Test #3

financial reporting of income taxes: balance sheet classification

-in 2015 (effective in 2016), the FASB issued ASU 2015-17: "Balance Sheet Classification of Deferred Taxes" which simplified the classification of deferred taxes -the board issued the update as part of its initiative to reduce complexity in accounting standards -historically, deferred tax assets and liabilities were classified as either current or non-current, based on the classification fo the related asset/liability -this method was more costly and provided little benefit to users of financial statements -the update requires that deferred tax liabilities and assets be classified as concurrent -aligns it with IFRS

FIN48

-requires firms to make disclosures regarding uncertain tax positions -companies with frequent tax controversies and litigation are already providing similar disclosures, but now everyone else will have to -reporting whether you believe the tax position they've taken will hold up in court and report them to the extent that you think they will hold up -"won't necessarily be tested on this"

cash flow hedge

-the derivative is used to reduce exposure from variability in future cash flows (meaning you lock in cash flow payment now) -derivative is reported on the balance sheet at its fair value, with the changes in the fair value of the derivative being included in "other comprehensive income" until the underlying hedged transaction occurs -when the "hedged" transaction occurs, the value of the derivative offsets the change in the cash flow: cumulative "Other Comprehensive Income" is "reversed" at the time the "hedged" transaction occurs, and this reversal is incorporated into the accounting for the actual transaction

Merck income tax footnote

-Merck had a lot of discussion with legal -lists out U.S. statutory rate and then differentials arising from things such as gain on equity investments (equity method is different under tax law), foreign earnings, tax rate change, state tax settlements, etc. -lits our deferred income tax assets and liabilities -"increases in deferred tax assets relating to pensions and other post retirement benefits, compensation related, and net operating losses and other tax credit carry forwards, as well as increases in deferred tax liabilities primarily reflect the impact of deferred taxes recorded in conjunction with the merger" -in reporting uncertain tax positions, they reconciliated the beginning and ending amount of unrecognized tax benefits -in one case, Merck thought they should carry forward, but the government didn't -IRS examined a ton of their income tax returns

ASU update

-2018: "requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income" -"however, a reporting organization may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment (if any), plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer" -says that changes in fair value are always recognized in net income, meaning that there is no longer a category for available for sale securities for equity investments (but you still have available for sale debt securities!)

partial balance sheet and income statement in fair value hedge example

-End of first year: -assets: equity investments (available for sale) for the amount you paid and put option recorded at the relative time value at the end of that year -income statement: unrealized holding loss-put option for the difference in time values -End of second year: -assets: equity investments (available for sale) for the original price you paid - the amount you sold the option for -assets: put option for the total amount of put option credited -on the income statement, unrealized holding loss (available for sale investment) for cash received from selling the option and unrealized holding gain (put option) for ?

Tax Losses at Sirius XM explain its attraction

-Sirius had $6 billion of cumulative tax losses and it was not clear if they would actually capture them -these tax benefits have value in the marketplace: other companies are willing to pay for operating losses for tax purposes -they have negative income tax expense and deferred tax assets -had negative income tax carry forwards -the IRS can challenge an action if they think something is done for tax purposes and not business purposes -however, the IRS couldn't challenge Sirius for making an acquisition -so if Sirius makes an acquisition and buys a profitable company, you can use their positive income for carry forward -as long as these losses stay with Sirius, they have little value because the company's future prospects for significant profits were slim, but in the eventual hands of another company, those tax losses could become extremely valuable, helping to wipe off more than $6 billion of taxable income -Liberty bought the company, rescuing them from a bankruptcy filing -IRS limits how much of the losses can be used as tax deductions each year

solving for pretax financial income from taxable income

-X+that year's temporary difference in assets=taxable income OR -X-that years temporary difference in liabilities=taxable income

deferred tax asset

-a company reports a "deferred tax asset" when, as a result of temporary differences, the cumulative amount of expenses recorded on the accounting books exceeds the cumulative deductions taken when calculating taxable income, or when the cumulative revenue reported for tax purposes exceeds the cumulative revenue included in accounting income -in other words, deferred tax assets are encountered when, as a result of timing differences, the (cumulative) taxable income reported by an enterprise exceeds the (cumulative) accounting income fo the enterprise

deferred tax liability

-a company reports a deferred tax liability when, as a result of timing differences, the cumulative income reported to date for "book purposes" is greater than the cumulative income reported to date for tax purposes -ex. a firm that accelerates their "deductions" for tax purposes or "defers" reporting income for tax purposes would typically report a deferred tax liability -deferred tax liabilities are very common because most firms prefer to delay paying taxes as long as possible, and will usually attempt to minimize taxable income -however, firms are not necessarily inclined to minimize reported accounting income -in some situations, a lack of flexibility in either the tax code or the accounting rules may result in a firm finding itself in a situation in which income is taxed prior to when it is reported under GAAP -this would occur when GAAP dictates that an expense must be reported in a current period, whereas the tax code does not allow a deduction until a later period -a similar effect would arise when the tax code dictates that revenue must be included in taxable income in the current period, while GAAP does not allow the revenue to be recognized in the current period

Tax-Break Battle Flares: A Big Break

-a lot of financial companies lost money for many years during the recession, but posted big profits in earlier years, so Congress passed a law that you can carry back losses for 5 years instead of 2 -the law doesn't say how recipients must use the refunds: some plan to pay down debt or stockpile cash and most aren't saying how they will use the money

firms keep stockpiles of foreign cash in U.S.

-a lot of the money companies say they've invested indefinitely overseas is actually sitting here right at home -the cash is actually sitting in U.S. bank accounts -the balances are in the U.S., but they are controlled outside the U.S. -as long as it doesn't flow back to the U.S. parent company, the U.S. doesn't tax it -the fact that much of the money already is in the US also undermines a central argument made by companies seeking tax relief to bring home money that they have earned abroad: that the cash is languishing overseas when it could be invested to the benefit of the U.S. economy -auditors don't require the companies to account for possible taxes on foreign earnings as long as they declare that the funds are permanently invested overseas -the upshot: American companies have a strong incentive to find ways of earning most of their profit overseas and keeping it in the hands of foreign units -these companies sit on a ton of cash and yet they are borrowing money: only 2-3% interest on borrowing, whereas you'd pay 35% to bring money back to the U.S. -low interest rates at home have allowed U.S. companies to borrow cheaply, helping them avoid tapping their foreign-held cash -recently the SEC has pressed companies to disclose how much tax they would owe if those funds were transferred to the U.S. parent -U.S. companies are lobbying Congress to replace the current corporate tax system with one. that would tax only their domestic profits

pensions

-a pension plan is an agreement by an organization to provide for a series of payments after an employee retires -pension plans have become more popular recently -two kinds of corporate sponsored pension plans: defined contribution plan or defined benefit plan -the future beneficiaries of these pension fund assets are the employees of the firm -because the beneficiaries of the assets are the employees, and not the employer, pension fund assets are generally not included on the employer's balance sheet -GAAP requires pension benefits to be recorded as compensation expense in the period in which the employee earns the pension benefits (as opposed to the period in which the benefits are paid) -this treatment is consistent with the matching concept, since the benefits related to the employee's work are received while the employee is working, and not when the employee is retired

consolidated income statement for control interest

-all of the revenues and all of the expenses of the subsidiary are included in the income statement -if the parent company owns less than 100% of the subsidiary, the percentage of income attributable to the Non-Controlling Interest is subtracted as a line item on the income statement

permanent differences

-arise when accounting and taxable income permanently differ in terms of what is considered revenue or expense -they do not wash out over a long horizon -said in class: the difference may be included in book income but not tax, or vice versa -permanent differences don't make a big difference and do not result in an enterprise reporting a deferred tax asset or deferred tax liability

example of whether to forego a carry back option

-if they elect to carry back the NOL, they will receive a refund equal to their tax rate in that year * the NOL -since the marginal tax rate for the next year increases, the expected tax savings are equal to the NOL * new tax rate (this number is much higher at 20,400) -if saving 20,4000 over the next year is preferred to receiving 9,000 today, they should not carry back the NOL

tax footnote disclosure requirements

-balance sheet disclosures: total deferred tax liabilities, total deferred tax assets, the total valuation allowance, the net change in the valuation allowance, and significant portions of the deferred tax assets and deferred tax liability -income statement disclosures: with respect to continuing operations a firm must disclosure current tax expense or benefit, deferred tax expense or benefit, investment tax credits (an investment tax credit is a direct offset against a future tax liability), government grants, the benefits of operating loss (NOL) carry forwards (when a carry forward is used, income tax expense is reduced), tax expense resulting from either allocating certain tax benefits directly to contributed capital or from allocating them to reduce goodwill or other noncurrent intangible assets of an acquired entity, and adjustments to the deferred tax liability or asset for enacted changes in tax laws or rates or a change in the tax status of the enterprise, and adjustments to the beginning of year balance of the valuation allowance because of a change in the circumstances that causes a change in the judgment about the realizability of the related deferred tax asset in future years -firms must also disclose a number of other income tax related items: the amount of income tax expense/benefit allocated to items other than continuing operations, the amount and expiration dates of operating loss and tax credit carry forwards for tax purposes, the amount of the valuation allowance for which subsequently recognized tax benefits will reduce goodwill or other noncurrent intangible assets of an acquired entity or will be allocated to the equity accounts -important one to know: companies are required to reconcile the legal federal rate to the effective rate -in other words, publicly-traded corporations must provide a reconciliation, using either percentages or dollar amounts, of the income tax expense that would have resulted from applying regular federal statutory tax rates (applied to pre-tax income from continuing operations) to the income tax expense that was actually reported -effective tax rate: total income taxes/income before taxes (aka taxable income) -with the abundance of information that firms are required to provide, it is no surprise that the content and format of the income tax footnote varies substantially

financial reporting of income taxes

-because GAAP and tax rules regulations are not always in agreement, income calculated under the two approaches will vary (accounting NI is calculated in compliance with GAAP and taxable income is calculated in accordance with prescribed tax rules) -as a result, the income taxes that an enterprise actually pays are usually not equal to the income taxes that would be applicable if the tax rates were applied to the enterprise's accounting income -two types of differences between GAAP and tax rules: temporary and permanent differences

example: trading securities using fair value

-brokerage fees are rolled into capital gains and capital losses down the road -2017 adjusting entry: debit unrealized holding loss-Net Income and credit Fair Value Adjustment (trading) for the difference between the fair value of the investment portfolio and the historical cost (here there is a loss because the fair value is lower) -sale of stock: debit cash, credit Equity Investments (trading) for the historical cost of those shares sold), and debit loss on sale of investments for the difference (net proceeds-acquisition price) -purchasing stock: debit equity investments and credit cash -2018 adjustment entry: find the 2018 adjustment (difference b/w fair value and historical cost) and then subtract by the 2017 (or cumulative) fair value adjustment to get the new number (need to record a further loss in this case) -2018 adjustment entry: debit unrealized holding loss-Net Income and credit Fair Value Adjustment (trading) for this difference

investments

-companies investing in the securities of other firms for various reasons -ex. a firm may have excess cash and invest it in the stock market on a short-term basis, hoping to benefit from an appreciation in stock prices or other firms may purchase an equity interest in a supplier, hoping that such a relationship will lead to more favorable purchase terms -historically, investments had been recorded on the balance sheet using the (conservative) "lower of cost or market" approach where investments were written down if the market price dropped, but no write up was allowed unless the investment was actually sold -criticisms of the lower of cost or market rule: 1. even though objective current valuations of investments were often available, historical cost numbers still appeared on the balance sheet 2. firms were able to manage earnings by strategically deciding which securities in a portfolio to sell: sell the ones with unrealized gains to manage income up, sell the ones with unrealized losses to manage income down -FASB 115 addresses many of these criticisms

investments in debt securities

-debt securities entitle the owner to receive a stream of cash flows over a pre-defined time period -the appropriate accounting for investments in debt securities is dependent on the length of time over which the investing firm expects to won the debt security (based on intent, so it is possible to say you intend to do something that you don't) -3 categories: held-to-maturity, trading securities, and available-for-sale

accounting for derivatives

-derivative: a contract whose value is derived from something else (kind of like a bet) -ex. put and call options, swaps, forward and future contracts -accounting for derivatives is very complicated -FASB #133: controversial standard issued in the late 1990s -per FASB #133, derivates should be reported on the balance sheet at their fair value as of the balance sheet date and the corresponding part of the accounting entry depends on the nature of the derivative -if the derivative is "speculative" in nature (meaning the company enters into the derivate contract in hopes of making a profit on the contract), the change in the value of the derivative is included in Net Income -if the derivative has been acquired as a "hedge," the appropriate accounting treatment depends on the nature of the hedge -3 types of hedges: fair value hedges, cash flow hedges, and foreign currency hedges -in addition to designating the appropriate accounting treatment for various types of derivatives, FASB #133 also has numerous disclosure requirements -ex. a firm must describe the reason why it entered into derivative contracts, and how those contracts relate to the risk management strategy of the firm

foreign current hedge

-derivatives used as hedges against foreign current risk are reported at their fair value, but depending on the nature of the exposure being hedged, the fluctuation in value may be included in either Net Income or Other Comprehensive Income

FASB 109

-dictates the GAAP for accounting for income taxes -takes an "Asset-Liability" approach with respect to deferred assets -the desired amount in the balance sheet accounts (deferred tax assets/liabilities) is calculated first, and the income statement accounts follow -under the "Asset-Liability" approach, "Income Tax Expense" is equal to the total amount of tax due in the current period adjusted for increases and decreases in the Deferred Tax Asset/Liability accounts -under FASB 109, the amount to be recorded as a deferred tax liability or asset is equal to the amount of future timing differences multiplied by the tax rates expected to be in effect at the time the differences reverse -even though the reversal of timing differences may occur in distant future time periods, future period amounts are not discounted (no present values) -unless a change in tax rates has been passed, future tax rates are usually expected to be the same as current tax rates -however, if a change in future tax rates has been enacted, deferred tax assets/liabilities should be calculated using the enacted rates

deferred tax asset valuation allowance

-firms report deferred tax assets when cumulative taxable income to date exceeds cumulative accounting income to date, and the excess is related to timing (as opposed to permanent) differences -however, the realization of tax benefits related to deferred tax assets depends on the firm having future taxable income -if management believes that it is more likely than not that some portion of the benefit will not be realized in its entirety, a "Deferred Tax Valuation Allowance" should be used (saying that the asset value is too high) -a Deferred Tax Valuation Allowance is a contra-asset and the amount included in the allowance should be sufficient to reduce the deferred tax amount that is more likely than not to be realized -"more likely than not" means greater than 50%, so it is actually somewhat of a precise mechanism -to determine whether a valuation allowance is necessary, the negative evidence suggesting that some portion of the benefit will not be used is weighted against the positive evidence suggesting that all of the benefit will be used -journal entry for deferred tax valuation: debit income tax expense and credit allowance to reduce deferred tax asset to expected realizable value for the amount you won't realize -thus, increasing the balance appearing in the allowance account increases the amount of income tax expense reported during that period -at the end of subsequent periods, the allowance account is reevaluated, and if necessary a journal entry is made to adjust the balance in the allowance account to a revised amount -an important point to note is that management sets deferred tax asset allowance accounts based on their expectations of the firm's future income -therefore, increases (decreases) in the deferred tax asset allowance account may be considered as an unfavorable (favorable) forecast of the future prospects of the firm -accordingly, a firm may be reluctant to implicitly provide a negative forecast about future prospects by increasing a deferred tax asset allowance -summary: changes in deferred tax assets can give you an insider's perspective on how the firm will do (a negative signal)

available for sale debt securities

-if a firm has failed to identify the category, the default category is "available-for-sale" -like trading securities, available for sale securities are marked to market at the end of each accounting period -available for sale securities differ from trading securities in that unrealized gains and losses do not flow through net income in the period of the market fluctuation -instead, these unrealized gains or losses are included in an alternative measure of performance, Comprehensive Income, in the period of the market fluctuation -when an available for sale security is actually sold, the entire realized gain (loss) flows through net income in that period -the initial entry and recording interest revenue and the gain is done in the same way, however the account "unrealized gain on available for sale securities" will be included in comprehensive income for the firm, but it is not included in net income (it is considered other comprehensive income) -recall that net income for a period finds its way to the balance sheet for the period when net income is closed to retained earnings (NI to RE) -in a similar manner, "other comprehensive income" is closed to a shareholders' equity account on the balance sheet, titled "accumulated comprehensive income" or something similar (OCI to accumulated OCI) -the only difference for journal entries is when you record the sale: -you credit other comprehensive income for the cumulative total so far (difference between unrealized loss and unrealized gain, which is credited here since this difference had a debit balance, so you want to reverse that) -in addition, you debit cash and loss on sale of AFS securities as the plug, credit interest receivable for 1/4 of that year's interest payment, and credit investment in AFS securities for the balance at the beginning of the year plus the addition to this account related to the interest accrual -the credit to "other comprehensive income" essentially closes the "accumulated comprehensive income" account with respect to the investment being discussed (the balance in this account had previously been credited 12,228 and debited 20,133. thus, prior to this entry, the account had a debit balance of 7,905)

tax exercise with a valuation amount example

-if it is more likely than not that the deferred tax asset will be realized: Step 1. the deferred tax asset for that year is the cumulative amount of the deferred tax asset amount * the tax rate for that year = cumulative deferred tax asset - deferred tax asset at the beginning of the year (450,000*.4= 180,000-150,000) Step 2. the income taxes payable is equal to the taxable income given in problem * enacted tax rate Step 3. the income tax expense is the plug, or can be gotten by doing income taxes payable-the increase in deferred tax asset account -summary: income tax expense: obligation +/- the change Step 4. debit income tax expense, debit deferred tax asset, and credit income taxes payable -if it is more likely than not that $30,000 of the deferred tax asset will not be realized: Step 1. debit income tax expense and credit allowance to reduce deferred tax asset to expected realizable value for 30,000

control in equity securities

-if one corporation controls another corporation (when the investors owns more than 50% of the common stock of another corporation), the investor corporation is required to prepare "consolidated financial statements" -at this level of ownership, the investor corporation is referred to as the parent corporation and the investee is referred to as a subsidiary corporation -when preparing a consolidated balance sheet, all of the individual assets and liabilities of the parent corporation and subsidiary corporation are included -if the parent company owns less than 100% of the subsidiary, the percentage not owned by the parent company is referred to as a "non-controlling (minority) interest," but all of the assets and all of the liabilities of the subsidiary are still included on the consolidated balance sheet -the amount of net assets owned by the Non-Controlling Interest is indicated on the balance sheet, and under current US GAAP is reported as part of equity (prior to then, this line item was frequently found between the liability and shareholders' equity sections)

significant influence in equity securities continued: if the amount that the investor pays for its 20-50% ownership interest is not equal to the proportional amount of shareholders' equity of the investee corporation

-if the amount that the investor pays for its 20-50% ownership interest is not equal to the proportional amount of shareholders' equity of the investee corporation, the reasons for the differences must be identified -the differential is broken into the following components: 1. the difference between the fair values and book values of the investor's net assets (as of the date of the investor's investment) -differences of these type are usually amortized over the remaining useful life of the related assets -ex. a differential related to PP&E would be amortized at a rate of the percent the investor acquired * (fair value-book value) /useful life at the time of the investment 2. the remaining difference between the fair value of the net assets and the cost of the investment, which is attributable to "goodwill" -prior to the issuance of SFAS #142, the second type of difference was amortized over a period not to exceed 40 years -however, subsequent to the issuance of SFAS #142, Goodwill is no longer amortized -in addition to indefinitely lived intangible assets, another component of the differential that would not be amortized is a "write-up" associated with "land" (due to the fact that land is generally not depreciated)

net operating losses

-if the tax deductions of a corporation exceed the corporation's taxable revenues, the corporation has a Net Operating Loss (NOL) -under the current U.S. Tax Code, when a corporation has a NOL, the corporation pays no income taxes in the current period -furthermore, when a corporation has a NOL, it may use the NOL as a deduction to offset taxable income in other years -prior to the passage of the Tax Cuts and Jobs Act of 2017, corporations could elect to carry back NOLs to offset taxable income reported in prior periods -in such cases, the corporation would receive a refund of taxes previously paid -carrybacks were applied to the two years prior to the year in which the firm reports a NOL -subsequent to the passage of TCJA, NOL's may not be carried back, and instead may only be carried forward -a corporation that elected to carry back a NOL was required to apply the NOL to the earliest year in the two year window -if the amount of the NOL exceeded the taxable income from two years prior, the "excess" NOL was then applied to the most recent year -finally, if the original NOL exceeded the taxable income for the two most recent years, the remaining NOL was to be "carried forward" to offset future taxable income -firms were not required to carry back NOLs, but most firms elected to do so as they were usually not in a strong financial position, and an infusion of cash in the form of a tax refund may ease the firm through a difficult period -even if a firm does not have an immediate need for the refund, the time value of money suggests that the firm is better off receiving a tax refund in the current period, as opposed to using the NOL to offset taxable income in future periods -nevertheless, on occasion a firm may find it more advantageous to forego their carry back option -for example, if a corporation was in a low marginal tax bracket in prior years, and is expected to be in a high marginal tax bracket in future years, it may make sense to forego the carry back option

fair value hedges

-in a fair value hedge, the derivative is used to "lock in" the fair value of an asset or liability -the change in the fair value of the derivative acquired for this purposes is included in Net Income (meaning it is accounted for in the same way: fair value with changes running through net income) -the firm must designate the asset/liability that is being "fair value hedged," and the carrying value of that asset/liability will be "written up/down" in an amount equal to the change in its fair value during the period in which the asset/liability is being fair value hedged, with the corresponding part of the write up/down being included in Net Income -of special note is that the rules related to fair value hedging "override" regular GAAP -for example, inventory that has been fair value hedged will be written up if its fair value increases -thus, if a hedge is perfect, an item that has been fair value hedged will have no impact on Net Income as the change in the value of the derivative is offset by the change in the value of the hedged item (no economic gain or loss)

breakdown of net assets increasing for available for sales securities

-in looking at the entire life of the investment, net assets as a result of making the investment increased by the amount you paid-the amount you received -amount received is equal to the amount of interest payments you've received before selling + cash received from sale -looking at the year by year breakdown of the increase in net assets into "net income" and "comprehensive income:" -comprehensive income=net income+other comprehensive income -note that the only component of comprehensive income not included in net income is the unrealized change in the market value of the investment in available-for-sale securities -in the year the investment is sold, the cumulative unrealized gains (losses) are realized in net income (in the year of sale, the realized gain included in net income is equal to the sum of the unrealized gains from previous years plus the fluctuation in the market price from the beginning of the year of sale) -note that because net income is included in comprehensive income, the adjustment made to other comprehensive income in the year of the sale ensures that fluctuations in market values of AFS Securities do not flow through Comprehensive Income twice -excluding the periodic fluctuations of market values in the calculation of Net Income presumably reduces the volatility of Net Income -one final observation is that on a year-by-year basis, comprehensive income calculated according to the rules for "SAFS" is equal to net income, calculated according to the rules for "trading securities" -comprehensive income is the same for trading securities or available for sale, so it doesn't really matter -sum of NI=sum of CI, also equal to the change in wealth

taxable income example with the carry back provision being employed for net operating losses

-in recording the benefits of a loss carry forward, assume in this problem that is is more likely than not that the related benefits will be realized 1. in the year of the first loss, debit income tax refund receivable and credit benefit due to loss carry back for (taxable income two years prior to that date * its tax rate) + (taxable income one year prior * its tax rate) -with a carry back, its "income tax refund receivable" b/c you will receive that amount now -since there is still taxable income left over, debit deferred tax asset and credit benefit due to loss carry forward for (income in the year of the loss - total income in two years prior * the year of the losses' tax rate 2. the income tax expense portion of the income statement: net loss is the operating loss before income taxes - (the benefit due to loss carry back + benefit due to loss carry forward) 3. in the year after the loss: credit deferred tax expense for the amount in deferred tax asset from before, credit income tax payable for that year's income - the income from the loss that hasn't been accounted for yet, and debit income tax expense as the plug 4. the income tax expense portion of the income statement: net income is that years income before taxes-income tax payable of that year-deferred tax asset used 5. journal entry in a different loss year: debit income tax refund receivable and credit benefit due to loss carry back for (taxable income two years prior to that date * its tax rate) + (taxable income one year prior that is left over * its tax rate) 6. the income tax expense portion of the income statement: net loss= that year's operating loss + benefit due to carry back from last journal entry

interest cost

-increases pension expense -the interest cost of a defined benefit plan is the increase in the discounted PV of pension benefits due to the passage of time (as you discount by less periods, PV goes up) -for a given year, it may be calculated by multiplying the pension obligation at the beginning of the year by an appropriate interest rate -FASB 87 requires firms to use the same interest rate for calculating the interest cost as is used in calculating the service cost

service cost

-increases pension expense -the service cost of a defined benefit plan is the increase in the discounted present value of the pension benefits that is attributable to an additional year of employment (the extra benefit you earn by working another year) -while simple in concept, there are a number of possible methods for measuring the present value of pension obligations at any point in time 1. Vested Benefit Obligation: if an employee is vested, he is entitled to receive benefits even if he renders no additional service to the firm -the vested benefit obligation is the PV of all vested pension payments (the PV of expected payments for everyone above the vesting period) -the future benefits that are discounted in this calculation are the benefits that the vested employees would be entitled to given their current salary levels 2. Accumulated Benefit Obligation: many employees may have performed years of service for which they are not yet vested, but expect to be vested in the future -the Accumulated Benefit Obligation is the PV of all future pension payments that employees would be entitled to under the assumption that all unvested years of service will eventually be vested -the future benefits that are discounted in this calculation are the benefits that employees would be entitled to given their current salary levels 3. Projected Benefit Obligation: considers all vested and unvested service up to the measurement date -the future benefits discounted in calculating the Projected Benefit Obligation are the expected benefits that employees will be entitled to based upon their expected future salary levels -PV of expected payments with the anticipation that your salary will grow=a lot of subjectivity here -this is the measure we use: for purposes of measuring the service cost for a particular period, the increase in Projected Benefit Obligation attributable to service rendered during the period is used -when calculating the PV of future benefits, FASB 87 suggests that the appropriate discount rate to use is the rate that is "implicit in current prices of annuity contracts that could be used to effect settlement of the obligation" -this rate is referred to as the settlement rate (the rate that a 3rd party would embed in the calculations)

the consolidated balance sheet for control interest

-put all of the assets and liabilities of the subsidiary on the balance sheet, regardless of your ownership percentage -under SFAS #141R and 160, Goodwill is calculated based on the implied value of 100% of the firm less the fair value of 100% of the net assets: -ex. if you paid 920,000 for 80% ownership: (920,000/.80)-(assets-liabilities) -Non-controlling Interest is calculated based on the implied fair value: (all assets included goodwill-liabilities-cash paid of 920,000=non-controlling interest) -note that if a similar investment were accounted for with the Equity Method (significant influence), the investor's balance sheet would initially only include an asset titled, "Investment in Non-Consolidated Subsidiary" in the amount of $920,000 (single line item rather than permeating all accounts) -if a business combination is being accounted for under the acquisition (purchase) method, and if the fair values of assets and liabilities at the time of acquisition of the ownership interest were not equal to their book values, the assets and liabilities are adjusted to reflect their fair values -specifically, the assets and liabilities will be written0up or down by an amount equal to the different between the fair value and the book value at the time of acquisition

fair value hedge example

-investment in available for sale securities -the hedge is the put option, in which the investor paid an option premium on the option -two aspects of fair value: intrinsic value and time value of the derivative/put option -on day of investment: debit equity investments (available for sale) and credit cash -also on day of investment: debit put option and credit cash for the option premium -at the end of the first year record change in value of the put option: debit unrealized holding loss-income and credit put option for the amount its gone down (original purchase price-time value of put option at the end of the year) -when the value of the stock goes down: debit unrealized holding loss-income and credit fair value adjustment (available for sale) for the change in market price from this date to the last date it changed * number of shares -when the value of the stock goes down: debit put option and credit unrealized holding gain-income for the same number as the previous entry (the gain in value of the derivate offsets the loss in the value of the stock) -when the value of the put option goes down: debit unrealized loss-income and credit put option for the difference in value -selling the put option: debit cash for the difference between the market price on that date and exercise price * number of shares, debit loss on settlement of put option for the time value of the put option, and credit put option to make it balance -on the date of sale: debit cash for selling the shares for market price at that time * number of shares, credit equity investments (available for sale) for the original amount/cumulative, and credit loss on sale of investments -last entry on the date of sale: debit fair value adjustment (available for sale) and credit unrealized holding gain-income for the difference between the market price of stock on that date and exercise price of put* number of shares

investments in equity securities

-investments in equity securities are categorized according to the amount of influence/control that the investor is able to exert over the investee -in the absence of other information, influence/control is usually measured by the percentage of common stock of the investee that is owned by the investor -three categories of influence: 1. little or no influence: 0-20%, use fair value method 2. significant influence: 20-50%, use equity method 3. control: 50-100%, consolidated financial statements -note said in class: less common, but there would be disclosure if you were not where you "should be," such as if you owned 25% but did not have significant influence for some reason -unlike debt securities, there is no "held to maturity" classification for Investments in Equity securities, since equity securities do not have a maturity date

FASB #115

-issued in 1993, addresses many of these criticisms from lower of cost or market rule -requires many types of investments to be recorded on the balance sheet at their fair market value, regardless of whether they have increased or decreased in value -further, for certain investments, fluctuations in the market value of investments are to flow through net income in the period of the fluctuation (or you may be able to run the change through other comprehensive income" -the accounting for investments is broken down into accounting for debt securities and accounting for equity securities

Coco-cola income tax footnotes

-liability side of the balance sheet: deferred income taxes -income tax payments in each year is a disclosure requirement -lists out current and deferred income tax expense (benefit) for each year -disclosure requirement: a reconciliation of the statutory federal rate (35%) and effective rate -effective rate is lower in this case -"our effective tax rate reflects the tax benefits from having significant operations outside the US that are taxed at rates lower than the statutory US rate of 35%. our effective tax rate reflects further benefit from realization of tax benefits on charges related to streamlining initiatives recorded in locations with tax rates higher than our effective tax rate" -valuation allowances when it was determined that it would be more likely than not that tax benefits would not be realized were recorded to offset the future tax benefit, resulting in an increase in the effective tax rate -foreign subsidiaries are not taxed until you break the money back in the form of dividends or in another way -the Jobs Creation Act provided a one time benefit related to foreign tax credits generated by equity investments in prior years, resulting in an income tax benefit -the Jobs Creation Act also includes a temporary incentive for U.S. multinationals to repatriate foreign earnings at an effective 5.25% tax rate -income outside of US doesn't have any income tax expense until you bring it back into the U.S. and companies don't have to if they don't want to bring it back -in 2017, because of the Tax Reform Act, money that was housing abroad got taxed all in 2017, which led to a high effective tax rate of 80% (income taxes before continuing operations 2017/net income from continuing operations 2018)

Sun Microsystems income tax footnote

-lists out significant components of all deferred tax assets and liabilities -they have a valuation allowance for gross deferred tax assets

tax bill will deliver a corporate earnings gusher

-majority of firms want to defer income tax forward -when the tax code changed from 35% to 21%, the aggregate deferred tax liabilities gets smaller -when you adjust your balance sheet, it would result in a large one time gain on multi-national earnings -"financial institutions and other companies that had bad experiences during the financial crisis are going to have to take big charges against earnings as the value of their deferred tax assets (passed losses that can be used to defray future tax bills) goes down with the corporate tax cut" -Citigroup, which a huge pile of deferred U.S. tax assets, had to take a large earnings charge (this is a bad thing) -companies are far more likely to have large deferred tax liabilities-which means that the new tax law will, along with cutting their taxes going forward, deliver a big one-time boost to 2017 earnings as the lower corporate tax rate shrinks the value of the liabilities -2017=some quirky numbers

considerations for deferred tax valuation allowances

-negative evidence: suggesting an allowance is needed 1. a history of operating loss or tax credit carry forwards expiring unused 2. losses expected in early future years 3. unsettled circumstances that, if unfavorably resolved, would adversely affect future operations and profit levels on a continuing basis in future years (ex. when its likely you will lose a case -existing of taxable income: if sufficient, no allowance is needed 1. future reversals of existing taxable temporary timing differences result in taxable income 2. enough taxable income to realize the deferred tax asset 3. a strong earnings history exclusive of the loss that created the future deductible amount 4. taxable income in prior carryback year(s) if carry back is permitted under the tax law

variable interest entities

-relationships that should be consolidated, even though one company does not control the other through ownership of a majority of outstanding common shares

held-to-maturity

-not recorded at fair value because fluctuations are not as meaningful: fluctuations in market value do not impact the amount reported on the balance sheet, nor do they impact the amount of income related to the security recorded in a given period -if a firm has both the ability and the intent to hold a debt security until its maturity date, the investment is recorded on the balance sheet at its acquisition cost, adjusted for any unamortized discount or premium related to the security (a firm may not have the ability to hold it until maturity date if they don't have the assets to cover it) -interest revenue is calculated using the effective interest method -if a held to maturity debt security is actually sold prior to the maturity date, the entire realized gain or loss is recorded in the period of the sale -journal entry at the time of investment: debit investment in "held-to-maturity" securities and credit cash for purchase price using the investor's required rate of return (it is not necessary to make a discount account) -create an amortization table including date, cash received, interest revenue, discount amortized, and carrying amount -journal entry to record interest revenue: debit cash for amount of coupon and debit investment in "held-to-maturity" securities for the plug and credit interest revenue -on the maturity date, debit cash and credit investment in "held-to-maturity" securities for the face value

defined benefit plans

-oblige a firm to make predetermined payments to the employee (and possibly their beneficiaries) after retirement -these amounts are most frequently based on some function of the employee's wages at the end of his/her working life -ex. a firm may be obliged to make lifetime payments to a retired employee in an amount equal to 60% of his/her average salary during their last three years of employment -thus, the distinction between the two types of plans relates to when the employer's obligations are defined -a defined contribution plan specifies the payments into a pension fund, a defined benefit plan species the payments out of a pension fund -because a defined pension plan gives you benefit of life, the sponsoring organization retains that risk (large amount due to increase in life expectancies) -there has been a drop in the number of participants of defined benefit plans (its more of an older approach), but the total dollars in Defined Benefit Plans still total in the trillions -for defined benefit plans, the calculation of compensation expense under GAAP is quite complicated -this is because the ultimate future obligation fo the firm is unkown

temporary differences (timing differences)

-occur when a revenue (gain) or expense (loss) enters into the determination of accounting (GAAP) income in a different period that it does for tax purposes -over a long horizon, temporary differences "wash out," meaning the cumulative total of revenue (expense) recorded by a firm for such items will be equal for both accounting and tax income -this type of difference where amounts differ from year to year has a big impact (said in class) -temporary differences result in an enterprise reporting a "deferred tax asset" or a "deferred tax liability"

Carry your losses (further) forward

-old rules: net operating loss could be carried back 2 years and forward 20 years to offset taxable income -new rules: can't carry back at all, but can carry forward indefinitely -the TCJA changes to the net operating loss carryback/carry-forward rules may lessen the full effect of the rate reduction or deduction for taxpayers -only 80% of taxable income can be offset by carry forwards -both the repeal of carry backs and the 80% limitation, by deferring more of the loss recognition to future years, will generally have the effect of increasing the present value of total federal income taxes owed -taking into account the time value of money, companies with intermittent loss years and startup companies with initial years of losses may fare less well than under previous law -more generally, the changes to the NOL rules put greater emphasis on taxpayers' understanding of the timing of their income and deductions when assessing expected future tax liabilities -a NOL generally is the amount by which a taxpayer's business deductions exceed its gross income

tax liability example

-on the Dec. 2015 balance sheet, consider all timing differences that will reverse in the future (starting with 2016), resulting in taxable income exceeding book income 1. record the excess of future tax income over book income (if tax deduction is higher than financial reporting expense, then this number would be negative) 2. these reversals are then multiplied by the tax rates expected to be in effect during the applicable time period -reversal of timing difference*tax rate in effect=contribution to tax liability 3. add up the contribution to tax liability and report as deferred tax liability (if its negative this decreases contribution) -ex. -80+40+70=$30 4. record 2015 journal entry: debit income tax expense for the actual income tax obligation (which is 0 starting balance in this example) + the new contribution of $30, credit income tax obligation for 2015 for the initial balance (but it would be 0 here), and credit deferred tax liability for $40 -in the next year, Dec 31 2016: 1. the reversals are again multiplied by the tax rates to get the total contribution to deferred tax liabilities of $110 2. do new contribution to deferred tax liability (110) - old deferred tax liability/beg balance (30) to get the deferred tax liability to report for the end of this year (80) -the total deferred tax liability is now $110 -income tax expense for 2016 would be calculated as the actual income tax obligation related to 2016 plus $80, which the journal entry: debit income tax expense for xx+80, credit income tax obligation for 2016 for xx, and credit deferred tax liability for 80

Coca-cola balance sheet

-on their balance sheet, they report "equity method investments," which is a pretty large number -on their income statement, they report equity income (or loss,) which is income from non-consolidated affiliates -"our consolidated net income includes our company's proportionate share of the net income or loss of our equity method invests" -Coca-cola still reports the equity method even thought they technically have a small financial stake (18%) because in reality they have a significant amount of control -fairly extensive disclosures for equity method investments

post retirement benefits

-post-retirement benefits are a form of compensation that a firm uses to attract and retain employees -one common post-retirement benefit is a pension plan, another is the provision of health care benefits after the employee retires -the dollar amounts included in such plans can be quite large -"unfunded defined benefit plan liabilities means that the government has not set aside enough money to fulfill their current obligations related to retirement benefits (there's a deficit) -total assets in U.S. retirement income plans has decreased in recent years -as of year end 2002, assets held in individual retirement accounts were the largest component of total retirement assets in the U.S., which has been a significant increase -the amount of defined benefit plans has decreased, while the amount of defined contribution plans has increased

example: what is shareholders' equity in a certain year?

-the difference is always equal to the ownership percentage*shareholders equity (aka you don't need to have net income to figure it out??) -total shareholder's equity= total equity at the beginning of the year (which is equal to assets-liabilities)+total net income-total dividends -twenty percent of this amount is equal to the reported amount of net income-(the unamortized write-up of depreciable assets+the unamortized goodwill)?

defined contribution plan

-the employer makes a specified contribution on behalf of the employee -the contribution is made while the employee is working, and the amount of the contribution is usually based on the employee's salary, age, years of service, or position -ex. at WashU, employees with two or more years of service receive a defined contribution of 7% of their salary and WashU has selected two fund families to manage these assets and the employee may designate in which fund the money should be invested -summary: the beneficiary directs the contribution and lives with the result and the university has no further obligation -the sponsor would debit compensation expense and credit cash -upon retirement, the employee will receive his (her) retirement benefits based on the amount in the employee's retirement fund -of particular note is the fact that the employer is usually under no further obligation to the employee after making the defined contribution -recently, defined contribution lans have become more and more common (they are more common than defined benefit plans) -for defined contribution plans, the impact of a pension contribution on compensation expense is quite simple - compensation (pension) expense is increased by the amount of the contribution -while the number of dollars invested by employees in defined contribution plans is quite large, the accounting for such plans is relatively straight-forward and non-controversial

impairments related to investments

-the tests that are applied to determine impairment are slightly different if a business, such as a bank, originates a loan and expects to collect cash flows directly from the party that borrowed the money because there is no market upon which to rely to determine the fair value of the asset -current GAAP uses an "Incurred Loss" model: a loan receivable would be considered impaired when "it is probable that the investor will be unable to collect all amounts due according to the contractual terms" (this delays recognition until it is probable a loss has been incurred, possible preventing organizations from recording credit losses earlier on) -however, beginning in 2020, the FASB will transition to an "Current Expected Credit Loss (CECL)" model for institutions that hold determining a valuation allowance for investments in debt securities, in which you accrue expected losses on the day you make the investment with an estimate of bad debt expense -"requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. the standard requires organizations to immediately record the full amount of credit losses that are expected in their loan portfolios, resulting in more timely and relevant information that better meets the needs of investors and other users of financial statements" -"the income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period" -this change results from the issuance of ASU 2016-13: Measurement of Credit Losses on Financial Instruments: the amendments affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income (ex. loans, debt securities, net investments in leases) -while "Available for Sale" will soon disappear as a category for Equity Method Investments, current GAAP says that an equity investment is considered impaired when there is a decline in fair value that is "other-than-temporary" in nature (have to access whether a decline in value is temporary or permanent) -other-than-temporary can be evaluated based on whether positive investment suggests the carrying amount is recoverable outweighs the negative evidence to the contrary -an impairment might be considered other than temporary after one year -"true up" means that the actual losses the firm reports will be consistent with what it should be at the end of the loan -the FASB issued Final Staff Positions in 2009 to clear up what it means to determine fair value when there is no active market, and to break greater consistency to the timing of impairment recognition for other-than-temporary impairments -the ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts -summary: eliminates the probable initial recognition threshold in current GAAP and instead reflects an organization's current estimate of all expected credit losses over the contractual term (amendment affects financial assets and net investments in leases that are not accounted for at fair value with changes in fair value reported in net income) -summary: expected credit loss model reflecting more forward-looking information, at each reporting date, an organization recognizes an allowance for credit losses to reduce the financial asset to the amount expected to be collected and recognizes the change in income, and provides enhanced disclosures compared to current GAAP

example: fair value and equity methods

-they acquired 10,000 out of 50,000 outstanding shares of common stock, which means 20% ownership, so it could be little to no influence or significant influence -they don't say what type of security it is, so you assume available for sale -under little to no influence/the fair value method: -buying the stock: debit Available-for-sale Securities and credit cash -dividend payment: debit cash and credit dividend revenue for the amount of the total dividend*ownership percentage -end of year adjustment: debit Unrealized Holding Loss (other comp. inc) and credit Securities Fair-Value Adjustment-Available for Sale for acquisition price-fair value price at end of year*number of shares -it is a loss since the market price is no lower -under significant influence/the equity method: --buying the stock: debit Investment in Stock and credit cash -dividend payment: debit cash and credit Investment in Stock (dividend reduces investment -end of year adjustment: debit Investment in Stock and credit Revenue from Investment (that year's net income*ownership percentage) -additional journal entry for amortization adjustment: debit revenue from investment and credit investment in stock (reduces income and reduces investment) by: -Step 1. amount paid - book value of the investee (book value of the investee: assets-liabilities * ownership percentage) -Step 2. allocate to assets subject to depreciation by doing fair value-book value of these assets * ownership percentage, and allocate the rest to goodwill -Step 3. amortization of allocation: do the allocation amount/useful life for the undervalued depreciable assets and allocation amoung/20 years for the intangible assets/goodwill pre-FASB #142 and no amortization for post FASB #142 -Step 4. add these two numbers together for one year and report as the journal entry number

West Coast Bancorp footnote example

-they recorded an other-than-temporary impairment charge, relating to declines in the value of the preferred stock held in the company's available for sale investment portfolio

new impairment rules for each type of investment

-trading securities are "marked-to-market" at the end of every accounting period with fluctuations in market values flowing through net income, so the issue of impairment is not particularly relevant for securities within this class -however, fluctuations in the fair value of other classes of securities do not immediately flow through net income unless they are deemed impaired -if a "Security Available for Sale" is considered impaired, the security should be reported on the balance sheet at its fair value and net income in the period of the impairment should include a loss equal to the difference between the security's original cost and the fair value as of the date of the impairment -for Securities Available for Sale, prior period Comprehensive Income would have included unrealized losses, so a reclassification adjustment must be made so that the write-down is not "double counted" with respect to Comprehensive Income -in the case of "Hold-to-Maturity" investments, investments calculated using the Equity Method, and investments requiring Consolidated Financial Statements, impairment of the investment will result in writing the investment down to its fair value, and a loss will be included in Net Income in an amount equal to the difference between the carrying value of the investment and its fair value at the date of impairment

trading securities

-trading securities are purchased with the intention of being sold within a short time period -these securities are reported on the balance sheet at their fair market value as of the balance sheet date -at the end of any accounting period, they are marked to market, and any fluctuations in their market value is included in net income in the period of fluctuation as an "unrealized gain/loss" with the corresponding entry of the unrealized gain/loss entry being a debit or credit to the investment account -when trading securities are sold, only an amount equal to the proceeds from the sale less the amount appearing on the balance sheet as of the beginning of the period is included in net income in the period of the sale (since unrealized gains or losses from prior periods were included in prior years' income) -since trading securities may be sold shortly after acquisition, interest accruing on these investments if often minimal -however, FASB 115 does indicate that any interest revenue (including amortization of a premium/discount) should be included in net income in the period earned -note that the amount you are selling the bond for includes accrued interest -you will still use the original amortization table, but now also need to consider market value -the first journal entry: debit investment in "trading securities" and credit cash -at the end of the year: debit cash, credit interest revenue, and debit investment in trading securities as you would normally -but you also need another journal entry to adjust to fair value: debit investment in "trading securities" and credit unrealized gain on trading securities for the market value on that date-the carrying amount (this number will be included in net income) -this entry adjusts the book value of the investment in trading securities to the market value at that point in time, and unrealized gain is included in the income statement (see entry in notes) -the total pre-tax impact on income is equal to interest revenue+the unrealized gain, which is also equal to the cash received+the change in the market value of the investment (face value + (market value in that year-original carrying value)) -this is your change in wealth during the year -in a period of loss (where carrying amount is higher than market value): debit unrealized loss on trading securities and credit investment in trading securities for (market value of that year-carrying value- prior periods gain) and the pre-tax impact on income is equal to interest revenue-unrealized loss (or cash received+change in the market value of the investment) -when the bonds are sold 1/4 of the way through the year on March 31, interest revenue is recorded from the beginning of the period through the date of sale: debit interest receivable for cash received in one year * (1/4), investment in trading securities is debited for one forth of the amount related to entire 2019 discount amortized, and interest revenue is credited for the difference -the sale is then recorded: debit cash, debit loss on sale of trading securities as the plug, credit interest receivable for the same amount as last entry, and credit investment in trading securities equal to the balance at beginning of year+the addition to this account related to the interest accrual (aka sum of all prior entries)

pension expense for a defined benefit plan

-under GAAP, pension expense for a defined benefit plan is comprised of four separate components, with the impact on pension expense indicated in parentheses -the ones on this sheet: service cost and interest cost

net income using the three different method

-under the equity method, the Investment account of the investor increases when the investee reports income and the Investment account decreases when the investee reports a loss or pays a dividend -thus, in the absence of the investee issuing/repurchasing stock, the change in the "Investment" account should be proportionate to the change in the Total Shareholders' Equity of the investee -as a general rule, the amount in the Investment account less the unamortized components of the original difference should be equal to the proportionate share of the Total Shareholders' Equity -net income is always higher under the equity method

income tax benefit for an NOL

-when a firm has an NOL, it will report an "income tax benefit" (aka negative income tax expense) on its income statement in the year in which the NOL is incurred -journal entry: debit deferred tax asset and credit income tax benefit (expense) -a firm carrying NOLs forward will report a Deferred Tax Asset on its Balance Sheet -the deferred tax asset arises from the fact that the NOL will eventually lead to a reduction in taxable income, which leads to a reduction in income taxes -the expected reduction in future taxes is the amount due to the NOL that is reflected in the Deferred Tax Asset account -because NOL carry forwards will only prove beneficial if the firm has future taxable income, Deferred Tax Assets resulting from NOL carry forwards should be analyzed for reasonableness -if a firm is not likely to use all of the NOLs, a valuation allowance should be set up in order to state the Deferred Tax Asset at its realizable value -the valance in the allowance account should be reviewed at the end of each period -upward or downward revisions should be made to the allowance account to reflect the changes in the likelihood that the benefits will be realized

little or no influence

-within 0-20% ownership, investors are assumed to be able to exert little or no influence or control over the investee corporation -the appropriate accounting depends on whether the fair values of the investments are available -if the fair values are not readily available (ex. a private company), the firm can use the Cost Method, in which the investment is reported on the balance sheet at its original cost and any dividends received are recorded as income -per FASB 115, which is now incorporated into Accounting Standards Codification as Topic 320, if the fair value of such securities is determinable, the securities must be reported on the balance sheet at their fair value -until recently, there were only two categories for reporting equity securities for which fair values were available, "trading securities" or "available for sale securities" (no held to maturity) -classification into "trading securities" is based upon the intent of management -changes in the market value of equity "trading securities" flow through net income in the period of the change -changes in the market value of "available-for-sale" securities" (aka unrealized gains/losses) are included in Comprehensive Income in the period of the change (but do not flow through NI), with the entire realized gain (loss) being included in Net Income in the period of the sale -when firms invest in many different securities that fall into these different categories, firms may calculate the fluctuation in the market price based on the entire portfolio of the securities, as opposed to calculating the fluctuation of each individual security -because firms within the 0-20% category are assumed to have little or no influence over the investee corporation's dividend policy, dividends received from such investments are recognized as revenue and therefore are included in Net Income (for both trading and AFS securities) -when dividends are paid, the price of a stock usually drops by an amount approximately equal to the amount of the dividend -therefore, when a dividend is received from a "trading security," the increase in Net Income attributable to the dividend is offset by a corresponding "unrealized loss" in the price of the stock (which flows through net income in the same account period) -however, the drop in the value of a share of stock corresponding to a dividend from an "available for sale" is not included in Net Income, as the unrealized loss is included in "other comprehensive income"

significant influence in equity securities

-within 20-50% ownership, investors are said to have significant influence and account for their investment using the "equity method" -if conditions exist in which a corporation owns 20-50% of a stock but is unable to exert significant influence, the corporation should not use the equity method (ex. if a corporation owned 30% of the common stock of a company, but the other 70% of the common stock was held by one shareholder) -under the Equity Method, the investor records income in an amount proportional to the income reported by the investee corporation -this amount appears as a single line item on the income statement of the investor corporation, usually designated as "Income from Unconsolidated Investment" (or something similar) -if the investee reports Discontinued Operations on their income statement, the investor corporation must record the proportionate amount of those line items separately on the investor's income statement -on the balance sheet, the investor (eventually) reports an asset equal to the proportionate share of the shareholder's equity reported by the investee corporation, again this amount is reported as single line item "investment in net assets of unconsolidated subsidiary" (or something similar) -because the equity method results in one line item being reported on the income statement and one line item being reported on the balance sheet, the method is often referred to as a "one line consolidation" -when the investor received dividends from the investee corporation, these dividends are not recorded as income (which is what happens under trading securities) -instead, the dividends are treated as a reduction in the investment of the investor -accordingly, when the investor receives dividends form the investee, the investor corporation debits cash and credits the Investment account (this rule is based on the assumption that the investor has significant influence at the 20-50% level, so in the absence of such a rule, the investor might be able to manage income by influencing an investee to pay a dividend)

amount of service cost and interest cost in the calculation of pension expense example

1. Projected Benefit Obligation for current year: -even though he has not yet vested, PBO assumes that all years of service to date will eventually become vested -multiply (the yearly pension benefit amount you receive per year of life * the PV of number of years it is expected that he will draw upon the pension fund at 20 years and the discount rate) * (PV of 3 years and discount rate * (9/10)) -it is 20 years because he retires and will receive the first payment in 2021, but since its the annuity formula, you have to discount it back one year to 2020, and then you will receive payments until 2040 -it is 9/10 because he has worked at the firm for 9 years and needs one more year to vest -it is PV of 3 years because you have to further discount it back 3 years to present day: 2017 2. what is the Projected Benefit Obligation for 2018 assuming he works through 2018: -20,000*PV of 20 years and 8% * PV of 2 years and 8% * (10/10) -the projected benefit obligation goes up while working from 2017 to 2018 3. what is the Projected Benefit Obligation for 2019 assuming he works through 2019: -22,000*PV of 20 years and 8% * PV of 1 year and 8% 4. what is the interest cost for 2018: -benefit at end of 2017 (answer 1) * interest rate at .08 5. what is the service cost for 2018: -20,000 * PV of 20 years and 8% * PV of 2 years and 8% * (1/10) -the worker earned 1/10 of the PBO by working in 2018 -note that in this simple example, the increase in PBO is equal to the sum of interest cost plus service cost 6. what is the interest cost for 2019: - PBO 2018 (answer 2) * interest rate 7. what is the service cost for 2019: -2,000* PV of 20 years and 8% * PV of 1 year and 8% -the service cost attributable to 2019 is equal to the discounted additional pension benefits to be received as a result of working in 2019 -again, note that while the employee is working, the increase in PBO s equal to t he sum of the interest cost and service cost

examples of permanent differences

1. revenue or gains included in book but not in the tax return -dividends received are included in book income but wholly or partially exempt from taxation 2. revenue or gains included in the tax return but not in book income -dividends received on equity-accounting investments are treated as an investment reduction and subject to only partial taxation 3. expenses or losses deductible in the books but not in the tax return -goodwill amortization -interest expense on money borrowed to invest in tax-exempt securities -fines and penalties payable to a government 4. expenses or losses deductible in the tax return but not in the books -compensation expense from early disposition of stock acquired under incentive stock plans -excess of fair value over cost or basis in assets contributed to selected charities

examples of temporary (timing differences_

2. revenue or gains recognized in the books in advance of the tax return -long-term contracts (use percentage of completion for books and completed contract for tax return) -foreign exchange gains (recognize as accrued for book treatment and as realized for tax treatment) 2. revenue or gain recognized in the tax return in advance of the books -rent received in advanced (recognized over the term of the prepayment for book treatment and when cash is received for tax return) 3. expense or loss recognized in the books in advance of recognition in the tax return -investment write down (recognized in the period of the write-down for books and upon sale of the investment for taxes) -warranty expense (recognized on an estimated basis in the year of sale of the item under warranty for books and recognized when the warranty service is provided for sales) 4. expense recognized in the tax return in advance of the books -depreciation (straight line for books and accelerated for tax)

Income Tax Expense

=income tax obligation +/- the change in deferred tax asset/liability

partial balance sheet and income statement - more general

Partial Balance Sheet 1. Equity Investments (AFS) -amount in account-unrealized holding losses from fair value adjustment in that year (or plus gains) 2. Put Option -cumulative amount in debts/credits (which takes into account gains/losses) Partial Income Statement 1. Unrealized holding loss/gain for AFS investment (cumulative amount) 2. Unrealized holding loss/gain for put option (cumulative amount -add up total amount for "other income:" losses are negative amounts, gains are positive

income tax exercise pre-ASU 2015-17

Step 1. multiply future "taxable amounts" by the enacted tax rate to get the deferred tax liability -multiply future "deductible amounts" (resulting from actual of a loss contingency) by enacted tax rate to get deferred tax asset Step 2. add up each year to get total deferred tax asset and liability Step 3. debit deferred tax asset for the amount of the loss accrual, credit deferred tax liability for the amount of the deferred tax liability, credit income taxes payable for the amount of taxable income for that year given in the problem * the enacted tax rate -debit income tax expense -income tax expense is that year's income taxes payable + deferred tax expense for that year (deferred tax liability at the end of the year-deferred tax liability at the beginning of the year) - the deferred tax benefit for the year (deferred tax asset at the end of the year-deferred tax asset at the beginning of the year) -or you can just do it at the plug -where do they show up on the balance sheet? under non-current liabilities -on the BS, the deferred tax liability would be the deferred tax liability-deferred tax asset

credit losses: comparison of models

timing: current US GAAP is when "probable" that a loss is incurred, while the Current Expected Credit Loss" model has no recognition threshold since it is updated at each reporting date -measurement: current US GAAP is the amount of the incurred loss, while the CECL is the amount that reduces net carrying value to amount expected to be collected -underlying inputs: current US GAAP uses past events & current conditions, while the CECL also uses past events & current conditions while also taking into account reasonable and supportable expectations about future