FAR 2

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The accounting and reporting of an investment in debt securities depends on management's intent for holding the debt security. In addition, an important factor in the valuation of the debt security is...

if there is a readily determinable fair value.

Some firms classify the natural resource as an _____________ because they have purchased the rights to utilize the land and do not own the land itself. These mineral rights are an intangible asset.

intangible asset

Legal Capital— __________ is the minimum legal issue price for capital stock in most states and appears on the stock certificate.

Par value

If the total cost of construction exceeds fair value, then...

a loss is recognized for the difference and the asset is recorded at fair value.

Margin on Cost =

(Sales − Cost of Goods Sold) / Cost of Goods Sold

Notes issued for nonmonetary consideration (goods and services) are measured at the more reliable of...

(a) fair value of the consideration, or (b) present value of future cash payments discounted at the prevailing rate.

Social security legislation levies the OASDI (Federal Old Age, Survivor, and Disability Insurance) tax, also called FICA (Federal Insurance Contribution Act) tax, on annual salaries and wages __________________________________. In addition, the Medicare tax is levied on all salaries and wages...

1. up to a certain annual salary limit per employee 2. without limit. Both employer and employee pay the same amount for both taxes.

bond (def)

A financial debt instrument that typically calls for the payment of periodic interest with the face value being due at some time in the future. The bondholder (creditor or investor) pays the issuing firm an amount based on the stated and market rates of interest and receives interest and the face amount in return, over the bond term. Bonds and notes are the major sources of general debt funding for corporations.

Paid for merchandise and received cash discount JE under periodic:

A/P X Purch Discount X Cash X

Returned damaged or defective merchandise JE under periodic:

A/P X Purch. Returns & Allow X

Sold merchandise on account JE under periodic:

A/R X Sales X

(equation to get to this number) = AR 12/31

AR 1/1 + Credit sales - Sales returns - Write-offs - Collections

The adjusting journal entry for depreciation on nonmanufacturing assets is:

DR: Depreciation expense; CR: Accumulated depreciation

If allowed to lapse, write off the stock rights and recognize a loss - JE:

DR: Loss on Expiration of Stock Rights CR: Equity Investment in Stock Rights

If the Error is Discovered in Year 3:

No entry is needed because retained earnings are correct—the error has counterbalanced. The statements for Years 1 and 2 would be corrected if shown comparatively with Year 3.

Advantages and disadvantages of the corporate form of business Corporations are subject to a great deal more regulation, including...

SEC reporting requirements for publicly held corporations.

If cost > market or NRV...

a loss is recognized and the inventory is written down as described below.

The 3/10, n30 terminology indicates that...

a cash discount of 3% is available to the buyer if payment is remitted within 10 days after the sale. Otherwise, the gross price net of any returns and allowances is due 30 days after the sale.

Recording Acquisitions For companies employing the periodic inventory system, acquisitions of merchandise during the year will be recorded in the purchases and related accounts. The purchases account is used rather than the inventory account because...

a continuous record of the cost of inventory on hand at any time is not maintained under the periodic system.

Interest on the specific loan for the construction is used first, and then interest at the average rate for all other debt is applied to the excess of AAE over the construction loan. Interest is capitalized only up to...

avoidable debt on the AAE.

Trade Receivable—Another name for...

customer accounts receivable

Only __________ intangibles are amortized.

definite life

IFRS uses the term "associates" to refer to...

investees over whom investors have significant influence

Recall that for __________________ previous impairment losses can be recovered.

plant assets held for sale

Under IFRS, accruals and provisions are reported...

separately

IFRS - In the reset method, accumulated depreciation is "reset" to...

zero by closing it to the building account, and then the building is adjusted for the revaluation.

IFRS IAS 36 requires goodwill impairment testing to use a single-step quantitative test that is performed at the cash-generating unit (or group of cash-generating units). A company is likely to have more cash-generating units than reporting units. Therefore, more ____________________ will be tested under IFRS than under U.S. GAAP within a given entity.

"buckets" of goodwill

Liability—Definition under IFRS—The IFRS definition for liabilities:

"present obligations arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits."

U.S. GAAP—IFRS Differences The items reported in other comprehensive income are referred to as ___________ for international accounting.

"reserves" For example, the net unrealized gain or loss on available-for-sale securities under the fair value method is referred to as investment revaluation reserve. Another is the revaluation reserve from upward revaluation of plant assets.

Continuing with the previous example, where the equity investment is carried at $137,000, assume that the equity investment is sold for $140,000. The realized gain would be recorded as...

$3,000 ($140,000 selling price less $137,000 carrying value): JE: DR: Cash - 140,000 CR: Realized gain on equity securities (reported on the income statement) - 3,000 CR: Investment in equity securities carried at cost - 137,000

Example with more than one nonspecific construction loan—This example shows how to compute two different weighted averages. Construction on a project began January 1, 20X6 with a construction payment of $100,000 to the contractor. One additional payment of $120,000 was made July 1, 20X6. Debt outstanding during 20X6 (entire year): 5%, $120,000 construction loan 6%, 20,000 note payable unrelated to construction 4%, 30,000 note payable unrelated to construction Average method Average interest rate on all loans =

(.05($120,000) + (.06)$20,000 + (.04)$30,000) / ($120,000 + $20,000 + $30,000) = .0494

LIFO liquidations occur either from...

(1) poor planning, or (2) lack of supply.

"bigger, better, or last longer." In other words, the asset must have increased or improved functionality, make better products, or have a longer life.

Criteria for Reclassifying Current Liabilities as Noncurrent Liabilities Reclassification of a current liability to noncurrent status is possible provided two conditions are met:

1. *Intent*—The intent to refinance the short-term obligation as a long-term obligation must be proven. This proof might be in the form of board of directors' meeting minutes or through written correspondence with the financial institution. 2. *Ability* - The firm must also be able to refinance the obligation and demonstrate that ability before the issuance of the financial statements.

Types of Notes:

1. *Interest-Bearing Notes Receivable*—The interest element is explicitly stated. For example, the note might be identified as a three-year, 9% note receivable. The amount of cash to be collected from an interest-bearing note is the face amount of the note (principal) plus interest. 2. *Non-Interest Bearing Note Receivable*—The interest element is not explicitly stated. For example, the note might be identified as a two-year, $13,000 non-interest-bearing note. The amount of cash to be collected from a non-interest-bearing note is the face amount of the note. That is, the face amount of the note includes principal and interest that will be collected at maturity date.

Intangibles are classified as:

1. Definite life intangibles (all of these are identifiable); or 2. Indefinite life intangibles (further subdivided into identifiable intangibles and goodwill).

At the time of the initial investment, the investor must also:

1. Determine book value of assets/liabilities of investee at date of investment; 2. Determine fair value of assets and liabilities of investee at date of investment. Assets and liabilities of the investee are valued at fair value. 3. The fair value of the consideration transferred less the net fair value of the identifiable assets acquired and liabilities assumed is goodwill. 4. This diagram presents a tool that can be used to organize the components of the purchase of a significant equity investment

The two main categories of Owner's Equity are listed below:

1. Earned 2. Contributed

Excluded from R&D Are:

1. Engineering follow-through 2. Quality control and routine testing 3. Troubleshooting 4. Adaptation of an existing capability to a particular customer's needs 5. Routine design of tools, jigs, molds, and dies 6. Legal work in connection with patent applications 7. Software development costs

Because payroll tax rates and salary limits change, the CPA Exam will provide approximate values. However, we recommend that you be aware of the general magnitude of such costs. Approximate rates and limits:

1. FICA, 6.5% on the first $110,000 of salary per year; 2. Medicare, 1.5% with no limit; 3. FUTA, 6% on the first $7,000 reduced by up to 5.5% for contributions to SUTA; 4. SUTA, 5.5% on first $7,000.

The three methods of assigning value to inventory under IFRS are:

1. FIFO, 2. specific identification, and 3. weighted average. IAS 2 presumes that the inventory valuation method will follow the physical flow of goods to the extent possible.

Declared off-limits—This amount of retained earnings has been declared off-limits for dividends so that funds may be conserved for a specific purpose or objective, such as:

1. Financial planning—The purpose might be related to financial planning, such as debt retirement or plant expansion. 2. Legal requirement—The purpose or objective might be related to some legal requirement, such as the appropriation of retained earnings related to treasury stock transactions. 3. Contractual obligation—Finally, the purpose of the appropriation might be related to a contractual obligation, such as a clause in a loan agreement requiring the appropriation

A manufacturing company has all three types of inventory items. That is, a manufacturing company has:

1. Finished goods inventory 2. Work-in-process inventory 3. Raw materials inventory

Units of output method The life of the asset is defined in terms of units of output, and the depreciation rate per unit of output is calculated using the formula shown below. The number of total units the asset will produce must be estimated and used as the denominator. Depreciation Rate =

(Cost − Salvage Value) / (Useful Life in Units of Production) *Depreciation for any given year is calculated by multiplying the units of output for the year by this constant depreciation rate per unit of output. Annual depreciation varies depending on the number of units produced in the year. There is no expectation that depreciation will be the same amount each year. Justification—The asset will provide essentially the same benefits per unit produced. Oil drilling equipment is an example of an asset appropriately depreciated on the units of production method.

(hint: using margin on cost - what is the equation?) = Margin on sales

(Margin on cost) / (1 + Margin on cost)

(hint: using margin on sales - what is the equation?) = Margin on cost

(Margin on sales) / (1 − Margin on sales)

Gross Margin Percentage = Margin on Sales =

(Sales − Cost of Goods Sold)/Sales

Straight-line (SL) method—This method recognizes a constant amount of amortization each month of the bond term. The straight-line method should not be used when...

(a) the term to maturity is quite long and there is more than a minor difference between the market and stated rates, or (b) when there is a very significant difference between the market and stated rates regardless of the length of the term. An example of (b) is a zero coupon bond. Such bonds pay no interest (stated rate = 0). However, they yield competitive rates. The effective interest method must be used for these bonds.

Returns and allowances Example A $200 allowance is made for a defect in the merchandise on the fifth day after sale (hint - show JE on gross and net methods)

*JE: Gross Net* Sales R&A 200 194 A/R 200 194

Requirements for a Quasi-Reorganization:

1. *Approval*—Shareholder and creditor approval. 2. *Balance becomes zero*—The retained earnings balance must be zero immediately after the quasi-reorganization. 3. *No negative balance after*—No contributed capital account can have a negative balance after the quasi-reorganization. 4. *Assets down to market*—Assets must be written down to market value (asset write-ups are possible but would be rare). 5. *Dated years after*—Retained earnings must be dated for a period of 3 to 10 years after the quasi-reorganization to indicate that the balance reflects income earned after the quasi-reorganization.

IFRS To be classified as a debt instrument at amortized cost, the instrument must not be a derivative debt instrument and meet the following two conditions:

1. *Business model test*—The objective of the entity (its business model) is to hold the investment to collect the contractual cash flows; its business model is not to sell the instrument prior to its contractual maturity to realize changes in fair value. 2. *Cash flow characteristic test*—The contractual terms of the investment give rise on specified dates to cash flows that are solely payments of principal and interest on the principal outstanding, where interest is only consideration for the time value of money and credit risk.

Summary of Accounting Treatment of Software Costs:

1. Software development (coding and testing) before technological feasibility: DR. R&D expense 2. Software development (coding and testing) after technological feasibility to production of product masters: DR. Capitalized Software Development Costs 3. Duplication of product, packaging, etc.: DR. Inventory of product 4. Sell product: DR. Cost of Goods Sold 5. Customer service: DR. Expense

There are two rates of interest relevant to notes payable:

1. Stated rate is the contractual rate listed in the note; this rate determines the cash interest payments. 2. Yield or market rate is the rate on notes of similar risk and term (the prevailing rate). If the two rates are equal, the note is issued at face value

Judgment is required for determining whether an exchange has commercial substance. The following characteristics of an exchange may indicate commercial substance:

1. The amount of cash paid or received on exchange is significant in relation to the fair value of the assets exchanged; 2. The functions of the assets exchanged are different. For example, exchanging land for equipment would imply at the very least a different timing and duration of cash flows.

A firm in such an arrangement for which the total amount of the debt is fixed at the reporting date, reports the obligation at the sum of:

1. The amount the firm agreed to pay (the required amount according to the arrangement); plus 2. Any additional amount the firm expects to pay on behalf of the others in the arrangement.

Impairment Test of Definite Life Intangibles—The test for impairment is a two-step process and it is the same as for plant assets in use:

1. The book value (BV) of the definite life intangible is compared to the recoverable cost (R) of the intangible asset. Recoverable cost is the sum of net cash inflows attributable to using the asset and from the ultimate disposal. If the BV is greater than the recoverable costs, then the asset is impaired. 2. The second step is to compare the BV to the fair value (FV). If the BV is greater than the FV, the asset is written down to FV. The impairment loss equals BV − FV. Subsequent amortization proceeds based on the new BV.

The exchange lacks commercial substance—the cash flows of the firm are not expected to change significantly as a result of the exchange, which means:

1. The cash flows from the acquired asset will not be significantly different from those of the asset exchanged in terms of amount, timing, or risk; or 2. The use value of the acquired asset is not significantly different from that of the asset exchanged, in relation to the fair value of the assets exchanged.

If an expenditure merely maintains the asset at its anticipated level of productivity and length of life, the following occurs:

1. The cost is not capitalized on the balance sheet. 2. Instead, it is recorded as a maintenance expense on the current year income statement.

The following are indicators that the investor will not have significant influence, even though there is more than 20% ownership:

1. The investee opposes investment; 2. There is a standstill agreement between the investor and the investee; this means that the investor cannot acquire more stock or other attempts to exert significant influence; 3. Significant influence or control is exercised by shareholders other than the investor.

The following are indicators that the investor has significant influence even though ownership is less than 20%:

1. The investor has representation on the investee's board of directors; 2. The investor participates in investee's policy making; 3. There are material transactions between the investor and the investee; 4. There is technological dependence on the investor; or 5. No other single investor has a material voting ownership in the investee

The Parties Involved in a Transfer of Receivables are:

1. The maker, which is the debtor that has borrowed funds or purchased an asset and provided a note to the original creditor. 2. The original creditor (transferor), which is the firm that has loaned funds or sold an asset to the maker. 3. The third-party financial institution (transferee), which provides the funds to the original creditor.

Residual Value—For amortized intangibles, residual value is assumed to be zero unless:

1. The useful life to the firm is less than legal or economic life; 2. Another entity could obtain some benefit from the asset after the first firm was finished with it; and 3. There is reliable evidence as to its amount (which would consist of a market for the asset at that time or a commitment from another firm to purchase the asset at end of its useful life).

If the decision to dispose precedes the period of disposal...

1. an estimated loss is recorded if it is probable and estimable. 2. Estimated gains are not recognized.

debt securities includes...

1. bonds, 2. notes, 3. convertible bonds/notes, 4. redeemable preferred stock.

debt securities excludes...

1. common/preferred stock, 2. stock warrants/options/rights, 3. futures/forward contracts.

If the inventory is measured using LIFO or the Retail Inventory Method (RIM), then the subsequent measurement is...

1. cost (as determined by LIFO or RIM) or 2. market (L-CM) with market defined below and limited to a ceiling and a floor.

Thus, if FIFO is chosen, the inventory value in the balance sheet is a ________________, but cost of goods sold (and, therefore, gross margin and income) are considered to be __________________. FIFO favors the balance sheet. These effects hold regardless of the direction of price level changes (increase or decrease) during the period.

1. current and relevant amount 2. less current or relevant

Most companies will use one of two methods to account for bad debt expense:

1. direct write-off method 2. allowance method

Assets to Be Disposed of Other Than by Sale This category includes...

1. disposal by abandonment, 2. by exchange for a similar asset, and 3. by distribution to shareholders as a spin-off. Note that dissimilar asset exchange is not included in this category because that transaction is considered a sale—the culmination of an earnings process.

The amortization of premiums and discounts is accomplished through the use of the ________________ method. Due to materiality, many companies employ the straight-line amortization method. The straight-line method is acceptable only if...

1. effective interest 2. the results do not depart materially from the effective interest method.

A realized gain or loss is recognized upon the sale of the equity investment carried at cost. The realized gain or loss is the difference between the...

1. equity investment carrying value and 2. the selling price.

IFRS does not specifically address internal software costs; therefore, the rules of research and development are applied. Under IFRS, software costs for research are __________ and those for development are ____________. U.S. GAAP specifically addresses software costs and identifies the threshold of technological feasibility for capitalization.

1. expensed 2. capitalized

The costs incurred during research and development (R&D) of the software will be _____________, while the costs incurred subsequent to research and development activities will be ________________.

1. expensed 2. capitalized.

All notes have an interest element. In an interest-bearing note, the interest element is __________, while in a non-interest-bearing note, the interest element is not explicitly stated but rather is...

1. explicitly stated 2. included in the face value of the note.

Stock issued in exchange for nonmonetary consideration Value most clearly determined—When stock is sold and a nonmonetary asset is received, the recording of the transaction will be based on the...

1. fair value of the stock sold or 2. the fair value of the asset received (or services received), whichever can be most clearly determined.

The Contract Can be Modified—In this case, the loss is required to be ________________________, but is not accrued in the accounts because....

1. footnoted as a contingent liability 2. the loss is not probable given that the contract can be revised.

Preferred stock may be...

1. fully or 2. partially participating.

Research and development costs include...

1. labor costs, 2. materials costs, and 3. overhead costs.

Debt Issue Costs These costs include...

1. legal fees, 2. printing costs, and 3. promotion costs related to the issuance of a debt instrument such as a bond or note.

Land Improvements This asset differs from land in that it has a finite useful life and is depreciated. Examples of land improvements include...

1. parking lots, 2. fencing, 3. external lighting, and 4. some landscaping.

Categories Within Plant Assets:

1. plant and equipment 2. land improvements 3. land 4. natural resources

Unasserted Claims and Assessments Entities may be subject to future claims and assessments not yet filed as of the balance sheet date. Examples include...

1. possible IRS actions against the entity for violations of the tax law, 2. EPA claims against the entity for environmental violations, and 3. other events that have occurred as of the balance sheet date.

inventory - For a typical business entity inventory includes:

1. property held for resale, 2. property in the process of production, and 3. property consumed in the process of production.

To assign a value to ending inventory and cost of goods sold, we apply one of four cost-flow assumptions. These cost-flow assumptions are identified below. Although the merits of each flow assumption are discussed below, remember that firms are free to decide which assumption to choose:

1. specific identification 2. Weighted Average Cost flow assumption 3. FIFO 4. LIFO

accelerated methods:

1. sum of the years digits method 2. declining balance method

Covenants can be established either...

1. unilaterally by the creditor, or 2. through negotiation between creditor and debtor. Firms emerging from corporate reorganization or bankruptcy may be subject to more stringent covenants. A description of the covenant is disclosed in the notes to the debtor's financial statements.

Examples of accruals include...

1. utilities payable and 2. wages payable.

IFRS for small and medium-sized companies require goodwill to be amortized over the estimated useful life. If an estimate useful life is not reliably determinable, the goodwill should be assigned a life of...

10 years

Overhead—The overhead charges related to the construction of the asset will be capitalized. Usually, the capitalization of overhead charges is accomplished by one of two approaches. *Pro rata overhead allocation approach* Another approach is to capitalize the overhead on a pro rata basis. For example, if the project represents 15% of the total direct labor hours for the period...

15% of the total overhead will be allocated to the project.

Interest Is Capitalized During Periods in Which All Three of the Following Conditions Are Met

1. Qualifying expenditures have been made. Cash payments, transfers of other assets, or the incurrence of interest-bearing debt all qualify. The incurrence of short-term non-interest-bearing debt (e.g., accounts payable) does not qualify because the firm has no opportunity cost on such debt. 2. Activities that are necessary to get the asset ready for its intended use are in progress. (Construction is proceeding.) 3. Interest cost is being incurred. Only actual interest cost is capitalized. Imputed interest is not capitalized. The total amount of interest to be capitalized for a period is limited to actual interest incurred in the period. *If any of the three conditions is not met, interest capitalization ceases. The capitalization period concludes when the asset is substantially complete and ready for its intended use

Note that the test for impairment uses BV and RC while the measurement of the loss uses...

BV and FV.

Small stock dividend —(% of dividend is less than 20-25%)... (hint, what is the accounting?)

Capitalize at market price.

_________ is the most "monetary" of all assets.

Cash

weighted average cost flow assumption for inventory The term weighted average always implies the periodic inventory system. If the business entity selects this cost flow assumption, the weighted average cost per unit must be calculated. This calculation is shown: Weighted Average Cost per Unit =

Cost of Goods Available for Sale / Number of Units Available for Sale

original selling price (def)

Cost plus initial markup

Straight-line method—Annual depreciation is calculated by the formula: (hint, what is the formula?)

Cost − Salvage Value / Useful Life = Annual Depreciation *Annual depreciation is the same each year. Justification—The asset will provide essentially the same benefits per year. Buildings are appropriately depreciated on an SL basis.

If exercised, remove the stock rights and record the additional shares purchased with the rights. - JE:

DR: Equity Investment CR: Equity Investment in Stock Rights CR: Cash

Once the value of the stock rights is calculated, transfer the value of the rights from the equity investment to the investment in stock rights (hint - JE)

DR: Equity Investment in Stock Rights CR: Equity Investment

If sold, write off the stock rights and recognize a gain/loss - JE:

DR:Cash CR: Equity Investment in Stock Rights CR: Gain on Sale of Stock Rights

extraction costs (def)

Depreciation on removable assets, wages, and material costs pertaining to the extraction effort; these costs are debited to the inventory of resource, not to the natural resources account.

Investee's dividends The investor recognizes its proportionate share of investee dividends as a reduction in its investment in the investee. The entry made by the investor when the investee declares/pays a cash dividend would be:

Dividends receivable/cash X Equity Method Investment X

The retail inventory method The method can be shown in equation form:

EI*(cost) = EI*(retail) × C/R, where EI is ending inventory and C/R is the cost-to-retail ratio for the period. The retail inventory method can be used with FIFO, LIFO, and average cost-flow assumptions. Cost of goods sold is found by subtracting ending inventory at cost from cost of goods available for sale.

Entry made by the investor if the investee has net income under equity method:

Equity Method Investment X Equity Method Income X

Entry (assuming OCI items increased equity):

Equity Method Investment X OCI X

______________________ all have salary limits beyond which no more tax is levied either for employer or employee (there is no limit for Medicare) for a particular year. Look for these limits in payroll problems and take care not to exceed them when computing these expenses for the employer and for FICA withholdings for the employee.

FICA, FUTA, and SUTA

LIFO However, the ending inventory reflects the lowest (earliest) costs. Whenever the firm purchases (or produces) more units than it sells, a layer is added. This layer is costed with the earliest costs of the period in which the layer is added, under the periodic system. After several years of adding layers, ending inventory may reflect very old costs. Ending inventory under LIFO is a less reliable amount compared with...

FIFO ending inventory.

Although net income is not a formal variable in all covenants, higher earnings will contribute to a greater probability of compliance with many covenants. Choices such as...

FIFO, straight-line depreciation, longer useful lives for plant assets, higher recoverable costs for plant assets, the specific method of capitalizing interest, full-costing method of accounting for natural resource exploration costs, and others can help in this regard.

An impaired asset is written down to...

FV. The loss equals BV less FV

Cash is frequently paid or received on exchange. When recording the journal entry for the exchange, the following common-sense relationships may help: If cash is paid on the exchange (more common): Fair Value of Acquired Asset =

Fair Value of Asset Exchanged + Cash Paid

Cash is frequently paid or received on exchange. When recording the journal entry for the exchange, the following common-sense relationships may help: If cash is received on the exchange (less common): Fair Value of Acquired Asset =

Fair Value of Asset Exchanged −Cash Received

Limitation on Recorded Value is...

Fair value at completion

Pledging of Accounts Receivable Pledging of accounts receivable is less formal than assignment. Rights to specific receivables are not noted as collateral, and accounts receivable are not reclassified. Neither the accounting for the receivables nor the loan is affected by the pledge. Receivables in bulk are transferred to a trustee and can be used for payment of the loan in the event of default by the borrower (original creditor for the accounts receivable). The cash flows from the receivables are used to pay the loan. ______________ of the pledge is required.

Footnote disclosure

stock right (def)

Gives the holder the option to purchase a certain number of shares of the issuing firm at a specified price during a specified time period.

Otherwise, the expenditure is expensed. Although an argument can be made that ordinary maintenance and repairs prolongs the useful life of an asset, the estimated useful life of an asset assumes...

a minimum level of periodic service.

Formal communication—A retained earnings appropriation is management's formal communication that...

a portion of retained earnings has been declared off-limits for dividends.

book value (def)

Original cost less accumulated depreciation to date.

U.S. GAAP-IFRS Differences Gains and losses on debt extinguishment are reported in...

Other Income, the same category as interest expense, on international income statements.

equity securities (def)

Securities that represent ownership interest or the right to acquire or dispose of ownership interest.

Purchase Discounts —_____________ in the cost column only, before computing the cost-to-retail ratio.

Subtracted

The range of possible values issue appears on the CPA Exam from time to time. The candidate must remember that conservatism plays an important role in recognizing contingent liabilities, but when only a range of possible values is known, an exception is made:

The lowest rather than the highest amount is used for reporting purposes. If a range of values is given but one value in the range has a higher probability assigned to it than any other, the value with the higher probability is used for reporting.

fair value (def)

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date

goodwill (def)

The result of a business combination that is measured as the difference between the fair value of the acquired company as a whole (the acquiree) and the fair value of the identifiable net assets (assets—liabilities). The fair value of the acquiree as a whole is often greater than the fair value of the identifiable net assets. Goodwill is the excess of the fair value of the entity as a whole over the fair value of its identifiable assets.

Interest on Borrowed Funds In some cases, the proceeds from a specific construction loan are not fully used for financing the construction until well into the construction phase. Part of the proceeds may be invested in a bank account or a debt security may be purchased. Interest revenue on unused proceeds temporarily invested is not offset against interest to be capitalized. The interest revenue is reported separately and has no effect on interest capitalized. Exception If the funds are externally restricted tax-exempt borrowings, then...

a right of offset exists because the funds are restricted to use in construction.

End of the period Under the periodic inventory system, a physical count of ending inventory is required. Once the number of units in ending inventory has been counted...

a value is assigned to the ending inventory, and the following year-end adjusting entry is prepared.

development (def)

The translation of research findings or knowledge into a plan or design of a new product or significant improvement in an existing product or process whether intended for sale or use. Development includes formulation, design and testing of product alternatives, construction of prototypes, and operations of pilot plants.

Recognition is an __________________—it means that we have reported the item on the financial statements.

accounting concept

IFRS The fair value option would be available when its use would eliminate or significantly reduce a measurement or recognition inconsistency that would otherwise result from measuring assets or liabilities, or recognizing the gains or losses on them, on a different basis. These measurement or recognition inconsistencies are sometimes referred to as...

accounting mismatches.

Debt Investments at Amortized Costs Impairment If the impairment is recognized, the investment in the debt security will be adjusted to the new basis. The amount of the impairment recognized in OCI will be...

accreted over the remaining life of the debt security.

When expenses precede cash payments, a liability typically is recorded. The liability is paid at a later date. The service or good is received and used before payment. These items are called...

accruals (payment after expense).

Purchased Services—R&D services purchased from other firms are included in R&D. But if a firm performs R&D services for another firm, the costs are...

accumulated in an inventory account and expensed as cost of goods sold or cost of services provided at the conclusion of the contract.

A debt security must be classified as trading when it is...

acquired with the intent to sell in the near term (hours or days). That is, the investor buys and holds the security for the purpose of selling in the near term with the objective of generating profits from short-term price changes. However, the investor can classify securities in this category even though the investor does not intend to sell in the near term.

The investor is not expected to make an exhaustive effort to search for observable transactions. But if the investor is aware that the issuer has similar (or identical) securities with observable transactions, the investor is expected to use information from those transactions to...

adjust the carrying value of the investment in the equity security.

Stock Splits—A stock split is not a dividend. Rather it is an...

adjustment to par value and number of issued shares.

U.S. GAAP-IFRS Differences If a preferred stock issue does not explicitly meet either of the two criteria above but is expected to meet one later during its term, then...

again it is treated as a liability.

agreeing to terms less favorable than under the original debt agreement.

The get-ready costs include..

all costs incurred to get the asset on the company's premises and ready for use. For example, the setting up and testing of new machinery is a get-ready cost.

When AAE > total interest-bearing debt...

all interest cost is capitalized and there is no reported interest expense for the period. In this case, all debt could have been avoided had construction activities not taken place.

Calling and Redeeming Preferred Stock—When preferred stock is called (by the issuer) or redeemed (by the stockholder) or is acquired and retired...

all related OE accounts are removed. The issuer can call in callable preferred stock at a specified price during a specified period. No gain or loss is recognized for any of these events because the transactions are between the firm and its owners.

In choosing the appropriate cost-flow assumption, a business entity should select the cost-flow assumption that...

allows the company to do the best job of determining periodic net income.

Nonparticipating preferred stock is entitled only to the annual dividend percentage noted in the stock certificate—the...

annual dividend requirement.

The debtor may have few options after a covenant violation, depending on the response by the creditor. Therefore, the debtor firm seeks to...

avoid a violation and the potential negative impact on its operations.

Remember that if you use the balance sheet approach, you are calculating a...

balance sheet number (allowance for doubtful accounts).

If discovery occurs in Year 3, no entry is needed because counterbalancing has taken place. All year 2 ending account balances are correct. However, both year 1 and year 2 statements should...

be corrected if shown comparatively with year 3. All accounts for those years affected by the error would be restated to their correct amounts.

Errors made by the bank This amount represents errors made by the bank. For CPA Exam purposes, it might be presented as a situation in which checks written by the ABC Company are subtracted from the balance of the ABZ Company. Alternatively, a deposit made by the ABZ Company may be added to the balance of the ABC Company. There are many types of errors that can be tested. The key is to determine which balance (_______ or _________) is in error, and by how much. The amount of the error is the adjustment to appear in the reconciliation.

book or bank

other property dividends The credit to the asset is for the adjusted book value, which equals the fair value on the declaration date. Ignoring income tax effects, the net reduction in retained earnings resulting from a property dividend is the book value of the asset to be distributed. Retained earnings is reduced by the fair value of the asset distributed, but the gain or loss decreases or increases that effect to a net amount equaling the...

book value of the asset distributed.

If book value (BV) > RC, then the asset is impaired because...

book value will not be recovered. If BV is $100 and RC is $70, then there is no accounting justification for reporting the asset at $100.

both international and U.S. reporting.

Purchase Returns and Allowances—The amount of merchandise available for sale has declined. This amount is subtracted in...

both the cost and retail columns before computing the cost-to-retail ratio.

Scrip Dividends Interest Paid—Interest is paid on the note until...

cash is paid.

GAAP allows flexibility in application of LC-M, but the lower of cost or market comparison must be...

completed on a consistent basis from year to year. In making the comparison, a company can employ one of three approaches

When goodwill is recognized, it must be allocated to a reporting unit. A reporting unit is a...

component of an operating segment for which discrete financial information is available and regularly used by management for decision-making purposes.

Transportation In—Added in the cost column only, before...

computing the cost-to-retail ratio.

IFRS An investment that meets the conditions of debt instrument at amortized cost will be measured and reported at amortized cost unless...

conditions warrant the investor electing to measure the investment at fair value with changes in fair value recognized through profit or loss (net income).

Sometimes firms retire their shares after purchasing them on the market, rather than treating them as treasury shares. Retired shares are placed back into the authorized but unissued category. Accounting for the purchase and retirement of shares is the same as the purchase of treasury shares under the par value method, except that common stock account is used instead of the treasury stock account. If the purchase price is greater than the original issue price, then...

contributed capital from stock retirement is debited until exhausted, and retained earnings is debited for the remainder, if any. Subsequent issuance of the retired shares is recorded as a normal stock issuance, because the retired shares were treated as unissued.

Description of the Cost Method—At purchase, treasury stock is debited for the cost of the shares purchased. The contributed capital in excess of par account that was credited when the stock was issued is not affected. Re-issuances credit the treasury stock account at cost, and the difference between the purchase price and reissue price is recorded in...

contributed capital from treasury stock.

If the investor has >50% ownership of an investment, it is presumed that the investor...

controls the investee. An investment of this magnitude creates a parent/subsidiary relationship.

if the investor has < 20% ownership If the investee does not have a readily determinable fair value, then the investment can be carried at...

cost less any impairment.

Factoring with recourse When receivables are factored with recourse, the three criteria of Codification 860-40 must be used to determine if the transaction is accounted for as a sale or a loan. 1. The transferred assets have been isolated from the transferor, even in bankruptcy. 2. The transferee is free to pledge or exchange the assets. 3. The transferor does not maintain effective control over the transferred assets either through an agreement that allows and requires the transferor to repurchase the assets or one that requires the transferor to return specific assets. The seller (transferor) bears the...

cost of bad debts as well as the cost of sales adjustments.

Stock rights The existing shareholders are given rights (via a stock warrant) to purchase their pro rata number of shares to keep their...

current percentage in the firm.

The violations assumed above are called "objective acceleration clauses" because the potential covenant violations are listed as specific events, such as failure to make an interest payment or the current ratio has decreased below the minimum specified in the covenant. Other clauses are less objective and are called "subjective acceleration clauses." They enable the creditor to call the debt for reasons not objectively specified, such as a decline in the earnings of the debtor or deterioration of the debtor's balance sheet. If circumstances suggest the possible calling of the debt, then the liability is classified as...

current. However, if the likelihood of acceleration of the due date is considered remote (including similar past situations in which the creditor did not call the debt), then the classification remains noncurrent.

U.S. GAAP-IFRS Differences Under international standards, the feature that makes an item debt is that the issuer is...

currently, or can be required to, deliver cash or other financial instrument to the holder of the instrument with terms that are potentially unfavorable to the issuer.

Cash, and other property dividends reduce the distributing firm's assets and retained earnings. A liability is recognized for these liabilities on the...

date of declaration. Stock dividends also reduce retained earnings but do not involve a distribution of assets. No liability is recognized for stock dividends.

The Write-Down (Loss) This is accomplished with a... (hint, JE - what accounts?)

debit to bad debt expense and a credit to a contra-receivable account.

Comparison of Cost and Par Value Methods When treasury shares are purchased at a cost greater than par but less than original issue price, what is the relative impact of the cost and the par value methods on additional paid-in capital and retained earnings? Cost Method—Under the cost method, when treasury stock is purchased for an amount less than original price, the treasury stock account is...

debited. This is a contra OE account. Additional paid-in capital and retained earnings are unaffected.

An example is redeemable preferred stock. This security may seem like an equity security, but since it is redeemable (usually by the issuing entity for a set value), it is classified as...

debt because it has a set principal payment as well as a contractually determined stream of cash flows (dividends), similar to the interest on debt.

U.S. GAAP-IFRS Differences Some modifications of terms restructuring are treated as...

debt extinguishments for international accounting.

The firm makes an irrevocable decision to choose the FVO on the date of issuance. The choice is by...

debt instrument. The option can be applied to all or a subset of debt instruments, even within the same type.

IFRS Investments (and other financial assets) that meet the preceding conditions (i.e., business model test and cash flow characteristic test) are classified as...

debt instruments at amortized cost (except as noted in B.1., below); all other investments constitute the other classification. Classification is made at the time an investment is initially recognized.

The categories of trading or available-for-sale apply only to...

debt securities and not to equity securities.

Additions—Extensions or enlargements of existing assets. If an integral part of the larger asset, depreciate the addition over the shorter of its useful life or the remaining useful life of the larger asset. If not...

depreciate the addition over its useful life.

Additions—Extensions or enlargements of existing assets. If an integral part of the larger asset...

depreciate the addition over the shorter of its useful life or the remaining useful life of the larger asset.

Relative to matching, the recent emphasis has been on determining whether an asset or liability is to be recognized. The conceptual framework definitions are followed in this regard. This is a balance sheet emphasis and is a concept competing with matching as a major underlying concept used for determining the timing of expense recognition. An expense is a...

derived concept, based on the decrease in an asset or increase in a liability.

An entity is permitted, and may elect, to begin its determination of whether goodwill is impaired by performing a qualitative assessment. The purpose of the qualitative assessment is to...

determine if it is more likely than not (i.e., a likelihood of more than 50%) that the fair value of the reporting unit with which the goodwill is associated has declined below the carrying value of that reporting unit, including its goodwill.

IFRS distinguishes between research and development, like U.S. GAAP. However, IFRS allows companies to capitalize...

development costs.

The fair value of notes must be...

disclosed—that is, the estimate of the amount required to pay off the note at the balance sheet date. Also disclosed are the details of noncurrent notes such as 1. interest rates, 2. assets pledged, 3. call and conversion provisions and restrictions, and 4. the aggregate maturity amounts for each of the five years following the balance sheet date.

Entry made by the investor if the investee has net loss under equity method: Equity Method Loss X Equity Method Investment X If investee losses reduce the investment to zero, the investor should...

discontinue applying the equity method unless the investee's imminent return to profitability is assured.

Under U.S. GAAP, when using equity method accounting, if investee losses exceed the investor's investment, but imminent return to profitable operations by the investee appears assured, the investor may continue to recognize its share of investee losses (even if it has not guaranteed obligations of the investee or committed to provide further financial support). Under IFRS, when investee losses exceed the investor's investment, the investor should...

discontinue recognizing its share of investee losses even if the associate's (investee's) future profitability appears imminent and assured. However, if the investor has obligations or commitments to make payments on behalf of the associate, it may continue to recognize its share of losses to the extent of those obligations.

Transportation out (also called delivery expense and freight-out) is not included in inventory. Transportation out is a...

distribution or selling expense and is not an inventoriable cost.

Scrip Dividends Returns on Capital—Cash, property, and scrip dividends are returns on capital. They are ________________, not contributed capital.

distributions of earnings

Note on Fair Value Option If the investor elects to use the fair value option to report an investment that otherwise would be accounted for using the equity method, the investor recognizes the investee's cash dividends as...

dividend income in earnings.

IFRS: The method and amortization method of the intangible asset should be reviewed...

each annual reporting period. U.S. GAAP requires a review when the events or circumstances change

Partially Participating If the total dividends declared are not sufficient to provide the maximum additional participating percentage to both preferred and common (after common receives its share based on the preferred percentage), then...

each class of stock receives a share of the remainder in proportion to total par.

Separation of Duties, in effect, forces employees to collude if they attempt to fraudulently remove any of the company's cash resources. At a minimum, the duties related to cash that should be separated are:

1. Custody of cash 2. Recording of cash 3. Reconciliation of bank accounts

For a variety of reasons, companies may need to estimate ending inventory using the gross margin method. A company may use an estimate of ending inventory for internal purposes during interim periods when a physical count is prohibitively expensive or when inventory is destroyed as the result of a casualty. The gross margin method can be used only for estimation purposes. It may not be used for...

financial reporting of inventory.

GAAP allows flexibility in application of LC-M, but the lower of cost or market comparison must be completed on a consistent basis from year to year. In making the comparison, a company can employ one of three approaches: The individual item basis yields the most conservative (lowest) inventory value (and largest holding loss) because...

for each item the lower of cost or market is chosen. There is no chance for items with market exceeding cost to cancel against items with cost exceeding market, as there is with the other two approaches.

Ensuring compliance with covenants is an ongoing task for many debtor firms. Both management and audit committees continuously monitor the financial condition of the firm so that adjustments can be made in time to avoid situations that would cause the firm to be out of compliance. A ___________________ facilitates risk assessment and risk management.

forward-looking process

Quasi-Reorganization—An alternative to bankruptcy in some cases, quasi-reorganization allows a firm a...

fresh start and new, more conservative asset values.

Criteria for Sale—Criteria for determining if the transfer of receivables is a sale: The transaction is a sale of the receivable if three conditions are met. If the three conditions are met, then control has effectively passed to the third party (transferee) and a sale is implied. Conditions Are *not* Met—If the listed conditions are not met, the transaction is actually a situation in which the transferor is borrowing funds and using the receivables as collateral for a loan. In this case, the receivable remains on the books of the transferor, and the transferor records a liability related to the borrowing transaction. In this case, the transferor will not record any...

gain or loss on sale of the receivable. Rather, the transferor will record interest expense related to the borrowing transaction.

Margin on cost is always ____________ margin on sales because sales exceed cost. The two ways of expressing the margin are related. The goal is to use one of the two formulas to determine cost/sales. It is the cost/sales ratio that is used to determine cost of goods sold.

greater than

The number of issued shares is always ___________________ the number of outstanding shares.

greater than or equal to

Outstanding checks This amount represents checks written and mailed by the company that...

have not cleared the bank by November 30, 20X7.

Goodwill Costs Subsequent to acquisition, the costs to maintain, enhance, or repair purchased goodwill are expensed. The acquirer understandably wishes to maximize the return on its investment and often spends considerable sums to integrate the acquiree operations into its (acquirer's) operations. All such expenditures are...

expensed. They are not added to the recorded purchased goodwill.

Stated rate equals market rate—If the stated rate and market rate are equal, the bond sells at...

face value and no premium or discount is recorded. (Sell at face value: stated rate = market rate)

Assets in Use Assets in use are written down to ____________ if their recoverable cost is less than book value. The amount of the impairment loss recognized is the difference between book value and fair value. Note that the determination of impairment is a step separate from the measurement of the loss; both use different values.

fair value

Investments in Equity Securities Changes in the classification of investments in equity securities are accounted for prospectively. The general rule is that transfers between classifications are accounted for at...

fair value (FV) at the date of transfer. That is, the value of the investment transferred into the new category will be at fair value (if determinable) on the date of the transfer. The treatment of any unrealized gains or losses (G/L) is accounted for in accordance with the new classification.

Fair value: Equity securities with a readily determinable fair value are reported at fair value with unrealized holding gains or losses reported in net income. Using the fair value method requires a...

fair value adjustment (FVA) entry to adjust the value of the investment to fair value.

Balance Sheet Classification—Mandatorily redeemable financial instruments (such as redeemable preferred stock) must be classified as debt (rather than owners' equity) unless the redemption is required to occur only if the issuing firm goes out of business. If either the maturity date or maturity value (redemption price) is not known, then the...

fair value is used for balance sheet reporting and the change in fair value is used for interest expense measurement.

An asset held for sale is impaired if its BV exceeds its...

fair value less cost to sell at the end of the reporting period.

As part of a share repurchase plan, firms may write an option allowing other entities to sell the firm's stock to the firm at a fixed price (option price) on a specific date or during a specified period. The purchaser (option holder) pays a fee for the option. The fee typically approximates the...

fair value of the option using an option-pricing model

If the investment in the equity security is nominal, the investor cannot exercise influence over the investee. Investments in equity securities with nominal influence are recorded at...

fair value when there is a readily determinable fair value.

ASU 2016-01, Financial Instruments—Overall: Recognition and Measurement of Financial Assets and Financial Liabilities,significantly changed the accounting for investments in the equity of another entity. Investments in equity securities with readily determinable fair value are required to be reported at...

fair value with changes in fair value recognized in net income. The categories of trading or available-for-sale for investments in equity securities no longer exist.

Under the fair value option, the investment is carried at...

fair value with changes in fair value recorded in net income.

if the investor has < 20% ownership If there is a readily determinable fair value for the investee, then the investment must be carried at...

fair value with changes in fair value recorded in net income.

Measurement—Investments in debt securities that are classified as trading are measured and reported at...

fair value with the changes in the fair value recorded in earnings.

Transferor to factor In a factoring, the transferor (original creditor) transfers the receivables to a factor (transferee, a financial institution) immediately as a normal part of business. The transferor prefers to pay the factor a...

fee in return for the factor's administration of the receivables. The factor often performs credit checks and collects the payments.

Zero Coupon Bonds—These bonds pay no interest (coupon rate is zero), but the accounting procedure remains the same except that no cash interest is paid during the term. The entire amount of interest is...

included in the face value, just like a non-interest-bearing note.

Debt issuance costs are the...

incremental costs of issuing debt (third-party costs), excluding those paid to the lender.

After the write-down, ______________ is recognized under any of several methods found in practice, including the interest method and cost-recovery methods (Codifications 310-10-35).

interest revenue

Although other types of impairment loss are reversible under IFRS, goodwill impairment loss cannot be reversed. The IFRS believes that any subsequent increase in goodwill is more likely to be...

internally generated goodwill rather than a reversal of the impairment of the purchased goodwill. The IFRS and U.S. GAAP prohibit recording internally generated goodwill; therefore, goodwill impairment cannot be reversed.

AFS investments in debt securities are presented in the statement of cash flows as...

investing activities.

Zero coupon bonds, and also "deep-discount" bonds with very low coupon rates, are...

issued at a large discount.

Effective interest method—This method first computes interest expense based on the beginning book value of the bond and the market rate at issuance. The difference between interest expense and the cash interest paid is the amortization of the discount or the premium. The market rate at issuance is always used to compute interest expense. The rate is not changed after issuance because...

it represents the true interest rate over the bond term. The amortization of discount or premium is a "plug" figure.

An alternative to the effective interest method is the straight-line method, which is allowed only if...

it results in interest expense amounts not materially different from the effective interest method. An equal amount of discount or premium amortization is recognized each period.

Matching, however, continues to be the justification for other practices including accounting for bond issue costs, the full costing method of accounting for natural resource exploration costs, and capitalization of interest. In these cases, assets are not enhanced. However, an asset is recorded in each case so that...

its cost can be matched against the related future revenues.

Note on Fair Value Option: If the investor elects to use the fair value option to report an investment that otherwise would be accounted for using the equity method, the investor does not recognize...

its share of the investee's results of operation. The investee's results of operation are assumed to be reflected in the change in fair value of the investment (which is recognized in net income).

How the equipment is depreciated depends on whether it can be moved from one site to another. Equipment that can be used at more than one natural resource site—depreciate as usual over...

its useful life.

When fair value is the appropriate valuation of the acquired asset, the preferred amount is the fair value of the assets given in exchange. However, if the fair value of the asset acquired is more objectively determinable, then that amount should be used for...

its valuation.

Bonds with detachable warrants separate the debt and equity components at issuance. This treatment is...

just the opposite as that for most convertible bonds.

In all TDR cases, the present value of the consideration paid under the restructured agreement is...

less than the carrying value of the debt (including any unpaid interest) at date of restructure.

In all TDR cases, the present value of the consideration paid under the restructured agreement is less than the carrying value of the debt (including any unpaid interest) at date of restructure. If the debt is modified, the present value of the restructured cash flows (computed using the original interest rate) is...

less than the carrying value of the debt at date of restructure (creditor grants a concession).

In all TDR cases, the present value of the consideration paid under the restructured agreement is less than the carrying value of the debt (including any unpaid interest) at date of restructure. If the debt is settled, the fair value of consideration transferred is...

less than the carrying value of the debt at date of restructure (creditor grants a concession).

Simple interest notes have a face value that is also the...

maturity amount, the amount due at the end of the note term. The stated interest rate and face value determine the annual interest to be paid. A 5%, $10,000 (face value) note pays $500 interest per year, with the $10,000 maturity amount due at the end of the note term.

The determination of OTTI is very subjective and requires significant...

professional judgement.

Reasonable Estimate of Amount Based on ____________________________, a determination is made about the possibility of estimating the amount of the contingency. Either the amount of resulting gain or loss is reasonably estimable or it is not. In addition, firms may be able to estimate a possible range of amounts for the gain or loss, but be unable to assign any amount in the range a higher probability of occurring than any other amount.

professional judgment and experience

Accounting for certain direct response advertising programs is different. Direct response advertising is a...

promotional method designed to encourage prospective customers to respond directly to the advertiser. Methods include the use of coupons, toll-free telephone numbers and Internet links.

A merchandising company typically holds the inventory item that is best described as...

property held for resale. That is, a merchandising company has a single type of inventory item, usually referred to as merchandise inventory.

IFRS The transfer between categories for investments in debt can be made only when the investor's business model objective for debt investments changes so that the (previous) category no longer applies. Such transfers, if appropriate, are treated...

prospectively in financial statements effective the first day of the first reporting period following the change in business model. Restatement of previously recognized gains/losses or interest income is not permitted. Transfers between classifications (reclassification) is not permitted based on changes in the characteristics of the instrument (e.g., the conversion option on an investment in convertible bonds lapses/expires).

An example is a claim against an insurance company that an entity is pursuing legally. If, later, the receipt of benefits from the insurance company becomes virtually certain (much higher than probable), then it is recognized; it is no longer contingent at that point. This is in contrast with U.S. standards, which require...

realization before recognition

Service charges This amount represents service charges that the bank deducted from the company's checking balance on November 30, 20X7. The company will record the transaction upon...

receipt of the November 30, 20X7 bank statement.

Preferred Stock Is Participating When preferred stock is participating, the stock may...

receive dividends in addition to the annual current dividend requirement. When preferred participates, common receives a matching amount.

Internally Developed Goodwill Internally developed goodwill exists for most business entities. However, due to conservatism and objectivity/verifiability, internally developed goodwill is not...

recognized as an asset in the accounting records of a business entity. Internally developed goodwill cannot easily be measured or verified. This is a major reason that only purchased goodwill, resulting from an arm's length transaction, is recognized for accounting purposes.

Goods to be considered in the calculation of cost of goods sold: A periodic system assumes all goods purchased anytime during the year are available for sale. The time period assumption of accounting supports this view. In this example, the last purchase occurred after the last sale. Thus, the last purchase could not possibly have been sold. However, LIFO included the last purchase as the very first purchase assumed sold, and the weighted average method also included the purchase in the computation of cost per unit. Given the ________________ of accounting, the inclusion of the last purchase in the computations is appropriate.

time period assumption

IFRS Fair Value Remeasurement Under IFRS, PPE can be remeasured to fair value if fair value can be reliably measured. If remeasurement is used, it must be applied to the entire class or components of PPE, such as land, buildings, or equipment. Increases in an assets fair value above original cost are recorded in a revaluation surplus account. Any decreases in an assets fair value below the original cost are recorded as losses to the income statement. When revaluation results in an increase in the asset, a debit is made to increase the assets value and a credit is made to an equity account (part of OCI) called revaluation surplus. If the asset is subsequently decreased during revaluation, then the previously established revaluation surplus is...

reduced to zero and a loss is recognized for any excess.

Book Value per Share—Effect of Treasury Stock Purchase A firm purchased treasury shares at a cost exceeding the original issuance but less than book value per share. This transaction...

reduces total stockholders' equity but increases book value.

Patent Costs—The internal costs of developing a patent are considered R&D and therefore are expensed. The result is that the only costs capitalized for internally developed patents are...

registration and legal costs. This contrasts with the cost of purchasing a patent from an outside party. The entire cost of such a patent is capitalized. The treatment appears somewhat inconsistent but stems from the reasoning that it is better to err on the side of conservatism when the benefits of R&D are so uncertain.

In general, FOB shipping point means title passes at the shipping point and FOB destination means title passes at the destination. The test of title is important for the...

year-end cut-off because goods in transit can be included in only one firm's inventory: the buyer or seller.

Many debtors are not in a position to pay the debt immediately and often request a...

renegotiation of the debt terms enabling lower or deferred payments.

revaluation surplus account.

When purpose fulfilled—When the purpose for which an appropriation is made has been fulfilled, the above entry is...

reversed, reinstating the amount to unappropriated retained earnings.

Notes payable are more formal than accounts payable and involve interest. A formal document called a "promissory note" details the...

rights and duties of both parties to the note. Notes can be classified as current or noncurrent.

Factoring without recourse This type of factoring is usually accounted for as a sale because the factor has no recourse against the transferor if there is a default on the receivables. The factor (transferee) bears the cost of uncollectible accounts, but the seller (transferor) bears the cost of...

sales adjustments such as sales discounts and returns and allowances because they are considered preconditions.

A realized gain/loss occurs when the investment (or any other item) is...

sold (or otherwise disposed of). The difference between the cash or other consideration received and the carrying value of the investment is a realized gain or loss.

Stock Not Discounted—In most states, stock cannot be...

sold at a discount.

inventory - specific identification: If the business entity has _____________________, it might be appropriate to use specific identification.

somewhat large, distinguishable products

Direct Write-Off Method This method records bad debt expense only when a...

specific account receivable is considered uncollectible and is written off. It can be used only when the firm is unable to estimate uncollectible accounts receivable reliably. Most large firms do not use this method.

Donated Assets IFRS does not...

specifically address the accounting when an asset or other resource is donated. U.S. GAAP requires that the fair value of the donated asset or service be recognized as an expense and a gain (or loss) is recognized on the revaluation of the donated item.

EPS Decreased—Earnings per share is decreased by a...

stock dividend.

There are no significant differences between U.S. GAAP and IFRS in the treatment of...

stock dividends, stock splits, and stock rights by the investor.

In some cases, strict use of the declining-balance method results in recognizing more depreciation than depreciable cost. In the year that total depreciation exceeds depreciable cost, firms will change to the...

straight-line method and depreciate the remaining depreciable cost over the remaining useful life beginning in that year.

Under international standards, a financial instrument is classified as liability or equity, based on the...

substance of the transaction.

DV LIFO Cost of goods sold is computed as in any periodic inventory context. Ending inventory as computed for DV LIFO is...

subtracted from cost of goods available for sale. The result is cost of goods sold.

As per ASC 985, research and development activities continue until the...

technological feasibility of the software has been established.

A firm in such an arrangement for which the total amount of the debt is fixed at the reporting date, reports the obligation at the sum of: 1. The amount the firm agreed to pay (the required amount according to the arrangement); plus 2. Any additional amount the firm expects to pay on behalf of the others in the arrangement *If there is an amount within the range for the second part (2.) that is a better estimate than any other in the range, then...

that amount is used for (2.). If not, the minimum amount in the range is used. **There is no corresponding international standard although joint and several liabilities are treated as contingencies under IFRS.

Small stock dividend —(% of dividend is less than 20-25%) Market price measure—The market price of the stock at the declaration date is used to measure the stock dividend because...

that is the date on which the commitment to distribute the dividend is made.

Interest earned This amount represents interest earned on the checking account. This amount was added to the company's checking balance by the bank on November 30, 20X7. The company will record this amount upon receipt of...

the November bank statement.

FVO The firm makes an irrevocable decision to choose the FVO on the date of issuance. The choice is by debt instrument. The option can be applied to all or a subset of debt instruments, even within the same type. If the option is chosen, then...

the accounting also proceeds as discussed above but in addition, the firm increases or decreases the resulting book liability to fair value using a fair value adjustment account (FVA: adjunct or contra account).

If the decision to dispose of an asset and the ultimate disposal occur in the same period...

the actual gain or loss on disposal is recognized in income from continuing operations. The disposal loss or gain equals the difference between FV and BV (if BV > FV, then a loss occurs; if BV < FV, then a gain occurs). Depreciation should be recognized to the date of the disposal unless the firm uses a convention for fractional year depreciation. The accumulated depreciation account is removed along with the asset's original cost.

Partially Participating Common stock receives any dividends in excess of...

the additional amount allocated to preferred.

Scrip Dividends Interest expense is computed from the date of declaration to the date of payment using the interest rate in the note. The principal amount is...

the amount of dividend declared.

Other Property Dividends In this type of dividend, the distribution of earnings will take the form of a noncash distribution. The related liability and the gain or loss on disposal of the asset is recognized on the date of declaration. The dividend is recorded at...

the asset's fair value at declaration date. Retained earnings are reduced by the true economic sacrifice of declaring the dividend at the time of making the commitment to distribute the asset. The liability is also measured at fair value. In addition to the above entry, one of the following two entries is made to adjust the asset to fair value at declaration date. The amount recorded is the difference between book value and fair value.

If the outflow of benefits is more likely than not but not estimable, then...

the entity discloses the possible obligation and refers to it as a contingent liability.

If the outflow of benefits is not more likely than not but reasonably possible, then...

the entity discloses the possible obligation and refers to it as a contingent liability.

After assessing the totality of the above kinds of events and circumstances, an entity determines that it is not more likely than not that the fair value of the reporting unit is less than its carrying value, then...

the quantitative steps of the goodwill impairment test are unnecessary.

Balance Sheet Classification—Mandatorily redeemable financial instruments (such as redeemable preferred stock) must be classified as debt (rather than owners' equity) unless...

the redemption is required to occur only if the issuing firm goes out of business.

Subsequent issuance of the retired shares is recorded as a normal stock issuance, because...

the retired shares were treated as unissued.

In many other situations, both concepts (matching, and the definitions of asset and liability) lead to...

the same accounting. For example, the recognition of estimated warranty expense in the year of sale both matches the expense in the year of sale, and records the probable obligation of the firm to transfer resources in the future as a result of a past transaction.

FIFO The results (values placed on cost of goods sold and ending inventory) for this cost flow assumption are...

the same for both the periodic and perpetual systems. The cost of the beginning inventory and earliest units purchased are assigned to cost of goods sold leaving the most recent purchase costs to be assigned to ending inventory.

U.S. GAAP-IFRS Differences Most aspects of bond accounting are...

the same for international accounting standards and U.S. standards.

Assets Held-for-Sale (Disposal)—Recoverable cost is not used for assets held for disposal. Rather, the test for impairment and the loss computation both use...

the same values (BV and FV less cost to sell).

IFRS If there is objective evidence that impairment may exist, the entity should...

measure and record the impairment loss.

How the equipment is depreciated depends on whether it can be moved from one site to another. Equipment dedicated to one site (often not movable or removable)—depreciate over...

the shorter of useful life or life of natural resource site. The most efficient method in this case is to use the units-of-production method with the same denominator as the depletion base.

Fully Participating After any dividends in arrears are allocated, the remaining dividends are allocated based on...

the total par value of the preferred and common stock outstanding.

Example A firm using FIFO for many years decides to change to LIFO and use DV LIFO as the specific method of applying LIFO. The beginning inventory in that year is $40,000. That value, if not reduced to market via the LC-M valuation process, is the beginning inventory in base year dollars for DV LIFO. If it represents market, then...

the value must be increased back to cost before applying LIFO. If an external index is unavailable, the conversion index at the end of a year for a pool equals: (Current Cost of Ending Inventory) / (Base-Year Cost of Ending Inventory) When FIFO is used internally, the ending inventory under FIFO is used as the current cost.

Only definite life intangibles are amortized. For example, some licenses and franchises that are renewable or even perpetual are not amortized because...

their benefits are indefinite in duration and no means exists to determine the useful life.

Removable assets such as drilling equipment, vehicles, and the like are recorded in...

their own separate accounts as plant assets.

Possible reason for changes from fair value to cost An investment that was initially valued at fair value may change because...

there is no longer a readily determinable fair value.

In choosing the appropriate cost-flow assumption, a business entity should select the cost-flow assumption that allows the company to do the best job of determining periodic net income. However, firms often choose FIFO to maximize their reported income. This in turn improves certain financial ratios and may be helpful in meeting requirements placed on the firm by its creditors. In addition, management compensation, if tied to income, will be maximized. On the other hand, the main reason for choosing LIFO is to...

minimize income tax. The main advantage of choosing LIFO is tax minimization. The reporting benefit of providing the most current cost of goods sold figure is an unintended consequence for most LIFO firms. A negative consequence to LIFO that sometimes occurs is the tax effect of a LIFO liquidation.

Modifications—Improvements (betterments), replacements, and extraordinary repairs all involve a...

modification of an existing component or part of the larger asset

Whereas, at present, U.S. standards address financial instruments on an individual basis, international standards apply...

more general concepts.

more limited under IFRS.

Joint and Several Liability Arrangements—Joint and several obligations arise when...

more than one entity agrees to be liable for the entire amount of an obligation. If one of the entities is unable to make payment when the liability is due, each of the other entities is fully liable for the debt. Such arrangements may arise through a borrowing that involves a note payable

Among all the possible types of liabilities, the focus in this section is on estimated liabilities. These include accruals and provisions. Accruals are ________________ than provisions.

much less uncertain

Thus, if LIFO is chosen, the inventory value in the balance sheet can be a very noncurrent and irrelevant amount, but cost of goods sold (and, therefore, gross margin and income) are considered to be ____________________. LIFO favors the income statement. These effects hold regardless of the direction of price level changes (increase or decrease) during the period.

much more current or relevant

The debtor develops a system that signals conditions which may lead to a violation well before it actually happens. All relevant personnel within the organization...

must participate, to avoid the potentially devastating effects of a violation.

balance sheet valuation of receivable Receivables are valued on the balance sheet at...

net realizable value, the amount of cash that the entity expects to collect at due date or at maturity. Depending on the type of receivable, there are several factors that cause the valuation of a receivable to be less than its face or nominal value.

An addition is a...

new major component of an asset, such as an additional room in or on a building, that did not exist before.

If the probability of receipt of benefits is remote, then...

no disclosure is warranted.

If the compensating balance is related to a long-term liability, the compensating balance is a...

non-current asset.

If the investor has between 20% and 50% ownership Investments with significant influence are usually reported as a _____________________ because buying and selling equity shares of this magnitude is relatively difficult to do. For example, if you owned 40% of a company, it would be very difficult for you to sell all of your shares in one block without diluting the selling price.

noncurrent asset

The natural resource account is presented as a...

noncurrent asset. The property associated with the natural resource is not classified as land because the land is not held as a building site, but, rather, to utilize the natural resource on the land.

If a liability is callable on demand if a debt covenant is violated, and there is violation, but that violation is waived by the creditor, then the liability is classified as a...

noncurrent liability.

What is meant by other-than-temporary impairment (OTTI)? The FASB purposefully uses the term "OTTI" and not the term "permanent." A decline in value need not be permanent—it would be very difficult to determine if a decline is permanent. The decline in value needs to meet the threshold of "not temporary," which means...

there is no recovery anticipated in the foreseeable future. When completing this assessment, the entity must evaluate if it has the ability to hold the security until there is a recovery in value.

Promotional costs such as advertising are not included in inventory because...

these costs do not help prepare the inventory for sale.

Shares outstanding—Earnings per share and most other per-share calculations are made on shares outstanding because...

these shares represent the active shares—those in the hands of the investors. These are the shares that vote and receive dividends.

Preferred Stock Rights—Preferred stock is called preferred because...

these shares typically are paid dividends before common stock. Preferred shareholders, however, usually give up their right to vote in return for the dividend preference.

If the preferred stock is noncumulative and any part of the current-year dividends are not paid, then...

they are never paid.

If the six criteria are not met at the balance sheet date but are met before issuance, treat the asset as held for use in...

those statements. If an asset held for sale fails to meet all six criteria at a later date, it is reclassified as held for use.

Noncurrent liabilities—Are defined by exclusion. That is, noncurrent liabilities are...

those that do not meet the criteria necessary for classification as a current liability.

Under IFRS, the reporting dates (period-ends) of the investor and its associates cannot be different by more than...

three months. Further, any significant transactions that occur during the up-to-three-month period must be adjusted to the accounts in recognizing the equity method effects. Under U.S. GAAP, the difference between reporting dates of the investor and investee should not be more than three months, but adjustments for significant transactions that occur during the intervening period do not have to be made to the investee accounts in applying the equity method. The entity may make adjustments for such transactions, but it is only required to disclose such effects.

Terms of Transaction With Recourse or Without Recourse The transaction can be completed with recourse or without recourse. If the transaction is completed with recourse, the transferor is responsible for...

nonpayment on the part of the original maker of the receivable. This means that if the maker (original debtor) defaults, the original creditor must assume all the payments on the receivable.

compensating balance example: A firm borrows $10,000 for one year at 6% but must maintain a $700 compensating balance in an account with the lender financial institution. The $700 is....

not included in the cash account but is rather reported in restricted cash, a current asset. The annual effective interest rate is 6.45% [($10,000 x (.06)/$9,300]. The net loan is only $9,300 ($10,000 - $700).

When using equity method accounting, dividends are...

not income.

For HTM debt securities, the OTTI loss associated with credit loss is recognized in earnings, and the OTTI loss associated with other factors is recognized in OCI. Subsequent gains are...

not recognized.

An impairment loss cannot be reversed unless there are...

observable price changes in a similar or identical security

Timing of Cash Payment—The incurrence of cost can occur before, at the same time, or after expense or loss recognition. Over the life of the resource obtained, total cost and total expenses (plus losses) will be...

of equal amount. But for any reporting period, the amounts are often different.

Assets should be evaluated for impairment when certain indications are present, rather than...

on a regular basis. 1. Significant declines in FV, 2. changes in legal climate or 3. physical nature of the asset are examples of signals that suggest an impairment may have occurred.

The entity must review the classification of the investment in debt securities... (hint, when?)

on an annual basis to determine if the classification is appropriate or if a change in classification is warranted.

Example If the firm incorporated $20,000 of materials into a project as of the end of the period, but paid only $15,000 for them ($5,000 in accounts payable), qualifying expenditures include...

only $15,000 for purposes of computing AAE.

Classification of Held-to-Maturity Investments Criteria for This Classification Applies only to investments in debt securities because...

only debt has a maturity.

Cash flows associated with trading investments in debt securities typically are presented in the statement of cash flows as...

operating activities. The very nature of trading securities, indicates that part of the entity's operations is to regularly buy and sell securities. If the trading investments are not part of the entity's core operations, then those cash flows are classified as investing activities.

Creditor Response to a Covenant Violation The debt contract describes the actions that may be taken by the creditor in the event of a covenant violation by the debtor. Typically these are...

options rather than requirements. The financial position of the creditor, and the general relationship between the firms, may affect how the creditor responds to a violation.

U.S. GAAP—IFRS Differences Common stock and its account in the ledger are referred to as "_______________________" for international accounting.

ordinary shares

Current liability — An overdraft of a bank account occurs when checks honored by the bank exceed the balance in the account. An overdraft may be offset against...

other cash accounts with the same bank, but *not against cash accounts with other banks.* In the latter case, the overdraft is listed as a current liability.

IFRS If the investor does not hold an equity investment for trading purposes, it may elect to report changes in fair value through...

other comprehensive income (FV - OCI).

Direct loan origination fees and points are recognized...

over the loan term.

Therefore, additional paid-in capital decreases under the ______________________________________, but there is no difference in the effect on retained earnings under the conditions imposed.

par value method relative to the cost method

Large stock dividend—(% of dividend is greater than 20%-25%). Capitalize at par value. Thus, only the __________________ is permanently capitalized. Subsequent changes in market price do not affect the accounting.

par value of shares issued

Large stock dividend—(% of dividend is greater than 20%-25%). Capitalize at...

par value.

Control is presumed when there is greater than 50% ownership of voting stock. In this situation, the investor is the...

parent of the investee, and the parent will consolidate the investee for financial reporting purposes.

gain contingencies - assets A disclosable contingent asset under international standards is one that is...

possible or probable (> 50%) but less than "virtually certain," arising from past events and whose existence will be confirmed by the occurrence or nonoccurence of a future uncertain event not wholly in the control of the entity. Contingent assets arise from unplanned or unexpected events that give rise to the possibility of an inflow of economic benefits to the entity.

Capital budgeting and other planning processes within the firm consider the...

potential effect on debt covenant compliance.

Stock rights are often used to convey...

preemptive rights.

U.S. GAAP—IFRS Differences Preferred stock is referred to as...

preference shares.

Common Stockholders' Equity—Common stockholders' equity is total OE after...

preferred dividend claims are removed.

Preferred Stock—Is handled the same way; the issuance of preferred stock credits the...

preferred stock account and contributed capital in excess of par (preferred).

When the yield rate is less than the stated rate, the note is issued at a...

premium (more than face).

Stated rate > market rate—If the stated interest rate is greater than the market rate of interest, the bonds will sell at a...

premium.

Tangible assets such as catalogues and billboards are recognized as...

prepaids and amortized to advertising expense until they are no longer owned or expected to be used.

NCLs are reported at the...

present value of all future payments (principal and interest), discounted at the prevailing rate of interest for similar debt on the date of issuance. Present value is the current sacrifice to retire the debt. Interest is the difference between the total future payments and present value. Interest is not recognized until time passes.

The issue price or proceeds is the...

present value, also called principal

Initially record the investment in the debt security at the...

price paid. Usually this is the present value of its future cash flows as of the date of the investment.

The weighted average method treats each unit available for sale (beginning inventory and purchases) as if it were costed at the average cost during the period. It produces cost of goods sold and ending inventory results between those of FIFO and LIFO when...

prices change during the period.

An entity can elect a practicability exception to fair value measurement for investments in an equity security when there is no readily determinable fair value. As the term implies, this exception can be used when it is impracticable to obtain a fair value measurement of the investment. In most cases, the investor uses the practicability exception because the investee is a...

privately held company. The practicability exception means that the entity can carry the equity investment at cost because determination of a readily determinable fair value cannot be practically obtained.

Compensating Balance (def)

A minimum balance that must be maintained by the firm in relation to a borrowing. Such a balance increases the effective rate of interest on the borrowing and reduces the risk to the lender.

To use the gross margin method, a company must have a...

consistent gross margin percentage (margin as a percentage of sales or margin based on cost). If inventory is heterogeneous, the method should be applied to pools of inventory with relatively homogeneous gross margin percentages.

An improvement is the replacement of a...

major component of an asset, such as an air conditioning system for a building.

The following information relates to Jay Co.'s accounts receivable for 2004: Accounts receivable, 1/1/04 $ 650,000 Credit sales for 2004 2,700,000 Sales returns for 2004 75,000 Accounts written off during 2004 40,000 Collections from customers during 2004 2,150,000 Estimated future sales returns at 12/31/04 50,000 Estimated uncollectible accounts at 12/31/04 110,000 What amount should Jay report for accounts receivable, before allowances for sales returns and uncollectible accounts, on December 31, 2004?

1,085,000 *The question is asking for the gross accounts receivable balance, before allowances for future sales returns, allowances, and uncollectible accounts: AR 1/1 + Credit sales - Sales returns - Write-offs - Collections = AR 12/31 $650,000 + $2,700,000 − $75,000 − $40,000 − $2,150,000 = $1,085,000

Allowance Method - typical entries:

1. *EOY entry* - The allowance for doubtful accounts is recorded at year-end because the identity of the specific accounts that will be uncollectible and written off in a later period is unknown. The account is contra to accounts receivable. *Bad Debt Exp AFDA* 2. *Write-Off of Uncollectible Accounts* —This entry has no effect on income or net assets or even net accounts receivable because the income effect of uncollectibles has already been recognized in the previous adjusting entry. The debit to the allowance decreases the allowance and thus increases net accounts receivable. The credit to accounts receivable decreases net accounts receivable. *AFDA A/R* 3. *Recovery of Accounts Previously Written Off* —These two entries reinstate the allowance account and record cash received. *A/R AFDA* *Cash A/R*

bank to true balance equation:

1. Balance Per Bank, November 30, 20X7 XX + Deposits in Transit + Cash on Hand − Outstanding Checks ± Errors made by Bank = *True Cash*

Negative Aspects of the Direct Write-Off Method Aspects of the direct write-off method:

1. First, if the direct write-off method is employed, accounts receivable are overvalued on the balance sheet. 2. Second, for companies employing the direct write-off method, the company usually recognizes the revenue from a credit sale in one year and typically recognizes the bad debt expense in a subsequent year. So, due to poor balance-sheet valuation and poor matching of revenues and expenses, the direct write-off method is not considered in accordance with GAAP unless there is no basis for estimating bad debts.

Excluded from cash — Cash does not include certificates of deposit, legally restricted compensating balances, or restricted cash funds (such as a bond sinking fund). These amounts are either:

1. Not available for the immediate payment of debts; or 2. Management's intent is to use these resources for specific purposes. In addition, cash excludes postdated checks received from customers (include these in accounts receivable), advances to employees (a receivable), and postage stamps (a prepaid expense).

Because cash is easily concealed and has universal value, companies go to great lengths to safeguard their cash. A variety of internal control measures are used to safeguard cash. The auditing section of this course considers these measures in detail. For cash, the most popular ones are:

1. Separation of duties 2. Bank reconciliations

Remember that if you use the income statement approach, you are calculating...

an income statement number (bad debt expense).

(equation to find this number) = end. rent receivable

beg. rent receivable + accrual revenue - collections - write-offs

If a business enterprise uses the term cash on the statement of cash flows, the term used on the balance sheet will be ____.

cash

The Sales Discounts Forfeited account is a miscellaneous revenue account. The net method separately records...

cash discounts not taken by customers.

The analysis of ending accounts receivable has one simple objective: the determination of the neededor desired balance in the allowance account. By needed balance, we mean the balance needed to properly value accounts receivable on the balance sheet. The desired allowance balance equals the expected amount of write-offs to occur in the future based on the receivables at the balance sheet date. Once the needed balance in the allowance account has been determined, the needed balance is...

compared to the existing balance in the allowance account. The difference in these two balances is the amount of bad debt expense to be recorded for the accounting period.

With respect to compensating balances, if the balance is related to a short-term liability, the compensating balance is shown as a...

current asset (as in the example below), but is not considered a part of the unrestricted cash balance.

Cash is a Monetary Asset — A monetary asset is an asset with fixed nominal (stated) value. The nominal value of a monetary asset _____________ with inflation. Cash is the most "monetary" of all assets. There is no uncertainty as to the stated or nominal value of cash at present or in the future. A $100 bill is always worth exactly $100. However, the purchasing power of cash declines with inflation. The amount of real goods and services a fixed amount of cash can buy decreases as the general price level increases. The effect is the opposite during times of deflation.

does not change

The Sales Discount account is a contra account to sales. It reduces gross sales to sales at its net amount. The net method records sales net of cash discount and...

does not require an adjustment for cash discounts taken by customers. The gross method separately records cash discounts taken by customers.

If the income statement approach is chosen, the bad debt expense is equal to a percentage of the credit sales during a given accounting period. That is, if this approach is chosen, no consideration is given to the...

existing balance in the allowance account.

If the income statement approach is chosen, the bad debt expense is equal to a...

percentage of the credit sales during a given accounting period. That is, if this approach is chosen, no consideration is given to the existing balance in the allowance account.

Allowance Method (A/R): Due to appropriate balance sheet valuation of receivables and much better matching of revenues and expenses, the allowance method is in accordance with GAAP when...

uncollectible accounts are estimable.

A note is a more formal financial instrument than an accounts receivable. The key reporting issues are...

valuation of the note (at present value).

Held for sale Only _________________ are used in the computation of cost to sell.

direct incremental costs

Inventories NOT Carried at LIFO or RIM (i.e., Carried at FIFO or Weighted Average) use LC-NRV Subsequent valuation of inventories carried at FIFO or weighted average are measured at the lower of the cost basis or net realizable value. Net realizable value is defined in the Master Glossary in the FASB's Accounting Standards Codification as the...

"estimated selling prices in the ordinary course of business, less reasonably predictable cost of completion, disposal, and transportation."

The violations assumed above are called ____________________ because the potential covenant violations are listed as specific events, such as failure to make an interest payment or the current ratio has decreased below the minimum specified in the covenant.

"objective acceleration clauses"

Cost—Costs are the economic sacrifices incurred by firms for goods and services used in their business. Costs are measured at the cash equivalent or fair value of consideration transferred, or liability assumed, for the good or service. The conceptual framework description of cost is...

"the value of cash or other resources given up (or the present value of an obligation incurred) in exchange for a resource measures the cost of the resource acquired."

Data for a firm using the FIFO-LCM retail inventory method is as follows: *Cost Retail* Beginning inventory $ 300 $ 467 Net purchases 1,200 2,000 Net additional markups 100 Net markdowns (300) Sales $1,700 Compute cost of goods sold.

$1,177 *Ending inventory at retail = $567 (= $467 + $2,000 + $100-$300-$1,700). The cost-to-retail ratio for FIFO LCM excludes both the beginning inventory amounts, and net markdowns. C/R = $1,200/($2,000 + $100) = .57. Ending inventory at cost = $567(.57) = $323. Cost of goods sold = $300 + $1,200 - $323 = $1,177. Note, that cost of goods sold is based solely on cost.

$100,000(12/12) + $120,000(6/12) = $160,000

The firm starts construction on January 1. By December 31 it has spent $120,000 in qualifying expenditures on the projects. Payments were made evenly throughout the year. AAE =

$120,000/2 = ($0 + $120,000)/2 = *$60,000 = AAE* Although $120,000 was expended during the year, on average the firm had $60,000 invested in the project during the year. (This is the same logic as with a bank account; if you deposited equal amounts into your account each day for a year and ended with a $120,000 balance, your average balance would be $60,000 for the year, assuming interest is paid at year's end.)

Information for a firm using the dollar value (DV) LIFO retail method follows. The cost to retail (C/R) is provided along with price level indices. The data reflects the use of the method through year one. *Retail Retail DV LIFO Layer Base Index Cur. C/R Cost* *Base* $200 1.00 $200 .40 $80 *year one*80 1.10 88 .34 $30 For year two, ending inventory at retail (by count) totaled $450. The ending price-level index for the year was 1.15. The cost-to-retail ratio was .42. What is the ending inventory for financial reporting purposes for this firm?

$164 *The DV LIFO retail process applies the DV LIFO method to retail dollars, and then deflates the retail layer added, now reflecting current prices, to cost, using the cost-to-retail ratio. The calculations are: Ending inventory, retail, at base = $450(1.00/1.15) = $391 Increase in retail, current = $111(1.15/1.00) = $128 Increase in cost = $128(.42) = $54 Ending inventory at cost = ($80 + $30) + $54 = $164

On July 1, 2005, Lee Co. sold goods in exchange for a $200,000, 8-month, noninterest-bearing note receivable. At the time of the sale, the note's market rate of interest was 12%. What amount did Lee receive when it discounted the note at 10% on September 1, 2005?

$190,000 *Six months remain in the note term at the date of discounting. Maturity value of note: $200,000 Less discount: $200,000(.10)(6/12) (10,000) Equals proceeds on note $190,000

The impairment loss for the equity investment carried at cost using the practicability exception would be recorded as follows: Assume an equity investment was purchased for $150,000 and is carried at cost using the practicability exception. (The investment does not qualify to use NAV as a practical expedient.) Subsequent factors indicate that there may be an impairment. A valuation model was employed, and it was determined that the fair value of the equity investment is $128,000. The impairment loss would be recorded as...

$22,000 ($150,000 less $128,000) JE: DR: Impairment loss 22,000 CR: Investment in equity sec. carried at cost 22,000

Example with more than one nonspecific construction loan—This example shows how to compute two different weighted averages. Construction on a project began January 1, 20X6 with a construction payment of $100,000 to the contractor. One additional payment of $120,000 was made July 1, 20X6. Debt outstanding during 20X6 (entire year): 5%, $120,000 construction loan 6%, 20,000 note payable unrelated to construction 4%, 30,000 note payable unrelated to construction Interest capitalized in one period becomes part of AAE for the next period. Using the example above (average method), the balance in the construction-in-process account at the end of the first period is...

$227,904 ($100,000 construction payment + $120,000 construction payment + $7,904 capitalized interest) *The next year, the calculation of AAE will begin with $227,904(12/12), with the payments during the second year receiving the appropriate rate for the period of time in the project. Thus, the $7,904 of interest capitalized the previous period will be part of the base on which interest is capitalized the next period—interest is compounded.

Example The fair value of a plant asset exchanged for another plant asset is $40,000. Cash of $6,000 is received on the exchange. The implied fair value of the asset acquired is...

$34,000 ($40,000 fair value of asset exchanged - $6,000 cash received).

A firm uses the dollar value LIFO retail method and has $2,000 in beginning inventory at retail at the beginning of the current year. The base year equivalent of this amount is $1,600. The base year index is 1.00. The beginning inventory reported in the Balance Sheet is $800. During the current year, the firm purchased $12,000 of inventory at cost and marked that up to $40,000. Sales for the year were $28,000. The relevant ending price index is 1.60. What amount does this firm report as inventory in its Balance Sheet at the end of the current year?

$4,232 *This is a two-step process. First, DV LIFO is applied to retail dollars to determine the layer added in current-year retail dollars. Then, the FIFO cost-to-retail ratio (C/R) is applied to convert that layer to cost. Finally, this layer is added to beginning inventory at cost to yield ending inventory at cost. The calculation is: EI retail, current index = $2,000 + $40,000-$28,000 = $14,000 EI retail, base = $14,000/1.6 = $8,750 Increase in EI retail, base = $8,750-$1,600 = $7,150 Increase in EI retail, current = $7,150(1.6) = $11,440 C/R (use FIFO, not LCM) = $12,000/$40,000 = .30 Increase in EI, cost = .30($11,440) = $3,432 EI, cost = $800 + $3,432= $4,232

Example A firm begins construction on January 1 by making a $40,000 construction payment to a contractor. On July 1, another $40,000 payment is made. AAE =

$40,000 + $40,000(6/12) = *$60,000* = AAE. The July 1 payment was invested in the project only half of a year. The $60,000 represents the amount of debt, outstanding the entire year, which could have been retired

Ace Co. sold King Co. a $20,000, 8%, 5-year note that required five equal annual year-end payments. This note was discounted to yield a 9% rate to King. The present value factors of an ordinary annuity of $1 for five periods are as follows: 8% 3.992 9% 3.890 What should be the total interest revenue earned by King on this note?

$5,560 *Total interest over the life of the note equals the total amount paid by Ace over the life of the note less the proceeds to Ace. The proceeds equal the present value of the payments at the 9% yield rate. The annual payment is found using the 8% rate because that rate is contractually set and determines the annual payment. The annual payment P is found as: $20,000 = P(3.992). P = $5,010 Total interest revenue = total payments by Ace - proceeds to Ace = 5($5,010) − $5,010(3.89) = $5,560.

An acquired intangible is separately recognized in the accounts if either...

(1) the benefit of the asset is obtained through contractual or other legal rights (as in a patent), or (2) if the intangible is otherwise separable, i.e., can be sold, transferred, licensed, rented, or exchanged regardless of the acquirer's intent to do so.

Notes typically result from the...

1. sale of property, 2. conversion of accounts receivable, and 3. lending transactions.

Overhead—The overhead charges related to the construction of the asset will be capitalized. Usually, the capitalization of overhead charges is accomplished by one of two approaches. *Incremental overhead approach* One approach is to capitalize only the incremental overhead. For example, if a company typically has $5,000,000 of overhead, but during the period of construction, overhead increased to $5,500,000, the incremental overhead related to the project is...

$500,000.

Roth, Inc. received from a customer a one-year, $500,000 note bearing annual interest of 8%. After holding the note for six months, Roth discounted the note at Regional Bank at an effective interest rate of 10%. What amount of cash did Roth receive from the bank?

$513,000 *Maturity value of the note: $500,000(1.08) $540,000 Less discount to the bank: $540,000(.10)(6/12) (27,000) Equals proceeds to Roth $513,000 The bank charges its discount on the maturity amount, for the period it holds the note. In effect, it is charging interest on interest yet to accrue (for the last six months). This procedure is followed because the maturity value is the amount at risk.

Example Using the previous examples of AAE ($60,000), if the interest rate were 10%, then $6,000 of interest would be capitalized ($60,000 × .10) assuming at least that much interest cost was actually incurred. If total interest expense for the period before capitalizing interest amounted to $11,000, then...

$6,000 of interest would be debited to the asset under construction, and only $5,000 of interest expense would be reported in the income statement.

Continuing with the previous example, assume an observable transaction is identified regarding the equity investment that was purchased for $150,000 and was impaired by recording an impairment loss of $22,000, as described above. Assume that an observable transaction indicates that the fair value of the equity investment should be $137,000. The adjustment for the unrealized holding gain would be recorded as...

$9,000 ($137,000 less $128,000): JE: DR: Investment in equity securities carried at cost $9,000 CR: Unrealized gain on equity securities $9,000 (reported on the income statement as 9,000 also)

Assume that the total owners' equity and number of shares before the treasury stock purchase is $4,000 and 400 respectively. Book value per share is $10. The firm purchases 20 shares of treasury stock for $8 (less than book value). The new book value per share is:

($4,000 − $160)/(380) = $10.11. Book value per share has increased.

Example with more than one nonspecific construction loan—This example shows how to compute two different weighted averages. Construction on a project began January 1, 20X6 with a construction payment of $100,000 to the contractor. One additional payment of $120,000 was made July 1, 20X6. Debt outstanding during 20X6 (entire year): 5%, $120,000 construction loan 6%, 20,000 note payable unrelated to construction 4%, 30,000 note payable unrelated to construction Specific method Average interest rate on nonconstruction loans =

((.06)$20,000 + (.04)$30,000) / ($20,000 + $30,000) = .048

Capitalized interest is limited to actual interest incurred because avoidable debt is the lower of...

(1) AAE (average accumulated expenditures) and (2) total interest-bearing debt. The actual amount of interest incurred sets the ceiling on interest to be capitalized.

Mandatorily Redeemable Shares—Mandatorily redeemable financial instruments are classified as liabilities if both of the following criteria are met:

(1) They are obligations to repurchase the firm's equity shares or are indexed to such an obligation, and (2) They require or may require the issuer to settle the obligation by transferring assets. However, if the redemption is required only upon liquidation of the entity, then the classification is equity. An example of an instrument that is classified as debt is a written put option on the issuer's shares that is to be settled in cash. Mandatorily redeemable financial instruments are initially measured at fair value.

Disclosures for Contingent Liabilities under International Standards Include:

(1) an estimate of the financial effect, (2) information about the uncertainties relating to the amount and timing of the outflow of benefits, and (3) the possibility of any reimbursement or recourse for the entity.

A Two-Step Process Is Involved in Computing Capitalized Interest—The two steps are:

(1) compute average accumulated expenditures, and (2) apply the appropriate interest rate(s).

Classification of Liabilities—Liabilities are classified in two ways:

(1) current liabilities (CL) or noncurrent liabilities (NCL), and (2) definite or contingent.

Intangibles are similar to plant assets except that they lack physical substance. Many intangibles are legal rights. ASC 350 governs the accounting for intangibles by...

(1) dividing intangibles into definite or indefinite life intangibles, and (2) requiring that all intangibles be evaluated for impairment.

The general principle is that advertising costs are either...

(1) expensed as incurred or (2) when the advertising first occurs. This is a policy choice and must be consistently applied. Although the advertising may be for an extended period of time, both alternatives reflect the lack of probable future benefit and are consistent with accounting for R&D.

IFRS vs GAAP In comparing the two sets of standards in this area, examples of provisions under international standards include...

(1) income taxes payable, property taxes payable and compensated absences liability; and also (2) warranty liability and premium liability. The first group refers to estimated liabilities under U.S. standards and the second group refers to recognized contingent liabilities under U.S. standards. Thus, provisions include but are not limited to U.S. recognized contingent liabilities.

Under IFRS, if an equity method investment is to be sold, the investment is reported at the lower of...

(1) its fair value less cost to sell or (2) the carrying amount as of the date the investment is classified as held-for-sale. Under U.S. GAAP, an investor continues to account for an equity method investment that is to be sold using the equity method of accounting until it loses significant influence over the investee.

Equity Method Accounting—after Acquisition After the date of acquisition, the investor...

(1) recognizes its share of investee's net income or loss, (2) recognizes its share of investee's dividends, and (3) accounts for any difference between the cost of its investment in the investee and the book value of the investee's net assets it acquired. *Equity method accounting affects both the investor's investment account (on the balance sheet) and the income recognized from the investee by the investor (on the income statement).

Redeemable preferred stock may require the issuing firm to...

(1) redeem the stock (purchase the stock from the shareholder) at a specified future date at a specified price, or (2) redeem the stock at the option of the shareholder.

The effect of bond issue costs on the issuing firm's financial statements is to...

(1) reduce the initial net bond liability and (2) increase interest expense in the future.

International accounting standards do not identify modifications of loans as troubled. Rather, there are two cases based on whether the modification is...

(1) significant, (2) not significant. These do not correspond to the two modification-of-terms cases under U.S. standards.

Several methods of depreciation are acceptable under GAAP. They can be categorized into two basic types:

(1) straight-line methods and (2) accelerated methods.

Preferred Stock with Warrants—Preferred stock, like bonds, may be issued with warrants for the purchase of common stock entitling the holder to purchase common stock at a fixed price. The issue price of the preferred stock is allocated to...

(1) the preferred stock accounts, and (2) another OE account for the common stock warrants. The allocation is based on fair value. When the warrants are exercised, cash is debited, the warrant account is closed, common shares are issued, and the common stock accounts are established.

Property taxes are levied by state and local governments based on the assessed valuation of property as of a given date. The tax becomes a lien against the property on the date specified by law and thus legally the liability comes into existence on that date. From the perspective of the taxing authority, property taxes do not "accrue" over time. The fiscal periods of the taxing authority and the firm paying the tax (the property owner) often do not coincide. The issues then are...

(1) what is the period over which to recognize the tax, and (2) what is the amount of any liability or prepayment for balance sheet reporting.

Service hours method The life of the asset is defined in terms of service hours, and the depreciation rate per service hour is calculated by using the formula shown below. The number of total service hours the asset will provide must be estimated and used as the denominator. Depreciation Rate =

(Cost − Salvage Value) / (Useful Life in Service Hours) *Depreciation for any given year is calculated by multiplying the service hours for the year by this constant depreciation rate per service hour. Annual depreciation varies with the number of service hours provided in the year. There is no expectation that depreciation will be the same amount each year. Justification—The asset will provide essentially the same benefits per service hour. A delivery vehicle is an example of an asset appropriately depreciated on the service-hours method.

Depletion for a Period =

(Depletion Rate) × (Number of Units Removed in Period)

Depletion Rate =

(Natural Resources Account Balance − Residual Value) / (Total Estimated Units)

Fixed overhead is one of the four manufacturing input costs—The others are direct material, direct labor, and variable overhead. Fixed overhead does not vary with small changes in production volume and, therefore, is often allocated to production based on a predetermined overhead rate. For example, if direct labor hours is used for allocation purposes, and the fixed overhead allocation rate is $4 per direct labor hour, then a production run using 1,000 direct labor hours would receive an allocation of $4,000 of fixed overhead cost. The $4 rate is the ratio: (hint - what is the equation?)

(budgeted fixed overhead)/(budgeted direct labor hours).

Quantitative Assessment—Step 2: Measuring Impairment Goodwill impairment is measured by comparing the...

(current) implied fair value of a reporting unit's goodwill with the carrying amount of that goodwill.

The following list of expenditures shows a variety of costs related to plant assets and how to account for them. (hint - what is the accounting treatment of these expenditures?) *Expenditure* Sales tax on equipment purchase Cost of delivery, to set up and test equipment Cost to train employees to use equipment Title fee on land purchase Attorney fee for land purchase Cost to raze an old building on land purchased Proceeds on salvage material from razing Cost of landscaping Cost to excavate foundation for a building Interest on purchase of plant assets Interest during construction of building Back property taxes on land just purchased Annual property taxes on land Cost of permits for construction

*Accounting treatment* Capitalize to equipment Capitalize to equipment Expense Capitalize to land Capitalize to land Capitalize to land Reduce recorded land cost Capitalize to land improvements Capitalize to building Expense Capitalize to building Capitalize to land Expense Capitalize to building

Valuation of Inventory—The acquisition cost of inventory includes all costs incurred in getting the merchandise to the seller's premises and ready for sale. A good general rule is:

*Capitalize in Inventory All Costs Necessary to Bring the Item of Inventory to Salable Condition.* *These costs include: 1. freight and insurance in transit paid to the seller firm, 2. any taxes paid on acquisition of inventory, 3. material handling costs, and 4. packaging costs. *Interest on the purchase or construction of inventory is never included in inventory.*

*U.S. GAAP* 1. Goodwill is tested at the reporting unit level 2. A qualitative prestep and quantitative two-step test

*IFRS* 1. Goodwill is tested at the cash generating unit level 2. One-step test

*U.S. GAAP* (hint - match to IFRS treatment) 1. Revaluation to fair value is not permitted. 2. Reversal of impairment loss is not allowed. 3. Estimated useful life and amortization method reviewed when events or circumstances change

*IFRS* 1. Intangibles can be revalued to fair value if there is an active market. 2. Reversal of impairment loss is permitted. 3. Estimated useful life and amortization method reviewed annually

The retail inventory method, which is really a family of related methods, is based on three basic calculations:

1. First, ending inventory at retail is calculated or counted at year-end. 2. Second, the cost-to-retail ratio is calculated. 3. Third, the ending inventory at retail is multiplied by the cost-to-retail ratio to arrive at estimated inventory at cost

differences between GAAP & IFRS (hint - state the IFRS rule to the GAAP rules listed below) *U.S. GAAP* 1. Lower of cost or market (LC-M) or LC-NRV 2. May use more than one cost formula for similar inventories with similar use 3. Reversal of the write down is prohibited. 4. LIFO permitted 5. Cost flow assumption does not mirror physical flow.

*IFRS* 1. Lower of cost or net realizable value (LC-NRV) only 2. Same cost formulas must be used for inventory with a similar nature and use 3. Reversal of write down to net realizable value permitted 4. LIFO prohibited 5. Cost flow assumption mirrors physical flow.

Example Trade discount and initial recording Assume we sell $2,000 (list price) of goods, terms 3/10, n30. The sale is subject to a 5% trade discount. (hint - show JE on gross and net methods)

*JE: Gross Net* A/R 1,900 1,843 Sales 1,900 1,843 *The 3/10, n30 terminology indicates that a cash discount of 3% is available to the buyer if payment is remitted within 10 days after the sale. Otherwise, the gross price net of any returns and allowances is due 30 days after the sale. The gross invoice price is $1,900, the amount after the trade discount but before the cash discount. The net method records the sale at the gross amount less the 3% cash discount, or 97% of the gross invoice price.

Cash discount Example Trade discount and initial recording Assume we sell $2,000 (list price) of goods, terms 3/10, n30. The sale is subject to a 5% trade discount. Payment is received within the 10-day discount period. (hint - show JE on gross and net methods)

*JE: Gross Net* Cash 1,843 1,843 Sales Discount 57 A/R 1,900 1,843 *The Sales Discount account is a contra account to sales. It reduces gross sales to sales at its net amount. The net method records sales net of cash discount and does not require an adjustment for cash discounts taken by customers. The gross method separately records cash discounts taken by customers.

.0494($160,000) = $7,904 Again, if AAE had been $200,000, then all the interest for the period would be capitalized because total debt is less than $200,000. Interest capitalized = .05($120,000) + (.06)$20,000 + (.04)$30,000 = $8,400

.05($120,000) + .048($160,000 − $120,000) = $7,920 Interest on the specific loan for the construction is used first, and then interest at the average rate for all other debt is applied to the excess of AAE over the construction loan. Interest is capitalized only up to avoidable debt on the AAE. If AAE had been less than the amount of the construction loan (e.g., $100,000), then only the construction loan interest would be capitalized (interest capitalized in that case would be .05 × $100,000 = $5,000). If AAE had been $200,000 (more than total debt), then all the interest for the period would be capitalized because total debt is less than $200,000. All the debt could have been avoided. Interest capitalized = .05($120,000) + .048($50,000) = $8,400

Common Stock—When a corporation is formed, the total number of shares that may be issued is called the authorized shares. This amount can be increased only by vote of the shareholders. For common stock, this total can be broken down into:

1. *Number issued:* The number of shares ever issued by the firm but not retired 2. *Number outstanding:* The number of shares currently held by stockholders 3. *Number in the treasury:* The number of shares purchased by the issuing firm and not yet reissued. Treasury shares are included in the number of issued shares: # Issued Shares = # Outstanding Shares + # Treasury Shares

Choose the correct accounting by the creditor for a loan impairment. Column (1): recognize a loss or expense upon recognizing the impairment. Column (2): rate of interest to use in computing the revised book value of the receivable after the impairment.

1 - Yes 2 - original effective rate *A loan impairment is recorded by reducing the net book value of the receivable to the present value of probable future cash inflows, discounted at the original rate in the receivable. The original rate is used because the loan continues to exist. The loss to the firm is measured at the rate existing when the original loan was created. The difference between the book value and present value, at the date of recognizing the impairment, is recorded as an expense or loss. There is no reason to report overstated assets.

Example Assume an investor holds 10% equity investment in Probert Co. If there is no readily determinable fair value for Probert Co. shares, but Probert's net assets are reported at fair value in the amount of $100,000. The investor with a 10% ownership in Probert Co. could qualify for using the net asset value as a practical expedient and report the investment at _________________. However, if Probert Co., does not report its net assets at fair value and there is no readily determinable fair value for Probert's shares, then...

1. $10,000 ($100,000 ×10%). 2. the investor may elect the practicability exception and report the investment in Probert Co. at cost.

The amount capitalized as natural resources is the sum of three different types of costs:

1. *Acquisition costs*—The amount paid to acquire the rights to explore for undiscovered natural resources or to extract proven natural resources. 2. *Exploration costs*—The amount paid to drill or excavate or any other costs of searching for natural resources. 3. *Development costs*—The amount paid after the resource has been discovered but before production begins.

other bond terminology:

1. *Bond term*—The period from issuance date to maturity date 2. *Bond issue costs*—The cost of printing, registering, and marketing the bonds 3. *Accrued interest on bond sale*—The amount of interest, based on the coupon interest rate for the period, between the issuance date and the immediately preceding interest payment date 4. *Bond price*—The current market price of a bond exclusive of accrued interest 5. *Bond proceeds*—The sum of the bond price and any accrued interest

Methods of Acquiring Plant Assets:

1. *Cash purchase*—The cash equivalent price is simply the amount of cash paid for the asset on acquisition date. 2. *Deferred payment plan (credit purchase)*—The cash equivalent price for an asset acquired through a deferred payment plan is the present value of future cash payments using the market rate of interest for similar debt instruments. 3. *Issuance of securities*—The acquisition cost of an asset acquired through the issuance of stocks or bonds is the fair value of the security or the fair value of the asset acquired, whichever can be most clearly determined. When a significant number of shares is issued, care must be taken to ensure that the issuance did not affect the share price. 4. *Donated assets*—Assets received in donation are recorded at their fair value. A revenue or gain is also recorded. 5. *Group purchases*—If a group of fixed assets is acquired in a single transaction, the total negotiated price is allocated to the individual assets acquired. This allocation is based on the respective fair values of the individual assets acquired.

Natural Resources Include such items as...

1. a gravel pit, 2. a coal mine, 3. a tract of timber land, and 4. an oil well. This category of assets will produce income until all the natural resources are extracted and sold. These assets are frequently referred to as depletable assets.

A wide variety of measures is used in debt covenants. Typically, a minimum or maximum value for the measure is the condition beyond which the debtor is in violation. The following list provides examples:

1. *Current ratio (Current Assets/Current Liabilities)*—A measure of liquidity. If the debtor's current ratio falls below 2.0 for example (a minimum level), the debtor has violated the covenant. The creditor then has the right to respond in specific ways defined in the contract. This aspect is discussed below. 2. *Working capital (Current Assets - Current Liabilities)*—A minimum level is specified in the covenant. 3. *Income measures,* such as net income before tax, net income, income from continuing operations, and EBITDA (earnings before interest, taxes, depreciation, and amortization). The covenant specifies a minimum absolute level, or possibly one based on a percentage of the previous year's amount. 4. *Interest coverage ratio(EBITDA/Interest Expense)*—A minimum level is specified. 5. *Retained earnings balance, or total owners' equity balance*—A minimum level is specified. 6. *Debt to equity ratio*—A maximum level is specified. 7. *Total debt*—A maximum level is specified. 8. *Interest expense*—A maximum level is specified. 9. *Total assets or net assets*—A minimum level is specified.

Payroll liabilities In their role as employers, firms incur definite current payroll-related liabilities from two different sources:

1. *Employer costs* including gross salary, employer share of fringe benefits, employer share of FICA and Medicare, and federal and state unemployment tax (FUTA and SUTA). The employer recognizes an expense for these costs. 2. *Employee costs* withheld from paychecks including income tax withholding, employee share of FICA, Medicare and fringe benefits, and also personal expenses such as parking, union dues and others. The employer does not recognize an expense for these costs but acts as a collection point resulting in an employer liability.

The following is a list of expense categories from strong to weak relationship with revenue:

1. *Expenses with a direct causal link to revenues*—Cost of goods sold, and sales commissions based on sales revenue are examples. The link between revenues and expenses is the strongest for this category. For example, when inventory is sold, cost of goods sold is recognized for the cost of the item sold. Before sale, the inventory is reported as an asset. 2. *Expenses associated with revenues in a specific time period*—Salaries, property taxes, and other similar costs are examples. These costs are only indirectly related to revenues produced in the same period because they serve many different efforts. The presumption is that they contributed to the overall effort of generating revenues in that period. 3. *Expenses associated with benefits over more than one period*—This category includes depreciation and amortization expenses that are allocated on a systematic and rational basis to time periods or units of production (if the asset is involved in manufacturing). Long-term prepaids are included in this category. As they expire, they give rise to operating expenses including rent and insurance. 4. *Expenses recognized in the period incurred*—Examples are advertising and research and development (R&D) expense. The relationship between these costs and revenues is not determinable. There is no way to determine whether these expenditures have future benefit (with some exceptions).

Variations—The variations of the retail inventory method are directly related to the calculation of the cost ratio. There are five variations, four of which are summarized below. The fifth is covered in the "Dollar-Value LIFO Retail" lesson:

1. *FIFO*—The C/R excludes the cost of beginning inventory from the numerator and the retail value of beginning inventory from the denominator. Thus, C/R measures the cost-to-retail ratio only for the current-period purchases on the assumption that all beginning inventory will be sold (first-in, first-out). If ending inventory consists entirely of current-period purchases, the C/R should not include beginning inventory. 2. *FIFO, LC-M*—The cost ratio excludes the cost of beginning inventory from the numerator and the retail value of beginning inventory from the denominator. Then, in an effort to arrive at a more conservative cost ratio, the calculation also excludes net markdowns from the cost ratio. This causes the denominator of C/R to be larger, because net markdowns are not subtracted, and thus the ratio itself is smaller. When C/R is multiplied by EI (retail), the resulting EI (cost) is smaller, approximating the effect of LC-M 3. *Average*—The cost ratio includes beginning inventory, along with current-period purchases in both the numerator and the denominator of C/R. 4. *Average, LC-M*—The cost ratio includes beginning inventory, along with current-period purchases, in both the numerator and the denominator, but excludes net markdowns from the cost ratio calculation. 5. DV LIFO

There are seven items of information that must be known to account for a bond:

1. *Face (maturity) value*—The amount paid to the bondholder at maturity. This amount is often $1,000. 2. *Stated (coupon) interest rate*—The rate at which the bond pays cash interest. The rate is stated on the bond. If the rate is 6% and the bond's face value is $1,000, then one bond pays $60 interest each year. 3. *Interest payment dates*—The dates the bond pays the cash interest. Semi-annual interest payments are the norm. 4. *Market (yield, effective) interest rate*—The rate equating the sum of the present values of the cash interest annuity and the face value single payment, with the bond price. If a 6%, $1,000 bond was issued for $900, the market rate of interest equates the $900 amount with the present value of the annuity of $60 (or $30 twice a year), and the $1,000 face value to be paid in the future. The market rate is the true compounded rate of return on the bond. This rate is determined by the market and does not appear on the bond. 5. *Bond date*—The planned issuance date. This date is listed on the bond. 6. *Issuance date*—The date the bonds are actually issued. This date cannot be earlier than the bond date but may be later. This information is not on the bond. 7. *Maturity date*—The date the maturity value is paid, the end of the bond term.

Fixed Assets—In relation to the use of fixed assets in research and development activities, three specific situations need to be addressed:

1. *Fixed Assets Used in Several Research and Development Projects*—These assets are capitalized and annual depreciation is included in the annual research and development costs. The debit is to R&D expense rather than to depreciation expense; the credit is to accumulated depreciation. 2. *Fixed Assets Used Temporarily in a Research and Development Project*—The depreciation related to the time frame of the project is included in the annual research and development costs. 3. *Fixed Assets Used in a Single Research and Development Project, the Asset has no Alternative Uses*—Even though the fixed asset has a useful life exceeding one year and the single R&D project will be in process for more than one year, the entire cost of the fixed asset is expensed as R&D immediately.

1. *Individual item basis*—If a company has 1,000 inventory items and chooses the individual item approach, a total of 1,000 comparisons will be made to determine the lower of cost or market for ending inventory. 2. *Category basis*—If a company has 1,000 inventory items grouped into 10 categories, a total of 10 comparisons will be made to determine the lower of cost or market for ending inventory. 3. *Total basis*—If a company wishes, it can make a single comparison to determine the lower of cost or market for ending inventory.

Partial Year Computations—Construction projects may begin or end during a reporting period. Also, new debt may be incurred and other liabilities may be retired during a reporting period. Guidelines:

1. *Interest rate*—Adjust the interest rate for the fraction of the year the debt is outstanding. If new interest-bearing debt is incurred during an interest capitalization period, the interest rate reflects the period the debt was outstanding. Assume a firm capitalizes interest quarterly. If $100,000 of 12% debt is incurred May 1, then for quarter 2, $2,000 of interest is included in the numerator of the rate (2 months' interest), and $100,000 is included in the denominator. 2. *Expenditures*—Weight by the percentage of the period invested in the project. An expenditure occurring at the beginning of the second month of a quarter receives a weight of 2/3.

Components of Capitalized Cost—The capitalized cost of a self-constructed asset includes four components:

1. *Labor*—The direct labor charges related to the construction of the asset will be capitalized. Usually, labor charges are expensed in the period incurred, but in this instance, the labor charges are capitalized. This component of the cost of the asset includes any fringe benefits related to the basic labor cost. 2. *Material*—The direct materials related to the construction of the asset will be capitalized. 3. *Overhead*—The overhead charges related to the construction of the asset will be capitalized. Usually, the capitalization of overhead charges is accomplished by one of two approaches. A. Incremental overhead approach—One approach is to capitalize only the incremental overhead. For example, if a company typically has $5,000,000 of overhead, but during the period of construction, overhead increased to $5,500,000, the incremental overhead related to the project is $500,000. B. Pro rata overhead allocation approach—Another approach is to capitalize the overhead on a pro rata basis. For example, if the project represents 15% of the total direct labor hours for the period, 15% of the total overhead will be allocated to the project. 4. *Interest cost incurred during the construction period*—(This topic is separately discussed in detail in a later lesson.) Capitalization of interest is allowed only when assets are constructed. When assets are purchased outright, any interest on debt incurred to purchase the asset cannot be capitalized.

Types of Intangibles:

1. *Marketing-related*—Trademarks, Internet domain names, noncompetition agreements. - Some of these items are indefinite life intangibles. Indefinite life intangibles include trademarks because they are renewable every 10 years indefinitely 2. *Customer-related*—Customer lists, contractual relationships with customers. - These are definite life intangibles because they could not have benefit periods of indefinite or unlimited life. 3. *Artistic-related*—Copyrights (these are not renewable). Definite life 4. *Contract-related*—Franchises, licensing agreements, broadcast rights, service/supply contracts - Some of these are definite life intangibles, and some are indefinite life intangibles (as in the case of a perpetual franchise or one that is renewable indefinitely). 5. *Technology-related*—Patents (both product and process type) that have a 20-year life and give the holder the exclusive right to use, manufacture, or sell a product or process. Capitalize successful legal defense costs. - These are definite life intangibles and, although small modifications can lead to a new patent that effectively extends the life of the old (the BV of the old is added to the new), the new patent is still considered to have a definite life. 6. *Goodwill*—Arises only from a business combination in which the fair value of the entity purchased exceeds the fair value of the entity's identifiable net assets (assets—liabilities). (More on goodwill in the next lesson!) - Indefinite life and tested for impairment annually

The rights of preferred shareholders are:

1. *Nonvoting*—Typically, preferred shareholders do not have voting rights. That is, preferred shareholders are not participants in the major operating and financing decisions made by the company. 2. *Dividend preferences*—In relation to dividends, preferred shareholders receive their dividend allocation first. Then, the remainder of the dividend is allocated to common shareholders. 3. *Additional features*—Additional features, such as with cumulative preferred stock and participating preferred stock, can enhance this dividend preference for preferred shareholders. The process of allocating dividends to the two types of stock is illustrated in a later lesson. 4. *Dividends in arrears* If preferred stock is cumulative and dividends for a year are not paid, then the dividends are said to be in arrears. No dividends may be paid to any other class of stock, including the current preferred stock dividend requirement, until the dividends in arrears are paid. This is how the dividend preference for preferred stock is preserved. However, there is no liability for dividends in arrears until the dividends are declared. Undeclared dividends in arrears are disclosed in the footnotes until the dividends are paid. 5. *Liquidation preferences* In the event of liquidation, the creditors are paid first. Second, the preferred shareholders receive their specified liquidation values per share. This amount may be different from par value, or the value paid for the shares. The liquidation preference per share of preferred stock must be disclosed in the equity section of the balance sheet when the preference exceeds par value. There is no preemptive right for preferred shareholders because preferred stock does not vote in the affairs of the corporation. Finally, any remainder is allocated to the common shareholders.

Major Account Types—For a corporation, the major account types in OE are:

1. *Preferred stock*, the total par value of issued preferred stock; 2. *Common stock,* the total par value of issued common stock unless the stock is no-par stock and a stated value is not used; 3. *Additional paid-in capital, preferred*—This account reports the amount received for preferred stock issuances in excess of the par value; - Additional paid-in capital is also referred to as contributed capital in excess of parand paid-in capital in excess of par. 4. *Additional paid-in capital, common*—This account reports the amount received for common stock issuances in excess of the par value; - In general, additional paid-in capital is a category of OE used for several different sources such as paid-in capital from treasury stock transactions, stock award plans, and others. 5. *Retained earnings,* the net of the firm's earnings to date less dividends to date, plus or minus other items including prior period adjustments and certain accounting changes. 6. *Accumulated other comprehensive income*, the running total of all other comprehensive income items through the balance sheet date. See the lesson on the "Statement of Comprehensive Income." This category can be considered part of the "earned" component of OE, although the transactions causing changes in this category are not run through earnings and therefore are not included in retained earnings. 7. *Treasury stock*, which is the cost or par value of the common stock of a firm purchased by that firm, depending on the method used by the firm. Treasury stock of Coca-Cola Company, for example, is stock of Coca-Cola purchased by Coca-Cola. This account is a negative or contra OE account.

In assessing the probability of occurrence, professional judgment is employed to classify the probability into one of three categories:

1. *Probable*—Based on professional judgment, the probability of occurrence is considered very high or a near certainty. 2. *Reasonably possible*—Based on professional judgment, the probability of occurrence is neither very high nor remote. In other words, when probability of occurrence is considered along a spectrum of possibilities, the probability of occurrence is not at either end of the spectrum, but is in the large middle section of the spectrum. 3. *Remote*—Based on professional judgment, the probability of occurrence is considered to be very low, or as the title implies, remote.

advantages of dollar value LIFO:

1. *Reduces the Effect of the Liquidation Problem*—The dollar-value LIFO conversion technique takes a company's ending inventory in FIFO dollars (usually) and converts them to LIFO dollars. In doing so, the impact of the liquidation problem is reduced. 2. *Allows Companies to Use FIFO Internally*—Most companies prefer to use FIFO for internal management reports and internal operating decisions. dollar-value LIFO allows companies an opportunity to do so. 3. *Reduces Clerical Costs*—As mentioned earlier, most LIFO companies prefer LIFO for external reporting purposes and prefer FIFO for internal purposes. Through the use of Dollar-Value LIFO, a company can maintain a FIFO system for internal purposes, and then convert those results to LIFO for external purposes. Please note that through the use of dollar-value LIFO, a company must maintain only a single inventory system (FIFO) during the accounting period, thus reducing clerical costs

Breakdown of Software Costs and Their Accounting:

1. *Research and Development*—Costs incurred to establish technological feasibility (costs incurred before technological feasibility is established) expense as incurred, as R&D expense. - The quest for technological feasibility is the activity in software development most similar to general R&D. During this period, the firm has not reached a decision on the feasibility of its product. Costs during this period include planning, designing, coding, and testing of programs. 2. *Costs Subsequent to Establishing Technological Feasibility*—Through the completion of product masters: capitalize as computer software costs (intangible asset) and amortize. - This second category of costs includes additional costs of coding, testing, debugging, and preparation of final product master and final documentation manual. It does not include duplication of product masters and manuals. This category ends when a product master is ready for duplication. This is the only category of software costs that is capitalized as an intangible asset and subsequently amortized. 3. *Software Production Costs*—(Duplication of software and manuals). Capitalize in inventory and expense through cost of goods sold as sales take place. 4. *Customer Support and Maintenance*—Expense as incurred.

Amortization of Capitalized Computer Software Costs—These are amortized using one of the two following methods, whichever results in a larger amortization amount. Each year the computation for both methods must be made to ensure the larger amount is recognized. The same method need not produce the larger amount each year. The amortization is an operating expense:

1. *Revenue Method* Amortization for current year = B × R Where: B = book value of capitalized software costs at beginning of year R = (current year revenue)/(current year revenue + estimated future revenue) 2. *Straight-Line Method* Amortization for current year = B/N Where: B = book value of capitalized software costs at beginning of year N = number of years remaining in product sales life at beginning of year **Remember to choose the higher of the two amounts each period. Also, the inputs to both methods change each year. The beginning book value changes, as does the estimate of future revenue and remaining years in the product life.

Types of bonds—There are several classifications of bond issues. The most important for the exam are:

1. *Secured versus unsecured (debentures)*—A secured bond issue has a claim to specific assets. Otherwise, the bondholders are unsecured creditors and are grouped with other unsecured creditors. An unsecured bond is backed only by the credit of the issuing firm and is called a debenture. 2. *Serial versus single maturity term*—A serial bond matures serially, that is at regular or staggered intervals. The total face value of this issue is paid gradually rather than all at once, as is the case with a single maturity or term bond. 3. *Callable versus redeemable*—An issuer can retire callable bonds before maturity at a specified price. The bondholder can require a redeemable bond to be retired early. 4. *Convertible versus nonconvertible*—A convertible bond can be converted into capital stock by the bondholder; a nonconvertible bond cannot.

Lower of Cost or Market—Journal Entry Once the lower of cost or market comparison is completed and the ending valuation is found (using either LC-M or LC-NRV), the formal entry of this information can be achieved by employing the...

1. *direct method* - Under the direct method, any holding loss (difference between a higher cost and a lower market value) related to inventory is simply included in cost of goods sold. It is directly included in cost of goods sold. 2. *the allowance method.* - Under the allowance method, any holding loss related to inventory is separately identified in a contra inventory account with separate disclosure of the holding loss. Cost of goods sold does not include the holding loss under this method.

The types of ownership, and, therefore, the types of accounts recorded in OE, include:

1. *Sole proprietorship* With a proprietorship, the ownership of the business enterprise consists of a single individual or party. 2. *Partnership* With a partnership, the ownership of the business enterprise consists of two or more participants. 3. *Corporation* With the corporate form of business, the stock may be closely held by a small number of investors or, in the case of a publicly traded company, the stock may be held by a large number of investors with the stock traded on an organized exchange. The stockholders' section of the corporate balance sheet includes the contributed capital accounts, such as common stock and contributed capital in excess of par, the retained earnings account and others referred to above. Capital stock (preferred or common) is the means by which ownership is conveyed. If there is only one class of stock, it is common stock.

Accounting Approaches - capitalized assets that have been modified or added to:

1. *Substitution*—Remove the accumulated depreciation and original cost of the old component, recognize the loss, and capitalize the post-acquisition expenditure to the larger asset. This alternative is available only if the accounting system maintained records of the old component cost and accumulated depreciation. 2. *Increase the larger asset account by the post-acquisition cost.* This approach is used when the productivity rather than the useful life of the larger asset is enhanced, and when the accounting system does not maintain records of the old component cost and accumulated depreciation. 3. *Debit accumulated depreciation.* This approach is used when the expenditure increases the useful life of the larger asset. The debit to accumulated depreciation turns back the clockon the life of the larger asset. This approach is suited especially to extraordinary repairs. *For each of these three approaches, the post-acquisition cost is depreciated over the shorter of its useful life or remaining useful life of the larger asset.

Methods of Accounting for Exploration Costs:

1. *Successful-efforts method*—Only the cost of successful exploration efforts is capitalized to the natural resources account; unsuccessful efforts are expensed. 2. *Full-costing method*—All costs of exploring for the resource are capitalized to the natural resources account. (The total amount capitalized cannot exceed the expected value of resources to be removed.) The choice between the successful-efforts and full-costing methods is among the most important a firm has to make. The choice can have a large effect on net income and total assets. The successful-efforts method best reflects the definition of an asset because only those efforts that located the resource are capitalized to the natural resource account. The full-costing method reflects the matching principle—and capitalizes all costs until the natural resource deposit produces revenue through sale of the inventory. Another justification for full costing is that all exploration efforts contributed to finding the resource

Relevant dates—In relation to dividends, there are three important dates (listed in chronological order):

1. *The declarative date* is the date the board of directors formally declares the dividend. This is the most important date in terms of the effect on the firm's resources and therefore its balance sheet. At this date, the firm recognizes a liability and a reduction in retained earnings. The firm's net assets are reduced. 2. *The date of record* is simply a cut-off date. The shareholders of record on this date will be the recipients of the dividend payments. This date is used because it requires a certain amount of time to compile the list of shareholders as of a particular date. 3. *The payment date* is the date the dividends are actually distributed to the shareholders. Firms typically pay dividends quarterly. The time lag between declaration and payment can be a few weeks. The fourth-quarter dividend is declared near the end of the fiscal year, but payment often occurs early the next year. Therefore, the amount of dividends declared in a year often is not the same as the amount of dividends paid in that year. Payment does not reduce the firm's retained earnings and net assets; rather, it is the declaration that reduces retained earnings and net assets

LIFO Liquidations are to be Avoided for Two Reasons:

1. *The main purpose for using LIFO is tax minimization.* In the above example, assuming the firm will replenish the 5,000 units liquidated anyway, the firm increases its taxable income by $20 per unit unnecessarily. The $20 amount is the difference between the current-period cost of $55 and the $35 cost in the older layer. Thus, taxable income will increase by $100,000 ($20 x 5,000). If the firm had been able to purchase 505,000 units in the period, this extra tax liability would have been avoided because the entire cost of goods sold would be based on the $55 unit cost. 2. *For financial statement reporting*, the main advantage of LIFO is in matching current-period costs with current revenues. The liquidation distorts the relationship between current sales and current cost of goods sold. *The larger the liquidation, the worse the distortion.*

Common Stock Rights—In return for purchasing a share of common stock, the common shareholder receives the following rights:

1. *Voting rights* Common shareholders have the right to participate in the decision-making process of a corporation by voting for the board of directors, the external auditors, and other major issues. That is, the shareholders have a right to participate in major operating and financing decisions through the exercise of voting rights. They do not, however, have the right to participate in day-to-day management functions. 2. *Dividend rights* Common shareholders have rights related to the receipt of dividends. The dividend rights of common shareholders are subordinate rights in that preferred shareholders receive their dividend allocation prior to any allocation to the common shareholders. Dividends are not mandatory. The Board of Directors must declare dividends before the firm is liable to the shareholders for dividends. 3. *Preemptive rights* The preemptive rights of common shareholders allow current shareholders to maintain their existing percentage of the firm in the event of a new stock issuance by the firm. Preemptive rights are not always present, depending on state law and the corporate charter. The preemptive right is important to shareholders owning an appreciable percentage of the firm. Without the preemptive right, management could issue shares in an effort to reduce the percentage ownership (and influence) of a shareholder who disagrees with the current management over major issues affecting the direction of the firm.

quasi-reorg Accounting Steps:

1. *Write assets down to market value*, further reducing retained earnings (increasing the deficit). 2. *Reduce contributed capital* to absorb the retained earnings deficit. 3. *Change value/number of shares*—If needed, change par value or the number of shares of common stock to absorb the remaining deficit.

Summary—The LC-M valuation process has two steps:

1. Compute market value (the middle of the three amounts). 2. Value inventory at the lower of original cost or market value (LC-M)

Large stock dividend—(% of dividend is greater than 20%-25%). Capitalize at par value. We have distinguished small and large stock dividends by referring to "less than 20%-25%," which is sufficient in most cases. However, for SEC registrants, less than _____ is considered small. For other firms, if the dividend percentage is between 20% and 25%, the firm may choose to record the dividend at ______________________________. If less than 20%, ___________ is used; if more than 25%, __________ is used. The expectation is that the CPA Exam would not use a percentage of 20-25% in order to avoid this confusion.

1. 25% 2. fair value or at par value of the shares 3. fair value 4. par value

Each reporting period the investor must consider qualitative factors in assessing whether the investment is impaired. ASC 321-10-35-3 lists the following factors to consider in the evaluation of a potential impairment:

1. A significant deterioration in the earning performance, credit rating, asset quality, or business outlook of the investee. 2. A significant adverse change in the regulatory, economic, or technological environment of the investee. 3. A significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates. 4. A bona fide offer to purchase, an offer by the investee to sell, or a completed auction process for the same or similar investment for an amount less than the carrying amount of that investment, 5. Factors that raise significant concerns about the investee's ability to continue as a going concern, such as negative cash flows from operations, working capital deficiencies, or noncompliance with statutory capital requirements or debt covenants.

The impairment model for equity securities that are not reported at fair value has been simplified. Each reporting period the investor must consider qualitative factors in assessing whether the investment is impaired. The qualitative assessment is similar to what is completed for long-lived assets, goodwill, and indefinite-lived intangible assets. ASC 321-10-35-3 lists the following factors to consider in the evaluation of a potential impairment:

1. A significant deterioration in the earnings performance, credit rating, asset quality, or business outlook of the investee 2. A significant adverse change in the regulatory, economic, or technological environment of the investee 3. A significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates 4. A bona fide offer to purchase, an offer by the investee to sell, or a completed auction process for the same or similar investment for an amount less than the carrying amount of that investment 5. Factors that raise significant concerns about the investee's ability to continue as a going concern, such as negative cash flows from operations, working capital deficiencies, or noncompliance with statutory capital requirements or debt covenants

A covenant also may require that the firm's debt rating not fall below a minimum level. Two rating agencies are Standard & Poor's Corporation and Moody's Investor Services. Moody's corresponding ratings are:

1. Aaa, 2. Aa, 3. A, 4. Baa. A debtor, for example, may be required to maintain at least an A S&P rating for compliance with the covenant.

Criteria for Reclassifying Current Liabilities as Noncurrent Liabilities Reclassification of a current liability to noncurrent status is possible provided two conditions are met: *Ability* There are three ways to meet this requirement. Each must occur in the period between the balance sheet date and the date the financial statements are issued or are available to be issued.

1. Actually refinance the liability on a long-term basis. In this case, the firm replaces the current liability with a noncurrent liability. 2. Enter into a noncancellable refinancing agreement supported by a viable lender. The agreement must extend more than one year beyond the balance sheet date. The purpose of the agreement is to refinance the liability on a noncurrent basis. 3. Issue equity securities replacing the debt.

Assets subject to impairment fall into one of three categories:

1. Assets in use 2. Assets held for disposal (sale) 3. Assets to be disposed of other than by sale (by spin-off to shareholders, by exchange for other assets, or by abandonment)

Justifications—There are two justifications for depreciation:

1. Assets wear out over time. 2. Assets become obsolete.

Unappropriated Retained Earnings is divided into the following sections:

1. Available for declaration—This portion of retained earnings is available for dividend declaration. In other words, the future use of this amount of retained earnings has not been determined. 2. No specific purpose—Unappropriated retained earnings have not been earmarked for a specific purpose. 3. Not all are paid—Not all unappropriated retained earnings must be paid in dividends, however.

Requirements for Inclusion in Plant Assets To be included in plant assets, an asset must:

1. Be currently used in operations; 2. Have a useful life extending more than one year beyond the balance sheet date; and 3. Have physical substance. Intangible assets are different from plant assets in that they have no physical substance.

The amount of depreciation recognized each period is affected by the following four factors. Only the first factor, capitalized cost, is a definite amount. Two estimates are used, and the firm has a free choice among the available methods:

1. Capitalized cost 2. Estimated useful life 3. Estimated salvage value (the cost of the asset not subject to depreciation—that is,the portion of initial cost expected to be returned at the end of the useful life) 4. Method chosen

Quasi-Reorganization—An alternative to bankruptcy in some cases, quasi-reorganization allows a firm a fresh start and new, more conservative asset values. Effects of a quasi-reorg:

1. Conditions—Operating losses have created a deficit in retained earnings (negative balance) and certain asset values are overstated. 2. Positive prospects—However, the firm has positive prospects for the future but will be unable to pay dividends until the deficit is absorbed by future income. 3. Updated balance sheet—Rather than continue with unrealistic asset values and negative retained earnings (the inability to pay dividends will hurt the firm's ability to raise capital), a quasi-reorganization will provide an updated balance sheet with no retained earnings deficit.

There are two methods to account for treasury stock:

1. Cost Method—Records the treasury stock account at the cost of shares reacquired; 2. Par Value Method—Records the treasury stock account at the par value of shares reacquired. **Owners' equity is reduced by the same amount, regardless of which method is used, but the balances of certain OE accounts are different under the two methods

Accounting and Reporting for an HTM Investment Record investment at cost:

1. Cost includes the purchase price (e.g., per security cost). 2. Carry and report held-to-maturity investments at amortized cost: - Recognize periodic interest income.

Financial Statement Reporting of Investment in Debt Securities—HTM The HTM investment (net of premium or discount) will be reported in the balance sheet as...

1. Current—if maturity is within one year (or operating cycle) of the balance sheet date; 2. Noncurrent—if maturity is not within one year (or operating cycle) of the balance sheet date.

How to Remember which Step Comes First Because inventory is counted at retail and the method is called DV LIFO retail, apply...

1. DV LIFO first, then 2. apply the retail method that deflates the amounts back to cost.

The dollar-value LIFO retail method (DV LIFO) is used by companies that use the LIFO cost-flow assumption when they apply the retail inventory method. The companies must use the dollar-value approach in order to determine the LIFO layers. There are two independent steps:

1. DV LIFO is first applied to inventory at retail only—and in the same way it was illustrated before. This results in the measurement of the current-period layer measured in current retail dollars. So, DV LIFO is restricted to retail dollar application. 2. Then, the FIFO retail method (not LC-M; i.e., subtracting markdowns when computing C/R) cost-to-retail ratio is applied to this retail layer yielding the increase in cost at current prices. Finally, this cost layer is added to beginning inventory at DV LIFO cost to yield ending inventory at DV LIFO cost.

IFRS No. 9 establishes two categories of investments (as financial assets) for accounting purposes:

1. Debt instruments (to be measured) at amortized cost 2. All other investments, including debt instruments not measured at amortized cost and all equity instruments and derivative instruments

Debt Issue Cost Accounting and Reporting:

1. Debt issue costs are reported in the balance sheet as a direct deduction from the liability's carrying amount. This is the same treatment afforded stock issue costs. Debt issue costs are not capitalized as an asset. 2. Debt issue costs are amortized to interest expense over the term of the related debt instrument. *IFRS accounting is the same.

Appropriated Retained Earnings is divided into the following sections:

1. Declared off-limits—This amount of retained earnings has been declared off-limits for dividends so that funds may be conserved for a specific purpose or objective. 2. End result—When retained earnings are appropriated, the amount of unappropriated retained earnings declines, and the amount of possible dividend declarations declines as well.

General guidance on adjustments to investments in debt securities classified as AFS follows:

1. Determine fair value of the AFS debt investments. 2. Determine carrying value of the AFS debt investments. 3. Adjusting the AFS debt investments to fair value. A. *If the fair value is greater than the carrying value:* - Recognize an unrealized holding gain. - The gain is recorded in other comprehensive income. B. *If the fair value is less than the carrying value:* - Recognize an unrealized holding loss. - The loss is recognized in other comprehensive income, and the investment security is assessed for impairment.

Protection for creditors—Legal capital provides a measure of protection for the creditors of the corporation, such as:

1. Dividends may not be paid from legal capital. 2. If there were no such protection, management could liquidate the corporation by paying back the shareholders their investment, leaving the creditors with assets that might not be worth their book value. 3. In many states, firms may not pay dividends to common stock in an amount that would cause total assets to be less than total liabilities plus the liquidation preference of preferred stock. The liquidation preference of preferred stock is the amount payable on liquidation of the company.

Current liabilities—Are those that meet two criteria:

1. Due in the coming year or the operating cycle of the business, whichever is longer; 2. An obligation to be met by the transfer of a current asset or the creation of another current liability. - The operating cycle is the period from acquiring inventory and other resources, to sale, to receipt of cash from the receivable. Most firms have operating cycles much shorter than a year. One measure of the operating cycle is 365/inventory turnover + 365/AR turnover = number of days required to sell the inventory on hand + number of days required to collect receivables.

Disposition (sale) of an AFS Investment in Debt Securities (steps):

1. First recognize interest income and amortization of premium or discount to date of sale. 2. Determine carrying value of investment to be sold. 3. Recognize any gain or loss at date of sale, if any, as difference between sales price and carrying value of investments sold. 4. Any related unrealized holding gain or loss on securities sold that is in accumulated other comprehensive income at the date of sale is recognized in income.

The entry shown above allows a business entity to achieve multiple objectives:

1. First, the ending balance of inventory is formally entered into the accounting system. 2. Second, the beginning balance of inventory is closed. Also, the purchases and related accounts are closed. 3. Finally, the cost of goods sold for the year is formally entered into the accounting system. Before this entry, cost of goods sold did not exist in the accounting records. Cost of goods sold is not directly observable in a periodic system. Rather, the value recorded for cost of goods sold is derived from the other amounts in the above entry.

Sum-of-the-years' digits method:

1. First, the sum of the years' digits must be calculated by using the formula shown below. 2. N = useful life in years. 3. SYD =(N(N+1))/2 = 1 + 2 + ... + N 4. SYD is the denominator of the fraction used each year to compute depreciation. The numerator is the number of years remaining at the beginning of the year. *Year 1 Depreciation:* (N/SYD)(Cost − Salvage Value) *Year 2 Depreciation:* ((N-1)/SYD)(Cost − Salvage Value)) *Year N Depreciation:* (1/(SYD))(Cost − Salvage Value)) This method is accelerated because the highest annual amount of depreciation is recognized in year 1, the next highest in year 2, and so forth.

IFRS Because there is only one category for equity investments, there are no transfers related to equity securities. There are two categories for debt securities, and it is possible to have a transfer from one classification to the other:

1. From debt at amortized cost to fair value with changes recognized through profit/loss, or 2. From fair value with changes recognized through profit/loss to debt at amortized cost.

Gain or Loss—The amount of the gain or loss on exchange is based solely on values pertaining to the asset exchanged. The book value of a plant asset is, for example, the difference between its cost and accumulated depreciation to date. The amount of gain or loss recorded, if any, is:

1. Gain = Fair Value of Asset Exchanged −Book Value of Asset Exchanged 2. Loss = Book Value of Asset Exchanged −Fair Value of Asset Exchanged

A covenant also may require that the firm's debt rating not fall below a minimum level. Two rating agencies are Standard & Poor's Corporation and Moody's Investor Services. S&P ratings are:

1. Highest, AAA; 2. High, AA; 3. Medium, A; 4. Minimum investment grade, BBB.

IFRS Equity Investments at Fair Value Reported through Other Comprehensive Income (OCI)—When equity investments are measured at fair value and reported through other comprehensive income (OCI), the entity must disclose:

1. Identification of the investments that have been designated to be measured at fair value with changes in fair value reported through OCI and the reasons for choosing the OCI alternative for those investments; 2. The fair value of each such investment at period-end; 3. Dividends recognized during the period on those equity investments, showing separately the amounts for investments held at the period end and those that were disposed of during the period; 4. Transfers during the period from accumulated OCI to retained earnings and the reasons for those transfers; and 5. For equity investments reported through OCI that are disposed of (derecognized) during the period, all of the following should be disclosed: A. The reasons for disposal; B. The fair value at the date of disposal; and C. The gain or loss on disposal.

In assessing the relative attributes of FIFO, it is important to remember three important points of emphasis:

1. If FIFO is employed by a business entity, the flow of costs is the same as the physical flow of goods for most firms. 2. If FIFO is employed by a business entity, the balance sheet valuation of inventory is an approximation to current cost, which is considered more relevant than historical cost. 3. If FIFO is employed by a business entity, however, the matching of revenues and expenses on the income statement is not considered ideal. Frequently, a company will be matching the revenues of the current year with the cost of merchandise acquired in a prior accounting period.

In assessing the relative attributes of LIFO, it is important to remember three important points of emphasis:

1. If LIFO is employed by a business entity, the matching of revenues and expenses on the income statement is significantly improved over FIFO. That is, the income statement involves the matching of revenues of the current year with the cost of merchandise acquired in the current year. 2. If LIFO is employed by a business entity, there are usually income tax advantages associated with that choice. In periods of rising prices, LIFO will result in a higher cost of goods sold and a lower tax burden for the business enterprise. However, due to the LIFO conformity rule, if LIFO is chosen for tax purposes, the firm must also use it for the books. Thus, the firm cannot reduce its taxes with LIFO and at the same time use FIFO for financial reporting purposes in the quest to maximize reported income. 3. If LIFO is employed by a business entity, the balance sheet presentation of inventory is less than ideal. For the company employing LIFO, inventory on the balance sheet typically reflects the cost of the "oldest" merchandise included in the company's inventory records. This means the balance sheet does not reflect the current cost of inventory and often times, means the inventory is undervalued on the balance sheet.

Criteria for Transfer under IFRS 39:

1. If the entity transfers substantially all the risks and rewards of ownership, the transfer is treated as a sale. 2. If the entity retains substantially all the risks and rewards of ownership, the transfer is treated as a secured borrowing. 3. If neither conditions 1 or 2 hold, the entity accounts for the transaction as a sale if it has transferred control and as a secured borrowing if it has retained control.

Compared with the normal procedure (recording at present value), there are three effects of the above accounting for modification type 1 TDRs on the debtor's financial statements:

1. Liabilities are larger (nominal sum is larger than the present value). 2. Income is smaller in year of restructure (the gain is smaller than if the note payable were recorded at present value). 3. Future interest expense is smaller (there is no interest recognized).

Inventories Carried at LIFO or RIM Use LC-M Calculate Market Value:

1. If the replacement cost value is within the range established by the ceiling value and the floor value, market is equal to replacement cost. 2. If the replacement cost value is greater than the ceiling value, market is equal to the ceiling value. 3. If the replacement cost value is less than the floor value, market is equal to the floor value. 4. Market is also simply the middle amount (in dollar terms) of the three amounts: replacement cost, net realizable value, and net realizable value less normal profit margin. Market cannot exceed the ceiling or be less than the floor.

Nonmonetary Asset Exchanges Gains (gain = fair value of asset exchanged - book value):

1. If there is commercial substance, recognize gain in full, and record the acquired asset at fair value. 2. If there is no commercial substance and cash is not received on the exchange, recognize no gain, and record the acquired asset at book value of asset exchanged + cash paid. 3. If there is no commercial substance and cash is received on the exchange, recognize the gain in proportion to the cash received and record the asset acquired at fair value less the unrecognized portion of the gain. A. Exception—if the proportion of cash received is 25% or more, account for the exchange as if there were commercial substance (recognize gain in full and record acquired asset at fair value).

Using Accounts Receivable and Notes Receivable as Sources of Cash Frequently, business entities use receivables as immediate sources of cash. The firm uses the receivables as collateral for a loan or sells the receivables to a third party rather than wait for the maker of the note to make all the required payments on the note. The reasons for the transactions that will be described are varied:

1. In some cases, a company may elect to forgo the establishment of a collection department. That is, the company could decide that the establishment of a collection department is not economically feasible. 2. In other cases, companies may need the cash related to a note receivable or accounts receivable to meet current operating expenses or to take advantage of a unique opportunity.

Direct Response Advertising The types of costs that are capitalized include:

1. Incremental direct costs such as the costs of logos, advertisements on the Internet, and others 2. Salary costs of employees directly involved in the advertising activities including developing the concepts, artwork, advertising copy etc. 3. Assets used as prizes directly related to direct response advertising programs

Appraisal methods—These methods are used when it is impractical to depreciate assets on an individual basis. Accumulated depreciation records are not maintained on individual assets, and no gain or loss is recorded on disposal:

1. Inventory (appraisal) method—This method is applied to groups of smaller homogenous assets. At the end of each year, the assets are appraised and recorded at market value. The appraisal is for the entire group, which saves accounting costs. The decline in market value from the previous year is depreciation expense for the year. If assets were sold during the year, the proceeds from sale reduce depreciation expense. 2. Group/composite methods This system applies the straight-line method to groups of assets rather than to assets individually. Accumulated depreciation records are not maintained by asset; rather, only a control account is used to accumulate depreciation. Gains and losses are not recorded. The entry to dispose of an asset plugs the accumulated depreciation account. The composite depreciation rate = (Annual group SL depreciation) / (Total original cost of group) Depreciation for a year is the product of the rate and the original cost of assets remaining at the beginning of the year. Asset additions increase the total original cost on which depreciation is computed; asset disposals reduce the total original cost.

In this section, we show the equity method entries depicted in the T-accounts above. Recall the purpose of equity method accounting is to reflect the changes in the investee's net book value. These changes include:

1. Investee's results of operation (income/loss) 2. The investor's share of the investee's results of operations are recognized by the investor when reported by the investee. The investor recognizes its proportionate share of the investee's reported income/loss, excluding its share of any intercompany profits/losses in assets (e.g., in inventory, etc.).

Significant influence or control is exercised by shareholders other than the investor. For example:

1. Investor A owns 35% of the voting stock, but Investor B owns the other 65% (has control) and does not cooperate with Investor A. 2. Investee is in bankruptcy or legal reorganization and under the control of the courts. 3. Investee is a foreign entity that operates under foreign government restrictions that preclude exercise of significant influence. 4. The investor lacks information for use of equity method (very rare); or 5. The investor cannot obtain representation on the investee board of directors.

In a sale of all or part of an investment accounted for using the equity method, first update the equity method accounts to date of sale by recording:

1. Investor's share of the investee's income or loss to date of sale. 2. Investor's share of the investee's dividends declared or paid to the date of sale. 3. Investor's depreciation or amortization on of the excess cost over book value to date of sale.

IFRS defines an intangible asset as "an identifiable nonmonetary asset without physical substance." This definition has three key characteristics. (The definition and characteristics are very similar to U.S. GAAP.) The asset:

1. Is controlled by the entity and the entity expects to derive future economic benefits 2. Lacks physical substance 3. Is identifiable to be distinguished from goodwill

LC-NRV applies to all inventory valuation methods that are not...

1. LIFO or 2. Retail Inventory Method. *In essence, this means that LC-NRV is applied to inventories carried at FIFO or weighted average

Included in R&D Are:

1. Laboratory research 2. Conceptual formulation and design of possible products or process alternatives 3. Modification of the formulation or design of a product or process 4. Design, construction, and testing of preproduction prototypes and models 5. Design of tools, jigs, molds, and dies involving new technology 6. Design of a pilot plant

There are two general sources of present obligations or liabilities:

1. Legal obligations that derive from a contract, legislation, or other legal process 2. Constructive obligations deriving from the entity's established practices, published policies or other statements that create a valid expectation on the part of other parties that the entity will discharge those responsibilities

Liabilities have three key elements, which are shown below. This definition is taken from the FASB's conceptual framework:

1. Liabilities represent probable future sacrifices of economic benefits. 2. Liabilities are obligations to transfer assets or provide services in the future. 3. Liabilities are the result of past transactions or events

Covenants also may describe a restriction on the debtor's transactions during the debt term for the protection of the creditor. Otherwise, the debtor is in violation of the covenant. Such as...

1. Limit dividends or treasury share purchases to a specific amount, or prohibit them. 2. Limit additional borrowings. A "leverage" covenant may limit total debt to some multiple of an earnings variable, such as EBITDA. 3. Alternatively, the firm may be required to maintain a minimum specified interest coverage ratio if additional debt capital is acquired. Require that the borrower not voluntarily cause a reduction in net assets (weakening of the balance sheet) or not take any action that might impede the ability to service the debt. 4. Prohibit risky investments or expansion projects.

Examples of deferred charges are listed below:

1. Long-term prepaid insurance 2. Long-term prepaid rent 3. *Machinery rearrangement costs*—Related to an assembly line for a manufacturing concern, the costs of an efficiency study. These costs are typically amortized over five to ten years. 4. *Deferred income taxes*—When transactions in the current or past periods give rise to future deductible temporary differences (which reduce future taxable income relative to future pretax accounting income), a deferred tax asset is created. Coverage of this topic is significantly expanded in a subsequent lesson. 5. *Deferred bond issue costs*—The costs of issuing bonds is recorded in a deferred charge and amortized over the term of the bonds.

There are six criteria for determining when an asset is considered held for sale. All six must be met for the accounting provisions to apply. Otherwise, the asset is considered in use:

1. Management commits to a plan to sell the asset or group of assets. 2. The asset must be available for immediate sale in its present condition subject only to terms that are usual and customary for such sales. This criterion does not preclude a firm from using the asset while it is held for sale nor does it require a binding agreement for future sale. 3. An active program to locate a buyer has been initiated. 4. The sale is expected to take place within one year. In limited cases, the one-year rule is waived for circumstances beyond the firm's control (e.g., due to a new regulation or law, environmental remediation, or deteriorating market). 5. The asset is being actively marketed for sale at a price that is reasonable in relation to its current value. 6. Sale of the asset must be probable.

Adopted Standards—The FASB has adopted accounting standards that require certain items related to equity are to be reported as liabilities. These items obligate the firm to deliver assets of a fixed monetary value, either cash or equity shares, in the future, and they include:

1. Mandatorily redeemable shares 2. Certain stock appreciation rights (discussed in a previous lesson) 3. Financial instruments obligating the issuing firm to issue stock worth a fixed value 4. Written put options and other financial instruments obligating the issuing firm to repurchase its own shares

Inventories Carried at LIFO or RIM Use LC-M. Determine Market Value:

1. Market is generally replacement cost, subject to a range of values defined by an established ceiling value and an established floor value. 2. The ceiling value is net realizable value. That is, the ceiling value is calculated by reducing the sales price by the estimated cost to complete and sell the inventory. 3. The floor value is net realizable value reduced by the normal profit margin.

In evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying value, an entity should consider all relevant events and circumstances, including:

1. Microeconomic conditions such as deterioration in general economic conditions, limited access to capital, fluctuation in exchange rates, or other adverse events in equity and credit markets 2. Industry and market conditions such as deterioration in the industry environment, increased competition, decline in market-dependent multiples, change in the market for the entity's products or services, or a regulatory or political development 3. Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows 4. Overall financial performance such as negative cash flows or actual or projected declines in revenues, earnings, or cash flows 5. Entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy or litigation 6. Factors affecting a reporting unit such as changes in composition or carrying amount of its net assets, anticipation of selling or disposing all or a portion of a reporting unit, or recognition of goodwill impairment loss by a subsidiary that is a component of a reporting unit 7. If the reporting unit is publicly traded, a sustained decrease in share price (considered both in absolute terms and relative to the peer group)

A post-acquisition cost is capitalized if, as a result of the expenditure, the asset is:

1. More productive (provides more benefits); or 2. Has a longer useful life.

Accounting Generalizations About Treasury Stock—The following statements hold regardless of the method used to account for treasury stock, which are shares of a firm's common stock purchased (bought back) by that firm:

1. No one owns treasury stock—there is no shareholder for this stock. A firm cannot own itself. 2. Treasury stock is not an asset. 3. A firm cannot record any income account in a treasury stock transaction. 4. A firm cannot profit from treasury stock transactions. 5. The treasury stock account is debited upon purchase of treasury stock. The account is a contra OE account. The common stock account is not affected by treasury stock transactions because treasury stock is considered issued stock. 6. Treasury stock reduces the number of shares outstanding but not the number of shares issued, because treasury stock is issued stock. 7. When treasury stock is purchased, earnings per share increases because the denominator of EPS is reduced with no effect on the numerator. 8. The net assets and owners' equity of the firm decrease by the cost of treasury shares purchased. 9. Retained earnings can be decreased in some cases, but never increased by treasury stock transactions.

There are three kinds of noncurrent assets subject to depreciation or similar process. Different terms are used for each, but all involve a systematic and rational allocation of historical cost to time periods of use:

1. Plant assets are depreciated; 2. Natural resources are depleted; 3. Intangible assets are amortized.

Classification of Held-to-Maturity Investments Criteria for This Classification Applies when investor has:

1. Positive intent to hold the securities to maturity; and 2. Ability to hold the securities to maturity

Partially Participating The steps in the allocation are:

1. Preferred: Any dividends in arrears 2. Preferred: Current-period dividend 3. Common: Matching amount: preferred percentage x total par of common outstanding 4. Preferred: Additional percentage Common: Remainder

When preferred stock does not participate beyond its annual percentage or amount, the order of dividend payments is:

1. Preferred: Any dividends in arrears (only if preferred stock is cumulative) 2. Preferred: Current-period dividend 3. Common: Remainder

Allocating Methods—For example, common stock and preferred stock might be bundled together and sold in a single transaction. In allocating the proceeds to the common stock sold and the preferred stock sold, the company will use the proportional method or the incremental method:

1. Proportional method—When both securities have established market values, the allocation will be based on their respective fair values. 2. Incremental method—When only one security has an established fair value, that security is assigned proceeds equal to the known fair value. Any incremental proceeds are allocated to the remaining security sold.

Nonmonetary Asset Exchanges osses (loss = book value of asset exchanged - fair value):

1. Recognize loss in full, and 2. record the acquired asset at fair value regardless of whether there is commercial substance. (Losses are always recognized in full.)

Regardless of the debt extinguishment method, however, the accounting is the same:

1. Record interest and amortization of discount or premium, and amortization of debt issue costs, to the date of extinguishment. Accrued interest from the most recent interest payment date will be included in the amount paid to retire the bonds. 2. Remove the related debt accounts at their remaining amounts (face value, unamortized discount or premium, and any unamortized debt issue costs) 3. Record the gain or loss, which is the difference between the current bond price and the net bond liability. The net bond liability is the face value of the bond plus or minus unamortized premium or discount, and less unamortized bond issue costs. If the current bond price exceeds the net bond liability, a loss is recognized, and vice versa.

Debtor—In settlement restructures, the debtor:

1. Records a gain for the difference between the book value of the debt, including any unpaid accrued interest, and the fair value of consideration transferred in full settlement of the debt (debtor always records a gain of this type and never a loss) 2. Records a gain or loss, if any, on the disposal of nonmonetary assets transferred in full settlement of the debt (if the debtor pays cash only to settle the debt, there is no gain or loss of this type recorded) 3. Removes the debt accounts from the books 4. Records any stock issued in settlement at the fair value

Creditor—In settlement restructures, the creditor:

1. Records a loss for the difference between the book value of the receivable and the fair value of assets or stock of the debtor received 2. Removes the receivable accounts from the books 3. Records assets received at fair value

Modification type 2—In modification of terms restructures in which the nominal sum of the restructured flows is greater than the book value of the debt plus accrued interest, the debtor:

1. Records no gain or loss and does not change the carrying value of the debt 2. Computes the new rate of interest equating the present value of restructured cash flows and the book value of the debt 3. Records interest expense based on the new rate for the remainder of the loan term

Modification type 1—In modification of terms, restructures in which the nominal sum of the restructured flows is less than or equal to the book value of the debt plus accrued interest, the debtor:

1. Reduces the carrying value of the debt to the nominal sum of restructured cash flows 2. Records a gain for the difference between the book value and the nominal sum of restructured cash flows 3. Records no further interest; all future cash payments are returns of principal

Default by subscriber—If the subscriber fails to make all the payments and defaults, the journal entry to record the default depends on the contract and applicable state law. Possibilities include:

1. Return all payments to subscriber. 2. Issue shares in proportion to payments made. 3. The subscriber receives no refund or shares.

Footnote disclosures for equity can be extensive if the entity has several classes of stock. The following are required disclosures:

1. Rights and preferences of each class of stock including liquidation preferences and voting rights 2. Number of shares authorized, issued, and outstanding for each class of stock 3. Par value for each class of stock 4. Treasury shares 5. Restrictions regarding dividends and dividends in arrears 6. Call and conversion information

Hybrid organizations—These organizations have some of the characteristics of both corporations and partnerships or sole proprietorships:

1. S corporation. This is a classification for tax purposes. If the relevant tax rules are followed, limited liability is retained but the income is taxed only once, at the owner level. 2. Limited liability companies allow all owners to be involved in the management of the business with each being liable only to the extent of their investment. Double taxation is avoided. 3. Limited liability partnerships are less generous with respect to the limited liability feature.

Classification of Held-to-Maturity Investments Criteria for This Classification Sale of debt securities before maturity that meet the following conditions can be considered held-to-maturity (HTM):

1. Sale is near enough to maturity date so that interest rate risk is substantially eliminated as a factor in pricing. 2. Sale occurs after investor has collected (through periodic payments or prepayment) a substantial portion (at least 85%) of the principal outstanding at acquisition date.

Investments in equity securities should be recorded at fair value when there is a readily determinable fair value. Readily determinable fair value is defined in the (ASC) Master Glossary as follows: An equity security has readily determinable fair value if it meets any of the following conditions:

1. Sales prices or bid-and-ask quotations are currently available on a securities exchange registered with the U.S. Securities and Exchange Commission (SEC) or in the over-the-counter (OTC) market if the OTC prices are publicly reported. 2. Prices or quotations are in a foreign market that has the breadth and scope of the U.S. markets. 3. Prices or quotations for investments in mutual funds (or structures similar to mutual funds, such as a limited partnership or venture capital entity) when the fair value per share is published based on current transactions.

Declining-balance method This method differs from those discussed previously in three ways:

1. Salvage value is not used in the computation of depreciation. 2. Annual depreciation is based on the beginning book value of the asset. This book value declines over time, hence the name of this group of methods. This also is why salvage value is not subtracted. Book value always includes salvage value because salvage value is never depreciated. 3. Each year, accumulated depreciation must be checked to ensure that book value does not fall below salvage value.

Stock Sold on a Subscription Basis Sale of stock on a subscription basis requires a contract specifying:

1. Share price 2. Number of shares 3. And the payment dates

Indicators of Impairment—Impairment testing must be completed when any of the following conditions occur:

1. Significant decrease in the fair value of the asset 2. Significant change in the way asset is used or physical change in asset 3. An unfavorable change in laws, regulations, or the business climate that would adversely affect the use of the asset 4. Significantly higher than expected costs involved with the construction or acquisition of an asset 5. There have been or projected to be negative operating or cash flow (losses) from the asset. 6. The entity decides to sell the asset before the end of its expected life.

Under IFRS, a long-lived asset is impaired when its carrying value exceeds the recoverable amount.The recoverable amount is the higher of:

1. The asset's fair value less cost of disposal (the price that one would receive to sell an asset in an orderly transaction with a market participant); or 2. The asset's value in use (which represents the entity-specific pretax cash flows discounted to present value).

An exchange lacks commercial substance whenever the cash flows to the firm are not expected to change significantly as a result of the exchange:

Extinguishment of debt can be accomplished in a variety of ways:

1. The company can simply pay off the debt. 2. Also, debt may be replaced by a new debt issue (a refinancing, also called a "refunding"). - For a refunding, the present value of the new debt issue is used as the price of retiring the old issue. 3. Alternatively, the company may purchase a bond issue on the open market and retire the bonds payable. 4. Finally, the company may retire callable bonds by exercising the call feature of the bonds if the bonds are callable, and pay the call price.

Restructuring of debt is commonplace. Extension of terms, changes in interest rates, and other aspects of the debt agreement are examples. In a troubled debt restructure (TDR), however, the creditor grants a concession by agreeing to terms less favorable than under the original debt agreement. For a restructuring to be considered a TDR, the both of the following must hold:

1. The creditor granted a concession in the expectation that more ultimately will be received from the debtor compared with other strategies, such as forcing the debtor into bankruptcy. 2. The debtor is in financial difficulty, which means that without the concession, it is likely that the debtor will default.

Rights related to liquidation—In the event of liquidation, common shareholders are again in a subordinate role:

1. The creditors are satisfied first. 2. Then, the preferred shareholders are eligible to receive the liquidation values for the preferred shares. 3. Finally, the remaining assets are distributed to the common shareholders. The common shareholders are the very last to receive assets on liquidation. They have the residual interest in the firm. Positive total owners' equity does not necessarily imply that any shareholders will receive assets upon liquidation. If the fair value of assets is less than total liabilities at liquidation, no shareholder would receive any assets.

First the company must determine if the cloud computing arrangement includes a software license. The arrangement contains a software license if both one and two are true:

1. The customer has the contractual right to take possession of the software at any time during the hosting period without significant penalty. - Significant penalty means that the customer can take delivery without incurring significant costs and can use the software separately without a significant reduction in utility or value. 2. It is feasible for the customer to either run the software on its own hardware or contract with another party unrelated to the vendor to host the software.

IFRS Reclassifications Due to Changes in Business Model—When an entity reclassifies investments between categories due to changes in its business model, it must disclose:

1. The date and amount of each reclassification by category; and 2. A detailed explanation of the underlying change in business model and a qualitative description of the effects on the financial statements. 3. If the reclassification is from fair value measurement to amortized cost measurement, it must disclose: A. For the period of reclassification, the fair value of the reclassified investments as of the end of the period and the gain or loss that would have been recognized during the period if reclassification had not occurred; and B. For the remaining life of the investment, the effective interest rate at the date of reclassification and interest income recognized during each period.

Debt is considered extinguished when one of two conditions is met:

1. The debtor pays the creditor and is relieved of any obligation related to the debt. 2. The debtor is legally released from being the primary obligor of the liability, and it is probable that the debtor will make no further payments. This legal release may be done by the creditor or by the courts. (An example is the release from a mortgage note upon sale of the related property.)

True No Par Stock—When the stock is true no-par stock (without stated value):

1. The entire proceeds from issuance of stock are credited to the common stock account. 2. No contributed capital account is recorded.

Equity investments are not required to be reported at fair value in the following circumstances:

1. The equity investment is accounted for under the equity method (i.e., there is significant influence and the fair value option is not elected), or 2. The equity investment is controlled and will be consolidated with the investee, or 3. The equity investment does not have readily determinable fair value; the investor can elect to measure the investment at cost. A. Cost is adjusted for any impairment. B. Cost also must be adjusted for changes in observable prices of orderly transactions for identical or similar equity investments.

Steps in Implementing Dollar-Value LIFO:

1. The establishment of inventory pools simply means the company needs to group similar products into inventory groups. For example, a department store might have one inventory pool that includes appliances. 2. The conversion index can be calculated internally or obtained from an external source. Regardless of the method of acquisition, the conversion index represents the calculation shown below: Conversion Index = Ending Inventory in Current-Year Dollars / Ending Inventory in Base-Year Dollars

If the expenditure is material in amount, the accounting treatment of the expenditure will be determined by examining the estimated time of benefit related to the expenditure. To be capitalized and then depreciated, an expenditure must make the asset "bigger, better, or last longer." In other words, the asset must have increased or improved functionality, make better products, or have a longer life. Three examples of this concept follow:

1. The estimated useful life of the asset is extended beyond the original estimation (i.e., expenditures for a major overhaul of a bread oven in a commercial bread bakery that might extend the life of the oven beyond the original estimate). 2. The asset becomes more efficient or productive, meaning it can produce higher quantities or operate at a lower cost (i.e., a new laser product sorter might be added to a machine, replacing human efforts to sort out defective products and speeding up the process). 3. Quality of the asset's output is improved (i.e., upgrades to equipment for a textile entity, which enable it to produce a sheet with a higher thread count).

In evaluating whether it is more likely than not that the goodwill of a reporting unit with zero or negative book value is impaired, an entity should take into account:

1. The events and circumstances described previously (IV. B.) 2. Whether there are significant differences between the carrying amount and the estimated fair values of its assets and liabilities 3. The possible existence of significant unrecognized intangible assets

ASC 845 requires that fair value be used to record a nonmonetary asset acquired in an exchange with another nonmonetary asset, with full recognition of gains and losses, unless any of the following apply:

1. The fair value of neither asset can be determined. 2. The exchange is made solely to facilitate sales to customers (e.g., inventory is exchanged for other inventory in the same line of business to enable one of the firms to make a sale to an outside party). 3. The exchange lacks commercial substance—the cash flows of the firm are not expected to change significantly as a result of the exchange, which means: A. The cash flows from the acquired asset will not be significantly different from those of the asset exchanged in terms of amount, timing, or risk; or B. The use value of the acquired asset is not significantly different from that of the asset exchanged, in relation to the fair value of the assets exchanged.

No Par Value Alternatives—If the stock has no par value, two alternatives exist:

1. The firm may designate a stated value, which serves the same function as par value except that it does not appear on the certificate. 2. The firm may not use a par value or stated value at all, in which case the stock is referred to as no par stock.

There are two parts to the guarantee:

1. The first part is the *obligation of the guarantor to be ready to comply with the guarantee if the triggering event occurs* (e.g., default by the debtor whose debt is guaranteed by the guarantor). The guarantor recognizes this liability at fair value initially even if there is no expectation of payment. The debit depends on the nature of the guarantee. 2. The second part is *the uncertain contingent obligation*—the contingent liability. This part is subject to the usual principles regarding contingent liabilities. When a contingent liability is recognized, the amount recorded is the greater of the initial fair value for part 1 above, and the amount to be recognized as a contingency. Subsequent measurement is not addressed by GAAP although recognition of the change in value is presumed with a corresponding change in earnings.

The decline in value is considered other than temporary if any of the following factors exist:

1. The holder has the intent to sell the impaired debt security. - Recognize the OTTI in earnings. The impairment loss is the difference between the amortized cost and the fair value of the debt security. 2. It is more likely than not that the holder will be required to sell the impaired debt security before it can recover the amortized cost basis (i.e., the holder's need for cash for operations or other investment purposes likely will require that it sell the impaired debt security). - Recognize the OTTI in earnings. The impairment loss is the difference between the amortized cost and the fair value of the debt security. 3. The holder does not expect the present value of the estimated cash flows to recover the entire amortized cost basis of the debt security, regardless of whether it intends to sell the security. The entity must evaluate whether any of the loss is due to credit loss of the issuer. - Recognize in earnings the portion of the OTTI that is associated with credit losses. - Recognize in other comprehensive income (OCI) the portion of the OTTI that is associated with other factors.

The decline in value is considered other-than-temporary if any of the following factors exist:

1. The holder has the intent to sell the impaired debt security. - Recognize the OTTI in earnings. The impairment loss is the difference between the amortized cost and the fair value of the debt security. 2. It is more likely than not that the holder will be required to sell the impaired debt security before it can recover the amortized cost basis (i.e., the holder's need for cash for operations or other investment purposes likely requires that it sells the impaired debt security). - Recognize the OTTI in earnings. The impairment loss is the difference between the amortized cost and the fair value of the debt security. 3. The holder does not expect the present value of the estimated cash flows to recover the entire amortized cost basis of the debt security, regardless of whether it intends to sell the security. The entity must evaluate whether any of the loss is due to credit loss of the issuer. - Recognized in earnings the portion of the OTTI that is associated with credit losses. - Recognize in OCI the portion of the OTTI that is associated with other factors.

Differences between the cost of the investment and the book value of the net assets to which the investment gives the investor a claim may be due to:

1. The identifiable assets/liabilities carrying values on the books of the investee are different from the fair value of those assets/liabilities at the date of the investment. 2. Goodwill was paid for by the investor.

When the equity method is used to report investments in common stock, the following disclosures are appropriate:

1. The name of each equity method investee and the percentage of ownership. 2. The name of any investee in which the investor owns 20% or more (but not more than 50%) of the voting stock that is not accounted for using the equity method and the reason for that treatment. 3. The name of any investee in which the investor owns less than 20% of the voting stock that is accounted for using the equity method and the reason for that treatment. 4. Any difference between the carrying amount of the investment and the investor's share of the underlying claim to net assets and how that difference is treated. 5. When a bargain purchase gain is recognized, the amount of the gain recognized, the line item where the gain is recognized and a description of the transaction that resulted in the gain. 6. When there is a quoted market price for the common stock, the market value of each investment. 7. When the equity method is used for investments in corporate joint ventures that are material to the investor, summary information about the assets, liabilities, and results of operation of those joint venture investees. 8. Possible effects of conversion or exercise of outstanding securities (e.g., options, convertible securities, etc.) on the investor's ownership claim.

The guarantor is required to disclose the following:

1. The nature of the guarantee, the term of the guarantee, how the guarantee came into existence, and the triggering event 2. The maximum future amount payable under the guarantee 3. The carrying amount of the liability 4. A description of recourse provisions or available collateral enabling the guarantor to recover the amounts paid under the guarantee, if any

Example An asset with a book value of $100 has a recoverable cost of $90 and a fair value of $75. Test for Impairment: BV of $100 > RC of $90. The asset is impaired because the book value is not fully recoverable. Loss Measurement: Loss = BV of $100 - FV of $75 = $25. The asset is written down to $75. The loss is a component of income from continuing operations. The entry to record the loss of $25: Impairment Loss 25 Asset or A/D 25 *Accounting after recognizing the $25 loss*

1. The new BV of the asset is the FV of 75 and is used as the cost for future depreciation. The new depreciable cost is $75 less any residual value. 2. An impairment loss on an asset in use cannot be recovered; there is no upward revaluation or gains recognized if FV increases. 3. Additional impairments are possible.

Compensated absences include vacation, holiday, and sick-leave periods for which the employee is compensated. GAAP requires that accrual accounting be applied if certain criteria are met. The expense of these benefits is accrued during the period employees earn these benefits if all of the following four criteria are met:

1. The obligation is attributable to services rendered as of the balance sheet date. 2. The rights vest (benefits are no longer contingent on continued employment) or accumulate (carry over to future periods). 3. Payment of the obligation is probable. 4. The amount of the obligation is estimable.

FVO Classification of the unrealized gain or loss:

1. The portion of the total unrealized gain or loss attributable to credit risk (risk of default or delay in payment of interest or principal) is recognized in other comprehensive income. 2. The portion attributable to the change in interest rates is recognized in net income.

Measured at Par or Stated:

1. The preferred stock and common stock accounts are always measured at par or stated value. 2. Any excess of issuance price over the par value is credited to additional paid-in capital (preferred or common).

Impaired Loans Receivables are Written Down to:

1. The present value of the future cash flows expected to be collected using the original effective interest rate for the loan, or 2. Market value if this value is more determinable.

declining balance method:

1. The rate (2/N) is twice the straight-line rate. 2. N =useful life in years. 3. 150% of declining-balance method 4. The calculations are the same as for double-declining balance except that (1.5/N) is the rate used.

International standards require that the debtor firm must exhibit its ability to refinance the current liability by taking action or having an agreement in-place before the balance sheet date. If the action is delayed until after the balance sheet date but before the financial statements are issued or available to be issued, the current liability is not reclassified. This is in contrast with U.S. standards. The options available under international standards for refinancing a current liability to noncurrent status then are:

1. The refinancing of the current liability on a long-term basis must occur before the balance sheet date. 2. If a refinancing agreement is the chosen method, the refinancing agreement must be in place before the balance sheet date and the intent of the firm must be to refinance the obligation on a long-term basis within one year of the balance sheet date. An existing loan facility and intent of the firm to rollover the debt suffices as well. 3. Issuing equity securities to extinguish the liability before the balance sheet is not an option because the firm would have no current liability to report at the balance sheet date. Rather than reclassify the current liability, the liability would be retired.

IFRS Present value measurement can be applied using either of the following techniques:

1. The traditional present value technique applies the risk adjusted rate directly to estimates of cash flows. If the cash flows are contractual, this technique may be appropriate. 2. The expected present value technique applies the risk-free rate to multiple cash flow projections each with an associated probability of outcome. If the cash flows are considerably uncertain and there is a wide range of possible amounts, this technique may be appropriate.

1. The transferred assets have been isolated from the transferor, even in bankruptcy. 2. The transferee is free to pledge or exchange the assets. 3. The transferor does not maintain effective control over the transferred assets either through an agreement that allows and requires the transferor to repurchase the assets or one that requires the transferor to return specific assets.

With reference to determining the fair value of net identifiable assets, there are two notable points:

1. The use of the term net implies that all liabilities assumed in the acquisition have been subtracted from all assets acquired in the acquisition. 2. The use of the term identifiable assets implies that all identifiable assets are included, both tangible (such as property, plant, and equipment) and intangible (such as patents), including those that have a definite life and those that have an indefinite life.

An equity security does not have a readily determinable fair value in any of the following situations:

1. There are no sales prices or bid-and-ask quotations available on a securities exchange registered with the U.S. Securities and Exchange Commission (SEC) or in the over-the-counter (OTC) market if the OTC prices are publicly reported. 2. There are no prices or quotations in a foreign market that has the breadth and scope of the U.S. markets. 3. There are no prices or quotations for investments in mutual funds (or a limited partnership or venture capital entity) if the fair value per share is published based on current transactions.

The effects on the investment account and on the equity revenue account generally would be the same under IFRS as under U.S. GAAP, with these significant exceptions:

1. Under IFRS, entities may have reserve accounts, which do not exist under U.S. GAAP. 2. Under IFRS, changes in reserve accounts of the associate (investee) are recognized by the investor under the equity method.

Items of other comprehensive income that might change equity would include:

1. Unrealized gains/losses on available-for-sale debt securities; 2. Foreign currency items; and 3. Pension and postretirement benefit items not recognized in period cost.

IFRS Under IFRS, only certain types of investors that have significant influence over an investee and would otherwise use the equity method may elect to carry and report the investment at fair value. Only the following types of investors may elect to carry and report investments in associates using fair value:

1. Venture capital organizations—private equity investment firms 2. Mutual funds—investment companies offering a managed open-end portfolio of securities 3. Unit trusts—investment companies offering a fixed (unmanaged) portfolio of securities with a fixed life

But What Interest Rate Should Be Used? U.S. GAAP does not limit capitalized interest to specific construction loan interest. Rather, the more general concept of avoidable interest is used. Two ways of computing total interest to be capitalized are allowed:

1. Weighted Average Method—Capitalizes interest using the weighted average rate on all interest bearing debt. 2. Specific Method—Capitalizes the interest on specific construction loans first. Then, if needed, capitalize interest on all other debt based on the average interest rate for that debt

There are two exceptions to book value reporting when there is no commercial substance:

1. When a loss is evident, it is recognized in full, and the acquired asset is recorded at market value. Cash can be paid or received on the exchange for this exception. Thus, losses are always recognized in full—an example of conservatism. 2. When a gain is evident and cash is received (only), the gain is recognized in proportion to the amount of cash received, and the acquired asset is recorded at market value less the portion of the gain unrecognized. If the proportion represented by cash is 25% or more, then the entire gain is recognized, and the acquired asset is recorded at market value.

Depreciation on Assets Used in Extraction Depreciation on equipment used in the extraction effort is a component of total extraction costs. It does not contribute to depletion. The entry for extraction costs generally includes...

1. a debit to extraction costs and 2. a credit to accumulated depreciation for depreciation on the cost of assets used in extraction. How the equipment is depreciated depends on whether it can be moved from one site to another.

Relative Sales Value Method Firms may be able to obtain significant discounts by purchasing different types of inventory from the same supplier. This may occur, for example, in... U.S. GAAP requires that the total price be allocated based on the...

1. a liquidation or distress sale. 2. market values or selling prices of the individual inventory items.

Definite liabilities actually exist at the balance sheet. Contingent liabilities have some uncertainty at the balance sheet date. Their existence is contingent on an event that may or may not occur after the balance sheet. A contingent liability may be...

1. accrued as a definite liability, 2. is disclosed as a contingency, or 3. is not considered a liability at all. Most liabilities are definite. Examples of contingent liabilities include lawsuits, warranties, and guarantees.

Sources of Intangibles—Intangibles are either...

1. acquired from other parties or 2. internally developed

Contingencies Acquired in Business Combinations After acquisition, as new information is obtained, the contingency is reported at the greater of...

1. acquisition date fair value, and 2. the amount that would be recognized under normal contingency rules. Any changes in the reported liability are recognized as gains or losses.

Additional restrictions may be placed on the debtor. If a covenant is violated because of reduced earnings, for example, then the debtor may be prohibited from paying dividends or taking on more debt until the violation is cured. The creditor may...

1. agree to renegotiate or restructure the debt. 2. Legal action may be taken against the debtor, including the initiation of a breach of contract lawsuit.

U.S. GAAP-IFRS Differences IFRS requires the effective interest method in _______, and the amortization period is the expected term of the bond, as opposed to...

1. all cases 2. the contractual period as per U.S. standards.

U.S. GAAP—IFRS Differences In addition to the usual disclosures involving equity as per U.S. statements, international disclosures also include...

1. amounts of capital not yet paid in, 2. restrictions on the repayment of capital, and 3. changes in reserve accounts.

Example - part one of the guarantee If the guarantee is for the debt of a customer incurred to buy the products of the entity guaranteeing the customer's debt, the debit is a reduction in the profit on the sale. In a stand-alone guarantee to an unrelated party without consideration, the debit is to _______________. For a lessee guarantee of residual value in an operating lease, the debit is to ________________.

1. an expense. 2. prepaid rent.

Calculation of cost of goods sold: This example calculated cost of goods sold directly. Although this may be possible for firms with low unit volume, for most firms using a periodic system, the ending inventory cost is measured through....

1. an inventory count and application of unit costs, and 2. then cost of goods sold is computed by subtracting the ending inventory cost from cost of goods available for sale.

Internally developed intangibles (such as organization costs) are expensed immediately if they...

1. are not specifically identifiable, 2. have indeterminate values, or 3. are inherent in a continuing business and related to the entity as a whole. Firms routinely expense the amount of internal expenditures devoted to the development of intangibles, most notably for patents, research and development (R&D), and goodwill.

Most current liabilities (CL) are due within one year of the balance sheet. All other debt is noncurrent. Liabilities are presented on the balance sheet in increasing order of maturity. That is, current liabilities are presented first, and then, noncurrent liabilities are presented. CL include accounts payable, wages payable, income taxes payable, utilities payable, accrued payables, some notes payable, and many others. Noncurrent liabilities (NCL) include...

1. bonds payable, 2. some notes payable, 3. lease liabilities and 4. pension liabilities.

Plant and Equipment This category of fixed assets is composed of...

1. buildings, 2. machinery, and 3. equipment. These assets have a finite useful life and can also be referred to as depreciable assets.

The maker of a note is the..... The holder of the note (seller or lender) is the....

1. buyer or borrower (the debtor firm or individual). This party is making an unconditional promise to pay principal and interest over the note term. 2. creditor and is the firm recording the note receivable on its books.

Loan Impairment and IFRS If there is any indication that the loan value has declined, an impairment loss would be taken as the difference between the ________________________________. If the loan value subsequently increases, IFRS...

1. carrying value and the recoverable amount 2. permits recovery of the impairment loss.

equities securities include...

1. common stock, 2. preferred stock (except redeemable preferred stock), 3. stock warrants, 4. call options/rights, 5. put options.

The accounting and reporting of an investment in equity securities applies to those equity investments (or other ownership interests) in...

1. corporations, 2. partnerships, 3. joint ventures, and 4. limited liability companies. Ownership rights may be rewarded with dividends, but dividends are not required to be paid to the owners.

subsequent measurement of inventory Effective January 1, 2017, if the entity uses FIFO or weighted average inventory valuation method, then the subsequent measurement is...

1. cost (as determined by FIFO or weighted average) or 2. net realizable value (LC-NRV).

Measurement of the Accrual—The measurement of the accrual can be based on...

1. current or 2. future wage rates although typically current rates are used. Current rates result in a lower expense accrual and do not telegraph future pay raises.

Both expenses and losses are...

1. debited when they are recognized and 2. both reduce net income.

equity securities excludes...

1. debt securities (including convertible debt), 2. redeemable preferred stock, 3. written equity options, 4. cash settled options, and 5. treasury stock.

payroll liabilities Employer costs including...

1. gross salary, 2. employer share of fringe benefits, 3. employer share of FICA and Medicare, and 4. federal and state unemployment tax (FUTA and SUTA). The employer recognizes an expense for these costs.

Fair Value Option—Both U.S. GAAP and IFRS permit the use of the fair value option to measure equity method investments, which gives the investor significant influence over an investee; however, the entities that may elect the fair value option are more limited under IFRS. Under U.S. GAAP, any investor that has significant influence over an investee and would otherwise use the equity method of accounting may elect to carry and report the investment at fair value. Under IFRS, only certain types of investors that...

1. have significant influence over an investee and 2. would otherwise use the equity method may elect to carry and report the investment at fair value.

It is important to note that, for a liability to be recognized in the accounts, it is not necessary to know the...

1. identity of the creditor, 2. the exact amount that will be paid, or 3. even the due date. Contingent liabilities, discussed later, are a category of liability for which one or more of these information items are not known as of the balance sheet date. However, the three elements from the conceptual framework above must be met by all liabilities if one is to be recognized in the accounts.

An intangible has a definite life either...

1. if the asset has a finite legal life or 2. if the firm believes the useful life is finite. The useful life for amortization is set by economic factors (market and obsolescence) as well as by its legal life.

payroll liabilities Employee costs withheld from paychecks including...

1. income tax withholding, employee share of FICA, 2. Medicare and fringe benefits, and 3. also personal expenses such as parking, union dues and others. The employer does not recognize an expense for these costs but acts as a collection point resulting in an employer liability.

Examples of provisions include...

1. income taxes payable, 2. property taxes payable and 3. compensated absences liabilities.

If the covenant states that the debt can be called in the event of noncompliance (e.g., if the debtor's working capital falls below the minimum $20 million as specified in the covenant), then the creditor has the option to demand immediate payment. Other actions include...

1. increasing the interest rate, 2. requiring the borrower to specify assets as collateral, 3. accelerating the payment terms (other than immediate payment), 4. reducing the amount available in a line of credit, and 5. repossessing collateral.

Loan Impairment and IFRS Cash-generating unit (CGU) is the smallest group of assets that can be identified that generates cash flows independently of the cash flows from other assets. Impairment tests are all applied to the ______________. If the cash flows for the individual asset are not identifiable, then you measure the cash flows from the __________________.

1. individual asset level 2. cash-generating unit

Amortization of definite life intangibles is recorded just like depreciation expense. The debit is to an expense account such as amortization expense or selling, general and administrative expense (SG&A) for _____________________, and the debit is to work in process (and ultimately cost of goods sold) for ____________________________. The credit is usually made directly to the intangible rather than to a contra account.

1. intangibles devoted to nonmanufacturing activities 2. manufacturing intangibles

The Retail Inventory Method This method is used by retailers to estimate ending inventory at cost. Most retailers know the markup on the inventory items and are able to count ending inventory at retail prices (ever see the store employees counting items on a shelf?). This method is used both for...

1. internal decision purposes and 2. for financial reporting of cost of goods sold and ending inventory.

Classification of Held-to-Maturity Investments Criteria for This Classification Held-to-maturity classification is not appropriate if...

1. investor may sell due to need for cash or better investment opportunities, or 2. if the debt can be settled (e.g., prepaid) and the investor would not recover all of the recorded investment.

U.S. GAAP—IFRS Differences Owners' equity in international statements has three main categories:

1. issued share capital, 2. retained earnings, and 3. other equity including reserves. The term reserve is not commonly used in U.S. financial reporting.

Covenants are one form of protection for the creditor. Others include...

1. requiring the issuing firm to redeem bonds according to a prespecified schedule (sinking fund debentures), 2. requiring the issuing firm to accumulate a sinking fund for the eventual retirement of bonds, and 3. structuring the bonds as serial bonds.

Development does not include...

1. routine or periodic alterations to existing products, processes, or other ongoing operations. 2. It also does not include market research.

IFRS impairment tests The test must be performed at least annually or whenever there is evidence that an impairment may have occurred. IFRS requires a one-step impairment test. The carrying value of the cash-generating unit is compared to its recoverable amount. The impairment loss is the excess of the carrying amount of the cash-generating unit over the recoverable amount. The calculated value of the impairment loss reduces goodwill to zero. If there is additional value associated with the impairment loss, it is allocated to the other assets of the unit pro rata based on the carrying amount of each asset in the group. The unit is not reduced below the highest amount of...

1. its fair value less cost to sell, 2. its value in use, or 3. zero.

specific identification example If a firm has many identical items in inventory and desires to maximize net income, it can sell the ________ expensive items rather than the _______ expensive items. This example assumes a gradual increase in the specific price level of the inventory. The resulting lower cost of goods sold may erroneously imply to users of the financial statements that the firm can continue the reported level of gross margin (sales less cost of goods sold). However, the firm must eventually begin selling the more expensive items.

1. least 2. more

An intangible has an indefinite life if no...

1. legal, 2. regulatory, 3. contractual, 4. competitive, or 5. other factor limits the life. Indefinite means there is no foreseeable limit on the period of time over which the intangible is expected to provide cash flows. A renewable and very recognizable trademark is an example.

The successful-efforts method results in a ________ depletion rate but a ___________ exploration expense in periods of significant exploration.

1. lower 2. higher

Another terminology difference is probable versus more likely than not. In U.S. GAAP the term probable is interpreted to mean "likely to occur." This distinction is usually a legal opinion made by attorneys. In IFRS, more likely than not is interpreted to mean __________________. U.S. GAAP is a higher threshold for accrual because likely to occur would mean more than....

1. more than 50%. 2. 70% or so probability of occurrence—where more likely than not is a threshold of more than 50% likelihood of occurrence.

If the intangible asset is an indefinite life and not subject to amortization, then it must be tested for impairment at least...

1. on an annual basis, or 2. when circumstances indicate there may be impairment. The procedure to test for impairment is the same as for plant assets held for sale. The FV is used to test for impairment AND measure the loss. An asset is impaired if BV exceeds FV.

The debtor may have few options after a covenant violation, depending on the response by the creditor. Therefore, the debtor firm seeks to avoid a violation and the potential negative impact on its operations. If a violation leads to a debt default...

1. operations can be disrupted, 2. access to the capital markets is hindered, 3. higher borrowing costs and penalties may be incurred, 4. employee morale may decline, 5. administrative time is wasted, 6. suppliers and customers may end their relationship with the debtor, and 7. the debtor's going concern may be placed in doubt.

Legal Capital—The legal capital or minimum capital of a corporation is usually the...

1. par value of the stock or 2. the stated value of the stock issued.

When cash payments precede expense recognition, an asset typically is recorded because payment of the good or service occurs before its use in the business. Over the period of the asset's benefit, an expense is recognized. Examples include...

1. plant assets (depreciation) and 2. prepaids (rent expense, insurance expense). These items are called deferrals (payment before expense).

basket sale Allocating Methods—For example, common stock and preferred stock might be bundled together and sold in a single transaction. In allocating the proceeds to the common stock sold and the preferred stock sold, the company will use the...

1. proportional method or 2. the incremental method.

There are a few differences in IFRS and U.S. GAAP for the recognition and measurement of contingencies. The main difference is in terminology. The term contingent liability under U.S. GAAP refers to both recognized and unrecognized uncertain obligations. Under IFRS a recognized contingent obligation is referred to as a _____________ and an unrecognized contingent obligation is referred to as a ______________.

1. provision 2. contingent liability.

Initial recognition of the equity investment is at the price paid. Cost includes...

1. purchase price (e.g., per security cost) and 2. any costs directly related to the purchase such as a. brokerage fees, b. transfer fees, etc. **Note that the initial recognition includes transaction costs, but the subsequent measurement of the equity investment is at fair value excluding the transaction costs.

If the Error is Never Discovered - year 2 effects:

1. purchases are overstated, 2. CGS overstated, 3. net income understated, 4. ending retained earnings is correct (error has counterbalanced)

If the Error is Never Discovered - year 1 effects:

1. purchases are understated, 2. CGS understated, 3. net income overstated, 4. ending retained earnings overstated

Nonmonetary Asset Exchanges Fair value not determinable:

1. recognize no loss or gain, and 2. record the acquired asset at book value of old asset + cash paid or - cash received.

Change in total OE—Neither type of stock dividend causes a change in total OE, but retained earnings is ___________ and contributed capital is ___________ (except for a large stock dividend accounted for as a stock split).

1. reduced 2. increased

The only costs related to internally developed intangibles that are capitalized are...

1. registration fees and 2. legal costs paid to outsiders.

IFRS Estimated Useful Life and Depreciation Method Under IFRS, the company must review the...

1. remaining useful life, 2. residual value, and 3. depreciation method on an annual basis. Any changes in the estimated useful life, residual value, or depreciation method are accounted for prospectively.

The gross or net method of recording the note and interest expense are both acceptable. The gross method.... The net method...

1. separates the face value (note payable) and discount or premium in different accounts 2. uses one combined net account (note payable), which is the present value and net note liability under the effective interest method

The accounting for the restructure depends on whether the debt is...

1. settled (a settlement) or 2. whether it continues (a modification of terms).

U.S. GAAP—IFRS Differences The amount of treasury stock can be disclosed either in...

1. the OE section of the balance sheet or 2. in the notes.

If any of the above three criteria apply, then...

1. the accounting is simpler and based on book value, not fair value. 2. No gain or loss is recorded (there are exceptions—see below), and t 3. he acquired asset is recorded at the book value of the asset exchanged plus cash paid on the exchange (or minus cash received on the exchange).

The acquisition cost of property, plant, and equipment includes two components:

1. the cash equivalent price or negotiated acquisition cost and 2. the so-called get-ready costs.

1. the consideration transferred to settle the obligation, and 2. regardless of whether the issuer has restrictions on the ability to settle the obligation or regardless of the way the obligation is settled.

The general principle is that advertising costs are either (1) expensed as incurred or (2) when the advertising first occurs. The second alternative assumes that the cost of advertising has been incurred and the advertising service will take place in the future. Examples are...

1. the first television commercial to be aired, and 2. the first appearance of an advertisement in a newspaper

Entities may guarantee a future payment based on a future event. An example is the guarantee of the debt of an affiliate to help the affiliate obtain a loan. Others include...

1. the guarantee of a line of credit and 2. guarantees to repurchase receivables that have been sold or assigned.

Equity method accounting affects both...

1. the investor's investment account (on the balance sheet) and 2. the income recognized from the investee by the investor (on the income statement).

A preferred stock or other financial instrument issued in the form of shares is mandatorily redeemable if...

1. the issuer is unconditionally required to redeem the instrument by transferring its assets at a specified or 2. determinable date(s) or when an event certain to occur takes place. If the obligation to redeem is dependent on a future uncertain event, the instrument is considered to be mandatorily redeemable when that event occurs, or when the event becomes certain to occur.

A loan impairment is recorded by reducing the net book value of the receivable to the present value of probable future cash inflows, discounted at the original rate in the receivable. The original rate is used because _________________________. The loss to the firm is measured at the rate existing when the original loan was created. The difference between the book value and present value, at the date of recognizing the impairment, is recorded as an expense or loss. There is no reason to report overstated assets.

1. the loan continues to exist

1. the loss and 2. any additional gain is recognized in revaluation surplus.

The result is that inventory is reported at...

1. the lower of cost or market (LC-M) or 2. lower of cost or net realizable value (LC-NRV). The total expense or loss is limited to the historical cost of the inventory. But the subsequent valuation requirement shifts a portion of the cost as a loss or expense to the period in which the inventory has declined in value.

Direct response advertising costs are capitalized if...

1. the main purpose is to produce sales from customers who respond directly to the advertising, and 2. if it is probable that future benefits will result and extend beyond the current period.

The calculation to determine the portion of OTTI that is associated with credit loss is beyond the scope of what the CPA Exam tests. However, if you are given the information, you should know to record in net income... and record in OCI....

1. the portion of OTTI associated with credit loss and 2. the portion associated with other factors.

In accounting for contingencies, a determination must be made related to...

1. the probability of occurrence of the future event (which will resolve the contingency) and 2. the possibility of estimation.

The accounting for contingencies is dependent on...

1. the probability of the future event occurring, and 3. whether the amount of the gain or loss is estimable.

IFRS Two methods are used to adjust accumulated depreciation:

1. the proportional method and 2. the reset method.

Perpetual inventory system The main differences between these entries and those for the periodic system are:

1. the use of the inventory account rather than purchases for the acquisition of inventory and adjustments such as returns and discounts; and 2. the recording of cost of goods sold at sale, rather than at the end of the period.

Cost: This method is used when...

1. there is < 20% ownership or no significant influence, or 2. there is no readily determinable fair value, or 3. there is no NAV as a practical expedient. Assume there are no indicators of impairment and there are no observable transactions of similar or identical securities.

Equity method: This method is used when...

1. there is ≥ 20% ownership or 2. significant influence and there is no readily determinable fair value.

Separate Recognition—Many intangibles must be separately identified:

1. trademarks and trade names, 2. non-competition agreements, 3. customer lists, 4. order or production backlogs, 5. copyrights and patents, 6. secret formulas and processes, 7. licensing agreements, and 8. supply contracts. A major reason for identifying these is that intangibles with definite life are amortized. To include them in goodwill in an acquisition would mean they would not be amortized.

Investments in debt securities that are reported at fair value are classified as either...

1. trading or 2. available-for-sale investments.

Investments in debt securities that are recorded at fair value are classified as either...

1. trading or 2. available-for-sale, **depending on how long management intends to hold the security. Note that only investments in debt securities have classification of trading or available-for-sale (Investments in equity securities no longer have these classifications.)

Upon acquisition of the investment in debt securities, the investor must document the classification of the investment into one of three categories:

1. trading, 2. available-for-sale, or 3. held-to-maturity.

The effect of bond issue costs on the issuing firm's financial statements is to (1) reduce the initial net bond liability and (2) increase interest expense in the future. If instead, the bond issue costs were erroneously recognized as expense, the firm's net income is ___________ and liabilities are ____________ in the year of issuance.

1. understated 2. overstated

ASU 2016-01, Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, significantly changed the accounting for investments in the equity of another entity. This standard is effective for fiscal years beginning after December 15, 2017, and eligible for testing on the CPA Exam beginning January 1, 2018. The accounting for an investment by the acquiring entity depends on various factors, including...

1. whether the investment is an equity or debt security, 2. the intent of the investor, the amount held, and 3. whether the investment has a readily determinable fair value.

IFRS A modification is significant if the difference between the present values of the two debts (computed with the original rate of interest) is...

10% or more of the present value of remaining cash flows on the old debt. The original rate is used only for purposes of determining the 10% threshold. The rate used to record the new debt and recognize subsequent interest is the effective rate of interest on similar debt.

A bank reconciliation with the headings "Balance per Books" and "Balance per Bank" lists three adjustments under the former and four adjustments under the latter. The company makes separate adjusting entries for each item in the reconciliation that requires an adjustment. How many adjusting entries are recorded?

3 *Only amounts adjusting the balance per books require an adjusting entry because only those amounts explain why the firm's recorded cash balance is not the same as the true cash balance. Common adjustments of this type include bank service charges, notes collected, and interest. The firm cannot alter the bank balance.

Type of Transaction When a company transfers receivables to a third party or uses the receivables as collateral for a loan, a determination must be made as to the substance of the transaction: Is it a sale or is it a loan? Codification _____________ identifies the key characteristics of a sales transaction.

860-40

In an exchange of plant assets, Transit Co. received equipment with a fair value equal to the carrying amount of equipment given up. Transit also contributed cash. The exchange lacks commercial substance. As a result of the exchange, Transit recognized...

A loss equal to the cash given up. *The fair value of the new asset equals the old asset's book value. Because cash was paid, the fair value of the old asset is less than the fair value of the new asset. Therefore, the fair value of the old asset is also less than the old asset's book value resulting in a loss. Using dollar amounts, assume the fair value of the new asset is $10. The book value of the old asset is also $10 by assumption. Assume Transit paid $2 cash. Then the fair value of the old asset is $8 implying a loss of $2, the amount of cash paid. Even without commercial substance, losses are recognized in full.

net markdowns (def)

A net decrease in the original selling price. This amount is the net difference between markdowns, which are reductions in the original selling price, and markdown cancellations. This amount is subtracted only from the retail column and before computing the cost-to-retail ratio.

net additional markups (def)

A net increase in the original selling price. This amount is the net sum of additional markups above the original selling price less additional markup cancellations. This amount is added only in the retail column and before computing the cost-to-retail ratio.

natural resource (def)

A noncurrent asset that contains the cost of acquiring, exploring, and developing a natural resource deposit (e.g., timber, oil and minerals). It does not include the cost of extracting the resource.

When the allowance method of recognizing uncollectible accounts is used, how would the collection of an account previously written off affect accounts receivable and the allowance for uncollectible accounts?

A/R - no effect Allowance - increase *When an account is written off, the journal entry is debit the allowance for uncollectible accounts and credit accounts receivable. If the account is subsequently collected, an entry is made to reinstate the account receivable by debiting accounts receivable and crediting the allowance for uncollectible accounts. A second entry is made for the cash collection which involves debiting cash and crediting accounts receivable. Therefore, there is no change in accounts receivable when a previously written-off account is collected; accounts receivable is debited for the reinstatement, and credited for the payment. However, when the previously written-off account is collected, there is an increase in the allowance for uncollectible accounts.

The factors to consider if the decline in value of debt securities is other-than-temporary are essentially the same for securities classified as...

AFS or held-to-maturity. The difference is the treatment of the OTTI loss.

production costs (def)

Additional processing costs after extraction; this cost also is debited to the inventory of resource, not to the natural resources account.

_____________ intangibles are subject to impairment

All

contingency (def)

An existing condition (at the balance sheet date) involving uncertainty as to a possible gain or loss that will be resolved when a future event occurs or fails to occur. Resolution of the uncertainty may confirm an increase in assets (or reduction in a liability), or the incurrence of a liability or an asset impairment.

Error in Recording Purchases—What if a purchase at year-end was not recorded in the year of purchase (Year 1), but rather was recorded in the next year (Year 2), the year of payment?

Assume the goods were counted in EI in year of purchase.

Example An asset with a book value of $100 has a recoverable cost of $120 and a fair value of $75. Test for Impairment:

BV of $100 < RC of $120. The asset is not impaired because the book value is recoverable. There is no loss computation; there is no impairment loss.

Example An asset with a book value of $100 has a recoverable cost of $90 and a fair value of $75. Test for Impairment:

BV of $100 > RC of $90. The asset is impaired because the book value is not fully recoverable.

Income Statement Approach (def)

Based on observations of prior years, under this approach a company may estimate bad debt expense as a percentage of credit sales.

Calculating Cost of Goods Sold in a Periodic System: Counting the items in inventory at the end of the year and applying the appropriate costs, depending on the cost-flow assumption, to the items on hand, typically find the ending inventory cost. Cost of goods sold is computed last. To calculate cost of goods sold for a company employing the periodic inventory system, the calculation shown below is used. This approach is the equation approach illustrated previously, placed into a schedule format:

Beginning Inventory + Net Cost of Purchases = goods available for sale - ending inventory = Cost of Goods Sold

The entry shown above allows a business entity to achieve multiple objectives. First, the ending balance of inventory is formally entered into the accounting system. Second, the beginning balance of inventory is closed. Also, the purchases and related accounts are closed. Finally, the cost of goods sold for the year is formally entered into the accounting system. Before this entry, cost of goods sold did not exist in the accounting records. Cost of goods sold is not directly observable in a periodic system. Rather, the value recorded for cost of goods sold is derived from the other amounts in the above entry. Another common way of computing cost of goods sold is by the basic inventory equations:

Beginning Inventory + Net Purchases = Ending Inventory + Cost of Goods Sold *Cost of goods sold is the last amount computed. In other words, it is a derived amount based on the other three values in the above equation. Also, Cost of Goods Available for Sale equals the value of either side of the above equation, although in published reports, cost of goods available for sale is shown as the subtotal of beginning inventory and net purchases.

(equation to find this number) = ending allowance balance

Beginning allowance balance + uncollectible accounts expense - write-offs + recoveries

How does the retail inventory method establish the lower-of-cost-or-market valuation for ending inventory?

By excluding net markdowns from the cost to retail ratio. *Although the result is approximate, by excluding net markdowns from the denominator of the cost-to-retail ratio, the ratio is a smaller amount, resulting in a lower ending inventory valuation.

Book Value per Share Ratio Equals:

Common stockholders' equity per share of outstanding common stock, at the end of the period

Example The annual premium on a life insurance policy for a corporate executive is $800. In the third year, cash surrender value begins accumulation, at $200. Entry for third-year premium:

DR: Insurance Expense $600 DR: Cash Surrender Value of Life Insurance $200 CR: Cash $800 In subsequent years, the cash surrender value portion of the premium increases. The fourth year might be $300, for example. At the end of the fourth year, the balance in cash surrender value then would be $500.

A corporation entered into a purchase commitment to buy inventory. At the end of the accounting period, the current market value of the inventory was less than the fixed purchase price, by a material amount. Which of the following accounting treatments is most appropriate?

Describe the nature of the contract in a note to the financial statements, recognize a loss in the Income Statement, and recognize a liability for the accrued loss. *The firm has committed to a fixed price but must recognize the loss in the period the decline in price occurred, much like under lower-of-cost-or-market. Inventory is not reduced because the firm has not purchased the inventory under contract. There is no asset to reduce, but the decrease in net assets is accomplished by recording the liability for the portion of the purchase price that has no value.

The discount is the amount below face value and is recorded in...

Discount on Bonds Payable, a contra account to Bonds Payable. If a $1,000 bond sells for $950, then the discount is $50. The price decreases (and yield rate increases) to the point at which the yield rate equals the market rate for similar bonds.

Conversion Index = (equation)

Ending Inventory in Current-Year Dollars / Ending Inventory in Base-Year Dollars

If the goodwill associated with the acquisition of the equity investee is impaired, the investor should record that impairment in its equity method accounting. Entry:

Equity Method Income X Equity Method Investment X

When the fair value of the depreciable assets is greater than the book value of those assets, the investor makes an entry for depreciation or amortization on its share of fair value in excess of book value as it relates to the identifiable depreciable or amortizable assets. There is no amortization of goodwill. Entry:

Equity Method Income X Equity Method investment X *The investor does not debit expense but reduces the amount of income picked up from the investee and reduces the carrying amount of the investment.

Entry made by the investor if the investee has net loss under equity method:

Equity Method Loss X Equity Method Investment X

manufacturing assets (def)

For manufacturing assets, depreciation is included in overhead and allocated to production based on machine hours or direct labors. The result is that Work in Process is debited for depreciation cost. When the products are sold, Cost of Goods Sold includes depreciation. A separate expense for depreciation is not recorded for manufacturing assets.

A creditor's note receivable has a carrying value of $60,000 at the end of Year 1. Based on information about the debtor, the creditor believes the note is impaired and establishes the new carrying value of the note to be $25,000 at the end of Year 1. During Years 2 and 3, the debtor pays $14,000 on the note each year (total payments, $28,000). For Year 3, under which method of the two indicated is interest revenue recognized? Interest method - yes/no? cost recovery method - yes/no?

Interest method - yes cost recovery method - yes *The interest method recognizes interest revenue each year until the note is collected because the note was written down to present value when the impairment was recorded. The estimated future cash flows to be received include interest, which is recognized over the remaining term of the note. The cost recovery method recognizes interest revenue only after cash equal to the new carrying value is collected. During Year 3, total collections surpassed the $25,000 new carrying value. $3,000 of interest revenue is recognized under this method in Year 3 ($28,000 − $25,000).

In addition, LIFO tends to minimize...

Inventory profits (also called phantom or illusory profits).

*Look Through Is Not Permitted* "Look through" means that the investor would "look through" the form of the investment to the nature of the securities held by the investee. That is, if Kemnitz Corp. invested in U.S. debt securities, Dean Co.'s investment in Kemnitz is an equity investment even though...

Kemnitz is totally made up of debt securities. Another illustration is an investment in a limited partnership where the limited partnership invests only in artwork. The investor is an equity owner of the limited partnership, not an owner of the artwork owned by the partnership.

Since DV LIFO is a form of LIFO, the subsequent measurement and testing for declines in inventory value would be...

LC-M

No matter which retail inventory method is used (FIFO, LIFO, or average), the entity would apply ______________ when determining if there had been a decline in the value of the inventory that would warrant an inventory write-down.

LC-M (not LC-NRV)

Any associated trade-in allowance is used only to determine the amount of cash to be paid: Cash paid on exchange = (hint - give the equation)

List price −Trade-in allowance. The trade-in allowance is not equal to the fair value of the asset exchanged.

intangible asset (def)

Long-term operational assets that lack physical substance or presence, but are currently used in the operation of a business and have a useful life extending more than one year from the balance sheet date.

Loss = BV of $100 - FV of $75 = $25. The asset is written down to $75. The loss is a component of income from continuing operations. The entry to record the loss of $25: Impairment Loss 25 Asset or A/D 25

The Contract Cannot be Modified—In this case, the loss must be accrued because the loss is probable and estimable. The inventory, when acquired, is recorded at market value and a loss is recognized for the difference between the market value and the contract price. If the contract has not been executed as of the balance sheet date, the following adjusting entry is made:

Loss on purchase commitment X Liability on purchase commitment CR: X *The amount equals the difference between the unit contract price and market price at year-end, multiplied by the number of units required to be purchased.

contra account (def)

Many firms include depreciation expense in Selling, General, and Administrative Expense and report the components in a footnote. Accumulated depreciation is a contra-plant asset account. The use of a contra account preserves the original cost information in the plant asset account.

EOY JE:

Merchandise Inventory (Ending) X Purch. Returns & Allowances X Purchase Discounts X Cost of Goods Sold X Merchandise Inventory (Beginning) CR: X Purchases CR: X Transportation In CR: X

Inventories NOT Carried at LIFO or RIM (i.e., Carried at FIFO or Weighted Average) use LC-NRV Example An item of inventory had cost using FIFO of $100. Selling price = $99 Replacement cost = $88 Cost of completion, disposal, and transportation = $9 The entity compares the FIFO cost ($100) to.... (hint, what is the ending recorded cost?)

NRV (selling price less cost to sell $99 − $9 = $90). Since the NRV is less than cost, the inventory is written down to its NRV of $90.

Under U.S. GAAP inventory is reported at lower of cost or net realizable value (LC-NRV) for all inventory methods that are not LIFO or Retail Method and at lower of cost or market (LC-M) for all methods that are LIFO or Retail. In the LC-M application, market is defined as replacement cost with a ceiling and a floor. Although U.S. GAAP defines NRV the same as IFRS, U.S. GAAP uses...

NRV to determine a floor and ceiling when determining LC-M.

For AFS debt securities, the portion of the OTTI loss associated with credit loss is transferred out of AOCI into earnings. Any subsequent gains are recognized in...

OCI and are not recognized as a gain in earnings. (The OTTI losses in earnings are not recoverable in earnings.)

For AFS debt securities, the portion of the OTTI loss associated with credit loss is transferred out of OCI into earnings. Any subsequent gains are recognized in...

OCI and are not recognized as a gain in earnings. (The OTTI losses in earnings are not recoverable in earnings.)

For HTM debt securities, the OTTI loss associated with credit loss is recognized in earnings, and the OTTI loss associated with other factors is recognized in...

OCI. Subsequent gains are not recognized.

Firms that carry whole life insurance policies on key employees enjoy an annual increase in the investment portion of the policy. Cash surrender value is appropriately classified as an investment account but may be reported by some firms in...

Other Assets in the balance sheet.

Common stock subscribed—...

Owners' equity

If the stock has no par value but a stated value is specified, the contributed capital account is titled:

Paid-in capital in excess of stated value (common).

Interest cost is typically expensed in the period incurred. However, when a company constructs a fixed asset, the interest cost incurred during the construction period is considered a get-ready cost and is, therefore, capitalized. Interest capitalization increases both plant assets and income. Assuming that all interest is first recorded in interest expense, the following adjusting entry capitalizes some or all of that interest:

Plant assets under construction X interest expense CR: X

The premium is the amount received above face value and is recorded in...

Premium on Bonds Payable, an adjunct account to Bonds Payable. If a $1,000 bond sells for $1,100, then the premium is $100. The bond price increases (and yield rate decreases) to the point at which the yield rate equals the market rate for similar bonds.

Fair value (FV)—The price that would be acceptable to the firm and another party for the transfer of the asset. ______________ is used when no active market exists for the asset.

Present value

If the Error is Discovered in Year 2 - JE:

Prior Period Adjustment (to RE) X Purchases X Retained earnings at the beginning of Year 2 are corrected by this entry, and year 1's income (and any other accounts affected) would be corrected in the Year 1 statement reported comparatively with Year 2.If the Error is Discovered in Year 3

Beginning inventory Merchandise inventory: January 1, 20X7 Purchase of merchandise on account: (hint - JE)

Purchases X A/P X *Purchases is a holding account for inventory charges and credits and is closed to ending inventory and cost of goods sold at the end of the period. The inventory account is not used to record purchases in a periodic system.

RC always exceeds FV because...

RC is not a discounted amount.

The gain or loss on the sale is the difference between selling price (SP) and book (carrying) value (BV) of the equity investment sold. If SP > BV =

Realize gain.

The gain or loss on the sale is the difference between selling price (SP) and book (carrying) value (BV) of the equity investment sold. If SP < BV =

Realize loss

minimum book value (def)

Salvage value. In no case is salvage value depreciated. Thus, book value always includes salvage value. An asset cannot be depreciated such that its book value is less than salvage value

debt securities (def)

Securities that represent the right of buyer/holder (creditor) to receive from the issuer (debtor) a principal amount at a specified future date and (generally) to receive interest as payment for providing use of funds.

debt securities (def)

Securities that represent the right of buyer/holder (the creditor) to receive from the issuer (the debtor) a principal amount at a specified future date and (generally) to receive interest as payment for providing use of funds.

non monetary asset (def)

Such an asset does not have a fixed nominal or stated value, as is the case with cash, accounts receivable, and other monetary assets.

Which of the following statements regarding inventory accounting systems is true? A disadvantage of the perpetual inventory system is that the inventory dollar amounts used for interim reporting purposes are estimated amounts. A disadvantage of the periodic inventory system is that the cost of goods sold amount used for financial reporting purposes includes both the cost of inventory sold and inventory shortages. An advantage of the perpetual inventory system is that the record keeping required to maintain the system is relatively simple. An advantage of the periodic inventory system is that it provides a continuous record of the inventory balance

TRUE: A disadvantage of the periodic inventory system is that the cost of goods sold amount used for financial reporting purposes includes both the cost of inventory sold and inventory shortages. *A periodic system does not record the cost of each item as it is sold; nor does it maintain a continuously current record of the inventory balance. Rather, cost of goods sold is the amount derived from the equation: Beginning inventory + Purchases = Ending inventory + Cost of goods sold. A count of ending inventory establishes the inventory remaining at the end of the period, but there is no recording of cost of goods sold during the period. Cost of goods sold is the amount that completes the equation. Thus, cost of goods sold is really the cost of inventory no longer with the firm at year-end - an amount that includes shrinkage. Inventory shrinkage refers to breakage, waste, and theft. Shrinkage cannot be identified directly with a periodic inventory system.

example A firm signed a contract to perform services the following year. At the current balance sheet date, the firm has no liability because no resources have been exchanged. Only a contract has been signed. There is no past transaction that substantiates the liability as of the balance sheet date. There is no future obligation to provide services because neither party has executed the contract. None of the elements of the liability is met. Do airline frequent flyer programs create liabilities for airline companies?

The answer is yes, because all three parts of the definition of a liability are met. The airline has (1) an obligation to provide service (2) in the future (3) as a result of a past transaction (customers achieving the requisite miles or credit card purchases for a free flight). Airline companies accrue this liability. Again, none of the following is known at the time of the accrual: the identity of the creditor, amount to be paid, or due date.

research (def)

The attempt to discover new knowledge aimed at the development of new products, services, processes, or techniques, or the significant improvement in an existing product.

Example An asset costing $22,000 with a salvage value of $2,000 and a useful life of 5 years is depreciated on the service-hours method. The asset is expected to provide 10,000 hours of service. In a given year, 2,500 hours of service are provided. (hint - solve for depreciation)

The constant rate is $2 per service hour ($22,000 − $2,000)/10,000. Depreciation for the given year is $5,000 (2,500 × $2).

Example An asset costing $22,000 with a salvage value of $2,000 and a useful life of 5 years is depreciated on the units of production method. The asset is expected to produce 1,000 units. In a given year, 300 units are produced. (hint - solve for depreciation)

The constant rate is $20 per unit ($22,000 − $2,000)/1,000. Depreciation for the given year is $6,000 (300 × $20).

depreciable cost (def)

Total depreciation to be recognized over the life of the asset. This amount equals original cost less salvage value.

If cost > market...

a loss is recognized and the inventory is written down to market.

a loss is recognized.

Provisions—A provision is a liability that is uncertain in terms of timing and amount but is not of uncertain existence. A provision is recognized if the entity has...

a present obligation (either legal or constructive) as a result of an obligating event that will result in an outflow that is more likely than not. In order to recognize the provision, you must be able to reliably estimate the amount.

Goodwill represents an expectation on the part of the acquiring business enterprise that, because of synergies, there will be...

above normal earnings in the years immediately following the acquisition. If the acquiring company had created a new business, it would have had to develop a client base, reputation, and other favorable intangible characteristics. In acquiring an existing business enterprise, the acquiring company pays for the established client or customer base, the established business reputation, and other intangible characteristics.

Small stock dividend —(% of dividend is less than 20-25%) If there is a significant period of time between declaration and distribution of shares, or if the two events occur in different fiscal periods, then the...

account Stock Dividend Distributable is credited instead of Common Stock in the above entry. At distribution, Stock Dividend Distributable is debited and Common Stock is credited.

Depletion is not an expense but an allocation of the natural resource from noncurrent assets to inventory. When units of the natural resource are depleted, inventory is debited and the natural resource account is credited. Because the useful life is directly associated with the amount of resources extracted, the _________________________ method is widely used.

activity or units of production base

Intermediate accounting considers the general issue of costing inventory but limits its consideration to merchandise inventory—that is, inventory purchased for resale. The Management Accounting section of CPAexcel® addresses a related issue: how to determine the cost of manufactured inventories. Manufactured inventory ultimately should reflect the...

actual cost of manufacturing.

FIFO This cost-flow assumption is based on a first-in, first-out philosophy. At the end of the accounting period, it is assumed the ending inventory is composed of units of inventory most recently acquired. Conversely, the cost of goods sold is made up of the oldest merchandise. The FIFO cost-flow assumption reflects the way most firms...

actually move their inventory. However, GAAP does not require that firms choose the inventory cost-flow assumption that reflects the actual movement of goods.

Example A firm owns a patent with a total capitalized cost of $45,000. At the beginning of the current year, the patent has been amortized four years of a total estimated nine-year useful life. During the current year, the firm won a patent infringement suit concerning its patent. Legal costs amounted to $15,000. The legal costs are...

added to the book value of the patent. The book value at the beginning of the current year plus the $15,000 legal costs are amortized over the remaining five years of the patent's life. Book value of patent at beginning of current year = $45,000 − $45,000(4/9) = $25,000

Balance Sheet Approach Based on observations of prior years, under this approach, the company estimates bad debt expense by analyzing the ending accounts receivable. This analysis may result in the application of a percentage to the ending accounts receivable. Alternatively, the company may analyze the ending accounts receivable by....

aging the ending accounts receivable. This aging process involves grouping receivables by the amount of time they have been outstanding. Once the aging schedule is completed, the company then applies the various estimates of inconvertibility to each group of receivables.

Earned Capital—There is no one measurement basis for earned capital (retained earnings) because...

all of the measurement bases that are reflected in net income are also reflected in retained earnings.

The acquisition cost of plant assets is a cost of doing business. Because plant assets have a useful life exceeding one year, their cost is...

allocated to the periods they benefit. Although the amount of asset decline is not observable, depreciation expense provides at least some measure of the cost of the asset to be included in total expenses on an annual basis.

The debtor may request relief from the covenant. This involves a request to either eliminate or weaken the covenant by...

amending the debt contract. For example, if the violated leverage covenant is 5 times EBITDA, the debtor may request to increase the multiple to 6.5. Such a change to the covenant may occur when the compliance review or general review of the contract occurs or earlier, depending on the severity of the violation.

amortization

Changes in Classification—If an amortized (definite life) intangible is later deemed to have an indefinite life, then...

amortization ceases. An impairment might result because fair value would now be used to test for impairment rather than recoverable cost.

Assume the investment in the debt security is classified as held-to-maturity (HTM): Debt securities classified as HTM are reported at...

amortized cost. There is no adjustment to fair value.

Small stock dividend —(% of dividend is less than 20-25%) Debit to retained earnings—Under the above assumption, the debit to retained earnings is the value of the stock distributed and therefore represents the...

amount of retained earnings to be permanently capitalized to contributed capital. This amount of retained earnings will never be available for cash dividends.

Held For Sale The asset can be written up or down if held for another period; gains are limited to the...

amount of the initial impairment loss. (BV cannot exceed the amount immediately before recording the initial impairment loss.)

CLs are reported valued at the amount due, or nominal amount. Liabilities for services are measured at the...

amount received. For example, the unearned revenue (liability) for an amount received by an airline before a flight is provided is measured at the amount received for the ticket.

Partially Participating The preferred stock receives dividends up to...

an additional percentage.

Effect Like Appropriation—It has the same effect as an appropriation and may be accompanied by...

an appropriation.

Government Grant Transfers IFRS specifically addresses the accounting for assets transferred to the entity from a government. These transfers in general recognize...

an asset and income. U.S. GAAP does not specifically address this type of transaction.

Cash is a Monetary Asset — A monetary asset (def)

an asset with fixed nominal (stated) value.

The Loss Contingency is Probable and Can be Reasonably Estimated at the Balance Sheet Date GAAP requires that if a contingent loss is both probable and estimable, then....

an estimated loss and estimated liability will be recognized—actually recorded in the accounts in the amount estimated. The guiding theoretical considerations here are conservatism and the definition of a liability. Because the loss (asset decrease or liability increase) will most likely occur in the future and because the firm can estimate the amount, there is no reason to postpone the loss and liability recognition until it actually occurs. The general definition of a liability is essentially met when the contingent liability is probable and estimable.

If the expenditure is immaterial, the company will account for the expenditure in the most expedient way possible. This usually means the expenditure is recorded as...

an expense in the period of acquisition.

Quantitative Assessment—Step 2: Measuring Impairment If the carrying amount of goodwill exceeds the implied fair value of that goodwill, then...

an impairment loss is recognized for the amount of the excess.

When the amount of the tax bill for the year becomes known, the difference between the estimated annual amount and the actual annual amount is treated as...

an increase or decrease to the monthly property tax expense amount based on the annual estimate.

A bond investment classified as AFS is reported at fair value with the unrealized gains and losses associated with the changes in fair value recorded as...

an unrealized holding gain or loss in comprehensive income.

Goodwill, like all indefinite life intangibles, must be tested for impairment at least _________ or when certain circumstances indicate that its carrying value may be greater than its fair value (called an impairment).

annually

Covenants are periodically revisited and modified as debtor financial health and macroeconomic conditions change. At a minimum, adjustments should be considered...

annually. In a line of credit, a review also occurs upon renewal of the credit line.

The practicability exception can be made on an investment-by-investment basis, but once elected, it must be...

applied consistently to that investment as long as the investment meets the criteria. The investor must reassess each year whether the equity investment continues to qualify for the practicability exception.

The investor can elect to use fair value to measure the equity investment. Once the election is made, the investor must...

apply fair value consistently

Partition retained earnings—Retained earnings appropriations have no effect on...

assets. They do not "reserve" assets. They simply partition retained earnings into two parts.

Quantitative Assessment—Step 2: Measuring Impairment The implied fair value of the goodwill is determined by...

assigning fair value to all the assets and liabilities of a reporting unit, including any intangible assets, and comparing that net fair value with the fair value of the reporting unit as a whole.

Ownership of goods in transit is determined by the test of title: FOB (free-on-board). FOB shipping point means title passes...

at the shipping point (the selling company's warehouse), therefore the goods belong to the purchaser as soon as it is loaded on a common carrier.

Cash — The current asset, represents unrestricted cash. This is cash that is...

available to meet current operating expenses and obligations as they arise.

If there is no evidence of positive ability and intent to hold the bond investment to maturity and the entity does not intend to trade the security in the near term, the bond investment is classified as...

available-for-sale (AFS).

AAE = (equation/math def)

average cash (or other qualifying expenditures) investment in the project during the period. This is the amount of debt that could have been retired during the period.

Interperiod tax allocation is an example of the....

balance sheet emphasis. The firm directly determines its income tax liability and the change in deferred tax accounts for the period. Income tax expense is the net change in these assets and liabilities. The firm is not attempting to match income tax expense with the benefits of operating in the United States.

If a company elects to use the balance sheet approach, the company is more concerned with the _______________________ related to the allowance method.

balance sheet valuation objective

Stock Issue Costs Are Treated as a Reduction in the Proceeds of the Stock Issuance—This reduces the contributed capital in excess of par account. Rationale—There is no future benefit of the issue costs—that is, the costs have served their purpose as soon as the stock is issued. No future periods benefit. This view emphasizes the...

balance sheet. The accounting is the same as for debt issue costs.

When the fair value of the depreciable assets is less than the book value of those assets, the investor will recognize a...

bargain purchase gain.

The general rule for capitalizing expenditures related to the acquisition of plant assets is similar to the rule for capitalizing costs to inventory. Capitalize all expenditures necessary to...

bring the plant asset to its intended condition and location.

Dividends in Arrears Unpaid dividends for a particular year on cumulative preferred stock. Dividends are not required to be paid but are said to accumulate if unpaid. However, no liability is recognized for dividends in arrears until there has been a dividend declaration. The cumulative feature of preferred stock simply means in the event of a dividend declaration, preferred shareholders are entitled to...

be paid the dividends in arrears before any distribution related to the current period occurs. Dividends in arrears are disclosed in the footnotes.

Determination of Present Value of Future Cash Flows *Noncash Transaction*—If the transaction is a noncash transaction, such as the sale of a noncash asset and the receipt of a note receivable, the transaction will...

be recorded at the fair value of the noncash asset or the fair value of the note receivable (present value of future cash flows), whichever one can be more clearly determined.

Legal Capital—The legal capital or minimum capital of a corporation is usually the par value of the stock or the stated value of the stock issued. Establishes minimum investment—This legal requirement establishes the minimum investment necessary to...

become a part of the ownership group of a corporation.

U.S. GAAP—IFRS Differences International and U.S. accounting for stockholders' equity are very similar. Some areas are not addressed by international standards and the U.S. treatment is typically prescribed in these situations. In terms of presentation on the balance sheet, OE is often presented ________________ in international statements.

before liabilities

A debtor may also ask for a waiver granting time to cure the violation or to void the violation. These requests are more likely when the reasons for the violation are...

beyond the immediate control of the debtor. General economic downturns and inflation with their respective effects on the debtor's earnings and liquidity are factors. For example, goodwill impairments due to declining stock prices can cause parent firm earnings to decline with no change in the parent's core operations.

Goodwill is recognized only when a...

buyer firm (the acquirer) obtains control of another enterprise. If a firm has never acquired another enterprise, then that firm would not have goodwill listed in its balance sheet.

The Loss Contingency is Remote In this situation, whether the loss can be reasonably estimated or not, the loss contingency...

can be disclosed in the footnotes to the financial statements. Please note that footnote disclosure is permitted but not required.

The costs incurred subsequent to the establishment of the technological feasibility will be...

capitalized and amortized over the estimated economic life of the software.

If the cloud computing arrangement contains a software license then the license is accounted for like other acquired intangible license agreements. Generally this means that the license is...

capitalized as an intangible asset and amortized over the life of the license (if definite lived) or tested annually for impairment (if indefinite life).

The amount of depreciation recognized each period is affected by the following four factors. Only the first factor, _____________, is a definite amount. Two estimates are used, and the firm has a free choice among the available methods.

capitalized cost

AAE is used only to compute...

capitalized interest. The ending balance in construction in progress is typically much larger than AAE for the period. Using the specific method in the above example, the ending balance in construction in progress after capitalizing interest is $104,600 ($100,000 construction payments + $4,600 interest capitalized).

After resources are discovered on the property, the cost to develop the property to enable extraction of the resource is...

capitalized to the natural resources account. Development costs pertain to facilities that will not be removed when the project is finished.

If the estimated time of benefit is related to the current and future accounting periods, the expenditure is...

capitalized. The term "capitalized" means included in an asset account.

Quantitative Assessment—Step 2: Measuring Impairment The amount of loss recognized cannot exceed the...

carrying amount of the goodwill.

The realized gains or losses is the difference between the...

carrying value reflecting the most recent fair value adjustment and the fair value on the date sold.

IFRS allows reversal of impairment losses on intangible assets to the...

carrying value that would have been recognized had the impairment not occurred. GAAP does not allow for reversals of impairment losses.

If current rates are used for the accrual, and a pay raise is enacted between the accrual of the expense and its payment, the effect of the raise is treated as a...

change in estimate and is recognized currently and prospectively, retroactive application does not apply. The liability is not discounted but rather is reported at nominal (future) value.

Deferred charges are accounts that are difficult to classify. A variety of practice exists for these accounts. They should not be included in intangibles but are often listed...

close to intangibles in the balance sheet and are sometimes confused with intangibles.

This issue has appeared in CPA Exam questions in the past. To some candidates, the treatment in the third situation below appears unusual because the fixed asset has a useful life of more than one year. ASC 730 views the purchase of such an asset as an irrevocable commitment of resources. Since the intent is to use the equipment only in the one R&D effort, and since it has no future value, _______________________________ with other R&D expenses would imply immediate expensing.

conservatism and consistency

Goods on consignment A business entity is located in Austin, Texas, and has signed an agreement with a manufacturer to be the sole retailer of the manufacturer's merchandise in the state of Texas. The Austin-based entity sells the merchandise in its Austin-area stores and reaches a consignment agreement with retail establishments in Houston, Dallas, San Antonio, Lubbock, and El Paso. The agreement is the typical consignment agreement. The retail stores outside of Austin will receive the merchandise and attempt to market the merchandise in their selected markets. If the merchandise is sold, the retailer will retain a sales commission and remit the remainder to the Austin-based business entity. If the merchandise is not sold, the retailer will return the merchandise to the Austin-based business entity. In this example, the Austin-based entity is the consignor, and the business establishments located in Houston, Dallas, San Antonio, Lubbock, and El Paso are all consignees. In consignment arrangements, the merchandise is owned by the...

consignor. The merchandise is always included in the consignor's ending inventory even though the inventory typically is never on the consignor's premises.

Contingencies Acquired in Business Combinations If the contingency is contractual (e.g., a regular warranty) at acquisition, then...

contingent liability is recognized by the acquirer at fair value.

Definition—Recall that the definition of a current liability includes the incurrence of other current liabilities. This means that if a firm refinances a current liability with another current liability, the liability remains classified as current. Even though no current asset may be required for extinguishment in the coming year, the debtor firm cannot guarantee it will be able to...

continue to refinance on a short-term basis indefinitely.

Notification or Non-Notification Basis The transaction can be completed on a notification basis or on a non-notification basis. If the transaction is completed on a non-notification basis, the maker of the receivable is not informed of the transaction and...

continues to make payments to the original creditor.

The unrealized gain on the change in the fair value of the bond investment is recorded in other comprehensive income as shown below. Note that the fair value adjustment to the investment account on the balance sheet is achieved by using a...

contra or adjunct account to adjust the unamortized value of the bond to fair value.

Account classifications—Stock subscriptions receivable:

contra-common stock subscribed (contra OE)

Accounting Choices—Where GAAP allows a choice or allows leeway in estimation of certain variables, the debtor firm may consider choosing the methods which...

contribute to maintaining compliance with the debt covenant.

Capital Account Debited—Rather than debiting retained earnings for the liquidating portion, a ____________________ is debited.

contributed capital account

Calling and Redeeming Preferred Stock—When preferred stock is called (by the issuer) or redeemed (by the stockholder) or is acquired and retired, all related OE accounts are removed. The issuer can call in callable preferred stock at a specified price during a specified period. No gain or loss is recognized for any of these events because the transactions are between the firm and its owners. Any credit difference is recorded in a...

contributed capital account.

contributed capital from stock retirement is credited.

Preferred stock often has a larger par value than common stock, and has a dividend stated in dollar terms or as a percentage of face value. An issue of 6%, $100 par preferred stock is equivalent to an issue of $6, $100 par preferred stock for example. Upon issuance, any excess of proceeds over total par value of shares issued is credited to...

contributed capital in excess of par. The credit to the preferred stock account is relatively much larger than the credit to contributed capital excess compared with common stock, which usually carries a small par value.

On the CPA Exam, average LC-M is frequently referred to as the...

conventional retail inventory method. This method is the one most emphasized on the exam. The variations are presented here for completeness; however, the probability of questions on these variations is relatively low.

Convertible preferred stock allows the preferred shareholder to...

convert the preferred shares to common shares. The journal entry for issuance of convertible preferred stock does not allocate any of the proceeds to the conversion feature. As with convertible bonds, the securities are recorded at issuance in the same way nonconvertible securities would be.

Advantages and disadvantages of the corporate form of business Lack of mutual agency for a corporation. The actions of one shareholder (unless that shareholder is an officer of the corporation) do not bind the...

corporation or other shareholders. In contrast, each partner's actions bind the partnership.

The specific identification assumption is not...

cost effective for most firms and allows firms to manipulate earnings.

What happens when the number of units purchased or produced is less than the number of units sold? Under LIFO, the computation of cost of goods sold for the current period first uses all the purchases for the period. Then it works backward in time and liquidates layers that were added in previous periods (latest layer added first), until the total number of units sold for the period is costed. A LIFO liquidation is that part of current-period cost of goods sold represented by the...

cost of goods acquired in prior years.

During periods of rising specific inventory prices, FIFO produces the highest net income because...

cost of goods sold is costed with the lowest-cost (earliest) purchases in the period. Ending inventory reflects the highest (latest) costs. Sometimes FIFO ending inventory is used as an approximation to the current cost of ending inventory.

When the inventory of resource is sold, the costs that have been debited to it (depletion, extraction, production) are recognized as expense through...

cost of goods sold.

Another example is the use of the successful efforts method of accounting for natural resource exploration costs. This method capitalizes (debits an asset) only the...

costs of successful explorations (finding the resource). Unsuccessful efforts are expensed.

A rearrangement is a restructuring of an asset that does notextend its life but...

creates a new type of benefit. Relocation of an entity to another city is an example.

Cash Transaction—In recording a cash sale of common stock, the corporation will...

credit the stock account for the par or stated value of the stock sold. Any remainder is recorded in an account such as contributed capital in excess of par value or in excess of stated value.

Trading investments in debt securities usually are presented in the balance sheet as a...

current asset. However, in some instances, management can make a case to report them as noncurrent. Classification as noncurrent should be rare since noncurrent is not consistent with the definition of a trading security held for sale in the near term.

Inventories also include land (if the firm is a real-estate development company), and partially completed buildings and bridges (if the firm is a construction company). Inventories are always _______________________ to the seller even though they may be noncurrent assets to the buyer.

current assets

If a liability is callable on demand if a debt covenant is violated, and there is violation, the liability is classified as a...

current liability if there are no other relevant circumstances.

If a liability is callable on demand without qualification, then the liability is classified as a...

current liability, even if not due within one year from the balance sheet date. This category includes liabilities that are not callable as of the balance sheet date but will become due on demand within one year of the balance sheet date.

If the debtor firm enters into a revolving credit agreement whereby one current liability is continually replaced with another current liability, even though no current assets may actually be used for a significant time period, the agreement does not allow reclassification of the liabilities to noncurrent status. This arrangement falls within the definition of a...

current liability.

FVO Fair value is the quoted market price of the security. If that is not available, the _________________________________ is used to estimate fair value.

current market rate of interest on similar debt instruments

Firms may retire their debt at any time (before maturity) unless the debt agreement prohibits it. The amount paid to retire bonds early reflects the...

current yield rate and may be different from the book value of the bonds on the retirement date. The result is that a gain or loss is recorded. The gain or loss is included in income from continuing operations.

The standard also requires that costs including idle facility expense, excessive spoilage, double freight, wasted materials, and rehandling costs be treated as...

current-period costs rather than allocated to inventory and carried over to future periods. This is an example of invoking the conceptual framework definition of an asset rather than the matching principle.

For all classifications of the investments in debt securities, any dividend or interest income is reported in...

current-period earnings. The amortization of any premium or discount is also included in current-period earnings.

Allowance for Sales Discounts is contra to accounts receivable. The entry thus reduces both net sales and net accounts receivable. In 20X9, assuming $25,000 of discounts are actually taken on 20X8 sales (see above flash-card), the allowance for sales discounts account is...

debited rather than sales discounts (which were recognized in the previous entry). The remaining $5,000 is treated as an estimate change, reducing the amount of estimated sales discounts to be recognized in the 20X9 year-end adjusting entry. A similar journal entry is required for estimated sales returns and allowances.

Convertible bonds are treated the same as nonconvertible bonds at issuance and throughout the term—as...

debt. There is no separation of the debt and equity components. Only at conversion does the equity component surface. There is an exception—when convertible bonds can be settled in cash. This exception is consistent with the notion of a liability—that is, the obligation to transfer assets in the future as a result of a past transaction.

decline in price. The firm is betting the price will stay above the option price.

Depreciation is not a process of valuation. The amount of depreciation recognized in a period is not necessarily the...

decline in the market value of the asset, nor is it a measure of the amount of the asset used up. If depreciation expense is $10,000, this does not mean that $10,000 of the cost of the asset was used in generating revenue. The $10,000 amount is simply the amount allocated to the period based on the method chosen by the firm. The book value of a depreciable plant asset (original cost less accumulated depreciation to date), is the amount of original cost yet to be depreciated. Only coincidentally does book value equal market value.

Asset Groups Many, if not most, assets do not function independently but are rather part of a working group. For purposes of the test for impairment, assets are grouped at the lowest possible organizational level at which cash flows can be identified. The three amounts (BV, FV, RC) are measured at this level. One intended effect of this rule on grouping at the LOWEST level rather than a higher one is to...

decrease the incidence of merging assets with impairment losses with those for which FV > BV in which case there would be fewer or no impairment losses recognized.

Not a significant modification. If the 10% threshold is not met, then the difference in present values is...

deferred and amortized over the new debt term. The new debt is not measured at fair value but rather takes on the original loan book value plus or minus the loss or gain. Any costs or fees adjust the carrying value of the debt and are thus amortized over the new debt term. A deferred gain is a liability and its amortization is reported in other income.

Quantitative Assessment—Step 1: Testing for Potential Impairment If the qualitative assessment determines that it is more likely than not that the fair value of the reporting unit is less than its carrying value, then a quantitative assessment must be performed. The first quantitative step used to identify potential goodwill impairment compares the fair value of a reporting unit with its carrying amount, including any...

deferred income taxes and previously recognized goodwill.

The choice between the successful-efforts and full-costing methods is among the most important a firm has to make. The choice can have a large effect on net income and total assets. The successful-efforts method best reflects the...

definition of an asset because only those efforts that located the resource are capitalized to the natural resource account.

Bonus Compensation Liabilities A bonus is an additional amount of compensation in excess of a base salary. Frequently, liabilities related to bonus compensation are...

dependent on operating results for the accounting period. The bonus may be based on income before or after the bonus, and before or after income tax effects. We recommend converting the problem statement directly into an equation. These types of problems require solving for up to two unknowns.

IFRS If a financial instrument is an obligation to transfer cash or other financial assets, it is classified as a liability, regardless of form. It may be necessary to separate the liability and equity components as is the case with convertible bonds under international standards. The classification is made at issuance and continues until it is derecognized. When there is uncertainty about measurement, the liability component is...

directly measured with the equity component treated as a residual.

For example, a firm is a defendant in a lawsuit. The suit is not resolved as of the balance sheet date. The firm does have a definite liability at year-end, but is contingently liable. The outcome of the suit in the following year will result in either a definite liability or no liability at all. Contingent liabilities are generally...

disclosed and possibly recognized, as discussed below.

Reduces Contributed Capital Account— The liquidating portion of a dividend reduces a contributed capital account, rather than retained earnings, and must be...

disclosed as a liquidating dividend.

The Gain Contingency is Reasonably Possible In this situation, regardless of whether the gain can be reasonably estimated, the gain contingency is...

disclosed in the footnotes to the financial statements.

The Loss Contingency is Probable and Cannot be Reasonably Estimated In this situation, the loss contingency should be...

disclosed in the footnotes to the financial statements.

The Loss Contingency is Reasonably Possible In this situation, regardless of whether the loss can be reasonably estimated, the loss contingency is...

disclosed in the footnotes to the financial statements.

The Gain Contingency is Probable In this situation, whether the gain can be reasonably estimated or not, the gain contingency is...

disclosed in the footnotes to the financial statements. Probable and estimable gain contingencies, in contrast with loss contingencies, are not recognized in the accounts. Conservatism dictates that the future event must first occur before recognizing the gain and asset increase (or liability decrease).

The details of the refinancing arrangement must be...

disclosed in the footnotes.

Disclosure—Both restrictions and appropriations are...

disclosed in the notes to the financial statements.

U.S. GAAP-IFRS Differences There is no recognition of dividends declared after the balance sheet date but before the financial statements are authorized for issue. No liability or reduction in retained earnings is recorded. This is the case for both international and U.S. reporting. However, for international reporting, the amount of dividends proposed (but not formally approved) or declared before the financial statements were authorized for issue must be...

disclosed. This disclosure can be made within the OE section of the balance sheet or in the notes. There is no recognition until declaration.

When the yield rate is greater than the stated rate, the note is issued at a...

discount (less than face).

Stated rate < market rate—If the stated interest rate is less than the market rate of interest, the bonds will sell at a...

discount.

Held for sale The asset is written down to (FV less cost to sell)—here the test for impairment and the measurement of the loss are the same. The term "recoverable cost" is not used for assets for sale. If sale is expected beyond one year, the cost to sell is...

discounted.

Direct Write-Off Method This method records bad debt expense only when a specific account receivable is considered uncollectible and is written off. It can be used only when the firm is unable to estimate uncollectible accounts receivable reliably. Most large firms...

do not use this method.

In general, the recognition of costs and expenses under IFRS is similar to US GAAP. One main difference related to the topics covered in this lesson relate to advertising and promotional expenses. U.S. GAAP permits capitalization of certain direct-response advertising costs. IFRS...

does not allow capitalization of these costs; all must be expensed as incurred.

Dividend/Split Similarity—Although both a 100% stock dividend and 2-for-1 stock split ________________________, there are few other similarities.

double the number of shares outstanding

IFRS Component Depreciation When an item of PPE comprises individual components for which different depreciation methods or rates are appropriate...

each component is depreciated separately. For example, a building can be broken down into components: roofing, electrical system, plumbing system, structural, etc. Component depreciation is based on the premise that each component of the asset has its own useful life and fair value.

Moving Average The term moving average always implies the perpetual inventory system. Rather than having a single weighted average cost per unit for the accounting period, the company computes a new weighted average cost per unit after...

each purchase of inventory. That moving average is used for costing all subsequent sales until another purchase takes place, at which time the moving average is modified by the new purchase. When merchandise is sold, the current weighted average cost per unit is multiplied by the number of units sold to determine the amount of the cost-of-goods-sold entry.

If the fair value option was elected, the debt security still would be reported at fair value, but the unrealized gains and losses would be recognized in...

earnings rather than in OCI

If the investment in debt securities is classified as trading, the changes in the fair value are recorded in...

earnings. Most likely this investment would be classified as current because the intent of a trading security is to sell in the near term.

If the investor has between 20% and 50% ownership If there is a readily determinable fair value for the investment, then the investor has the option to value the investment at fair value. If this option is chosen, then the investment is recorded at fair value with the unrealized gains and losses recorded in...

earnings. Once the investor chooses the fair value option, it is irrevocable and the investment continues to be recorded at fair value.

Realization is an ___________________; it means that there is a culmination of the earnings process, and cash or other consideration is given or received.

economic concept

Periodic interest expense is computed as the product of the yield rate at the date of issuance, and the beginning net note liability (present value). This approach is called the __________________________ and is required by GAAP. The difference between cash interest paid and interest expense recognized at each payment date is the amortization of discount or premium.

effective interest method

Impairment losses cannot be reversed for...

either definite life or indefinite life intangibles. This is the same as for impairment of assets in use—impairment losses are not recoverable.

IFRS The fair value option would be available when its use would...

eliminate or significantly reduce a measurement or recognition inconsistency that would otherwise result from measuring assets or liabilities, or recognizing the gains or losses on them, on a different basis.

Payroll tax liabilities are paid by the...

employer at specific dates set by law.

Employers pay federal and state unemployment taxes. Both (1) Federal Unemployment Tax Act (FUTA) and (2) State Unemployment Taxes (SUTA) are levied on each employee's salary up to a certain limit per year. Only _____________ pay this tax

employers

Increasing liquidity is another aspect that helps compliance for several types of covenants. Covenants involving the current ratio and working capital are examples. Refinancing short-term debt to noncurrent classification is a specific strategy that would assist the debtor in complying with this type of covenant. In general, specific transactions may...

enable compliance with covenant ratios.

Purchases is a holding account for inventory charges and credits and is closed to...

ending inventory and cost of goods sold at the end of the period. The inventory account is not used to record purchases in a periodic system.

Beg. Inventory + Net Purchases = End. Inventory + Cost of Goods Sold Beg. Inventory + Net Purchases = End. Inventory + Sales*(Cost/Sales) The second equation shows that cost of goods sold is estimated by sales multiplied by the cost-to-sales ratio. This ratio equals 1 − gross margin %, which can easily be computed using the conversion methods shown above. The unknown in the equation is...

ending inventory. The gross margin method allows an estimate of ending inventory.

Successful Legal Defense—If the rights associated with the intangible asset are successfully defended, the economic benefits associated with the intangible asset have been...

enhanced. Therefore, the related legal costs are recorded as an increase in the capitalized value of the intangible asset.

Determination of Present Value of Future Cash Flows *Cash Transaction*—If the transaction is a cash transaction, such as a lending transaction, the present value of future cash flows will....

equal the amount of cash that exchanged hands on the date of note creation.

Recording a Note Receivable: Market Value—If the stated interest rate is equal to the market rate of interest, the present value of future cash flows will be...

equal to the face amount of the note. In this situation, no discounts will exist.

Investee's book value does not equal investment cost or fair value—If the cost of investment to the investor and the fair value of the investee's net assets is different from the investee's book value at the date of investment, the investor will recognize periodic adjustment(s) to its...

equity investment account and to the equity investment income account.

Election of the practicability exception applies only to...

equity investments that do not qualify for using net asset value (NAV) as the practical expedient for fair value.

IFRS All investments in equity are measured and reported at fair value, with changes in fair value reported through profit or loss (net income) (FV - NI), except...

equity investments that the entity elects to report through other comprehensive income (FV - OCI).

Typically, on the CPA Exam, when it is stated that the investor has significant influence over the investee, the investor will use _______________ accounting unless the question says that the fair value method is elected.

equity method *Equity method accounting is designed so that the investor records changes in the equity investment that reflect the changes in the net assets of the investee

When there is significant influence over the investee, the investor can use the...

equity method of accounting.

If the investment in the equity security provides the investor significant influence, the investor can elect to use the fair value option to account for the investee. Alternatively, the investment is accounted for using the...

equity method.

IFRS More specifically, under international standards, an item is a liability if the firm has a contractual obligation to deliver cash or other financial asset to the holder, or to exchange another financial instrument with the holder under conditions that are potentially unfavorable to the issuer. Liability classification is required under these circumstances regardless of the consideration transferred to settle the obligation, and regardless of whether the issuer has restrictions on the ability to settle the obligation or regardless of the way the obligation is settled. For example, the instrument could be settled by issuing shares and yet be classified as a liability (the obligation to issue shares of a fixed dollar amount is an example). If the circumstances are not met, then the instrument is classified as...

equity, which implies that the instrument evidences a residual interest in the assets of an entity after deducting its liabilities.

If fair value is not available, the firm is forced into using book to record the acquired asset. If the exchange is made simply to facilitate the sale of goods to a customer, or if the exchange lacks commercial substance, then the firm is in...

essentially the same economic position after the exchange as before. Only the "identity" of the asset has changed. For example, exchanging an office building for a slightly different one leaves the firm in the same position. There is enough uncertainty inherent in fair values that it is considered more prudent to continue the accounting with the historically more reliable amounts (book value). Computationally, the exception also leaves future depreciation calculations unchanged.

U.S. GAAP-IFRS Differences The accounting for debt retirement is...

essentially the same for both sets of standards.

If accounted for as a sale, the entries are similar to factoring without recourse except that the transferor must...

estimate and record a recourse liability.

Until the amount of the tax bill for the year is known, the firm...

estimates the annual amount for purposes of recording the monthly property tax expense.

If the decline in the fair value of the HTM debt security is below the amortized cost, you must...

evaluate whether the impairment is temporary or other than temporary.

Market value cannot...

exceed the ceiling or be less than the floor.

Under U.S. GAAP, if an investor determines that a decrease in the fair value of an equity investment is other than temporary, an impairment loss is measured as the excess of the carrying amount of the investment over the fair value. Under IFRS, if an investor determines that an equity investment is impaired, the impairment loss is measured as the...

excess of the carrying amount of the investment over the recoverable amount.

If land is held for investment purposes or for future development, it is...

excluded from plant assets because it currently is not a productive asset.

Like U.S. GAAP, IFRS presumes an investor that holds between 20% and 50% of the voting stock of an investee can...

exercise significant influence, unless there is evidence otherwise, and requires the use of the equity method for those investments.

stock rights The rights have an expiration date and must be...

exercised by this date.

Significant influence is not just a bright line rule. You must look at other factors to determine if the investor can...

exert significant influence over the investee.

International standards require that the debtor firm must...

exhibit its ability to refinance the current liability by taking action or having an agreement in-place before the balance sheet date. If the action is delayed until after the balance sheet date but before the financial statements are issued or available to be issued, the current liability is not reclassified. This is in contrast with U.S. standards.

Recoverable cost (RC)—RC is the sum of...

expected future net cash inflows from use and ultimate disposal. Costs of maintaining the asset are included in the computation of RC, reducing it. RC is a nominal sum, not a present value. RC is based on how the firm currently uses the asset; the expected remaining useful life is used in computing RC. RC is the net increase in cash expected from using and disposing of the asset over its remaining life.

If the estimated time of benefit is related to the current accounting period only, the expenditure is recorded as an...

expense. Such expenditures are called "revenue expenditures"or "period costs."

The difference between R&D and Software is the latter establishes a point after which development costs are capitalized to an intangible asset and subsequently amortized. In contrast, all R&D is...

expensed as incurred

The range in production volume over more than one period establishes the normal capacity amount. Shorter-range budgeted volumes should not be used as the denominator. During periods of abnormally low production, the use of actual production volume would result in higher overhead rates, causing more overhead to be allocated to product. By requiring normal capacity, higher amounts of fixed overhead will not be allocated to the product during low production periods. Fixed overhead that has not benefited production is not an asset and should be...

expensed as incurred

Stock Issue Costs Are Treated as a Reduction in the Proceeds of the Stock Issuance The annual costs of maintaining the stockholder records and processing dividends are...

expensed as incurred.

The initial investment in securities is recorded at the price of the equity security (e.g., price per share). The price per share assumes the acquisition is an arm's-length transaction negotiated by two independent parties. All other costs related to the purchase of the equity security are... (hint - also, what is the JE to record the initial investment?)

expensed because they are not considered an attribute of the investee. Other costs (sometimes referred to as direct costs) are finder's fees, audit fees, and legal fees related to the acquisition. JE: Equity Method Investment X Cash X

General Rule—ASC 730 requires that research and development costs are...

expensed in the period incurred.

Fixed overhead rates These are subject to estimation errors and are affected by the choice of denominator measure and the budgeting horizon reflected in the denominator. Assuming no numerator (fixed overhead cost) variation, if actual production is less than the production budgeted for the denominator, less fixed overhead will be applied to product than is actually incurred. Under-applied fixed overhead resulting from low production volume must be...

expensed rather than allocated back to product. Low production volume does not imply that the inventory produced should carry a higher cost or is in any way more valuable.

The matching principle is frequently used to determine the amount of expense to be recognized for a given period. This is an income statement emphasis and is a major underlying concept used for determining the timing of expense recognition. The principle states that...

expenses are to be recognized in the same period as the related revenues. The revenues drive the recognition of expense. The wording of the principle presumes a causal relationship but depending on the expense, the strength of the relationship between expenses and revenues varies.

The fair value of the option is reported as a liability. Changes in the option's fair value are recognized at each year-end before the exercise. An increase in the fair value represents a potential decrease in the share price because the option is more valuable. The option will be exercised if the share price during the exercise period is less than fixed option price. At exercise, the firm extinguishes the liability and pays the option price. If the option is not exercised (because the share price exceeds the option price during the exercise period), the liability is...

extinguished and a gain is recorded.

Refinancing Short-Term Obligations Many firms have a preference for classifying liabilities as noncurrent rather than current to improve their reported liquidity position and reduce the perceived immediate riskiness of the firm. Refinancing on a current basis is of no help here, but if a current liability is refinanced on a long-term basis, the classification of a current liability can be successfully changed to noncurrent without...

extinguishing the original liability.

International accounting standards treat settlements of debt the same way as do U.S. standards, although the term troubled is not used. The transaction is an...

extinguishment of debt with a gain recognized by the debtor in profit or loss if the settlement is troubled.

IFRS Significant modification—When the modification of the original loan is considered significant, the transaction is treated as an...

extinguishment of the old debt and recognition of the new debt. The new debt is recorded at fair value. Any gain or loss is fully recognized and any costs or fees reduce the gain or increase the loss on retirement. This is consistent with the normal application of noncurrent liability accounting.

A valuation account will be used to constantly adjust the carrying amount of the investment in debt securities to fair value. Therefore, you will need to keep track of the carrying value of the debt securities (_________________________) and the balance in the valuation account. Adjust the valuation account so that debt security is presented at fair value. (See the next example.)

face amount plus or minus any premium or discount

The discount or premium on a bond issue is amortized over the bond term. The book value of the bond issue must equal...

face value on the maturity date because that is the amount paid to retire the bonds.

Investments in Debt Securities Changes in the investments in debt securities are also accounted for prospectively. The general rule is that transfers between classifications are accounted for at...

fair value (FV) at the date of transfer. That is, the value of the investment in the new category will be at fair value (if determinable) on the date of the transfer. The treatment of any unrealized gains or losses (G/L) is accounted for in accordance with the new classification.

If the equity investment was impaired and subsequently there was an observable transaction for a similar or identical equity security indicating there is an increase in the security, then the investor may adjust the investment to equal the change in value indicated by the observable transaction. The adjustment would be a...

fair value adjustment with an unrealized gain reported on the income statement.

If the sale is not for entire investment and results in the investor losing significant influence over the investee (e.g., < 20% ownership), the remaining investment should be accounted for at...

fair value with any difference between the carrying amount of the remaining investment and its fair value recognized as a gain or loss in current income.

IFRS All other investments in debt (i.e., those not measured at amortized cost) must be measured at...

fair value, with changes in fair value reported through profit or loss (net income).

Receipt or payment of cash to even the exchange does not necessarily imply that gains and losses should be recognized. For example, in situation 2 above, one firm may pay the other a certain amount of cash to even the exchange of inventory made to facilitate sales to customers. The cash flow does not cause the inventory to be valued at...

fair value.

Recognizing an impairment loss and subsequently increasing to fair value is consistent with the desire to reflect the equity investment as close as possible to its...

fair value.

In general, GAAP prohibits the recording of assets in excess of their...

fair values. Recording a constructed asset at an amount exceeding its fair value carries forward losses due to inefficient construction to later.

U.S. GAAP-IFRS Differences Fair Value Option—This option also is available under international standards but is less of a free choice compared with U.S. standards. The option works the same way. The choice is irrevocable and unrealized gains and losses are recognized in income. However, the option is limited to...

financial assets and liabilities that are managed and evaluated as a group on a fair value basis as part of a risk management or investment strategy. The entity cannot arbitrarily choose which liabilities will receive the optional accounting treatment. As such, the application of the FVO is more faithful to the underlying purpose of reducing the effect of different accounting measurements on financial assets and liabilities.

Cash Dividends The distribution of earnings will take the form of a cash distribution. The related liability will be recognized on the date of declaration. Dividends are not recognized as an expense for the...

firm paying the dividends.

At the signing of the contract—Subscribers may make their...

first payment.

Operating Strategies—Relevant strategies available to the debtor are implied by the covenant. If the covenant requires a limitation or elimination of dividends, for example, then that strategy must be...

followed to avoid a violation. In this example, shareholders should be informed about the reduction and the reason for it.

The Gain Contingency is Remote In this situation, regardless of whether the gain can be reasonably estimated...

footnote disclosure of the gain contingency is not recommended

When debt is retired at maturity, any discount or premium, and debt issue costs, are...

fully amortized. The final payment extinguishes the liability at its maturity value, which is also the net liability amount at maturity. No gain or loss is recognized.

Goodwill is the only intangible asset that is not identifiable. Goodwill is attributable to many different factors such as reputation, management skills, location, customer loyalty, etc. Goodwill is the value of the acquiree that cannot be attributable to specific identifiable tangible or intangible assets, or liabilities. Goodwill has an indefinite life because the ______________ concept assumes that, in the absence of evidence to the contrary, the combined entity (acquirer and acquiree) will continue indefinitely.

going-concern

Abnormal Casualty Losses—Shown at both cost and retail, the amount of merchandise available for sale has declined. Reduce the cost and retail value of...

goods available for sale before computing the cost-to-retail ratio. This loss is usually recoverable through insurance.

In recording the acquisition of another business enterprise, the fair value of the acquiree is compared to the fair value of net identifiable asset of the acquiree. Any excess of entity fair value over fair value of identifiable assets is...

goodwill

Quantitative Assessment—Step 1: Testing for Potential Impairment If the carrying amount of the reporting unit is greater than zero and its fair value exceeds that carrying amount, then...

goodwill of the reporting unit is considered not impaired and the second quantitative step of the impairment test is not required.

net purchases = (equation)

gross purchases + transportation in - purchase returns & allowances - purchase discounts

Significant influence is presumed if there is 20%-50% ownership of voting stock. Twenty percent is a...

guideline. There are circumstances when the investor can exert significant influence with less than 20% ownership and there are circumstances when the investor cannot exert significant influence even with 20% stock ownership

IFRS v GAAP For subjective acceleration clauses, U.S. standards require current classification when relevant conditions are present because the callable on demand feature cannot be controlled by the debtor. International standards...

have no such requirement.

Statistic Represents—The statistic represents the...

historical value of the firm per common share and may be used as a benchmark for comparisons with market value per share. However, it is very unlikely that book value per share would ever equal market value per share for most firms.

An unrealized gain/loss occurs from...

holding an investment. In some circumstances, the unrealized gain/loss is recognized by recording the changes in the fair value of that investment. The unrealized holding gain/loss can be recognized (reported) in net income for certain equity and debt securities accounted for at fair value and recognized (reported) in other comprehensive income for debt securities accounted for under the available-for-sale method.

The asset exchanged should be tested for ________________ before recording the exchange.

impairment

Quantitative Assessment—Step 2: Measuring Impairment The excess of the fair value of a reporting unit over the fair value amounts assigned to its net assets is the...

implied goodwill of the reporting unit.

When the full amount of preferred stock dividend is not paid on cumulative preferred stock for any given year, the unpaid dividends are...

in arrears and must be paid before any other dividend, including the current-year dividends on preferred stock

Covenants also may describe a restriction on the debtor's transactions during the debt term for the protection of the creditor. Otherwise, the debtor is...

in violation of the covenant.

The unrealized gain or loss on a trading security are recognized in the...

income statement over the period of ownership. The gains or losses during the holding period are unrealized because the security is not yet sold, but those gains and losses parallel the movement in the fair value of the security during each reporting period.

If a violation leads to a debt default, operations can be disrupted, access to the capital markets is hindered, higher borrowing costs and penalties may be incurred, employee morale may decline, administrative time is wasted, suppliers and customers may end their relationship with the debtor, and the debtor's going concern may be placed in doubt. Likewise, creditors do not want debtors to default. Covenant violations place the creditor in an uncertain position and at a minimum cause additional work for its managers. Defaults also may attract scrutiny from bank examiners, which in turn may require an...

increase in a reserve against the possible loan loss. A default also raises the possibility that a loss is imminent.

conversion index Base-year dollars refers to the specific price level for the pool in effect at the beginning of the year in which the firm adopted LIFO. When this index is multiplied by the increase in inventory for the year as measured in base-year dollars, the result is the...

increase in inventory in current costs—the layer added to DV LIFO ending inventory.

increase the assets value and a credit is made to an equity account (part of OCI) called revaluation surplus.

Direct Response Advertising Not capitalized are...

indirect costs such as facility costs and depreciation

Caution on List Price— The list price of the acquired asset should not be used for fair value-list prices are notoriously...

inflated.

Promotional costs such as advertising are not included in inventory because these costs do not help prepare the inventory for sale. Also not included are...

interest costs.

Disclosure The amount of interest capitalized and expensed must be disclosed during a period in which...

interest is capitalized. Note that the amount of interest paid for the period to be disclosed as part of the Statement of Cash Flows—either as part of the statement, as a supplemental schedule, or in a footnote.

Control is presumed when there is greater than 50% ownership of voting stock. In this situation, the investor is the parent of the investee, and the parent will consolidate the investee for financial reporting purposes. The parent company may use a variety of methods (including the equity method) to account for the investment in its subsidiary. However, since the parent will consolidate the subsidiary for financial reporting purposes, the method used by the parent company is...

irrelevant as the equity investment is eliminated upon consolidation

Losses provide no benefit to the primary operations of the entity. Losses are incidental to the primary operations. Losses are recognized when_____________________________________________________________________. When assets are "written off" as worthless, a loss is recognized. Losses also occur from casualties. The loss represents the amount of asset reduction for which there is no benefit. Losses also arise from the sale of assets for less than book value or the retirement of liabilities for more than book value.

it becomes evident that a previously recognized future benefit (an asset) has been reduced.

Recoverable cost is not used to test for impairment for indefinite life intangibles because...

it could be argued that an indefinite life intangible could have unlimited recoverable costs given the potential for indefinite life. That is, how do you determine the future cash flow streams for a life that is indefinite? You can't!

No liability recorded—It is important to remember that no liability is recorded for a stock dividend because...

it does not involve the distribution of goods or services, and therefore, does not meet the definition of a liability.

Example Land is not depreciated because...

it does not wear out and does not become obsolete

U.S. GAAP-IFRS Differences Under international standards, when (1) preferred stock provides for mandatory redemption for a fixed or determinable amount at a fixed or determinable date, or (2) gives the holder the right to require the issuer to redeem the stock at or after a particular date for a fixed or determinable amount, then...

it is classified as a liability. As such, more preferred stock is reported as debt for international reporting

Advantages and disadvantages of the corporate form of business A firm "goes public"—i.e., becomes a corporation—because...

it is easier to raise significant amounts of capital. Any investor in the world can purchase shares of a publicly traded corporation. Current shareholders can likewise sell their shares easily. In contrast, each time the ownership composition of a partnership changes, the partnership agreement is redrawn.

Held for sale The asset is removed from plant assets because...

it is no longer in use.

When the investor elects the practicability exception and carries the investment in the equity security at cost, the investor must also make a "reasonable effort" to determine if there are...

known (or can be reasonably known) price changes that should be made to the equity security.

Pledging of accounts receivable is ___________ than assignment.

less formal

U.S. GAAP-IFRS Differences Fair Value Option—This option also is available under international standards but is...

less of a free choice compared with U.S. standards. The option works the same way. The choice is irrevocable and unrealized gains and losses are recognized in income.

Sales Taxes—Firms collect sales taxes from their customers and periodically submit them to the state or local government. Between collection and submission of the tax, the firm has a...

liability to the government.

Unsuccessful Legal Defense If the rights associated with the intangible asset are unsuccessfully defended, the economic benefits associated with the intangible asset have...

likely been decreased to zero. Therefore, the related legal costs are recorded as legal expenses of the period incurred. In addition, the intangible is written off as a loss.

If accounted for as a loan, the transferor maintains the receivables on its books, and records a...

loan and interest expense over the term of the agreement.

Applying the general rule helps in classifying expenditures. For example, the cost to train employees to use equipment benefits the employees, not the equipment. Razing an old building on land just purchased is part of the process of preparing the land for use. However, the cost to raze a building already owned by the firm increases the...

loss on disposal of the building.

In a period of steadily rising prices, the moving average method (perpetual) results in...

lower cost of goods sold than the weighted average method (periodic). The moving average method applies earlier (and, therefore, lower) costs to sales during the year relative to the overall higher weighted average cost for the entire period.

LIFO The results for LIFO-perpetual differ from those of LIFO-periodic. In the perpetual system, each sale is costed with the most recent purchase available preceding that sale. The periodic system uses the latest purchases for the entire period. Thus in a year of steadily rising prices, perpetual LIFO yields a...

lower cost-of-goods-sold figure because it uses earlier purchases. Periodic LIFO would assume the sale of the very latest purchases in the period irrespective of the sequencing of sales and purchases.

If the firm is able to estimate a range of possible losses, with no amount in the range having a higher probability of occurring than any other amount, the amount recognized in the accounts is the...

lowest amount in the range. Use of the lowest amount is the least conservative alternative. The footnotes should describe the entire range, however. In all other cases (other than probable and estimable), no accrual of the loss is required. Footnote disclosure is required unless the probability of occurrence is remote.

A 2-for-1 split halves the par value and doubles the number of shares. The reason firms split their shares is to reduce the market price and make the shares available to a larger number of shareholders. No accounting entry is needed although firms may...

make a memo entry to record the split. No change in OE—There is no change in any account balance within owner's equity.

Changes in the observable prices in similar or identical securities may indicate that the investor should...

make an adjustment to the equity security being held as an investment.

Notification or Non-Notification Basis The transaction can be completed on a notification basis or on a non-notification basis. If the transaction is completed on a notification basis, the maker of the receivable is informed of the transaction and typically is instructed to...

make payments to the third party.

Loan Impairment and IFRS Impairments under IFRS have some general guidelines that will apply to loan impairment and other impairments we will discuss throughout the specific financial accounts. IAS 36 governs impairment of assets and in general the purpose of the standard is to...

make sure that assets are not carried at more than the recoverable amount. If the assets carrying value is greater than the amount that could be recovered through the assets use or by selling the asset, then it is impaired.

The balance sheet presentation of the equity investment is current or noncurrent, depending on...

management's intent for holding the equity security for the short term or long term.

if the investor has < 20% ownership The balance sheet presentation of the investment is a current or noncurrent asset, depending on...

management's intent for holding the security for the short term or long term.

AFS investments in debt securities are presented in the balance sheet as a current and/or noncurrent asset, depending on...

management's intent.

Note that except for the 50% threshold, an item meeting the above requirements would qualify as a recognized contingent liability under US standards. However, for U.S. contingent liabilities, there also must be a probable outflow of benefits, where probable means much higher than the 50% threshold for international standards. As a result, international standards recognize...

many more liabilities (as provisions) compared with recognized contingent liabilities under U.S. standards.

Stock issued in exchange for nonmonetary consideration Small number of shares—When the stock is actively traded, and the number of shares issued is small in relation to the number of shares already outstanding, generally the ____________________ is the more reliable of the two measures

market price of the issued shares

The definition of an asset is not the underlying justification for interest capitalization. Interest does not increase the probable future value of an asset. Capitalization of interest exemplifies the _____________ as the benefit of the constructed asset will be over its useful life.

matching principle

matching principle—and capitalizes all costs until the natural resource deposit produces revenue through sale of the inventory. Another justification for full costing is that all exploration efforts contributed to finding the resource

Although net income is not a formal variable in all covenants, higher earnings will contribute to a greater probability of compliance with many covenants. Choices such as FIFO, straight-line depreciation, longer useful lives for plant assets, higher recoverable costs for plant assets, the specific method of capitalizing interest, full-costing method of accounting for natural resource exploration costs, and others can help in this regard. However, the effect of choices on the quality of earnings must also be considered. Firms with low quality of earnings may suffer in the equity capital markets. Also, some covenants require consistent application of accounting policies and compute compliance based on the policies in effect at the time of the borrowing. An improvement in an accounting-related measure used in a debt covenant caused by a change in accounting policy therefore...

may not be "counted" toward improved debt covenant compliance.

Quantitative Assessment—Step 2: Measuring Impairment The assignment of fair values to assets and liabilities, including any previously unrecognized intangible assets, is used only for the purpose of...

measuring goodwill impairment; those assigned values are not used to change the recorded values of recognized assets or liabilities, or to recognize any previously unrecognized assets or liabilities, including intangible assets.

Loan Impairment and IFRS IFRS is _____________ in allowing reversal of impairment losses than U.S. GAAP. In each topical area where impairment is discussed, CPAexcel® will let you know when the impairment can be reversed.

more flexible

For example, if the investee becomes a public company and fair value is determinable, the equity security will...

need to be accounted for at fair value with changes in fair value recognized in net income.

debt investments Record the periodic interest income along with any amortization of the premium or discount first, then calculate the unrealized gain or loss as the difference between the carrying value of the debt and its fair value. The unrealized gain or loss is recorded in...

net income, and the investment is adjusted to fair value.

Debt investments Interest income, including the amortization of any premium or discount on the investment, is recorded in...

net income.

Dividends received by the investor from the investee are recorded like normal dividends. Cash would be collected, and dividend income is recognized in...

net income.

Financial Statement Reporting of Investment in Debt Securities—HTM Interest income or revenue (including increase/decrease from amortization of discount or premium) is recorded in...

net income.

Impairment—There are no impairment losses on investments in debt securities classified as trading. Trading securities are recorded at fair value with the unrealized gains or losses already included in...

net income.

Note on Fair Value Option If the investor elects to use the fair value option to report an equity investment that otherwise would be accounted for using the equity method, the investor does not record the entries that are part of the normal equity method accounting. The investment is reported at fair value with the changes in fair value recognized in...

net income.

The unrealized holding gains and losses and the interest income (net of any amortization of a premium or discount) is reported in...

net income.

After amortizing the capitalized costs for a particular year, the ending book value is compared with the net realizable value of the software (future estimated gross revenues less operating costs). If the ending book value exceeds the net realizable value, the book value is written down to...

net realizable value, with a loss recognized. The net realizable value becomes the beginning book value for the next period, for purposes of amortization. Write-ups are not allowed.

Interest on the purchase or construction of inventory is...

never included in inventory

U.S. GAAP-IFRS Differences—There are _____ differences between U.S. GAAP and IFRS for estimating the allowance for uncollectible receivables.

bank reconciliations - U.S. GAAP-IFRS Differences There are ____ differences between U.S. GAAP and IFRS in the preparation of bank reconciliations.

General risks and contingencies such as the possibility of a strike or casualty are not recognized or disclosed because...

no event or transaction has occurred as of the balance sheet date to substantiate that a liability has been incurred. A firm cannot accrue future casualty losses for example.

If BV ≤ RC, then the asset is not impaired and...

no impairment loss is recognized. In this case, the book value is recoverable.

Stock Dividends A stock dividend is a distribution by a firm of its stock to its shareholders in proportion to their existing holdings. The shareholder does not pay for these shares. Stock dividends do not involve a future transfer of assets or a future provision of services. Therefore, in relation to stock dividends, ___________ is recorded. Each investor simply holds more shares, but each share is worth proportionately less than before the dividend. Each investor maintains the previous ownership percentage.

no liability

For accounting purposes, a cost can cause the recognition of an asset, expense, loss, or liability. Many costs, as evidenced by expenditures, are first recognized as assets, and then later expensed or written off as a loss. Only the expense and loss dispositions enter into the determination of income. Expenses and losses are the portions of costs that...

no longer have future value.

Held for sale Depreciation is...

no longer recognized on the asset.

Unasserted Claims and Assessments If, at the balance sheet date, it is not probable that a claim or assessment will occur or if the outcome is not expected to be unfavorable to the entity, then...

no recognition or disclosure is required.

If the investor has < 20% ownership, it is presumed that there is...

nominal influence or no significant influence over the operating and financing activities of the investee.

If a liability callable on demand if a debt covenant is violated, and there is a violation, if the creditor grants a grace period and it is probable that the debtor will rectify that violation within the grace period, then the liability is classified as a...

noncurrent liability. Otherwise, the liability is classified as a current liability

Nontrade Receivables—Those receivables created in ___________ transactions.

noncustomer

To ensure that unallocated fixed overheads are expensed, Codification 330-10-30 requires for external financial reporting purposes, that.....

normal activity be used for the denominator level

Benefits not Accrued—In practice, not all earned compensated absence benefits are accrued because...

not all earned benefits are taken by employees. For example, not all vacation pay benefits are taken because some employees let a portion of their benefits lapse.

Recording a Note Receivable: For a non-interest-bearing note, the present value of future cash flows will...

not be equal to the face amount of the note. In this situation, a discount related to the note will exist.

Recording a Note Receivable: Interest/Market Rate—If the stated interest rate is not equal to the market rate of interest, the present value of future cash flows will...

not be equal to the face amount of the note. In this situation, a discount related to the note will exist

Remember that all liabilities must be the result of a past event. The same holds for a contingent liability. As of the balance sheet date, there must have been a transaction or event implying that a liability may have been incurred (or asset impaired). However, a future event also plays an important role in the recognition of a contingent liability. A contingent liability is...

not definite as of the balance sheet date.

Land This category includes the site of a manufacturing facility, the site of administrative offices, and the site of any storage warehouses. Any plot of land in which a company has constructed facilities specifically related to primary business operations is included in this category. This category does not include real estate held for investment purposes. Land has an indefinite life and is, therefore, not depreciated. It is the only asset in the plant asset category that is...

not depreciated or amortized.

For debtor accounting purposes, there are two very different cases for modification of terms for TDRs. The cases are distinguished by the relationship between the prerestructure book value of the debt, and the nominal sum of restructured future cash flows. The book value of the original debt always includes unpaid accrued interest. The creditor's accounting for modification terms TDRs is...

not parallel to the debtor's accounting and is covered in the lesson on loan impairment.

goodwill After the impairment loss is recognized, the adjusted carrying amount is the new accounting basis for goodwill. Subsequent reversal of a goodwill impairment loss is...

not permitted.

Recorded goodwill remains on the books of the acquirer unless...

the acquiree is sold or the goodwill becomes impaired (as described in IV. below).

The accounting recognition of the realized/unrealized gains or losses is consistent with the classification of the security as "trading," which implies a sale is anticipated in the near term. Until the point that the owner sells the security, the changes in the fair value of the security are...

not realized (but are recognized!).

Effect of Dividend—The effect of a stock dividend is to increase the...

number of shares issued and outstanding

Bargain Purchases Occasionally a firm acquires another enterprise for a price less than the fair value of the acquiree's net assets. This situation is referred to as a bargain purchase. The amount by which the fair value of the acquiree's net assets exceeds the price paid is recognized by the acquirer in the period of the acquisition as...

ordinary income.

Assume the investment in the debt security is classified as available-for-sale (AFS): Debt securities classified as AFS are reported at fair value with unrealized holding gains or losses reported in...

other comprehensive income. In addition, a contra/adjunct account is used on the balance sheet to value the investment at fair value.

If the investment in debt securities is classified as available-for-sale, the changes in the fair value are recorded in...

other comprehensive income. This investment could be classified as current or noncurrent, depending on how long management intends to hold the security.

Only expenses provide a benefit to the firm. Expenses are...

outflows of resources that are incurred in production or other activities central to the ongoing primary operations of the entity. Examples include 1. salary expense, 2. rent expense, and 3. many others. In each case, the firm obtains a benefit.

Construction Payables Unpaid construction input costs are not included in AAE until...

paid in cash. Until cash is paid, debt can be considered avoidable. Payables include wages payable, accounts payable for material, and utilities payable.

Direct Response Advertising The firm must be able to support the contention that there are future benefits from this form of advertising through...

past experience.

Example Grotex Inc. sells merchandise to Swemby on account. Grotex is the original creditor. Grotex then transfers the receivable to a financial institution and receives 94% of the value of the receivable. Grotex is the transferor and the financial institution is the transferee. If the transfer is with recourse and Swemby fails to pay the receivable, then Grotex must...

pay the financial institution the full amount of the receivable. During the term of the receivable, Grotex has a contingent liability that can be noted in a footnote, or a contra asset account can be recorded, such as note receivable discounted, or the liability may need to be accrued in the accounts, depending on the probability that Grotex will be required to pay. ***If the transaction is completed without recourse, the transferor is not responsible for nonpayment on the part of the maker of the receivable. Typically, nonrecourse transfers are accounted for as sales because control has passed to the transferee (financial institution).

NAV (net asset value) is used as a practical expedient for those investees that report their net assets at fair value, and that fair value of the investees is used to determine the...

per share value of the investors' ownership

The debtor must periodically demonstrate compliance with the covenants. The frequency may be quarterly, semiannually, or annually and is set at the time of borrowing. Information in the audited annual financial statements reflects a higher degree of verifiability compared with quarterly statements. The frequency may reflect the...

perceived riskiness of the borrower. For example, for a troubled line of credit, demonstration of compliance might be required monthly.

The gross margin method estimates cost of goods sold from sales using a...

percentage based on historical data. Then, ending inventory can be inferred from beginning inventory, purchases, and cost of goods sold.

The FASB also reaffirmed the concept that selling, general, and administrative expenditures are not to be treated as manufacturing costs but rather as....

period costs. Selling costs are not production costs.

Held for sale The results of operating the asset during the holding period are recognized in...

period of occurrence—that is, estimated future operating losses or gains are not recognized until they actually occur. Note that although these assets are held for disposal, they may require maintenance and other cash expenditures. These are expensed as incurred.

Sometimes firms retire their shares after purchasing them on the market, rather than treating them as treasury shares. Retired shares are...

placed back into the authorized but unissued category. Accounting for the purchase and retirement of shares is the same as the purchase of treasury shares under the par value method, except that common stock account is used instead of the treasury stock account.

The critical criteria for accounting for debt investments as held-to-maturity (HTM) is whether the company has the...

positive ability and intent to hold the debt security to maturity. HTM securities are carried at amortized cost.

Recording a Note Receivable: Present Value In accordance with U.S. GAAP, all notes are recorded at the...

present value of future cash flows (notes of less than one-year term need not be recorded at present value). The discount rate used in this calculation is the market rate of interest on the date of note creation (this rate may be different from the note's stated rate—the rate that appears on the note). Furthermore, any discounts related to notes will be amortized by applying the effective interest method.

Determination of Selling Price of the Bond (Initial Book Value)—The selling price of a bond is equal to the...

present value of future cash flows face value and cash interest. The discount rate used for this calculation is the market rate of interest on the date the bonds are issued.

Balance Sheet Classification—Mandatorily redeemable financial instruments (such as redeemable preferred stock) must be classified as debt (rather than owners' equity) unless the redemption is required to occur only if the issuing firm goes out of business. At the end of each year the liability is reported at the...

present value of the amount to be paid at maturity. The implicit rate at date of issuance is used for the discounting. Interest expense is recorded for the amount of cash dividends paid, as adjusted for the change in present value for the maturity amount.

Purchase or Sale of Equity Method Investment If prior ownership with no significant influence is followed by additional purchase of equity shares resulting in significant influence, then a change to equity method accounting will occur when the entity switches from fair value to equity method accounting. A change to the equity method accounting is accounted for...

prospectively.

A debt covenant is a part of the larger contract underlying the debt instrument. A bond indenture (contract) details the rights and duties of the issuing firm (debtor, borrower) and the bondholder (creditor, lender), for example. A covenant, also called a "restriction," is a section of the contract that describes the responses available to the creditor if certain events or conditions occur, such as the debtor's current ratio declining below a certain level. The covenant may allow the creditor to call the debt (demand immediate payment). Covenants also...

protect the debtor from such actions should the conditions not occur (debtor maintains compliance with the covenant).

If stock is sold at a discount, a contingent liability equal to the difference between the par or stated value and the acquisition cost of the stock is borne by the original shareholder. This requirement is an attempt to...

provide some legal protection for creditors.

Purpose—The purpose of the Statement of Retained Earnings is to...

provide the reader of the financial report with a detailed account of increases and decreases in retained earnings that were recorded in a given accounting period. The retained earnings statement may be shown separately, or more frequently, as part of the statement of changes in equity. If part of the Statement of Changes in Equity, the Statement of Retained Earnings occupies one column.

Example A firm plans to issue 100,000 shares of common stock. A shareholder currently owns 2% of the outstanding common stock. The shareholder must be allowed to ____________________________ if the preemptive right is present. The shareholder cannot be compelled to make the purchase, however.

purchase 2,000 of the new shares

Installment Notes — Each payment includes principal and interest—have no maturity value because the last payment reduces the note payable balance to zero. These notes are often used to...

purchase plant assets and may be secured by those assets. A mortgage note is an example.

Cash is a Monetary Asset —A monetary asset is an asset with fixed nominal (stated) value. The nominal value of a monetary asset does not change with inflation. Cash is the most "monetary" of all assets. There is no uncertainty as to the stated or nominal value of cash at present or in the future. A $100 bill is always worth exactly $100. However, the _____________ of cash declines with inflation. The amount of real goods and services a fixed amount of cash can buy decreases as the general price level increases. The effect is the opposite during times of deflation.

purchasing power

An entity may elect to use a ______________________ of whether impairment is likely to have occurred as a basis for determining if the quantitative two-step assessment is required. This qualitative assessment is often referred to as a pre-step.

qualitative assessment

If the goodwill associated with the acquisition of the equity investee is impaired, the investor should...

record that impairment in its equity method accounting.

A recognized gain/loss occurs when a gain or loss related to an investment (or other item) is...

recorded (recognized) in the financial statements, regardless of whether the investment has been sold. For example, a gain or loss from the change in fair value of an equity or debt security is reported in the financial statements before the securities are sold.

Sometimes a restructuring is a combination settlement and modification of terms. In these cases, the settlement portion is...

recorded first with the liability reduced by the fair value of consideration paid (no gain is recorded). The remainder of the debt restructure is treated as a modification of terms

Capitalized Interest—Under IFRS, the interest earned on the funds received for a construction loan can...

reduce interest cost. U.S. GAAP does not allow reduction of interest cost for the interest earned on the construction loans.

The justification for interest capitalization is that had the construction not taken place, the funds used in construction could have been used to...

reduce interest-bearing debt. This avoidable interest is the amount of interest that would have been avoided had the construction not taken place. In a sense, the construction then caused that amount of interest, which, therefore, should be included in the cost of the asset constructed.

Off-balance sheet activities, such as structuring leases as operating leases, will...

reduce reported debt, a variable used in several measures incorporated into covenants.

Both restrictions and appropriations may cause the amount of dividends to be reduced. However, a firm need not appropriate retained earnings or be subject to a constraint on retained earnings in order to lower the amount of dividends paid. The firm simply needs to...

reduce the amount of dividends declared. However, an appropriation supports this decision and may make such a decision more acceptable to shareholders.

NSF checks This represents nonsufficient funds checks received from customers. For example, a customer wrote a $500 check to the company, but the customer's checking balance was not large enough to cover the check payment. Upon determining the NSF check, the bank will...

reduce the company's checking balance. The company will record the NSF check upon receipt of the November 30, 20X7, bank statement or upon receipt of separate correspondence related to the NSF check.

The ability to use a qualitative assessment about the likelihood of goodwill impairment is intended to...

reduce the complexity and costs associated with assessing goodwill for impairment.

A 2-for-1 split halves the par value and doubles the number of shares. The reason firms split their shares is to...

reduce the market price and make the shares available to a larger number of shareholders.

Advertising Revenue Determined by Reference to Nonbarter Transaction Under IFRS, advertising revenue is determined by reference to a nonbarter (another transaction in which cash is paid) transaction. U.S. GAAP permits measurement of the revenue by using the fair value of the advertising services given or received. IFRS assumes the value of these services is determinable only by...

referencing paid for services.

Description of the Par Value Method— At purchase, the treasury stock account is debited for par value, and the contributed capital in excess of par account that was credited when the stock was issued is debited for the original amount recorded. Re-issuances are treated as a...

regular issuance of stock except that treasury stock is credited, rather than common stock.

If the debtor firm places assets into an irrevocable trust for the purpose of retiring debt (in-substance defeasance), the liability nonetheless...

remains on the balance sheet, along with the assets, separately reported. The liability is not extinguished, nor is a gain or loss recorded.

Example Inventory costs have been rising. Sales for the year are $100,000 and cost of goods sold is $70,000 under LIFO and $60,000 under FIFO. The $70,000 of cost of goods sold under LIFO is an approximation to the cost of replacing the inventory sold during the period because it represents later purchases in the year. If the firm chooses FIFO, it reports $10,000 more in pretax earnings but that amount really is not disposable income because it must be used to...

replace higher cost inventory in the next accounting period. The $10,000 is thus illusory income.

Investee's other comprehensive income (OCI) If the investee reports changes to equity resulting from items of other comprehensive income, the investor recognizes its proportionate share of those items when...

reported by the investee.

During periods of rising specific inventory prices, LIFO produces the lowest net income because cost of goods sold is costed with the highest-cost (latest) purchases in the period. This feature of LIFO is considered an advantage because...

reported gross margin reflects the latest purchase costs and therefore is more indicative of future gross margin.

reported income. This in turn improves certain financial ratios and may be helpful in meeting requirements placed on the firm by its creditors. In addition, management compensation, if tied to income, will be maximized.

reported separately and has no effect on interest capitalized.

The impairment model for equity securities that are not reported at fair value has been simplified. Each _____________ the investor must consider qualitative factors in assessing whether the investment is impaired. The qualitative assessment is similar to what is completed for long-lived assets, goodwill, and indefinite-lived intangible assets.

reporting period

Goodwill impairment testing must be done at the...

reporting unit level or one level below the reporting unit.

U.S. GAAP—IFRS Differences The term ________ is commonly used.

reserve

Once extracted, the natural resource noncurrent asset is transferred to...

resource inventory, a current asset.

IFRS - In the proportional method, accumulated depreciation is...

restated proportionately so the asset's carrying value after revaluation equals the revalued amount.

U.S. GAAP—IFRS Differences In some international jurisdictions, reserves are similar to retained earnings appropriations under U.S. GAAP in that they...

restrict dividends. Paid-in capital, for example, is typically off-limits for dividends as well as amounts paid for treasury stock (capital redemption reserve). Firms may set up a reserve account for that purpose (a credit to an OE account). Likewise, the revaluation surplus or reserve from upward revaluation of plant assets is not available for dividends.

Conversion of Preferred Stock—When convertible preferred stock is converted into common stock, the preferred stock accounts are transferred to the common stock accounts. Again, there is no gain or loss. Retained Earnings Debited—If the total recorded value of the preferred stock is less than the par value of the common stock issued on conversion, then...

retained earnings is debited for the difference.

retained earnings.

A prior-period adjustment is to the account in which the correction of an error in prior year earnings is recorded. The income statement impact of the prior-period error is closed to...

retained earnings. The prior-period adjustment increases the year 2 beginning balance of retained earnings to its correct amount as if year 1 income were correct. In the comparative statements for years 1 and 2, income for year 1 would be increased to its correct amount. All other affected accounts for year 1 also would be corrected

Dividends and splits—Stock dividends and splits are not substantive transactions. They do not cause a change in the firm's assets or relative ownership in the firm. For calculation purposes, they are __________________ to all issuances of stock preceding the stock dividend or split.

retroactively applied

Liquidating Dividends—A liquidating dividend is a return *of* capital, rather than a _____________.

return *on* capital It is a return of contributed capital—an amount invested by the shareholder.

Assignment of Accounts Receivable When accounts receivable are assigned, the borrower assigns rights to specific accounts receivable as collateral for a loan. The lender has the right to seek payment from these receivables should the borrower (original creditor for the accounts receivable) default on the loan. The borrower reclassifies the receivables as accounts receivable assigned, a subcategory of total accounts receivable. The borrower maintains the receivable records, and as cash is received, it is remitted to the lender in payment of the loan. The loan and the receivables are not offset on the borrower's balance sheet. When the loan is repaid, any remaining accounts receivable assigned are...

returned to ordinary accounts receivable status.

The investor should make an effort to monitor observable price changes in transactions of the same issuer for any security that is similar or identical to the equity security being held. To determine if the security is similar or identical to the one being held, the investor should look at the...

rights and obligations of the security. Rights and obligations are things like voting rights, distribution rights, preferences, and conversion features.

Both U.S. GAAP and IFRS seek to determine if the arrangement is a sale of the receivables or a secured borrowing. it is often noted that under IFRS criteria the transfer is less likely to be treated as a _____.

sale

sale. The receivable is removed from the books of the transferor and a gain or loss on the sale of the receivable will be recorded.

gross margin =

sales - cost of goods sold

If the transaction is completed without recourse, the transferor is not responsible for nonpayment on the part of the maker of the receivable. Typically, nonrecourse transfers are accounted for as...

sales because control has passed to the transferee (financial institution).

End of the Period A physical count of ending inventory should be completed to confirm inventory records. If inventory shrinkage has occurred (loss, theft, breakage), or if recording errors have been made, an appropriate adjusting entry would be prepared to reduce inventory to the amount per the physical count. The entry would reduce the inventory account and record a...

shrinkage loss.

Adjusting Entries—At the end of the year, material probable and estimable cash discounts (under the gross method) and sales returns and allowances must be recorded in the year of sale for correct reporting of net sales and accounts receivable. *Example* At the end of 20X8, a firm estimates that $30,000 of cash discounts will be taken by customers in 20X9, on 20X8 sales. The following adjusting entry is made at the end of 20X8:

sales discounts 30,000 Allow. for Sales Disc. 30,000 *Allowance for Sales Discounts is contra to accounts receivable. The entry thus reduces both net sales and net accounts receivable. In 20X9, assuming $25,000 of discounts are actually taken on 20X8 sales, the allowance for sales discounts account is debited rather than sales discounts (which were recognized in the previous entry). The remaining $5,000 is treated as an estimate change, reducing the amount of estimated sales discounts to be recognized in the 20X9 year-end adjusting entry. A similar journal entry is required for estimated sales returns and allowances.

Employee Discounts—The difference between the normal retail value of merchandise sold to employees and the amount actually paid by employees. This amount is subtracted along with...

sales from Goods Available for Sale at Retail to arrive at Ending Inventory at Retail, after computing the cost-to-retail ratio.

Normal Spoilage—Shown at retail value, subtracted along with...

sales from Goods Available for Sale at Retail to arrive at Ending Inventory at Retail, after computing the cost-to-retail ratio.

IFRS Gains or Losses on Sale of Investments Measured at Amortized Cost—If debt instruments measured at amortized cost are sold or disposed of prior to maturity, any gain or loss must be recognized...

separately on the face of the financial statements.

IFRS If a debt instrument measured at amortized cost is sold or disposed of prior to maturity, the gain or loss on disposition must be...

separately presented in the statement of comprehensive income with disclosure of the reasons for the disposal.

Useful Life—For amortized intangibles, if an asset is valuable only when it is used with other assets, the useful life of the other assets in the group can be a factor in setting useful life. For example, if a number of patents are used for one combined purpose, and the patents do not have any usefulness apart from the group, then the shortest useful life of the assets in the group...

sets the useful life for them all.

U.S. GAAP—IFRS Differences Paid-in capital in excess of par (or additional paid-in capital) is referred to as...

share premium.

Shares Worth a Fixed Dollar Amount (Variable Number of Shares) When a firm agrees to issue shares in the future worth a fixed dollar amount, a liability rather than equity is recognized. The vendor is not at risk for fluctuations in the price of the stock to be received because...

shares worth the fixed amount will be received, regardless of the stock price

IFRS specifically prohibits the use of LIFO as a cost-flow assumption. In the U.S. approximately 30% of publicly traded companies use LIFO. The main motivation for LIFO in the U.S. is that it lowers net income and therefore lowers taxes. This difference in accounting is viewed as a...

significant barrier to convergence, as U.S. companies would be forced to recognize significant gains if they had to abandon LIFO.

If the investor has between 20% and 50% ownership, it is presumed that the investor has...

significant influence over the operating and financing activities of the investee.

Accounting for Dividends—Accounting for stock dividends depends on the...

size of the stock dividend (small or large).

A valuation account (contra or adjunct) typically is not used when the debt security is classified as trading. A debt security classified as trading is one that will be...

sold in the near term and is highly liquid. There is no need to keep track of changes in fair value using a valuation account.

"Covenant-lite" loans are drawn with fewer or less stringent covenants. Such loans provide less protection for the creditor. One reason for less onerous covenants is that loans can be...

sold on a secondary market, effectively passing the risk on to investors. The ability to refinance the loans is another factor.

inventory - specific identification example For example, an automobile dealer might find this cost flow assumption appropriate. To continue the example, the dealer counted a total of 49 automobiles in inventory at year-end. The dealer can identify each automobile by vehicle number and match the invoice cost by vehicle number as well. To value its ending inventory, the dealership is able to...

specifically identify the cost of each of the inventory items and then total the individual cost of all the inventory items. Likewise, the dealership can specifically identify the cost of each item sold and total these amounts to determine cost of goods sold for the period.

If the actual and estimated returns are not equal, the factoring agreement will..

specify which party receives the savings or bears the cost.

HTM investments in debt securities are presented in the...

statement of cash flows as investing activities

U.S. GAAP—IFRS Differences Depending on the jurisdiction, a firm may be required to establish a reserve, called a ___________________, based on the requirements of the law. These reserves may be required for protection of creditors. The reserve is created in an account similar to an appropriation under U.S. standards.

statutory or legal reserve

Real estate trusts and other firms may declare dividends that may be paid in cash or shares at the election of the shareholders with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate. For this type of distribution, the stock portion of the distribution is treated as a...

stock issuance, not a stock dividend.

Large stock dividend—(% of dividend is greater than 20%-25%). Capitalize at par value. Large stock dividends also can be accounted for as a...

stock split effected in the form of a stock dividend. The debit would be to contributed capital in excess of par, rather than retained earnings in the above example. As such, retained earnings is not capitalized to permanent capital if this alternative is chosen.

U.S. GAAP—IFRS Differences If a firm reserves shares for future issuance under stock options or subscription contracts, the number of shares, terms, and amounts are disclosed. A firm must have _______________ to satisfy these commitments. The reserved shares are not available for other transactions.

sufficient shares

The firm makes an irrevocable decision to choose the FVO on the date of issuance. The choice is by debt instrument. The option can be applied to all or a subset of debt instruments, even within the same type. If the option is not chosen, then...

the accounting proceeds as discussed previously

After all costs are capitalized to the natural resources account, the resource begins to be removed and depletion is recorded. Depletion is the term used to refer to...

the allocation of the cost of the natural resource to inventory. Depletion is taken on the natural resource asset (sum of the three costs above less the residual value).

IFRS loan impairment Fair value less cost to sell (def)

the amount obtainable from the sale in an arms-length transaction between knowledgeable, willing, and able parties.

Apply the Appropriate Interest Rate If AAE is the amount of debt that could have been retired for the year, then an interest rate multiplied by AAE is...

the amount of interest that could have been avoided. This is the amount of interest to be capitalized, subject to the limitation that capitalized interest cannot exceed actual interest cost for the period.

If the factors indicate that the equity security is impaired, the impairment loss is recorded. The impairment loss is measured as...

the amount that the carrying value exceeds the fair value of the equity security. Since this equity security does not have a readily determinable fair value, the fair value will need to be estimated based on valuation models. The impairment loss is recorded in net income, and the fair value becomes the new basis of the equity investment.

IFRS Previously recognized impairment loss is subject to reversal if...

the annual impairment test determines a recovery of a previously recognized impairment loss. The recovery cannot exceed the initial loss.

Matching Principle Interest capitalization exemplifies the matching principle. Until the asset is in service, it cannot produce revenue. The asset is also not yet in its intended condition and location. Thus, expensing of the interest is deferred until...

the asset can provide revenues against which to match the interest expense.

Example A city providing a perpetual license to run a ferry across a body of water. The same logic holds for land; this asset also has an indefinite life and is not depreciated, so this is not a new concept. Only now that concept is being applied to intangibles. However, if an intangible has an indefinite legal life (e.g., trademark) but management believes that the asset has a finite life, then...

the asset is treated as a definite life intangible.

Held for sale The impairment loss recorded equals the difference between....

the asset's BV and its (FV less cost to sell). The estimated cost to sell increases the loss.

Normal activity is a measure of...

the average production volume (as measured in units, direct labor cost or hours, machine hours, or other predicted amount) expected for a budget horizon typically extending beyond one year and takes into account lost production due to planned maintenance.

IFRS Even investments in equity securities with no ready market must be reported at fair value; there is no cost method alternative as there is under U.S. GAAP. Cost, however, can be...

the best estimate of fair value.

Provisions are measured at...

the best estimate of the amount required to settle the obligation at the balance sheet date.

For land used as a building site, the cost of the land is included in AAE for the building, and interest is capitalized to...

the building; (the land is not being constructed.)

IFRS Note: The impairment loss exists when the recoverable amount is less than...

the carrying amount.

Unasserted Claims and Assessments If it is probable that a claim or assessment will occur, and there is at least a reasonable probability that the outcome will be unfavorable to the entity, then...

the claim or assessment is treated as a contingency, even though no claim or assessment has been filed. The event before the balance sheet that would trigger the claim or assessment (such as a previous year's tax return filing or environmental violation) must have occurred, before the entity recognizes or discloses the contingency. If the amount is estimable, the contingent liability is recognized. Otherwise, it is footnoted only.

Amount Payable—The liquidation preference of preferred stock is the amount payable on liquidation of the company. It must be paid before...

the common stock receives any assets

Capitalization of interest applies only to...

the construction of qualifying assets, such as assets constructed for an enterprise's own use or assets intended for sale or lease that are constructed as discrete projects (ships, real estate developments, etc.).

Interest cost is capitalized only during...

the construction period. Prior to the construction period, interest cost was expensed. Any interest cost incurred subsequent to the construction period will likewise be expensed.

Default by subscriber—If the subscriber fails to make all the payments and defaults, the journal entry to record the default depends on...

the contract and applicable state law.

If the market price drops further in the second year, an additional loss is recognized when...

the contract is executed. Recoveries result in a gain but only to the extent of the previously recognized loss

Recorded at signing—Note that the contributed capital in excess of par is recorded when...

the contract is signed indicating that, in all probability, the shares will be issued.

Depreciation is a systematic and rational allocation of capitalized plant asset cost to time periods. The term systematic implies that the allocation is not random but rather is made on an orderly basis. The term rational means that by appealing to how the asset is used, the process can be supported. The process of depreciation matches...

the cost of the plant asset to periods in which the asset is used to generate revenue

Treasury Stock Transactions—Another attempt to provide some protection for creditors is a limit on the amount of treasury stock transactions. In many states, treasury stock may not be purchased in excess of the amount of unrestricted or unappropriated retained earnings. The corollary of this constraint is that...

the cost of treasury stock is a restriction on retained earnings.

Advertising costs include...

the costs of content production and communicating that content.

IFRS v GAAP If the debtor firm breaches a debt covenant causing the debt to be payable on demand, it is classified as current, unless...

the creditor agrees, by the balance sheet date, to allow a "grace" period ending at least one year after the balance sheet, during which the debtor can cure the breach and during which the creditor cannot demand payment.

If the covenant states that the debt can be called in the event of noncompliance (e.g., if the debtor's working capital falls below the minimum $20 million as specified in the covenant), then...

the creditor has the option to demand immediate payment.

Scrip Dividends Partial Payment—If a partial payment is made after declaration (to shareholders of record), then the interest expense is computed from...

the date of that partial payment to the date the final payment is made. The principal amount on which interest is computed is the amount of the final payment.

When the purchase price per share is less than book value per share, then...

the denominator of book value per share decreases by a greater percentage than does the numerator, and book value per share increases.

Caution A CL and NCL reported in the balance sheet at equal values (e.g., both $100,000) may require greatly different cash payment totals over their terms due to interest on the NCL principal. Although in theory all debt should be reported at present value, for practical reasons CL are not discounted because...

the difference between present and nominal (future) value is typically not material.

When AAE < total interest-bearing debt, reported interest expense for the period is...

the difference between total interest cost and the amount of interest capitalized. In this case, because AAE is less than total debt, not all debt could have been avoided

IFRS loan impairment Value in use (def)

the discounted present value of the futures cash flows expected from the asset.

Advantages and disadvantages of the corporate form of business Double taxation of corporate profits. A corporation must pay income taxes and file an annual tax return. Dividends to shareholders are taxed on their personal returns. This double taxation is mitigated to some extent through...

the dividends received deduction if a shareholder of one corporation is another corporation (discussed in the taxation section of this review course). In contrast, partnerships and sole proprietorships file only an information return. The owners pay income tax on their portion of the income from the business.

Depreciation is not a source of funds. Although it provides a tax deduction, the same can be said for any deductible expense. Note that most firms use straightline (SL) depreciation for financial reporting, and MACRS (modified accelerated cost recovery system) for income tax reporting. MACRS is the same as...

the double-declining balance (DDB) method with a half-year convention applied.

U.S. GAAP-IFRS Differences International standards use the term derecognition of the liability as well as extinguishment of debt when a liability is retired. A liability is extinguished or derecognized only when the obligation is discharged, canceled or expired. The terminology for what constitutes an extinguishment is somewhat different between U.S. and international standards, but the meaning and effect is essentially the same. The focus of both is on...

the economic substance of the transaction.

The Fair Value Option allows certain financial assets and liabilities to be reported at fair value, with unrealized gains and losses reported in earnings in the year they occur. This option reduces the accounting mismatch inherent in using fair value for assets and a different measurement basis for liabilities and reduces earnings volatility because...

the effect of interest rate changes on investments in debt securities is opposite that on liabilities such as bonds payable.

Vesting is more valuable to the employee than accumulation because...

the employee can leave the firm and be paid the benefits if they are vested. However, if benefits accumulate, the employee does not lose the benefits if the holiday or vacation is not taken by the balance sheet date. Limits on accumulation (e.g., at most 10 weeks of vacation pay can be accumulated for some firms) place a cap on the amount of liability accrued.

Capitalized costs are amortized as advertising expense over the expected period of benefit. Expiration of an offer is an example of...

the end of an amortization period.

This process illustrates that DV LIFO uses price-level indices to measure the inventory increase first in base-year cost, and then expresses each year's layer at current cost through the conversion index. The result is a DV LIFO ending inventory that is the sum of layers measured in current dollars for the period the layers were added. This method is called the double-extension method because...

the ending inventory is extended at both base-year cost and ending current-year cost.

IFRS allows intangible assets to be revalued to fair value if there is an active market for the intangible assets. If an intangible asset is valued at fair value, then...

the entire class of intangible assets must be valued this way, not just select individual intangible assets. U.S. GAAP does not allow revaluation to fair value.

No Par Stock Credited—If the stock is no-par stock, then...

the entire issuance proceeds is credited to the capital stock account and there is no additional paid-in capital account (contributed capital in excess of par).

The qualitative assessment (before the quantitative assessment) is optional; however, if the qualitative assessment indicates that the fair value of the reporting unit is more likely than not below the carrying value of the reporting unit, then the quantitative assessment is required. If the qualitative prestep is not completed, then...

the entity must complete the quantitative two-step assessment.

If the investor has >50% ownership of an investment The default accounting for an investment with >50% ownership is...

the equity method of accounting. The parent company will record its equity investment in the subsidiary on the parent's books.

Sick Pay Benefits—Accumulated sick pay benefits need not be accrued (but may be) because...

the event causing payment (illness) cannot be predicted. However, if unused sick pay benefits are routinely paid to employees (e.g., upon leaving the firm), then accrual is required because in this case the benefits vest.

Improving products and services, enhancing marketing, encouraging innovation, seeking the best management talent, and avoiding risk are ways to improve operating results and help maintain compliance. Leverage should be used sparingly, and only if...

the expectations for increased profitability are sufficiently strong to warrant increased debt, if allowed under the covenant.

Until the tax is paid, the firm records a liability for the recognized expense to date. When the tax is paid, the liability is extinguished and a prepayment of tax is recognized for the remaining months of the taxing authority's fiscal year. That prepayment is reduced as...

the expense for the remaining months is recognized.

The tax-paying firm accrues the property tax monthly as expense over the fiscal year of the taxing authority because...

the expense should be recognized in the same period the firm benefits from the services provided by the governmental unit (taxing authority).

Scrip Dividends—A scrip dividend is first distributed in note payable (scrip) form because...

the firm does not have the cash at the date of declaration to pay the dividend but wants to assure the shareholders that the dividend is forthcoming.

More specifically, under international standards, an item is a liability if...

the firm has a contractual obligation to deliver cash or other financial asset to the holder, or to exchange another financial instrument with the holder under conditions that are potentially unfavorable to the issuer.

After assessing the totality of the above kinds of events and circumstances, an entity determines that it is more likely than not that the fair value of the reporting unit is less than its carrying value, then...

the first step of the two-step quantitative assessment must be performed.

Periodic internal self-evaluation precedes...

the formal compliance review that involves the creditor. All administrative requirements pertaining to the covenant within the debt agreement including progress reports are fulfilled on a timely basis.

Ownership of goods in transit is determined by the test of title: FOB (free-on-board). FOB destination means that title to the goods transfers to the buyer when...

the goods reach the destination. Therefore, shipping terms of FOB destination Chicago means that the buyer owns the goods when they reach Chicago.

Cost-Flow Assumption A perpetual system considers only goods on hand when computing cost of goods sold for a specific sale. As opposed to the periodic system, which considers all goods on hand during the period when computing cost of goods sold, a perpetual system computes cost of goods sold only for...

the goods that have actually been purchased through the date of sale.

Loan Impairment and IFRS recoverable amount (def)

the higher of the fair value less cost to sell or value in use *Fair value less cost to sell is the amount obtainable from the sale in an arms-length transaction between knowledgeable, willing, and able parties. **Value in use is the discounted present value of the futures cash flows expected from the asset.

Contributed Capital—The primary measurement basis for contributed capital is...

the historical value of direct investments made in the firm by investors, in return for shares of capital stock

Since equity ownership provides voting rights, the level of economic influence is determined by...

the impact of the voting rights. The voting rights are a guideline to the level of influence because other factors may contribute to the investor's ability to exercise significant influence or control over the equity investee.

IFRS Impairment applies to those assets carried at cost or amortized cost. Assets carried at fair value with the unrealized gains and losses recording in income do not create an impairment loss because...

the impairment is already captured in the fair value.

Basket sale The total amount received must be allocated to...

the individual securities sold.

U.S. GAAP-IFRS Differences If a preferred stock issue does not explicitly meet either of the two criteria above but is expected to meet one later during its term, then again it is treated as a liability. An example is preferred stock with a dividend that increases over time such that the issuer will be required to redeem the preferred stock. Another is if the holder has the option to require redemption if a future event occurs, and that event is probable, then...

the instrument is classified as debt.

Noncurrent Interest-Bearing Note Payable An interest-bearing note payable is one in which...

the interest element is explicitly stated. These notes are recorded at the present value of future cash flows, using the market rate of interest as the discount rate. If the stated interest rate and the market rate of interest are not equal, the present value of the future cash flows is not equal to the face amount of the note, and a discount or premium is recorded.

Qualifying assets require a significant time period for construction and are not routinely produced. Rather, the assets must be discrete projects individually constructed. Interest is not capitalized on the construction or manufacture of inventory items, even if...

the inventory requires significant time for completion (e.g., interest on the production of wine and tobacco products is not capitalized).

IFRS If the investor does not hold an equity investment for trading purposes, it may elect to report changes in fair value through other comprehensive income (FV - OCI). The election must be made when...

the investment is first recognized and is irrevocable. Amounts recognized although other comprehensive income will never be reclassified to profit or loss (net income), even on disposal or impairment, but will remain in equity (e.g., transferred to retained earnings). Dividends from these investments would be recognized in net income.

Possible reason for changes from fair value to equity method An investment that was initially value at fair value may change when...

the investor gains significant influence over the investee and now accounts for the equity investee using the equity method of accounting.

Possible reason for a change from held-to-maturity to fair value The investor's ability to hold to maturity has changed because...

the investor now needs to sell the security to raise needed cash.

IFRS The transfer between categories for investments in debt can be made only when...

the investor's business model objective for debt investments changes so that the (previous) category no longer applies.

The initial purchase of the equity security would be recorded at...

the investor's cost. The initial purchase is an arm's-length transaction and would be the initial fair value of the investment.

Stock issued in exchange for nonmonetary consideration Significant number of shares—If the number of shares issued is significant, then the market value of the consideration received may be a better measure because...

the issuance of a large number of shares could affect the market price of the stock.

For land developed for sale, interest is capitalized to...

the land

For land held for speculation, no interest is capitalized because...

the land is in its condition of intended use, and there is no asset under construction.

Contingencies Acquired in Business Combinations At acquisition, if the contingency is not contractual and has more than a 50% probability of becoming a definite liability when a future event occurs or does not occur, then...

the liability is recognized at fair value. Otherwise, there is no recognition.

Compute Average Accumulated Expenditures A key concept in determining the amount of interest to be capitalized is avoidable interest. This is the interest on debt that could have been retired had the construction not taken place. To quantify that amount of debt, average accumulated expenditures (AAE) must be computed. AAE is...

the measure of the amount of debt, on an annual basis, that could have been avoided.

If a range of equally likely amounts is possible for a provision, international standards require recognition of...

the midpoint of the range (U.S. standards use the lowest amount in the range)

The presentation of the cash flows associated with the purchases and sales of equity securities should be classified on the basis of...

the nature and purpose for which it acquired the securities. In general, the classification of cash flows would be investing activities unless the purpose of the entities equity transactions is part of its normal operations (i.e., a financial institution), where the classification would be operating activities.

Under IFRS, inventory is reported at the lower of cost or net realizable value (LC-NRV). Net realizable value is defined by IAS 2 the same as in U.S. GAAP as "the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale." This definition is consistent with the IASB philosophy that an asset should not be reported on the balance sheet at more than...

the net cash that is expected from the sale or use of that asset.

weighted average cost flow assumption for inventory The ending inventory valuation is equal to...

the number of units in ending inventory multiplied by the weighted average cost per unit.

weighted average cost flow assumption for inventory Likewise, the cost of goods sold for the period is equal to...

the number of units sold multiplied by the weighted average cost per unit.

Revaluation of Book Value From time to time, the rights associated with an intangible asset must be legally defended. For example, a company might have a patent on a unique product. If a competitor infringes on the rights represented by the patent and manufactures a similar product, the company holding the patent might elect to defend those rights through legal action. Accounting for the legal costs of this action is dependent on...

the outcome of the legal action.

If the investor has >50% ownership of an investment In some instances, the parent company can choose to use the cost method to account for its subsidiary. The cost method can be used by the parent company because...

the parent's stand-alone financial statements are not issued on a stand-alone basis. The parent must consolidate the subsidiary investment. Upon consolidation, the parent eliminates the investment in the subsidiary, so the parent's investment in the subsidiary is not reported on the consolidated statements.

Partially Participating Common stock receives a matching amount equal to...

the preferred percentage times total par of common stock outstanding before the preferred stock receives its additional allocation.

Current notes payable are reported at the amount due when they mature. Non-current notes are reported at...

the present value of future payments, discounted at the prevailing interest rate at time of issuance.

At subsequent balance sheet dates, notes are reported at...

the present value of remaining payments, using the yield rate at the date of issuance. Present value also equals face value plus unamortized premium or less unamortized discount.

The initial investment in securities is recorded at...

the price of the equity security (e.g., price per share). The price per share assumes the acquisition is an arm's-length transaction negotiated by two independent parties.

The critical point for software cost accounting is technological feasibility. The establishment of the technological feasibility of the software typically occurs when...

the program model or working model of the software is complete. The product is not yet ready to market, but the commitment is made at this point to continue with the product. There is sufficient reason, at this point, to allocate additional resources to the effort.

Specific Identification The results (values placed on cost of goods sold and ending inventory) for this cost-flow assumption are...

the same for both the periodic and perpetual systems. The specific cost of each item sold is used to compute the cost of goods sold.

U.S. GAAP-IFRS Differences In-substance defeasance is treated...

the same way as for U.S. standards. It is not accounted for as an extinguishment of debt or derecognition of the assets used for that purpose.

If the carrying amount of a reporting unit is zero or negative then...

the second quantitative step must be performed to measure the amount of impairment loss, if any, when it is more likely than not that a goodwill impairment exists.

Quantitative Assessment—Step 1: Testing for Potential Impairment If the carrying amount of the reporting units is greater than its fair value, then...

the second quantitative step of the impairment test is required to measure the amount of the goodwill impairment loss.

When stock is sold on a subscription basis, the implication is that...

the selling price of the stock will be received in a series of payments from the shareholder. Once the full amount is received, the stock will be issued.

the shares are acquired (retained earnings is debited).

Credited upon final payment—Common stock is not credited until the final payment is made because...

the shares are not issued at that time.

Small stock dividend —(% of dividend is less than 20-25%) Market to pay dividend—Market price is used on the assumption that the market price of the stock will not change given...

the small size of the dividend, and the shareholder then can sell the shares received while maintaining the predividend market value of the investment. In effect, the firm is using the market to pay the dividend.

Stock Dividend Purpose—Stock dividends are distributed to reduce the market price of the firm's stock (often because...

the stock price has become too high for potential investors) and also to reduce demand by shareholders for cash dividends.

Only if the qualitative assessment determines that is it more likely than not that an impairment has occurred, then...

the subsequent complex and costly two-step assessment is required.

Treasury shares usually do not receive stock dividends. However, if the treasury shares were intended to be used to meet a commitment under a stock option plan for example, then...

the treasury shares would be adjusted for the stock dividend.

The factors to consider if the decline in value of debt securities is other than temporary is essentially the same for securities classified as AFS or held-to-maturity. The difference is...

the treatment of the OTTI loss.

LIFO This cost-flow assumption is based on a last-in, first-out philosophy. At the end of the accounting period, it is assumed the ending inventory is composed of the oldest inventory layers, while the cost of goods sold is composed of...

the units of inventory most recently acquired.

Advantages and disadvantages of the corporate form of business Shareholders have limited liability; the corporation is a separate legal entity. Shareholders are not liable for the actions of the corporation and can lose only...

their investment. Partners and sole proprietors have unlimited liability. If the business cannot satisfy its debts, the creditors can seek relief from the owners of those types of businesses

Plant assets, inventories, and many investments are nonmonetary because...

their value changes with the market. The determination of the fair value and recorded value of nonmonetary assets presents a challenge when they are acquired in an exchange for other nonmonetary assets.

Discounting is required if...

there is a material difference between the expected amount paid, and its present value. This is contrary to U.S. standards, which, in most cases, do not apply discounting. Changes in the present value over periods are recognized as a borrowing cost.

Some benefits do not require accrual. For example, some holiday-pay benefits, military leave, and maternity leave benefits do not accumulate if the employee does not use these benefits. Therefore, no accrual is required. In general, if the probable and estimable criteria are not met...

there is no accrual. Such expenses are recognized when paid (pay-as-you-go).

due to poor balance-sheet valuation and poor matching of revenues and expenses, the direct write-off method is not considered in accordance with GAAP unless...

there is no basis for estimating bad debts.

If cost < market or NRV...

there is no loss recognition and the inventory is reported at cost.

If cost < market...

there is no loss recognition and the inventory is reported at cost.

Fully Participating If total dividends are not sufficient to provide common with a matching amount equal to the preferred percentage times total par value of common, then...

there is no participation and common receives all the dividends after the current year preferred dividend requirement and any dividends in arrears are allocated.

If the outflow of benefits is only remotely possible, then...

there is no recognition or disclosure.

Bonds Issued between Interest Dates—When bonds are issued between interest dates, the total cash received by the company issuing the bonds equals...

to the selling price of the bonds plus interest (at the stated rate) accrued since the last interest date. This sum is called the "proceeds." By requiring the investor to pay the interest accrued since the last interest date, the issuing company can pay the usual amount of interest at the next interest date.

The total interest expense over the note term equals the difference between the total payments required under the note and the principal amount. Total interest expense also equals...

total cash interest over the term plus the discount or minus the premium at issuance.

Purchases discounts, and returns and allowances reduce the...

total cost allocated to inventory.

The purchase of treasury stock at any price decreases...

total owners' equity.

Assume the investment in the debt security is classified as trading: Debt securities classified as ___________ are reported at fair value with unrealized holding gains or losses reported in net income. A fair value adjustment (FVA) is made to report the bond at fair value.

trading

The interest income on the bond investment (including any amortization of the bond discount or premium) is reported in net income. The interest income entry is the same as when the investment is accounted for as a...

trading security. After the interest income and bond amortization are recorded, the investment in the bond would be adjusted to fair value.

If the decline in the fair value of the AFS debt security is below the amortized cost, you must evaluate whether the impairment is other-than-temporary. If the decline is determined to be other-than-temporary, then the unrealized losses in accumulated other comprehensive income (AOCI) associated with the other-than-temporary are...

transferred out of AOCI and recognized in earnings.

Conversion of Preferred Stock—When convertible preferred stock is converted into common stock, the preferred stock accounts are...

transferred to the common stock accounts. Again, there is no gain or loss.

Paid delivery charges on purchased merchandise JE under periodic:

transportation in X Cash X

Treasury not outstanding—Cash and property dividends are not paid on treasury stock because...

treasury shares are not outstanding.

IFRS An entity must complete a review of its long-lived assets when...

triggering events occur and at each balance sheet date to determine if there is evidence that impairment may exist.

A basket sale occurs when...

two or more securities are bundled together and sold in a single transaction.

Repairs keep the asset in an ordinarily efficient operating condition. Repairs do not typically extend the life of the asset or increase its value. Repairs are...

typically expensed in the period incurred.

Permanent Capitalization—A stock dividend is a permanent capitalization (reduction) of retained earnings (or possibly paid-in capital for large stock dividends) into contributed capital. The firm's net assets are...

unaffected. Only OE accounts are affected.

Comparison of Cost and Par Value Methods When treasury shares are purchased at a cost greater than par but less than original issue price, what is the relative impact of the cost and the par value methods on additional paid-in capital and retained earnings? Par Value Method—Under the par value method, the treasury stock account is debited for par value, and additional paid-in capital is debited for the amount in proportion to the original issue price. Because less was paid for the treasury stock than was received on original issuance, retained earnings is...

unaffected. Rather, additional paid-in capital from treasury stock is credited for the difference, but not by as much as the debit to the original issuance additional paid-in capital account. Therefore, additional paid-in capital decreases under the par value method relative to the cost method, but there is no difference in the effect on retained earnings under the conditions imposed.

In accounting for inventories, business entities may elect to employ a periodic inventory system. If so, the beginning inventory balance is reflected in the merchandise inventory account throughout the year. That is, the merchandise inventory account will have an...

unchanging balance throughout the accounting year. The firm uses other means to obtain current inventory information for internal purposes. The periodic system is much less expensive to administer than is the perpetual system.

Note in Exchange for Rights or Other Privileges A firm may borrow from a customer and ask for an interest rate less than the prevailing rate in exchange for a reduced price on goods or services to be sold to the customer. Part of the consideration received on the borrowing is a prepayment by the customer for the reduced price. The note is recorded as always using the prevailing rate. The difference between the amount borrowed and the present value of the note is...

unearned revenue.

Accounting Policies—Under U.S. GAAP, the accounting policies used by an investee accounted for using the equity method do not have to conform to the accounting policies of the investor, as long as the investee accounting policies comply with U.S. GAAP. Under IFRS, in using the equity method, the investor and the investee must apply...

uniform accounting policies for similar transactions and events

FVO The required change in the FVA for the period is recognized as an...

unrealized gain or loss.

FVO If the required fair value adjustment has decreased, the firm recognizes an...

unrealized gain.

FVO If the required fair value adjustment has increased, the firm recognizes an...

unrealized loss. The amount required to pay off the liability relative to the book value under the effective interest method at the balance sheet date has increased.

Assets to Be Disposed of Other Than by Sale Accounting—Continue to classify the asset as held for use...

until disposal occurs, and continue to depreciate the asset. Apply the impairment standards for assets in use. Compute recoverable cost as for assets in use. These assets are treated as such because even though the plan is to dispose of the asset, the firm will derive the remaining utility of the asset (if any) from operations rather than via disposal. For exchanges and spin-offs, an additional impairment is recorded at disposal if BV > FV.

In mergers and acquisitions, the acquiring firm may acquire contingencies of the acquired firm. The amounts ascribed to contingencies, as is the case for any other identifiable asset or liability, affect the...

valuation of recorded goodwill on the acquisition. The amount recognized for this type of contingent liability is somewhat different than that discussed above.

If the investor has >50% ownership of an investment Whether the parent uses the equity method or the cost method to account for its subsidiary, the consolidated financial statements will be the same. The only difference is...

what is reported on the parent's stand-alone statements. Note that the parent's stand-alone statements are not in compliance with GAAP. GAAP requires that the parent present consolidated statements.

Obligations to Issue Shares of a Fixed Dollar Value Firms may pay for services or goods by issuing stock after the goods or services are received. Recall that when shares are issued immediately upon receipt of goods or services, the expense or asset, and the stock issued, are measured at the more reliable of the fair values (good/service, or stock). When there is a period of time between receipt of consideration and the issuance of stock, the stock price can change. The issue then arises at the receipt of consideration: Does the firm have a liability, or equity? The answer depends on...

whether the agreement specifies shares worth a fixed dollar amount, or a fixed number of shares.

Companies often commit (in a contract) to the purchase of materials to lock in the unit price of an item needed for production or resale in order to aid in cash flow budgeting and to protect against price increases. Sometime the market price of the item declines below the contract price. The accounting for this price decline depends on...

whether the contract can be revised in light of the changing market conditions.

Both U.S. GAAP and IFRS seek to determine if the arrangement is a sale of the receivables or a secured borrowing. U.S. GAAP focuses on whether control has shifted from the transferor to the transferee. IFRS focuses on...

whether the transferor has transferred the rights to receive the cash flows from the receivable and whether substantially all the risk and rewards of ownership were transferred. Application of these criteria are quite complex. However, it is often noted that under IFRS criteria the transfer is less likely to be treated as a sale.

Accounting for R&D is another example. Because future benefit is not probable for most R&D efforts, there is insufficient justification for recording an asset, which is a probable future benefit controlled by the firm as a result of a past transaction. Here the focus is on...

whether there is an asset. The definition is not met; therefore, an expense is recognized. The firm is not attempting to match R&D expense with the future revenues of inventions developed from current R&D efforts.

Fixed Number of Shares By comparison, when the number of shares is fixed rather than the dollar amount, the issuing firm records an owner's equity account upon receipt of consideration. During the period between providing the goods or service, and receipt of stock, the vendor is at risk in the same way any other shareholder is at risk. If the stock price declines during this time, the value received by the vendor...

will also decline.

In addition to the normal valuation of inventory at cost and choice of inventory cost-flow assumption (FIFO, LIFO), GAAP requires that firms recognize an end-of-period loss on inventory if its utility has declined. If market is below cost, then inventory must be...

written down to market. The loss cannot be postponed until the period of sale.

Cash discount Example Trade discount and initial recording Assume we sell $2,000 (list price) of goods, terms 3/10, n30. The sale is subject to a 5% trade discount. Payment is received after the 10-day discount period. (hint - show JE on gross and net methods)

*JE: Gross Net* Cash 1,900 1,843 Sales Disc. Forfeit 57 A/R 1,900 1,900 *The Sales Discounts Forfeited account is a miscellaneous revenue account. The net method separately records cash discounts not taken by customers.

The cash account typically includes all cash owned by the firm. (true or false?)

FALSE

During the year, Hauser Co. wrote off a customer's account receivable. Hauser used the allowance method for uncollectable accounts. What impact would the write-off have on net income and total assets?

N/I - no effect Total Assets - no effect *Under the allowance method for uncollectible accounts there is no impact on the balance sheet or net income when the receivable is written off. The estimated uncollectible is recognized at the time of the sale; therefore, when the account is written, off the allowance and the accounts receivable are both reduced resulting in no effect on the income statement or balance sheet.

book to true balance equation:

1. Balance Per Book, November 30, 20X7 XX + Interest Earned + Note Collected − Service Charges − NSF Check ± Errors in Firm's Records = *true cash*

Cash equivalents include:

1. U.S. Treasury obligations (bills, notes, and bonds), 2. commercial paper (very short-term corporate notes), and 3. money market funds.

A note receivable is usually related to a longer time frame than an account receivable, and due to that fact, all notes have...

an interest element. Notes provide increased security for the seller firm, are often negotiable, and usually can be converted to cash with a third party more easily than accounts receivable.

The analysis of ending accounts receivable has one simple objective: the determination of the neededor desired balance in the allowance account. By needed balance, we mean the balance needed to properly value accounts receivable on the balance sheet. The desired allowance balance equals the.... Once the needed balance in the allowance account has been determined, the needed balance is compared to the existing balance in the allowance account. The difference in these two balances is the amount of bad debt expense to be recorded for the accounting period.

expected amount of write-offs to occur in the future based on the receivables at the balance sheet date.

The Allowance Method This method records an estimate of bad debt expense at the end of each year in an adjusting entry. An allowance (contra accounts receivable) is created at that time and reduces net accounts receivable. Thus, both ______________________ are reduced in the year of sale by the estimate of uncollectible accounts on the year's sales.

income and net accounts receivable

If the income statement approach is chosen, the _________________ related to the allowance method is the objective that is receiving the primary emphasis.

matching objective

When an account is written off, the journal entry is debit the allowance for uncollectible accounts and credit accounts receivable. If the account is subsequently collected, an entry is made to reinstate the account receivable by debiting accounts receivable and crediting the allowance for uncollectible accounts. A second entry is made for the cash collection which involves debiting cash and crediting accounts receivable. Therefore...

there is no change in accounts receivable when a previously written-off account is collected; accounts receivable is debited for the reinstatement, and credited for the payment. However, when the previously written-off account is collected, there is an increase in the allowance for uncollectible accounts.

The Allowance Method The allowance method is the method of choice for most large firms and is required under GAAP if...

uncollectible accounts are probable and estimable.

Accounts Receivable Typically related to customer transactions. That is, an account receivable is usually related to the sale of goods to customers or the provision of services to customers. The length of time related to this claim is...

very short, 30 to 90 days for most business enterprises. Due to this short time frame, an account receivable typically does not have an interest element.

In addition, two different methods of accounting for receivables may be used:

1. The gross method, which records receivables at gross invoice price (before cash discount) 2. The net method, which records receivables at net invoice price (after cash discount)

A/R The main difference in the recognition criteria between U.S. GAAP and IFRS is that IFRS defines revenue from a balance sheet point of view and is based on the inflow of economic benefits during the ordinary course of business. This means that accounts receivable (and revenue) can be recognized if there is a firm sales commitment and the recognition criteria have been met. The revenue and asset are recognized when:

1. There are probably future economic benefits. 2. Revenue can be measured reliably. 3. Costs can be measured reliably. 4. Significant risk and rewards of ownership are transferred. 5. Managerial involvement is not retained as to ownership or control. Therefore, a firm sales commitment may meet the IFRS criteria for recognition, but in the U.S. the revenue and asset from a firm sales commitment would not be recognized. *The measurement criteria for reporting receivables is very similar; the future economic benefit of the accounts receivable is analogous to the net realizable value. Therefore, the valuation of AR is similar.

Factors Affecting Receivable Valuation Several items affect the net valuation of receivables (and net sales). Accounts receivable typically reflects more adjustments than notes receivable. Accounts receivable is shown at its net collectible amount. The adjustments to accounts receivable include:

1. Trade (quantity) discounts 2. Cash (sales) discounts 3. Sales returns and allowances 4. Noncollectible accounts

A/R The main difference in the recognition criteria between U.S. GAAP and IFRS is that IFRS defines revenue from a _____________ point of view and is based on the _____________________ during the ordinary course of business. This means that accounts receivable (and revenue) can be recognized if there is a firm sales commitment and the recognition criteria have been met.

1. balance sheet 2. inflow of economic benefits

Excluded from cash—Cash does not include...

1. certificates of deposit, 2. legally restricted compensating balances, or 3. restricted cash funds (such as a bond sinking fund).

Included in cash — The components of cash include...

1. coin and currency, 2. petty cash, 3. cash in bank, and 4. negotiable instruments such as ordinary checks, cashier's checks, certified checks, and money orders.

Note collected This amount represents principal and interest added to the company's checking balance by the bank upon collection of a note receivable. To fully understand the transaction, it must be remembered that the company secured the services of the bank to collect a note receivable. When the bank collected the note, the amount was added to the company's checking balance by the bank. The company will record the transaction when...

1. it receives the November bank statement or 2. receives separate correspondence related to the note collection.

cash - examples of negotiable instruments

1. ordinary checks, 2. cashier's checks, 3. certified checks, and 4. money orders.

Benefits of this Method—The positive aspects of the Allowance Method:

1. the allowance method allows companies to value accounts receivables at net realizable value on the balance sheet. 2. the use of the allowance method allows companies to recognize the revenues and expenses from credit sales in the same accounting year. So, due to appropriate balance sheet valuation of receivables and much better matching of revenues and expenses, the allowance method is in accordance with GAAP when uncollectible accounts are estimable.

1. the income statement approach or 2. the balance sheet approach. *As per a later discussion, it is possible to combine the two approaches. Regardless of the chosen approach, a business entity generally will choose one approach and apply it consistently from year to year.

Notes Receivable Often related to noncustomer transactions although many larger consumer items and transactions between businesses require a promissory note. Examples of transactions that relate to a note receivable include...

1. the sale of noncash assets, 2. lending transactions, and 3. the conversion of other receivables.

Positive Aspects of the Direct Write-Off Method Aspects of the direct write-off method:

1. the use of the direct write-off method may not be materially different in its effect on the company's financial statements relative to the allowance method. 2. the direct write-off method is simple and practical to use.

The fourth factor affecting accounts receivable valuation is uncollectible accounts (the first three were trade discounts, cash discounts, and sales returns and allowances). This is the major issue affecting receivable valuation and income determination in the area of receivables. Bad debt expense (also called ___________________ on the CPA Exam) is the account that records the effect of uncollectible accounts. Bad debt expense is on the income statement. The allowance for uncollectible accounts is a balance sheet account contra to accounts receivable. Bad debt expense traditionally has been considered a...

1. uncollectible accounts expense 2. cost of doing business rather than a sales adjustment.

cash equivalent (def)

a security with a fixed maturity amount and an original maturity to the purchaser of three months or less.

Errors in firm's records This represents errors made in the company's records. For CPA Exam purposes, this situation might include some discussion of incorrect recording of cash receipts and disbursements. For example, a payment of $96 might have been recorded as a payment of...

$69. Alternatively, a cash receipt of $11,000 might have been recorded as a cash receipt of $1,100.

Orr Co. prepared an aging of its accounts receivable at December 31, 2005 and determined that the net realizable value of the receivables was $250,000. Additional information is available as follows: Allowance for uncollectible accounts at 1/1/05 - credit balance $ 28,000 Accounts written off as uncollectible during 2005 23,000 Accounts receivable at 12/31/05 270,000 Uncollectible accounts recovery during 2005 5,000 For the year ended December 31, 2005, Orr's uncollectible accounts expense would be...

$10,000 *Beginning allowance balance + uncollectible accounts expense - write-offs + recoveries = ending allowance balance $28,000 + uncollectible accounts expense − $23,000 + $5,000 = ($270,000 − $250,000) Uncollectible accounts expense = $10,000 Under the aging method, the ending allowance balance equals the difference between gross accounts receivable ($270,000) and net realizable value of accounts receivable ($250,000). Write-offs decrease the allowance balance, and uncollectible accounts expense increases the allowance. Recoveries also increase the allowance because the amount by which the allowance was decreased when the account was written off is reinstated on recovery.

Marr Corp. reported rental revenue of $2,210,000 in its cash basis federal income tax return for the year ended November 30, 2004. Additional information is as follows: Rents receivable - November 30, 2004 $1,060,000 Rents receivable - November 30, 2003 800,000 Uncollectible rents written off during the fiscal year 30,000 Under the accrual basis, Marr should report rental revenue of...

$2,500,000 *The cash basis revenue in the tax return is the amount of rent collected for tax purposes. beg. rent receivable + accrual revenue - collections - write-offs = end. rent receivable $800,000 + accrual revenue - $2,210,000 - $30,000 = $1,060,000 accrual revenue = $2,500,000

On June 1, 2005, Pitt Corp. sold merchandise with a list price of $5,000 to Burr on account. Pitt allowed trade discounts of 30% and 20%. Credit terms were 2/15, n/40 and the sale was made FOB shipping point. Pitt prepaid $200 of delivery costs for Burr as an accommodation. On June 12, 2005, Pitt received from Burr a remittance in full payment amounting to...

$2,944 *$5,000(1 - .30)(1 - .20)(.98) + $200 = $2,944. The chain trade discounts are applied to each successive net amount as shown in the calculation, and the cash discount of 2% is then applied to the final invoice amount. The cash discount applies because the payment was made within 15 days of purchase. The goods were shipped FOB shipping point. Therefore, title transferred to Burr at the shipping point, meaning Burr bears the shipping charges. Because Pitt prepaid them as an accommodation, Burr must reimburse Pitt for the $200, the last term in the calculation leading to $2,944.

income statement method example Credit sales for 20X7: $500,000 In the past five years, approximately 5% of credit sales have been uncollectible. The bad debt expense for 20X7 is...

$25,000 (.05 × $500,000). Please note the bad debt expense is $25,000 regardless of the balance in the allowance account prior to the adjusting entry.

The following information pertains to Tara Co.'s accounts receivable on December 31, 2004 Days outstanding Amount Estimated % uncollectible 0-60 $120,000 1% 61-120 90,000 2% Over 120 100,000 6% ======== $310,000 During 2004, Tara wrote off $7,000 in receivables and recovered $4,000 that had been written off in prior years. Tara's December 31, 2003, allowance for uncollectible accounts was $22,000. Under the aging method, what amount of allowance for uncollectible accounts should Tara report on December 31, 2004?

$9,000 *The data on write-offs and recoveries is not relevant. The aging method computes a required ending allowance balance based on the aging schedule. That required ending balance is the sum of the products of the receivables in each age category and the uncollectible percentage: $120,000(.01) + $90,000(.02) + $100,000(.06) = $9,000. The write-offs and recoveries do affect the preadjustment allowance balance and therefore the amount of uncollectible accounts expense to recognize. In this case, the preadjustment balance is $19,000 ($22,000 − $7,000 + $4,000), which means no uncollectible accounts expense would be recognized in 2004 because the preadjustment balance is more than sufficient (exceeds the $9,000 required balance).

There are three formats for the simple bank reconciliation:

1. Bank to book—The starting point is the balance per bank. All adjustments are made to this balance to arrive at the balance per book. 2. Book to bank—The starting point is the balance per book. All adjustments are made to this balance to arrive at the balance per bank. 3. Bank and book to true balance—In this format, the bank balance and the book balance are separately reconciled to the true cash balance, which is reported in the balance sheet. The adjustments to the two starting points (bank balance and book balance) are those changes in cash that have not been recorded in the bank or the books at the end of the period.

Benefits—Bank reconciliations provide the following benefits:

1. Enable a periodic comparison of the bank account balance and cash balance 2. Help identify errors in the firm's records or bank records 3. Establish the correct ending cash balance 4. Provide information for adjusting entries 5. Help reduce cash theft by employees if the reconciler does not have access to cash records or does not have access to cash (authorization to make disbursements, or cash custody)

Example Balance Sheet Approach Accounts receivable on December 31, 20X7—$200,000 Based on past experience, the company estimates that 6% of ending receivables will be uncollectible. Prior to the end-of-period adjustment, the allowance for doubtful accounts had an existing $3,000 debit balance due to greater than expected write-offs. (hint - solve for allowance recorded in ADJ JE by starting with desired balance....)

Desired balance in the allowance account: $200,000 × 6% = $12,000 As the existing balance in the allowance account is a $3,000 debit balance, the amount recorded in the end-of-period adjusting entry is *$15,000.*

The analysis of ending accounts receivable has one simple objective:

the determination of the needed or desired balance in the allowance account. By needed balance, we mean the balance needed to properly value accounts receivable on the balance sheet. The desired allowance balance equals the expected amount of write-offs to occur in the future based on the receivables at the balance sheet date.

On October 31, Dingo, Inc. had cash accounts at three different banks. One account balance is segregated solely for a November 15 payment into a bond sinking fund. A second account, used for branch operations, is overdrawn. The third account, used for regular corporate operations, has a positive balance. How should these accounts be reported in Dingo's October 31 classified balance sheet?

The segregated account should be reported as a noncurrent asset, the regular account should be reported as a current asset, and the overdraft should be reported as a current liability. *The accounts are with different banks. Thus, the accounts cannot be offset against one another. The overdraft is a liability because the bank honored a check or withdrawal causing the account to be negative. The firm owes the bank this amount. The regular corporate account is part of the cash account, a current asset. The segregated account is a long-term investment. The cash in this asset is set aside for a specific purpose. There is no intent to use the cash for ordinary operating purposes.

Balance Sheet Approach Based on observations of prior years, under this approach, the company estimates bad debt expense by...

analyzing the ending accounts receivable. This analysis may result in the application of a percentage to the ending accounts receivable. Alternatively, the company may analyze the ending accounts receivable by aging the ending accounts receivable. This aging process involves grouping receivables by the amount of time they have been outstanding. Once the aging schedule is completed, the company then applies the various estimates of inconvertibility to each group of receivables.

Estimating Bad Debt Expense This section takes a closer look at the estimation of bad debt expense. The amount of bad debt expense in the first entry above, the year-end adjusting entry, may be estimated using two different approaches: the income statement approach or the balance sheet approach. As per a later discussion, it is possible to combine the two approaches. Regardless of the chosen approach, a business entity generally will choose one approach and...

apply it consistently from year to year.

Under the allowance method for uncollectible accounts there is no impact on the...

balance sheet or net income when the receivable is written off. The estimated uncollectible is recognized at the time of the sale; therefore, *when the account is written, off the allowance and the accounts receivable are both reduced resulting in no effect on the income statement or balance sheet.*

Deposit in transit These deposits have been made by the company but have not cleared the bank as of November 30, 20X7. This situation is typically related to a...

bank policy. For example, some banks have a policy that all deposits made after 2 p.m. of a given day will be reflected by the bank on the next business day.

If a business enterprise uses the term cash and cash equivalents on the statement of cash Flows, the term on the balance sheet will be...

cash and cash equivalents.

Cash on hand This amount reflects petty cash and undeposited cash receipts. You might think of cash on hand as being one step removed from being a deposit in transit. For example purposes, let's say a company makes a deposit at 3 p.m. on November 30, 20X7. Per bank policy, this deposit will be reflected by the bank on thenext business day. This 3 p.m. deposit will be a deposit in transit. During the last two business hours of November 30, 20X7, the company collected additional cash of $200. This $200 of undeposited cash receipts will be considered...

cash on hand. This amount could not have been known by the bank as of November 30, 20X7.

Notes Receivable Often related to...

noncustomer transactions although many larger consumer items and transactions between businesses require a promissory note. Examples of transactions that relate to a note receivable include the sale of noncash assets, lending transactions, and the conversion of other receivables. A note receivable is usually related to a longer time frame than an account receivable, and due to that fact, all notes have an interest element. Notes provide increased security for the seller firm, are often negotiable, and usually can be converted to cash with a third party more easily than accounts receivable.

CASH - U.S. GAAP-IFRS Differences The main difference between U.S. GAAP and IFRS is that bank overdrafts can be...

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