It is often asserted that using the LIFO inventory costing method during an extended period of rising prices and the expensing of all human resource costs are among the accepted accounting practices helping create “secret reserves.”

Required:

a. Describe a secret reserve. Explain how companies create or increase such reserves.

b. Explain the basis for saying the two specific practices cited create secret reserves.

c. Discuss the possibility of creating a secret reserve in connection with accounting for a liability. Explain and give an example.

d. Describe objections to the creation of secret reserves.

e. “Watered stock” is arguably the opposite of a secret reserve.

(1) Explain the nature of watered stock.

(2) Describe the circumstances where watered stock can arise.

(3) Discuss steps that can be taken to eliminate “water” from a firm’s capital structure.