Applied Research in Financial Reporting: Text and Cases

Applied Research in Financial Reporting: Text and Cases Chapter 8 Critical and Creative Thinking and Problem Solving in Accounting

Presentation Plan • Objectives • Definitions • Attributes of Tasks that Require CCT • CCT Frameworks • Blooms’ Taxonomy • Good & Bad CCT Habits • Connections With Communication Skills

Objectives • Definitions of critical and creative thinking. • Attributes related to the nature, process, and performance of the tasks that indicate a need for critical and creative thinking. • A basic framework of thinking skills and their functions. • A complex framework of thinking skills linking critical and creative thinking with problem solving and decision making.

Objectives • Bloom's taxonomy of thinking skills by various levels of cognitive complexity. • Problem solving in accounting according to Bloom’s taxonomy. • Habits that enhance critical and creative thinking. • Attributes of good versus poor thinkers. • Relationship between critical and creative thinking and communication skills.

CCT Defined • Critical comes from the Greek word, Kriticos. It means to question, to make sense of, to analyze -- constructively • Not to be confused with the word criticize -- negatively • Thinking is a mental activity -- to search for answer or reach for meaning • it is active, purposeful, and organized.

CCT Defined • Critical Thinking is an active, purposeful, and organized process of thinking about one’s own thinking • It is the result of the judgment phase of the mind • Creative Thinking refers to original or imaginative thinking to produce innovative solutions or alternative courses of action • It is the result of the production phase of the mind • Should not be confused with creative accounting that can be fraudulent.

Task Attributes That Require CCT Exhibit 8-1 • CCT is task dependent: • Nature of the task • Task process • Task performance

CCT Frameworks • A Basic Framework of Thinking Skills (Exhibit 8-2) • Causation -- dependent and independent variables • Transformation from the known to the unknown -- induction • Relationship -- deduction • Classification -- common qualities • Qualification -- unique characteristics

CCT Frameworks • A Complex framework of Thinking Skills (Exhibit 8-3) • Problem solving • Decision making • Critical thinking • Creative thinking

CCT Frameworks • Bloom’s Taxonomy of Thinking Skills (Exhibit 8-4): • An ascending order of CCT by cognitive difficulty: • Knowledge • Comprehension • Application • Analysis • Synthesis • Evaluation

Good & Bad CCT Habits • Bad Habits: • Mine-is better • Face-saving or defense mechanism • Resistance to change • Conformity • Stereotyping • Self-deception

Good & Bad CCT Habits • A list of desirable attributes (Exhibit 8-5) • General attributes • Attributes related to goals • Attributes related to actions • Attributes related to evidence

Good & Bad CCT Habits • Can these attributes be taught? • Not all: • some are innate • others are trainable • and some can be developed over time

Connections With Communication Skills • Poor thinking results in poor communication • Fuzzy writing is the result of fuzzy thinking, so be: • specific • concise • clear

FLX Medical Technology, Inc: Objectives • To use analogy, identify alternative solutions, and use critical and creative thinking based on indirect professional literature to make judgments. • The case also illustrates how poor thinking might result in reaching quick, but questionable conclusion.

FLX Medical Technology, Inc: Facts • FLX manufactures and distributes a broad range of respiratory care products • FLX has decided to expand its distribution of smoke filtration systems into Europe, and has established PS Medical Systems, Inc. to do so.

FLX Medical Technology, Inc: Facts • Proctor Venture Capitalist Group will contribute $6 million for a 90 percent equity interest; • FLX will contribute $300,000 and exclusive European marketing rights of the smoke filtration systems for 5 years in exchange for a 10 percent equity interest.

FLX Medical Technology, Inc: Facts • PS is required to purchase all its smoke filtration systems from FLX at predetermined wholesale prices, and FLX is required to deliver the systems on a timely basis. • FLX will appoint three board members, and Proctor Venture Capitalist Group will appoint the remaining four.

FLX Medical Technology, Inc: Facts • After 3 years, FLX has the option of purchasing Proctor's 90% equity in exchange for 600,000 shares of FLX (currently trading at $20 per share). • Cumulative operating losses of $5 to $7 million are projected during the first several years of PS’ operations, • FLX is planning to account for its 10 percent interest in PS Medical Systems by the cost method.

FLX Medical Technology, Inc:Requirement 1 • No direct guidance for treatment • SFAS No. 68, "Research and Development Arrangements” can be used by analogy • Paragraph 5 states that: "If the enterprise is obligated to repay any of the funds provided by the other parties regardless of the outcome of the research and development, the enterprise shall estimate and recognize that liability. • However, FLX has the option (not an obligation) of purchasing Proctor's interest in exchange for 600,000 shares of FLX common.

FLX Medical Technology, Inc:Requirement 1 • If the venture is not successful, then it does not appear likely that FLX would exchange 600,000 shares of its common stock ($12 million current market value) for Proctor's equity interest. • There is no indication that a related party transaction exists between FLX and Proctor at the time FLX enters into the arrangement.

FLX Medical Technology, Inc:Requirement 1 • There does not appear to be any evidence that success is assured. Losses are projected during the first several years of operation. • In conclusion, it appears that the venture capital funds are at risk, and FLX should not record a liability for the funding. • So, what is the appropriate method of accounting for FLX’s investment?

FLX Medical Technology, Inc:Requirement 1 • General rule: • Ownership in excess of 50% presumes that consolidation is appropriate. • Ownership of 20% to 50% usually presumes using the equity method • Ownership of less than 20% is indicative of the cost method. • Thus, the simple response (an example of poor thinking) is that FLX should use the cost method to account for its investment

FLX Medical Technology, Inc:Requirement 1 • According to APB No. 18, Paragraph 17 the equity method of accounting should be followed if the investor has the ability to exercise significant influence over investee (even if investor does not own more than 20% of investee) • FLX has three of the seven board seats • FLX is the sole supplier of air filtration systems for PS Medical Systems.

FLX Medical Technology, Inc:Requirement 2 • Equity method indicates that FLX should record its share of losses, • FLX’s original cost is $300,000, and FLX's 10 percent share of projected losses would be $500,000 to $700,000 • According to APB No. 18, paragraph 19i the investor should discontinue applying the equity method when the investment (and net advances) is reduced to zero

FLX Medical Technology, Inc:Requirement 2 • However, as long as PS has a positive book equity ($6,300,000 before accounting for losses), it would appear appropriate for FLX to continue to recognize sales on an accrual basis. This assumes that a receivable held by FLX would have a priority claim to assets in the event of liquidation of PS Medical Systems.

FLX Medical Technology, Inc:Requirement 3 • If FLX exercises its option to purchase Proctor's 90 percent equity interest, and the acquisition of PS were economically justified, then there would be a business combination: • A business combination accounted for by the purchase method would be based on the fair market value of the consideration given up or received whichever is more clearly evident. • The value of the 600,000 shares of FLX common stocks at the date it committed to exercise the purchase option would be more evident of fair value in this case.

Applied Research in Financial Reporting: Text and Cases