Running head: CASE 6-1 INCOME RECOGNITION 1

Case 6-1 Income Recognition in the Motion Picture Industry

What markets are available to Warmen Brothers for this film?

The basic markets available to Warmen Brothers are domestic screening, foreign

screening, video rentals, cable broadcasting, network television stations and independent

television stations.

In what order would you suggest Warmen Brothers attempt to enter each market? Why?

The order by which Warmen Brothers should enter their film into each market would be

as they are listed in the opening question of this discussion board above. Deviating from this

order could jeopardize the maximization of revenue from each market. For example, if a film

were sold first to independent television stations, prior to distribution to cable and network

stations, the viewership levels of cable and network stations would decrease.

How should revenues be recognized from each market?

Revenues should be recognized from each market as they are earned under the realization

principle. According to this concept, revenue from each of the markets should be recognized as

contracts are signed or as film rights are sold to each of the various markets. The recognition of

revenues is “based on the additional tests of their being realized or realizable and being earned

before recognized as income” (Schroeder, Clark, & Cathey, 2017, p. 46).

How should costs be matched against these revenues?

The matching of costs with revenues for the motion picture industry is a complicated

process. The amount of revenue available from secondary markets is highly dependent upon the

success of the film in the domestic screening market. Consequently, holding production costs to

match in distorted net income figures. Additionally, many top film stars’ contracts are based
upon a percentage of totals profits. A conservative method of recognizing costs is to charge all

production costs against domestic and foreign screenings, and to charge other secondary markets

only incremental costs. This is somewhat comparable to the sunk cost method of income

recognition. Although this method is generally not appropriate for most situations, the highly

speculative nature of the secondary film markets make it an acceptable practice. During the past

several years some film making companies have experienced bankruptcy partially due to faulty

revenue recognition methods. Attempting to allocate production costs across all the secondary

markets will require estimates of the total revenues to be received from each of those markets

prior to the distribution of the film. This is a very risky process and could lead to distorted

financial statements against secondary markets may result.

What effect will your decisions have on Warmen Brothers’ income statements for the

year’s revenue?

“It is assumed initially that the timing of income recognition does not affect the present

of the firm’s cash flows” (Trueman & Titman, 1988, p. 130). Recognizing all production costs

in the period of domestic and foreign screenings will result in conservative income figures until

the secondary market revenues are realized. This procedure might also be criticized as distorting

future net income amounts because all production costs have been recognized prior to the

recognition of some revenues. Regardless, holding production cost and matching them with

secondary market revenues is a less favorable option.

Biblical Integration

In Colossians 3:9-10 it states, “do not lie to each other, since you have taken off your old

self with its practices and have put on the new self, which is being renewed in knowledge in the

image of its Creator” (NIV). The Christian virtue of honesty and a relevant one with regards to
the topic of income recognition. Warmen Brothers must follow the path of honesty as it decides

the best way for their organization to recognize their income. We must look for to God for

guidance in situations where we find ourselves facing the struggles between doing the right thing

and doing the profitable thing. Psalm 32:8 says, “I will instruct you and teach you in the way

you should go; I will counsel you with my loving eye on you” (NIV).

References

Schroeder, R.G., Clark, M.W., & Cathey, J.M. (2017). Financial Accounting Theory and

Analysis: Text and Cases (12th ed.). (pp. 11-27). Hoboken, NJ: John Wiley & Sons.

Trueman, B., & Titman, S. (1988). An Explanation for Accounting Income Smoothing. Journal

of Accounting Research, 26, 127-139. doi:10.2307/2491184

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Case 6-4 Accounting Changes

It is important in accounting theory to be able to distinguish the types of accounting changes.

Required:

a. If a public company desires to change from the sum-of-year’s-digits depreciation

method to the straight-line method for its fixed assets, what type of accounting
change will this be? How would it be treated? Discuss the permissibility of this
change.

If a company desires to change depreciation methods, this act is considered as a change in

an accounting principle. “This principle requires restating the affected balance sheet

account to reflect the balance as if the new accounting principle has been used form the

beginning; offsetting debits and credits on the income statement”(Cosmin & Dumitru,

2006). GAAP requires that changes in an accounting principle be done retrospectively.

 Companies do not report growth in the year of the depreciation change. “Retrospectively

recast prior years’ financial statements when the company reports the statements

again”(Spiceland, Sepe & Tomassini,2007). Whenever a company has difficulty with the

period-specific effects, there is an alternative. “FASB ASC 250 requires that the new

accounting principle must be applied to the balances of the appropriate asset and

liabilities as of the beginning of the earliest period for which retrospective application is

practicable…”(Schroeder, Clark & Cathey, 2014).

b. If a public company obtained additional information about the service lives of some
of its fixed assets that showed that the service lives previously used should be
shortened, what type of accounting change would this be? Include in your
discussion how the change should be reported in the income statement of the year of
the change and what disclosures should be made in the financial statements or
notes.

This type of accounting change is known as a change in accounting estimates. This form

of change does not require an adjustment to previous financial statements. “These

changes are accounted for in the period of the change, or if more than one period is

affected, in both the period of change in the future” (Schroeder, et al, 2014). There are 2

disclosures described for the financial statements or notes.

- An entity shall disclose the nature and amount of a change in an accounting estimate that
has an effect in the current period or is expected to have an effect in future periods, except
for the disclosure of the effect on future periods when it is impracticable to estimate that
effect.

- If the amount of the effect in future periods is not disclosed because estimating it is
impracticable, an entity shall disclose that fact.
 c. Changing specific subsidiaries comprising the group of companies for which
consolidated financial statements are presented is an example of what type of
accounting change? What effect does it have on the consolidated income
statements?

This form of accounting change is known as a change in a reporting entity. “Reporting

entities prepare GPFRs. GPFRs include financial statements, which present information

about such matters as the financial position, performance and cash flows of the entity,

and financial and non-financial information that enhances, complements and supplements

the financial statements”(Reporting Entity, 2013). FASB addresses the question

pertaining to consolidated income statements. “When a reporting entity becomes the

primary beneficiary of a collateralized financing entity, the financial assets and financial

liabilities of the collateralized financing entity will be measured using the more

observable of the fair value of the financial assets and the fair value of the financial

liabilities”(2014).

Biblical Perspective

Each one of the questions is relevant to accounting changes. Managers have to consider what is

best for their company. The managers have to choose which reporting method will work for the

company during that particular time frame. As a Christian, we have a God that never changes.

The Bible says in Hebrews 13:8, “Jesus Christ is the same yesterday and today and forever.”

People change their minds every second of the day. Managers have to comply with FASB or

SEC. Christians have to comply with God.

Resources:

CHAPTER 4: REPORTING ENTITY. (2013). New York: International Federation of

Accountants: IFAC. Retrieved from

http://search.proquest.com/docview/1347809117?accountid=12085Pa

Cosmin, L. I., & Dumitru, A. P. (2006). Cumulative effect of a change in accounting principle:

Remove it from the income statement. Romanian Economic and Business Review, 1(3),

88-92. Retrieved from http://search.proquest.com/docview/1118293285?

accountid=12085 Moeinaddin, M., & Abadi, F. S. R. (2013).

FASB GUIDANCE ADDRESSES CONSOLIDATED COLLATERALIZED FINANCING

ENTITIES. (2014). Bank Auditing and Accounting Report, 47(11), 2-3. Retrieved from

http://search.proquest.com/docview/1626183357?accountid=12085

IAS 8: Accounting policies, changes in accounting estimates and errors. (2004). International

Accounting Standards.IAS, , 697-730. Retrieved from

http://search.proquest.com/docview/192338345?accountid=12085

Schroeder, R.G., Clark, M.W., & Cathey, J.M. (2014). Financial accounting theory and analysis:

Text and cases (11th ed.). John Wiley & Sons.

Spiceland, D. J., Sepe, J. & Tomassini, L. (2007). Intermediate accounting (5th ed.). McGraw-

Hill

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