Accounting Concepts Exam 1

What is a contingent loss? A contingent gain? under GAAP

A contingent loss is an existing condition, situation, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur. Contingent gain is the same except word gain is substituted for loss.

What does "best" estimate mean?

A settlement value - the amount the firms would pay someone else to assume the liability from the firm. This is usually unobservable and will vary from circumstance to circumstance. In general, IAS 37 tends to favor an "expected value" approach over the "most likely" approach of ASC 450.

How are internally-developed intangible assets treated under US GAAP?

Absent specific guidance, costs to internally develop intangibles (like brand value, customer or employee loyalty, goodwill, etc) are expensed as incurred Only exception is certain direct costs of identifiable assets with determinable lives can be capitalized: EX: direct filing cost and legal costs associated with successful defense of patent rights can be capitalized Importantly though, all of the R&D needed to develop new patents and products is expensed as incurred

Summarize the recognition guidance for restructuring costs under IFRS.

Accrue liability when: Formal plan exists and identifies: The business area and location Location, function, and approximate number of employees to be terminated Expenditures to be made When the plan will be implemented Started to implement plan or announced its features to those affected

How are software development costs amortized under US GAAP?

Amortization of capitalized development costs are amortized once the product is ready for sale/when sale starts. Theses costs are amortized over the useful life of the product using (each year) the greater of straight line over the remaining life or ratio of current revenue from the product to total current and expected future revenue

What are exit and disposal activities?

An exit activity includes but is not limited to a restructuring, such as the sale or termination of a line of business, the closure of business activities in a particular location, the relocation of business activities from one location to another, changes in management structure, or a fundamental reorganization that affects the nature and focus of operations. A restructuring is defined as a program that is planned and controlled by management, and materially changes either the scope of a business undertaken by an entity, or the manner in which that business is conducted, as defined by the International Accounting Standard No. 37 in 2002. A disposal activity is one governed by ASC 205-20 (Discontinued Operations), where a component of an entity is sold or disposed of or is held for sale. You will learn more about this in Intermediate accounting. We will not cover disposal activities in this class.

What are the important elements of the FASB's definition of an asset?

Assets are (1)probable future economic benefits, (2) obtained or controlled by a particular entity, (3) as a result of past transactions or events.

Why are termination benefits for employees retained beyond the minimum retention period accrued ratably into the future instead of recognized all at once?

Because they have to meet some criteria in order to earn their bonus If employees have to work beyond the minimum retention period to get benefits (usually 60 days), we presume the payments pertain to future services provided by employees. Thus, they are not a liability now because no obligating event has occurred. If employees do not have to work (or only have to work for less than 60 days) to get benefits, we presume the payments are for past services. Thus, the obligating event has already occurred a liability for the full benefits is accrued.

What are the recognition and disclosure criteria for contingent losses? Contingent gains? under GAAP

Contingent Losses: If future event is remote: no accrual or note required. Note is permitted (but unlikely) If future event is reasonably possible: Do not accrue. Footnote disclosure required. If future event is probable: Accrue if amount is reasonably estimable For large groups of homogenous transactions, past averages are usually used (expected value approach) For more unique individual contingencies: pick "best" (most likely) estimate from range ->evaluate uniquely If no amount is most likely, choose lowest end of the range (but must disclose reasonably possible additional exposure) This is a departure from expected value If range cannot be reasonably estimated... don't accrue, but must disclose if material. If material becomes available after year end but before financial statements are issued, can be used to update probability of loss but loss must relate to the period of the financial statements Contingent Gain: Recognition? Never accrued. Wait until future events occur to confirm existence of gain (i.e. realization) Disclosure? In footnotes (but not required) if probable or possible)

What are the disclosure requirements for exit and disposal liabilities?

Describe the activity Details of the timing of the amount of each cost type Reconciliation of those amounts for each period Where the amounts are aggregated in the financial statements (i.e. line items) Details of costs by reportable segment Why unrecognized liabilities cannot be estimated.

How is technological feasibility defined under US GAAP?

Either all of these requirements are met Detail program design has been completed (ready for coding) Consistent with product specifications High risk development issues resolved OR only this If detailed program design is not used, must have a working model -> in/embedded in hardware and showcases that it works

How are intangible assets defined under US GAAP?

Either internally developed (must be expensed) or externally acquired either on a standalone basis or through a business combination. Non-financial assets that lack physical substance.

What are the important elements of the FASB's definition of an expense?

Expenses are outflows or other using up of assets or incurrences of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity's ongoing major or central operations.

Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value, or both. What does that mean?

Financial information has predictive value if it can be used as an input to processes employed by users to predict future outcomes. Financial information need not be a prediction or forecast to have predictive value. Financial information with predictive value is employed by users in making their own predictions. Financial information has confirmatory value if it provides feedback (confirms or changes) about previous evaluations. The predictive value and confirmatory value of financial information are interrelated. Information that has predictive value often also has confirmatory value. For example, revenue information for the current year, which can be used as the basis for predicting revenues in future years, also can be compared with revenue predictions for the current year that were made in past years. The results of those comparisons can help a user to correct and improve the processes that were used to make those previous predictions.

What does "identifiable" mean and how is it defined?

Identifiable means that an item is either: separable - capable of being licensed, sold off, or otherwise transferred to another entity, or protected by a contractual or legal right, or both.

In IAS 37, what distinguishes a provision from a contingent liability?

In US GAAP, everything is called a contingent liability, whether it is recognized or not. IAS 37 uses different terminology and labels recognized items as provisions and unrecognized items as contingent liabilities.

What are the important elements of the FASB's definition of a liability?

Liabilities are (1) probable future sacrifices of economic benefits, (2) arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future, (3) as a result of past transactions or events.

Are restructurings defined differently in IAS 37 relative to ASC 420?

No - the definition of restructuring in ASC 420 comes from IAS 37. ASC 420 does indicate that the topic applies to more than just restructurings but, at a practical level, it's hard to imagine a variety of activities that would be exit costs under ASC 420 that could not be characterized as restructurings in IAS 37.

(Multiple choice) Pear Company is a market leader in consumer electronics and has a distinctive logo (a pear) that is a registered trademark. The logo is recognizable to consumers around the world. This logo and Pears related brand reputation: Do not meet the definition of an asset because it is too uncertain whether these items will yield future economic benefits to Pear Do not meet the definition of an asset because no past transaction or event has occurred that gives rise to probable economic benefits Do not meet the definition of an asset because Pear has no way to control these economic benefits All of the above a and b b and c None of the above

None of the above For many iconic companies (i.e., Apple = Pear), few could argue that brand reputation is not an asset. Past transactions (advertising and / or selling products people like) have led to probable economic benefits (the probability that people will buy products in the future given the firms' reputation). These benefits are controlled through product sales and law. Others cannot access the brand benefits of, say, McDonald's due to trademark laws.

How are costs incurred to develop software for external sales after technological feasibility is achieved treated under US GAAP?

Once technological feasibility is established, additional development costs are capitalized until the product is available for sale. Any additional costs after this point are expensed.

Summarize the recognition guidance for the three types of disposal costs under US GAAP.

One-time termination costs should be recognized when all the criteria in ASC 420-10-25-4 are met, and not before then. Contract termination costs and other costs are essentially recorded as incurred (e.g., when contracts are cancelled), but not before. Thus, the mere intention to cancel contracts or intention to relocate employees does not trigger liability recognition. Liability is recognized and measured at Fair Value in the period in which the liability is incurred

What are the three types of exit costs addressed by ASC 420?

One-time, involuntary-employee-termination benefits Costs to terminate a contract Other associated costs (relocation or facility closure costs)

What does probable mean? Reasonably possible? Remote? under GAAP

Probable: Greater than a 75-80% probability of it occurring Reasonably possible: between 20-75% possibility of it happening Remote: less than 20%

How are R&D expenditures accounted for under US GAAP? What is the rationale for this treatment?

R&D costs are expensed as incurred. The historical arguments for this treatment are that the potential benefits are too uncertain and too difficult to measure reliably or accurately and there is often a lack of correspondence between amounts spent on R&D and resultant benefits (ASC730-10-05-2). In the context of what we have discussed in the course thus far, the rationale is that R&D expenditures often do not meet the definition of an asset (benefits not probable). Even if they are probable, there is no relevant measurement attribute that can be measured in a representationally faithful way. Historical cost won't work because of the lack of correspondence between amounts spent and potential payoffs.

What are the recognition and disclosure criteria for provisions? Contingent assets? IFRS

Recognize when: • Present obligation exists • Outflow of resources is probable • Amount can be estimated reliably If you are unsure whether a present obligation exists, consider the probability of future events. Disclosure requirements are fairly similar except IAS 37 requires a detailed "rollforward" (reconciliation of beginning to ending balances) of recognized provisions. Contingent assets are not recognized, just like under US GAAP.

How are intangible assets accounted for subsequent to initial recognition?

Recognized intangibles are amortized over their useful lives, usually on a straight line basis Some intangibles have indefinite useful lives (e.g., trademarks, goodwill, certain licenses) These assets are not amortized, but are evaluated for impairment annually

Define representational faithfulness and its components.

Representationally faithful means that a depiction of an item in the financial statements (e.g., inventory, a security, a loan payable) faithfully represents what it purports to represent. Information that is representationally faithful should not omit material information (should be complete), should not be biased (should be neutral), and should be free of material (though not total) error.

What are major differences you observe between IAS 37 and ASC 420?

Requirements to accrue a liability for severance or other costs appear to be less stringent under IAS 37. For example, IAS 37 requires you to be able to identify only the approximate number of employees to be laid off and does not mention that the precise details of the severance package be in place. No discussion in IAS 37 of minimum retention periods and how that affects the timing liability recognition. No specific guidance on contract termination costs in IAS 37, unless the contract becomes "onerous" (which means the costs of fulfilling the costs outweigh the expected benefits) Employee relocation costs are not part of a restructuring provision under IAS 37, while they are under ASC 420.

How are R&D expenditures accounted for under IFRS? What is the rationale for this treatment?

Research activities are expensed as incurred. Development costs are capitalized assuming certain conditions in IAS 38 are met. These costs are amortized over the expected life of the development asset. The rationale is that once the development stage is reached, future benefits are sufficiently probable to warrant recognition. Additionally, once the development stage is reached and a marketable product exists, it is more likely that the historical costs incurred to develop the asset will be recouped via future revenue. Thus, historical development costs should have a stronger correspondence to future revenue, which makes the historical cost of development a more relevant attribute.

Since there is no specific standard governing software for IFRS, how should these costs be accounted for under IFRS?

Same as before using five criteria: Technological feasibility (not defined specifically for software) Intent and ability to sell or use Usefulness of product (e.g., external market, internal use) Technical know-how and financial resources Ability to measure expenditures

How are acquired (i.e., purchased from external sources) intangible assets treated under US GAAP?

Standalone purchase: Recognized at their cost (FMV when they are acquired) If more than one intangible is acquired, allocate the purchase price using relative fair values (split the mf cost) Business comno: All identifiable assets and liabilities of the acquired entity are recognized at their FMV (IMP: acquirer recs identifiable intangibles even if acquired entity did not) Any excess of the purchase price over the FMV of the net assets acquired is recognized by the acquirer as goodwill Internally generated goodwill is never recognized as an asset

Tom Herman's contract calls for a bonus payment of $500,000 if he wins a bowl game. The Longhorns are scheduled to play LSU in the Cotton Bowl on Jan 2, Year 2. As of December 31, Year 1, the Horns are a 7 point favorite to win. Should the potential bonus payment be accrued as a liability? If the Horns are a 21 point favorite does your answer change?

The key question here is when does a present obligation exist? At the signing of the contract? Or the winning of the game in Year 2? If it's the former, there is an obligation at the end of year 1 involving an uncertain payout and the outcome of the game in year 2 simply serves to resolve that uncertainty. If it's the latter, there is no present obligation, so there's no liability. The point spread here affects the probability of future payment, but has no bearing on the more fundamental question as to whether a present obligation exists at the end of year 1. Though interpretations may vary, my own view is that the potential payout is not an obligation related to period 1. The obligation does not arise until the game is won in year 2. Herman has no potentially enforceable claim against UT at the end of Year 1 and UT has not obligated itself to stand ready to do anything at the end of Year 1 as a result of Year 1's transactions or events. People could reach different conclusions on this issue, however, so you should be comfortable understanding both sides of the argument.

If a range of possible future contingent payouts is possible, what amount should be accrued (assuming some payment is probable)? Under GAAP?

The outcome amount most likely to occur should be accrued. If no amount is most likely, use minimum end of range, with disclosure required of reasonably possible exposure beyond this amount.

What is the FASB's definition of owners' equity?

The residual interest in a firm's assets once liabilities have been subtracted. Literally, E=A-L.

What is the role of recognition criteria?

The role of recognition criteria is to cope with uncertainty, and to enhance the representational faithfulness of the balance sheet. Thus, the recognition criteria provide a minimum acceptable threshold of reliability or accuracy (freedom from error) that must be achieved before an asset or liability will be included on the balance sheet, or before a revenue or expense will be included on the income statement.

How are costs incurred to develop software for external sales prior to technological feasibility being established treated under US GAAP?

They are treated as R&D and expensed as incurred

8. (Multiple choice) The accounting for R&D costs can best be characterized as representing a tradeoff between: Timeliness and neutrality Verifiability and timeliness Verifiability and relevance Accuracy (free from material error) and comparability All of the above

Verifiability and relevance

Do the definitions of research and development activities in IFRS differ substantially from US GAAP? If yes, in what ways?

no

What does probable mean? IFRS

over 50%This is a lower recognition threshold relative to US GAAP.