FRA Exam 2
What are the 5 steps?
Accumulate costs Bill customer Receive cash Recognize revenue, costs and gross profit Closing out the project
What is the criteria to transfer over time?
- Criteria to Meet Revenue Over Time Only need to meet one: • The customer receives and consumes the benefits of the goods or services simultaneously. • The customer controls the asset as the seller creates it or enhances it over time. • The asset the seller is creating does not have an alternative use to the seller, and the seller has an enforceable right to payment for the performance completed to date. - Transfer Over Time Recognize revenue over time as long as seller can measure progress towards completion. • If progress not estimable, then recognize once fully delivered. • Can measure progress toward completion using output or input measures.
What is the criteria to transfer at a point in time?
- Transfer at a Point in Time Must transfer control in order to recognize revenue. Five indicators (these are not criteria): • The seller has a present right to payment for the asset. • The customer has a legal title to the asset. • The seller has transferred physical possession of the asset. • The customer has the significant risks and rewards of ownership of the asset. • The customer has accepted the asset.
Accounting Procedures for Percentage of Completion
1. Initially accumulate costs by debiting an asset account called construction in progress (CIP). 2. As bills are sent to the customer throughout the project, increase accounts receivable with a debit and increase with a credit the account billings on construction contract. 3. When cash is received from the customer, increase cash with a debit and decrease accounts receivable with a credit. 4. Recognize the revenue and the associated costs each year, basing the amount of gross profit in a given year on the progress to date. •Credit revenue from long-term contracts, debit the cost of construction, and debit the difference between the revenue and the cost of the contract (i.e., the gross profit) to the CIP account. 5. At the end of the project, remove the CIP account from the books with a credit and remove the billings on construction contract account with a debit.
Accounting Procedures for Completed Contract
1. Initially accumulate costs by debiting construction in progress (CIP). 2. As bills are sent to the customer throughout the project, increase accounts receivable with a debit and increase billings on construction contract with a credit. 3. When cash is received from the customer, increase cash with a debit and decrease accounts receivable with a credit. 4. Recognize the actual costs incurred and the same amount of revenue each year. Report any gross profit at the end of the project. 5. At the end of the project, remove the CIP account from the books with a credit and remove the billings on construction contract account with a debit.
In step 2, if determined to have only one performance obligation, step (blank) is not necessary.
4
Consideration Payable to a Customer
A seller may pay the buyer, if it is trying to incentivize the buyer to purchase its goods/services. Unless this payment is in exchange for a distinct good/service, the consideration should be deducted from the transaction price.
Subsequent events
Accounting depends on whether condition existed as of balance sheet date
What are the three classification of accounts found in balance sheet?
Assets, Liabilities and Equity
Bill and hold arrangements- what is the purpose of the criteria?
Bill-and-hold arrangements are transactions where a buyer accepts title and billings but delays the physical receipt of the goods.
Single-step IS Presentation Format
Combines all revenues and gains and all expenses and losses into single categories ○ Not used very often Doesn't show key measures
What is a discontinued operation (big picture)?
Components of an entity that have been disposed of in the current period or held for sale at the end of the reporting period • IFRS defines entity differently than GAAP does
(blank) captures the degree to which reported income provides financial-statement users with useful information for predicting future firm performance.
Earnings quality
How do we determine the percentage complete?
Firms estimate the degree of completion by using input measures, output measures, or engineering estimates. • For example, under the cost-to-cost approach, the firm estimates the cumulative percentage of completion by dividing the total cost incurred to date by total estimated costs. • Other examples: direct labor hours, miles of highway, floors constructed, and engineering estimates.
How to determine performance obligations
First identify the goods or services Then determine if they are distinct
SCF - US GAAP vs. IFRS Dividend paid
GAAP- Finance IFRS- Operating or Financing
If more than one performance obligation (where standalone prices are determinable)...
If sum of standalone selling prices > transaction price, allocate discount to separate performance obligations based on relative standalone prices
Application Question - identify the section: - Loss on the sale of equipment
Investing activities?
Bill and hold arrangements- 4 criteria - what are they?
Must meet four criteria to recognize revenue: • The reason for the bill-and-hold must be substantive. • The product must be separately identified as belonging to the customer. • The product must be ready for physical transfer to the customer. • The entity cannot have the ability to use the product in any way, including delivering it to another customer.
What are the three different sections of the SCF?
Operating, Investing and Financing
Cookie jar reserves
Reduce earnings now, save funds to boost future earnings
Standalone selling price
SSP: price the seller would charge for the same goods/services if it sold them on a standalone basis to similar customers under similar circumstances.
What happens with sales with right of returns?
Sales returns are common and usually not a significant problem for most companies. However, in certain industries, such as publishing, high sales returns cause companies to postpone revenue recognition until the product can no longer be returned. • Right of return is not a separate performance obligation—it is variable consideration. • Liability: amount of expected return (Refund Liability) • Cost of goods sold: reduced by the cost of the goods attributable to the products estimated to be returned • Inventory: should be reduced by full amount • Difference between debit to CGS and credit to inventory goes to Other Assets— Estimated Returns.
What is the criteria for companies to use POC?
Same criteria as recognizing revenue over time Must meet one of these: • The customer receives and consumes the benefits of the goods or services simultaneously. • The customer controls the asset as the seller creates it or enhances it over time. • The asset the seller is creating does not have an alternative use to the seller, and the seller has an enforceable right to payment for the performance completed to date. Also must be able to estimate progress towards completion
Statement of Cash Flows
Summarizes cash inflows and outflows over a period of time.
SEE PIC ON DESKTOP OF CHART
WRITE IT OUT
Differences between the two approaches?
We do recognize revenue and cost even if completed contract, just not gross profit (4th step is the different between the two methods) Revenues and cost will equal to each other every year in completed contract- until the last year?- but does not impact bottom line (or income statement) until the end Completed contract method waits to recognize profit until the contract is complete. Recognizes revenue and costs throughout the project, but profit equals zero.
If more than one performance obligation (where standalone prices are not determinable)...
guidance provides three suggestions suitable to determine stand alone pricing
Income Statements: Presentation Formats
single step and multiple step
In Completed-Contract Method, when are revenue, costs and gross profit recognized and what is the journal entry?
step 4?
Define Consigned Goods Transaction
• A consignment sale is an arrangement where a seller (referred to as the consignor) delivers goods to a third party (the consignee), who sells the goods to the customer. • A consignment sale is an example of a principal-agent arrangement, where one party (the agent—the consignee) acts on behalf of another party (the principal—the consignor).
Channel stuffing (trade loading) - what is it?
• Channel stuffing (trade loading) is a practice in which a company induces wholesale distributors to buy more inventory than they can sell in the current period, thus "stuffing" the distribution channel. • Firms should not recognize revenue from a channel stuffing arrangement because the risks and rewards of ownership have not passed to the buyer, given the buyer's ability to return the product.
What happens in a consigned goods transaction upon sale of the inventory?
• Consignee records cash, commissions earned, and an amount that is due to the consignor for the sale. • Consignor makes no entry.
What happens in a consigned goods transaction upon transfer of cash to consignor?
• Consignor records cash, revenue, commission expense, and cost of goods sold, and removes inventory. • Consignee removes liability and records reduction in cash.
Implementation of the Fourth Step for Percentage of Completion
• Cost for the period is the actual costs incurred. • Cumulative revenue is the total estimated revenue multiplied by the percentage complete. Revenue for the current period is equal to the cumulative revenue less revenue recognized in all prior periods. • Gross profit for the period is revenue for the period less the actual costs for the period. • If the reported costs exceed the reported revenues in a given year for an otherwise profitable contract, then the gross profit is negative. In this case, the firm credits construction in progress in the journal entry made to record revenues, costs, and gross profit.
Long term contracts - what are the two approaches for recognizing revenue in long term contracts?
• Percentage of completion: recognize revenue and gross profit before delivery • Completed contract
What happens in a consigned goods transaction on delivery date?
• The consignor credits inventory and debits inventory on consignment. • The consignee makes no entry.
Financing Activities
○ Financing activities involve the cash receipts and payments from debt and equity financing ○ Cash flows from financing activities primarily include: ○ Cash receipts from issuing equity to owners ○ Cash receipts from borrowing through bonds and notes or other debt instruments ○ Cash payments to repurchase equity from owners ○ Cash payments for dividends
SCF - US GAAP vs. IFRS Interest Payments
GAAP- Operating IFRS- Operating or Financing
SCF - US GAAP vs. IFRS Interest/Dividends Received
GAAP- Operating IFRS- Operating or Investing
SCF - US GAAP vs. IFRS Tax payments
GAAP- Operating IFRS- Operating unless directly tied to investing or financing
Operating Section
Reports the revenues and expenses related to the entity's principal operations. Operating profit is a key measure.
Notes to Financial Statements
(Footnotes) • Summary of Significant Accounting policies • Additional details for reported items • Supplemental disclosures for items not reported in financial statements
Financial Statement Articulation
**see pic on desktop Statement of Income Statement of Stockholders' Equity Statement of Financial Position Statement of Cash Flows
What two approaches can we use to estimate the transaction price? Briefly explain each.
- Expected-value approach: ○ Sum the probability- weighted amounts in a range of possible consideration amounts. - Most-likely-amount approach: Use the single most likely amount in the range of possibilities as the estimate of the transaction price.
In the case of failing to identify a contract, the company will recognize revenue when it had received the consideration and one of the following holds:
- It has no remaining obligations to transfer goods/services and substantially all of the consideration has been received and it nonrefundable, OR - The contract has been terminated and any consideration received is nonrefundable, OR - The entity has transferred control of the goods or services, is no longer transferring the goods or services, and has no obligation to transfer the goods or services, and the consideration received is nonrefundable.
A performance obligation...
- is a promise to transfer a good/service or a bundle of goods/services that is distinct or - is a promise to transfer a series of distinct goods/services that are substantially the same and have the same pattern of transfer to the customer
A distinct good or service must meet two conditions
1. Customer can benefit from good/service on it's own or with other readily available resources 2. Promise of the seller to deliver that good/service is separately identifiable from other contract promises If the promise to deliver is separable from another promise, then the two promises are not highly dependent or interrelated.
(blank) consists of permanent accounts - from our conceptual framework - are the balance sheet elements point in time or period of time?
Balance Sheet ○ Is also called the statement of financial position ○ Lists an entity's assets, liabilities, and equity as of a specific point of time Consists of permanent accounts with cumulative balances that the company carries forward period to period over the life of the firm
MC5-6. On May 15, Year 1, Moran Inc. approved a plan to dispose of a component of its business. It is expected that the sale will occur on February 1, Year 2, at a selling price of $500,000, which was the current fair value of the component. During Year 1, disposal costs incurred by Moran totaled $15,000. The disposal of the component represents a strategic shift in the financial results for the entity. The component had actual or estimated operating losses as follows: January 1 - May 14, Year 1 $130,000 May 15 - December 31, Year 1 50,000 January 1 - January 31, Year 2 15,000 The carrying amount of the component on May 15, Year 1 was $850,000. Before income taxes, what amount should Moran report for discontinued operations in its Year 1 Income Statement? a. $545,000 b. $365,000 c. $15,000 d. $380,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 209). Pearson Education. Kindle Edition.
Choice a is correct. There would be a loss on remeasurement of the component during Year 1. The net fair value of the component would be its fair value of $500,000 less the $15,000 disposal costs, for a total of $485,000. The loss on remeasurement would be the net fair value of $485,000 minus the $850,000 carrying value of the component, for a total of $365,000. The results of operations would be reported for Year 1 as a loss of $180,000 ($130,000 + $50,000) and for Year 2 as $15,000. The amount that Moran should report for discontinued operations in its Year 1 income statement would be the loss from operations for Year 1 of $180,000 and the loss on remeasurement for Year 1 of $365,000, for a total of $545,000.
➍ MC8-5. Items that may cause variable consideration include: a. Discounts. b. An hourly rate for services. c. A fixed fee. d. A retainer. Gordon, Elizabeth A.. Intermediate Accounting (p. 428). Pearson Education. Kindle Edition.
Choice a is correct. Discounts may cause variable consideration.
MC8-11. Disclosures for annual periods of public companies must include all but which of the following with respect to contracts with customers? a. Identification of the top five largest customers. b. Disaggregation of reported revenues. c. Explanations of changes in balances. d. Information about performance obligations. Gordon, Elizabeth A.. Intermediate Accounting (p. 428). Pearson Education. Kindle Edition.
Choice a is correct. Identification of the top five largest customers is not a required disclosure.
MC6-2. During Year 1, Brianna Company had the following transactions related to its financial operations: Payment for the retirement of long-term bonds payable (carrying value $740,000) 750,000 Distribution in Year 1 of cash dividend declared in Year 0 to preferred shareholders 62,000 Carrying value of convertible preferred stock of Brianna converted into common shares 120,000 Proceeds from sale of treasury stock (carrying value at cost $86,000) 95,000 On its Year 1 statement of cash flows, net cash used in financing activities should be: a. $717,000 b. $716,000 c. $597,000 d. $535,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 271). Pearson Education. Kindle Edition.
Choice a is correct. In this question, the information wanted is the net cash used in financing activities. Normally when this kind of question is asked, a list of amounts is provided, some of which are financing activities and some of which are not. The first amount on the list is a payment for retirement of the company's long-term bonds. The payment certainly is cash used in financing, so that is $750,000 to start with. Dropping down to the last transaction, the proceeds from the sale of the treasury stock of $95,000 is financing, a source of cash and thus a positive use. That gives a total of $655,000 ($750,000 − $95,000) cash used. Moving up to the third transaction, conversion of stock into common stock is a non-cash item that only has to be disclosed. Dividends of $62,000 are cash outflows and added to $655,000.
MC8-10. Assume a retailer sells 10 widgets for $2,000 each. The widgets cost $100 and the sale includes a return right for 90 days. The retailer determines that the probability of returns associated with sales of the widgets is 10% based on prior customer behavior. The asset recognized at the point of sale for potential returns should be: a. $100 b. $900 c. $1,000 d. $20,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 428). Pearson Education. Kindle Edition.
Choice a is correct. The asset recognized at the point of sale should be $100. It is calculated by multiplying the probability of returns (10%) by the product cost and the number of units sold ($100 x 10% x 10).
MC5-3. Beach and Poole, CPA is reviewing income statement presentation with some interns that are working with the firm during the summer break. The interns were asked to list three things that were true about the multiplestep income statement. Choose the item below that is a true statement. a. The multiple-step income statement lists gains and losses as part of income from normal operations. b. The multiple-step income statement shows income or loss from operations after the gross margin and operating expenses lines but before other revenues and gains. c. Freight out is classified as part of the inventory cost and moved to cost of goods sold when the item is purchased by a third party. d. Gain/loss on the sale of equipment held for disposal from discontinued operations is included in the continuing operations section of the income statement. Gordon, Elizabeth A.. Intermediate Accounting (p. 208). Pearson Education. Kindle Edition.
Choice b is correct. Freight out is a selling expense, not part of the cost of inventory. (Freight in is a cost of inventory.) Gain/loss on the sale of equipment held for disposal is associated with discontinued operations and reported in the discontinued operations section.
MC5-4. Mission Flowers Company had the following transactions for the year ended December 31: • Sales revenues of $775,000. • Operating expenses of $550,000. • Losses due to employee strike of $200,000. This was the first employee strike in the history of the company. Operating income of $100,000 from a subsidiary sold on November 1. The decision to dispose was made on February 28. The income was earned evenly over the 10 months ended October 31. • The company's effective tax rate is 35%. What amount should Mission Flowers report as income from continuing operations for the year ended December 31? a. $33,750 b. $16,250 c. $81,250 d. $146,250 Gordon, Elizabeth A.. Intermediate Accounting (p. 208). Pearson Education. Kindle Edition.
Choice b is correct. Mission Flowers' income from continuing operations is calculated as follows: Sales revenue $ 775,000 Operating expenses (550,000) Loss from strike (200,000) Income from continuing operations before taxes 25,000 Income tax expense (8,750) Income from continuing operations $ 16,250 The operating income from the subsidiary sold during the year is not included in income from continuing operations but is reported net of tax as income from discontinued operations, along with any gain or loss on the sale of the subsidiary.
MC5-8. Szuba Corporation reported the following transactions for the current year: Sales $500,000 Cost of goods sold 300,000 Operating expenses 100,000 Cash dividend 50,000 Unrealized gain on available-for-sale security 10,000 Unrealized gain on trading security 20,000 Ignoring income taxes, Szuba should report other comprehensive income of: a. $80,000 b. $10,000 c. $60,000 d. $30,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 209). Pearson Education. Kindle Edition.
Choice b is correct. The only item that fits is the unrealized gain on the available-for-sale security. The unrealized gain on the trading security is included in income. Dividends are not included in income or other comprehensive income (but as an adjustment to retained earnings). The other items in the list are normal income statement items and thus are not part of other comprehensive income.
MC8-9. All of the following are indicators that the vendor is acting as an agent instead of as a principal except: a. The other party is primarily responsible for fulfilling the contract. b. The vendor has latitude in establishing prices for the other party's goods or services. c. The vendor does not have inventory risk. d. The vendor's consideration is in the form of a commission. Gordon, Elizabeth A.. Intermediate Accounting (p. 428). Pearson Education. Kindle Edition.
Choice b is correct. If the vendor has latitude in establishing prices for the other party's goods or services, the vendor will be considered to be acting as a principal. If the vendor does not have latitude in establishing prices, it will be considered to be acting as an agent.
MC6-7. In its year-end income statement, Black Knights Company reported cost of goods sold of $450,000. Changes occurred in several balance sheet accounts during the year as follows: Inventory $160,000 decrease Accounts payable-suppliers 40,000 decrease What amount should the Black Knights Company report as cash paid to suppliers in its cash flow statement prepared under the direct method? ➎ a. $250,000 b. $330,000 c. $570,000 d. $650,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 271). Pearson Education. Kindle Edition.
Choice b is correct. In order to compute the cash paid to suppliers, the Black Knights Company must determine how much inventory was purchased and the change in accounts payable. Accounts Payable increases with purchases and decreases with payments. Thus: Purchases = COGS - Decrease Inventory = $450,000 - $160,000 = $290,000 However, because Accounts Payable decreased, the Black Knights Company paid more cash to suppliers than just the amount for purchases: Cash paid = Purchases + Decrease Accounts Payable = $290,000 + $40,000 = $330,000
➍ MC8-4. The transaction price must reflect the time value of money if: a. The vendor expects the period between customer payment and delivery of goods or services will be less than two years. b. The contract has a financing component that is significant to the contract. c. The interest rate in the contract is higher than 13%. d. Consideration would not differ if paid in cash or under normal credit terms. Gordon, Elizabeth A.. Intermediate Accounting (p. 428). Pearson Education. Kindle Edition.
Choice b is correct. The contract has a financing component that is significant to the contract.
➏ MC8-7. Which of the following indicators is not considered when determining whether performance obligations are satisfied at a point in time? a. The vendor has a present right to payment for the asset. b. The customer is likely to reject delivery of the asset. c. The customer has the significant risks and rewards of ownership of the asset. d. The customer has legal title to the asset. Gordon, Elizabeth A.. Intermediate Accounting (p. 428). Pearson Education. Kindle Edition.
Choice b is correct. Whether a customer is likely to reject delivery of the asset is not an indicator that is considered when determining if performance obligations are satisfied at a specific point in time.
➎ MC8-6. When allocating the transaction price to separate performance obligations, one must determine the standalone selling price of the goods or services. Which of the following is not an estimation method for determining the standalone selling price? a. Adjusted market assessment. b. Expected cost plus a margin. c. Residual approach. d. Observable prices when goods or services are sold separately. Gordon, Elizabeth A.. Intermediate Accounting (p. 428). Pearson Education. Kindle Edition.
Choice d is correct. Observable prices when goods or services are sold separately is not an estimation method for determining the standalone selling price.
MC5-7. Chili Co. had the following balances at December 31: Foreign currency translation gain $150,000 Unrealized loss on trading security (35,000) Net income 650,000 Loss on discontinued operations (75,000) The company's effective tax rate is 40%. What amount should Chili Co. report as comprehensive income for the year ended December 31? a. $674,000 b. $719,000 c. $740,000 d. $800,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 209). Pearson Education. Kindle Edition.
Choice c is correct. Comprehensive income includes all items included in net income, plus all other comprehensive income items (pension funded status changes, unrealized gains and losses on available-for-sale securities, foreign currency translation gains/losses, and unrealized gains/losses on the effective portion of a cash flow hedge). The unrealized loss on the trading security and the loss on discontinued operations are already included in net income, so comprehensive income is: Net income $650,000 Foreign currency translation gain (net of tax)* 90,000 Comprehensive Income $740,000 * - Translation gain (net of tax) = $150,000 x (1 - 0.40) = $90,000
MC5-2. Moore Furniture Inc., a public company, has experienced a consistent 5% increase in net income over the past three years. Moore's management team is under a lot of pressure from investors to maintain its earnings ratios. In order to do so, the CEO could manipulate net income in order to manage the earnings of the company. Which one of the following is not a method typically used to manage earnings? a. Acquire a related business to allow management the opportunity to restructure transactions. b. Move up the timing related to the launch of a new product that has a huge demand. c. Engage in research and development projects to entice investors. d. Recognize revenues prematurely from sales promotions with retailers. Gordon, Elizabeth A.. Intermediate Accounting (p. 208). Pearson Education. Kindle Edition.
Choice c is correct. All of the above items except number c are strategies used by management to manipulate and manage earnings. When a company engages in research and development, it will result in higher expenses. Under U.S. GAAP all research and development expenses must be expensed.
➋ MC8-1. All of the following are elements of a contract except: a. The contract has commercial substance. b. The vendor can identify payment terms for the goods or services. c. It is not approved by both parties to the agreement. d. The vendor can identify each party's rights. Gordon, Elizabeth A.. Intermediate Accounting (p. 427). Pearson Education. Kindle Edition.
Choice c is correct. Approval by both parties to the agreement is an element of a contract.
MC6-6. Big Dollars Corporation's comparative financial statements included the following amounts for the current year: Net income $650,000 Depreciation expense 93,000 Equity in earnings of unconsolidated affiliate 61,000 Gain on sale of fixed assets 4,000 Increase in accounts receivable 25,000 Decrease in inventory (57,000) Decrease in fixed assets 38,000 Increase in accounts payable 42,000 Decrease in notes payable (nontrade) (75,000) On its current-year statement of cash flows, what is Big Dollars' net cash provided by operating activities? a. $677,000 b. $714,000 c. $752,000 d. $790,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 271). Pearson Education. Kindle Edition.
Choice c is correct. Big Dollars' net cash provided by operating activities is calculated as follows under the indirect method: Net income $ 650,000 + Depreciation expense 93,000 - Equity in earnings of unconsolidated affiliate (61,000) - Gain on sale of fixed assets (4,000) - Increase in accounts receivable (25,000) + Decrease in inventory 57,000 + Increase in accounts payable 42,000 Net cash provided by operations $ 752,000 The decrease in notes payable is a financing activity that should be reported in the financing section of the statement of cash flows. The cash flows related to the decrease in fixed assets should be reported in the investing section.
MC6-1. Sykes Corporation's comparative balance sheets at December 31, Year 2 and Year 1, reported accumulated depreciation balances of $800,000 and $600,000, respectively. Property with a cost of $50,000 and a carrying amount of $40,000 was the only property sold in Year 2. Depreciation charged to operations in Year 2 was: a. $190,000 b. $200,000 c. $210,000 d. $220,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 271). Pearson Education. Kindle Edition.
Choice c is correct. Depreciation is a part of operating activities and is added back because it was subtracted to produce net income in the first place. This question is a question on the SCF although it does not look like the question is phrased in exactly that manner. Looking at the facts, an accumulated depreciation Account Analysis Format can be used. The beginning and ending balances are available. The format is as follows: Beginning balance $ 600,000 Add: depreciation charged to operations ? Subtract: A/D on equipment sold ? Ending balance $ 800,000 To obtain the accumulated depreciation of the property sold, subtract the $40,000 carrying amount from the $50,000 original cost, and the difference is the accumulated depreciation that was eliminated when the equipment was sold. Beginning balance $ 600,000 Add: depreciation charged to operations ? Subtract: A/D on equipment sold (10,000) Ending balance $ 800,000 In this Account Analysis Format, the depreciation charged to operations is $210,000. Accumulated Depreciation Beginning balance $ 600,000 Add: depreciation charged to operations 210,000 Subtract: A/D on equipment sold (10,000) Ending balance $ 800,000 Depreciation charged to operations in this question differentiates it from any depreciation that might have been charged to work-in-progress and might have become a part of inventory cost.
MC6-3. Which of the following items would not be included in the operating activities section of an entity's statement of cash flows under U.S. GAAP? a. Interest received b. Proceeds from the sale of trading securities c. Dividends paid d. Income taxes paid Gordon, Elizabeth A.. Intermediate Accounting (p. 271). Pearson Education. Kindle Edition.
Choice c is correct. Dividends paid are a financing cost and are included in the financing section of the statement of cash flows.
MC6-8. On its current year income statement, Vegas Parties, Inc. reported sales revenue of $945,000. Changes occurred in several balance sheet accounts, including the following: Accounts receivable: 90,000 decrease Unearned revenue: $75,000 increase What amount should Vegas report as cash received from customers in its current year statement of cash flows prepared using the direct method? a. $780,000 b. $930,000 c. $960,000 d. $1,110,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 272). Pearson Education. Kindle Edition.
Choice d is correct. The $90,000 decrease in accounts receivable and the $75,000 increase in unearned revenue both represent cash receipts from customers and are therefore added to sales revenue from the income statement to determine total cash received from customers.
Expenses
Outflows or other consumption of assets or incurrences of liabilities from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing primary or central operations.
MC8-8. During Year 1, Meriwether Construction Company started a construction job with a contract price of $3,000,000. The job was completed in Year 2, and the company uses the percentage of completion method. The following information is available for Year 1 and Year 2: Year 1 Year 2 Cost incurred to date $500,000 $2,400,000 Estimated cost to complete 1,500,000 0 Billings to date 300,000 1,800,000 Collections to date 100,000 1,600,000 What amount of gross profit should Meriwether recognize for this job for Year 2? a. $250,000 b. $1,000,000 c. $350,000 d. $600,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 428). Pearson Education. Kindle Edition.
Choice c is correct. The total cost for the contract was $2,400,000. The contract price was $3,000,000. So Meriwether ended up making a $600,000 ($3,000,000 - $2,400,000) profit cumulative for the two years together. To determine how much was recognized in the second year, a determination of how much was recognized in the first year must be made. Meriwether incurred $500,000 of cost in the first year and expected to incur $1,500,000 more. At the end of year 1, Meriwether expected to make a profit of $1,000,000 on the job ($3,000,000 - $2,000,000). Meriwether had incurred 25% ($500,000/$2,000,000) of the total estimated cost and would have recognized $250,000 of profit. In year 2, total costs were higher. Total profit is now $600,000 for the entire project. Because Meriwether had already recognized $250,000 in year 1, $350,000 is still to be recognized in year 2 ($600,000 - $250,000).
➌ MC8-3. Telecom Co. enters into a two-year contract with a customer to provide wireless service (voice and data) for $40 per month. To induce customers, Telecom Co. provides a free phone. Telecom Co. normally sells the phone on a standalone basis for $200. Telecom Co. also charges the customer a one-time activation fee of $35. Which of the following is true? a. The free phone constitutes a marketing expense. b. The activation fee is a separate performance obligation. c. There are two distinct performance obligations: the wireless service and the phone. d. There are two distinct performance obligations: the voice service and the data service. Gordon, Elizabeth A.. Intermediate Accounting (p. 427). Pearson Education. Kindle Edition.
Choice c is correct. The two distinct performance obligations are the wireless service and the phone.
MC5-5. Allison Corporation's current year income from continuing operations before taxes was $1,000,000 before taking the following items into consideration: • Depreciation was understated by $100,000. • A strike by the employees of a supplier resulted in a loss of $200,000. This strike was the first such strike that Allison had encountered. • The inventory at December 31 of the prior year was overstated by $300,000. The inventory at December 31 of the current year was correct. • A flood in Allison's Houston facility destroyed equipment worth $500,000. The facility had just been rebuilt from damages that occurred in a flood in the prior year. What was Allison's adjusted income from continuing operations before taxes? a. $1,000,000 b. $900,000 c. $700,000 d. $500,000 Gordon, Elizabeth A.. Intermediate Accounting (p. 208). Pearson Education. Kindle Edition.
Choice d is correct. Income from continuing operations should be adjusted for all of the items. The $100,000 in additional depreciation needs to be deducted from income from continuing operations. The $200,000 loss from the strike by the supplier's employees and the $500,000 flood loss should be included in income from continuing operations. The inventory overstatement in the prior year results in a cost of goods sold overstatement in the current year, so $300,000 should be added back to income from continuing operations. Allison Corporations adjusted income from continuing operations before tax is calculated as follows: Unadjusted income from continuing operations before tax $ 1,000,000 Less: Additional depreciation (100,000) Less: Loss from strike (200,000) Plus: Adjustment to COGS for inventory misstatement 300,000 Less: Loss from flood (500,000) Adjusted income from continuing operations before tax $ 500,000
MC5-9. Glass Doors Inc. (GDI) is preparing the stockholders' equity section of their balance sheet. The following items occurred during the year. Which one of the following will not directly impact the stockholder's equity section of the balance sheet? a. GDI owns securities classified as available for sale (AFS) with a cost basis of $376,000 and a fair value of $321,000. An unrealized loss was recorded of $55,000. b. 100 shares of treasury stock were repurchased under the cost method for $7,500. The stock had a par value of $10.00 per share. c. GDI sold 1,000 shares of common stock with a par value of $10 for $15,000. d. GDI sold some old inventory for lower than originally paid. Gordon, Elizabeth A.. Intermediate Accounting (p. 209). Pearson Education. Kindle Edition.
Choice d is correct. The write down of the inventory will be a loss included in net income. While net income will eventually be transferred to stockholders' equity, it will not go directly to equity. All the remaining options are adjustments or entries directly posted to the stockholders' equity section of the balance sheet. The write-down of the available-for-sale securities will be reported in stockholders' equity as accumulated other comprehensive income until the securities are sold. Treasury stock would be a debit to stockholders' equity for $7,500 under the cost method. Issuances of common stock are always recorded in stockholders' equity.
MC5-1. Lyon Company has the following transactions in the current year. Assuming that all of the transactions are material, which of them will most likely have no effect on current year net income? a. The sale of a factory building that was contributed by a shareholder in the prior year. b. The settlement of litigation over an accident that occurred in the prior year but for which a loss had not previously been considered to be probable and reasonably estimable. c. The determination that certain junk bonds purchased on a speculative basis several years previous were worthless. d. The collection of a receivable from a customer whose account was written off in the prior year by a charge to the allowance for bad debts account. Gordon, Elizabeth A.. Intermediate Accounting (p. 208). Pearson Education. Kindle Edition.
Choice d is correct. This is the collection of an account receivable previously written off. The original write off would have been Dr. Allowance and Cr. Accounts Receivable. The collection would have been recorded in two transactions. The first would be to reestablish the account as Dr. Accounts Receivable and Cr. Allowance. The second would be to treat the collection as if the account had never been written off as Dr. Cash and Cr. Accounts Receivable. The net of the two journal entries is Dr. Cash and Cr. Allowance. There is nothing here that could potentially affect income.
➌ MC8-2. A performance obligation is: a. An enforceable promise in a contract with a customer to transfer a good or service to the customer. b. An offer to transfer a good or service to the customer. c. An expectation of a customer for the receipt of a good or service by a vendor. d. A promise in a contract with a customer to transfer a good or service to the customer. Gordon, Elizabeth A.. Intermediate Accounting (p. 427). Pearson Education. Kindle Edition.
Choice d is correct. A promise in a contract with a customer to transfer a good or service to the customer.
MC6-4. Kong Co. purchased a three-month U.S. Treasury bill. Kong's policy is to treat as cash equivalents all highly liquid investments with an original maturity of three months or less when purchased. How should this purchase be reported in Kong's statement of cash flows? a. As an outflow from operating activities b. As an inflow from investing activities c. As an outflow from financing activities d. Not reported Gordon, Elizabeth A.. Intermediate Accounting (p. 271). Pearson Education. Kindle Edition.
Choice d is correct. The U.S. Treasury bill is considered to be a cash equivalent item, so purchasing the T-bill merely changes the form of cash held, it does not change the cash position of the entity. Thus, the purchase is not reported on the statement of cash flows.
MC6-5. Bales Company is preparing a statement of cash flows. Which of the following would be shown on the statement? ➍ a. Stock dividend b. Stock split c. Appropriation of retained earnings d. None of the answer choices is correct Gordon, Elizabeth A.. Intermediate Accounting (p. 271). Pearson Education. Kindle Edition.
Choice d is correct. Which of the items in the list impacts cash? None of them. Thus, none of them would be shown on the face of the statement of cash flows but would be disclosed in the footnotes pertaining to stockholders' equity or the statement of stockholders' equity.
How does the Conceptual Framework distinguish net income from other comprehensive income?
Common items reported here include (net of tax): - Unrealized G/L for AFS securities ▪ Please note FASB is in the process of changing this - Derivatives classified as CF hedges - Foreign currency translation G/L - Unrecognized pension costs - Unrealized G/L from revaluation of PPE (IFRS only)
Other comprehensive income (OCI)
Comprises revenues, expenses, gains, and losses that are explicitly excluded from net income in specific accounting standards § FASB determines which items are OCI and which items are net income
If cash is received, but is not appropriate to recognize revenue yet:
Credit a liability account Don't remove inventory
Losses
Decreases in equity from an entity's peripheral or incidental transactions. Losses also arise from outflows affecting the entity, except those that result from expenses or distributions to owners.
• If delivery occurs before payment will we record interest revenue or interest expense? - How will we allocate between sales revenue and other?
If delivery happens before payment: seller is providing financing to the customer. If time between delivery and payment is more than one year, then we need to separate the revenue from providing the good/service from the interest revenue/expense—if the financing component is significant. To determine if significant, consider... If significant, then use time value of money to determine financing component: If delivery occurs before payment (interest revenue): determine sales/service revenue by taking PV of consideration; the rest is interest revenue. PV = FV x 1/(1+r)n
• If payment occurs before delivery will we record interest revenue or interest expense? - How will we allocate between sales revenue and other?
If payment happens before delivery: customer is providing financing to the seller. If time between delivery and payment is more than one year, then we need to separate the revenue from providing the good/service from the interest revenue/expense—if the financing component is significant. To determine if significant, consider... If significant, then use time value of money to determine financing component: If payment occurs before delivery (interest expense): determine sales/service revenue by taking FV of consideration; the difference is interest expense. FV = PV x (1+r)n
Gains
Increases in equity from an entity's peripheral or incidental transactions. Gains also arise from inflows affecting the entity, except those that result from revenues or investments by owners.
Revenues
Inflows or other enhancements of an entity's assets. Revenues also include the settlements of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations.
(blank) know company's financial position and financial performance best
Managers
Net income
Measure of financial performance resulting from the aggregation of revenues, gains, expenses, and losses that are not items of other comprehensive income Sum of the income from continuing operations and the gains or losses from discontinued operations
Noncontrolling interest
One company controls another company (i.e., a subsidiary) but owns less than 100 percent of its voting shares ○ Income of subsidiary is reported (consolidated) on controlling company's income statement
Multiple-step IS Presentation Format
Operating Non-Operating Income Tax Discontinued operations Net income and EPS
Application Question - identify the section: - Cost of goods sold
Operating activities
Application Question - identify the section: - Gain on the sale of a business segment
Operating activities
Application Question - identify the section: - Interest expense
Operating activities
Application Question - identify the section: - State income tax expense
Operating activities
Application Question - identify the section: - Advertising expense
Operating activities?
Application Question - identify the section: - Sales revenue
Operating activities?
SCF- Investing
Relates to acquiring and disposing of productive PPE and debt/equity securities • These are typically non current assets (though some non current assets can be operating) • Can you provide an example of items belonging here? Tell us if it's a cash inflow or outflow..
SCF- Financing
Relates to financing assets through debt or equity • Financing items are typically non current liabilities or equity • Can you provide an example of items belonging here? Tell us if it's a cash inflow or outflow..
SCF- Operating
Relates to production/delivery of goods and services • These are working capital accounts and are typically (not always) current assets and liabilities. • Can you provide an example of items belonging here? Tell us if it's a cash inflow or outflow..
Net Income and Earnings per Share
Reports net income and several computations of the amount of earnings available to each shareholder in a company.
Income Tax Provision
Reports the income taxes related to continuing operations from all jurisdictions in which the entity operates (e.g., federal taxes, state taxes, income taxes levied by foreign countries).
Discontinued Operations
Reports the results of operations for a component of an entity that has been disposed of by the end of the reporting period or that is held for sale at the end of the reporting period; also includes any gain or loss from the actual disposal of the component of the entity.
Nonoperating Section
Reports the revenues and expenses related to any secondary operations of the entity; also includes net financing costs (interest expense less interest income) and other gains and losses.
Earnings per share (EPS)
The amount of earnings assigned to each outstanding share of the company's common stock
Comprehensive income
The change in a company's equity during a period of time resulting from transactions and other events and circumstances, apart from transactions with owners § Comprehensive income = Net income + other comprehensive income
What are the three types of income that are included in this section of the income statement?
Three main reporting items (all net of tax): - Income/loss from disc op - Gain/loss on net asset remeasurement ▪ Held for sale less disposal - Gain/loss on disposal of assets or group
Related party transactions
Transactions between entity and owners, management or affiliated entities
Balance Sheet Presentation
US GAAP reporters - Assets and liabilities listed in order of liquidity either via the account or report format (current followed by non current) • IFRSreporters - Assets and liabilities listed in reverse order of liquidity Assets - Liabilities = Equity (or Net Assets)
Big bath
When low earnings are expected, reduce net income
Contract
is defined as an agreement between two or more parties that creates enforceable rights • Five criteria related to the contract • Must meet criteria for step one before continuing revenue recognition process 1. All parties to the contract have agreed to the contract and are committed to performing under the contract 2. Each party's rights with respect to the goods or services that are being transferred are identifiable 3. They payment terms for the goods or services that are being transferred are identifiable 4. The contract has commercial substance, meaning that the risk, timing or amount of the entity's future cash flows is expected to change as a result of the contract 5. It is probable that the seller will collect the consideration to which it is entitled in exchange for the goods or services i. Collectability is assess on expected consideration, not contract price (e.g. discount amount would not be part of collectability) 1) US GAAP: probable- likely to occur- typically 70-75% IFRS: probable- more likely than not- typically >50%
Multiple contracts
with same customer will be combined into a single contract if: - Contracts are negotiated as a package and have one commercial objective - Amount of consideration to be received related to one contract depends on price or performance of another contract - Goods/services promised in separate contracts are all part of one performance obligation
What items are reported on a statement of stockholders' equity?
• Contributed Capital accounts • Retained Earnings • AOCI • Treasury Stock • Non-controlling interest (NCI)
Annual Report
• Financial statements • Footnotes • Letter to shareholders • Financial summary • Management Discussion and Analysis(MD&A) • Auditor report
Noncash Consideration
• Seller may be paid in something other than cash. • Record the transaction price at the fair value at contract inception of the non-cash consideration received. -- If this amount cannot be reasonably estimated, use the standalone selling price of the good/service.
Revenue Recognition Steps
• Step 1: Identify the contract(s) with customers • Step2:Identifyperformanceobligationswithin contract • Step 3: Determine the transaction price • Step 4: Allocate transaction price to performance obligations • Step 5: Recognize revenue when, or as, each performance obligation is satisfied
Investing Activities
○ Cash flows from investing activities relate to the acquisition and disposition of productive property and debt and equity securities, as well as making and collecting loans ○ Cash flows from investing activities primarily include the following: ○ Cash receipts from the collection or sale of notes receivable ○ Cash payments for loans made by the entity ○ Cash payments and receipts from the sale of debt and equity securities of other entities ○ Cash payments and receipts from the sale of productive assets (e.g., property, plant, and equipment, or PPE)
Owners' Equity
○ Contributed capital ○ The amounts invested by shareholders, also called paid-in capital ○ Retained earnings ○ The cumulative earnings of the company that have not been distributed as dividends to shareholders ○ Accumulated other comprehensive income ○ The cumulative amount of other comprehensive income (or loss) over the life of the entity ○ Noncontrolling interest ○ The amount of the company's net assets owned by outside shareholders
Assets
○ Current assets are resources that the firm expects to convert to cash, use, or consume within one year or one operating cycle, whichever is longer ○ Cash ○ Accounts receivable ○ Inventory ○ Prepaid expenses ○ The operating cycle is the period of time from the acquisition of goods to the point at which the entity receives cash from the sale of the goods ○ Long-term investments are noncurrent assets that are not used directly in the operations of the business ○ Property, plant, and equipment are assets that are tangible, long-lived, and used in the production and sale of the company's goods and services ○ Desk ○ Land or a factory building ○ Intangible assets are assets that lack physical substance but have economic value due to the rights they confer upon the holder ○ Does not include financial assets ○ Other assets is a category that includes any asset that does not fall into any of the primary balance sheet classifications
Liabilities
○ Current liabilities are obligations that the firm expects to liquidate through the use of current assets or the creation of other current liabilities within one year or one operating cycle, whichever is longer ○ E.g., accounts payable, short-term notes payable, and unearned revenues ○ Long-term liabilities are obligations an entity does not expect to satisfy within one year or operating cycle, whichever is longer ○ E.g., bonds payable and long-term notes payable
Operating Activities
○ Operating activities include cash receipts and disbursements related to the production and delivery of goods and services that are reported on an accrual basis on the statement of net income ○ Cash flow from operating activities primarily includes the following: ○ Cash receipts from customers ○ Cash receipts from interest and dividends ○ Cash payments for the purchase of goods ○ Cash payments to employees ○ Cash payments for taxes ○ Cash payments for interest
What is the different between permanent and transitory earnings? Which one typically provides higher earnings quality? Provide examples of permanent income items. Provide examples of transitory income items.
○ Permanent: Likely to continue; higher quality (ex: sales) ○ Transitory: Unlikely to continue; lower quality (ex: income from discontinued operation)
US GAAP offers two balance-sheet formats:
○ The account format lists assets on the left side and liabilities and stockholders' equity on the right side of the statement ○ The report format lists liabilities and stockholders' equity directly below assets on the same page
The statement of cash flows enables financial-statement users to
○ The statement of cash flows summarizes a firm's cash inflows and outflows over a period of time ○ The statement of cash flows enables financial-statement users to ○ Assess the entity's ability to meet its obligations and pay dividends ○ Determine whether the entity will require external financing ○ Identify the differences between net income and the associated cash receipts and payments
What are the two main concepts companies are considering in relation to revenue recognition?
○ Timing (when to recognize revenue) § Main principle: when control of the asset has been transferred ○ Measurement (how much revenue to recognize) Main principle: use the amount that the seller expects to be entitles to receive in exchange for the good/service
