FAR 2
Royalties are normally received
"after" the period in which they are earned
Falton Co. had the following first-year amounts related to its $9,000,000 construction contract: Actual costs incurred and paid $ 2,000,000 Estimated costs to complete 6,000,000 Progress billings 1,800,000 Cash collected 1,500,000 What amount should Falton recognize as a current liability at year end, using the percentage-of-completion method?
$0 The excess of accumulated costs ($2,000,000) plus estimated earnings ($250,000) over related billings ($1,800,000) will represent a current asset. A liability only exists when progress billings exceed costs and estimated earnings. Estimated earnings under the completed contract method are calculated as follows: Calculate estimate profit = $9,000,000 − ($2,000,000 + $6,000,000) = $1,000,000 Percent complete = $2,000,000 / ($2,000,000 + $6,000,000) = 25% Calculate gross profit earned to date = $1,000,000 × 25% = $250,000
Beam Co. paid $1,000 cash and traded inventory, which had a carrying amount of $20,000 and a fair value of $21,000, for other inventory in the same line of business with a fair value of $22,000. What amount of gain (loss) should Beam record related to the inventory exchange?
$0. Under U.S. GAAP, this appears to be a transaction (1) that lacks commercial substance and (2) appears to be an exchange that was made merely to facilitate sales to customers (inventory was traded). In order to have commercial substance, either (1) the risk, timing, and amount of the expected future cash flows from the asset transferred differs significantly from the risk, timing, and amount of the expected future cash flows from the asset received, or (2) the entity-specific value (based on the company's expectations of value of the asset and not that of the marketplace) of the asset received differs significantly (in relation to the fair values of the assets exchanged) from the asset transferred. In this case, inventory was traded for inventory, and only $1,000 of cash was paid in the transaction. The future cash flows configuration does not appear to be affected (as both assets are inventory and the $1,000 cash is not significant), nor would it appear that the entity-specific value of the assets received compared to the assets transferred differs much (and is certainly not significant in relation to the fair value of the assets exchanged). Further (and perhaps even more compelling for the exchange to be treated as lacking commercial substance), the exchange is inventory for inventory, and inventory is a product that is ordinarily held to be sold to customers. One of the three exceptions (the second one) to the general rule of valuing a transaction at fair value is if the exchange was made solely to facilitate a sale to a third party that is not a party to the exchange (such as a customer). Remember that lack of commercial substance was the third exception. It appears that this exchange "lacks commercial substance" or falls under the "exchange that facilitates the sale" rules and, since boot was paid, there would be no gain recognized for accounting purposes. Since the fair value of the inventory relinquished exceeded the carrying amount of that inventory, there would be no loss either.
On December 31, Year 1, an entity adopted the IFRS revaluation model for reporting its long-term assets and revalued a patent with a carrying value of $85,000 and a 10 year life to its fair value of $75,000. On December 31, Year 2, before recording any amortization, the entity determined that the patent had a fair value of $90,000. In its December 31, Year 2 financial statements, the entity will report a revaluation gain of:
$10,000 on the income statement and $5,000 in other comprehensive income. The total Year 2 revaluation gain is $15,000 ($90,000 fair value on 12/31/Y2 - $75,000 fair value on 12/31/Y1). $10,000 of the revaluation gain will be recognized on the income statement to reverse the revaluation loss of $10,000 ($75,000 fair value - $85,000 carrying value) reported on the income statement in Year 1. The remaining $5,000 will be recognized as a revaluation surplus in Year 2 other comprehensive income
Deferred gross profit for Year 2 sales = Accounts receivable for Year 2 sales x Gross profit percentage for Year 2 sales
$252,000 = $900,000 x Gross profit percentage for Year 2 sales Gross profit percentage for Year 2 sales = $252,000 / $900,000 = 28%
On July 1, Year 1, Balt Co. exchanged a truck for 25 shares of Ace Corp.'s common stock. On that date, the truck's carrying amount was $2,500, and its fair value was $3,000. Also, the book value of Ace's stock was $60 per share. On December 31, Year 1, Ace had 250 shares of common stock outstanding and its book value per share was $50. What amount should Balt report in its December 31, Year 1 balance sheet as investment in Ace assuming the transaction had commercial substance?
$3,000 (fair value of the truck surrendered). If a nonmonetary exchange has commercial substance, the transaction is accounted for using the fair value of the asset surrendered or received, whichever is more evident. In this question, it appears that the exchange has commercial substance, as it appears to culminate the earnings process (i.e., a truck is exchanged for stock, which would appear in a business sense to have affected the expected configuration of cash). Therefore, the accounting uses the fair value of the asset surrendered or the fair value of the asset received, whichever is more evident, as the value for the exchange. The question indicates that the fair value of the truck is $3,000 on the date of the exchange, and it does not provide the fair value of the stock (don't use the book value of the stock as an "approximation" of the fair value); therefore, the $3,000 fair value of the truck is used for measuring the transaction.
Rule: The functional currency of a company may be:
1. A foreign entity's local currency, which is typically the one in which the entity keeps its books; 2. The currency in which the financial statements will be presented, which is the currency of the parent company; or 3. A foreign currency other than the one in which the foreign entity maintains its books.
On December 31, special insurance costs, incurred but unpaid, were not recorded. If these insurance costs were related to work-in-process, what is the effect of the omission on accrued liabilities and retained earnings in the December 31 balance sheet? 1. Accrued liabilities 2. Retained earnings
1. Accrued liabilities - Understated 2. Retained earnings - No effect Since the unrecorded liability affects work-in-process inventory (rather than cost of sales/retained earnings), there is no effect on retained earnings, but accrued liabilities (and inventory) are understated.
One approach for converting from cash-basis to accrual-basis is as follows:
1. Add increases in current assets. For example, when AR increases, the increase is not considered to be income under the cash basis because the cash has not been collected, but the increase is income under the accrual basis. Subtract decreases in current assets. 2. Conversely, when AR decreases, then cash-basis counted it as revenue when the cash was collected, but under the accrual basis, the income was recognized in a prior period and should not be recognized again in the current period. 3. Add decreases in current liabilities. For example, when AP decreases, this represents a cash outflow that is recorded as an expense under the cash basis. However, under the accrual basis the paid expenses were recorded in a prior period and should not be recorded again in the current period. Subtract increases in current liabilities. 4.Conversely, when AP increases, this represents expenses incurred under the accrual basis method that have not been recorded under the cash basis method because they have not been paid.
The exception to capitalize certain costs associated with intangibles that are specifically identifiable are
1. Legal fees and other costs related to a SUCCESSFUL defense of the asset 2. Registration or consulting fees 3. Design costs (of a trademark) 4. Other direct costs to secure the asset
The research costs associated with an internally developed asset will always be expensed. Assuming a company can reliably measure the costs associated with each component, under IFRS the development costs may be capitalized if all of the following criteria are met:
1. Technical feasibility has been established. 2. The company intends to complete the asset. 3. The company has the ability to sell or use the asset. 4. Sufficient resources are available to complete the development and sell / use the asset. 5. The asset will generate future economic benefits. Kriger Corp. has met four of the criteria, with the one issue being that they do not have sufficient resources to complete the development of the patent. Because all five criteria are not met, they cannot capitalize the development costs associated with the patent. For companies operating under U.S. GAAP, all research and development costs are expensed.
When there is an unlimited right of return, nothing should be recorded as sales revenue unless four conditions are satisfied. These conditions are the following:
1. The sales price is substantially fixed 2. The buyer assumes all risk of loss 3. The buyer has paid some form of consideration 4. The amount of returns can be reasonably estimated
Cumulative foreign exchange translation loss should be reported as a component of accumulated other comprehensive income.
A cumulative foreign exchange translation loss would be a debit to accumulated other comprehensive income; therefore, contra to shareholders' equity.
Slate Co. and Talse Co. exchanged similar plots of land with fair values in excess of carrying amounts in an exchange that lacks commercial substance under U.S. GAAP. In addition, Slate received cash of less than 10% of the total consideration received from Talse to compensate for the difference in land values. As a result of the exchange, Slate should recognize:
A gain in an amount determined by the ratio of cash received to total consideration.
On October 1, Velec Co., a U.S. company, contracted to purchase foreign goods requiring payment in francs one month after their receipt at Velec's factory. Title to the goods passed on December 15. The goods were still in transit on December 31. Exchange rates were one dollar to 22 francs, 20 francs, and 21 francs on October 1, December 15, and December 31, respectively. Velec should account for the exchange rate fluctuation as:
A gain included in net income before discontinued operations. The transaction would first be journalized when title transfers to the buyer on December 15. At fiscal year-end, the exchange rate has increased from one dollar to 20 francs on 12/15 to one dollar to 21 francs on 12/31, so a foreign exchange gain would be recognized.
Which of the following is an intangible asset that is subject to the recoverability test when testing for impairment?
A patent is a type of intangible asset that has a limited useful life. The recoverability test is only performed on intangible assets with a limited life. The recoverability test compares undiscounted future cash flows to the carrying value of the asset. If the carrying value is greater, then a fair value test would be performed.
Rule: Balance sheet accounts are generally included at the current exchange rate, except for:
A self contained subsidiary with a 3 year inflation rate of 100% or more (hyperinflationary economy). A foreign entity which does not maintain its accounts in a foreign functional currency.
All relevant costs incurred before technological feasibility is established should be expensed as research and development expenditures
After technological feasibility is established, all relevant costs are capitalized until the product is released for sale. At that point all relevant costs are included in "Inventory" (normal product costs) and charged to "Cost of Goods Sold" when sold.
Because the trademark is expected to be renewed indefinitely, there will be no amortization expense on the books
Amortization is only recorded for intangible assets with a definite life.
UVW Broadcast Co. entered into a contract to exchange unsold advertising time for travel and lodging services with Hotel Co. As of June 30, advertising commercials of $10,000 were used. However, travel and lodging services were not provided. How should UVW account for advertising in its June 30 financial statements?
An asset and revenue for $10,000 is recognized. Revenues should be recognized in the period in which they were earned and realized or realizable. Expenses are recognized when an entity's economic benefits are used up in delivering or producing goods, rendering services, or other activities that constitute its ongoing major or central operations. UVW provided advertising services but did not yet benefit from the travel or lodging.
Under the rule of conservatism, losses are recognized in all nonmonetary exchanges when the book value exceeds the fair value of the asset given up.
An asset's cash equivalent price is the asset's fair value. Assets should not be valued at more than fair value, so when book value exceeds fair value, the asset should be recorded at the lower fair value. When a loss is recorded, the asset received is recorded at the book value of the asset given up plus any cash paid minus any cash received minus the loss recognized.
Under IFRS, goodwill impairment is calculated by using a one-step test at the cash generating unit level in which the carrying value of the cash generating unit is compared to the cash generating unit's recoverable amount ($45,000 − $32,000 = $13,000).
An impairment loss is then recognized to the extent that the carrying value of the cash generating unit (including goodwill) exceeds the recoverable amount of the cash generating unit impairment loss, which is $13,000. This amount is first allocated to goodwill. Any remaining impairment loss would be allocated on a pro rata basis to the other assets of the cash-generating unit.
Rule: If an entity's books are not maintained in its functional currency, remeasurement into the functional currency is required.
Any gains or losses are included in determining net income and are classified as part of continuing operations.
Shore Co. records its transactions in U.S. dollars. A sale of goods resulted in a receivable denominated in Japanese yen, and a purchase of goods resulted in a payable denominated in French francs. Shore recorded a foreign exchange gain on collection of the receivable and an exchange loss on settlement of the payable. The exchange rates are expressed as so many units of foreign currency to one dollar. Did the number of foreign currency units exchangeable for a dollar increase or decrease between the contract and settlement dates?
Approach: Set up assumed values for transactions and test for appropriate gain or loss. Receivable Denominated in yen. Assume transaction is for 1,000 yen. On settlement date, there is a foreign exchange gain on the receipt of 1,000 yen. In order for there to be a gain, the 1,000 yen must be worth more dollars than on the transaction date. Therefore fewer yen must be equal to a dollar (for there to be more dollars), so the number of yen exchangeable into dollars decreased. Payable Denominated in francs. Assume transaction is for 2,000 francs on settlement date, there is a foreign exchange loss on the payment of 2,000 francs. For there to be a loss, it must take more dollars to buy the same francs. Therefore, the number of francs exchangeable into dollars must have decreased.
"Current cost" of cost of goods sold is less than "historical cost."
As such, "current cost" income from continuing operations would be higher than "historical cost" income from continuing operations.
Which of the following is the proper treatment of the cost of equipment used in research and development activities that will have alternative future uses?
Capitalized and depreciated over its estimated useful life. Equipment used in research and development activities that has alternative future uses is capitalized and depreciated over its useful life.
Sanni Co. had $150,000 in cash-basis pretax income for the year. At the current year end, accounts receivable decreased by $20,000 and accounts payable increased by $16,000 from their previous year-end balances. Compared to the accrual-basis method of accounting, Sanni's cash-basis pretax income is:
Cash basis pretax income would be $36,000 higher than accrual basis income because: The $20,000 decrease in accounts receivable represents cash paid in the current period on accounts receivable from prior periods. Under the cash basis, this $20,000 would be recorded as current period income but under the accrual basis the revenue would have been recorded in the prior periods. Therefore cash basis income in the current period is $20,000 higher than accrual basis income. The $16,000 increase in accounts payable represents expenses incurred but not yet paid. Under the cash basis, no expense would be recorded for the $16,000 increase because cash has not been paid. Under the accrual basis, expenses totaling $16,000 are recorded when the payables are recorded. As a result, cash basis income is $16,000 higher than accrual basis income.
For the purpose of estimating income taxes to be reported in personal financial statements, assets and liabilities measured at their tax bases should be compared to assets and liabilities measured at their:
Choice "c" is correct. On personal financial statements, all items are reported at their fair market values (estimated current values).
Rule: Holding net monetary assets during inflation will result in a loss of purchasing power.
Conversely, holding net monetary liabilities will result in a gain.
The accounting treatment under GAAP for computer software development costs is that costs before technological feasibility is established and during the preliminary project stage are expensed.
Costs incurred after technological feasibility is established and the preliminary project stage are capitalized. Thus, the costs incurred prior to technological feasibility including the $4 million of the development of a working model of the software and the $2 million of the customer support and training will be expensed against earnings.
Deb Co. records all sales using the installment method of accounting. Installment sales contracts call for 36 equal monthly cash payments. According to the FASB's conceptual framework, the amount of deferred gross profit relating to collections 12 months beyond the balance sheet date should be reported in the:
Current asset section as a contra account. The amount of deferred gross profit relating to installment AR collections 12 months beyond the balance sheet date should be reported in the current asset section as a contra account.
A company receives an advance payment for special order goods that are to be manufactured and delivered within six months. The advance payment should be reported in the company's balance sheet as a:
Current liability. The advance payment received for special order goods that are to be manufactured and delivered within six months should be reported in the company's balance sheet as a current liability. (It is not a "deferred credit" because the "special order" goods have not yet been manufactured).
During Year 1, Tidal Co. began construction on a project scheduled for completion in Year 3. At December 31, Year 1, an overall loss was anticipated at contract completion. What would be the effect of the project on Year 1 operating income under the U.S. GAAP percentage-of-completion and completed-contract methods?
Decrease - Decrease. On Year 1 operating income under both the percentage-of-completion method and the completed-contract method will decrease. For "percentage-of-completion" and "completed-contract," the entire estimated loss is recorded for a loss contract in progress (not only the loss incurred to date).
A retail store sold gift certificates that are redeemable in merchandise. The gift certificates lapse one year after they are issued. How would the deferred revenue account be affected by each of the following?
Deferred revenue represents future income collected in advance. When the gift certificates are sold, deferred revenue is increased. When the certificates are redeemed, the revenue is earned and shown in the income statement. Deferred revenue is decreased. When the certificates lapse, the company has no further liability and revenue is earned. Deferred revenue is decreased.
Which of the following expenditures related to internally generated intangible assets is most likely to be capitalized, rather than expensed as incurred, under IFRS?
Development costs incurred in designing a product that has just been granted a patent. Under IFRS, development costs may be capitalized if certain criteria are met. If the patent has been granted, it is generally appropriate to capitalize the related design costs.
Constant dollars
Dollars restated based on calculations of CPI ratios (inflation)
Purchasing power gains and losses are associated with monetary assets and liabilities.
During periods of inflation, current dollars purchase less so any liability would then be settled with dollars with lower purchasing power. Thus, a purchasing power gain is recognized.
Young & Jamison's modified cash-basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual-basis operating expenses, what would be the amount of operating expenses?
During the year, prepaid expenses increased $5,000 from $10,000 to $15,000. Prepaid expenses represent assets where no benefit has been received yet. In accrual accounting, they are not officially expenses until there is associated benefit. Therefore, the $5,000 needs to be subtracted from $150,000. Also during the year, accrued liabilities increased from $5,000 to $25,000. This represents benefit received but no cash paid out yet. The expense of $20,000 (representing the increase) should be booked now (which creates the liability), and when cash payment is made, the liability will be removed. Given the starting point of $150,000, subtracting $5,000 and adding $20,000 will bring accrued expenses to $165,000.
It is proper to recognize revenue prior to the sale of merchandise when: I. The revenue will be reported as an installment sale. II. The revenue will be reported under the cost recovery method.
Neither Revenue can be recognized prior to the completion of a long-term project but generally not prior to a merchandise sale, especially not one recognized on the installment method.
For $50 a month, Rawl Co. visits its customers' premises and performs insect control services. If customers experience problems between regularly scheduled visits, Rawl makes service calls at no additional charge. Instead of paying monthly, customers may pay an annual fee of $540 in advance. For a customer who pays the annual fee in advance, Rawl should recognize the related revenue under U.S. GAAP:
Evenly over the contract year as the services are performed.
Accounting for installment sales
Gross profit = sales - COGS Gross profit % = Gross Profit/Sales Price Earned Gross Profit = Cash collections X Gross Profit % Deferred Gross Profit = Installment Receivable X Gross profit %
Rule: The functional currency of an entity generally depends upon the environment in which the entity generates and expends cash (unless there is a requirement by law to use another currency)
However, the functional currency cannot be the local currency if the foreign entity operates in a highly inflationary environment (i.e., approximately 100% over three years).
Delect Co. provides repair services for the AZ195 TV set. Customers prepay the fee on the standard one-year service contract. The Year 1 and Year 2 contracts were identical, and the number of contracts outstanding was substantially the same at the end of each year. However, Delect's December 31, Year 2, deferred revenues' balance on unperformed service contracts was significantly less than the balance at December 31, Year 1. Which of the following situations might account for this reduction in the deferred revenue balance?
If Year 2 contracts were signed earlier in the year than before, more warranty work would have been performed by year-end, thus reducing the deferred revenue balance more than in prior years.
In nonmonetary exchanges, losses always impact the recorded amount of the asset received.
If a loss is recorded, the asset received is recorded at the book value of the asset given up plus any cash paid minus any cash received minus the loss recognized.
Under U.S. GAAP, impairment analysis begins with a test for recoverability in which the net carrying value of the asset is compared to the undiscounted cash flows expected from the asset.
If the net carrying value exceeds the undiscounted cash flows, then an impairment loss is recorded equal to the difference between the carrying value and fair value of the asset. In this problem, the carrying value of $500,000 is less than the undiscounted future cash flows of $515,000, so no impairment loss is recorded.
A subsidiary's financial statements are usually maintained in its local currency. If the subsidiary's functional currency is its local currency, the subsidiary's financial statements are simply "translated" to the reporting currency. The resulting adjustment is reported as other comprehensive income.
If the subsidiary's functional currency is not the same as its local currency (the functional currency may be the reporting currency or another currency), the subsidiary's financial statements must be "remeasured" into the functional currency. The resulting gain or loss on remeasurement is reported in the consolidated income statement.
Rule: Gains or losses on hedges of firm commitment's for a future purchase (or sale) be recognized in current income.
In addition, the firm commitment must be adjusted to fair value with the resulting gain or loss recognized in current income. The difference between the gain or loss on the hedge contract and the gain or loss on the firm commitment is the net effect on current income.
According to the installment method of accounting, gross profit on an installment sale is recognized in income:
In proportion to the cash collection. Under the installment method, total gross profit is deferred until cash payments are received. Realized gross profit equals the gross profit percentage on the sale times the cash received.
Under a royalty agreement with another company, Wand Co. will pay royalties for the assignment of a patent for three years. The royalties paid should be reported as expense
In the period incurred Royalties paid should be reported as expense in the period incurred.
Under IFRS, exchanges of dissimilar assets are regarded as exchanges that generate revenue and all gains and losses are recognized.
In this problem, the entity gave up cash and an asset in exchange for equipment with a fair value equal to the carrying value of the asset given up. The following JE can be used to illustrate this problem, assuming that the fair value of the new equipment is $10,000 and that $1,500 in cash was paid: The new equipment is recorded at fair value and the asset is removed from the books at its equivalent carrying value, along with the cash paid. To balance the journal entry, a loss equal to the cash given up must be recorded.
This transaction is a nonmonetary exchange that lacks commercial substance under U.S. GAAP. As such, the transaction is an exception to the general rule of basing the measurement value of the exchange on fair value.
In this question, as in many such questions on the CPA exam, cash (boot) is received. Because the cash is less than 10% of the total consideration, a proportional amount of the gain is recognized.
Under IFRS, which of the following statements about intangible assets is correct?
Internally generated goodwill cannot be recognized as an asset. it will be treated as an expense in the period incurred.
The matching principle:
Matches expenses against revenues in the same accounting period. Expenses are necessarily incurred to generate revenues. All expenses incurred to generate a particular revenue should be recorded in the same period in which the revenue is recorded.
Purchasing power measures the impact of inflation through index adjusted constant dollar accounting. As the monetary unit decreases in value constant dollar accounting will measure purchasing power gains and losses.
Monetary assets, assets fixed in monetary value, will experience a purchasing power loss. Appreciation is measured by evaluating replacement costs using current dollar accounting. In a period of rising prices, we would anticipate that non-monetary assets would appreciate in value.
Compared to the accrual basis of accounting, the cash basis of accounting understates income by the net decrease during the accounting period of: 1. Accounts Receivable 2. Accrued Expenses
No - Accounts receivable; Yes - Accrued expenses payable. A net decrease in A/R means cash collected exceeds revenue recognized on the accrual basis. This would mean higher cash basis income than accrual basis income. This yields a "no" for Accounts Receivable. A net decrease in Accrued Expenses means cash paid to reduce Accrued Expenses was more than the accrual basis expense recorded. This would mean a higher expense under the cash basis than under the accrual basis. This yields a "yes" for Accrued Expenses.
For financial statement purposes, the installment method of accounting may be used if the ultimate amount collectible is indeterminate.
Otherwise, the installment method of recognizing revenue is not acceptable for GAAP, and the entire gain is recognized in the year of sale.
Monetary Assets
Purchasing power gains during a period of deflation Purchasing power losses during a period of inflation
Monetary Liabilites
Purchasing power gains during a period of inflation Purchasing power loss during a period of deflation
Which of the following is an example of activities that would typically be excluded in research and development costs under U.S. GAAP?
Quality control during commercial production, including routine testing of products. Research is the planned efforts of a company to discover new information that will help either create or improve a new product, service, process, or technique or one in current use. Items not considered research and development include: Routine periodic design changes to old products or troubleshooting in production stage, marketing research, quality control testing and reformulation of a chemical compound.
Income tax-basis financial statements differ from those prepared under GAAP in that income tax-basis financial statements:
Recognize certain revenues and expenses in different reporting periods Income tax-basis financial statements recognize events when taxable income or deductible expenses are recognized on the entity's tax return. Non-taxable income and non-deductible expenses are shown on the financial statement and included in the determination of income (and become M-1 adjustments to arrive at taxable income).
If revenues are recognized when earned, rather than when received, then the financial statements are prepared using the accrual basis.
Recording long-term liabilities, accrual of income taxes, and capitalization of inventory are all common modifications made to cash basis financial statements.
Legal fees and other costs associated with registering a patent are capitalized.
Research and development costs are expensed under U.S. GAAP.
When service contracts are sold, the entire proceeds are reported as deferred revenue.
Revenue is recognized, and deferral reduced as the service is performed
Tomahawk Exporters, Inc. is the owner of patent #1234. On January 1, Year 1, Tomahawk entered into a patent license agreement with Cherokee Manufacturers, Inc. The agreement calls for an initial lump-sum payment of $100,000 and an ongoing royalty of 5% of the selling price of any product produced under patent #1234. These payments are to be made yearly on January 31 covering all sales made in the previous calendar year. The $100,000 is non-refundable but can be applied against any on-going 5% royalty payments. During Year 1, Cherokee's sales of licensed product amounted to $1,800,000. How much royalty revenue should Tomahawk record in Year 1?
Royalty revenue for the year = $1,800,000 x .05 = $90,000. Since the initial $100,000 payment can be applied against future royalty payments, it should be recorded as "Deferred Revenue" (a liability). The fact that it is non-refundable does not change the accounting.
The evaluation of goodwill impairment involves two major steps.
Step 1: Identify potential impairment by comparing the fair value of each reporting unit with its carrying amount, including goodwill. Assign assets acquired and liabilities assumed to the various reporting units. Assign goodwill to the reporting units. Determine the fair values of the reporting units and of the assets and liabilities of those reporting units. If the fair value of a reporting unit is less than its carrying amount, there is potential goodwill impairment. The impairment is assumed to be due to the reporting unit's goodwill since any impairment in the other assets of the reporting unit will already have been determined and adjusted for (other impairments are evaluated before goodwill). If the fair value of a reporting unit is more than its carrying amount, there is no goodwill impairment and Step 2 is not necessary. Step 2: Measure the amount of goodwill impairment loss by comparing the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. Allocate the fair value of the reporting unit to all assets and liabilities of the unit. Any fair value that cannot be assigned to specific assets and liabilities is the implied goodwill of the reporting unit. Compare the implied fair value of the goodwill to the carrying value of the goodwill. If the implied fair value of the goodwill is less than its carrying amount, recognize a goodwill impairment loss. Once the goodwill impairment loss has been fully recognized, it cannot be reversed.
Yellow Co. spent $12,000,000 during the current year developing its new software package. Of this amount, $4,000,000 was spent before it was at the application development stage and the package was only to be used internally. The package was completed during the year and is expected to have a four-year useful life. Yellow has a policy of taking a full-year's amortization in the first year. After the development stage, $50,000 was spent on training employees to use the program. What amount should Yellow report as an expense for the current year under U.S. GAAP?
The $4,000,000 that was spent before the application development stage (during the preliminary project state) would certainly be expensed. The $50,000 for training employees would certainly be expensed (costs for training and maintenance are expensed). The total so far is $4,050,000. The package was completed during the year and a full year's worth of amortization is taken ($8,000,000 / 4 = $2,000,000). The total then is $6,050,000 under U.S. GAAP.
Historic Cost
The actual exchange value in the dollars at that time an asset was acquired or a liability was assumed (appreciation)
When a fixed asset is sold (voluntarily or involuntarily), gain or loss is recognized as part of income from continuing operations.
The amount of the gain or loss is equal to the difference between the proceeds from the sale and the carrying amount of the fixed asset sold or converted.
Current cost
The cost that would be incurred at the present time, the replacement cost. Use the recoverable amount if lower. (appreciation)
A foreign subsidiary of a U.S. parent company should measure its assets, liabilities, and operations using
The functional currency is the currency of the primary economic environment in which the entity operates, usually the local currency or the reporting currency. The foreign subsidiary itself should measure its assets, liabilities, and operations using the currency of its primary economic environment.
The carrying amount of both tangible and intangible assets held for use needs to be reviewed whenever events or changes in circumstances indicate that the carrying amount may not be recoverable
The future cash flows expected to result from use of the asset and its eventual disposition need to be estimated. If this sum of undiscounted expected (future) cash flows is less than the carrying amount, an impairment loss or expense needs to be recognized. Tech Co anticipates that cash flow will be generated indefinitely at the current level resulting in no impairment. No expense is recognized.
Goodwill is capitalized only when
incurred in the purchase of another entity. Costs incurred for maintaining or developing goodwill are expensed.
Campbell Corp. exchanged delivery trucks with Highway Inc. Campbell's truck originally cost $23,000, its accumulated depreciation was $20,000, and its fair value was $5,000. Highway's truck originally cost $23,500, its accumulated depreciation was $19,900, and its fair value was $5,700. Campbell also paid Highway $700 in cash as part of the transaction. The transaction lacks commercial substance. What amount is the new book value for the truck Campbell received?
The gain or loss is calculated by subtracting the net book value of the asset surrendered from its fair value. The fair value of the asset surrendered must always equal the fair value of the asset received, even if only one of these amounts is given. In this fact pattern, the net book value of Campbell's truck is $3,000 ($23,000 − $20,000) and its fair value is $5,000, so there is a gain of $2,000. However, because this exchange lacks commercial substance, Campbell will only recognize a gain if it received boot/cash. If boot/cash is given, or there is no boot/cash in the transaction, then no gain is recognized. Because Campbell pays cash of $700, no gain is recognized.
A company's cash-basis net income for the year ended December 31 was $75,000. The following information is from the company's accounting records: January 1 December 31 Accounts receivable $ 15,000 $ 20,000 Prepaid expenses 7,000 4,000 Accrued liabilities 2,500 2,000 What is the accrual-basis net income?
The increase in accounts receivable will increase cash basis net income. An increase indicates more sales on account occurred during the year than cash collections on sales. These sales on account are not reflected in the cash basis net income number as no cash was received, but do impact accrual basis net income. The decrease in prepaid expenses indicates more expense was incurred during the year than cash payments for prepaids. These incurred expenses are not captured in the cash basis net income number as the cash outflow occurred in the previous year. Therefore, cash basis net income must be reduced by the decrease in prepaids to calculate an accrual basis net income number. Lastly, the decrease in accrued liabilities indicates that more cash was paid this year for previously accrued expenses than expenses accrued this year. The cash basis net income number is too low because it accounts for these cash outflows as expenses. The decrease must be added to cash basis net income to reflect a lesser accrual basis expense. 75,000 + 5,000 - 3,000 + 500 = $77,500 accrual basis net income.
If both an asset group in a company and goodwill in one of its reporting units have to be tested for impairment, which of the following statements is correct regarding impairment testing and impairment losses?
The other asset group should be tested for an impairment loss before goodwill is tested. A company will perform impairment analysis and record necessary entries on all assets of the company prior to performing impairment analysis related to goodwill. Reporting units (segments) will be separately tested for impairment analysis. If the fair value of a reporting unit is less than the carrying value, the impairment is assumed to be due to the goodwill as all other assets of the reporting unit would already have been properly adjusted.
Roro, Inc. paid $7,200 to renew its only insurance policy for three years on March 1, Year 5, the effective date of the policy. At March 31, Year 5, Roro's unadjusted trial balance showed a balance of $300 for prepaid insurance and $7,200 for insurance expense. What amounts should be reported for prepaid insurance and insurance expense in Roro's financial statements for the three months ended March 31, Year 5?
The prepaid insurance reflected in the unadjusted trial balance would be fully expensed ($300) and one month (March 1 through March 31) of the renewed policy cost would be expensed. Insurance expense equals $500 ($300 plus $7,200/36 months). Prepaid insurance equals $7,000 ($7,200 × 35/36). The $300 was the last remaining amount from a previous policy that needed to be expensed. When the $7,200 was paid, it was recorded as a debit to Insurance Expense. However, it should have been recorded as a debit to Prepaid Insurance, and amortized over the 36 months. Therefore, one month's expense ($200) will remain in the expense account, and the remaining 35 months of expense will be moved to Prepaid Insurance ($7,000).
Research and development performed under contract for others is not an R&D cost
The purchaser buying the research and development will be able to expense its expenditures as R&D costs.
In all nonmonetary transactions, the fair value given is equal to the fair value received.
Therefore, the carrying amount of the asset surrendered must exceed the fair value of the asset surrendered
Under fair value accounting
individual fair market values are identified for each item. No specific price indexes are applied.
Offshore oil "exploration" costs (assumed to be geological and geophysical expenses) that is the primary activity of a company is not an R&D cost.
These costs would be expensed (as cost of services sold) by a company whose primary activity is the incurring of such geological and geophysical costs. If these "exploration" costs are not assumed to be geological and geophysical expenses, they would be the drilling of exploratory wells looking for commercial oil & gas deposits; in that event, they would be capitalized and then amortized. Either way, the costs are not an R&D cost.
Current cost financial statements report holding gains for goods sold during the period and holding gains on inventory at the end of the period.
They also include holding gains and losses on all other accounts in the financial statements.
Rule: When a "nondealer" in real estate and a "nonmerchant" in personal property make an installment sale, they need only report income over the period in which the cash payments are received.
They merely compute the gross profit from the original sale and apply the gross profit percentage to cash collected to arrive at realized gross profit. Income recognized using the installment method of accounting generally equals cash collected multiplied by the gross profit percentage
The calculation of the income recognized in the third year of a five-year construction contract accounted for using the percentage-of-completion method includes the ratio of:
Total costs incurred to date to total estimated costs.
Nominal dollars
Unadjusted for changes in purchasing power (inflation)
On December 31, an entity tested its goodwill for impairment and determined the following for one of its cash-generating units: Carrying value $ 1,015,000 Fair value less costs to sell 955,000 The entity also determined that the present value of the future cash flows expected from the cash generating unit is $940,000. The cash generating unit reports goodwill of $130,000. What is the goodwill impairment loss that will be reported on the December 31 income statement under IFRS?
Under IFRS, the goodwill impairment test is a one-step test in which the carrying value of a cash-generating unit ( CGU) is compared to the CGU's recoverable amount, which is the greater of the CGU's fair value less costs to sell and its value in use (PV of future cash flows expected from the CGU). For this CGU, the fair value less costs to sell of $955,000 is the recoverable amount because it exceeds the value in use of $940,000. The impairment loss is: Impairment loss = Recoverable amount - Carrying value Impairment loss = $955,000 - $1,015,000 = $(60,000) Under IFRS, the CGU impairment loss is applied first to the goodwill of the CGU.
During the current year, Jase Co. incurred research and development costs of $136,000 in its laboratories relating to a patent that was granted on July 1. Costs of registering the patent equaled $34,000. The patent's legal life is 17 years, and its estimated economic life is 10 years. In its December 31, balance sheet, what amount should Jase report as patent, net of accumulated amortization under U.S. GAAP?
Under U.S. GAAP, the research and development costs should be expensed. The patent will be capitalized and amortized over 10 years (the lesser of legal life or economic life). Current year amortization equals $1,700 ($34,000/10 x 6/12). The patent balance at year-end is $32,300 ($34,000 - $1,700).
If a foreign subsidiary's local currency is the functional currency and the economy of the foreign entity is not highly inflationary, then the translation (current) method is used to convert the financial statements of the foreign subsidiary from the local/functional currency to the reporting currency.
Under the translation (current) method, all income statement items, including salaries expense and sales to external customers, are translated using the weighted-average exchange rate for the current year.
A transaction was reported as a nonmonetary exchange of assets. Under which of the following circumstances should the exchange be measured based on the reported amount of the nonmonetary asset surrendered?
When the transaction lacks commercial substance. When a transaction involving a nonmonetary exchange lacks commercial substance, the reported amount of the nonmonetary asset surrendered is used to record the newly acquired asset. If the transaction has commercial substance, the fair value approach is used.
Rule: Goodwill acquired in an arms-length transaction is capitalized, but
internally created goodwill is expensed because an objective measure of its value is difficult to obtain.
On January 2, Yardley Co. sold a plant to Ivory, Inc. for $1,500,000. On that date, the plant's carrying cost was $1,000,000. Ivory gave Yardley $300,000 cash and a $1,200,000 note, payable in 4 annual installments of $300,000 plus 12% interest. Ivory made the first principal and interest payment of $444,000 on December 31. Yardley uses the installment method of revenue recognition. In its year-end income statement, what amount of realized gross profit should Yardley report?
Yardley has collected $300,000 on January 2 and $300,000 from the note (interest is recorded separately). $600,000 x 1/3 profit rate ($500,000 profit on $1,500,000 sale) is $200,000.
Under the percentage-of-completion method, annual gross profit equals
[total cost incurred/total expected cost] × [total expected gross profit] less total gross profit previously recognized. In the final year of the contract, actual rather than expected amounts are used.
Rule: "Translation adjustments" are not included in determining net income for the period but are disclosed and accumulated as
a component of other comprehensive income in consolidated equity until disposed of.
Development or improvement of techniques and processes is
a research and development (R&D) cost.
A business interest that constitutes a large part of an individual's total assets should be presented in a personal statement of financial condition as
a single amount equal to the estimated current value of the business interest.
Personal financial statements usually consist of:
a statement of financial condition (similar to a balance sheet) and a statement of changes in net worth (similar to an income statement).
When a foreign currency transaction is not settled at year-end,
a transaction gain or loss must be reported on the year-end income statement. The gain or loss is calculated using the change in exchange rates between the transaction date and year-end.
OCBOA financial statements cannot use
accrual basis financial statement titles
Conversion adjustments associated with translation of financial statements are displayed in
accumulated other comprehensive income.
The franchisor should report revenue from initial franchise fees when
all material conditions of the sale have been "substantially performed."
Rule: Gains or losses on fixed assets (including involuntary conversions) are
always recognized during the period incurred based on recorded amount (NBV) plus any costs associated with the transaction.
The statement of assets and liabilities arising from cash transactions is
an acceptable title for a modified cash basis financial statement.
The statement of income - income tax basis is
an acceptable title for an income tax basis financial statement.
Expected losses on contracts
are recognized prior to job completion (conservatism).
Deferred revenues
are revenues that have been received in cash but not yet earned is a liability until the service has been performed.
Changes in current cost of non-monetary assets such as equipment and land are not included in "current cost" income from continuing operations,
but instead are classified as "holding gains or losses" in the current cost statements.
Rule: Deferred credit represents future income contracted for and/or collected in advance,
but which has not yet been earned by the passing of time or other criteria.
When there is no boot, transactions that lack commercial substance are recorded at
carrying value, and no gain is recognized for accounting purposes. However, in this question, cash/boot is received, and a proportional amount of the gain is recognized. The question did not ask that the gain actually be calculated.
Under U.S. GAAP, R&D
contracted out to a third party, preproduction prototypes and models costs, and, costs for searching for new products or new process alternatives are reported as R&D expense.
Under U.S. GAAP, Research and development includes
costs incurred prior to technological feasibility for developed software that is to be sold, leased, or marketed. This software is for internal use, unrelated to production and is not considered research and development. Market research is also not research and development because it is not aimed at discovery of new knowledge to develop a new product or service.
Current cost amounts of inventory and property, plant and equipment are measured at
current cost or lower recoverable amount at the measurement date:
When the installment method is used to recognize revenue,
deferred gross profit is equal to the installment receivable multiplied by the gross profit percentage.
The installment sales method
delays revenue recognition by recognizing revenue as cash is collected rather than accelerating revenue recognition.
The cost recovery method
delays revenue recognition until all costs have been collected rather than accelerating revenue recognition.
Rule: Foreign exchange transactions gains and losses are generally included in
determining net income for the period in which exchange rates change.
OCBOA financial statement titles should
differentiate the financial statements from accrual basis financial statements.
. Non-monetary assets (e.g., inventory) and liabilities (e.g., warranty obligations)
do not result in a purchasing power gain or loss during periods of inflation because they change in value as price levels change.
When the "percentage of completion" method of recording revenue is used,
engineering estimates of completion or "costs incurred to date" vs. "total estimated costs" is the basis for recognizing revenue, not progress billings
The timing of future cash flows of the asset received differing significantly from the configuration of the future cash flows of the asset transferred is
evidence of an exchange with commercial substance in which the fair value approach would be used.
GAAP requires that start-up costs, including organizational costs, be
expensed as incurred, without exception
To calculate the gross profit earned under the percentage of completion method,
first calculate the estimated gross profit of the completed contract and then multiply that amount by the % of completion to date.
When a nonmonetary transaction has commercial substance,
gains and losses are recognized based on the difference between the fair value and the book value of the asset given up:
For nonmonetary exchanges that contain commercial substance, meaning that the amount and timing of future cash flows changes as a result of this exchange,
gains and losses are recognized immediately.
Under the cost recovery method
gross profit is not realized until cash is collected equal to the cost of the goods sold.
Gains or losses from remeasuring the foreign subsidiary's financial statements from the local currency to the functional currency should be included
in "income from continuing operations" of the parent company.
Proceeds received from the advance sale of nonrefundable tickets for a theatrical performance should be reported
in the seller's financial statements before the performance as unearned revenue for the entire proceeds.
Rule: Gains and losses resulting from foreign exchange transactions that are an "extension" of the parent's domestic operations are
included as a component of "income from continuing operations" in the period in which they occur.
In financial statements prepared on the income-tax basis, the nondeductible portion of expenses (such as meals and entertainment) should be
included in the expense category in the determination of income.
When a company uses the "percentage-of-completion" method of accounting for a five-year construction contract,
income previously recognized would be used to calculate the income recognized in the second year (but not progress billings to date).
This exchange appears to have commercial substance because it
is an exchange that is the culmination of the earnings process-the goods are exchanged for promotional purposes, and the economic position (or cash configuration) of each company changed because they received advertising in exchange for their goods (i.e., neither company is in the same economic position as it was before). Note that there is nothing to indicate that the exchange was purely to facilitate the sale of a product to a party that was not a party to the exchange (the second exception). Gains on exchanges culminating the earnings process are fully recognized and are equal to the difference between the fair value and the cost of the asset(s) surrendered. The retail prices are not a factor. Note that under IFRS, all gains would be recognized because this is an exchange of dissimilar assets.
Gross profit
is calculated as sales less cost of goods sold
UN-successful defense of an intangible
is expense and the asset is tested for impairment.
Market research, even though the term contains the word research,
is not an R&D cost.
Under the acquisition method, goodwill is a representation of an acquired company's fair value over the fair value of the entity's net assets and
is not recognized solely because the fair market value of a company's assets exceeds the book value of the company's assets
Under the accrual basis of accounting, all gross profit
is recognized and realized at the time of the sale. Recognition is deferred under the installment method.
The statement of cash and equity
is the balance sheet equivalent under the cash basis of accounting.
Goodwill is recognized in the balance sheet when
it has been created from a business acquisition.
The installment sales method should only be used when
it is impossible to establish a reasonable bad debt percentage. It is probable that some amount will be collected, but the amount cannot be projected.
Once the patent is established
legal costs to successfully defend the patent should be capitalized and amortized over the lesser of the patent's useful economic life or its legal life.
Intangible assets should be amortized over the
lesser of the useful economic life or the legal life.
Under U.S. GAAP, the only acceptable method of accounting for research and development is a direct charge to expense, except for
materials, equipment, or facilities that have alternate future uses that are capitalized and depreciated over their useful lives.
The purchase of a copyright should be recorded as an intangible asset
not as a royalty expense
The cost of a trademark is amortized
over its economic life.
For software developed internally, costs incurred in the
preliminary project stage are expensed under U.S. GAAP.
A liability only exists when
progress billings exceed costs and estimated earnings.
Under U.S. GAAP, subsequent reversal of intangible asset impairment losses is
prohibited unless the intangible asset is held for sale
Under the cost recovery method, revenue is
recognized after cash equaling the cost of the item is collected
Under the installment method, gross profit is
recognized as a gross profit percentage times the cash collected from the sale.
Rule: Under "current cost" accounting, holding gain on inventory is the excess of
replacement cost at the balance sheet date over the original purchase price. Note 1: Price level index is used for the "historic cost/constant dollar" method - not the "current cost" method. Note 2: Selling prices are not a component of "holding gains."
U.S. GAAP requires that goodwill be tested for impairment at the
reporting unit level.
Under the completed contract method
revenue is recognized when the contract is complete, however expected losses are recognized immediately in their entirety.
Collections received for service contracts
should be recorded as an increase in a "deferred revenue account."
Under current cost accounting
specific price indexes may be used to restate financial statements items.
A company that wishes to disclose information about the effect of changing prices should report this information in
supplementary information to the financial statements.
Under IFRS, goodwill impairment is analyzed at
the cash-generating unit level.
Using the cost recovery method, all gross profit on the sale is deferred until
the cost of the item sold is collected.
Under U.S. GAAP, unless the tangible assets associated with the research and development (R&D) expenses have alternative future uses or the work is undertaken on behalf of others under a contractual agreement,
the costs associated with the R&D expenses are direct charged as an expense on the income statement.
The foreign subsidiary's functional currency is
the currency of the environment in which the subsidiary primarily generates and expends cash.
The rate to be used to translate all assets and all liabilities from the functional currency to the reporting currency (the U.S. dollar) is
the current rate, that is, the exchange rate in effect at the balance sheet date.
On a personal statement of financial condition, estimated income taxes equals
the difference between fair values and tax bases of assets and liabilities.
In transactions that have commercial substance, gain is recognized in a nonmonetary exchange equal to
the difference between the fair value of the asset given up and the book value of the asset given up.
Amortization of capitalized software costs equals
the greater of straight-line amortization or sales revenue from the software for the period ÷ total projected sale.
Capital accounts are translated into the functional currency using
the historical exchange rates.
When a company uses the U.S. GAAP "completed contract" method to account for a long-term construction contract, revenue is recognized when
the job is completed, not when progress billings are collected or when they exceed recorded costs.
Under U.S. GAAP, the research and development costs should be expensed. The patent will be capitalized and amortized
the lesser of legal life or economic life
Royalties received should be reported as revenue in
the period earned.
the equipment purchased for current and future projects because the equipment has alternate future uses. This equipment will be capitalized, but
the related depreciation expense will be allocated to R&D while the equipment is being used for R&D.
A transaction denominated in a foreign currency is recorded at
the spot rate on the date of the transaction
If sales are subject to a high rate of return
then no sale will be recognized until returns can be determined.
The cost recovery method is appropriate when
there is no reasonable basis for estimating collectibility.
When the entity's future cash flows are expected to change as a result of the exchange of nonmonetary assets,
this exchange is referred to as having commercial substance. In this situation, the fair value method approach is used.
"Advances" affect cash flow but do not affect accrual basis expense
thus information on "advances" is a "distractor."
Research and development costs are expensed
whether they are incurred internally or by contract with outside firms under U.S. GAAP
When the translation method is used, all assets and liabilities are translated to the reporting currency using the current (year-end) exchange rate,
while common stock and additional paid-in capital are translated using historical exchange rates.
Testing in search of a product or process alternatives
would be classified as a research and development cost.
