AC 430 Exam 1

If we suspect a contract has multiple performance obligations, which steps come into play?

Steps 2 (identify the PO) and 4 (allocate the transaction price to each PO)

Codification: subtopics

Subsets of topics, generally distinguished by type or scope, each topic contains an overall subtopic

In what situation is there a deferred tax asset?

When pre-tax book income is less than taxable income and the firm will realize a future deductible amount

Companies report changes in accounting estimates retrospectively. (T/F)

False

When is the completed contract method used?

1) only when the percentage of completion method is inapplicable (uncertain) 2) for short term contracts

What is the percentage-of-completion method?

1) terms of contract must be clear and enforceable 2) buyer can be expected to satisfy all obligations 3) contractor can be expected to perform

Five steps to recognize revenue

1. Identify the contract - establish legal rights of seller and customer with respect to one or more performance obligations (POs) 2. Identify performance obligation(s) - a promise to transfer a good or service that is distinct, can have single or multiple POs 3. Determine the transaction price - amount seller is entitled to receive from the customer 4. Allocate the transaction price - a portion allocated based on the relative stand-alone selling prices of the goods or services in each performance obligation (s) 5. Recognize revenue when each performance obligation is satisfied - at the point in time when control passes to the customer, over a period of time, or at whatever time is appropriate

Examples of items that can cause differences between GAAP and IRS

1. The MACRS depreciation system is used for tax purposes, and the straight-line depreciation method is used for financial reporting purposes 2. A landlord collects some rents in advance. Rents received are taxable in the period when they are received 3. Expenses are incurred in obtaining tax-exempt income 4. Costs of guarantees and warranties are estimated and accrued for financial reporting purposes 5. Proceeds are received from a life insurance company because of the death of a key officer (the company carries a policy on key officers) 6. Estimated losses on pending lawsuits and claims are accrued for books. These losses are tax deductible in the period(s) when the related liabilities are settled 7. Sales of investments are accounted for by the accrual method for financial reporting purposes and the installment method for tax purposes 8. Municipal bond interest (tax exempt income)

Which of the following statements is correct? Changes in accounting principle are always handled in the current or prospective period. Correction of an error related to a prior period should be considered as an adjustment to current year net income. A change from expensing certain costs to capitalizing these costs due to a change in the period benefited, should be handled as a change in accounting estimate. Prior statements should be restated for changes in accounting estimates.

A change from expensing certain costs to capitalizing these costs due to a change in the period benefited, should be handled as a change in accounting estimate.

What is a change in accounting principle?

A change from one accepted accounting policy to another. Examples include average cost to LIFO, or completed-contract to percentage-of-completion methods (latter is the focus)

Which of the following is accounted for as a change in accounting principle? A change from the cash basis of accounting to the accrual basis of accounting. A change from expensing immaterial expenditures to deferring and amortizing them as they become material. A change in inventory valuation from average cost to FIFO. A change in the estimated useful life of plant assets.

A change in inventory valuation from average cost to FIFO

More likely that not means...

A level of likelihood of at least slightly more than fifty percent

Chapter 20

Accounting Changes and Error Analysis

Chapter 16

Accounting for Income Taxes

The codification contains which of the following types of information?

Accounting guidance

Three approaches to estimate stand-alone selling prices

Adjusted market assessment approach, expected cost plus margin approach, and the residual approach

What is the correct Codification hierarchy?

Area, topic, subtopic, section

Temporary differences between book income and tax income

Book income may be higher than tax income this year, but will be lower in a future year (or vice versa) so that cumulative profit will be the same for both

A good or service is distinct and therefore a separate PO if it is both what?

Capable of being distinct AND separately identifiable from other goods or services in the contract

Which type of accounting change should always be accounted for in current and future periods?

Change in accounting estimate

Types of accounting changes

Changes in accounting principle and estimate

The new revenue recognition standard by FASB says that...

Companies recognize revenue when goods or services are transferred to customers for the amount the company expects to be entitled to receive in exchange for those goods and services (again: when - upon transfer to customers. how much - amount the seller is entitled to receive)

Future taxable income example

Current reported profitability is higher than taxable income reported to the IRS

Future deductible expense example

Current reported profitability is lower than taxable income. A common example is restructuring expenses. When firms restructure their operations they accrue expenses for severance, etc. that are not deductible for tax purposes until paid

What are the three approaches for reporting accounting changes? Which one does FASB require?

Currently, retrospectively, and prospectively FASB requires the retrospective approach

Prior to GAAP, the realization principle required that revenue be recognized when... and... What were the three problems of this principle?

Earnings process is virtually complete, and when there is reasonable certainty as the to collectability of the assets to be received Revenue recognition was poorly tied to the FASB's conceptual framework, the focus on the earnings process led to similar transactions being treated differently in different industries, and it was difficult to apply to complex arrangements that involved multiple goods or services (such as bill-and-hold)

What difference would result in future taxable amounts?

Expenses or losses that are tax deductible before they are recognized in financial income.

Give two examples that are performance obligations

Extended warranties: a warranty is extended if the customer has the option to purchase the warranty separately, or the warranty provides a service to the customer beyond quality assurance

Module 1

FASB Codification

When a company changes an accounting principle, it should report the change by reporting the cumulative effect of the change in the current year's income statement. (T/F)

False

It is important not only to determine _____________ revenue to record, but also __________

How much; when to recognize it

Step 5: recognizing revenue over a period of time

If any ONE of three criteria is met: - the customer consumes the benefit of the seller's work as it is performed (ex. cleaning service) - the customer controls the asset as it is created (ex. constructing a building extension) - the seller is creating an asset that has no alternative use to the seller and the seller has the legal right to receive payment for progress to date (ex. an order of jets customized for the US Air Force)

When should a company reduce a deferred tax asset by a valuation allowance?

If it is more likely than not that is will not realize some portion or all of the deferred tax asset

Revenue Recognition for bill-and-hold sales

In such an arrangement where a customer purchases goods but requests that the seller not ship the product until a later date, transfer of control has not occurred so revenue typically should not be recognized until actual delivery to the customer occurs

Step 5: recognizing revenue as a single point in time

Indicators are used to determine when control has transferred from the seller to the customer A customer is more likely to control a good or service of the customer has: - an obligation to pay the seller - legal title to the asset - physical possession of the asset - assumed the risks and rewards of ownership - accepted the asset

Revenues

Inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combo of both) from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major or central operations

Assuming a 40% statutory tax rate applies to all years involved, which of the following situations will give rise to reporting a deferred tax liability on the balance sheet? I. A revenue is deferred for financial reporting purposes but not for tax purposes. II. A revenue is deferred for tax purposes but not for financial reporting purposes. III. An expense is deferred for financial reporting purposes but not for tax purposes. IV. An expense is deferred for tax purposes but not for financial reporting purposes

Items II and III

Progress towards completion: input-based estimate

Measured as the proportion of effort expended thus far relative to the total effort expected to satisfy the performance obligation

Progress towards completion: output-based estimate

Measured as the proportion of the goods or services transferred to date

Deferred tax liability

Must be accrued for the future tax liability (taxable income multiplied by the firm's tax rate). This liability will remain on the company's balance sheet until taxable income is, in fact, higher and the tax liability is paid.

Net operating loss (NOLs) What are they? How much tax is payable the year of an NOL? What are NOLs used for? What does an NOL carryforward create? Do they expire? What are their limits?

NOLs are negative taxable income on the tax return that occur when tax deductible expenses exceed taxable revenues. No tax is payable in the year an NOL occurs. NOL can be used to reduce taxable income in subsequent profitable years. NOL carryforward creates a deferred tax asset. NOLs do not expire; they can be carried forward indefinitely until they are used. Companies are limited to offsetting a max of 80% of taxable income with NOL carryforwards in any given year

Codification: sections

Nature of content in a subtopic, such as recognition, measurement or disclosure. Sectional organization for all subtopics is the same

Is the adoption of a new principle in recognition of events that have occurred for the first time (or that were previously immaterial) an accounting change?

No

The Codification is the source of authoritative guidance to be applied to...

Nongovernmental entities

Which difference (temporary or permanent) has implications for deferred taxes and income tax expense?

Only temporary differences

Deferred taxes

Over an asset's life, taxable income will be higher in future years when accelerated depreciation is less than straight-line. Company's tax liability will be higher as well

If there is a loss on an overall unprofitable contract, how do the percentage of completion and the completed methods recognize that loss?

Percentage of completion method: recognize entire loss now (and "backing out" any previously recognized gross profit) Completed method: recognize loss currently

If there is a current loss on an otherwise overall profitable contract, how do the percentage of completion and the completed methods recognize that loss?

Percentage of completion method: recognizes loss currently Completed method: no adjustment needed

Revenue may be recognized before delivery under certain circumstances. What two methods are available?

Percentage-of-completion, and the completed contract methods

Variable consideration, examples, and methods of estimation

Portion of transaction price depends on the outcome of future events Examples: Construction - incentive payments Entertainment and media - royalties Telecommunication - rebates Methods of estimation: expected value and most likely amount

Give three examples that are not performance obligations

Prepayments: these are part of the transaction price Quality-assurance warranties: part of the PO to deliver products only of acceptable quality Right of return: represents a potential failure to satisfy the original PO to provide goods that the customer wants to keep

Codification: main topics

Presentation, financial statement accounts, broad transactions, and industries

Sellers only include an estimate of variable consideration in the transaction price to the extent that it is... Indicators include...

Probable that a significant revenue reversal will not occur Indicators include poor evidence on which to base an estimate, a long delay before uncertainty resolves, etc.

To recognize revenue over time, a seller needs to estimate what?

Progress towards completion

If a performance obligation does not meet any of the three criteria for recognizing revenue over time...

Recognize revenue at the point in time when the performance obligation has been completely satisfied (usually occurs at the end of the contract)

Chapter 6

Revenue Recognition

Revenue recognition principle under Topic 605

Revenue is recognized when it is 1) realized or realizable and 2) when it is earned

Permanent differences between book income and tax income

The difference between book and tax will not reverse. Caused by GAAP treating some items as income or expenses that the IRS does not

When a company uses the retrospective accounting change approach, they adjust what two things?

The financial statements for each prior period presented to the same basis as the new accounting principle, and the carrying amount of assets and liabilities of the BEGINNING of the first year presented, plus the opening balance of retained earnings

The Codification is applicable to...

US entities that report using US GAAP

Estimating the transaction price involves a variety of considerations, including what two things?

Variable consideration and the constraint on its recognition, and sales with a right of return (a specific type of variable consideration)

An example of a correction of an error in previously issued financial statements is a change...

from the cash basis of accounting to the accrual basis of accounting.