10.1 Fair Value

capital deficiency

A capital deficiency is a debit balance in a partner's capital account and indicates that the partnership has a claim against the partner for the amount of the deficiency. 1. Right of Offset - If a partner with a capital deficiency has a loan account (the partnership has payable to the partner), the partnership has a legal right to offset and may use the loan account to satisfy the capital deficiency 2. Remaining Partners Charged If a deficiency still exists, the remaining partners must absorb the deficiency accord ing to their respective (remaining) profit and loss ratios.

variable interest entities (VIE)

A corporation, partnership, trust, LLC, or other legal structure used for business purposes that either does not have equity investors with voting rights or lacks the sufficient financial resources to support its activities.

goodwill method

The partners may elect to record the implied goodwill in the partnership based on the payment to the withdrawing partner. The amount of the implied goodwill is allocated to ALL of the partners in accordance with their profit and loss ratios

Example of the bonus method: A and B share profits and losses 60:40, and have capital accounts of $30,000 and $10,000, respectively. C has agreed to invest $35,000 for a one-third interest in the new ABC partnership. Journal entry to record the admission of C into the partnership and recognize the bonus to existing partners

total capital $75,000 ($30,000 + $10,000 + $35,000). C has purchased 1/3 interest, so the balance in C's capital account = 1/3 of $75,000 = $25,000. The extra $10,000 paid by C is recorded as a bonus to the old partners and is shared according to their profit and loss ratio. Dr. Cash Cr. A, Capital ($10000 * 60%) = 6000 Cr. B, Capital ($10000 * 40%) = 4000 Cr. C, Capital 25000

level 3 inputs

unobservable inputs for the asset or liability; reflect the reporting entity's assumptions and should be based on the best available information; discounted cash flows

withdrawal of a partner - bonus method journal entry

Step 1: Revalue the assets to reflect fair value Dr. Asset adjustment Cr. A, capital (%) Cr. B, capital (%) Cr. X, capital (%) Step 2: pay off withdrawing partner Dr. A, capital (%) Dr. B, capital (%) Dr. X, capital (%) Cr. Cash

Journal entry

Step 1: revalue the assets to reflect fair value Dr. Asset adjustment Cr. A, capital (%) Cr. B, capital (%) Cr. X, capital (%) Step 2: record goodwill to make withdrawing partner's capital account equal pay off Dr. Goodwill Cr. A, capital (%) Cr. B, capital (%) Cr. X, capital (%) Step 3: pay off withdrawing partner Dr. X, capital (100%) Cr. Cash

asset retirement obligation

a legal obligation associated with the retirement of a tangible long lived asset that results from the acquisition , construction , or development and/or normal operation of a long-lived asset, except for certain lease obligations

Creation of a New Partnership Interest with Investment of Additional Capital

1) Exact method 2) Bonus method 3) Goodwill method

identify a variable interest in a business entity

1. Company and Business Entity Have an Arrangement 2. Business Entity Is a Legal Entity 3. Business Entity Fails to Qualify for Exclusion 4. Interest Is More than Insignificant 5. Company Ha s an Explicit or Implicit Variable Interest in the Entity

characteristics of a Variable Interest Entity

1. Insufficient level of equity investment at risk 2. Inability to make decision or direct activities 3. No obligation to absorb entity's expected loss 4. No right to receive expected residual returns 5. Disproportional voting right

accretion expense

"interest expense" every year on ARO Accretion expense is the increase in the ARO liability due to the passage of time; calculated using the appropriate accretion rate; added to the ARO liability each period. Accretion expense $XXX Asset retirement obligation (liability) $XXX

recording ARO in balance sheet

= fair value of ARO = PV of future obligation

• Gearty holds Foxy Co. stock, which trades on two exchanges (Gearty Inc. can access both the New York and London markets). • The stock price and transaction costs at the measurement date are as follows: Exchange Quoted price Transaction Cost Net New York 52 (6) 46 London 50 (2) 48 What is the fair value of Foxy stock?

- NY is principal market --> 52 - London is principal market --> 50 - If no principal market, with London's price (net of transaction costs) having the most advantageous result --> 50

Under US GAAP, a private company may elect not to consolidate a lessor entity if met the following criteria:

- The lessee (the reporting entity) and the lessor are under common control - The lessee has a leasing arrangement with the lessor - Substantially all activities between the lessee and lessor are related to leasing activities - If the lessee explicitly guarantees or collateralizes any obligation of the lessor, then the principal amount of the obligation at inception of such guarantee does not exceed the value of the asset leased by the private company from the lessor

modification of term (creditor) impairment

- use present value - impairment should be measured based on the loan's PV or expected future cash flows discounted at the loan's historical effective interest rate; market rate can be used if more readily available Dr. Bad debt expense Cr. Allowance for credit loss

Order of Preference Regarding Distribution of Assets

1 . Creditors, including partners who are creditors, must be paid before the non creditor partners receive any payments. 2. Partners' Capital: Right of offset between a partner's loans to and from the partnership and that person's capital balances generally exists in liquidation .

When a note contains either no interest or an un reasonable rate of interest, what amount should be recorded in the balance sheet?

1 . Record ing the receivable or payable at its face amount; 2 . Recording the sale of the asset at the present value o f the obligation 3. Recording any difference between the face amount of the note and its present value as a discount or premium that must be amortized over the life of the note.

element of disproportional voting rights

1 . Substantially all of the activities of the entity are conducted on behalf of an equity investor or substantially all of the activities are involving an equity investor, 2 . The voting rights o f that equity investor are small in comparison with the focus of the entity on that investor 3. The voting rights of one or more of the equity investors, including that equity investor, are out of line with the investor's obligation to absorb expected losses, the investor's right to receive expected residual returns

admission of a partner

A new partner may be admitted by the purchase of an existing partnership interest or by investing additional capital into the partnership

By Purchase or Sale of Existing Partnership Interest

A partner, with the consent of all partners, may sell his partnership interest to a new partner. Payment for the partnership interest by the new partner would go directly to the selling partner. The retiring partner could sell his interest in the same manner to the remaining partners. No journal entry except for the change of name on the capital account.

modification of terms

A restructuring that does not involve the transfer of assets or equity will often involve the modification of the terms of the debt. In a modification, the debtor usually accounts for the effects of the restructuring prospectively. The debtor does not change the carrying amount unless the carrying amount exceeds the total future cash payments specified by the new terms.

troubled debt restructuring

A troubled debt restructuring is one in which the creditor allows the debtor certain concessions to improve the likelihood of collection that would not be considered under normal circumstances. Concessions include items such as reduced interest rates, extension of maturity dates, reduction of the face amount of the debt, and reduction of the amount of accrued interest.

losses considered in liquidation

All possible losses must be provided for in a liquidation before any distribution is made to the partners.

On December 31, Key Co. received two $10,000 non-interest-bearing notes from customers in exchange for services rendered. The note from Alpha Co., which is due in nine months, was made under customary trade terms, but the note from Omega Co., which is due in two years, was not. The market interest rate for both notes at the date of issuance is 8%. The present value of $1 due in nine months at 8% is .944. The present value of $1 due in two years at 8% is .857. At what amounts should these two notes receivable be reported in Key's December 31 balance sheet?

Alpha 10000, Omega 8570 Choice "b" is correct. Because the term of the Alpha note does not exceed one year, it is recorded at its face amount of $10,000, while the two-year Omega note must be reported at the present value of the obligation calculated using the market interest rate of 8%: $10,000 × 0.857 = $8,570

X Corp. offers its sales vice president a bonus equal to 10% of net income after deducting taxes but before deducting the bonus. Income without taxes or the bonus is $100,000, and the tax rate is 40%. Calculate the bonus.

Although the bonus is based on after-tax income, the bonus itself is deductible from pretax income. 1) Bonus = 10% ($100,000 - Taxes) 2) Taxes = 40% ($100,000 - Bonus) Substitute equation 2) for "Taxes" in equation 1) Bonus 10% [$100,000 - 40% ($100,000 - Bonus)] B = 10% [$100,000 - 40% ($100,000 - B)] B = 10% [$100,000 - $40,000 + 40% B)] B = $6,000 + 4% B B= $6,250

recognize (possibly extraordinary) gain on

Carrying amount of the payable <FV asset transferred> Gain (possibly extraordinary)

gain on transfer of equity interest recognize (possibly extraordinary) gain on

Carrying amount of the payable <FV equity transferred> Gain (possibly extraordinary)

In the Adel-Brick partnership, Adel and Brick had a capital ratio of 3:1 and a profit and loss ratio of 2:1, respectively. The bonus method was used to record Colter's admittance as a new partner. What ratio would be used to allocate, to Adel and Brick, the excess of Colter's contribution over the amount credited to Colter's capital account? a. Adel and Brick's old profit and loss ratio. b. Adel and Brick's new relative capital ratio. c. Adel and Brick's old capital ratio. d. Adel and Brick's new relative profit and loss ratio.

Choice "a" is correct. Adel and Brick's old profit and loss ratio would be used to allocate the excess of Colter's contribution over the amount credited to Colter's capital account.

Vadis Co. sells appliances that include a three-year warranty. Service calls under the warranty are performed by an independent mechanic under a contract with Vadis. Based on experience, warranty costs are estimated at $30 for each machine sold. When should Vadis recognize these warranty costs? a. When the machines are sold. b. Evenly over the life of the warranty. c. When the service calls are performed. d. When payments are made to the mechanic.

Choice "a" is correct. At the date of sale, the warranty costs are probable and estimable and must be recognized. Choice "b" is incorrect. The warranty expense is incurred because of the sale and must be matched with the associated revenues rather than allocated over a period of time. Choice "c" is incorrect. The warranty expense is incurred because of the sale and must be matched with the associated revenues. The warranty liability is reduced as warranty services are performed. Choice "d" is incorrect. Warranty expense must be recognized on the accrual basis rather than on a cash basis.

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? a. Most Year 2 contracts were signed earlier in the calendar year than were the Year 1 contracts. b. The Year 2 contract contribution margin was greater than the Year 1 contract contribution margin. c. The Year 2 contract contribution margin was less than the Year 1 contract contribution margin. d. Most Year 2 contracts were signed later in the calendar year than were the Year 1 contracts.

Choice "a" is correct. 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.

Which of the following statements regarding fair value is/are correct? I. The fair value of an asset or liability is specific to the entity making the fair value measurement. II. Fair value is the price to acquire an asset or assume a liability. III. Fair value includes transportation costs, but not transaction costs. IV. The price in the principal market for an asset or liability will be the fair value measurement.

Choice "a" is correct. Statements III and IV are correct. Statement I is incorrect because fair value is a market-specific measure, not an entity-specific measure. Statement II is incorrect because fair value is an exit price (the price to sell an asset or transfer a liability), not an entrance price.

On November 1, Year 2, Davis Co. discounted with recourse at 10% a one-year, noninterest bearing, $20,500 note receivable maturing on January 31, Year 3. What amount of contingent liability for this note must Davis disclose in its financial statements for the year ended December 31, Year 2? a. $20,500 b. $20,000 c. $20,333 d. $0

Choice "a" is correct. The contingent liability for a discounted note receivable is the maturity value or $20,500. This should be disclosed. Choice "d" is incorrect. A note endorsed "with recourse" means the endorser is liable if the maker of the note does not pay. This contingent liability should be disclosed. Choice "b" is incorrect. The contingent liability for a discounted note receivable is the maturity value. Choice "c" is incorrect. The contingent liability for a discounted note receivable is the maturity value.

In June, Northan Retailers sold refundable merchandise coupons. Northan received $10 for each coupon redeemable from July 1 to December 31 for merchandise with a retail price of $11. At June 30, how should Northan report these coupon transactions? a. Unearned revenues at the cash received amount. b. Revenues at the cash received amount. c. Revenues at the merchandise's retail price. d. Unearned revenues at the merchandise's retail price.

Choice "a" is correct. Unearned revenue at the coupon sales price (the cash received amount). It is unearned because the revenue is earned when the coupons are redeemed and the cost of the merchandise is matched with the recognition of revenue. The transaction is recorded at the cash received amount (coupon sales price), because it is more objective than the retail price of the merchandise for which it can be exchanged.

Leaf Co. purchased from Oak Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments of $5,009. The note was discounted to yield a 9% rate to Leaf. At the date of purchase, Leaf recorded the note at its present value of $19,485. What should be the total interest revenue earned by Leaf over the life of this note? a. $8,000 b. $5,560 c. $5,045 d. $9,000

Choice "b" is correct. Total cash to be received (5 payments × $5,009)$ 25,045 Present value of note 19,485 Total interest revenue $ 5,560 Choice "c" is incorrect. $5,045 equals the total cash flow less the face value of the note rather than the present value of the note.

House Publishers offered a contest in which the winner would receive $1,000,000, payable over 20 years. On December 31, Year 1, House announced the winner of the contest and signed a note payable to the winner for $1,000,000, payable in $50,000 installments every January 2. Also on December 31, Year 1, House purchased an annuity for $418,250 to provide the $950,000 prize monies remaining after the first $50,000 installment, which was paid on January 2, Year 2. In its December 31, Year 1, balance sheet, what amount should House report as note payable-contest winner, net of current portion?

Choice "b" is correct. $418,250 note payable at Dec 31, Year 1, net of current portion (of $50,000 paid on Jan 2, Year 2). $418,250 (the amount of the annuity purchased) is the present value of the 19 payments of $50,000, after the first payment. The first payment of $50,000 has a present value of $50,000 and is classified as current.

When a loan receivable is impaired but foreclosure is not probable, which of the following may the creditor use to measure the impairment? I. The loan's observable market price. II. The fair value of the collateral if the loan is collateral dependent. a. Neither I nor II. b. Either I or II. c. II only. d. I only.

Choice "b" is correct. A loan is impaired when it is probable that a creditor will be unable to collect all amounts due (including both principal and interest) according to the contractual terms of the loan agreement. When a loan is impaired and foreclosure is not probable, the creditor should measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate. However, as a practical expedient, the creditor may measure impairment based on (1) a loan's observable market price, or (2) the fair value of the collateral if the loan is collateral dependent. If foreclosure of a loan is probable, impairment must be measured based on the fair value of the collateral.

Invern, Inc. has a self-insurance plan. Each year, retained earnings is appropriated for contingencies in an amount equal to insurance premiums saved less recognized losses from lawsuits and other claims. As a result of a Year 10 accident, Invern is a defendant in a lawsuit in which it will probably have to pay damages of $190,000. What are the effects of this lawsuit's probable outcome on Invern's Year 10 financial statements? a. An increase in expenses and no effect on liabilities. b. An increase in both expenses and liabilities. c.No effect on expenses and an increase in liabilities. d.No effect on either expenses or liabilities.

Choice "b" is correct. An increase in both expenses and liabilities would result because the contingency is "probable" and the amount can be "reasonably estimated." As such, the loss would be "accrued," which would result in an increase in expenses and accrued liability of $190,000. The fact that Invern is self-insured would not be a factor.

House Publishers offered a contest in which the winner would receive $1,000,000, payable over 20 years. On December 31, Year 1, House announced the winner of the contest and signed a note payable to the winner for $1,000,000, payable in $50,000 installments every January 2. Also on December 31, Year 1, House purchased an annuity for $418,250 to provide the $950,000 prize monies remaining after the first $50,000 installment, which was paid on January 2, Year 2. In its December 31, Year 1, balance sheet, what amount should House report as note payable-contest winner, net of current portion? a. $368,250 b. $418,250 c. $950,000 d. $900,000

Choice "b" is correct. Noninterest bearing notes payable are reported at the present value of future cash flows. The present value of the noncurrent future cash flows totaling $950,000 equals $418,250 (creating a discount on notes payable of $531,750). The present value of the current portion ($50,000 due January 2, Year 2) of the liability is $50,000.

On October 1, Year 1, Gold Co. borrowed $900,000 to be repaid in three equal, annual installments. The note payable bears interest at 5% annually. Gold paid the first installment of $300,000 plus interest on September 30, Year 2. What amount should Gold report as a current liability on December 31, Year 2? a. $330,000 b. $307,500 c. $303,750 d. $300,000

Choice "b" is correct. On December 31, Year 2, Gold Co. should report a current liability related to the principal of the note which will be paid within the next year and the accrued interest at December 31st. Current liabilities associated with the note include the following: $300,000 note payable plus $7,500 of interest payable = $307,500. The interest is calculated as follows: Remaining note payable at December 31, Year 2 of $600,000 x 5% = $30,000 (this represents interest for 12 months). When $30,000 of interest is divided by 12 months, we get $2,500 per month. Interest is accrued for the months of October, November, and December. 3 x $2,500 = $7,500.

Zach Corp. pays commissions to its sales staff at the rate of 3% of net sales. Sales staff are not paid salaries but are given monthly advances of $15,000. Advances are charged to commission expense, and reconciliations against commissions are prepared quarterly. Net sales for the year ended March 31 were $15,000,000. The unadjusted balance in the commissions expense account on March 31 was $400,000. March advances were paid on April 3. In its income statement for the year ended March 31 what amount should Zach report as commission expense? a. $465,000 b. $450,000 c. $415,000 d. $400,000

Choice "b" is correct. The commission expense is 3% of net sales of $15,000,000, or $450,000. An adjustment would be required on March 31 to bring the expense to this amount. Choice "a" is incorrect. Advances should not be considered as expenses at year-end. Charging an expense subject to adjustment is permitted, but Zach should adjust the expense to 3% of net sales of $15,000,000. Choice "c" is incorrect. Advances should not be considered as expenses at year-end. Charging an expense subject to adjustment is permitted, but Zach should adjust the expense to 3% of net sales of $15,000,000. Choice "d" is incorrect. The unadjusted balance in the commissions expense account is not the amount reported as commission expense. Net sales for the period must be considered.

Under IFRS, a sponsoring company must consolidate a special purpose entity (SPE): a. When the company has voting rights that are disproportionate to its economic interest. b. Only if the company has a >50% interest in the SPE. c. If the company controls the SPE. d. When the company is the primary beneficiary of the SPE.

Choice "c" is correct. Under IFRS, a sponsoring company must consolidate an SPE if it controls the SPE. Control exists when the sponsoring company is benefitted by the SPE's activities, has decision making powers that allow it to benefit from the SPE, absorbs the risks and rewards of the SPE, and has a residual interest in the SPE.

Abel and Carr formed a partnership and agreed to divide initial capital equally, even though Abel contributed $100,000 and Carr contributed $84,000 in identifiable assets. Under the bonus approach to adjust the capital accounts, Carr's unidentifiable asset should be debited for: a. $16,000 b. $8,000 c. $46,000 d. $0

Choice "d" is correct, $0 debit to Carr's unidentifiable asset. Note: The examiners were trying to be tricky - it is important to reread the question to be sure you answered it.

Hayes and Jenkins formed a partnership, each contributing assets to the business. Hayes contributed inventory with a current market value in excess of its carrying amount. Jenkins contributed real estate with a carrying amount in excess of its current market value. At what amount should the partnership record each of the following assets?

Choice "d" is correct, Market value - Market value. Rule: Upon the formation of a partnership, tangible assets (inventory and real estate) would be recorded at fair market value at the date of the investment.

House Publishers offered a contest in which the winner would receive $1,000,000, payable over 20 years. On December 31, Year 1, House announced the winner of the contest and signed a note payable to the winner for $1,000,000, payable in $50,000 installments every January 2. Also on December 31, Year 1, House purchased an annuity for $418,250 to provide the $950,000 prize monies remaining after the first $50,000 installment, which was paid on January 2, Year 2. In its Year 1 income statement, what should House report as contest prize expense?

Choice "d" is correct. $468,250 contest prize expense. First payment on 1/2/Year 2 $ 50,000 Present value of 19 subsequent payments 418,250 Contest prize expense $ 468,250

Dunne Co. sells equipment service contracts that cover a two-year period. The sales price of each contract is $600. Dunne's past experience is that, of the total dollars spent for repairs on service contracts, 40% is incurred evenly during the first contract year and 60% evenly during the second contract year. Dunne sold 1,000 contracts evenly throughout the current year. In its December 31, balance sheet, what amount should Dunne report as deferred service contract revenue? a. $360,000 b. $300,000 c. $540,000 d. $480,000

Choice "d" is correct. When service contracts are sold, the entire proceeds are reported as deferred revenue. Revenue is recognized, and deferral reduced as the service is performed. Because repairs are made evenly (July 1 is average date), only ½ of the 40% of repairs will be in the current year. Current year deferral ($600 × 1,000) $ 600,000 Earned in current year (600,000 × 40% × 1/2) (120,000) Deferral at year-end $ 480,000

A change from the cost approach to the market approach of measuring fair value is considered to be what type of accounting change? a. Change in accounting principle. b. Change in accounting estimate. c. Error correction. d. Change in valuation technique.

Choice B is correct. Measured prospectively

GAAP and TAX rule regarding formation of partnership

GAAP rule: use FV of assets contributed Tax rule: use NBV of assets contributed

Jole Co. lent $10,000 to a major supplier in exchange for a non interest-bearing note due in three years and a contract to purchase a fixed amount of merchandise from the supplier at a 10% discount from prevailing market prices over the next three years. The market rate for a note of this type is 10%. On issuing the note, Jole should record:

Discount on notes receivable and deferred charge Choice "d" is correct. In this transaction, $10,000 is exchanged for a non-interest bearing note receivable and a commitment to purchase merchandise at a 10% discount. In order to correctly account for the transaction, interest must be imputed on the non-interest bearing note, which will result in the recognition of a discount on the note receivable, and the purchase commitment must be recognized, which will result in the recognition of a deferred charge.

Journal entry to record asset retirement cost

Dr. Asset retirement cost (asset) Cr. Asset retirement obligation (liability)

It is possible for the existing partners to credit a bonus to a new partner. In the example above, if C had invested $14,000 for a one-third interest in the resulting partnership, C would have received a bonus from A and B, because the one-third interest in the partnership is $18,000 [ 1/3 ($30,000 + $10,000 + $14,000)] and exceeds C's contribution of $14,000. The $4,000 ($18,000 - $14,000) is a bonus credited to C by A and B, and is charged to A's and B's capital accounts according to their profit and loss ratio (60:40).

Dr. Cash $14,000 Dr. A, Capital ($4,000 x 60%) 2400 Dr. B, Capital ($4,000 x 40%) 1600 Cr. C, Capital (30,000 + 10,000 + 14,000 = 54,000 x 1/3) 18000

Valuation techniques

Entities can use the market approach, the income approach , the cost approach, or a combination of these. The valuation technique should be appropriate to the circumstances and should maximize the use of observable inputs and minimize the use of unobservable inputs. A change in valuation technique or its application is accounted for as a change in accounting estimate (prospectively)

Exact method example A, B, and C are partners in a three-person partnership. They have capital accounts of $20,000, $30,000, and $50,000, respectively. A, B, and C decide to admit D as a new partner with a 25% interest in the new partnership. If D pays book value, how much should D contribute in order to have a 25% interest in the partnership?

Equity of new partnership = $20,000 + $30,000 + $50,000 + D's contribution. Since D will contribute an amount equal to 25% of the total book value of the new partnership, D's contribution can be shown as 25% of total new equity. Total new equity = $100,000 + .25 Total new equity $100,000 = .75 Total new equity Total new equity = $133,333 .25 total new equity = $33,333 Thus, D should pay $33,333 for a 25% interest.

record ordinary gain on

FV of asset transferred <NBV of asset transferred> Ordinary gain/loss

Fair Value

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal (or most advantageous) market at the measurement date under current market conditions.

Goodwill method

Goodwill is recognized based upon the total value of the partnership implied by the new partner's contribution (1) Compute new "net assets before GW" (before goodwill) after admitting new (or paying old) partner. (2) Memo: Compute new "capitalized" net assets (= total net worth) and compare "Capitalized Net Assets" with "Net Assets before Goodwill," (3) The "Difference" is "Goodwill" to be allocated to the old partners accord ing to their old partnership profit ratios.

Hierarchy of Inputs

Level 1 inputs have the highest priority, and Level 3 inputs have the lowest priority. If multiple levels (1,2,3) are used, the fair value is classified as based upon the "lowest level" used (the weakest link)

Level 1 Inputs

Level 1 inputs include quoted prices for identical liabilities when traded as assets, and when no adjustments to the quoted price of the assets are required. Level 1 inputs are the most reliable measures of fair value and should be used when available.

A and B share profits and losses 60:40, and have capital accounts of $30,000 and $10,000, respectively. On the basis of A and B's present total capital, C has agreed to invest $35,000 for a one-third interest in the new ABC partnership. The partnership decides to recognize goodwill. C pays $35,000 for a one-third interest in the partnership; goodwill is recognized as the difference between the implied value of the business and the total of the tangible net assets represented by the partners' capital account.

Implied value ($35,000 x 3 = $105,000) Total partner's capital accounts ($35,000 + $10,000 + $30,000 = $75,000) Goodwill $ 30,000 Journal entry to record the admission of C into the partnership and recognize goodwill: Dr. Cash $35,000 Dr Goodwill 30,000 Cr. A, Capital (60% x $30,000) $18,000 Cr. B, Capital (40% x $30,000) 12,000 Cr. C, Capital (equals amount contributed by C) 35,000

profit and loss distribution

Income or loss is distributed among the partners in accordance with their agreement, and in the absence of an agreement all partners share equally irrespective of what their capital accounts reflect or the amount of time each partner spends on partnership affairs. Unless the partnership agreement provides otherwise, all payments for interest on capital, salaries, and bonuses are deducted prior to any distribution in the profit and loss ratio . Such payments are provided for in full, even in a loss situation

primary beneficiary

The entity that is required to consolidate the VIE . The primary beneficiary is the entity that has the power to direct the activities of a variable interest entity that most significantly impact the entity's economic performance and: 1 . Absorbs the expected VIE losses, or 2 . Receives the expected V I E residual returns.

On January 2, Year 1, Emme Co. sold equipment with a carrying amount of $480,000 in exchange for a $600,000 non-interest bearing note due January 2, Year 4. There was no established exchange price for the equipment. The prevailing rate of interest for a note of this type at January 2, Year 1, was 10%. The present value of 1 at 10% for three periods is 0.75. In Emme's Year 1 income statement, what amount should be reported as interest income? a. $50,000 b. $45,000 c. $60,000 d. $9,000

Rule: A non-interest bearing note should be recorded at its present value calculated using the prevailing market interest rate. The market interest rate is then used to calculate interest on the note. Face amount of non-interest bearing note $ 600,000 Present value factor at 10% for 3 periods 0.75 Carrying amount at 1/2/Year 1 450,000 Interest rate 10% Interest income for Year 1 $ 45,000 Choice "b" is correct. $45,000 interest income for Year 1.

ABC Corp. has a three-year warranty against defects i n the machinery it sells. Warranty costs are estimated at 2% of sales in the year of sale, 4% and 6% in the succeeding years. ABC sales and actual warranty expenses for Year 1-Year 3 were as follows: Sales Actual Warranty Costs Year 1 $ 250,000 $ 10,000 Year 2 500,000 20,000 Year 3 750,000 30,000 $ 1,500,000 $ 60,000 ABC's total liability should be accrued in the year of sale even though it will not be incurred in that year. The balance in the account is total liability less actual expenditures and is calculated as follows:

Sales x Total estimated expense = total liability = $1,500,000 x 12% [2% + 4% + 6%] = 180000 Total liability - Actual expenditures = $180,000 - $60,000 = 120000

Service contract

Service contracts usually include cash received prior to the period in which the related expense occurs. As such, they are treated as unearned revenue and are estimated and accrued in the financial statements. Then, when services are performed , unearned revenue is debited and revenue is credited .

Income Approach

The income approach converts future amounts, including cash flows or earnings, to a single discounted amount to measure fair value. This method can be applied to assets or liabilities.

Market Approach

The market approach uses prices and other relevant information from market transactions involving identical or comparable assets or liabilities to measure fair value.

Cost Approach

The cost approach uses current replacement cost to measure the fair value of assets.

pass key

The cumulative accretion expense plus depreciation expense recognized on the income statements over the accretion period should be equal to the total asset retirement obligation: Cumulative accretion expense + Cumulative depreciation expense = Asset retirement obligation (ARO)

withdrawal of a partner - bonus method

The difference between the balance of the withdrawing partner's capital account and the amount that person is paid is the amount of the "bonus." The "bonus" is allocated among the remaining partners' capital accounts in accordance with their remaining profit and loss ratios. Goodwill not recorded

consolidation under US GAAP

The primary beneficiary must consolidate the variable interest entity. Under U.S. GAAP, all consolidation decisions a re evaluated first under the VIE model. If consolidation is not required under the VIE model, then the investor (parent) company determines whether consolidation is necessary under the voting interest model (consolidate when ownership is > 50% of the investee's voting stock).

liquidation of a partnership

The process of winding up the affairs of a partnership after dissolution. Liquidation involves the realization of cash from the disposal of partnership assets.

Warranties

Warranties are a seller's promise to "correct" any product defects. Sellers offering warranties must create a liability account if the cost of the warranty can be reasonably estimated. The entire liability for the warranty should be accrued in the year of sale to "match" the cost with the corresponding revenue. The accrual should take place even if part of the warranty expenditure will be incurred in a later year.

Exact method

When the purchase price is equal to the book value of the capital account purchased , no goodwill or bonuses are recorded .

Bonus method - to existing partners (new pays more) - to new partners (existing partners pay more)

When the purchase price is more or less than the book value of the capital account purchased, bonuses are adjusted between the old and new partners' capital accounts and do not affect partnership assets. Bonus Method- Recognize intercapital transfer.

Level 2 Inputs

a . Quoted prices for similar A/L in active markets. b . QP for identical/ similar assets not active. c. Quoted prices for identical liabilities when traded as assets, if adjustments to the quoted market price of the assets are required . d . Quoted prices for similar liabilities traded as assets. e . Inputs other than quoted prices that are observable. f. Inputs derived from or corroborated by observable market data.

gain on debt restructuring

all gains are aggregated and included in net income for the period

depreciation expense

decreases the ARC asset reported on balance sheet. At the end of the accretion period, the asset retirement cost (asset) should be fully depreciated Dr. Depreciation expense Cr. Accumulated depreciation (asset retirement cost)

calculate ending ARO

ending ARO = beginning ARO + PV of new ARO + accretion expense - ARO settled during the period

Assets are valued at

fair value.

Most Advantageous Market

is the market with the best price for the asset or liability, after considering transaction costs. Note that although transactions costs are u sed to determine the most advantageous market, transaction costs are not included in the final fair value measurement; The price in the most advantageous market will be the fair value measurement only if there is no principal market

Liabilities valued or recorded at

present value

creditor accounting and reporting

receipt of assets or equity = fair value recorded; the excess of the recorded receivables over the fair value of asset received is recognized as an ordinary loss

no gain on restructuring can be recognized unless

the carrying amount of the payable exceeds the total future cash payments

An ARO qualifies for recognition when it meets

the definition of a liability: 1. Duty or responsibility 2 . Little or no discretion to avoid 3. Obligating event

Principal Market

the market with the greatest volume or level of activity for the asset or liability. If there is a principal market for an asset or liabil ity, the price in that market will be the fair value measurement, even if there is a more advantageous price in a different market