CPA Far- Module 7

Types of Intangibles Goodwill—Arises only from a ________ 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

business combination

Internally Developed Software Costs and IFRS IFRS does not specifically address internal software costs; therefore, the rules of research and development are applied. Therefore, software costs for research are expensed and those for development are _____-U.S. GAAP specifically addresses software costs and identifies the threshold of technological feasibility for capitalization.

capitalized.

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 _______ intangible.

definite-life

Internally Developed Software to Be Marketed or Sold Capitalization of software development stops when the product is available for release to customers. Any costs associated with the maintenance of the software product (fixes or patches issued to users) and costs associated with customer support are _______

expensed as incurred.

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.

It is important to note that, for a liability to be recognized in the accounts, it is not necessary to know the identity of the creditor, the exact amount that will be paid, or 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.

With respect to determining the fair value of identifiable net assets, there are two notable points: The use of the term net implies that all liabilities assumed in the acquisition have been _______ 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. The FV increment of identifiable net assets is the revaluation of the book value of those assets to their fair value as of the date of the acquisition. These revaluations are recorded by the acquiring company and ultimately reported on the ______

subtracted from all assets acquired in the acquisition. consolidated balance sheet.

An entity may purchase software for internal use and implement the software with no customization (i.e., buy and use off the shelf). These costs are _______

capitalized and amortized over the expected useful life of the software.

Internally Developed Software to Be Marketed or Sold Once the software is marketed to customers, the intangible asset associated with the software must be amortized. Entities must calculate potential amortization of the capitalized software costs under both the revenue method and the straight-line method. The amortization recorded is whichever calculation results in a________. The computation for both methods must be made each year to ensure the larger amount is recognized. The same method need not produce the larger amount each year. The amortization is an _____

larger amortization amount operating expense.

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.

A Closer Look at Current Liabilities (CL) The essence of a CL is that it is expected to reduce the firm's liquidity within one year of the balance sheet date or operating cycle whichever is longer. A CL payable with a current asset clearly will _________- But what about the second part of the definition creation of another CL? CLs that are continuously refinanced (rolled over) by replacing them with other CLs due later (but within one year of the balance sheet date) must still be classified as CL, even though no current asset will be used to_________ the balance sheet date.

reduce the firm's liquidity. extinguish them in the year after

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 +_________. This contrasts with the cost of purchasing a patent from an outside party. The entire cost of such a patent is capitalized.

registration and legal costs

Valuation of Liabilities CLs are reported valued at the amount due, or nominal amount. Liabilities for services are measured at______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.

the amount received.

Internally Developed Software to Be Marketed or Sold An entity may develop software products to sell, lease, or otherwise market to customers. For example, Microsoft or QuickBooks internally develop software is to sell to customers. Costs incurred to establish technological feasibility are research and development (R&D) costs and are expensed as incurred.The activities associated with planning, designing, coding, and testing of programs are performed in order ________

to obtain technological feasibility.

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:

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

Included in_______Are Costs Associated With: Laboratory research Conceptual formulation and design of possible products or process alternatives Modification of the formulation or design of a product or process Design, construction, and testing of preproduction prototypes and models Design of tools, jigs, molds, and dies involving new technology Design of a pilot plant

R&D

Changes in Classification—If an amortized (definite-life) intangible is later deemed to have an indefinite life, then amortization-_______ An impairment might result because fair value would now be used to test for impairment rather than recoverable cost.

ceases.

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 ________ 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.

factor in setting useful life.

Goodwill is the only intangible asset that _____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 to a favorable liability. Because of the going-concern assumption, goodwill has an indefinite life. The life is assumed to be indefinite because in the absence of evidence to the contrary, the combined entity (acquirer and acquiree) will continue indefinitely.

is not identifiable.

Sources of Intangibles—Intangibles are either acquired from other parties or internally developed. Internally developed intangibles are expensed immediately if they are not specifically identifiable, have indeterminate values, or are inherent in a continuing business. Firms must expense the amount of internal expenditures devoted to the development of intangibles. The only costs related to internally developed intangibles that are capitalized are ____-

registration fees and legal costs paid to outsiders.

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. The book value (BV) of the definite-life intangible is compared to the recoverable cost (R) of the intangible asset. Recoverable cost is the ________to using the asset and from the ultimate disposal. If the BV is greater than the recoverable costs, then the asset is potentially impaired, and the second step must be completed. 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________

sum of net cash inflows attributable new BV.

Internally Developed Software to Be Marketed or Sold ASC 985-25 defines technological feasibility of a computer software product as "when the entity has ________ activities that are necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements."

completed all planning, designing, coding, and testing

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______. 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.

compute interest expense

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 any difference between the estimated taxes and actual is_______

adjusted in the current and future periods.

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.

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.

Creditor Response to a Covenant Violation Legal action may be taken against the debtor, including the initiation of a______

breach of contract lawsuit.

Provisions are measured at the_______ of the amount required to settle the obligation at the balance sheet date. 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.

best estimate

Covenants are periodically revisited and modified as debtor financial health and macroeconomic conditions change. At a minimum, adjustments should be _______ In a line of credit, a review also occurs upon renewal of the credit line.

considered annually.

Fair value is the quoted market price of the security. If that is not available, the current market rate of interest on similar debt instruments is used to estimate

fair value.

The gross or net method of recording the note and interest expense are both acceptable. The gross method separates the face value (note payable) and discount or premium in different accounts. The net method uses one combined net account (note payable), which is the present value and net note liability under the

effective interest method.

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 debtor may request relief from the covenant. This involves a request to either _________ 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.

eliminate or weaken the covenant by amending the debt contract.

Vesting is more valuable to the employee than accumulation because the__________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.

employee can leave the firm and be paid the benefits if they are vested.

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.

Reasonable Estimate of Amount—Based on professional judgment and experience, a determination is made about the possibility of ______-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.

estimating the amount of the contingency.

Types of Intangibles 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.

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

just the opposite as that for most convertible bonds.

Capital budgeting and other planning processes within the firm consider the _______ A periodic sensitivity analysis determines the leeway available on key factors used in the covenant, within current operations. How much room does the firm have to alter its tactics and strategies and continue to comply with its covenants?

potential effect on debt covenant compliance.

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.

Probability of Future Event In accounting for contingencies, a determination must be made related to the probability of occurrence of the future event (which will resolve the contingency) and the __-

possibility of estimation.

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. If the outflow of benefits is more likely than not but not estimable, then the entity discloses the________ If the outflow of benefits is only remotely possible, there is no______

possible obligation and refers to it as a contingent liability. recognition or disclosure.

Notes payable are more formal than accounts payable and involve interest. A formal document called a______details the rights and duties of both parties to the note. Notes can be classified as current or noncurrent.

"promissory note"

Examples of Definate liabilities

AP acrued rent interest utilities payroll income taxes

Definition _________: An existing condition (at the balance sheet date) involving uncertainty as to a possible loss that will be resolved when a future event occurs or fails to occur.

Contingency

Debt Issue Costs These costs include legal fees, printing costs, and promotion costs related to the issuance of a debt instrument such as a bond or note. Debt issuance costs are the incremental costs of issuing debt (third-party costs), excluding those paid to the lender. Accounting and Reporting:

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. Debt issue costs are amortized to interest expense over the term of the related debt instrument.

Intangibles are classified as: ____ _____

Definite-life intangibles; or Indefinite-life intangibles.

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

Employee and employer cost

The follow are (included/excluded) in R&DAre Costs Associated With: Engineering follow-through Quality control and routine testing Troubleshooting Adaptation of an existing capability to a particular customer's needs Routine design of tools, jigs, molds, and dies Legal work in connection with patent applications Software development costs

Excluded

ASC 410-20 Asset Retirement Obligations ASC 410-20 addresses the _________(AROs) and requires firms to capitalize future asset retirement costs in the underlying asset account and also in an ARO liability. Such future costs include the cost of dismantling an asset, removal, site reclamation, nuclear decommissioning, and closing mines. The costs are incurred at the end of the asset's life but are capitalized ___________. The rationale for capitalizing such costs to the asset is that the retirement activities are integral to the operation of the asset.

accounting and reporting for asset retirement obligations when they become estimable, often at the beginning of the asset's useful life

The method and amortization method of the intangible asset should be reviewed each______. U.S. GAAP requires a review when the events or circumstances change.

annual reporting period

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.

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

Convertible versus nonconvertible—A convertible bond can be converted into capital stock by the bondholder; a _______ bond cannot.

nonconvertible

The ______ method is typically used to compute amortization of definate life intangibles

straight-line

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).

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). This is essentially an impairment test that is done each year. 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. _______are not allowed.

Write-ups

Accounting for R&D General Rule—ASC ______ requires that research and development costs are expensed in the period incurred. Research and development costs include labor costs, materials costs, and overhead costs.

_730

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 ______and expensed as cost of goods sold or cost of services provided at the conclusion of the contract.

accumulated in an inventory account

Recorded goodwill remains on the books of the acquirer unless the_________ 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 workforce and customer base, the established business reputation, and other intangible characteristics.

acquiree is sold or the goodwill becomes impaired (as described in IV. below).

Current liabilities—Are those that meet two criteria: Due in the coming year or the operating cycle of the business, whichever is longer; 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 _________. Most firms have operating cycles much shorter than a year. One measure of the operating cycle is 365/inventory turnover + 365/AR turnover =

acquiring inventory and other resources, to sale, to receipt of cash from the receivable number of days required to sell the inventory on hand + number of days required to collect receivables.

The costs incurred to develop (or modify) the software to the point of technological feasibility is expensed as incurred. The costs incurred after technological feasibility but before the software is put to use is capitalized as an intangible asset. The capitalized costs of internally developed (or modified) software intended for internal use are________

amortized over the expected useful life of the software.

Internally Developed Goodwill—Internally developed goodwill exists for most business entities. However, 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.

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 __________. 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 a gain.

bargain purchase

Startup costs are those expenditures incurred as a new business is being formed. These costs occur before any ________ Startup costs may also be referred to as preopening costs, preoperating costs, or organization costs. All startup costs are expensed as incurred (ASC 720-15-25-1). Startup activities include: Opening a new facility Introducing a new product or service Conducting business in a new territory Conducting business with an entirely new class of customers Initiating a new process in an existing facility Commencing new operations

business activities commence.

An intangible has an indefinite life if no legal, regulatory, contractual, competitive, or other factor limits the life. Indefinite means there is________which the intangible is expected to provide cash flows. A renewable and very recognizable trademark is an example.

no foreseeable limit on the period of time over

The fair value of a reporting unit is compared to its carrying amount, including any deferred income taxes and previously recognized goodwill. If the carrying amount of the reporting unit is greater than zero and its fair value exceeds that carrying amount, goodwill of the reporting unit is _____ &-______

not impaired and no impairment is recognized.

Most current liabilities (CL) are due within +_______- 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 bonds payable, some notes payable, lease liabilities and pension liabilities.

one year of the balance sheet.

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________. 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 _______ on the carrying amount of each asset in the group. The unit is not reduced below the highest amount of its fair value less cost to sell, its value in use, or zero.

recoverable amount the other assets of the unit pro rata based`

When the cloud computing arrangement is a license, the implementation costs are capitalized to the software intangible asset and amortized as part of the software asset. When the cloud computing arrangement is a service agreement, the implementation costs are capitalized as a prepaid asset. The costs are not capitalized as an intangible asset (because there is no intangible asset) but are prepaid as part of the service agreement. The implementation costs, including the terms in which the entity would exercise the option to extend the agreement, are expensed over ______

the life of the service agreement.

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

The useful life to the firm is less than legal or economic life; Another entity could obtain some benefit from the asset after the first firm was finished with it; and 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).

Sources of Intangibles—Intangibles are either acquired from other parties or internally developed. 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 (e.g., customer lists).

Some examples provided in ________-of software that are development (or customized) for internal use are listed next. A manufacturing entity purchases robots and customizes the software that the robots use to function. The robots are used in a manufacturing process that results in finished goods. An entity develops software that helps it improve its cash management, which may allow the entity to earn more revenue. An entity purchases or develops software to process payroll, accounts payable, and accounts receivable. An entity purchases software related to the installation of an online system used to keep membership data. A travel agency purchases a software system to price vacation packages and obtain airfares. A bank develops software that allows customers to withdraw cash, inquire about balances, make loan payments, and execute wire transfers.

ASC 350-40-55

Deferred Charges Deferred charges are accounts that are difficult to classify. A variety of practice exists for these accounts. Deferred charges are not included in intangibles but are often listed close to intangibles in the balance sheet and are sometimes confused with intangibles. Examples of deferred charges are listed below. Long-term prepaid insuranceLong-term prepaid rent 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. ____ & _____

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 .Deferred bond issue costs—The costs of issuing bonds is recorded in a deferred charge and amortized over the term of the bonds.

_____- 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 accrued as a definite liability, is disclosed as a contingency, or is not considered a liability at all. Most liabilities are definite. Examples of contingent liabilities include lawsuits, warranties, and guarantees. Contingent liabilities are covered in a subsequent lesson.

Definite

________ are 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.

Definition Intangible assets

Payroll tax liabilities are paid by the employer at specific dates set by law.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 up to a certain annual salary limit per employee. In addition, the Medicare tax is levied on all salaries and wages without limit. Both employer and employee pay the same amount for both taxes.Employers pay federal and state unemployment taxes. Both _____ &_____Only employers pay this tax.

(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.

Classification of Liabilities—Liabilities are classified in two ways: ______ or ___________

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

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

(1) income taxes payable, property taxes payable and compensated absences liability;

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.

After the asset and ARO are increased by the initial fair value (present value) of future payments to retire the asset,_____ &__________The annual accretion expense and corresponding increase in ARO is found by multiplying the interest rate used in capitalizing the initial amount by the beginning balance in the ARO. The annual expense is considered an operating expense, not interest expense.

(1) total depreciation or depletion expense over the asset's life is automatically increased by the amount capitalized initially, and (2) the ARO is increased each year due to the passage of time, causing the firm to also record "accretion expense."

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.

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 ___________ 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.

(2) They require or may require the issuer to settle the obligation by transferring assets.

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.

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 more than 50%. U.S. GAAP is a higher threshold for accrual because likely to occur would mean more than 70% or so probability of occurrence—where more likely than not is a threshold of more than________

50% likelihood of occurrence.

FYI

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. 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. Working capital (Current Assets - Current Liabilities)—A minimum level is specified in the covenant. 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. Interest coverage ratio(EBITDA/Interest Expense)—A minimum level is specified. Retained earnings balance, or total owners' equity balance—A minimum level is specified. Debt to equity ratio—A maximum level is specified. Total debt—A maximum level is specified. Interest expense—A maximum level is specified. Total assets or net assets—A minimum level is specified.

The amount capitalized does not qualify as an expenditure for purpose of capitalizing interest. _________applies to all legal obligations associated with the retirement of a tangible noncurrent asset but does not apply to environmental remediation liabilities arising from improper use of an asset because such costs are not an integral part of the cost basis of the asset. (See next section on environmental obligations.)

ASC 410-20

There are seven items of information that must be known to account for a bond: Face (maturity) value—The amount paid to the bondholder at maturity. This amount is often $1,000. 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. Interest payment dates—The dates the bond pays the cash interest. Semi-annual interest payments are the norm. 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. _____ ______ _____-

Bond date—The planned issuance date. This date is listed on the bond. 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. Maturity date—The date the maturity value is paid, the end of the bond term.`

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. 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. ________ 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.

General economic downturns and inflation

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. __________is recognized.

No gain or loss

Gain contingencies are not accrued but rather are recorded when the actual gain takes place. For example, if the entity is the plaintiff in a lawsuit where it is probable that the entity will prevail, the entity does not accrue the gain until the actual payment is received (no matter the level of probability or precision of the estimate). Loss contingencies can occur when the entity:i

Is the defendant in a lawsuit, orprovides product warranty, or provides rebates or premiums on the product.

If it is probable that the triggering event will occur and the guarantor will be required to pay under the terms of the guarantee, then the guarantor must accrue a liability associated with the guarantee. In summary there are three main categories of contingent liabilities:

Lawsuits (or other legal action): Accrue and disclose when loss is probable and estimable Disclose when loss is possible (no accrual) No disclosure or accrual when loss is remote Product warranties, rebates, and premiumsAccrue an estimated liability based on historical payments and disclose information regarding the liability Financial guarantees of another entity's indebtedness Disclose information regarding the guarantee Accrue a liability associated with the guarantee only when the payment associated with the guarantee is probable

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." There are two general sources of present obligations or liabilities:

Legal obligations that derive from a contract, legislation, or other legal process 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

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:

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

In assessing the probability of occurrence, professional judgment is employed to classify the probability into one of three categories. Attorneys or legal counsel assess the likelihood of the event occurring and will classify the event into one of the following categories: Probable—Based on Reasonably possible—Based on Remote—BASED ON

Probable—Based on professional judgment, the probability of occurrence is considered very high or a near certainty. 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. Remote—Based on professional judgment, the probability of occurrence is considered to be very low, or as the title implies, remote.

Debtor and Creditor Recording and Reporting of Settlement Troubled-Debt RestructuresCreditor—In settlement restructures, the creditor:

Records a loss for the difference between the book value of the receivable and the fair value of assets or stock of the debtor receivedRemoves the receivable accounts from the booksRecords assets received at fair value

Debtor Reporting of Modification of Terms for Troubled-Debt Restructure 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:

Records no gain or loss and does not change the carrying value of the debtComputes the new rate of interest equating the present value of restructured cash flows and the book value of the debtRecords interest expense based on the new rate for the remainder of the loan term

Debtor Reporting of Modification of Terms for Troubled-Debt Restructure 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:

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

Debtor and Creditor Recording and Reporting of Settlement Troubled-Debt Restructures Debtor—In settlement restructures, the debtor: 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) 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) _______ ________

Removes the debt accounts from the books Records any stock issued in settlement at the fair value

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. Limit dividends or treasury share purchases to a specific amount, or prohibit them. Limit additional borrowings. A "leverage" covenant may limit total debt to some multiple of an earnings variable, such as EBITDA. 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. Prohibit risky investments or expansion projects.

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, _____may enable compliance with covenant ratios.

Special transaction

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. 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:____ & _____ 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.

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

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:____ &__

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.The debtor is in financial difficulty, which means that without the concession, it is likely that the debtor will default.

Debt is considered extinguished when one of two conditions is met.__________ __________

The debtor pays the creditor and is relieved of any obligation related to the debt.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.)

Measuring Provisions Present value measurement can be applied using either of the following techniques: 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. _________-

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.

There are many types of guarantees that an entity can provide. The more complex guarantees are beyond the scope of the CPA exam. However, the accounting and disclosure of the guarantee of another entity's indebtedness is something that the CPA candidate should understand. Entities may guarantee the debt of an affiliate to help the affiliate obtain a loan or a line of credit. The guarantor must 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 is required to disclose the following:

The nature of the guarantee, the term of the guarantee, how the guarantee came into existence, and the triggering event The maximum future amount payable under the guarantee The carrying amount of the liability A description of recourse provisions or available collateral enabling the guarantor to recover the amounts paid under the guarantee, if any

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:

The obligation is attributable to services rendered as of the balance sheet date. The rights vest (benefits are no longer contingent on continued employment) or accumulate (carry over to future periods). Payment of the obligation is probable. The amount of the obligation is estimable.

U.S. GAAP-IFRS Differences 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:______ ______ _____

The refinancing of the current liability on a long-term basis must occur before the balance sheet date. 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. 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.

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

a present obligation to transfer assets or provide services, that is unavoidable, and is the result of a past transaction or event.

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 effective interest method 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.

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.

Covenants are one form of protection for the creditor. Others include requiring the issuing firm to redeem bonds according to a prespecified schedule (sinking fund debentures), requiring the issuing firm to

accumulate a sinking fund for the eventual retirement of bonds, and structuring the bonds as serial bonds.

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.

If the cloud computing arrangement contains a software license, then the license is accounted for like other acquired intangible license agreements. This means that the license is capitalized as an intangible asset and amortized over the life of the license (if definite lived) or tested _____ for impairment (if indefinite life). If the cloud computing arrangement does not have a licensing arrangement, it is deemed to be a service contract. The service contract is expensed as ______-. A service contract does not give rise to a recognizable intangible asset.

annually incurred

Bond proceeds—The sum of the bond price and

any accrued interest

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 (the same type of model used to value employee stock options discussed in a previous lesson).`

Scope and Initial Measurement Fair value is used to measure the ARO, and the amount is recognized at the time the cost _______ The fair value is the amount the firm would be reasonably expected to pay today to cover the future costs and is the present value of all future payments expected to retire the asset. This amount is debited to the asset and credited to the ARO. The obligation must stem from a legal obligation—one that the firm is required to _______

becomes reasonably estimable. settle because of a law or contract.

Contingencies Acquired in Business Combinations 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 contingency is contractual (e.g., a regular warranty) at acquisition, then contingent liability is recognized ______- 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 ________- After acquisition, as new information is obtained, the contingency is reported at the greater of acquisition date fair value, and the amount that would be recognized under normal contingency rules. Any changes in the reported liability are recognized as ________

by the acquirer at fair value. at fair value. Otherwise, there is no recognition. gains or losses.

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 ________ .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_____-

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

There are two rates of interest relevant to notes payable: Stated rate is the contractual rate listed in the note; this rate determines the _____-1Yield 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.

cash interest payments.

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.

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.

Types of bonds—There are several classifications of bond issues. The most important for the exam are: Secured versus unsecured (debentures)—A secured bond issue has a )________ 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.

claim to specific assets.

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 __________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 _______ONLY

contingency, even though no claim or assessment has been filed. footnoted only.

U.S. GAAP-IFRS Differences 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 _______- 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 ________

cure the breach and during which the creditor cannot demand payment. no such requirement.

If a liability is callable on demand if a debt covenant is violated, and there is violation, the liability is classified as a _____ 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.

current liability if there are no other relevant circumstances.

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 _________ retroactive application does not apply. The liability is not discounted but rather is reported at nominal (future) value.

currently and prospectively,

Firms may retire their debt at any time (before maturity) unless the________-. 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.

debt agreement prohibits it

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

debt instrument.

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.

Bonus Compensation Liabilities—A bonus is an additional amount of compensation in excess of a base salary. Frequently, liabilities related to bonus compensation are ____________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.

dependent on operating results for the accounting period.

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.

Covenants can be established either unilaterally by the creditor, or 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.

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. 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. 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.

Accounting for Debt ExtinguishmentExtinguishment of debt can be accomplished in a variety of ways. The company can simply pay off the debt. 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. Alternatively, the company may purchase a bond issue on the open market and retire the bonds payable. 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.

Remember that all liabilities are the result of a past event. A contingent liability must_________which means there must have been a transaction or event implying that a liability may have been incurred. However, a future event also plays an important role in the recognition of a contingent liability. 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.

exist as of the balance sheet date,

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.

Payroll Liabilities In their role as employers, firms incur definite current payroll-related liabilities from two different sources: 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_________. 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_______-an expense for these costs but acts as a collection point, resulting in an employer liability.

expense for these costs does not recognize

US GAAP - IFRS Differences Gains and losses on debt extinguishment are reported in Other Income, the same category as interest expense, on international income statements. In-substance defeasance is treated the same way as for U.S. standards. It is not accounted for as an_________- Some modifications of terms restructuring are treated as debt extinguishments for international accounting. This topic is discussed in the "Troubled Debt" lesson.

extinguishment of debt or derecognition of the assets used for that purpose.

"Covenant-lite" loans are drawn with +++++=. 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.

fewer or less stringent covenants

U.S. GAAP-IFRS Differences Most aspects of bond accounting are the same for international accounting standards and U.S. standards. IFRS requires the effective interest method in all cases, and the amortization period is the expected term of the bond, as opposed to the contractual period as per U.S. standards. 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_________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_______ 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.

financial assets and liabilities liabilities will receive the optional accounting treatment.

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).

The accounting for contingencies is dependent on the probability of the _____&_____This lesson considers only contingent liabilities. Other contingencies such as uncollectible accounts receivable and asset impairments are discussed elsewhere.

future event occurring, and whether the amount of the gain or loss is estimable.

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, 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 _________may be placed in doubt. L

going concern

Goodwill is recognized only when the acquirer obtains control of another enterprise. If a firm has never acquired another enterprise, then that firm would not have______in its balance sheet.

goodwill

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. Although net income is not a formal variable in all covenants, higher earnings will contribute to a _________ 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.

greater probability of compliance with many covenants.

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 t-_______. 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.

he original loan book value plus or minus the loss or gain

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.

Both licensing arrangements and service contracts that are provided via a cloud computing arrangement will have implementation costs. Implementation costs are those incurred to ________. To determine which implementation costs may be capitalized and which costs are expensed, the entity follows the same guidance as capitalizing other intangibles.

implement the hosting arrangement

Accounting for Debt Extinguishment Regardless of the method, however, the accounting is the same: 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 _______ .Remove the related debt accounts at their remaining amounts (face value, unamortized discount or premium, and any unamortized debt issue costs )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 ________ or ______ or_________, and less unamortized bond issue costs. If the current bond price exceeds the net bond liability, a loss is recognized, and vice versa.

included in the amount paid to retire the bonds face value of the bond plus or minus unamortized premium or discount

Debtor Reporting of Modification of Terms for Troubled-Debt Restructure 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 __________ 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.

includes unpaid accrued interest.

ikewise, 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 ______-A default also raises the possibility that a loss is imminent.

increase in a reserve against the possible loan loss.

Types of Intangibles 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.

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.

FRS allows reversal of impairment losses on_______to the carrying value that would have been recognized had the impairment not occurred. GAAP does not allow for reversals of impairment losses.

intangible assets

Internally Developed Software to Be Marketed or Sold Once the software product has reached technological feasibility and there is a plan to continue the project, the costs are capitalized as _____

intangible assets

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 _________-of the impairment of the purchased goodwill. The IFRS and U.S. GAAP prohibit recording internally generated goodwill; therefore, goodwill impairment cannot be reversed.

internally generated goodwill rather than a reversal

Cash Surrender Value of Life Insurance 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 ________ but may be reported by some firms in Other Assets in the balance sheet.

investment account

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.

Bond term—The period from

issuance date to maturity date

ASC 410-30 Environmental Obligations ASC 410-30 addresses the accounting and reporting for environmental obligations. Unlike the AROs, an environmental obligation is not associated directly with an asset. An environmental obligation stems from a ___________(i.e., Clean Air Act). An environmental liability must be accrued when the liability is both probable and reasonably estimable. Frequently the company would accrue an environmental liability when it has been named the potentially responsible party (PRP) for the environmental remediation.

legal action in violation of one of various Environmental Protection Acts

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.

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.

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 +______ to the government.

liability

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 __________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.

liability is classified as current.

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 _______-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.

liability rather than equity

Measurement of the Accrual—The measurement of the accrual can be based on current or future wage rates although typically current rates are used. Current rates result in a _____

lower expense accrual and do not telegraph future pay raises.

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 _________, 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.

market and stated rates

Bond price—The current

market price of a bond exclusive of accrued interest

Bond issue costs—The cost of printing, registering, and

marketing the bonds

An alternative to the effective interest method is the straight-line method, which is allowed only if it results in interest expense amounts not _________ An equal amount of discount or premium amortization is recognized each period.

materially different from the effective interest method.

The amortization of premiums and discounts is accomplished through the use of the effective interest method. Due to materiality, many companies employ the straight-line amortization method. The straight-line method is acceptable only if the results do not depart

materially from the effective interest method.

Subsequent to the acquisition, the costs to maintain, enhance, or repair purchased goodwill are expensed. The acquirer understandably wishes to__________ 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 initial goodwill.

maximize the return

Quantitative Assessment To Measure Impairment If the qualitative assessment is not completed or if the assessment determines that it is ___________ that the fair value of the reporting unit is less than its carrying value, then a quantitative calculation must be performed.

more likely than not

The purpose of the qualitative assessment is to determine if it is________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.

more likely than not (i.e., a likelihood of more than 50%)

Zero Coupon Bonds—These bonds pay no interest (coupon rate is zero), but the accounting procedure remains the same except that ___________The entire amount of interest is included in the face value, just like a non-interest-bearing note. Zero coupon bonds, and also "deep-discount" bonds with very low coupon rates, are issued at a large discount.

no cash interest is paid during the term.

Stated rate < market rate—If the stated interest rate is less than the market rate of interest, the bonds will sell at a discount.The discount—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. 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)

Unasserted Claims and Assessments Entities may be subject to future claims and assessments not yet filed as of the balance sheet date. Examples include possible IRS actions against the entity for violations of the tax law, EPA claims against the entity for environmental violations, and other events that have occurred as of the balance sheet date. 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 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 ________Otherwise, the liability is classified as a current liability.

noncurrent liability.

A covenant also may require that the firm's debt rating ______-. Two rating agencies are Standard & Poor's Corporation and Moody's Investor Services. S&P ratings are: Highest, AAA; High, AA; Medium, A; Minimum investment grade, BBB. Moody's corresponding ratings are: Aaa, Aa, A, Baa. A debtor, for example, may be required to maintain at least an A S&P rating for compliance with the covenant.

not fall below a minimum level

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.

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_____________. 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.

obligation is discharged, canceled or expired

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 interest rates, assets pledged, call and conversion provisions and restrictions, and the aggregate maturity amounts for each of the five years following the balance sheet date. Direct loan origination fees and points are recognized ________

over the loan term.

A debt covenant is a _________ 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).

part of the larger contract underlying the debt instrument.

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 ______-For example, for a troubled line of credit, demonstration of compliance might be required monthly.

perceived riskiness of the borrower.

Determination of Selling Price of the Bond (Initial Book Value)—The selling price of a bond is equal to the _________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.

present value of future cash flows

Current notes payable are reported at the amount due when they mature. Noncurrent notes are reported at the ________ discounted at the prevailing interest rate at time of issuance. 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.

present value of future payments,

When the yield rate is greater than the stated rate, the note is issued at a discount (less than face). When the yield rate is less than the stated rate, the note is issued at a premium (more than face). The issue price or proceeds is the ______

present value, also called principal.

Installment Notes— Each payment includes_________ & )_______—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.

principal and interest

If a present value technique is used to measure fair value, then the _________ estimates of future cash flows are discounted using credit-adjusted risk-free rate. The probability-weighted cash flows incorporate risks and uncertainties regarding the future obligation.

probability-weighted

Internally Developed Software to Be Marketed or Sold Capitalized costs include costs of coding, testing, debugging, and preparation of final product master and final documentation manual. Capitalized costs do not include duplication of product masters and manuals. Capitalization of the software product as an intangible ends when a________

product master is ready for duplication.

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. 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.

Creditor Response to a Covenant Violation 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 increasing the interest rate, requiring the borrower to specify assets as collateral, accelerating the payment terms (other than immediate payment), reducing the amount available in a line of credit, and repossessing collateral. Additional restrictions may be placed on the debtor. If a covenant is violated because of reduced earnings, for example, then the debtor may be+__________ The creditor may agree to renegotiate or restructure the debt.

prohibited from paying dividends or taking on more debt until the violation is cured.

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.

An entity is permitted, and may elect, to begin its determination of whether goodwill is impaired by performing a _______

qualitative assessment.

Qualitative Assessment Outcomes 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_________is not required 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 _______must be preformed

quantitative goodwill impairment test is not required. quantitative assessment must be performed.

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

received above face value and is

These do not correspond to the two modification-of-terms cases under U.S. standards.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 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.

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 ___________ uncertain obligations. Under IFRS a recognized contingent obligation is referred to as a provision and an unrecognized contingent obligation is referred to as a contingent liability.

recognized and unrecognized

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 ________- Conservatism dictates that the future event must first occur before recognizing the gain and asset increase (or liability decrease).

recognized in the accounts.

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.

The FVO 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.

Criteria for Reclassifying Current Liabilities as Noncurrent Liabilities—Reclassification of a current liability to noncurrent status is possible provided two conditions are met. 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. AbilityThe firm must also be able to ___________. 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. The details of the refinancing arrangement must be ______

refinance the obligation and demonstrate that ability before the issuance of the financial statements disclosed in the footnotes.

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 ___________ 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. If the debtor firm enters into a revolving credit agreement whereby one current liability is ______________ the agreement does not allow reclassification of the liabilities to noncurrent status. This arrangement falls within the definition of a current liability. 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.

remains classified as current. continually replaced with another current liability, even though no current assets may actually be used for a significant time period,

Off-balance sheet activities, such as structuring leases as operating leases, will reduce______, a variable used in several measures incorporated into covenants.

reported debt

U.S. GAAP-IFRS Differences 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 __ or_____ 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.

restrictions on the ability to settle the obligation or regardless of the way the obligation is settled.

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.

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.

Among all the possible types of liabilities, the focus in this section is on estimated liabilities. These include accruals and provisions. Accruals are much less uncertain than provisions. Examples of accruals include utilities payable and wages payable. Examples of provisions include income taxes payable, property taxes payable and compensated absences liabilities. Under IFRS, accruals and provisions are reported _____

separately.

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.

Types of Intangibles 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.

U.S. GAAP-IFRS Differences, whereasat present, U.S. standards address financial instruments on an individual basis, international standards apply more general concepts. Under international standards, a financial instrument is classified as liability or equity, based on the ________.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 _______

substance of the transaction directly measured with the equity component treated as a residual.

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 ________-A firm cannot accrue future casualty losses for example.

substantiate that a liability has been incurred.

Benefits not Accrued—In practice, not all earned compensated absence benefits are accrued because not all earned benefits are______ For example, not all vacation pay benefits are taken because some employees let a portion of their benefits lapse.

taken by employees.

Impairment Test of Indefinite-Life Intangibles other than Goodwill— If the intangible asset is an indefinite life and not subject to amortization, then it must be________ at least on an annual basis, or when circumstances indicate there may be impairment.

tested for impairment

U.S. GAAP-IFRS Differences 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.

Compound Financial Instruments At present, GAAP addresses this issue on an individual standard basis. The expectation is that this area will be revised based on a more general standard. Previous lessons addressed the following two items, for example. Convertible bonds are treated___________ 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.

the same as nonconvertible bonds at issuance and throughout the term—as debt.

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,___________is 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 met when _______

then an estimated loss and estimated liability the contingent liability is probable and estimable.

Separate Recognition—Many intangibles must be separately identified: trademarks and trade names, noncompetition agreements, customer lists, order or production backlogs, copyrights and patents, secret formulas and processes, licensing agreements, and supply contracts. A major reason for identifying these is that intangibles with definite life are amortized. To include them in goodwill would mean ______

they would not be amortized.

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. 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 ______. 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.

time of the borrowing

the ARO gradually increases over time (to the final amount expected to be paid) while the net book value of the asset declines through the depreciation or depletion process. Only the initial fair value (present value) is capitalized _____ &______

to the asset and is subject to depreciation or depletion.

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 ____ .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.If the probability of receipt of benefits is remote, no disclosure is warranted.

to the possibility of an inflow of economic benefits to the entity

The total interest expense over the note term equals the difference between the __________ and the principal amount. Total interest expense also equals total cash interest over the term plus the discount or minus the premium at issuance. 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.

total payments required under the note

The required change in the FVA for the period is recognized as an unrealized gain or loss. If the required fair value adjustment has increased, the firm recognizes an ________-. 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. If the required fair value adjustment has decreased, the firm recognizes an unrealized gain. Classification of the unrealized gain or loss: 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_________ The portion attributable to the change________

unrealized loss recognized in other comprehensive income. in interest rates is recognized in net income.

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 _______

usual amount of interest at the next interest date.

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.

The purchaser of the option is betting that the firm's stock will decline in price. The firm is betting the price will stay above the option price. The fair value of the option is reported as a liability. Changes in the option's fair value are recognized at ___ 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 ________

year end before the excise liability is extinguished and a gain is recorded.

Impairment Test of Indefinite-Life Intangibles other than Goodwill— The quantitative 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 _________The impairment loss is the amount that the BV exceeds the FV of the indefinite-life intangible asset.

BV exceeds FV.

Revenue Method Amortization for the current year = B × R where: B = ______ R = (Current-year revenue) ÷ (Current-year revenue + Estimated future revenue)

Book value of capitalized software costs at the beginning of the year

Major Differences Between U.S. GAAP and IFRS U.S. GAAP _________ IFRS Goodwill is tested at the cash generating unit level

Goodwill is tested at the reporting unit level

Impairment Test of Indefinite-Life Intangibles other than Goodwill— The entity may elect to perform a qualitative assessment prior to completing the quantitative impairment test. The qualitative assessment takes into consideration all relevant factors that may impact the fair value of the indefinite-life intangible. Using these factors, the entity must determine whether it is more likely than not (more than 50%) that the indefinite life asset is impaired. If the entity determines that it is not more likely than not that the indefinite-life intangible is impaired, then the entity does not need to _______. If the entity determines that it is more likely than not that the indefinite-life intangible is impaired, then the entity must __________

calculate the quantitative impairment test complete the quantitative impairment test.

Fixed Assets—In relation to the use of fixed assets in research and development activities, three specific situations need to be addressed. Fixed Assets Used in Several R&D Projects—These assets are ___ &-_______included in the annual R&D costs. The debit is to R&D expense rather than to depreciation expense; the credit is to accumulated depreciation. Fixed Assets Used Temporarily in a R&D Project—The depreciation related to the time frame of the project is included in the annual R&D costs. Fixed Assets Used in a Single R&D Project and 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 _______

capitalized and annual depreciation is expensed as R&D immediately.

The critical point for capitalization is technological feasibility. Technological feasibility typically occurs when the model or working model of the software is complete. When there is a working model and evidence that a commitment is made to continue with the development, the software is deemed to be technologically feasible. The costs incurred after the establishment of technological feasibility are ________

capitalized.

If the carrying amount of the reporting units is greater than its fair value, there is an impairment. The impairment loss is measured as the excess of the ___________. The impairment charge cannot exceed the carrying amount of the goodwill. That is, goodwill is only written down to zero.

carrying value over the fair value

Alternatively, an entity may purchase software and customize it so that the software fits the entity's unique needs. An entity may also internally develop software for its specific needs. The accounting for modified or internally developed software that is for the entity's own use follows the criteria for research and development (R&D) costs under ASC ________. That is, the stage of the modification or development of the software dictates whether the costs are expensed or capitalized and when amortization commences.

985

Straight-Line Method Amortization for the current year = B ÷ N where: B = Book value of capitalized software costs at the beginning of the year N = ________

Number of years remaining in product sales life at the beginning of the year

GOODWILL- 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: 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 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 Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows Overall financial performance such as negative cash flows or actual or projected declines in revenues, earnings, or cash flows Entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy or litigation ______ _______

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 If the reporting unit is publicly traded, a sustained decrease in share price (considered both in absolute terms and relative to the peer group)

Cloud Computing Often an entity utilizes software in a cloud computing arrangement (also known as a hosting arrangement). This means that the entity does not have physical possession of the software but has use of the software on the cloud. First the entity must determine if the cloud computing arrangement includes a software license. The arrangement contains a software license if both one and two are true:T

T he 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. It is feasible for the customer either to run the software on its own hardware or to contract with another party unrelated to the vendor to host the software.

Research and Development and IFRSIFRS distinguishes between research and development, like U.S. GAAP. However, IFRS allows companies to capitalize development costs. Both IFRS and U.S. GAAP require research costs to be _________

expensed

Types of Intangibles Defensive intangible asset-is an intangible asset that the entity purchases, but does not intend to use. Rather, the entity intends to _______ An entity may "lock up" an intangible asset to reduce competition. Since the entity will receive the benefit from holding this asset through reduced competition, defensive intangible assets have definite life and should be amortized over the period the entity will reap these benefits.

hold the asset so it cannot be used by competitors.

IFRS 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 __________-units. Therefore, more "buckets" of goodwill will be tested under IFRS than under U.S. GAAP within a given entity.

cash-generating units than reporting

Internal and external costs to research, develop, or obtain the software cannot be capitalized and are expensed as incurred. These costs are at the preliminary stage and the software has not yet been implemented. The costs include those for ______- Internal and external costs associated with implementation of the software for use can be ______. Implementation activities are those associated with fees to customize or configure the service and payroll costs to employees who are directly associated with implementation during the development phase. Once the software is in use, costs can no longer be capitalized and must be ______

coding, testing, and conversion of old data into new systems. capitalized expensed in the period incurred.

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_________. Interest is the difference between the total future payments and present value. Interest is not recognized until time passes.

current sacrifice to retire the debt

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 _______Accounting for the legal costs of this action is dependent on the outcome of the legal action.

defend those rights through legal action.

An intangible has a ____- life either if the asset has a finite legal life or 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.

definite

Only ______- 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.

definite-life

Types of Intangibles Artistic-related—Copyrights (these are not renewable).Definite life Contract-related—Franchises, licensing agreements, broadcast rights, service/supply contracts Some of these are _____ & ______

definite-life intangibles, and some are indefinite-life intangibles

Definite Liabilities—Definite liabilities are not _______. The existence of these liabilities is determined by a ________-. Definite liabilities include liabilities payable in definite amounts (e.g., accounts payable), those that can only be estimated (e.g., estimated income tax payable), and accrued liabilities that are recorded for expenses recognized before payment is made (e.g., utilities payable). Not all definite liabilities can be measured with certainty. Some are estimated and reported at an approximate amount.

dependent on any future event current event or a past transaction or event

The amortization of definite-life intangibles is recorded just like _________- The debit is to an expense account such as amortization expense or selling, general and administrative expense (SG&A) for intangibles devoted to nonmanufacturing activities, and the debit is to work in process (and ultimately cost of goods sold) for manufacturing intangibles. The credit is usually made directly to the intangible rather than to a contra account.

depreciation expense.

Internally Developed Software to Be Marketed or Sold After technological feasibility is reached, the entity may capitalize direct costs associated with software product development and indirect costs that are related to the programmers and the facilities. The entity cannot allocate and capitalize general and administrative costs that are not

directly related to the product development.

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, the entire class of intangible assets must be valued this way, not just select individual intangible assets. U.S. GAAP _______fair value. I

does not allow revaluation to