOK 6th edition
11. Several reasons can be suggested why oil company managers have reservations about RRA:
• The discount rate of 10% might not reflect the firm’s cost of capital.
• Low reliability. RRA involves making a large number of assumptions and estimates. While SFAS 69 deals with low reliability in part by requiring end-of-period oil and gas prices to be used (rather than prices anticipated when the reserves are expected to be sold), management may feel that end-of-year prices bear little relationship to the actual net revenue the company will receive in the future. Furthermore, management may be concerned about low reliability of other estimates, such as reserve quantities. • Frequent changes in estimates. Conditions in the oil and gas market can change rapidly, making it necessary for the firm to make frequent changes in estimates.
• Investors may ignore. Investors may not understand the RRA information.
Even if they do, management may believe the RRA information is so unreliable that investors will ignore it. If so, why prepare it?
• Legal liability. Management may be concerned that if the RRA estimates are not realized, the firm will be subject to lawsuits from investors.
Management’s reservations may be an attempt to limit or avoid liability.
12. a. Most industrial and retail firms regard revenue as earned at the point of sale. Since sale implies a contract with the buyer and change of ownership, this is usually the earliest point at which significant risks and rewards of ownership pass to the buyer, the seller loses control of the items sold (e.g.., title passes to buyer) and at which the amount of revenue to be received can be determined with reasonable reliability.
b. Under RRA, revenue is recognized when oil and gas reserves are proven. This point in the operating cycle does not meet the IAS 18 criteria for revenue recognition. Since the oil and gas are
FROM SCOTT TEXTBOOK 6th edition
11. Several reasons can be suggested why oil company managers have reservations about RRA:
• The discount rate of 10% might not reflect the firm’s cost of capital.
• Low reliability. RRA involves making a large number of assumptions and estimates. While SFAS 69 deals with low reliability in part by requiring end-of-period oil and gas prices to be used (rather than prices anticipated when the reserves are expected to be sold), management may feel that end-of-year prices bear little relationship to the actual net revenue the company will receive in the future. Furthermore, management may be concerned about low reliability of other estimates, such as reserve quantities. • Frequent changes in estimates. Conditions in the oil and gas market can change rapidly, making it necessary for the firm to make frequent changes in estimates.
• Investors may ignore. Investors may not understand the RRA information.
Even if they do, management may believe the RRA information is so unreliable that investors will ignore it. If so, why prepare it?
• Legal liability. Management may be concerned that if the RRA estimates are not realized, the firm will be subject to lawsuits from investors.
Management’s reservations may be an attempt to limit or avoid liability.
12. a. Most industrial and retail firms regard revenue as earned at the point of sale. Since sale implies a contract with the buyer and change of ownership, this is usually the earliest point at which significant risks and rewards of ownership pass to the buyer, the seller loses control of the items sold (e.g.., title passes to buyer) and at which the amount of revenue to be received can be determined with reasonable reliability.
b. Under RRA, revenue is recognized when oil and gas reserves are proven. This point in the operating cycle does not meet the IAS 18 criteria for revenue recognition. Since the oil and gas are