ACC 3020 Final Exam

Annual retirement benefit formula

% x service years x final years salary (highest salary)

Correction of Accounting Errors steps

(1) a journal entry is made to correct any incorrect amounts, (2) previous years' financial statements presented for comparison are changed to reflect the correct amounts, (3) if retained earnings is one of the incorrect accounts, the correction is reported as a prior period adjustment to beginning retained earnings, (4) a disclosure note should describe the error and the impact of its correction

Reasons for the movement away from defined benefit plans include

(1) government regulations and accounting standards making them costly and complicated to administer, (2) employers' increasing desire to avoid the risk of these plans (including increasing lifespan of retired employees), and (3) a shift from employee/employer long-term loyalty) (pension plans are designed to provide income to individuals during their retirement years; we will focus on employer pension plans)

Error Affecting Previous Financial Statements, but Not Net Income could include

(1) recording a balance sheet item in the wrong account, (2) recording an income statement item in the wrong account without affecting net income, (3) classifying a cash flow incorrectly in the statement of cash flows; since these errors do not affect income, no prior period adjustment would be needed

The treasury stock method assumes

(1) the options, warrants, or rights were exercised and additional shares of stock were issued, (2) the assumed money from the assumed exercise is used to buy back treasury shares at the average market price for the year, (3) the difference between the number of shares assumed issued minus the number of treasury shares assumed repurchased is added to the denominator in calculating diluted EPS

net income minus any claim by senior securities such as preferred shareholders; preferred dividends are subtracted in the numerator if

(1) the preferred stock is cumulative, or (2) the preferred dividends were declared

Pension Expense Formula

(Service Cost + Interest Cost) - Expected Return on Assets

Potential Common Shares are

1) Stock Options, Warrants, and Rights 2) Convertible Securities

The plan assets increase by

1) any employer contributions/funding (2) the return on plan assets

What is a pension plan?

A form of retirement plan in which employers contribute money to a plan which provides employees a monthly income during retirements

Potential dilution now could become

Actual dilution later

Diluted EPS is a hypothetical number showing the dilutive effective of

All potential common shares

Revise Comparative Financial Statements: Balance Sheet

Appropriate balances, including retained earnings, will be adjusted as if the new method had been used in those prior years

If a company has no potential common shares outstanding, it has a simple capital structure and only needs to report

Basic EPS

Interest Cost =

Beginning PBO x Discount rate

If it has potential common shares outstanding, it has a complex capital structure and needs to report

Both basic EPS and diluted EPS

Exercise Period Journal Entry

Cash xx PIC - Stock Option xx Common Stock xx PIC - excess of par xx

Change in Accounting Estimate

Changing Depreciation, Amortization, and Depletion Methods

Fair Value expensed over vesting period : Journal Entry

Compensation Expense xx PIC - Stock Option xx

Errors

Corrections of errors are not accounting changes but are accounting for similarly using the retrospective approach

Diluted Earnings Per Share

Earnings per share calculation that requires dilutive securities be added to the denominator of the basic EPS calculation.

What is a defined benefit plan?

Employer promises a fixed amount when you retire

In a noncontributory pension plan, the funding all comes from the employee. True False

FALSE

In years prior to retirement, we would expect a company's accumulated benefit obligation for a specific employee to be higher than the company's projected benefit obligation for that employee. True False

FALSE

The fair value of plan assets increases each year by the service cost and the funding. True False

FALSE

Plan assets will increase for any amounts paid out to existing retirees

FALSE, it decreases

A simple capital structure has potential common shares outstanding True False

FALSE, it has no potential common shares outstanding

Service cost decreases the amounts owed in the future

FALSE, it increases

The PBO is more reliable than the ABO

FALSE, it is less reliable

A complex capital structure presents only diluted EPS True False

FALSE, it presents both BASIC EPS and DILUTED EPS

Funded status is the difference between the pension expense and the cash funding for a particular year. False True

False

If stock options expire without being exercised, the issuing company reverses the compensation expense that was recorded for those stock options. True False

False

The earnings per incremental share for convertible bonds is always $0. True False

False

The journal entry each year for a defined contribution pension plan would include a credit to Pension Expense. True False

False

Fair Value of Plan Assets (FVPA) formula

Funding + Expected Return - payments

Fair Value of Plan Assets =

Funding + Expected Return on Assets - Payments

Options, Rights, and Warrants

Give holders the right to exercise their option to purchase common stock, at a specified exercise price

The Retrospective Approach

Most Changes in Accounting Principle (most voluntary changes in accounting principle are treated retrospectively; this means we report all prior period financial statements (at least those which will be presented as comparative statements) as if the new method had been used in those prior periods; when a change in principle is made any time during a fiscal year, it is treated as having been made as of the beginning of that year

Basic Earnings per Share (EPS) formula =

Net Income - Preferred Dividends Weighted Avg # of shares of Common Stock

Expired Options Journal Entry

PIC - Stock Options xx PIC - Expired Options xx

Pension Expense Journal Entry

Pension Expense xx Cash xx Pension Related xx Asset/Liability

Defined Benefit Pension Plans

Plans in which the company promises to pay a certain annual amount (defined benefit) to the employee after retirement. The company bears the investment risk of the plan assets.

Projected Benefit Obligation (PBO) =

Service Cost + Interest Cost - Payments

PBO Formula

Service cost + interest cost - payments

A Simple Capital Structure presents only basic EPS True False

TRUE

A complex capital structure has one or more potential common shares outstanding True False

TRUE

A counterbalancing error self-corrects within a 2 year cycle True False

TRUE

An increase to the denominator in a convertible bond would be the additional shares of stock True False

TRUE

An increase to the denominator in a convertible preferred stock would be additional shares of stock True False

TRUE

An increase to the denominator in both a convertible bond and convertible preferred stock would be additional shares of stock True False

TRUE

An increase to the numerator in a convertible bond would be after-tax bond interest True False

TRUE

An increase to the numerator in a convertible preferred stock would be preferred dividends True False

TRUE

Convertible Securities are Convertible preferred stock and convertible bonds True False

TRUE

Fair Value is expensed over Vesting Period True False

TRUE

If the PBO is greater, we have an underfunded amount

TRUE

If the plan asset balance is greater, we have an overfunded amount

TRUE

Interest cost for a specific year is the beginning-of-period projected benefit obligation multiplied by the discount rate True False

TRUE

Service cost increases the PBO

TRUE

Service cost is the present value (at year end) of the retirement benefits earned by the employees for having worked during that one year

TRUE

Stock dividends and stock splits received are not "taxable events."

TRUE

The Interest cost obligation is increased each year for the interest which accrues on the existing obligation

TRUE

The PBO is less reliable than the ABO

TRUE

The PBO is more relevant and representationally faithful than ABO

TRUE

The company bears the investment risk of the plan assets in a Defined Benefit Pension Plan

TRUE

The debit or credit to this Pension-Related Asset/Liability account for the year will always equal the change in the funded status for the year

TRUE

The employee bears the risk of the investment returns in a Defined Contribution Pension Plan

TRUE

The employer bears no risk once the contributions are made in a Defined Contribution Pension Plan

TRUE

The fair value of plan assets increases each year by the Expected Return and the funding. True False

TRUE

The journal entry each year for a defined benefit pension plan would include a credit to Cash True False

TRUE

The journal entry each year for a defined benefit pension plan would include a debit to Pension Expense. True False

TRUE

The projected benefit obligation increases each year by the service cost and the interest cost. True False

TRUE

To calculate the expected return in FVPA, you multiply the contribution amount by the rate of return True False

TRUE

To calculate the interest cost in a PBO, you multiply the pension expense by the settlement rate True False

TRUE

We should treat a stock split retroactively as if it happened at the beginning of the year True False

TRUE

basic EPS is based on what actually happened during the year

TRUE

Accumulated Benefit Obligation (ABO)

The accumulated benefit obligation (ABO) represents the present value of future expected retirement benefits to be paid based on salaries already earned (accumulated)

under the if-converted method, convertible securities are assumed converted at

The beginning of the year or when the convertible security was issued, whichever is later

Revise Comparative Financial Statements: statement of shareholders' equity:

The beginning retained earnings balance for the earliest period presented in the comparative statements must be adjusted for the cumulative effect of the change prior to that date

The Pension Obligation

The deferred compensation obligation it has to its employees for their service under the terms of the pension plan

Reporting the Funded Status of the Pension Plan

The funded status of the pension plan is the difference between the PBO and the plan asset balance

What happens when a stock dividend or stock split is "paid"

The issuer sends extra shares to the stockholder, with each share having a reduced real value.

Projected Benefit Obligation (PBO)

The present value of the expected future retirement benefits to be paid based on future (projected) salary levels prior to retirement

Prior Period Adjustments

The prior period adjustment is applied to beginning retained earnings for the year following the error, or for the earliest year being reported in the comparative financial statements if the error occurred before then

Options, Rights, and Warrants uses which method?

The treasury stock method is used in calculating diluted EPS if the options, warrants, or rights are dilutive

Potential Common Shares

Things such as options, warrants, right, convertible bonds, or shares of convertible preferred stock which could be exercised or converted to become more shares of common stock

Changes in Estimates are only prospective true false

True

Diluted earnings per share is a hypothetical calculation. True False

True

Errors are treated retrospectively true false

True

For a defined benefit pension plan, the employer bears the risk on assets invested to pay the future promised benefits True False

True

For basic earnings per share, preferred dividends are subtracted in the numerator if the preferred stock is cumulative. True False

True

For basic earnings per share, preferred dividends are subtracted in the numerator if the preferred stock is cumulative. True False

True

If multiple potential common shares exist, diluted earnings per share is calculated by assuming the exercise or conversion of potential common shares one at a time starting with the item that has the lowest earnings per incremental share. True False

True

If multiple potential common shares exist, diluted earnings per share is calculated by finding the lowest possible earnings per share based on all possible dilution. True False

True

The if-converted method is used to determine the potential dilution of convertible bonds. True False

True

The journal entry each year for a defined benefit pension plan would include a debit or credit to Pension-Related Asset/Liability True False

True

The present value at retirement becomes the future value in calculating the new present value at a specific age before retirement True False

True

The prospective method is used when LIFO is the new accounting method being used true false

True

The treasury stock method is used to determine the potential dilution of stock options. True False

True

Vesting refers to the employee's right to receive benefits even if he/she leaves the company. True False

True

if it is impracticable to use the retrospective method, the prospective method may be used true false

True

the balance in the Pension-Related Asset/Liability account will always equal the funded status

True

Change in accounting principle

Use of an accounting principle in the current year different from the one used in the preceding year.

The Prospective Approach:

When Retrospective Application is Impracticable (if it is impracticable to use the retrospective method, the prospective method may be used

Convertible Securities

a bond or share of preferred stock that gives its holder the right to exchange it for a stated number of shares of common stock

changes in accounting principle

a change from one generally accepted accounting principle to another

Adjust Accounts for the Change

a journal entry needs to be made to adjust accounts to the correct balances reflecting the new principle as of the beginning of the year of the change

The prospective method is applied if

a mandated change in accounting principle requires it

changes in accounting estimates

a revision in estimate because of new information

What is a defined contribution plan?

a type of retirement plan in which the employer, employee or both make contributions on a regular basis

Convertible Bonds

add back to the numerator the after-tax bond interest that wouldn't have been subtracted in calculating net income if the bonds had instead been converted to stock; add back to the denominator the number of additional shares of common stock that would have been outstanding if the bonds had been converted

Convertible Preferred Stock

add back to the numerator the preferred dividends that wouldn't have been subtracted if the preferred stock had instead been converted to common stock; add back to the denominator the number of additional shares of common stock that would have been outstanding if the preferred stocks had been converted

Basic Earnings Per Share

all companies need to report basic EPS on the face of the income statement

because there is an assumed change to the denominator but no assumed change to the numerator, the "earnings per incremental share" of dilutive options, warrants, or rights is

always $0 ($0/assumed change to the denominator; this becomes relevant later)

Revise Comparative Financial Statements: income statement:

appropriate amounts in the income statement will be adjusted as if the new method had been used in those prior years

convertible securities are only included in diluted EPS if they

are actually dilutive

Two qualitative characteristics of accounting information that contribute to relevance and representational faithfulness are

consistency and comparability

Defined Contribution Pension Plans Employer Journal Entry

debit Pension Expense credit Cash for the contributions made

The journal entry we will use for a defined benefit pension plan

debit to Pension Expense for the calculated expense from the three items covered, a credit to Cash for the amount the employer contributes to the plan assets, and a debit or credit to Pension-Related Asset/Liability for the balance

When Options are Exercised, the company

debits Cash for the amount of the option price received, debits Paid-in Capital-Stock Options for the amount related to the options exercised, and credits Common Stock (and likely Paid-in Capital-Excess of par) to record the stock issued

Stock Option Plans

employees are given the option to buy ( a) a specified number of shares of the firm's stock, (b) at a specified price, (c) during a specified period of time; as the value of the stock increases, the value of the options also increases

Issuance of New Shares

if additional shares are issued during the year, these shares are included in the denominator, weighted for the fraction of the year they were outstanding

Reacquired Shares

if shares are reacquired during the year, the weighted average number of shares outstanding is reduced by the number of shares repurchased, weighted for the fraction of the year these shares were not outstanding

Antidilutive Securities

if the assumed exercise or conversion of potential common shares outstanding would increase the EPS, these items are antidilutive and are not considered for diluted EPS, but they would be included in the disclosure notes; if a company has a basic loss per share, no assumed exercise or conversion of potential common shares could reduce EPS; in these cases, all options, warrants, rights, convertible bonds, and shares of convertible preferred stock are antidilutive, and they are not considered for diluted EPS

In considering convertible securities for diluted EPS, we use the

if- converted method

stock splits and stock dividends

increases # of shares and divides the company into more pieces

Earnings Per Share

is calculated as income available to common shareholders divided by the weighted average number of common shares outstanding during the period

The service cost

is the increase in the PBO due to the employees having worked one more year, thus earning more retirement benefits

Error Affecting a Prior Year's Net Income

most errors affect net income and therefore affect the balance sheet also; they may also affect the statement of cash flows; most errors that affect income will also have tax effects, either taxes payable or refundable or deferred tax assets or liabilities

Earnings available to common shareholders

net income - preferred dividends (In the numerator)

changes in estimate are treated using the

prospective method

Pension Expense Components we discuss

service cost, interest cost, and expected return on the plan assets

Error Discovered in the Same Reporting Period That It Occurred

simply reverse the incorrect entry and make the correct entry; or make a correcting entry to get to the correct account balances

Stock Dividends and Stock Splits

stock dividends and stock splits divide the total value of the company into more pieces, each piece being smaller than it was before; therefore, stock dividends and stock splits have to be treated retroactive to the beginning of the year (to treat all shares as the same size for the year) for the current-year EPS calculation; they would need to be treated retroactive to the beginning of the first year presented for comparative purposes in comparative financial statements

Defined Contribution Pension Plans

the amount of the employer contribution is defined by the plan; the funds are invested

Pension Plan Assets

the employer needs to invest money such that enough will be available to pay the promised benefits

The Modified Retrospective Approach

the modified retrospective method applies the new principle only to the adoption period (not to prior periods for comparative statements) and adjusts the beginning retained earnings for the current period; numbers reported in comparative statements are not adjusted

When Unexercised Options Expire

the related amount in the Paid-in Capital-Stock Options account is reclassified to a Paid-in Capital-Expiration of Stock Options account

options, warrants, or rights are dilutive

this will occur only when the average market price of the stock for the year exceeds the exercise price of the option, warrant, or right

Prospective means moving forward true false

true

depreciation, amortization, or depletion is considered to be a change in estimate achieved by a change in accounting principle; these changes are treated as changes in estimate using the prospective method true false

true

when a new accounting standard mandates a change in accounting principle, the FASB may specify the approach for handling the change or may give companies a choice of how to handle the change:

using the retrospective method, the prospective method, or a modified retrospective method

If the plan asset balance is greater

we have an overfunded amount

If the PBO is greater

we have an underfunded amount

Return on Plan Assets

we use the expected return, which decreases pension expense

Correction of Accounting Errors

when errors are discovered, they need to be corrected; they are corrected using the retrospective method