Accounting Exam 2

Subsequent event types, treatment, and consideration

Type I - Recognized - Events that provide additional evidence about conditions that existed at the date of the balance sheet. Including the estimates inherent in the process of preparing financial statements. These events should be recognized in the financial statements Type 11- non-recognized - provide evidence about conditions that did not exist at the date of the balance sheet, but arose before the financial statements are issued or are available to be issued. These events should NOT be recognized in the financial statements, but should be disclosed if their effect is material.

Allowance for Doubtful Accounts

contra-asset account containing the estimated uncollectible accounts receivable -Many companies make large amounts of sales to customers on credit. Regardless of a company's collection efforts, it is likely to have a certain amount of bad debts - customer accounts that will not be collected. Although a company does not know which specific customers that will not pay their accounts until a later period, it must estimate bad debt expense in the period of the sale. Furthermore, the company must REDUCE ITS ASSETS so that at the end of the period its accounting records show the amount of accounts receivable that it expects to collect. - the adjusting entry to record the increase the increase in expenses and the decrease in assets requires the estimate of future uncollectible accounts. However, because the company does not know in the period of the sale which specific customers will default on their accounts, it does not directly reduce accounts receivable. Instead it increases a contra-asset account, ALLOWANCE FOR DOUBTFUL ACCOUNTS. This account is deducted from accounts receivable on the balance sheet to report the estimated collectible amount.

Treasury Stock

- A corporation sometimes will repurchase some of its own outstanding shares. When it does this, the number of shares outstanding is reduced. - the corporation usually records the cost to reacquire shares in a contra shareholders' equity account titled treasury stock. - debit balance - the corporation deducts the amount from the total of contributed capital , retained earnings, and accumulated other comprehensive income to determine its total shareholders' equity. - some companies that repurchase common shares will not recognize a treasury stock contra account, and will instead reduce common stock, additional paid-in-capital, and retained earnings for the amount used to repurchase shares. Companies use this approach if incorporated in states that require accounting for treasury share repurchases as if the shares have been retired.

Assets valued at other than cost (examples, how valued, why?)

- Measuring assets and liabilities under U.S. GAAP follows a mixed attribute measurement model. Different types of assets and liabilities are valued using different measurement bases, including historical costs, fair values, present values, net realizable values, and others. - accounting follows mixed attribute model because the objective of U.S. GAAP and IFRS is to provide the most relevant information that can be faithfully represented in the financial statements. -At the time a company acquires an asset or incurred a liability, historical measures are timely and objective, so are both representationally faithful and relevant to financial statement users. As time passes, current values update historical values with relevant information about the fair value of assets and liabilities as of the balance sheet date. - Measurement methods that reflect current values or a combination of historical cost and current values include: *fair value, present value, current replacement cost, net realizable value. Examples: - Monetary assets (and liabilities) such as cash, accounts receivable, and notes receivable - present value and adjusted present values - (when present value changes because of passage of time). Because it represents cash the company expects to receive in the future. It reports the assets in terms of current cash equivalent values by discounting future value of cash flows to a present value. when the monetary asset is initially recognized in financial statements, the PV computation uses interest rates appropriate for the particular financing arrangement at that time. If due within one year, GAAP permit companies to ignore discounting for the TVM. For certain types of monetary assets, the PV of the cash flows will change because of the passage of time. Companies typically recognize these assets using adjusted prevent values to reflect the passage of time. - Fair value - the relevance of historical cost measures may decrease over time if they do not reflect current economic conditions. As a consequence, to provide for decision-useful information, FASB have adopted standards that require certain assets (and liabilities) (such as trading securities and investment securities available for sale) to be measured at fair values. fair value is the price that would be received to sell an asset or paid to transfer liability in an orderly transaction between market participants at the measurement date. (measure of market-based exit value). on the date a company acquires an asset by paying cash, the fair value is known and is equal to the historical cost of the asset recorded for the asset (assuming independent buyer and seller). Initial recognition value of historical cost is equal to fair market value (optimal level of representational faithfulness and relavence) However, on a subsequent measurement date (such as end of accounting period) the fair value of asset has changed. FASB allows a fair value option for financial instruments like loans, notes receivable, etc. upon acquisition of financial asset, companies can elect to report the instrument at fair value (with subsequent changes in fair values to flow through earnings). Once elected, must remain on that measurement basis for the life of the financial asset or liability. Most useful for financial institutions because the majority of their assets and liabilities are financial in nature. Current replacement cost - amount a company would have to pay currently to acquire and asset it now holds, either through purchase or production. The most common use of current replacement cost is through application of lower of cost or market valuation of inventories.

Contributed Capital

- The amount of capital invested by owners - Contributed capital is recognized when the corporation raises capital by issuing shares directly to shareholders. When the investor purchases shares on the stock market or from another investor, it does not give rise to contributed capital for the corporation. -Accounting for contributed capital can involve as many as four (and sometimes more) components: 1. common stock 2. additional paid in capital 3. treasury stock 4. preferred stock

closing entries

- The final step in the accounting process involves preparing and posting closing entries. - Closing entries are journal entries that a company makes at the end of the period to reduce the balance in each temporary (periodic) account to zero and to update the retained earnings account. -A company uses the temporary accounts (all the revenue, expense, gain, loss, and dividend accounts) during each accounting period to accumulate and summarize information for its net income and dividends for that period. After the period is over and the company's financial statements are prepared, the balances in these accounts are no longer needed. The accounts must begin the next period with a zero balance to collect and summarize the company's net income and dividend information for that period. Retained earnings must be updated for net income and dividend information contained in the temporary accounts. - in closing, temporary income statement accounts with credit balances (like revenues) are debited and the total of the debits is credited to a temporary closing account titled income summary. -accounts with debit balances (like expenses) are credited and the total of the credits to these accounts is debited to income summary. - a resulting credit balance in the income summary account is the net income for the period. This credit balance is closed to zero with a debit to income summary and a credit to retained earnings. - if there is a debit balance in income summary, there is a net loss for the period. This debit balance is closed to zero with a credit to income summary and a debit to retained earnings. -the dividends account is credited and retained earnings is debited. - the result of the closing entries is that: - all the company's revenue, expense, gain, loss, and dividend accounts are closed (have zero balances) and are ready to accumulate the revenue, expense, gain, loss, and dividend information for the next period - The ending balance in retained earnings account is increased by the number that results from net income (income summary) - dividends. - only permanent accounts have non zero balances - always 3, maybe 4 if dividends - do opposite of normal balance to close out accounts ex) - expenses are a normal debit balance. Use credit to close out. Revenue has normal credit balance, use debit to close out.

Common stock

- carries the right to vote and to share in residual profits. The corporate charter includes the number of shares as well as the types and characteristics of its common stock. - common stock is the most prevalent type of stock, and large corporations typically list their common shares for exchange on a stock market and trading among investors establishes the market value of shares. - depending on state laws, a corporation may issue common stock with par-value or stated value or no par value. Legally, some states require common stock to carry a par value (stated value) which refers to the minimum dollar amount per share that investors are required to invest and is printed on the stock certificate. Often, this value is small because states generally do not allow a corporation to issue stock at less than par. - Par must be accounted for separately, apart from other contributed capital - when a corporation issues par value common stock, it must allocate the proceeds (market price per share x the number of shares issued) between a common stock at the par value account and an additional paid in capital account for the differences between the par and the market value. - The latter amount can also be called pain-in capital in excess of par, or premium on common stock. - when a corporation issues a common stock with no par or stated value, the corporation records the entire amount it receives in the common stock account. - because of various other stock transactions, it is possible for a corporation to have multiple accounts for paid in capital from differing sources, even if it issues no par stock. - additional paid in capital "contributed capital in excess of par"

Preferred stock

- corporations may issue preferred stock in addition to common stock. -Preferred stock has different ownership features than common stock, including the first right to a specified dividend, if one is paid. In bankruptcy, preferred stock typically has a lower priority to debt capital but higher priority to common equity. - preferred stock is usually reported on the balance sheet in the shareholders' equity sectioned valued at the amount of capital raised from the preferred stock issue. -In some instances, preferred shares may have a par or or stated value, in which case the preferred share issue proceeds would be reported in two accounts, preferred stock and additional paid in capital (similar to the accounting treatment for common share issues)

Earned Capital

- earned capital always consists of retained earnings and, for some companies, accumulated other comprehensive income. - Retained earnings ......is the total amount of corporate net income that has been earned but has not been distributed to shareholders' as dividends. At the end of the closing process, a corporations closes it temporary accounts, adds its total net income for the period to retained earnings, and subtracts from retained earnings the dividends declared during the period. A corporation may retain the assets generated from this net income to use in its daily operations, to maintain its productive facilities, or for growth. In any event, a retained earnings balance has no relationship to the cash that is available for dividends. The resources generated by net income are invested in all assets. The retained earnings account balance is an addition in shareholders' equity. A negative retained earnings balance (due to cumulative net losses and/or dividends exceeding cumulative net income) is called a deficit, and is subtracted in shareholders' equity. Sometimes a company restricts or appropriates a portion of retained earnings to indicate that it cannot be reduced by the distribution of dividends. This may occur as a result of a legal or contractual requirement. Usually, a company discloses such a restriction in the notes to its financial statements. - Accumulated other comprehensive income (loss) .......the second component of earned capital, accumulated other comprehensive income (loss), is the cumulative amount of other comprehensive income or loss items. Comprehensive income includes both net income and other comprehensive income items. Under U.S. GAAP, other comprehensive income items for a given period may include: *unrealized fair value Gaines or losses on investments in available-for-sale securities *translation adjustments from converting the financial statements of a company's foreign operations into U.S. dollars *cetain gains and losses on derivative financial instruments designated as cash flow hedges *certain pension plan gains, losses, and prior service cost adjustments. -some companies may not experience these items. In that case, net income and comprehensive income are the same, and accumulated other comprehensive income is zero. On the other hand, larger companies may experience significant events from all four items and may over time compile a large amount of accumulated other comprehensive income. -The corporation accumulates the other comprehensive income (or loss) items in its accumulated other comprehensive income (loss) account reported in shareholder' equity. If a corporation has more than one item of other comprehensive income, it may report the amount of accumulated other comprehensive income for each item in shareholders' equity separately, or it may report the total amount of accumulated other comprehensive income for all of the items and then disclose amounts for each of the items in the notes to its financial statements. -Noncontrolling (minority) interests .... some companies will recognize a third component of shareholders' equity, non controlling (minority) interests. This component of equity only arises when one company (known as the parent company) owns a majority of the common shares of another company (known as the subsidiary company) but does not own 100% of the shares. In a situation like this, the parent company will consolidate 100% of the subsidiary company's financial statements with its own financial statements. In consolidating the financial statements, the parent company includes all of the assets, liabilities, and equity of the subsidiary company. However, the parent company does not own all of the equity of the subsidiary. The non controlling shareholders own a minority portion of the subsidiary shares. For this reason, the parent corporation includes the non controlling interests account to recognize the amount of equity capital attributable to minority investors.

Subsequent Events

- events that occur between a company's balance sheet date and the date it issues or makes available to issue its annual report - a company does not issue its annual report for several weeks or months after the end of the accounting period because of the time needed for adjusting and closing the books and auditing the financial statements. During this time, it is possible for significant business events and transactions to occur that, if not disclosed in the company's annual report, would cause this report to be misleading. -the company must make an adjustment to the financial statements if a subsequent event occurs that provides additional evidence about conditions that existed on the balance sheet date and significantly affects the estimates used in preparing the company's financial statements. - when a subsequent event occurs that provides evidence concerning conditions that did not exist on the company's balance sheet date but instead occurred after that date, the company does not adjust its financial statements. Instead, the information is disclosed in a note in a pro forma "as if" statement, or in an explanatory paragraph in the audit report, depending on the materiality of the financial impact. -Types of subsequent events: *recognized - events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. These events should be recognized in the financial statements. A common example of a recognized subsequent event is the resolution of litigation when the event giving rise to the claim occurred before the balance sheet date. *non-recognized - events that provide evidence about conditions that did not exist at the date of the balance sheet, but arose before the financial statements are issued are are available to be issued. These events should not be recognized in financial statements, bu should be disclosed if their effect is material. Common examples include a loss of plant or inventories as a result of a fire or natural disaster that occurred after the balance sheet date or changes in the fair value of assets or liabilities (financial or non financial) or foreign exchange rates after the balance sheet date.

Related Party Transactions (definition, disclosure, examples)

- represent a transfer of resources, services, or obligations between related parties, regardless of whether a price is charged. - Parties are considered to be related if one party has the ability, directly or indirectly, to control the other party or to exercise significant influence over the other party in making financial and operating decisions. Parties are considered to be related if they are subject to common control or common significant influence. - related parties include key management personnel of the company and their close family members. -transactions (sales, purchases, or advances) with companies controlled by the directors, associates, joint ventures, the enterprises key management personnel and major shareholders are considered examples of related party transactions. - it is crucial to disclose information on related party transactions as they may affect users' financials -GAAP requires certain financial disclosures by the company: *nature of the relationship involved *description of the transactions *dollar amounts of the transactions *any amounts due to or from the related parties on the balance sheet date.

total contributed capital

- the sum of the balances in the preferred stock, common stock, and additional paid in capital accounts, minus the amount in the treasury stock contra account, determines the total amount of contributed capital. - the par value or stated value per share, as well as the number of shares authorized, issued, and outstanding should be disclosed either parenthetically in the contributed capital section, on the statement of shareholders' equity, or in the notes to the financial statements.

noncontrolling (minority) interest

-Arise when a parent company consolidates a less than 100% owned subsidiary company's financial statements with its own financial statements. -some companies will recognize a third component of shareholders' equity, non controlling (minority) interests. This component of equity only arises when one company (known as the parent company) owns a majority of the common shares of another company (known as the subsidiary company) but does not own 100% of the shares. In a situation like this, the parent company will consolidate 100% of the subsidiary company's financial statements with its own financial statements. In consolidating the financial statements, the parent company includes all of the assets, liabilities, and equity of the subsidiary company. However, the parent company does not own all of the equity of the subsidiary. The non controlling shareholders own a minority portion of the subsidiary shares. For this reason, the parent corporation includes the non controlling interests account to recognize the amount of equity capital attributable to minority investors.

Contingent losses (Loss Contingencies)

-Uncertain situations that exist on the balance sheet - gain contingencies are not recognized -loss contingencies may be recognized, disclosed, or not recognized. - on the balance sheet date, certain situations may exist that create uncertainty as to possible losses or gains that the company may incur if some future event occurs or fails to occur. (known as loss or gain contingencies). They may need to be recognized directly in the company's financial statements or disclosed in an accompanying note. -A contingent gain could arise if the company entered in a contract to sell a piece of land (which would trigger a gain) in which the buyer will only purchase the land if the buyer receives a change in municipal zoning restrictions. Because of the uncertainty about whether they will be realized, gain contingencies ARE NOT RECOGNIZED IN COMPANY'S FINANCIAL STATEMENTS until they are realized. If contingent gains are disclosed in a note, they should be carefully explained to avoid misleading implications as to the likelihood of future revenues or gains. - loss contingencies are much more common, including examples such as product warranties, uncollectible accounts receivable, guarantees of another company's debt, and pending litigation against the company. Companies must accrue a loss and a liability (or asset impairment) from a loss contingency if *it is probable that a liability has been incurred (or an asset impaired) *the amount of the loss can be reasonably estimated. -If either of these conditions are not met, the company must disclose the loss contingency in the notes to its financial statements. -recognition and disclosure of loss contingencies helps external users predict the company's future use of its financial resources. * Quantitative information disclosed would include the amount of any claims against the company, the company's best estimate of the maximum exposure to losses, and a tabulation of its recognized loss contingencies. *Qualitative disclosures would include a description of the contingency, factors that are likely to affect the ultimate outcome, an assessment of the most likely outcome, and the terms of relative insurance. -Examples of loss contingencies that are commonly disclosed in the notes to the financial statements include guarantees of the debts of others and pending litigation against the company, when either the outcome of the litigation or the amount of possible loss is uncertain.

related party transactions

-frequently occur in the normal corse of business. Related parties of a company include affiliated entities such as subsidiaries, trusts for the benefit of employees, its management and board of directors, and its principal owners or immediate families. - relationships between related parties may enable one of the parties to influence the other so that it is given preferential treatment. To provide sufficient information for external users to understand a company's financial statements, GAAP requires certain disclosures by the company. For related party transactions these include the following: - nature of the relationship involved -description of the transactions -dollar amounts of the transactions -any amounts due to or from the related parties on the balance sheet date.

Book Value

-when a company acquires a long-lived asset to use in its operations, the company records the cost as an economic resource (asset). Once the company has completed it use of the asset, the company will dispose of it at value much less than the original cost. The difference between the original cost and the estimate of this later value (called residual value or salvage value) is the asset's depreciable cost. This depreciable cost is allocated as an expense to each period in which the asset is used. This cost allocation is a process referred to as depreciation, which allocates a proportionate amount as an expense to each period. - the company records depreciation at the end of the period with an adjusting entry that increases depreciation expense and decreases the remaining depreciable cost of the asset. However, the company DOES NOT record this decrease directly in the asset account. Instead, it increases a A CONTRA-ASSET (negative) ACCOUNT, entitled accumulated depreciation. -subtracting this contra account from the asset account results in NET BOOK VALUE (or carrying value) of the asset. By reporting both the historical cost of the asset and the accumulated depreciation, financial statement users can estimate the age and remaining service life of the asset.

Intangible assets (categorization into 3 groups, examples)

1) Intangible assets with finite useful lives - amortized over their useful lives and reported on the balance sheet at their adjusted historical cost. (ex - patents, franchises, licenses, and computer software) 2) Intangible assets with indefinite useful lives - are NOT amortized but are reviewed for impairment annually. (such as trademarks or acquired brand names) are not amortized because their potential services are indefinitely long; however, they are reviewed for impairment annually (when earning power of intangible asset has been reduced to where its fair value is less than historical cost) These intangible assets are reported on the balance sheet at their historical cost or, if impaired, at their fair value, whichever is lower. 3) Goodwill - represents the purchase premium paid when one company acquires another company and is reviewed for impairment annually. -represents the purchase premium paid when one company acquires another company. In an acquisition, the acquiring company might pay a price that is greater than fair value of the net assets acquired because the target company has valuable intangible resources (such as popular and profitable products, a good reputation, a skilled workforce, access to key channels of distribution for supplies or products, or other arrangements) When a company acquires goodwill through merger or acquisition transaction, it is recognized as an asset but it is not amortized. It is reviewed for impairment annually. Goodwill is also reported on the balance sheet at its historical cost, or if impaired, at its lower fair value.

Closing journal entries process

Closes all nominal accounts at the end of the reporting period. 4 steps: Step 1: close revenue/income accounts into income summary Step 2: close expense accounts into income summary Step 3: close income summary into retained earnings Step 4: close dividends into retained earnings - post closing trial balance is prepared after closing entries are made to verify that the total debit balances are equal to the total credit balances in the permanent accounts.

Impaired Asset

Impairment arises when the earning power of an intangible asset has been reduced to the point where its fair value is less than its historical cost. These intangible assets are reported on the balance sheet at their historical cost, or, if impaired, at its lower fair value.

Intangible assets

Non-current economic resources that have no physical or financial nature. They generally derive their value from the legal, intellectual, and intangible benefits they convey to the company. Companies may acquire intangibles by purchasing them from an external third party and by developing them internally through research and development, marketing and advertising, training of executives and personnel, developing production processes, and similar activities. -Intangible resources are normally recognized as assets only when they have been acquired by a company in an external transaction. When intangible assets are developed internally, it is very difficult to measure and value them faithfully because of the lack of an exchange price. Many companies have developed valuable intangible resources, such as their Human Resources and intellectual capital, but these resources are not reported on the balance sheet as assets because of the difficulty in faithfully measuring the value. - the following three categories of intangible assets that have been acquired in external market transactions are commonly recognized on balance sheets: *Intangible assets with finite useful lives (such as patents, franchises, licenses, and computer software) are amortized over their useful lives and reported on the balance sheet at their adjusted historical cost (historical cost minus accumulated amortization) The accumulated amortization of these intangibles is disclosed in the notes of the financial statements - Intangible assets with indefinite useful lives (such as trademarks or acquired brand names) are not amortized because their potential services are indefinitely long; however, they are reviewed for impairment annually (when earning power of intangible asset has been reduced to where its fair value is less than historical cost) These intangible assets are reported on the balance sheet at their historical cost or, if impaired, at their fair value, whichever is lower. - Goodwill- represents the purchase premium paid when one company acquires another company. In an acquisition, the acquiring company might pay a price that is greater than fair value of the net assets acquired because the target company has valuable intangible resources (such as popular and profitable products, a good reputation, a skilled workforce, access to key channels of distribution for supplies or products, or other arrangements) When a company acquires goodwill through merger or acquisition transaction, it is recognized as an asset but it is not amortized. It is reviewed for impairment annually. Goodwill is also reported on the balance sheet at its historical cost, or if impaired, at its lower fair value.

Other assets

Other assets include miscellaneous assets that do not fit in one of the previous categories. examples of items that are sometimes classified in this section include long-term prepayments (such as for rent, insurance, or licenses), deferred tax assets (net), assets of a component of the company that is being discontinued, advances to officers, security deposits paid by the company, and assets temporarily restricted by foreign countries.

Limitations of the Balance Sheet

Some of the major limitations of the balance sheet are: 1. Most assets and liabilities are reported at historical cost. As a result, the information provided in the balance sheet is often criticized for not reporting a more relevant fair value. 2. Companies use judgments and estimates to determine many of the items reported in the balance sheet. 3. The balance sheet necessarily omits many items that are of financial value but that a company cannot record objectively.

Related party transactions examples

The financial accounting standards board (FASB) lists these examples of related party transactions: - a parent company and its subsidiaries -subsidiaries of a common parent -an enterprise and trusts for the benefit of employees, such as the trusteeship of the enterprise's management. -an enterprise and its principal owners, management, or members of their immediate families -affiliates Examples of common types of transactions with related parties include: - sales, purchases, and transfers of realty and personal property. -management, engineering, accounting and legal services received or furnished -use of property and equipment by lease or otherwise.

Goodwill

represents the purchase premium paid when one company acquires another company. In an acquisition, the acquiring company might pay a price that is greater than fair value of the net assets acquired because the target company has valuable intangible resources (such as popular and profitable products, a good reputation, a skilled workforce, access to key channels of distribution for supplies or products, or other arrangements) When a company acquires goodwill through merger or acquisition transaction, it is recognized as an asset but it is not amortized. It is reviewed for impairment annually. Goodwill is also reported on the balance sheet at its historical cost, or if impaired, at its lower fair value.

Consolidated Financial Statements

the parent company will consolidate 100% of the subsidiary company's financial statements with its own financial statements. In consolidating the financial statements, the parent company includes all of the assets, liabilities, and equity of the subsidiary company. However, the parent company does not own all of the equity of the subsidiary. The non controlling shareholders own a minority portion of the subsidiary shares. For this reason, the parent corporation includes the non controlling interests account to recognize the amount of equity capital attributable to minority investors.