2012 Edition Becker - Financial Final Review

2012 Edition - Financial Final Review

FINANCIAL 1Accounting Changes

• Classification and Approaches

• Changes in Accounting Estimate

• Changes in Accounting Principle

• Changes in Accounting Entity

Error Corrections

• Summary of Accounting Changes and Necessary Treatments

1-1© 2011 DeVry/Becker Educational Development Corp. All rights reserved.


NOTES



SUMMARY NOTES

I. CLASSIFICATION AND APPROACHES

• Changes in an accounting estimate

• Changes in an accounting principle

• Changes in the reporting entity

• Error correction

In accounting for accounting changes and error corrections, the objective is to maintain the validity ofcomparative information.

Accounting change approaches:

• Prospective application

• Retrospective application (cumulative effect)

• Restatement approach

II. CHANGES IN ACCOUNTING ESTIMATE (prospective approach)

Adjustments for changes in accounting estimate are made in the current and future accounting periods.They do not affect previous periods. Examples include:

• Change in useful life

• Change in salvage value

• Settlement of litigation

When a change in accounting principle is inseparable from a change in accounting estimate, it should bereported as a change in accounting estimate.

III. CHANGES IN ACCOUNTING PRINCIPLE - Retrospective Application (cumulative effect)

General rule: Any change from one generally accepted accounting principle to another generally acceptedaccounting principle is recognized by adjusting beginning retained earnings for the cumulative effect of the

change, net of tax. Prior period financial statements are restated (IDEA).

The cumulative effect of a change in accounting principle is computed as of the beginning of the earliestyear presented, regardless of the actual date of the change, by applying the new principle to the item to bechanged since inception. The difference between the two principles is the catch-up amount for all prioraffected periods. It includes direct effects and only those indirect effects that are entered into the accountingrecords.

Under IFRS, when an entity applies an accounting principle retroactively or makes a retrospectiverestatement of items in the financial statements, the entity must (at a minimum) present three balance sheets(end of current period, end of prior period, and beginning of prior period) and two of each of the other financialstatements (current period and prior period). The cumulative effect adjustment would be shown as anadjustment of the beginning retained earnings on the balance sheet for the beginning of the prior period. U.S.GAAP does not have a three balance sheet requirement.



A. Exceptions to the General Rule (prospective application):

1. Impractical to Estimate

If it is considered impractical to accurately calculate this cumulative effect adjustment, then thechange is handled prospectively (like a change in estimate). An example of a change handled inthis manner is a change in inventory cost flow assumption to LIFO (U.S. GAAP only). Since acumulative effect adjustment to LIFO would require the reestablishment and recalculation of oldinventory layers, it is considered impractical to try and rebuild those old cost layers.

2. Change in Depreciation Method

A change in the method of depreciation, amortization, or depletion is considered to be both a changein method and a change in estimate. These changes should be accounted for as changes in estimateand are handled prospectively. The new depreciation method should be used as of the beginning ofthe year of change in estimate and should start with the current book value of the underlying asset.No adjustment should be made to Retained Earnings.

IV. CHANGES IN ACCOUNTING ENTITY (retrospective application)

Include changes in the companies that make up the consolidated or combined financial statements from yearto year. Hence, if 5-year comparative statements are presented, all these statements would be restated asthough all the companies were always combined. The concept of a change in accounting entity is notdiscussed in IFRS.

V. ERROR CORRECTIONS (restatement approach)

Error corrections require retroactive restatement by adjusting the beginning balance of retained earnings, netof tax, in the earliest year presented. If the error occured in a year presented, the error is corrected in thoseprior financial statements.

Under IFRS, when it is impracticable to determine the cumulative effect of an error, the entity is required torestate information prospectively from the earliest date that is practicable. U.S. GAAP does not have animpracticality exemption for error corrections.

Gracie Company

STATEMENT OF RETAINED EARNINGS (Partial)

For the Year Ended December 31, Year 1

Beginning balance (as previously reported)

Prior period adjustments:

Correction of error (net of tal( benefit of $1,800,000)

Cumulative effect of accounting change (net of tal( el(pense of $2,000,000)

Beginning balance (restated)

$28,000,000

(2,700,000)

3,000,000

$28,300,000

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VI. SUMMARY OF ACCOUNTING CHANGES AND NECESSARY TREATMENTS

Statement ofAccounting Changes Example(s) Income Statement Retained Earnings

From one GMP!IFRS • Adopt a new standard Retrospective application,

principle to another• Change methods of inventory

compute cumulative effect and

GMP!IFRS principlecosting- FIFO to Average

report net of tax by adjusting

beginning retained earnings of

earliest year presented

Changes in principle- • From any inventory valuation • Prospective application, the

Exceptions {require method to LIFO (U.S. GMP beginning inventory of theprospective treatment) only) year of change is the first LIFO

• Change depreciation methodslayer

-SUo SYD • Apply new depreciation

method to remaining book

value as of the beginning of

the year

Changes in entity • Consolidation of a subsidiary • Retrospective adjustments

not previously included in (plus or minus) net oftax,

consolidated FS against the beginning balance

• Report consolidated FS inof the retained earnings under

place of individual statementsthe caption of "Prior Period

Adjustments"

• Restate all financial statements

presented

Neither a change in • Change from cost method to • Retroactive adjustments (plus

principle nor a change equity method or minus) net of tax, against

in estimate the beginning balance ofthe

earliest retained earnings

presented under the caption of

"Prior Period Adjustments"


presented

Correction of errors • From cash to accrual • Retroactive adjustments (plus

• Errors made in prioror minus) net of tax, against

statements the beginning balance ofthe

retained earnings under the

caption of "Prior Period

Adjustments"


presented that are affected

Changes in estimate • Depreciation method • Prospective application,

• Useful life of depreciable assetaccount for in the current

statement "above the line"• Residual value

• No cumulative effect• Bad debt %

• Loss accruals



NOTES



MULTIPLE-CHOICE QUESTIONS

QUESTION 1

On January 1, Year 1, Schreiber Company purchased a $300,000 machine with a five-year useful life and nosalvage value. The machine was depreciated by an accelerated method for book and tax purposes. Themachine's carrying amount was $120,000 on December 31, Year 2. On January 1, Year 3, Schreiber changed tothe straight-line method for financial statement purposes. Schreiber's income tax rate is 40%.

Assuming that Schreiber can justify the change, in its Year 3 statement of retained earnings, what amountshould Schreiber report as the cumulative effect of this change?

1. $60,0002. $36,0003. $04. $24,000

QU ESTION 2

Gonzales Company purchased a machine on January 1, Year 1 for $600,000. On the date of acquisition, themachine had an estimated useful life of six years with no salvage value. The machine was being depreciated ona straight-line basis. On January 1, Year 4, Gonzales determined that the machine had an estimated life of eightyears from the date of acquisition. An accounting change was made in Year 4.

What is the amount of the depreciation expense that should be recorded for the year ended Year 4?

1. $75,0002. $100,0003. $60,0004. $0

QUESTION 3

On December 31, Year 10, Brown Company changed its inventory valuation method from the weighted averagemethod to FIFO for financial statement purposes. The change will result in an $800,000 decrease in thebeginning inventory at January 1, Year 10. The tax rate is 30%.

The cumulative effect of this accounting change for the year ended December 31, Year 10 in the statement ofretained earnings is:

1. $02. $800,0003. $240,0004. $560,000



QUESTION 4

The proper accounting treatment to account for a change in inventory valuation from FIFO to LIFO under U.S.GAAP is:

1. Prospective application.2. Retrospective application.3. Retroactive approach.4. Ignored.

QUESTION S

Lore Co. changed from the cash basis of accounting to the accrual basis of accounting during the current year.The cumulative effect of this change should be reported in Lore's current year financial statements as a:

1. Prior period adjustment resulting from the correction of an error.2. Prior period adjustment resulting from the change in accounting principle.3. Component of income before extraordinary item.4. Component of income after extraordinary item.

QUESTION 6

How should the effect of a change in the accounting estimate be accounted for?

1. By restating amounts reported in financial statements of prior periods.2. By reporting pro forma amounts for prior periods.3. As a prior period adjustment to beginning retained earnings.4. In the period of change and future periods if the change affects both.

QUESTION 7

On August 31 of the current year, Harvey Co. decided to change from the FIFO periodic inventory system to theweighted average periodic inventory system. Harvey uses U.S. GAAP, is on a calendar year basis and does notpresent comparative financial statements. The cumulative effect of the change is determined:

1. As of January 1 of the current year.2. As of August 31 of the current year.3. During the eight months ending August 31, by a weighted average of the purchases.4. During the current year by a weighted average of the purchases.

QUESTION 8

On August 31 of the current year, Harvey Co. decided to change from the FIFO periodic inventory system to theweighted average periodic inventory system. Harvey uses IFRS and is on a calendar year basis.

The cumulative effect of the change is shown as an adjustment to beginning retained earnings on the balancesheet for:

1. August 31 of the current year.2. December 31 of the current year.3. January 1 of the current year.4. January 1 of the prior year.



TASK-BASED SIMULATIONS

TASK-BASED SIMULATION 1: Accounting Treatments

AIlcounllnll T.._nte Authoritative Literature I Help I

On January 1, Year 2, Riggs Corporation hired a new controller. During the year, the controller working with Riggs' outside accountants

and President, made changes to existing accounting policies, instituted new accounting policies, and corrected several errors in prior

year accounting. Riggs uses U.S. GAAP and does not present comparative financial statements

For each of the transactions below, identify the classification of the transaction by double-<:Iicking in the shaded cells under

·Classification" and selecting from the list provided. Also, identify the general accounting treatment required for each transaction's

classification by doubl&-clicking in the shaded cells under "Treatment" and selecting from the list provided. The aveilable treatments are:

Retrospective application

Include the cumulative effect of the adjustment resulting from an accounting change in the Year 2 financial statements as an

adjustment to beginning retained eamings.

Retroactive teSlatement 8DProach

Adjust the Year 2 beginning retained eamings if the error or change affects a period prior to Year 2.

Prospective application

Report Year 2 and future financial statements on a new basis, but do not adjust the beginning retained eamings.

Transaction CI...ifieation Treatment-

1. Riggs manufactures heavy equipment to customer specifications on a contract basis. On thebasis that it is praferable, accounting for thase long-term contracls was switched from thecompleted-contract method to the percentage-of-<:omplelion method.

2. As a result of a production breakthrough, Riggs determined that manufacturing equipmentpreviously depreciated over 15 years should be depreciated over 20 years.

3. The equipment that Riggs manufactures is sold INith a five-year warrenty. Because of aproduction breakthrough, Riggs reduced its computation of warranty costs from 3% of sales to1% of salas.

4. Riggs changed from FIFO to average cost to account for its raw materials and work in processinventories.

5. Riggs sells extended service contracls on its products. Because related services areperformed over several years, in Year 2 Riggs changed from the cash method to 1I1e accrualmethod of recognizing income from 1I1e88 service contr1lCts.

6. During Year 2, Riggs determined that an insurance premium paid and entirely expensed inYear 1 was for the period January 1, Year 1, through January 1, Year 3.

7. Riggs changed its method of depreciating office equipment from an accelerated method to thestraight-line method to more closely reflect costs in later years.

8. Riggs instituted a pension plan for all employees in Year 2 end adopl8d U.S. GAAPStandards relating to employer's accounting for pensions. Riggs had not previously had apension plan.

9. During Year 2, Riggs increased its investment in Brunner, Inc. from a 10% interest, purchasedin Year 1, to 30%, and acquired a seat on Brunner's board of directors. As a result of itsincreased investment, Riggs changed its method of accounting for investment in subsidiary fromthe cost method to the equity method.

10. Based on improved collection procedures, Riggs changed the percentage of credit salesused to determine the allowance for uncollectible eccounts from 2% to 1%.

1-9~ 2011 DeVryjBecker Educational Development Corp. All rights reserved.


Solution

Change in accounting principle

Change in accounting estimate

Correction of an error inpreviously presented financialstatements

Neither an accounting changenor an error corrrection


Restatement approach


-

1. Change in accounting principle I Retrospective application

Switching from the completed-contract method of accounting to the percentage of completion method is a change inaccounting principle.

In this case, the cumulative effect of a change in GAAP should be shown on the statement of retained earningsagainst beginning retained earnings net of tax.

2. Change in accounting estimate IProspective application

A change in the lives of fixed assets is considered a change in estimate.

A change in accounting estimate affects only the prospective (current and subsequent) periods, not prior periods orretained earnings. Simply implement the change and continue with the accounting in future periods.

3. Change in accounting estimate IProspective application

A change in the computation of warranty costs from 3% of sales to 1% of sales is a change in accounting estimate.

A change in accounting estimate affects only the prospective (current and subsequent) periods, not prior periods orretained earnings. Simply implement the change and continue with the accounting in future periods.

4. Change in accounting principle I Retrospective application

A change in an inventory pricing method from FIFO to average cost is a change in accounting principle.

In this case, the cumulative effect of a change in GAAP should be shown on the statement of retained earningsagainst beginning retained earnings net of tax.

5. Correction of an error in previously presented financial statements I Restatement approach

A change from the cash method to the accrual method is a correction of an error in previously presented financialstatements.

When comparative financial statements are not issued (as in this case), a correction of an error requires restatementof the retained earnings from the prior period end by adjusting (net of tax) the opening balance of the current retainedearnings statement.

6. Correction of an error in previously presented financial statements I Restatement approach

The change of the accounting practice of expensing insurance premiums when paid rather than allocating them tothe periods benefited is a correction of an error in previously presented financial statements.

When comparative financial statements are not issued (as in this case), a correction of an error requires restatementof the retained earnings from the prior period end by adjusting (net of tax) the opening balance of the current retainedearnings statement.

(continued)



(continued)

7. Change in accounting estimate I Prospective application

A change in the depreciation method from an accelerated method to the straight-line method for the purpose ofmore fairly presenting the financial statements is a change in accounting method and change in estimate,which shall be treated as a change in estimate.

The new depreciation method should be used as of the beginning of the year of change in estimate and shouldstart with the current book value of the underlying asset.

8. Neither an accounting change nor an error correction I Prospective application

Instituting a pension plan and adopting statements of accounting standards to account for it, is neither andaccounting change nor an accounting error.

When a company institutes a pension plan for the first time, it affects only the prospective (current andsubsequent) periods, not prior periods or retained earnings.

9. Neither an accounting change nor an error correction I Restatement approach

A change from the cost method (less than 20% ownership) to the equity method (20% or more ownership andan influential seat in the board of directors) of accounting for an investment in subsidiary is neither anaccounting change nor a correction of an error. Proper GAAP rules were followed for the situations.

When a corporation goes from not having significant influence in an investee « 20%) to having significantinfluence in an investee (20% or more and < 50%), the equity method should be used, and the periods duringwhich the cost method was used are retroactively restated.

10. Change In Accounting Estimate I Prospective application

A change in the percentage of credit sales used to determine the allowance for uncollectible accounts (bad debt)is a change in accounting estimate.

Changes in accounting estimate are recognized only in the current and future years under the prospectiveapproach (Le., implement the new method and continue into future years).



TASK-BASED SIMULATION 2: FIFO

LIFO Authoritative Literature I Help I

Effective January 1, Year 2, an entity changed from the average cost method to the FIFO method to account for itsfinished goods inventory. Cost of goods sold under each method was as follows:

Years

Prior to Year 1

Year 1

Average Cost

$71,000

79,000

FIFO

$77,000

82,000

For cells 81 and 82, double-click in the shaded cells and select from the list provided. Enter the appropriate amountin cell 83.

~ Ix II IA B

1. Classification of transaction

2. Accounting treatment for transaction

3. Dollar amount of transaction









2012 Edition - Financial Final RevIew

-1l:'lL~.l1

1. Change in accounting principle

A change in the cost method used to account for inventory is a change in accounting principle.

2. Retrospective application

A change in the cost method used to account for inventory is accounted for using a retrospective application(cumulative effect).

3. $9,000

Yeat3'

Prior to Year 1

Year 1

Average Cost

$71,000

79,000

FIFO

$77,000

82,000

Change

$8,000

3,000

$9,000

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TASK-BASED SIMULATION 3: Straight-fine Depreciation

8tnolght~l... DoprocIIlIon IAulhorllative L"erature I Help I

In January of Year 1, an entity purchased a machine with a five-year life and no salvage value for $40,000. Themachine was depreciated using the straight-line method. On December 31, Year 2, the entity discovered thatdepreciation on the machine had been calculated using a 25% rate.

For cells 81 and 82, double-click in the shaded cell and select from the list provided. Enter the appropriate amountin cell 83.

«tP Ix II IA B

1. Classification of transaction

2. Accounting treatment for transaction

3. Dollar amount of transaction








-


2012 Edition - Financial Final RevIew

-lnl~1

1. Correction of an error in previously presented financial statements

The use of a 25% rate rather than the proper 20% rate (e.g., 100%/5 =20%) is a correction of an error.

2. Restatement approach

The incorrect recording of depreciation is corrected for all prior periods by adjusting the beginning retainedearnings net of tax of the period in which the error is discovered if no comparative statements are issued (therestatement approach).

3. $2,000

The error was discovered in Year 2; therefore, the Year 2 depreciation expense will be calculated using theproper 20% rate. The Year 1 depreciation expense (and net income) were determined using the incorrect 25%rate. The difference (5% )l $40,000 = $2,000) is a prior period correction.

Incorrect: Year 1 depreciation (25% )( $40,000) = $10,000

Correct: Year 1 depreciation (20% )( $40,000) = ($8,000)

Total = $2.000



TASK-BASED SIMULATION 4: Research

R...arch Authoritative Literature I Help I

How is a change in reporting entity accounted for? Find the proper citation that provides guidance to answer this question.

Type the topic here. Correctly formatted

FASB ASC topics are 3 or 4 digits.

--FASBASC I l-eJ-eJ-c=J

Some examples of correctly fonnatted FASB ASC responses are205-10-05-1, 323-740-S25-1, 260-1 0-60-1 A, 260-10-55-99 and

115-60-35-128A

T Research Allthoritiltive Uterat\.lre I Help IB"'ck I Home Recent Page Visits

IEnter Search Herer Search I 5e;;rch Withn I Advanced Search

Table of Contents I Prev.ous Match II I~ext I~ata-, I I PreviOUS Result II Next Result I~ FASS Liter.tur. FASS LiteratureIt' Original Pronouncements as A

IV Current TextUniform CPA Examination Authoritative LiteratureIV TopIc.llndex

Il' FASS Import

To access Authoritative Literature:

Click on Table of Contents folders at left to locate and open appropriate

documents

OR

Perform a search for a particular topic by entering text in the text boxabove. Use the buttons to the right and the links above the text box toperform more detailed or advance searches.

41 I •

Solution

Source ofanswer for this question:

FASS ASC 250-10-45-21

Keyword: Change in Reporting Entity



FINANCIAL 211Accrual Accounting

Revenue Recognition Principle

• Completed Contract Method

Percentage of Completion Method

• Installment Sales Method

Cost Recovery Method

• Intangible Assets

• Accounts Receivable

• Impairment

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NOTES

2A-2© 2011 DeVry/Becker Educational Development Corp. All rights reserved.


SUMMARY NOTES

I. REVENUE RECOGNITION PRINCIPLE

A. U.S.GAAP

Under U.S. GAAP, revenue is recognized when it is earned and realized or realizable, which occurswhen the earnings process is complete, an exchange has taken place and collection of the salesprice is reasonably assured. There are exceptions to the revenue recognition principle for specialsituations, inclusive of the percentage of completion method, installment sales method and costrecovery method.

When cash is received in advance of the revenue being earned, a deferred credit (liability) isrecognized, e.g., unearned revenue.

B. IFRS

Under IFRS, revenue transactions are divided into four categories: 1) sales of goods, 2) rendering ofservices, 3) revenue from interest, royalties, and dividends, and 4) construction contracts. Commonrevenue recognition criteria for all four categories include:

• Revenue and costs can be measured reliably.

• It is probable that economic benefits from the transaction will flow to the entity.

Each category has additional revenue recognition criteria.

II. COMPLETED CONTRACT METHOD

The completed contract method is a method for recognizing revenue on long-term construction contractsunder U.S. GAAP. If the percentage of completion on a contract cannot be reasonably estimated, thecompleted contract method must be used and revenuelincome is recognized when the contract iscompleted.

Construction in progress

Cash / Accounts payable

Accounts receivable

Progress billings

xxx

xxxxxx

xxx

Losses (100%) for the completed contract method are recognized in full as they are discovered. Thecompleted contract method is prohibited under IFRS.

III. PERCENTAGE OF COMPLETION METHOD

The percentage of completion method recognizes revenue as it is being earned on a long-term constructioncontract (matching concept) and hence is the preferred method under U.S. GAAP and the requiredmethod under IFRS. If the percentage of completion on the contract can be reasonably estimated,revenue/income is recognized based on the ratio of the cost incurred to date to the total estimated cost.Under IFRS, if the final outcome of the project cannot be reliably measured, then the cost recovery methodis required.



Losses for the percentage of completion method are recognized in full as they are discovered (e.g., 100%).

Construction in progress XXX

Cash / Accounts payable XXX

Accounts receivable XXX

Progress billings XXX

Construction in progress XXX

Current gross profit XXX

calculation of Current Gross Profit

Step #1 Total Gross Profit Contract Price

(Total Estimated Cost)

Gross Profit

Step #2 % Completed Cost to Date

Total Estimated Cost

Step #3 Gross Profit Earned to Date Step #1 x Step #2

Step #4 Current Gross Profit Gross Profit Earned to Date

(Gross Profit Previously Recognized)

Current Gross Profit

IV. INSTALLMENT SALES METHOD (Cash basis)

Under the revenue recognition principle, revenue is recognized when the earnings process is complete, andthe earnings process is not complete until collection of the sales price is reasonably assured.

If no reasonable estimate can be made of the amount that will be collected, the installment method can beused. As such, gross profit is not recognized until the cash is actually collected.

4 Steps

1. Gross profit = Sales - Cost of goods sold

2. Gross profit % = Gross profit / Sales

3. Earned gross profit =Cash collections x Gross profit %

4. Deferred gross profit =Installment receivables x Gross profit %

V. COST RECOVERY METHOD (Cash basis)

The cost recovery method is an alternative to the installment sales method when there is doubt as tocollectibility. No gross profit is recognized until the original cost of the asset is recovered.



VI. INTANGIBLE ASSETS

• Patents, copyrights, franchises, trademarks, and goodwill are common intangible assets.

• Purchased intangibles are recorded at cost. Internally developed intangibles are expensed whenincurred under U.S. GAAP because research and development costs cannot be capitalized. UnderIFRS, research costs related to internally developed intangibles must be expensed, but developmentcosts can be capitalized if certain criteria are met.

• Costs of developing, maintaining, or restoring intangible assets that are not specifically identifiable, orhave indeterminate lives, such as goodwill, are expensed when incurred.

• For intangible assets with finite lives, the cost of the asset, less its residual value, is amortized over itsuseful life, generally using the straight-line method.

• Goodwill cannot be amortized, but is subject to the impairment test.

• Intangible assets that have no legal or economic lives are considered to have indefinite useful lives.These intangible assets are not amortized but are reviewed for impairment periodically.

• Under U.S. GAAP, intangible assets are reported at cost less amortization (finite life intangibles only)and impairment.

• Under IFRS, intangible assets are reported using the cost model (same as U.S. GAAP) or therevaluation model. Under the revaluation model, revalued intangible assets are reported at fair valueon the revaluation date less subsequent amortization and impairment. Revaluation losses are reportedon the income statement and revaluation gains are generally reported in other comprehensive income.

VII. ACCOUNTS RECEIVABLE

Accounts receivable are reported at their net realizable value (AR - Allowance for Doubtful Accounts).

There are two GAAP methods to compute bad debt expense using the allowance method. The DirectWrite-off Method is not GAAP.

A. Income Statement Approach

Bad debts are estimated as a percentage of net credit sales, resulting in bad debt expense for theperiod.

Allowance for D/A

Write-ofts Beginning Balance

Recoveries

Bad Debt Expense (% of Credit Sales)

Ending Balance

2A-S© 2011 DeVry/Becker Educational Development Corp. All rights reserved.


B. Balance Sheet Approach

Bad debts are estimated as a percentage of ending accounts receivable or based on an aging ofaccounts receivable; emphasis is on the valuation of the receivables. This results in the endingbalance for allowances for doubtful accounts and the bad debt expense is the "Plug."

Allowance for D/A

Write-ofts Beginning Balance

Recoveries

Bad Debt Expense (Plug)

Ending Balance (based

on AIR not expected to

be collected)

c. Pledging

A company may use its accounts receivable as collateral for loans. The company retains title to thereceivables but pledges that it will use the proceeds to payoff the loans. Pledging requires notedisclosure only.

D. Factoring

A company may sell its receivables to a factor either with or without recourse. With recoursemeans the seller retains the risk of any losses on collection. Without recourse means that the buyerassumes the risk of any losses on collection.

VIII. IMPAIRMENT (For intangibles and long-lived assets)

The carrying amounts of intangibles (including goodwill) and fixed assets held for use and to be disposed ofneed to be reviewed at least annually or whenever events or changes in circumstances indicate that thecarrying amount may not be recoverable. The process used to determine impairment depends on the typeof asset (Le., intangible or fixed).

A. Impairment Test (U.S. GAAP)

The future cash flows expected to result from the use of the asset and its eventual disposition need tobe estimated when testing for impairment. Under U.S. GAAP, if the sum of undiscounted expected(future) cash flows is less than the carrying amount, an impairment loss needs to be recognized.

When testing an intangible asset with an indefinite life (including goodwill) for impairment, the test forrecoverability is performed by comparing the fair value of the asset to its carrying value because it isdifficult, if not impossible, to estimate future cash flows. If the fair value is less than the carryingamount, an impairment loss needs to be recognized.

The impairment loss is calculated as the amount by which the carrying amount exceeds the fair valueof the asset. U.S. GAAP does not permit the reversal of impairment losses unless the asset is heldfor disposal.



B. Impairment Test (IFRS)

Under IFRS, an impairment loss for a long-lived asset other than goodwill is calculated by comparingthe carrying value of the asset to the asset's recoverable amount. IFRS define the recoverableamount as the greater of the asset's fair value less costs to sell and the asset's value in use. Value inuse is the present value of the future cash flows expected from the intangible asset. IFRS allow thereversal of impairment losses.

C. Goodwill Impairment (U.S. GAAP)

Under U.S. GAAP, goodwill impairment is calculated on the reporting unit level. A reporting unit is anoperating segment, or one level below an operating segment. The goodwill of one reporting unit maybe impaired, while the goodwill for other reporting units mayor may not be impaired.

The evaluation of goodwill impairment is a two-step process:

Step 1: Identify potential impairment by comparing the fair value of each reporting unit with itscarrying amount, including goodwill.

1. Assign assets acquired and liabilities assumed to the various reporting units. Assign goodwillto the reporting units.

2. Determine the fair values of the reporting units and of the assets and liabilities of thosereporting units.

3. If the fair value of a reporting unit is less than its carrying amount, there is potential goodwillimpairment. The impairment is assumed to be due to the reporting unit's goodwill since anyimpairment in the other assets of the reporting unit will already have been determined andadjusted for (other impairments are evaluated before goodwill).

4. If the fair value of a reporting unit is more than its carrying amount, there is no goodwillimpairment and Step 2 is not necessary.

Step 2: Measure the amount of goodwill impairment loss by comparing the implied fair value of thereporting unit's goodwill with the carrying amount of that goodwill.

1. Allocate the fair value of the reporting unit to all assets and liabilities of the unit. Any fair valuethat cannot be assigned to specific assets and liabilities is the implied goodwill of the reportingunit.

2. Compare the implied fair value of the goodwill to the carrying value of the goodwill. If theimplied fair value of the goodwill is less than its carrying amount, recognize a goodwillimpairment loss. Once the goodwill impairment loss has been fully recognized, it cannot bereversed.

D. Goodwill Impairment (IFRS)

Under IFRS, goodwill impairment testing is done at the cash-generating unit (CGU) level. A cashgenerating unit is defined as the smallest identifiable group of assets that generates cash inflows thatare largely independent of the cash inflows from other assets or groups of assets. The goodwillimpairment test is a one-step test in which the carrying value of the CGU is compared to the CGU'srecoverable amount, which is the greater of the CGU's fair value less costs to sell and its value inuse. Value in use is the present value of the future cash flows expected from the CGU. Animpairment loss is recognized to the extent that the carrying value exceeds the recoverable amount.The impairment loss is first allocated to goodwill and then allocated on a pro rata basis to the otherassets of the CGU.



E. Impairment Depends on Asset Type

1. Impairment of Intangible Assets (Including Goodwill)

The impairment of an intangible asset is recorded by reducing the cost basis of the intangibleasset (credit intangible asset) and recording an impairment loss. If the intangible asset is nottotally impaired and the intangible asset has a finite life, then the new cost basis is amortizedover the remaining life.

2. Impairment of Long-lived Tangible Assets

a. Total Impairment

The obsolete asset and related accumulated depreciation are removed from theaccounts, and a loss is recognized for the difference.

b. Partial Impairment

The asset should be written down to a new cost basis through the accumulateddepreciation account. The cost is then depreciated over the remaining life.



FINANCIAL 28Additional Topics

• Segment Reporting

• Notes to Financial Statements

Interim Reporting

SEC Reporting Requirements

• First-Time Adoption of IFRS

• Foreign Currency Accounting

Research and Development

• Franchises

Computer Software

• Imputing Interest

2B-1ttl 2011 DeVry/Becker Educational Development Corp. All rights reserved.


NOTES



SUMMARY NOTES

I. SEGMENT REPORTING

An operating segment is a part of an enterprise:

• That engages in business activities.

• Whose operating results are regularly reviewed by the enterprise's chief operating decision maker.

• For which discrete financial information is available.

An operating segment is a reportable segment if it has at least 10% of the combined amounts of either:

• Revenue from sales to unaffiliated customers and intersegment transfers for all of the entitiesreported, or

• Profit or Loss, or

• Assets

If the segment does not meet the 10% limit, it is not separately disclosed unless all the reportable combinedsales to unaffiliated customers is less than 75% of the total company sales revenue made to outsiders. Ifthis limit is not achieved, additional segments must be disclosed despite their failure to satisfy one of thethresholds.

II. NOTES TO FINANCIAL STATEMENTS

Notes are an integral part of the financial statements. The first note is the Summary of SignificantAccounting Policies, which includes methods, policies, and criteria (e.g., methods: LIFO, FIFO, StraightLine). The other notes provide the details of the financial statements.

IFRS requires an explicit and unreserved statement of compliance with IFRS in the notes to the financialstatements.

III. INTERIM REPORTING

A. Interim financial statements are an integral part of the annual financial statements. Costs andexpenses that clearly benefit more than one interim period are allocated to the periods affected.

B. Income tax expense is estimated each quarter using the effective tax rate expected to be applicableto the full fiscal year.

C. U.S. GAAP does not establish presentation minimums for interim reporting, but reporting minimumsare outlined by the SEC. Under SEC Regulation S-X, interim financial statements should bereviewed and should include:

1. Balance sheets as of the end of the most recent fiscal quarter and as of the end of thepreceding fiscal year. A balance sheet for the corresponding fiscal quarter for the precedingfiscal year is not required unless it is necessary to understand the impact of seasonalfluctuations.

2. Income statements for the most recent fiscal quarter, for the period between the end of thepreceding fiscal year and the end of the most recent fiscal quarter, and for the correspondingperiods of the preceding fiscal year. The financial statements may also include incomestatements for the cumulative 12 month period ended during the most recent fiscal quarter andfor the corresponding preceding period.



3. Statements of cash flows for the period between the end of the preceding fiscal year and theend of the most recent fiscal quarter, and for the corresponding period for the preceding fiscalyear. The financial statements may also present statements of cash flows for the cumulative12 month period ended during the most recent fiscal quarter and for the correspondingpreceding period.

D. Under IFRS, interim financial statements are required to include, at a minimum:

1. Condensed balance sheets as of the end of the current interim period and as of the end of theimmediately preceding financial year.

2. Condensed statements of comprehensive income (single-statement or two-statementpresentation) for the current interim period and the cumulative year-to-date with comparativestatements for the comparable periods (interim and year-to-date) of the immediately precedingfinancial year.

3. Condensed statements of changes in equity cumulatively for the current financial year and forthe comparable year-to-date period of the immediately preceding financial year.

4. Condensed statements of cash flows for the current financial year-to-date and the comparableyear-to-date period of the immediately preceding financial year.

IV. SEC REPORTING REQUIREMENTS

The SEC requires that more than 50 forms be filed to comply with reporting requirements. These forms arefiled electronically through the Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system and areavailable online to the public. The following is a brief overview of several significant forms that must be filedby companies registered with the SEC.

A. Securities Offering Registration Statements

When a company issues new securities, it is required to submit a registration statement to the SECthat includes disclosures about the securities being offered for sale, information similar to that filed inthe annual filing, and audited financial statements.

B. Form 10-K

Form 10-K must be filed annually by U.S. registered companies (issuers). The filing deadline forForm 10-K is 60 days after the end of the fiscal year for large accelerated filers, 75 days after the endof the fiscal year for accelerated filers, and 90 days after the end of the fiscal year for all otherregistrants. These forms contain financial disclosures, including a summary of financial data,management's discussion and analysis (MD&A), and audited financial statements prepared usingU.S. GAAP.

C. Form 10-Q

Form 10-0 must be filed quarterly by U.S. registered companies (issuers). The filing deadline forForm 10-0 is 40 days after the end of the fiscal quarter for large accelerated filers and acceleratedfilers, and 45 days after the end of the fiscal quarter for all other registrants. This form containsunaudited financial statements prepared using U.S. GAAP, interim period MD&A, and certaindisclosures.

D. Form 8-K

This form is filed to report major corporate events such as corporate asset acquisitions or disposals,changes in securities and trading markets, changes to accountants or financial statements, andchanges in corporate governance or management.



E. Forms 3, 4 and 5

These forms are required to be filed by directors, officers, or beneficial owners of more than 10percent of a class of equity securities of a registered company.

Regulation S-X outlines the form and content of financial statements to be included in SEC filings. UnderRegulation S-X, annual financial statements filed with the SEC must be audited and must include balancesheets for the two most recent fiscal years and statements of income, changes in owners' equity, and cashflows for each of the three fiscal years preceding the date of the most recent audited balance sheet.

V. FIRST-TIME ADOPTION OF IFRS

An entity's first IFRS financial statements are the first annual financial statements in which the entity adoptsIFRS and makes an explicit and unreserved statement in those financial statements of compliance withIFRS.

An entity's first IFRS financial statements must include at least three balance sheets (end of current period,end of prior period, and beginning of prior period), two statements of comprehensive income, two incomestatements (if using the two-statement approach to presenting comprehensive income), two statements ofcash flows, two statements of changes in equity, and related notes.

VI. FOREIGN CURRENCY ACCOUNTING

Foreign currency accounting includes:

A. Foreign Currency Translation

Foreign currency translation is the conversion of a financial statement of a foreign subsidiary intofinancial statements expressed in the reporting currency of the parent company. The method used toconvert the financial statements depends on the functional currency of the subsidiary.

1. Remeasurement Method

Foreign currency remeasurement is the restatement of foreign financial statements from theforeign currency to the entity's functional currency in the following situations:

• The reporting currency is the functional currency.

• The entity's books of record must be restated in the entity's functional currency prior totranslating the financial statements from the functional currency to the reporting currency.

Remeasurement starts with the balance sheet and converts monetary items using current/yearend exchange rates and non-monetary items using historical exchange rates. The incomestatement is then converted using a weighted average exchange rate for all items except thoserelated to the balance sheet (depreciation, amortization and cost of goods sold). Balance sheetrelated items are converted using the appropriate historical rate. A gain or loss is plugged tonet income to get the required balance needed to adjusted retained earnings so that thebalance sheet balances.

*Remeasurement gains and losses are included in income.



2. Translation Method

Foreign currency translation is the restatement of financial statements denominated in thefunctional currency to the reporting currency.

Translation starts with the income statement and converts all elements using a weightedaverage exchange rate. Translated net income is transferred to retained earnings. Assets andliabilities on the balance sheet are then converted using the current/year-end exchange rate,common stockiAPIC are converted using historical exchange rates, retained earnings is rolledforward, and then a gain or loss is plugged to OCI to make the balance sheet balance.

*Translation gains and losses are part of other comprehensive income (PUEE).

B. Foreign Currency Transactions

Foreign currency transactions are transactions with a foreign entity (e.g., buying from and selling to)denominated in (to be settled in) a foreign currency.

Foreign exchange transaction gains and losses must be computed at a given balance sheet date onall recorded transactions denominated in foreign currencies that have not be settled.

On 12!1Nr 1 Green company purchased goods on credit for 100,000 pesos. Green paid for the goodson 3!1Nr 2. The exchange rates were:

Date Rate

12/1!Yr 1 $0.10

12/31!Yr 1 $0.08

3!1!Yr 2 $0.09

The journal entries related to this foreign currency transaction are:

12!1!Yr 1 Transaction Date

Purchases (100,000 pesos x 0.10 exchange rate)

Accounts payable

12!31!Yr 1 Balance Sheet Date

Accounts Payable [100,000 pesos x ($0.10 - $O.OB)]

Foreign exchange transaction gain

10,000

2,000

10,000

2,000

3!1!Yr 2 Settlement Date

Accounts Payable ($10,000 original balance - $2,000 adjustment)

Foreign exchange transaction loss [100,000 x ($O.OB - $0.09)]

Cash (100,000 pesos x $0.09)

8,000

1,000

9,000

*Transaction gains and losses are included in income from continuing operations.



VII. RESEARCH AND DEVELOPMENT

A. U.S.GAAP

Under U.S. GAAP, research and development costs must be expensed in the period incurred. Ingeneral, items to be expensed as R&D include: equipment, material, labor, overhead, design, testing,engineering, modification, and salaries of research staff. Exceptions to expensing include:

1. Alternative Use

Capitalize and then depreciate as R&D expense if alternative use on other future projects isplanned; e.g., building will be used for other projects.

2. Expense as Operating Expenses (Not R&D)

Routine periodic design changes, market research, executive salaries, quality control testing,post production cost, and commissions.

B. IFRS

Under IFRS, research costs must be expensed, but development costs may be capitalized if certaincriteria are met.

VIII. FRANCHISES

The franchisor reports revenue from franchise fees when all material conditions of the sale have been"substantially performed." Substantial performance means that the initial services required of thefranchisor have been performed and there is no obligation to refund any payment received.

IX. COMPUTER SOFTWARE

Under U.S. GAAP, costs related to computer software developed to be sold, leased, or licensed, costs areexpensed until technological feasibility has been established and capitalized after that. Capitalized costsare amortized using the greater of the straight-line method or a percentage of revenue basis. For computersoftware developed for internal use, costs in the preliminary project stage and costs incurred in training andmaintenance are expensed. Costs after the preliminary project stage are capitalized. Capitalized costs areamortized on a straight-line basis.

IFRS does not provide specific guidance for computer software development costs. Under IFRS, researchcosts related to computer software development are expensed and development costs may be capitalized ifcertain criteria are met.

X. IMPUTING INTEREST

Notes receivable and notes payable contain an interest element. Money is not loaned for free or for abelow-market interest rate. Notes are recorded at present value when the interest rate is not stated orwhen the stated interest rate is unreasonably low. The difference between the face amount of the note andthe present value of the note is recorded as a discount and amortized over the life of the note.



NOTES



FINANCIAL 311Marketable Securities

• Trading Securities

• Available-far-Sale Securities

• Held-to-Maturity Securities

Realized Gains and Losses

• Summary of Marketable Security Investments

3A-l© 2011 DeVry/Becker Educational Development Corp. All rights reserved.


NOTES


2012 Edition - Financial FInal Review

SUMMARY NOTES

I. TRADING SECURITIES

Trading securities are securities (both debt and equity) that are bought and held principally for the purposeof selling them in the near term. Trading securities are normally reported as current assets.

Trading securities are valued and reported at fair value at the end of the current reporting period.

Unrealized gains and losses on trading securities are included in income.

~ Unrealized loss

(!ill Trading securities

~ Trading securities

(!ill Unrealized gain

xxx

xxx

xxx

xxx

II. AVAILABLE-FOR-5ALE SECURITIES

Available-far-sale securities are securities (both debt and equity) that could be available for sale in thefuture. Investments that do not meet the qualifications of trading or held to maturity securities are classifiedas available-far-sale. These securities are classified and reported as either current assets or non-currentassets, depending on the intent of the corporation.

Available-far-sale are valued and reported at fair value at the end of the current reporting period.

Unrealized gains and losses on available-far-sale securities are included in equity as accumulated othercomprehensive Income until the securities are sold (e.g., PYFE).

~ Unrealized loss

(!ill Available-for-sale securities

~ Available-for-sale securities

(!ill Unrealized gain

xxx

xxx

xxx

xxx

Under IFRS, unrealized gains and losses on available-for-sale securities are reported in othercomprehensive income, except for foreign exchange gains and losses on available-far-sale debt securities,which are reported directly on the income statement. Foreign exchange gains and losses on available-forsale equity securities are included in other comprehensive income.

III. HELD-TO-MATURITY SECURITIES

Held-to-maturity securities are investments in debt securities where the company has both the positiveintent and ability to hold the securities to maturity. Held-to-maturity securities are reported as current ornon-current assets, as appropriate.

Held-to-maturity debt securities are valued and reported at amortized cost.

3A-3~ 2011 DeVryjBecker Educational Development Corp. All rights reserved.


IV. REALIZED GAINS AND LOSSES

The sale of securities results in realized gains and losses that are included in income.

Permanent declines in value (impairments) for available-for-sale securities are treated as realized lossesand included in income.

Trading Securities

!!ll! Cash

[!ill Trading securities

[!ill Realized gain

xxxxxxXXX

[!Ii] Cash

[!ill Realized loss

[!ill Trading securities

XXX

XXX

XXX

$100

$120

$150

FV 1/01!Year 1

Sold 9/15/Year 1

AVtliltJble-tor-StJle Securities

Facts:Cost

[!Ii] Cash

[!Ii] Unrealized gain (PY,FE)

[!ill Available-for-sale securities

[!ill Realized gain

$150

20

$120

SO

V. SUMMARY OF MARKETABLE SECURITY INVESTMENTS

SUMMARY OF MARKETABLE SECURITIES INVESTMENTS

Classl/lcation Balance Sheet Re/J.orted Unrealized Gain/Loss Realized Gain/Loss

Trading stocks and Current or noncurrent Fair value at balance Income statement Income statementbonds sheet date

Available-far-sale Current or noncurrent Fair value at balance Other comprehensive Realized gain/loss instocks and bonds sheet date income P.!J.FER income statement

Unrealized gain/loss isreversed

Held-to-maturity Current or noncurrent Amortized cost None Not applicable

bonds




QUESTION 1

Sykes Company, which was formed on January 1, Year 1, owned the following marketable equity securities in itsavailable-for-sale portfolio at December 31, Year 1:

A CompanyB CompanyC CompanyTotal

Cost$100,000

70,000210,000

$380,000

Market Value$130,000

20,000180,000

$330,000

The decline in value of C Company is considered permanent. How much loss, if any, should Sykes include in itsYear 1 earnings?

1. $0

2. $30,000

3. $80,000

4. $50,000

QUESTION 2

Deutsch Imports has three securities in its available-for-sale investment portfolio. Information about thesesecurities is as follows:

SecurityNCBTRREnson

Cost$78,000

$117,000$58,500

Market Value12131/Year 1 12131/Year 2

$93,600 $100,000$120,000 $0

$53,300 $50,700

TRR was sold in Year 2 for $127,400.

Which of the following statements is correct?

I. On its 12/31Near 2 balance sheet, Deutsch should report the NCB stock at its fair value of $100,000.

II. On its 12/31Near 2 balance sheet, Deutsch should report an unrealized holding gain on the NCB stock of$22,000 in stockholders' equity.

III. On its income statement for the year ending December 31, Year 2, Deutsch should report an unrealizedholding gain on the NCB stock of $22,000.

1. I only is correct.

2. I and II only are correct.

3. I and III only are correct.

4. None of the listed answers are correct.



QUESTION 3

The following data pertains to Tyne Co.'s investments in marketable equity securities:

TradingAvailable-for-sale

Cost$150,000

150,000

Market value12/311Y2 12/311Y1$155,000 $100,000

130,000 120,000

What amount should Tyne report as unrealized gain (loss) in its Year 2 income statement?

1. $55,000

2. $50,000

3. $60,000

4. $65,000

QUESTION 4

The following data pertains to Tyne Co.'s investments in marketable equity securities:

TradingAvailable-for-sale

Cost$150,000

150,000

Market value12/311Y2 12/311Y1$155,000 $100,000

130,000 120,000

What amount should Tyne report as net unrealized loss on available-for-sale marketable equity securities atDecember 31, Year 2, in accumulated other comprehensive income on the balance sheet?

1. $0

2. $10,000

3. $15,000

4. $20,000




TASK-BASED SIMULATION 1: Definition

'i' Dellnlllon IA_live uterature I Help I

Select the proper classification or accounting treatment for the marketable securities transactions (orsituations) below by clicking in the shaded cell and selecting from the list provided.

Marketable security description/accounting treatment

1. Investments in bonds issued by a corporation which theinvesting company will not liquidate prior to collection ofprincipal and interest due.

2. Equity securities purchased by an entity that has noimmediate plans to sell them.

3. Cash activity associated with the purchase and sale ofsecurities displayed in the cash flows from operating activitiesin the statement of cash flows.

4. Securities purchased by a corporation with idle/ excess cashand the corporation routinely buys and sells these securities asongoing cash requirements.

5. Unrealized gains and losses resulting from changes in thevalue of securities receive no accounting treatment.

6. Unrealized gains and losses resulting from changes in thevalue of securities are accounted for through othercomprehensive income.

Classification-

Trading securities

Available-for-sale securities

Held-to-maturity securities



Solution _

1. Held-to-maturity securities

Investments in debt securities shall be classified as held-to-maturity if the reporting enterprise hasthe positive intent and ability to hold those securities to maturity.

2. Available-for-sale securities

Investments that do not meet the qualifications of trading securities or held-to-maturity securitiesare classified as available-far-sale securities.

3. Trading securities

Cash activity from trading securities is displayed in cash flows from operating activities while cashflows from available-far-sale and held-to-maturity securities are displayed in the investing activitiessection of the statement of cash flows.

4. Trading securities

Securities that are bought and held principally for the purpose of selling them in the near term (thusheld for only a short period of time) shall be classified as trading securities.

5. Held-to-maturity securities

Held-to-maturity securities are valued at amortized cost. Non-permanent changes in the fair valueof held-la-maturity securities do not result in any adjustment to the displayed value of theinvestment.

6. Available-for-sale securities

Unrealized gains and losses resulting from changes in the fair value of available-far-sale securitiesare accounted for as a component of other comprehensive income.



TASK-BASED SIMULATION 2: Marketable Securities

'i IIarka..ble 8ecurlllu IA_I..Jlarature I Help I

The following data has been provided relative to the investment portfolio of the Zarbo Corporation. Use this information asthe data for your marketable securities task solution.

Fair Value Activity In Year 2 Fair ValueCost 12/31/Year 1 Purchases Sales 12/31/Year 2

Held-to-maturity securities

Arbor Corporation 55,000 45,000

Trading securities

Delphi Corporation 100,000 120,000 105,000

Avallable-for-sale securities

Gorman Corporation 125,000 75,000 65,000

Jubiliee Creations 125,000 140.000 130.000

Additional notes:

• Securities of the Arbor Corporation were purchased at par.

• Delphi, Gorman, and Jubilee securities were purchased during Year 1.

For each of the securities listed below, enter the amount requested in the shaded cell.

1. Compute the carrying amount of each security at December 31, Year 2.

Held-la-maturity securities

Arbor Corporation

Trading securities

Delphi Corporation

Avaifable-for-sale securities

Gorman Corporation

Jubilee Creations

2. Compute the amount of recognized gain or loss on the income statement as a result of marketablesecurities transactions.

Available-far-sale securities

Gorman Corporation

3. Compute the amount of unrealized gain or loss on the income statement as a result of marketablesecurities transactions.

Trading securities

Delphi Corporation

4. Compute the amount of unrealized gain or loss in other comprehensive income as a result ofmarketable securities transactions for Year 1.

Avaifable-for-sale securities

Gorman Corporation

Jubilee Creations

5. Compute the ending balance for accumulated other comprehensive income for Year 2.

Other comprehensive income ending balance for Year 2



Solution

1.

Held-to-maturitv securities

Arbor ColpOl8tion 55,000

Held-to-maturity securities are valued and displayed at1l1eir amortized cost. The securities of 1I1e Arbor Corporation are displayed III theirorlglnel purchase price ($55.000). The security was purchased III par so there was no premium or discount to amortize by year end.

Trading securities

Delphi Corporaijon

Trading securities are displayed III their fair value as shown above.

Availabl&-for-saie securities

Gorman Corporation

Jubiliee Craatlons

105.000

130.000

Availabl&-for-sala securities are displayed atlheir fair value. Gorman Corporation s10ck was sold and 1herefore would not be displayed.Jubilee Craalions securities are displayed at fair value 8& shown.

2.

Available-for-sale securities

Gonnan Corpot'Btion (60.000)

Inception to date raalized gains or loss8& are would ba displayed in the year in which available-for-sale securities are sold.

Selling price 65.000

Original cost (125.000)

Recognized loss (60.000)

3.

Trading securities

DBlphi Corporation

Available for sale securities

Gennan Corporation

JubifiBs Craations

(15.000)

Unrealized gains and losses 88BOciated with the change in value of trading securities are reported in the income statement while changesin 1I1e value of available-for-eale securities are reported in other comprehensive income.

Delphi Corp. FV at Year 1

Delphi Corp. FV at Year 2

Unrealized 1088 In Income statement

120.000

105.000

15.000

(50,000)15,000

4.

Compute the amount of unrealized gain or loss In other comprehensive income as a result of marketable securities transactions for Year 1.

Available-for_le securities

Gorman Corporation - Unrealized loss

Jubiliee Creations - Unrealized gain

The amount of unrealized gains and losses on available-for-sale securities displayed in other comprehensive income include 1he changesIn value from year to year for securities owned at the end of the year.

5.

Jubilee Creations

Cost

Fairvalua Year 1

Unrecognized gain Year 1

Fair valueFair value Year 2

Unrecognized loss Year 2

Ending balance Year 2 - Unrecognized gain

$125.000

140.000

$140.000

130.000

$15.000

($10.000)

S5,000

The S50.000 unrealized loss on 1he Gorman securities has been reversed upon tha sale of securities in Year 2.




T _a"'" IA_live U1erature I Halp I

In a prior period, an entity recognized an impairment loss on a marketable security classified as available-forsale. The security subsequently recovered a portion of its fair value. The entity wants to know whether thecost basis of the security can be adjusted to reflect the recovery. Find the proper citation that providesguidance on this issue.

Type the topic here. Correctly formattedFASB ASC topics are 3 or 4 digits.

..........FASBASC I 1- c=J -c=J -c=J

Some examples of correctly formatted FASB ASC responses are205-10-05-1, 323-740-S25-1, 260-10-60-1 A, 260-10-55-99 and

115-60-35-128A

, Reuarch Authoritirtive Literature I Help IIf Back 'Homo Recent Page Vlallll

I

I

I

IEnter Search Here search Search W,th,n I Advanced Search

iTable of Contents I Prev'O\J<I~1ltch II Next 1~1ltch I Prev,au< Result II Next Re",it .,

~ FASB Literature FASB Liter.ture~ Original Pronouncements 8S AH,;.;.,;,.:.:....:=.;;;;,.;;:.:....:-----------------------------lII

~~~:::I::X Uniform CPA Examination Authoritative Literatureit' FASB Import


Click on Table of Contents folders at left to locate and open appropriatedocuments

OR


~ I

Solution


FASB ASC 320-10-35-34

Keyword: Impairment of Equity Securities

3A-ll© 2011 DeVry/Becker Educational Development Corp. All rights reserved.


NOTES



FINANCIAL 38Business Combinations

• Cost Method

• Equity Method

• Consolidation



NOTES



SUMMARY NOTES

ACQUISITION

DO NOT CONSOLIDATE

CONSOLI DATE 100

COST OR EQUITY USED INTERNALLY

• Pooling is not available for new acquisitions, which were initiated after JulV 1, 2001.

I. COST METHOD

The cost method should be used when the investor owns less than 20% of the investee's voting stock anddoes not exercise significant influence. However, if the investor owns less than 20% of the stock of an

investee company, but exercises significant influence, the equity method must be used.

With the cost method, income from the investee is the amount of cash dividends received. The

investment is accounted for as either a trading or an available-far-sale security at fair value.

Unrealized gains/losses on trading securities are included in income; unrealized gains/losses on available

for-sale securities are included in other comprehensive income.

Liquidating dividends are dividends in excess of retained earnings.

Investment(Trading/Available-for-Salel

Cost I Unrealized lossesUnrealized gains Liquidating dividends

Income(Trading Securities)

Income(Available-for-Sale)

I Cash dividends

Other Comprehensive Income(Available-far-Sale)

II. EQUITY METHOD

The equity method must be used if the investor has significant influence over the investee. Even if theinvestor owns less than 20% of the stock of an investee company, but exercises significant influence,the equity method must be used.

With the equity method, income/loss from the investee is the pro rata share of the investee'sincome/loss. The carrying amount of the investment is reduced by the pro rata share of the dividendspaid by the investee.

FV adjustment is the difference between the FV and BV of the assets and/or liabilities of the investee.FV adjustments for noncurrent assets other than land are subject to depreciation (e.g., equipment).



Investment IncomeCost%of net income

% of cash dividendsFV adjustmentDepreciation

FV adjustmentDepreciation

% of Net income

Under both U.S. GAAP and IFRS, joint ventures are accounted for using the equity method.

III. CONSOLIDATION

A. When to Consolidate

Consolidated financial statements are prepared when a parent-subsidiary relationship has beenformed. An investor is considered to have parent status when more than 50% of the voting stock ofthe investee has been acquired. Do not consolidate when subsidiary is in legal reorganization orbankruptcy (parent does not control the sUbsidiary).

B. Acquisition Method

In a business combination accounted for as an acquisition, the subsidiary may be acquired for cash,stock, debt securities, etc. The investment is valued at the fair value of the consideration given or thefair value of the consideration received, whichever is the more clearly evident. The accounting for anacquisition begins at the date of acquisition.

The following is a summary of the accounting for costs related to an acquisition businesscombination:

•

•

•

•

Direct out-of-pocket costs are expensed as incurred. (Debit: Expense)

Stock registration and issuance costs are a direct reduction of the value of the stock issued.(Debit: Paid-in capital account)

Indirect costs are expensed as incurred. (Debit: Expense)

Bond issue costs are capitalized and amortized. (Debit: Bond issue costs)

Consolidating Workpaper Eliminating Journal Entry

The year end consolidating journal entry known as the consolidating workpaper eliminating journalentry (EJE) is:

C !!ru Common stock - subsidiary $XXX

A !!ru A.P.I.C - subsidiary XXX

R i!li! Retained earnings - subsidiary XXX

I [!ill Investment in subsidiary $XXXN [!ill Noncontrolling interest XXX~ !!ru Balance sheet adjusted to fair value XXX

!!ru Identifiable intangible asset fair value XXX

G !!ru Goodwill XXX

The consolidated balance sheet will report the equity of the parent company only. The parent'sinvestment in the subsidiary is eliminated.



c. Noncontrolling Interest

Noncontrolling interest is recognized in the consolidated financial statements when the parentcompany owns less than 100% of the subsidiary. Noncontrolling interest on the balance sheet is thenoncontrolling shareholder's share of the fair value of the subsidiary. Under U.S. GAAP, thenoncontrolling interest included in equity on the balance sheet is calculated as:

Noncontrolling interest (BS) = Fair value of subsidiary x Noncontrolling interest percentage

Noncontrolling interest must be recognized as a line item deduction on the income statement for theportion of the subsidiary's net income not allocated to the parent company:

Noncontrolling interest in net income of subsidiary = Subsidiary net income x Noncontrolling interest percentage

Comprehensive income attributable to the noncontrolling interest is presented on the consolidatedstatement of comprehensive income. A reconciliation at the beginning and end of the period of thecarrying amount of the equity attributable to the noncontrolling interest is shown on the consolidatedstatement of changes in equity.

Under IFRS, noncontrolling interest (and goodwill) can be calculated using either the full goodwillmethod, which is the method required under U.S. GAAP, or the partial goodwill method. Under thepartial goodwill method, noncontrolling interest on the balance sheet is calculated as:

Noncontrolling interest (BS) = Fair value of subsidiary's net assets x Noncontrolling interest percentage

D. Fair Value Adjustment/Goodwill

The difference between the fair value of the subsidiary and the book value of the subsidiary netassets should be allocated as follows:

1. Balance sheet adjustment of the subsidiary's assets and liabilities from book value to fair value.

2. Identifiable intangible assets recorded at fair value.

3. Goodwill is excess. Under U.S. GAAP, goodwill is calculated as follows (full goodwill method):

Goodwill = Fair value of subsidiary - Fair value of subsidiary's net assets

IFRS permits the use of the full goodwill method or the partial goodwill method. Under the partialgoodwill method, goodwill is calculated as follows:

Goodwill = Acquisition cost - Fair value of subsidiary's net assets acquired

Goodwill recognized in a business combination is not amortized. Instead, it is tested forimpairment, and a loss is recognized in income from continuing operations if the goodwill isimpaired.

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E. Gain

When a subsidiary is acquired for less than the fair value of 100% of the underlying assets acquired,the acquisition cost is first allocated to the fair value of 100% of the balance sheet accounts and thefair value of 100% of the identifiable intangible assets acquired. This creates a negative balance inthe acquisition cost account, which is recognized as a gain in the period of the acquisition.

F. Eliminate 100% of Intercompany Transactions

Pavable / Receivable

In a consolidated balance sheet, all intercompany payables and receivables are eliminated.

!!l2 Account payable

[!G] Accounts receivable

xxxxxx

Inventorv

Affiliated companies often sell inventory to one another. Intercompany sales and intercompany costof goods sold should be eliminated. This entry is made if the books are open.

Any intercompany profit from the intercompany inventory transaction must also be eliminated againstthe purchaser'S ending inventory and cost of goods sold.

!!l2 Sales

[!G] Cost of goods sold

[!G] Cost of goods sold (RE)

[!G] Inventory

xxxxxxXXX

XXX

Fixed Assets

The gain or loss on the intercompany sale of a depreciable asset is unrealized from a consolidatedfinancial statement perspective until the asset is sold to an outsider. A working paper eliminatingentry in the period of the intercompany sale eliminates the intercompany gain/loss and adjusts theasset and the accumulated depreciation to their original balances on the date of sale. Theexcess depreciation on the gain must also be eliminated.

!!l2 Gain XXX

[!G] Equipment XXX

[!G] Accumulated depreciation XXX

!!l2 Accumulated depreciation XXX

[!G] Depreciation expense (RE) XXX



Bonds

If one member of the consolidated group acquires an affiliate's debt from an outsider, the debt isconsidered to be retired and a gain/loss is recognized. This gain/loss on extinguishment of debt iscalculated as the difference between the price paid to acquire the debt and the book value of thedebt.

This gain/loss is not reported on either company's books, but is recorded on the consolidated incomestatement through an elimination entry. All intercompany account balances are also eliminated;e.g., bond interest payable and bond interest receivable.

i!ll'! Bonds interest payable XXX

t!ii] Bond interest receivable XXX

!!l2 Bonds payable XXX

!!l2 Premium on bonds payable XXX

i!ll'! Loss XXX

t!ii] Investment in bonds XXX

t!ii] Discount on bonds payable XXX

t!ii] Gain XXX

G. Acquisition Method Summary

Assets Fair value

Liabilities Fair value

Retained earnings Parent only

Income After acquisition date

Goodwill Yes (subject to Impairment adjustment)

Noncontrolling interest Yes (up to 49%)

Investment in subsidiary Eliminated

Intercompany transactions Eliminate 100%



NOTES




QUESTION 1

Pal Corpo's current year dividend income included only part of the dividend received from its Ima Corp.investment. The balance of the dividend reduced Pal's carrying amount for its Ima investment. This reflects thatPal accounts for its Ima investment by the:

1. Cost method, and only a portion of Ima's current year dividends represent Ima's earnings.

2. Cost method, and its carrying amount exceeded the proportionate share of Ima's market value.

3. Equity method, and Ima incurred a loss in the current year.

4. Equity method, and its carrying amount exceeded the proportionate share of Ima's market value.

QUESTION 2

On July 1, Year 1, Houston Corp. purchased 3,000 shares of Astro Company's 10,000 outstanding shares ofcommon stock for $20 per share. On December 15, Year 1, Astro paid $40,000 in dividends to its commonstockholders. Astro's net income for the year ended December 31, Year 1 was $120,000, earned evenlythroughout the year. In its Year 1 income statement, what amount of income from this investment should Houstonreport?

1. $36,000

2. $18,000

3. $12,000

4. $6,000

QUESTION 3

Birk Co. purchased 30% of Sled Coo's outstanding common stock on December 31 for $200,000. On that date,Sled's stockholders' equity was $500,000, and the fair value of its identifiable net assets was $600,000. OnDecember 31, what amount of goodwill should Birk attribute to this acquisition?

1. $0

2. $20,000

3. $30,000

4. $50,000



QUESTION 4

On January 2, Year 1, Kean Co. purchased a 30% interest in Pod Co. for $250,000. On this date, Pod'sstockholders' equity was $500,000. The carrying amounts of Pod's identifiable net assets approximated their fairvalues, except for land whose fair value exceeded its carrying amount by $200,000. Pod reported net income of$100,000 for Year 1, and paid no dividends. Kean accounts for this investment using the equity method. In itsDecember 31, Year 1, balance sheet, what amount should Kean report as investment in subsidiary?

1. $210,000

2. $220,000

3. $270,000

4. $280,000

QUESTION S

Port, Inc. owns 100% of Salem, Inc. On January 1, Port sold Salem delivery equipment at a gain. Port hadowned the equipment for two years and used a five-year straight-line depreciation rate with no residual value.Salem is using a three-year straight-line depreciation rate with no residual value for the equipment.

In the consolidated income statement, Salem's recorded depreciation expense on the equipment will bedecreased by:

1. 20% of the gain on sale.

2. 331/3% of the gain on sale.



QUESTION 6

On December 31, Saxon Corporation was merged into Philadelphia Corporation. In the business combination,Philadelphia issued 200,000 shares of its $10 par common stock, with a market price of $18 a share, for all ofSaxon's common stock. The stockholders' equity section of each company's balance sheet immediately beforethe combination was:

Common stockAdditional paid-in capitalRetained earnings

Philadelphia$3,000,000

1,300,0002,500,000

$6,800,000

Saxon$1,500,000

150,000850,000

$2,500,000

In the December 31 consolidated balance sheet, additional paid-in capital should be reported at:

1. $950,000

2. $1,300,000

3. $1,450,000

4. $2,900,000

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QUESTION 7

On February 1, Plato Company issued 10,000 shares of its $10 par value common stock for all the outstanding20,000 shares of Socrates Company's $5 par value stock. Plato's shares were traded on the New York StockExchange at $30 per share on the acquisition date. In addition, Plato paid $10,000 for finder's fees toconsummate the acquisition. At that date, the fair values of all of the assets and liabilities of Socrates except forland were equal to their book values of $200,000. The replacement cost/fair value of the land was $40,000 inexcess of its book value. Socrates had no identifiable intangible assets.

What amount should Plato record as goodwill under U.S. GAAP?

1. $40,000

2. $60,000

3. $70,000

4. $100,000

QUESTION 8

Post Company paid $100,000 for all the assets and liabilities of Script Corporation. Script Corporation's assetshad a book value of $200,000 and a fair value of $210,000. Script's liabilities had a book value (equal to fairvalue) of $40,000. How much gain should Post recognize from this acquisition?

1. $0

2. $10,000

3. $50,000

4. $70,000



NOTES



FINANCIAL 411Inventory

• Perpetual and Periodic Concepts

Inventory Valuation Methods

• Inventory Costing Methods

Dollar-value LIFO

• Gross Profit Method

• Co nve ntio na IReta i I Method

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NOTES



SUMMARY NOTES

I. PERPETUAL AND PERIODIC CONCEPTS

Inventory is property held for resale, property held in production (work-in-process), or raw materialsconsumed in the process of production. Just like the cost of any other asset, the cost of inventory includesall costs incurred in getting the inventory onto the premises and ready for sale or use.

Inventory is accounted for under either a periodic method or a perpetual method. With the perpetualmethod, a running total of the inventory is maintained as goods are purchased and sold and the cost ofgoods sold is updated as sales occur. With the periodic method, a running total is not maintained, and thecost of goods sold cannot be determined until the end of the period when the ending inventory is counted.

A. Periodic Inventory - Cost ofGoods Sold

Beginning inventory

Plus: Purchases

Equal: Cost of goods available for sale

Less: Ending inventory

Cost of goods sold

B. Goods in Transit

1. FOB Shipping Point

xxxXXX

XXX

(XXX)

xxx

Title passes to the buyer when goods are shipped and in transit. Hence title passed whenshipped, but no possession.

2. FOB Destination

Title passes to the buyer when goods are received. Hence, no title and no possession untilreceived.

II. INVENTORY VALUATION METHODS

A. U.S.GAAP

Under U.S. GAAP, inventory is valued at the lower-of-cost-or-market. Cost is determined using anappropriate inventory cost flow assumption. Market generally means current replacement cost,provided the current replacement cost does not exceed net realizable value (the "market ceiling") orfall below net realizable value reduced by normal profit margin (the "market floor").

B. International Financial Reporting Standards (IFRS)

Under (FRS, inventory is valued at the lower-of-cost-or-net realizable value. Cost is determinedusing an appropriate inventory cost flow assumption. Net realizable value is net selling price lesscosts to complete and sell the inventory.

Under both IFRS and U.S. GAAP, the appropriate inventory valuation method can be applied to a singleitem, a category, or total inventory, provided that the method most clearly reflects periodic income.



III. INVENTORY COSTING METHODS

The common inventory cost flow methods are specific identification, FIFO, LIFO, and weighted average.LIFO is not permitted under IFRS.

A. FIFO

FIFO inventory consists of the most recent costs and the cost of goods sold consists of the oldercosts.

B. LIFO

UFO inventory consists of the older costs and the cost of goods sold consists of the most recentcosts.

In periods of rising prices, FIFO and LIFO will have opposite effects on inventory, cost of goodssold and net income. FIFO results in the highest inventory, and reports the lowest cost of goods soldand hence the highest net income. LIFO reports the lowest inventory, and reports the highest pricesin cost of goods sold and hence the lowest net income. In periods of decreasing prices, the effectsare of course the opposite.

On the CPA Exam, prices are generally rising, therefore:

LIFO = Lowest ending inventory I Lowest net income

FIFO = Highest ending inventory I Highest net income

Questions related to the effect of overstatement and understatement errors are common on theexam. Note that if ending inventory is overstated, then cost of goods is understated, and net incomeis overstated; if ending inventory is understated, the opposite is true. Errors in ending inventory havethe same effect on net income (move in the same direction); errors in beginning inventory move in theopposite direction.

Ending inventory -----+ Averaging methods

Weighted average -----+ Used with periodic inventory

W. h d . Cost of goods available for sale

elg te average cost per Unit = ------':::....--------Number of units available for sale

C. Moving Average - used with perpetual inventory

The unit cost changes each time there is a new purchase.

Units Units Cost Total Costs Total Units Moving Average

Beginning inventory

Purchases

100

200

$5

$6

$500

$1700

100

300

$5.00

$5.67



IV. DOLLAR-VALUE LIFO

• Inventory under dollar-value UFO is measured in dollars and is adjusted for changing price levels.When converting from FIFO to dollar-value LIFO, a price index is used.

• The company groups similar inventory items into "pools."

• Each pool is assigned a conversion index. It can be computed internally or obtained from externalsources.

A. Calculation

1. Internally computed price index formula:

P. . d Ending inventory at current year dollar

nce In ex = -----'''-----'------'-----Ending inventory at base year dollar

2. The LIFO layer added in the current year is multiplied by the price index and added to thedollar-value LIFO computation.

At Base At Current At Dol/or

Date Year Cost Year Cost Value LIFO

1/1/X1 $50,000 $50,000 $50,000

Year 1 Layer 10,000 40,000 ?? (aJ

12/31/X1 $60.000 $90.000 ?? (b)

Step #1: $90,000/$60,000 =3/2

Step #2: $10,000 x 3/2 =$15,000 [a)

Step #3: $50,000 + $15,000 =$65,000 [b)

V. GROSS PROFIT METHOD

The gross profit method can be used to prepare interim financial statements. The gross profit % is knownand is used to calculate cost of goods sold.

Sales

CGS

Gross Profit

100%

80% (Plug)

20%



VI. CONVENTIONAL RETAIL METHOD

Converts inventory at retail to inventory at cost. This is accomplished via a cost/retail ratio. Markups areincluded in the ratio, whereas, markdowns are excluded, resulting in lower of cost or market.

Beginning Inventory

Purchases

Markups

Available for Sale

Sales

Markdowns

Ending Inventory at Retail

Ending Inventory at LCM (15,000 x .40)

At Cost$15,000

5,000

At Retail$35,000

12,000

3,000

$50,000 = 40% Cost/Retail ratio

(30,000)

[5,000)

$15,000




QUESTION 1

Giddens Company adopted the dollar-value LIFO inventory method on December 31, Year 1. On December 31,Year 1, Giddens' inventory was in a single inventory pool and was valued at $400,000 under the dollar-valueLIFO method. Inventory data for Year 2 are as follows:

12/31/Year 2 inventory at year-end prices

Price index at 12/31/Year 2 (base year Year 1)

$550,000

110

Giddens' inventory at dollar-value LIFO at December 31, Year 2 is:

1. $440,0002. $510,0003. $500,000

4. $550,000

QU ESTION 2

Mixon Corporation, a manufacturer of small tools, provided the following information from its accounting recordsfor the year ended December 31, Year 1:

Inventory at December 31, Year 1 (based on a physical count ofgoods in Mixon's plant at cost on December 31, Year 1)

Accounts payable at December 31, Year 1

Net sales (sales less sales returns)

Additional information follows:

$1,750,000

1,200,000

8,500,000

1 Included in the physical count were tools billed to a customer FOB shipping point on December 31, Year 1. Thesetools had a cost of $28,000 and were billed at $35,000. The shipment was on Mixon's loading dock at 5:00 PM onDecember 31, Year 1 waiting to be picked up by the common carrier.

2. Goods were in transit from a vendor to Mixon on December 31, Year 1. The invoice cost was $50,000, and thegoods were shipped FOB shipping point on December 29, Year 1.

What would be the adjusted inventory at December 31, Year 1?

1. $1,750,0002. $1,715,0003. $1,700,000

4. $1,800,000



QUESTION 3

The financial statements of Seabrooke Imports for Year 1 and Year 2 had the following errors:

Ending inventoryRent expense

Year 1$4,000 overstated$2,400 understated

Year 2$8,000 understated$1,300 overstated

By what amount would Year 1 earnings be overstated or understated if these errors are not corrected?

1. $6,400 overstated.2. $6,400 understated.

3. $1,600 understated.4. $1,600 overstated.

QUESTION 4

The Loyd Company had 150 units of product Omega on hand at December 1, Year 1 costing $400 each.Purchases of product Omega during December were as follows:

DateDecember 7December 14December 29

Units100200300

Unit Cost$440$460$500

Sales during December were 500 units. The cost of inventory at December 31, Year 1 under the LIFO methodwould be:

1. $100,0002. $104,000

3. $75,0004. $125,000

QUESTION S

Simmons, Inc. uses lower-of-cost or market (U.S. GAAP) to value its inventory. Data regarding an item inits inventory is as follows:

CostReplacement costSelling priceCost of completionNormal profit margin

$262030

2

7

What is the lower-of-cost-or-market for this item?

1. $212. $203. $28

4. $26



QUESTION 6

Simmons, Inc. uses lower of cost or net realizable value (IFRS) to value its inventory. Data regarding an item inits inventory is as follows:

CostReplacement costSelling priceCost of completionNormal profit margin

$262030

27

What is the lower of cost or net realizable value for this item?

1. $182. $263. $284. $30

QUESTION 7

The following information pertained to Azur Co. for the year:

PurchasesPurchase discountsFreight-inFreight-outBeginning inventoryEnding inventory

$102,80010,28015,420

5,14030,84020,560

What amount should Azur report as cost of goods sold for the year?

1. $102,8002. $118,2203. $123,3604. $128,500



NOTES




TASK-BASED SIMULATION 1: Inventory

Inventory Authorltallve Literature I Help I

Blake Industries is computing the value of its inventory for financial statement presentation under U.S. GAAP. Ineach of the following independent circumstances, select the value of inventory that Blake Industries should use bydouble-clicking in the shaded cell and selecting from the list provided.

1. Inventory replacement cost is greater than historical cost but less thannet realizable value. Historical cost was greater than net realizable valuenet of normal profit margin.

2. Inventory historical cost exceeds replacement cost and replacementcost exceeds net realizable value.

3. Inventory historical cost is less than replacement cost but more than netrealizable value.

4. Replacement cost is less than net realizable value net of normal profitmargin and historical cost is less than net realizable value but greater thanthe net realizable value net of normal profit margin.

5. Historical cost is less than net realizable value net of normal profitmargin. Replacement cost is less than both the historical cost and the netrealizable value net of normal profit margin.

6. The net realizable value exceeds both historical cost and replacementvalue. The net realizable value net of normal profit margin is less than bothhistorical cost and replacement values. Replacement value is less thancost.

7. Abbott Corporation has a purchase agreement with Blake Industries tobuy product for a price 25 percent more than cost, an amount far morethan the product's replacement costs or current net realizable valueoutside of the purchase agreement.

Historical cost

Replacement cost

Net realizable value

Net realizable value net ofnormal profit margin



Solution

1. Historical cost

Inventory is valued at the lower of historical cost or market. Market is the median (middle) value of the inventory's replacementcost, net realizable value (market ceiling) and net realizable value net of nonnal profit margin (market floor). Determine thesolution by ordering the values presented, determine the market value and select the lower of cost or market. In this case, theorder of values is as follows:

Net realizable valueReplacement costHistorical costNet realizable value net ofnormal profit margin

The replacement cost is the market value in this circumstance. Market is greater than historical cost. Inventory would bevalued at historical cost.

2. Net realizable value


Historical costReplacement costNet realizable valueNet realizable value net ofnormsl profit margin

The net realizable value is the market value in this circumstance. Market is less than historical cost. Inventory would bevalued at market which is net realizable value.

3. Net realizable valua


Replacement costHistorical costNet realizable valueNet realizable value net ofnormal profit margin

The net realizable value is the market value in this circumstance. Market is less than historical cost. Inventory would bevalued at market which is net realizable value.

4. Net realizable value net of nonnal profit margin

Inventory is valued at the lower of historical cost or market. Market is the median (middle) value of the inventory's replacementcost, net realizable value (market ceiling) and net realizable value net of normal profit margin (market floor). Determine thesolution by ordering the values presented, determine the market value and select the lower of cost or market. In this case, theorder of values is as follows:

Net realizable valueHistorical costNet realizable value net ofnormal profit marginReplacement cost

The net realizable value net of normal profit margin is the market value in this circumstance. Market is less than historicalcost. Inventory would be valued at market which is net realizable value net of normal profit margin.

(continued)



(continued)

5. Historical cost


Net realizable valueNet realizable value net ofnormal profit marginHistorical costReplacement cost

The net realizable value net of normal profit margin is the market value in this circumstance. Market is greater than historicalcost. Inventory would be valued at historical cost.

6. Replacement cost


Net realizable valueHistorical costReplacement costNet realizable value net ofnormal profit margin

The replacement cost is the market value in this circumstance. Market is less than historical cost. Inventory would be valuedat market, which is replacement cost.

7. Historical cost

Inventory is generally valued at the lower of historical cost or market. The lower of cost or market rule does not apply if thecompany has a firm sales price contract. In this instance, Blake is assured of a sales price from its purchase contract withAbbott regardless of the market price. Inventory would be valued at historical cost.




Research IAuthorilallve Literature I Help

Comparisons of inventory costs with market value are necessary to determine fair presentation of inventory.Market value, however, is subject to a specific definition. How do the professional standards define market inrelation to inventory valuation?



--FASB ASC I l-eJ-eJ-c=J

Some examples of correctly formatted FASB ASC responses are205-10-05-1. 323-740-S25-1 , 260-1 0~0-1 A, 260-10-55-99 and

115-60-35-128A

,Research Authoritative lher:lture I H~lp II Back I Home Recent Peae Vis",

IEnter search Here.

5eardJ I Seer,h V-lith n I Advanced Search

Table of Contents I PreVlO\j, ',<&tch iii Next j~etdJ I I PrevlO\j, Result II I Next Result I~ FASB Literature FASB Literature

I.kI Ortg~al Pronouncement••• A

IV Current TextUniform CPA Examination Authoritative LiteraturelV Topical Index

II:' FASB Import



OR

Perform a search for a particular topic by entering text in the text boxabove. Use the buttons to the right and the lin ks above the text box toperform more detailed or advance searches.

• •

Solution


FASB ASC 330-10-20 (Glossary)

Keyword: Lower of cost or market



FINANCIAL 48Fixed Assets

Non-monetary Exchanges

• General Concepts

• Reporting Fixed Assets

• Investment Property (IFRS)

• Interest on Self-constructed Assets

Depreciation

• Impairment of Fixed Assets

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NOTES



SUMMARY NOTES

I. NON-MONETARY EXCHANGES

Non-monetary exchanges are categorized either as exchanges that have "commercial substance" orexchanges that "lack commercial substance."

A. Exchanges Having Commercial Substance (U.S. GAAP)

An exchange has commercial substance if the future risk, timing or amount of cash flows change as aresult of the transaction. A fair value approach is used.

• Gains/Losses are always recognized on exchanges having commercial substance.

• Gains/Losses are the difference between the FV and BV of the old asset.

• The fair value of assets given up is assumed to be equal to the fair value of assets received,including any cash given or received in the transaction.

New asset (FV of old asset plus cash given, if any)

Accumulated depreciation of asset given up

Cash received (if any)

Loss (if any)

Old asset at historical cost

Cash given (if any)

Gain (if any)

xxxxxxxxxxxx

xxxXXX

xxx

B. Exchanges Lacking Commercial Substance (U.S. GAAP)

If projected cash flows after the exchange are not expected to change significantly, then theexchange lacks commercial substance and a book value approach is used.

• All losses are recognized on exchanges lacking commercial substance.

• Gains are recognized based on the nature of the transaction:

o No boot received =No gain

o Boot given =No gain

o Boot >= 25% of total consideration received = Recognize all gain

o Boot < 25% of total consideration received = Recognize gain in proportion to boot received

C. Exchanges of Similar Assets and Dissimilar Assets (IFRS)

Under IFRS, nonmonetary exchanges are characterized as exchanges of similar assets andexchanges of dissimilar assets. Exchanges of dissimilar assets are regarded as exchanges thatgenerate revenue and are accounted for in the same manner as exchanges having commercialsubstance under U.S. GAAP. Exchanges of similar assets are not regarded as exchanges thatgenerate revenue and no gains are recognized.



II. GENERAL CONCEPTS

The cost of a fixed asset (or any other asset) is the cost to acquire the asset and place it in condition for itsintended use. As an example, purchased equipment would include purchase price, freight in, installation,sale taxes, etc.

• Ordinary repairs are expensed, not capitalized.

• Extraordinary repairs should be capitalized if they increase the usefulness of the asset and should berecorded by decreasing accumulated depreciation if they increase the life of the asset.

• Land is not a depreciable asset; land improvements are.

• Sometimes, fixed assets are acquired in a "basket" purchase. The amount paid must be allocated tothe various assets acquired, generally on a relative fair value or appraisal value basis.

III. REPORTING FIXED ASSETS

Under U.S. GAAP, the carrying value of a fixed asset is calculated as follows:

Carrying value =Historical cost - Accumulated depreciation - Impairment

Under IFRS, fixed asset carrying value can be calculated using the cost model or the revaluation model.The cost model is the method used under U.S. GAAP. Under the revaluation model, fixed assets arerevaluated to fair value by asset class at a specific point in time and then reported as follows:

Carrying value (revaluation model) = Fair value on revaluation date - Subsequent accumulated depreciation

- Subsequent impairment

When fixed assets are revalued under IFRS, revaluation losses are reported on the income statement andrevaluation gains are reported in other comprehensive income as revaluation surplus. When the fair valueof a revalued asset differs materially from its carrying amount, a further revaluation is required.

IV. INVESTMENT PROPERTY (IFRS)

Under IFRS, investment property is defined as land and/or buildings held to earn rental income or for capitalappreciation. Investment property is reported on the balance sheet using the cost model or the fair valuemodel. U.S. GAAP does not have an investment property classification.

A. Cost Model

Under the cost model, investment property is reported at historical cost less accumulateddepreciation. When the cost model is used, the fair value of the investment property must bedisclosed.

B. Fair Value Model

Under the fair value model, investment property is reported at fair value and is not depreciated. Theinvestment property should be revalued with regularity so that the carrying value does not differmaterially from fair value. A gain or loss arising from a change in the fair value of investment propertyis recognized in earnings in the period in which it arises.



V. INTEREST ON SELF-CONSTRUCTED ASSETS

Interest on self-constructed assets is capitalized based on the weighted average of the accumulatedexpenditures multiplied by an appropriate interest rate and cannot exceed actual interest costs. Intereston inventory routinely manufactured is not capitalized.

VI. DEPRECIATION

Generally, the depreciation methods on the CPA exam include straight-line, sum-of-the-years-digits, anddeclining balance methods. Depreciation is a rational and systematic cost allocation process closelytied to properly matching revenue and expenses. Under IFRS, the depreciation method used must matchthe expected pattern of fixed asset consumption. This is not required under U.S. GAAP.

A. Component depreciation is required under IFRS. Separate significant components of a fixed assetwith different lives should be recorded and depreciated separately. The carrying amount of parts orcomponents that are replaced should be derecognized.

Depreciation is caused by physical factors such as wear, tear and use.

1. Straight-Line

Cost-Salvage value

Estimated useful lifeDepreciation expense

2. Units-of-Production {Productive Output}

Cost -salvage value Depreciation Units produced or = DepreciationTotal estimated units or hours = rate xhours used in a period expense

3. Sum-of-Years'-Digits

Depreciation rateRemaining life

SYD

The numerator is the remaining life of the asset at the beginning of the current year.

The denominator is the sum of the digits for the number of years of asset life (3-year life = 1 + 2

+ 3 = 6):

( )Remaining life

Cost-Salvage value x---=---SYD

Depreciation expense

B. Declining Balance

The salvage value is not considered upfront; it is considered at the end.

The asset should never be depreciated below the estimated salvage value.

BV x * Rate = Depreciation for the period

100%*Rate=--=R

N

N= Useful life

If double = 2RIf 150% = 1.5R



VII. IMPAIRMENT OF FIXED ASSETS

Fixed assets are reviewed for impairment at least annually. Under U.S. GAAP, the impairment test is atwo-step test that is similar in concept to the two-step impairment test for goodwill. The details of theaccounting treatment are actually slightly different for long-term assets to be held and used than for longterm assets to be disposed of.

The first step of the impairment test is a screening test to determine if the asset is impaired. In the firststep, the total future undiscounted cash flows expected from the use of the asset is compared to thecarrying amount of the asset; if the total undiscounted cash flows is less than the carrying amount,there is an impairment loss. If not, there is no impairment loss and the second step of the impairment testis not needed.

The second step of the impairment test measures the amount of the impairment loss by the differencebetween the fair value of the asset and the carrying amount of the asset. The asset is written down to itsfair value, and an impairment loss is recognized in income from continuing operations.

Income statement presentation depends on whether the assets are to be held and used or are to bedisposed of.

$120.000 Undiscounted future net cash flows $80,000

(100,000) < Net carrying value> (100,000)

lli.2QQ ~

Positive ~

+ +I No impairment loss I I Impairment I

Assets held Assets heldfor use for disposal

I IFair value $60,000 Fair value $60,000< Net carrvlng value> 1100.000\ < Net canylng value> (100,000)Impairment 'Pss S4000Q Impairment loss $40,000

1. Write asset down+ Cost of disposal 5,000

Total Impairment Loss $450002. Depreciate new cost3. Restoration not permitted 1. Write asset down

2. No depreciation taken3. Restoration Is permitted

Under IFRS, impairment exists if the carrying value of the fixed asset exceeds the higher of 1) fair valueless costs to sell and 2) value in use (present value of expected future cash flows). Restoration is permittedunder IFRS for both fixed assets held for sale and fixed assets held for use.

PARTIAL IMPAIRMENT

Impairment loss

Accumulated depreciation

TOTAL IMPAIRMENT

Accumulated depreciation

Impairment loss

Asset

xxx

xxx

xxx

xxxXXX




TASK-BASED SIMULATION 1: Impairment

Impeln.-nt IAuthoritative Literature I Help I

The carrying amount of assets either held for disposal or held for use should be evaluated for impairment wheneverevents or changes in circumstances indicate that the carrying amount may not be recoverable. Check all theassertions below that are true under U.S. GAAP.

0 1.

0 2.

0 3.

0 4.

0 5.

0 6.

0 7.

0 8.

Solution

Impairment testing is based upon comparisons of carrying values to undiscounted future net cash

flows.

Impairment losses are computed based upon a comparison of carrying values to the undiscounted

future net cash flows.

Total impairments are written off with a debit to accumulated depreciation.

Partial impairments are written off with a debit to accumulated depreciation.

Depreciation is not recorded on assets held for use after they have been adjusted for impairments.

Assets held for use are written up by the associated cost of disposal before computing impairment

losses.

Once impairments have been recorded on impaired inventories held for resale, the inventory value

may be restored to its pre-impairment value if circumstances warrant.

Deferred tax assets are never subject to impairment.

1. Tru.The test for impainnent compares the carrying value of the asset to ils undiscounted cash flows. If the undiscounted cashflows are less than the carrying value, impairment is indicated, if the undiscounted cash flows are greater than the carryingvalue then no further impairment testing is required.

2. FalseThe test for impainnent compares the carrying value of the asset to ita undiscounted cash flows. The actual amount of theimpairment is computed based upon a comparison of the carrying value of the asset and the fair value of the asset.

3. True

Total impairments are written off with a debit to accumulated depreciation that writes off the asset as follows:

DR Accumulated depreciation

DR Loss due to impairmentCR Asset

$XXXXXX

$XXX

4. FalsePartial impairments are recognized as an increase in losses from impairments and a credit to accumulated depreciationrecorded as follows:

DR Loss due to impairmentCR Accumulated depreciation

$XXX$XXX

5. Fal••Depreciation is recorded on assets held for use after impairment is recorded.

6. FalseCosts of disposal are considered in determining impairments for assets held for disposal, not assets held for use.Furthennore costs of disposal effectively reduce carrying value, not increase carrying value.

7. Tru.

Restoration of assets held for disposal subsequent to recording impairment is permitted.

8. Tru.

Impairment does not apply to assets whose valuation is prescribed by other specific provisions of generally acceptedaccounting principles such as: deferred tax assets in addition to financial instrumenta, mortgage seNicing rights, etc.



NOTES



FINANCIAL 511Leases

• Operating Leases

• Capital (Finance) Leases

• Criteria for Capital (Finance) Lease Accounting - Lessee

Criteria for Direct Financing / Sales Type (Finance) Lease - Lessor

Sale-Leasebacks

SA-l(0 2011 DeVry/Becker Educational Development Corp. All rights reserved.


NOTES

SA-2© 2011 DeVry/Becker Educational Development Corp. All rights reserved.


SUMMARY NOTES

I. OPERATING LEASES

No risks or rewards have been transferred to the lessee. The lessor has the rights to the asset andcontinues to depreciate the asset.

Operating leases are considered off-balance sheet financing because the use of an asset is providedwithout any corresponding liability being recognized (although there is an economic and legal obligation topay).

Straight-Line Method

For an operating lease, the lessee records rent expense over the lease term. The lessor records rentrevenue. The lessee must take the total rent expense to be paid for the entire lease term inclusive of alease bonus or exclusive of free rent and divide it evenly over the entire lease term - straight-linemethod. The lessor must do the same when recording rent revenue.

Leasehold improvements should be amortized over the lease term or the asset/improvement life,whichever is shorter.

II. CAPITAL (FINANCE) LEASES

A capital lease (U.S. GAAP) or finance lease (IFRS) transfers substantially all of the benefits and risks ofownership of property to the lessee. It is an installment purchase in the form of a lease. If a lease does notmeet the requirements of a capital (finance) lease, it is an operating lease.

III. CRITERIA FOR CAPITAL (FINANCE) LEASE ACCOUNTING - LESSEE

Under U.S. GAAP, a lessee must capitalize a leased asset if one of the following four conditions is met:

Ownership transfers at end of lease (upon the final payment or a required buyout).

Written option for bargain purchase (called a bargain purchase option).

Ninety (90%) percent rule. The present value of the minimum lease payments is at least 90% of the FVof the leased asset.

Seventy-five (75%) percent rule. The life of the lease is at least 75% of the asset's economic life.

Under IFRS, a lease is classified as a finance lease if the lease transfers substantially all the risks andrewards of ownership to the lessee.

A. Capitalized Amount

The capitalized amount is the lesser of the fair value of the asset at the inception of the lease or thepresent value of the minimum lease payments.

Minimum Lease Payments - Include:

• Required payments (Present Value of Annuity)

• Bargain purchase option, if any (Present Value of $1)

• Residual value guaranteed by the lessee, if any (Present Value of $1)



Minimum Lease Payments - Exclude: Executory costs (Insurance, maintenance, and taxes).

Under IFRS, initial direct costs paid by the lessee are added to the amount recognized as a financelease asset.

B. Interest Rate

Use the lower (lesser) of:

1. Implicit Rate (if known by lessee)

2. Lessee's Incremental Borrowing Rate

C. Effective Interest Method

Once the asset is capitalized and the liability is recognized, the liability must be paid off over the termof the lease. Lease payments are separated into an interest component and a principal componentusing the effective interest method of amortization. The interest component for a period is thecarrying amount of the lease at the beginning of the period times the interest rate that was used tocapitalize the lease. The remainder of the lease payment is the principal component. The greaterportion of the payment at the beginning of the lease term is interest.

Date Lease Payment Interest Expense (10%) Principle Reduction Lease Liabilitv

12!31!Yl $50,000

12!31!Yl $10,000 $10,000 40,000

12!31!Y2 10,000 $4,000 6,000 34,000

12!31!Y3 10,000 3,400 6,600 27,400

12!31!Yl Capital (Finance) Lease 50,000

Lease Obligation 50,000

12!31!Yl Lease Obligation 10,000

Cash 10,000

12!31!Yl Interest Expense 4,000

Lease Obligation 6,000

Cash 10,000



D. Depreciation Period

U.S.GAAP:

Criteria Depreciation Period

Qwnership Transfers Asset Life

Written Bargain Option Asset Life

~inety (90%) Rule Lease Term

~eventy-five (75%) Rule Lease Term

IFRS:

The depreciation period is the shorter of the lease term and the useful life of the asset. If there is areasonable certainty that the lessee will own the leased asset after the lease term, then the leasedasset should be depreciated over its useful life.

IV. CRITERIA FOR DIRECT FINANCING/SALES TYPE (FINANCE) LEASE - LESSOR

U.S.GAAP:

Direct Financing Lease =Interest Income only

Sales Type Lease = Gross Profit plus Interest Income

For the lessor to account for the lease as a direct financing lease or a sales-type lease under U.S.GAAP, two conditions must be met in addition to one of the four classification criteria for a capital lease("OWNS"):

• The collectibility of the lease payments must be reasonably predictable.

• Performance by the lessor is substantially complete. If any costs have yet to be incurred they arepredictable.

IFRS:

A lessor classifies a lease as a finance lease if the lease transfers substantially all the risks and rewards ofownership to the lessee. A sales-type lease is referred to as a finance lease of an asset by a manufactureror dealer lessor. A direct-financing lease is simply referred to as a finance lease.

V. SALE-LEASEBACKS

A sale-leaseback is a transaction where the lessee sells an asset to another party and subsequently leasesit back. The leaseback will either qualify as a capital (finance) lease or as an operating lease.

Under U.S. GAAP, the accounting for gains on a sale-leaseback is dependent on the rights to remaininguse of property retained by the seller/lessee:

A. "Substantially All" Rights Retained (Greater than 90%)

If the present value of the rent payments is equal to or greater than 90% of the fair value of the asset,defer all gains and amortize over the leaseback period.



B. Rights Retained are Less than "Substantially All" but Greater than "Minor" (Between90%-10%)

If the present value of the minimum lease payments is greater than 10% and less than 90% of the fairvalue of the asset, a portion of the gain is deferred for an amount up to the present value of theminimum lease payments and the excess is recognized immediately.

C. "Minor" Portion of Rights Retained (Less than 10%/No Deferral)

If the present value of the rental payments is 10% or less of the fair value of the asset, or if theleaseback period is 10% or less of the asset's remaining life, the (operating) leaseback is considereda minor leaseback and the transaction is accounted for as two separate transactions, a sale with fullgain or loss recognized immediately and a separate lease.

D. IFRS

Under IFRS, the accounting for gains is dependent on the classification of the lease as operating orfinance.

1. Finance Lease

Gains are deferred and amortized over the lease term.

2. Operating Lease

Gains (and losses) are recognized based on the relationship between the leased asset'scarrying amount, fair value and selling price. If the sales price is equal to fair value (generalrule), any profit or loss is recognized immediately (no deferral).




QUESTION 1

On December 31, Year 1, Eve Company leased a machine under a capital (finance) lease for a period of tenyears, contracting to pay $50,000 on signing the lease and $50,000 annually on December 31 of each of the nextnine years. The present value at December 31, Year 1 of the ten lease payments discounted at 10% was$338,000. At December 31, Year 2, Eve's total capital (finance) lease liability is:

1. $303,980

2. $266,800

3. $259,200

4. $243,000

QUESTION 2

On January 1, Year 1, LaGuardia Company signed a five-year non-cancelable lease for a new machine with a fairvalue of $80,000, requiring $8,000 annual payments at the beginning of each year. The machine had a useful lifeof 10 years, with no salvage value. Title did not pass to LaGuardia, nor was there any bargain purchase option.LaGuardia uses straight-line depreciation for all of its plant assets. Aggregate lease payments had a presentvalue on January 1, Year 1 of $40,000 based on an appropriate interest rate. For Year 1, LaGuardia shouldrecord depreciation (amortization) expense for the leased machine under U.S. GMP at:

1. $0

2. $7,500

3. $6,000

4. $8,000

QUESTION 3

On December 1, Year 1, Tom V. Company entered into an operating lease for office space for its executives for10 years at a monthly rental of $200,000, increasing to $400,000 halfway through the lease. On that date, Tom V.paid the landlord the following amounts:

First month's rent

Last month's rent

Installation of new carpet

$ 200,000

400,000

600,000

$ 1.200.000

The entire amount was charged to rent expense in Year 1. What amount should Tom V. have charged toexpense for the year?

1. $1,200,000

2. $300,000

3. $200,000

4. $305,000



QUESTION 4

On December 31, Year 1, Stalla Corporation sold an asset to Newt Corporation and simultaneously leased it backfor one year. Stalla uses U.S. GAAP. The following information pertains to the sale and the leaseback:

Sales price

Carrying amount

Present value of minimum lease payments

Estimated remaining useful life

$720,000

700,000

30,000

15 years

In Stalla's December 31, Year 1 balance sheet, the deferred profit from the sale of this asset should be:

1. $20,000

2. $30,000

3. $2,000

4. $0




TASK-BASED SIMULATION 1: Operating Lease

OpendllllJ Leaee Aulhorllalive LIleralure I Help I

Hanne Corporation manufactured a piece of equipment at a cost of $7,000,000 and held it for resale fromJanuary 1, Year 1, to June 30, Year 1, at a price of $8,000,000. On July 1, Year 1, Hanne leased theequipment to Tanya, Inc. The lease is appropriately recorded on the books of both corporations as anoperating lease for accounting purposes. The lease is for a three-year period expiring on June 3D, Year 4.Equal monthly payments under the lease are $115,000 and are due on the first of the month. The firstpayment was made on July 1, Year 1. The equipment is being depreciated on a straight-line basis over aneight-year period with no residual value expected.

Answer the questions below, inserting the correct dollar amounts in the shaded cells.

~ fx II I1. What expense should Tanya, Inc. appropriately record as a result of theabove facts for the year ended December 31, Year 1?

2. What income or loss before income taxes should Hanne appropriately recordas a result of the above facts for the year ended December 31, Year 2?

Solution I

1. $690,000

Monthly rental expense $ 115,000

Times: 6 months x 6

Total Year 1 expense $ 690,000

2. $505,000

Monthly rental income $ 115,000

Times: 12 months x 12

Year 2 Income $1,380,000

Equipment cost $ 7,000,000

Divided by: Asset life + 8

Year 2 Depreciation ( 875,000)

Total Year 2 income on lease $ 505,000

SA-9~ 2011 DeVryjBecker Educational Development Corp. All rights reserved.


TASK-BASED SIMULATION 2: Safe / Leaseback

T Sale I Leaseback IAuthoritative Literature I Help IOn January 2, Year 1, Hanne Corporation sold equipment to Breana Manufacturing for cash and immediatelyleased it back for 9 years. Hanne uses U.S. GAAP. The cash paid was equal to the present value of the minimumlease payments. The carrying amount of the equipment was $540,000, and its estimated remaining life is 10 years.No bargain purchase option exists in the lease, and ownership does not transfer at the end of the lease term.Annual year-end payments of $153,000, which include executory costs of $3,000, are based on an implicit interestrate of 10%, which is known to Hanne. The first payment is made December 31, Year 1. Hanne's incrementalborrowing rate is 13%. Hanne uses the straight-line method of depreciation. The rounded present value factors ofan ordinary annuity for 9 years are 5.76 at 10% and 5.2 at 13%.

For each of the items below, double-elick in the shaded cell and select the appropriate answer from the listprovided.

1. Under the terms of the leaseback, how would the lease be reported forfinancial accounting purposes under U.S. GAAP?

2. Over what period of time should Hanne depreciate the equipment?

3. Which interest rate should be used by Hanne to calculate the presentvalue of the minimum lease payments?

4. What amount of depreciation is recorded on the books of the lessee(Hanne Corporation) at December 31, Year 1?

5. What amount of interest expense should be recognized by HanneCorporation at December 31, Year 2?

6. What is the amount of the lease liability on the books of HanneCorporation at December 31, Year 2?

Capital lease

Operating lease

10%

13%

$0

$80,040 [$800,400 x 10%]

$86,400 [$864,000 x 10%]

$107,422 [$826,320 x 13%]

$112,320 [$864,000 x 13%]

9 years$0 $0

~ 8 ~ 0 $96,000 ~ ~ $864,00010 years

$86,400 $800,400

$783,742

$730,440

$653,880

- '- - -

~ I Cancel I ~ I Cancel I ~ I Cancel I,~ ~

SA-lO© 2011 DeVry/Becker Educational Development Corp. All rights reserved.


Solution I

1. Capital Lea..

The sale-leaseback transaction is classified as a capital lease because the term of 9 years is greater than 75% of the equipment's eslimaledremaining economic life (10 years). [Note that the present velue of the minimum lease payments Is also greater than 90% of the fair velue ofthe property as determined by the cash sale, discussed below.)

Recall the following mnemonic to determine if a lease qualifies as a capital lease (only one criterion need be met10 classify the lease ascapilal):

Ownership

Written

Ninety

Seventy-five

Ownership transfers at the end of the leaae

A written bargain purchase option exists

Ninety percent (90%) of the FMV of the leased property <= to the present value of the minimum lease payments

At. least seventy-fIVe percent (75%) of the asset's economic life is committed in the lease term

Depreciate over aB8Bt life (Iegel tam)

Depreciate over a88Bilife (1Bg81 form)

Depreciate over lease term (substance overform)

Depreciate over lease term (substance over form)

2. 9yeara

Hanne should deprBclBte the asset over the lease term of 9 years bBCBuse the lease qualified as a capital lease only under the 75% and the90% rules. If there is no transfer of ownership and the lease term also does not contain a bargain purchase option, the asset cannot bedeprecleted over lls estimated remaining life. Recall the following rules:

Ownership

Written

Ninety % FMV

Seventy-five % Life

3. 10%

Breana's rete (the lessor's nete) of 10% should be used to calculate the present velue of the minimum lease payments (and thus the assetvalue) becauss that rate is LOWER than Hanne's (the lass.'s) inaemental borrowing rate of 13% and Breana's rata is KNOWN to Hanns.

4. $96.000

To arrive at PVMLP:

Annual lease pa)TYIents

Executory costs

Net amount

$153,000

(3,000)

$150,000 x 5.76 = $864,000

$864.000 /9 =$96,000

The asset Is depreciated over 9 years, as Indicated In the answer 10 Item 2.

5. $80,040

Note that the question asks for the interest axpenae afl8r two le8&B payments (on December 31, Year 2). The leaae is amortized uaing the10% Implicit rate. as Identified In Item number 3 (above). Following Is the calculBllon for the amount of Interest:

Step 1Lease liability at 112/Year 1 $ 864,000Times 10% 1L.-...1Q%

Year 1 IntllreBt expensa l....UdADStep 2Year 1 lease pa)TYIentLess: Executory costsLess: Year 1 interasl expense

Yaar 1 leasa principal reductionSlap 3Lease liability at 112/Year 1Less: Year 1 principal reductionLease liability al12J31/Year 1Times 10%

Year 2 intllreBt expensa

$153,000( 3,000)( 88,400)

~

$854,000( 63,600)

$800,400

!....-....1.!!%~

8. $730,440

Using the information obtained in item 6, above, following is the calculation for the lease liability at December 31, Year 2:

Year 2 lease pa)TYIent $153,000Less: Executory costs ( 3,000)Less: Year 2 interasl expense ( 80,040)

Yaar 2 leasa principal reduction ~

Lease liability at 12J31/Year 1 $800,400Less: Year 2 lease principal reduction ( 69,960)

Lease liability at 12131/Yaar 2 ~

[Note that all of the other answer options consider the liability at various yaar-ends using either the 10% rate or the 13% rate.]

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_'U RMaarch IAuthoritative Literature I Help I

Under operating leases, how should rent be charged to expense over the lease term? Find the proper citation thatprovides guidance in answering this question.

Type the topic here. Correctly formattedFASB ASC topics are 3 or 4 digits

--FASB ASC 1 1- c=J -c=J -c=J

Some examples of correctly formatted FASB ASC responses are205-10-05-1. 323-74D-S25-1 , 260-1 0-Q0-1 A. 260-10-55-99 and

115-60-35-128A

T Research Authoritative lher:lture I H~rp II Back I Home Recent Peae Visits

)Enter search Here Se",dJ Sear,h With n I Advanced Search

;rable of Contents I PreVIOUs I~etct, III Neltt j~etdJ I Prevlous Result II Neltt Result

~ FASB Literature FASB LiteratureIt:I Ortg~aIPronouncement •••ltt.H':";~:"'=':=':::":'----------------------------I1I

~~::::'::X Uniform CPA Examination Authoritative LiteratureIl' FASB Import



OR


• I

Solution

I


FASB ASC 840-20-25-1

Keyword: Operating leases



FINANCIAL 58Bonds

Bond Terminology

Issuance of Bonds

Issuance of Bonds Between Interest Dates

Amortization of Premiums and Discounts

• Convertible Bonds

• Bonds with Detachable Warrants

Retirement of Bonds



NOTES



SUMMARY NOTES

I. BOND TERMINOLOGY

A bond indenture is a contract that specifies the terms between the bond issuer and the bondholders.

Among the elements of the contract:

a. Face value - The total dollar amount of the bond. Bonds are generally sold in denominations of$1,000 and are quoted in 100s.

b. Stated/nominal/coupon rate - The interest to be paid to the bondholders.

c. Life of the bond - the number of periods from the bond date to the maturity date.

d. Frequency of interest payments (annual, semiannual).

II. ISSUANCE OF BONDS

The selling price of a bond is equal to the present value of the future cash payments related to the bond,including both the principal and interest payments using the effective rate of interest. The effective/marketrate is the rate of interest for bonds of similar risk and maturity on the date the bonds are sold. Theeffective market rate of interest on a bond is also referred to as the yield.

A discount results when the market/effective rate exceeds the stated/coupon rate because investors willpay less than the bond's face value (e.g., 97, 98, 99). Under U.S. GAAP, the discount is amortized over thecontractual life of the bonds. Under IFRS, the discount is amortized over the expected life of the bonds.

A premium results when the market/effective rate is lower than the stated/coupon rate because investorsare willing to pay more than the bond's face value (e.g., 101, 102, 103). Under U.S. GAAP, the premium isamortized over the contractual life of the bonds. Under IFRS, the premium is amortized over the expectedlife of the bonds.

If bonds are issued at par, the stated rate of interest equals the effective rate of interest.

Under U.S. GAAP, bond issue costs are debited to a deferred charge (asset) account at bond issuanceand are amortized straight-line over the life of the bond.

Cash

Bonds Issue Costs

Bonds Payable

Premium on B!P

OR

Cash

Bonds Issue Costs

Discount on B!P

Bonds Payable

xxxXXX

XXX

XXX

XXX

XXX

XXX

XXX

Under IFRS, bond issue costs are deducted from the carrying value of the liability and amortized using theeffective interest method.



III. ISSUANCE OF BONDS BETWEEN INTEREST DATES

When bonds are issued between interest dates, the amount of interest that has accrued since the lastinterest payment is added to the price of the bonds and is reimbursed at the next interest payment date tothe purchaser. (The purchaser gets the full interest payment regardless of how long he/she has held thebond.)

Cash

Discount B/P

Bonds Payable

Interest Expense

IV. AMORTIZATION OF PREMIUMS AND DISCOUNTS

xxxXXX

XXX

XXX

The carrying amount of a bond is the bond's face value plus the unamortized premium or minus theunamortized discount. At the maturity of a bond, the carrying amount of the bond is equal to the face.

There are 2 methods to amortize bond discount or premium:

a. Straight-line method - tolerated when not material under U.S. GAAP, prohibited under IFRS.

b. Effective interest amortization method - U.S. GAAP/IFRS.

The straight-line method amortizes the premium or discount equally over the life of the bonds.

With the effective interest method, each interest payment is divided into an interest and principalcomponent. The interest component is equal to the carrying amount of the bond at the beginning of theperiod times the effective interest rate. The difference between the interest component and the interestpayment is the amortization of the premium or discount, and is used to adjust the carrying amount of thebond by decreasing the unamortized premium or discount.

Bond Face

lC Coupon Rate

Interest Paid

Net carrying value

lC Effective Interest rate

Interest elCpense Amortization

Cash Interest Amortized Unamortized CarryingDate Interest 4%· Expense 5%·· Discount Discount Amount

1/1/X1 50,000 950,000

6/30/X1 40,000 47,500 7,500 42,500 957,500

12/31/X1 40,000 47,875 7,875 34,625 965,375

*(1,000,000 x .04)

**(950,000 x .05)



Interest Expense 47,500

Discount on B/P 7,500

Cash 40,000

OR

Interest Expense XXX

Premium on B/P xxxCash XXX

V. CONVERTIBLE BONDS

Under U.S. GAAP, no separate recognition is given to the conversion feature when convertible bonds areissued. On the CPA exam, the conversion of convertible bonds may be recorded under either the bookvalue method or the market value method (normally not GAAP). Under the book value method, no gainor loss is recognized, and additional paid-in capital is credited for the excess of the bond's carrying valueover the stock's par value less any conversion costs. Under the market value method, gain or loss isrecognized.

Book Value Method

Bonds Payable

Premium on B/P

Common Stock

APIC(plug)

(No gain/loss)

OR

Market Value Method

Bonds Payable

Premium on B/P

Common Stock

APIC

(CR - Gain/DR - Loss for the difference)

xxxxxx

xxxxxx

xxxxxx

XXX} FVxxx

Under IFRS, a liability (bond) and an equity component (conversion feature) should be recognized whenconvertible bonds are issued. The bond liability is recorded at fair value, with the difference between theactual proceeds received and the fair value of the bond recorded as a component of equity.



VI. BONDS WITH DETACHABLE WARRANTS

When a bond is issued with detachable stock warrants, two separate securities are issued. The warrantsgive the bondholder the right to buy stock at a fixed price within a specific time period. The total proceedsreceived from the issuance must be allocated between the bonds and the warrants. If the market value ofthe warrants only is given (or can be calculated), allocate to the warrants based on the total fair value of thewarrants and the remainder to the bonds. If both the market value of the warrants and the market value ofthe bonds are given (or can be calculated), allocate to the warrants and the bonds based on their relativefair values:

Cash

Discount on B/P

Bonds Payable

APIC - Stock Warrants

OR

Cash

Bonds Payable

Premium on B/P

APIC - Stock Warrants

xxxxxx

xxx

xxxxxx

xxxxxxxxx

If the warrants are not detachable no allocation of proceeds is needed.

VII. RETIREMENT OF BONDS

Corporations can call or retire bonds prior to maturity. Bonds are retired as a % of face value (e.g., 98,101).

{

Bonds Payable

BV Premium on B/P

Cash


OR

xxxxxx

xxx

BV{Bonds Payable

Discount on B/P

Cash


xxxxxxxxx

Under U.S. GAAP, the gain or loss is recognized as an extraordinary item only if the retirement meets thecriteria of both unusual and infrequent event.

SB-6© 2011 DeVry/Becker Educational Development Corp. All rights reserved.



QUESTION 1

On July 1, Year 1, Cobb Company issued 9% bonds in the face amount of $1 ,000,000 which mature in ten years.The bonds were issued for $939,000 to yield 10%, resulting in a bond discount of $61,000. Cobb uses theeffective interest method of amortizing bond discount. Interest is payable annually on June 30. At June 30, Year3, Cobb's unamortized bond discount should be:

1. $52,810

2. $57,100

3. $48,800

4. $43,000

QUESTION 2

On July 1, Year 1, Planet Corporation sold Ken Company 10-year, 8% bonds with a face amount of $500,000 for$520,000. The market rate was 6%. The bonds pay interest semiannually on June 30 and December 31. Forthe six months ended December 31, Year 1, what amount should Planet report as bond interest expense andlong-term liability in the balance sheet and income statement for Year 1?

BlS

1. $511,200

2. $500,000

3. $504,400

4. $515,600

QUESTION 3

I/S

$31,200

$20,000

$4,400

$15,600

On November 1, Year 1, Dixon Corporation issued $800,000 of its 10-year, 8% term bonds dated October 1, Year1. The bonds were sold to yield 10%, with total proceeds of $700,000 plus accrued interest. Interest is paidevery April 1 and October 1. What amount should Dixon report for interest payable in its December 31, Year 1balance sheet?

1. $17,500

2. $16,000

3. $11,667

4. $10,667

QUESTION 4

On December 30, Year 1, Wayne Corporation issued 1,000 of its 8%, 10-year, $1,000 face value bonds withdetachable stock warrants at par. Each bond carried a detachable warrant for one share of Wayne's commonstock at a specified option price of $25 per share. Immediately after issuance, the market value of the bondswithout the warrants was $1,080,000 and the market value of the warrants was $120,000. In its December 31,Year 1 balance sheet, what amount should Wayne report as bonds payable?

1. $1,080,000

2. $1,000,000

3. $900,000

4. $1,200,000



QUESTION S

On July 1, Year 1, after recording interest and amortization, Wake Company's shareholders converted $1,000,000of its 10% convertible bonds into 50,000 shares of its $1 par value common stock. On the conversion date, thecarrying amount of the bonds was $1,500,000, the market value of the bonds was $1,400,000, and Wake'scommon stock was publicly trading at $40 per share. Using the book value method, what amount of additionalpaid-in capital should Wake record as a result of the conversion?

1. $500,000

2. $1,500,000

3. $1,950,000

4. $1,450,000



FINANCIAL 611Income Statement / Deferred Taxes

Presentation Order of the Major Components of an Income and Retained

Earnings Statement

Comprehensive Income

• Accounting for Income Taxes

6A-lttl 2011 DeVry/Becker Educational Development Corp. All rights reserved.


NOTES



SUMMARY NOTES

I. PRESENTATION ORDER OF THE MAJOR COMPONENTS OF AN INCOME AND RETAINEDEARNINGS STATEMENT

Reported on Income Statement

A. Income (or Loss) from Continuing Operations (Report Gross; then Net of Tax)

Income from continuing operations includes operating activities (Le., revenues, costs of goods sold,selling expenses, and administrative expenses), non-operating activities (e.g., other revenues andgains and other expenses and losses), and income taxes.

B. Income (or Loss) from Discontinued Operations (Report "Net of Tax")

The (normal) loss from discontinued operations can consist of three "elements": (1) an impairmentloss, (2) income/loss from actual operations, and (3) a gain/loss on disposal. All of these amountsare included in discounted operations in the period in which they occur.

C. Extraordinary Items (Report "Net")

Extraordinary items are presented net of tax and include items that are unusual in nature and occurinfrequently. IFRS prohibits the reporting of extraordinary items.

Reported on Statement of Retained Earnings

D. Change in Accounting Principle (Report "Net of Tax")

The cumulative effect of a change in accounting principle is presented net of tax. It is the cumulativeeffect (calculated as of the beginning of the first period presented) of a change from one acceptablemethod of accounting to another ("GAAP to GAAP" or "IFRS to IFRS") because the new methodpresents the financial information more fairly than the old method.

II. COMPREHENSIVE INCOME

Comprehensive income includes all changes in equity during a period, except those resulting frominvestments by owners and distributions to owners. Comprehensive income is net income plus othercomprehensive income.

other comprehensive income includes:

Pension adjustments

Unrealized gains and losses on available-for-sale securities

Foreign currency items

Effective portion of cash flow hedges

Revaluation surplus (IFRS only)

III. ACCOUNTING FOR INCOME TAXES

A. Interperiod Tax Allocation

1. Total income tax expense or benefit for the year is the sum of:

a. Current income tax expense/benefit, and

b. Deferred income tax expense/benefit.



2. Current income tax expense/benefit is equal to the taxable income for the current year,multiplied by the current tax rate.

3. Deferred income tax expense/benefit is equal to temporary differences multiplied by the futuretax rate, or the change in deferred tax liability or asset account on the balance sheet from thebeginning of the current year to the end of the current year (called the "Balance SheetApproach").

4. Thus, total income tax expense/benefit can be depicted as follows:

- TEMPORARYDIFFERENCE - FINANCIAL

STATEMENT

K CURRENT TAX RATE

DR CURRENT TAX EXP

CR CURRENT LIABILITY

K FUTURE (ENACTED] TAX RATE

DR DEFERRED TAX EXP

+ CR DEFERRED LIABILITYOR

- DR DEFERRED ASSET

CR PEFERREP TAX BENEFIT

TOTAL TAX EXPENSE

B. Differences

There are two types of differences between pretax GAAP financial income and taxable income. Alldifferences are either permanent differences or temporary differences.

1. Permanent Differences

a. Permanent differences do not affect the deferred tax computation. They only affect thecurrent tax computation. These differences affect only the period in which they occur.They do not affect future financial or taxable income.

b. Permanent differences are items of revenue and expense that either:

(1) Enter into pretax GAAP financial income, but never enter into taxable income (e.g.,interest income on state or municipal obligations, life insurance,proceeds/expense).

(2) Enter into taxable income, but never enter into pretax GAAP financial income (e.g.,dividends received deduction).

2. Temporary Differences

Temporary differences are the differences between the tax basis of an asset or liability and itsreported amount in the financial statement that will result in taxable or deductible amounts infuture years when the reported amount of the asset or liability is recovered or settled,respectively.

There are four basic causes of temporary differences, which reverse in future periods.

(a) Revenues or gains that are included in taxable income, after they have been included infinancial accounting income, which results in a deferred tax liability (Le., sales onaccount).

(b) Revenues or gains that are included in taxable income, before they are included infinancial accounting income, which results in a deferred tax asset (Le., rents collected inadvance).



(c) Expenses or losses deducted from taxable income, after they have been deducted forfinancial accounting income, which results in a deferred tax asset (Le., warrantyexpense).

(d) Expenses or losses deducted for taxable income, before they are deducted from financialaccounting purposes, which results in a deferred tax liability (Le., accelerated taxdepreciation).

C. Deferred Tax Liability

A deferred tax liability is a future payable. Current financial income is greater than current taxableincome.

Expense First

1. Depreciation expense greater for tax than for book

Revenue Later

2. Prepaid expenses (cash basis for tax)

3. Installment sales (used for tax purposes)

4. Contractor accounting

D. Deferred Tax Assets

A deferred tax asset is a future receivable. Current financial income is less than current taxableincome.

Revenue First

1. Unearned rent (taxable income before book income)

2. Unearned interest (taxable income before book income)

Expense Later

3. Bad debt expense (allowance for GAAP and direct write-off for tax)

4. Estimated liability/warranty expense (allowance for GAAP and direct write-off for tax)

E. Valuation Allowance

Deferred tax assets are created by transactions that defer the tax benefits of expenses ortransactions that recognize tax income before book income. If it is more likely than not that part or allof a deferred tax asset will not be realized, a valuation allowance should be recognized to reduce theamount of the deferred tax asset.

1. IFRS prohibits the use of a valuation allowance. Under IFRS, a deferred tax asset isrecognized when it is probable that sufficient taxable profit will be available against which thetemporary difference can be utilized.

F. Balance Sheet Presentation

1. Under U.S. GAAP, deferred tax items should be classified based on the classification of therelated asset or liability for financial reporting. For example:

a. A deferred tax asset that relates to product warranty liabilities (accrued expenses) wouldbe classified as "current" because warranty obljgations are part of the current operatingcycle.

b. A deferred tax liability that relates to asset depreciation (fixed assets) would beclassified as "noncurrent" because the related assets are noncurrent.



2. Under U.S. GAAP, deferred tax items not related to an asset or liability should be classified(e.g., current or noncurrent) based on the expected reversal date of the temporary difference.Such items include:

a. Deferred tax assets related to carry forwards,

b. Organization costs expensed for GAAP financial income (no asset) but deducted in lateryears for tax purposes, and

c. Percentage of completion method used for contracts for GAAP financial income (no assetor liability) but completed contract method used for tax purposes.

3. Under U.S. GAAP, all current deferred tax assets and liabilities and all non-current deferred taxassets and liabilities should be offset (netted) and presented as one amount. However, currentand noncurrent amounts should not be netted.

4. Under IFRS, deferred tax assets and deferred tax liabilities are reported as noncurrent on thebalance sheet. Deferred tax assets and deferred tax liabilities may be netted if the entity has alegally enforceable right to offset current tax assets against current tax liabilities and thedeferred tax assets and deferred tax liabilities relate to income taxes levied by the same taxauthorities.

G. Operating Loss

A net operating loss (NOL) occurs when tax-deductible expenses exceed taxable revenues. In thiscase the corporation pays no income taxes and it may select one of two options under the U.S.Internal Revenue Code (IRC): 1) carry the NOL back 2 years (to the earlier year first then to thesecond) and then carry any remaining NOL forward up to 20 years; or 2) carry the NOL forward up to20 years. The NOL offsets taxable income. An NOL carryback results in a refund of taxes paid inprior years.

Carryback benefit:

l!ru Income tax refund receivable

(!ill Benefit due to loss carryback (income tax expense)

Carryforward benefit:

l!ru Deferred Tax Asset

(!ill Benefit due to loss carryforward (income tax expense)




QUESTION 1

On May 15, Year 1, Moran Inc. approved a plan to dispose of a component of its business. It is expected that thesale will occur on February 1, Year 2, at a selling price of $500,000, which was the current fair value of thecomponent. During Year 1, disposal costs incurred by Moran totaled $15,000. The component had actual orestimated operating losses as follows:

January 1 - May 14, Year 1

May 15 - December 31, Year 1

January 1 - January 31, Year 2

$130,000

50,000

15,000

The carrying amount of the component on May 15, Year 1 was $850,000. Before income taxes, what amountshould Moran report for discontinued operations in its Year 1 Income Statement?

1. $545,000

2. $365,000

3. $15,000

4. $380,000

QUESTION 2

Ray Corporation had the following transactions during the current year:

A $100,000 gain on reacquisition and retirement of long-term bonds. Ray frequently acquires and retires its debt.

A $500,000 loss on the disposal of its entire retail store business. Ray has never abandoned any of its variousbusinesses previously. It plans to operate only as a wholesaler in the future.

A $100,000 loss on the abandonment of assets that are no longer being used.

In its current year income statement, what would be the total amount to be included in extraordinary items underU.S. GAAP?

1. $100,000

2. $600,000

3. $400,000

4. $0



QUESTION 3

Cavan Company prepared the following reconciliation between book income and taxable income for the currentyear ended December 31, Year 1:

Pretax accounting incomeTaxable incomeDifference

Differences:Interest on municipal incomeLower financial depreciationTotal

$1,000,000(600,000)

$ 400,000

$ 100,000300,000

$ 400,000

Cavan's effective income tax rate for Year 1 is 30%. The depreciation difference will reverse equally over thenext three years at enacted tax rates as follows:

YearYear 2Year 3Year 4

Tax rate30%25%25%

In Cavan's Year 1 Income Statement, the current portion of its provision for income taxes should be:

1, $300,000

2, $250,000

3, $180,000

4, $150,000

QUESTION 4

Cavan Company prepared the following reconciliation between book income and taxable income for the currentyear ended December 31, Year 1:

Pretax accounting incomeTaxable incomeDifference

Differences:Interest on municipal incomeLower financial depreciationTotal

$1,000,000(600,000)

$ 400,000

$ 100,000300,000

$ 400,000

Cavan's effective income tax rate for Year 1 is 30%. The depreciation difference will reverse equally over thenext three years at enacted tax rates as follows:

YearYear 2Year 3Year 4

Tax rate30%25%25%

In Cavan's Year 1 Income Statement, the deferred portion of its provision for income taxes should be:

1, $120,000

2, $80,000

3, $100,000

4, $90,000




TASK-BASED SIMULATION 1: Calculations

Celculatlona Authoritative Literature I Help I

The following condensed trial balance of Allen Corporation, a publicly-owned company using U.S. GAAP, has beenadjusted except for income tax expense:

AI/en Corporation

CONDENSED TRIAL BALANCE

June 30, Year 1

Total assets

Total liabilities

5% preferred stock cumulative

Common stock

Retained earnings

Machine sales

Service revenues

Interest revenue

Gain on sale of factory

Cost of sales-machines

Cost of services

Administrative expenses

Research and development expenses

Interest expense

Loss from asset disposal

Debit

$25,080,000

425,000

100,000

300,000

110,000

5,000

40,000

$9,900,000

2,000,000

10,000,000

2,900,000

750,000

250,000

10,000

250,000

Other infonnation and financial data for the year ended June 30, Year 1 follow:

• The weighted average number of common shares outstanding during Year 1 was 200,000. The potentialdilution from the exercise of stock options held by Allen's officers and directors was not material.

• During Year 1, one of Allen's foreign factories was expropriated by the foreign government, and Allenreceived a $900,000 payment from the foreign government in settlement. The carrying value of the plantwas $650,000. Allen has never disposed of a factory.

• Allen frequently disposes of equipment with both gains and losses.

• Allen's tax rate is 30%.

Complete the following single-step income statement. Enter your answers in the shaded cells.

'<If' Ix II I1. Total revenues

2. Total expenses and losses

3. Inoome before extraordinary item

4. Extraordinary item

5. Net income


Solution


1. Total Revenues

Revenues:

Machine sales $750,000

Service revenues 250,000

Interest revenues 10,000

Total revenues $1,010,000

2. Total expenses and losses

Expenses:

Cost of sales machines $425,000

Cost of services 100,000

Administrative expenses 300,000

Research and development expenses 110,000

Interest expense 5,000

Loss from asset disposal 40,000

Income tax expense 9,0001

Total expenses and losses 989,000

3. Income before extraordinary items

Income before extraordinary gain 21,000

4. Extraordinary gain (net of tax)

Extraordinary gain (net of tax) $ 175,000 2

5. Net income

Net income $ 196,000

1 Income tax expense =$30,000 x 30% =$9,0002 Extl80rdlnery geln (net of tax) =($900,000 - $650,000) x (1 - 30%) =$175,000

6A-l0~ 2011 DeVryjBecker Educational Development Corp. All rights reserved.


TASK-BASED SIMULATION 2: Tax Reconciliation

'f Tax Reconciliation IAuthoritalive Literature I Help I

The following condensed trial balance of Allen Corporation, a publicly-owned company that uses U.S. GAAP, hasbeen adjusted except for income tax expense:

For each of the following independent situations, indicate whether the item results in a temporary difference, apermanent difference, or no difference for an accrual basis taxpayer. Double-click on the shaded cells and make aselection from the list provided.

1. Rental revenue was received during thecurrent fiscal year in full payment for a three-yearlease entered into in the current fiscal year.

2. The company paid a penalty to the IRS for latepayment of income taxes.

3. Treasury stock was sold in excess of its cost.

4. Goodwill exists on the balance sheet. Therewas no impairment loss during the year forfinancial reporting purposes. Proper 15-yearamortization was deducted on the tax return.

5. Bad debt expense under the allowancemethod was in excess of amounts actuallywritten off under the direct write-off method.

6. The company incurred and paid $4,000 ofstart-up costs during the current year.

7. Interest revenue was received on aninvestment in a state bond.

8. Depreciation deducted for tax purposes was inexcess of the depreciation expense for financialreporting purposes.

Temporary difference

Permanent difference

No difference



Solution

1. Temporarydifference

The rent revenue received in advance is deferred and not immediately recognized as revenue for financialreporting purposes. For tax purposes, it is reported as income in the year received.

2. Permanent difference

Although the penalty is an expense for financial reporting purposes, it is never deductible on a tax return.

3. No difference

Treasury stock sold in excess of cost is added to paid in capital and is not reported as a gain for eitherfinancial reporting or tax purposes.

4. Temporary difference

Goodwill is amortized over 15 years for tax purposes and subject to an impairment test for financial reportingpurposes.

Note: Many students incorrectly label this a permanent difference. However, the theory is that over time,goodwill will eventually be written off as impaired for financial reporting purposes.


The allowance method should be used for financial reporting purposes, while the direct write off method isrequired for tax purposes. This is a temporary difference because bad debts are fully written-off under bothmethods.

8. No difference

The startup costs will be expensed in the current year for both financial and tax reporting purposes. Generallythis is a temporary difference because start up costs are always expensed for financial reporting purposes,while tax rules allow the deduction of $5,000 in the year the costs are incurred and then a 180 monthamortization of the remainder. However, since the question indicates that the startup costs were $4,000, thecosts will be fully expensed for tax and financial purposes.

7. Permanent difference

State bond interest income is reported as revenue for financial reporting purposes but is tax-exempt.


Tax law and GAAP use different depreciation schedules. Over time, the depreciation will be the same.



TASK-BASED SIMULATION 3: Tax Reconciliation

1~ Tax Reconciliation IAuthoritative Literature I Help I

The following information pertains to the current year annual report to the shareholders of Texas Corporation.

Net Income

Effective portion of unrealized losses on cash flows hedge derivatives

Unrealized losses on marketable securities classified as AFS

Foreign currency translation gain

Pension funded status adjustment

$460,000

(120,000)

(26,000)

40,000

(4,000)

Assuming a tax rate of 30%, calculate the following by entering the appropriate values in the shaded cells.

1. Other comprehensive income

2. Comprehensive income

Solution

1. sn,ooo

2. $383,000

Net income

Other comprehensive income (net of tax)

Comprehensive income

(120,000)

(26,000)

(4,000)

40,000

(110,000) lC 30% tax(33.000)

$460,000

(77,000)

$383,000




Reaearch Authoritalive Literature I Help

The CEO of Logan Corporation wants to disclose EPS in the notes to the financials only. Find the proper citationthat defines the location of EPS presentation in the financial statements.



.........FASB ASC 1 1- c=J- c=J- c=J

Some examples of correctly formatted FASB ASC responses are205-10-05-1, 323-74D-S25-1 , 260-10-60-1 A, 260-10-55-99 and

115-60-35-128A

,Research Authoritativ. lher:lture I H~rp IBack I Home Recent Peae Vis",

)Enter 'Search Here Search I Sear<h 'oHith n I Advanced Search

Table of Contents I PreVIous I~atch III Next j~atdJ I I PrevIous Re5Ult III Next Result I~ FASB Literature FASB Literature

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IV Current TextUniform CPA Examination Authoritative Literature(E) TopIc.llndex

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Soiution I


FASB ASC 260-10-45-2

Keyword: EPS presentation



FINANCIAL 68Pensions

• Pension Plans

Pension Obligations - Defined Benefit Pension Plans

• Pension Plan Funded Status

Reporting Changes in Funded Status - OCI

• Pension Plan Contributions

Pension Expense Components (SIRAGE)

• Accounting for Postretirement Benefits Other than Pensions



NOTES



SUMMARY NOTES

I. PENSION PLANS

There are two types of pension plans: defined benefit and defined contribution. Defined benefit plansdefine the benefits to be paid to employees based on factors such as years of service and compensationlevels at retirement.

Defined contribution plans specify the amount of the employer's contributions to the plan; employeeretirement benefits are determined based on the value of such contributions upon retirement.

II. PENSION OBLIGATIONS - DEFINED BENEFIT PENSION PLANS

The Projected Benefit Obligation (PBO) is the actuarial present value of all benefits attributed by theplan's benefit formula. The PBO is used in the calculation of funded status, service cost, and interest costand is computed using future salary levels.

The Accumulated Benefit Obligation (ABO) is the actuarial present value of benefits attributed by aformula using current and past salary levels.

Under IFRS, the pension liability is called the Defined Benefit Obligation (DBO). The DBa is very similarto the U.S. GAAP PBO.

III. PENSION PLAN FUNDED STATUS

Pension plans are accounted for on the accrual basis. Defined benefit pension plans are reported on thebalance sheet based on funded status:

Fair value of plan assets

<PBO or DBO>

Funded status

Under U.S. GAAP, companies are required to aggregate all overfunded (fair value of plan assets> PBO)pension plans and report them as a noncurrent asset on the balance sheet. All underfunded (fair value ofplan assets < PBO) pension plans should also be aggregated and reported as a current liability, anoncurrent liability, or both. A pension plan is reported as a current liability to the extent that the benefitspayable in the next 12 months exceed the fair value of the plan's assets.

Under IFRS, the funded status (DBa - fair value of plan assets) of the pension plan is reported on thebalance sheet as the net defined benefit liability (asset). A liability is reported if the plan is underfunded(DBa> fair value of plan assets) and an asset is reported if the plan is overfunded (DBa < fair value of planassets). IFRS do not specify whether an entity should classify the net defined benefit liability (asset) ascurrent or noncurrent.

IV. REPORTING CHANGES IN FUNDED STATUS

Under U.S. GAAP, a change in the funded status of a pension plan due to pension net losses or gains orprior service cost is reported in the period incurred as a component of accumulated other comprehensiveincome, net of tax. Any unrecognized net transition obligation (or asset) is also reported in accumulatedother comprehensive income.



To report net loss or prior service cost:

i!lil Other comprehensive income

~ Pension benefit asset/liability

i!lil Deferred tax asset

~ Deferred tax benefit - OCI

To report net gain or net transition asset:

i!lil Pension benefit asset/liability

~ Other comprehensive income

i!lil Deferred tax expense - OCI

~ Deferred tax liability

Pension net gains or losses, prior service cost, and net transition assets or obligations remain inaccumulated other comprehensive income until recognized in net periodic pension cost throughamortization.

Reclassification adjustment to record amortization ofnet loss, prior service cost, or net transition obligation to netperiodic pension cost:

i!lil Net periodic pension cost

~ Other comprehensive income

i!li! Deferred tax benefit - OCI

~ Deferred tax benefit - income statement

Reclassification adjustment to record amortization ofnet gain or net transition asset to net periodic pension cost:

i!lil Other comprehensive income

~ Net periodic pension cost

i!lil Deferred tax expense - income statement

~ Deferred tax expense - OCI

Under IFRS, prior (past) service cost is reported as a component of service cost on the income statement inthe period incurred. Pension gains and losses are reported in other comprehensive income in the periodincurred and are not reclassified (amortized) to the income statement.



v. PENSION PLAN CONTRIBUTIONS

An employer's contribution to its defined benefit pension plan(s) increases the pension benefit asset(overfunded pension plans) or decreases the pension benefit liability (underfunded pension plans).

Journal entry to record pension plan contribution:

~ Pension benefit asset/liability

[!G] Cash

VI. PENSION EXPENSE COMPONENTS (SIRAGE)

Under U.S. GAAP, the amount of the net periodic pension cost is calculated using the following sixcomponents:

+ Service cost (current)

+ Interest cost (on the Projected Benefit Obligation)

Return on plan assets (expected or actual)

+ Amortization of unrecognized prior service cost

-/+ (Gains) and losses

-/+ Amortization of Existing net (asset) or obligation

Prior service cost, gains and losses, and existing net obligations or assets are amortized and charged to netperiodic pension cost over a specified period of time.

Under U.S. GAAP, net periodic pension cost is reported in total on the income statement. Under IFRS,defined benefit cost includes service cost and net interest on the defined benefit liability (asset). Thecomponents of defined benefit cost are generally reported separately on the income statement; there is norequirement that these amounts be aggregated and presented as one amount.

Journal entry to record the service cost, interest cost and return on pIon assets components ofnet periodic pensioncost:

~ Net periodic pension cost

[!G] Pension benefit asset/liability

~ Deferred tax asset

[!G] Deferred tax benefit - income statement



VII. ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS

Postretirement benefits include:

• Health care insurance

• Life insurance

• Welfare benefits

• Tuition assistance

Postretirement benefits must be reported on the balance sheet (funded status and DCI components),income statement (SIRAGE) and footnotes in the same manner as pensions if:

• The obligation is attributable to employees services already rendered,

• The employees' rights accumulate or vest,

• Payment is probable, and

• The amount of benefits can be reasonably estimated.

Postretirement benefits must be accrued during the period the employee works, called the "attributionperiod" (date hired to date fully vested).

The calculation of the funded status of a postretirement benefit plan is done using the APSD (accumulatedpostretirement benefit obligation), which is the present value of future benefits that have vested as of themeasurement date:

Fair value of plan assets

<APBO>

Fu nded status




QU ESTION 1

The following information pertains to Burnel Corporation's defined benefit pension plan for Year 1:

Service costActual and expected gain on plan assetsUnexpected loss on pension plan assets related to a Year 1 disposal of a subsidiaryAmortization of unrecognized prior service costAnnual interest on pension obligation

$160,00035,00040,000

5,00050,000

What amount should Burnel report as U.S. GAAP pension expense in its Year 1 Income Statement?

1. $250,000

2. $220,000

3. $210,000

4. $180,000

QUESTION 2

Do It Right, Inc.'s actuary provided the company with the following information regarding its defined benefitpension plan for the year ended December 31, Year 7:

Fair value of plan assetsAccumulated benefit obligationProjected benefit obligationUnrecognized prior service costUnrecognized transition obligationUnrecognized net gainExpected benefit obligation - Year 8

$5,580,0003,400,0004,930,000

400,000275,000140,000250,000

The company reported net periodic pension cost of $310,000 on its income statement and made a $500,000contribution to the pension plan during Year 7. The company's effective tax rate is 40%. What amount should DoIt Right record as a pension asset/liability on the December 31, Year 7 balance sheet under U.S. GAAP?

1. $650,000 current liability

2. $2,180,000 noncurrent liability

3. $650,000 noncurrent asset

4. $2,180,000 current asset



QUESTION 3

Do It Right, Inc.'s actuary provided the company with the following information regarding its defined benefitpension plan for the year ended December 31, Year 7:

Fair value of plan assetsAccumulated benefit obligationProjected benefit obligationUnrecognized prior service costUnrecognized transition obligationUnrecognized net gainExpected benefit obligation - Year 8

$5,580,0003,400,0004,930,000

400,000275,000140,000250,000

The company reported net periodic pension cost of $310,000 on its income statement and made a $500,000contribution to the pension plan during Year 7. The company's effective tax rate is 40%. What amount should DoIt Right report in accumulated other comprehensive income related to its pension plan on the December 31, Year7 balance sheet under U.S. GAAP?

1. $321,000

2. $489,000

3. $535,000

4. $815,000

QUESTION 4

Giant Jobs, Inc. amended its overfunded pension plan on December 31, Year 7, resulting in the recognition ofprior service cost of $700,000. On December 31, Year 7, Giant Job's employees had an average remainingservice life of 20 years. The company has an effective tax rate of 30%. How should the prior service cost bereported in the December 31, Year 7 financial statements under U.S. GAAP?

1. $490,000 increase in net periodic pension cost.

2. $490,000 decrease in comprehensive income.

3. $700,000 decrease in net income.

4. $700,000 increase in pension benefit asset.

QUESTION S

Giant Jobs Inc. amended its overfunded pension plan on December 31, Year 7, resulting in the recognition ofprior service cost of $700,000. On December 31, Year 7, Giant Job's employees had an average remainingservice life of 20 years. The company has an effective tax rate of 30%. How will the amortization of the priorservice cost affect Giant Job's December 31, Year 8 financial statements under U.S. GAAP?

1. $24,500 decrease in other comprehensive income.

2. $35,000 decrease in net income.

3. $24,500 increase in pension benefit asset.

4. $35,000 increase in net periodic pension cost.



FINANCIAL 711Stockholders' Equity

Stockholders' Equity

• Treasury Stock

• Dividends, Stock Dividends, and Stock Splits

• Retained Earnings

• Stock Options

• Earnings per Share

7A-l~ 2011 DeVry/Becker Educational Development Corp. All rights reserved.


NOTES



SUMMARY NOTES

I. STOCKHOLDERS' EQUITY

Common stock (CS) nonnally has a par (or stated) value. Hence, CS $1 par value issued at $5 per share.

l!ru Cash

[ijil Common Stock

[ijil APIC-CS

5

1

4

Preferred stock (PS) may be cumulative, noncumulative, or participating as to the payment ofdividends and generally has a preferred claim to assets on liquidation of the business. PS $10 par value isissued at $30.

l!ru Cash

[ijil Preferred Stock

[ijil APIC-PS

30

10

20

A. Cumulative preferred stockholders receive current dividends and all dividends in arrears (unpaid fromprior years) before dividends are paid to common stockholders.

B. Participating preferred stock - Any amounts available for dividend distribution after both preferred andcommon stockholders receive a specified payment based on the same percentage is divided betweenpreferred and common stockholders on a pro-rata basis.

C. Mandatorily redeemable preferred stock is classified as a liability because it has a maturity date,similar to debt instruments.

Number of shares: authorized. issued, and outstanding.

Authorized: Legal number of shares available for sale (maximum).

Issued: Number of shares sold.

Outstanding: Shares issued less treasury shares. Only outstanding shares are entitled to dividends.

II. TREASURY STOCK

Treasury stock (TS) is stock that has been issued and then repurchased by the issuer. Treasury stock isreported as a contra account to equity. There are two methods used to account for treasury stock underU.S. GAAP: the cost method and the par value method. IFRS requires the cost method.

Cost method. TS is recorded at cost. The total cost of a treasury share is deducted from the total of thestockholders' equity on the balance sheet. When the TS is reissued for less than its acquisition price theloss is recognized by debiting APIC-Treasury Stock. Retained earnings is debited if there is not a sufficientbalance in the APIC-TS account. When TS is reissued for more than its acquisition price the gain isrecognized by crediting APIC-Treasury Stock.

Par value method. TS is recorded at par value, and APIC is reduced for the amount of additional paid-incapital that was initially recognized on issuance. The total cost of the TS (par value) is deducted from thecommon stock account on the balance sheet. When treasury stock is reacquired for less than the originalissue price (gain), APIC-Treasury Stock is recognized. When TS is reacquired for more than the originalissue price (loss), any APIC-Treasury Stock is eliminated and then retained earnings is reduced.



Gains and losses on treasury stock transactions are not reported on the Income statement. Acompany cannot report income dealing in its own stock. Treasury stock is not an asset. Treasury stockdoes not vote and does not receive dividends.

SUMMARY CHART o F JOURNAL ENTRIES

1. Orilinallssue10,000 shares of $10 par value Cash 150,000CS are sold for S15 per share Common Stock 100,000

APIC-CS 50,000

Cost Method Par Value Method2. Buy Back Below

200 shares repurchased Treasury stock 2,400 Treasury stock 2,000for $12 per share Cash 2,400 APIC-CS 1,000

Cash 2,400APIC-TS 600

3. Reissue Above Cost100 shares repurchased Cash 1,500 Cash 1,500for $12 are resold for $15 Treasury stock 1,200 Treasury stock 1,000

APIC-TS 300 APIC-CS 500

4. Reissue Below Cast100 shares repurchased Cash 300 Cash 300for $12 are resold for $3 APIC-TS 300 APIC-TS 600

Retained earnings 600 Retained earnings 100Treasury stock 1,200 Treasury stock 1,000

Note: Retained earnings may be debited, but never credited in treasury stock transactions.

III. DIVIDENDS, STOCK DIVIDENDS, AND STOCK SPLITS

Cash dividends - Dates:

Declaration date

!!l2 Retained earnings

l!Ii! Dividends payable

Record date - The date the stockholders must own the stock in order to receive the dividend declared.

No entry

Payment date - The date the dividends are actually disbursed.

i!li! Dividends payable

l!Ii! Cash

Cash dividends may be declared on common and/or preferred stock.

Properly dividends - Distribute non-cash assets, such as inventories and investment securities. Propertydividends are recorded at fair value.



Stock dividends - A distribution of a stock dividend of less than 20-25% of the outstanding capital stock isrecorded at fair (market) value (small dividend), greater than 20-25% of the capital stock is recorded at parvalue (large dividend).

Liquidating dividends - Amount in excess of retained earnings.

Stock split - The number of shares outstanding is increased, and the par value is decreased. (In a reversesplit, the opposite is true.) There is no change in the total book value of shares outstanding and a memoentry is used to acknowledge a stock split.

Stock rights/stock warrants - The right to acquire shares of stock on the payment of a defined amount.Memo entry only when the rights are issued.

Note: The recipient of stock dividends and stock splits recognize no income. The basis of each share ofstock is adjusted accordingly.

IV. RETAINED EARNINGS

Retained earnings (or deficits) are cumulative earnings (or losses) during the life of the corporation thathave not been paid as dividends. A portion of retained earnings may be appropriated (restricted) for legalreasons or as a discretionary action of management. The appropriated retained earnings is distinguishedfrom the unappropriated retained earnings account in the Balance Sheet.

RETAINED EARNINGS

Beginning retained earnings

+ Net income/loss

Dividends (cash, property, and stock) declared

± Prior period adjustments

± Accounting changes (cumulative effect)

Treasury stock (when necessary)

+ Adjustment from quasi-reorganization

Ending retained earnings

V. STOCK OPTIONS

Compensatory stock options should be valued at the fair value of the options issued. The compensationexpense is allocated over the service period.

Either a Black-Scholes model or a lattice model, a type of binomial model, can be used to determine the fairvalue of the option. The statement requires the use of a valuation technique or model that returns the bestestimate of the fair value of the option. Fair value will be given on the CPA exam.

The models that estimate the value of stock based compensation should consider the following variables:

A. The exercise price.

B. The expected life of the option.

C. The current price of the stock.

D. The expected volatility of the stock.

E. The expected dividends on the stock.

F. The risk-free rate of return for the expected term of the option.



EXAMPLE

Accountll1l for Stack Options

On January I, Year I, Green Co. granted options exercisable after December 31, Year 2, to purchase 50,000 shares

of $1 par common stock for $8 per share. Using an acceptable valuation model, the options had a total fair value

of $50,000. The options are to serve as compensation for services during Year 1 and Year 2.

Journal Entry: January I, Year 1-No entry required

Journal Entry: To allocate compensation cost to Year 1 operations

i!li! Compensation expense

[!ill Additional paid-in capital- stock options

25,000

25,000

Journal Entry: To allocate compensation cost to Year 2 operations

!!l2 Compensation expense

[!ill Additional paid-in capital- stock options

25,000

25,000

On January I, Year 3, all options are exercised.

Journal Entry: To record the exercise of the options

SO,OOO

400,000

400,000

50,000Additional paid-in capital-stock options

Common stock (50,000 x $1 par)

Additional paid-in capital in excess of par (common stock)

Cash (50,000 x $8)

VI. EARNINGS PER SHARE

All public entities must present earnings per share on the face of the income statement.

• Simple capital structure - Has only common stock, or no other securities that can become commonstock. An entity with a simple capital structure is required to present basic earnings per share (EPS).

• Complex capital structure - If securities that can be converted into common stock, inclusive ofconvertible preferred stock, convertible bonds, options, and warrants. All entities with complex capitalstructures must present basic and diluted per share amounts (assuming that there is dilution).

Basic EPS:

Income available to common shareholders / Weighted-average number of common shares outstanding

The income available to common shareholders must be reduced by the dividends declared on noncumulative preferred stock, or by the dividends accumulated in the current period on any cumulativepreferred stock whether or not those dividends have actually been declared.

To determine the weighted average number of shares outstanding, weight each total of shares outstandingby the amount of time that the total was outstanding. Stock dividends and stock splits are treated as if theyhad occurred at the beginning of the earliest period presented.



Diluted EPS:

Diluted EPS is calculated taking into consideration any security (convertible preferred stock, convertiblebonds, stock option or warrant, or contingent issuance of stock) that can be converted into common stock.Any conversion, exercise, or contingent issuance that has an antidilutive effect (increases EPS ordecreases loss per share) is not included in the calculation. No anti-dilution is presented.

Income available to common shareholders + Interest on conversion of bonds (net of tax)

Weighted average number of common shares

assuming all dilutive securities are converted to common stock

Options and warrants are accounted for using the treasury stock method. An assumption is made that"in the money" (average market price> exercise price) options and/or warrants are exercised and that theproceeds from the exercise are used to buy back shares for the treasury. The incremental shares(difference between the shares "sold" and the shares "reacquired") are added to the denominator.

EXAMPLE:

A company has 1,000 stock options outstanding, which are exercisable at $30 each. If the averagemarket price is $50 per share, then the options are "in the money" and therefore dilutive. When theoptions are assumed to be exercised for the purposes of computing diluted EPS, it is assumed that thecompany will receive $30,000, which can be used to purchase 600 shares of stock ($30,000/ $50 share= 600 shares). The company will need to issue 400 new shares (1000 shares - 600 repurchased). The400 newly issued shares will be added to the weighted average number of common shares outstandingwhen computing diluted EPS.

. (1,000 x 30 option price) .1,000 options - = Shares added to denominator50 average price

1,000 - 600 = 400 shares



NOTES




QUESTION 1

Boone Corporation's outstanding capital stock at December 15 consisted of the following:

• 30,000 shares of 5% cumulative preferred stock, $10 par value.

• Fully participating as to dividends. No dividends were in arrears.

• 200,000 shares of common stock, par value $1 per share.

On December 15, Boone declared dividends of $1 00,000. What was the amount of dividends payable to Boone'scommon stockholders?

1. $10,000

2. $34,000

3. $40,000

4. $47,500

QUESTION 2

On September 1, Year 1, Royal Corp., a newly formed company, had the following stock issued and outstanding:

• Common stock, no par, $1 stated value, 5,000 shares originally issued for $15 per share.

• Preferred stock, $10 par value, 1,500 shares originally issued for $25 per share.

Royal's September 1, Year 1, statement of stockholders' equity should report:

AdditionalCommon Preferred paid-in

stock stock capital

1. $5,000 $15,000 $92,500

2. $5,000 $37,500 $70,000

3. $75,000 $37,500 $0

4. $75,000 $15,000 $22,500

QUESTION 3

Purple Corp. acquired treasury shares at an amount greater than their par value, but less than their original issueprice. Compared to the cost method of accounting for treasury stock, does the par value method report a greateramount for additional paid-in capital and a greater amount for retained earnings?

Additional Retainedpaid-in capital earnings

1. Yes Yes

2. Yes No

3. No No

4. No Yes



QUESTION 4

Hutchins Company had 200,000 shares of common stock, 50,000 shares of convertible preferred stock, and$2,000,000 of 10% convertible bonds outstanding during the current year. The preferred stock was convertibleinto 40,000 shares of common stock.

During the current year, Hutchins paid dividends of $1.00 per share on the common stock and $2.00 per share onthe preferred stock. Each $1,000 bond was convertible into 50 shares of common stock. The net income for theyear was $1,000,000 and the income tax rate was 30%.

Basic earnings per share for the current year was (rounded to the nearest penny):

1. $5.00

2. $4.50

3. $4.30

4. $4.55

QUESTION 5

Hutchins Company had 200,000 shares of common stock, 50,000 shares of convertible preferred stock, and$2,000,000 of 10% convertible bonds outstanding during the current year. The preferred stock was convertibleinto 40,000 shares of common stock.

During the current year, Hutchins paid dividends of $1.00 per share on the common stock and $2.00 per share onthe preferred stock. Each $1,000 bond was convertible into 50 shares of common stock. The net income for theyear was $1,000,000 and the income tax rate was 30%.

Diluted earnings per share for the current year was (rounded to the nearest penny):

1. $5.00

2. $3.35

3. $3.53

4. $3.06




TASK-BASED SIMULATION 1: Retained Earnings

R*lned ~Ing. Authorllallve Literature I Help I

Kansas, Inc. is a publicly-held company whose shares are traded in the over-the-counter market. The stockholders' equity accounts atDecember 31, Year 1 of the prior year had the following balances:

PrefelT8d stock, $100 par value, 6% cumulative; 5,000 shares authorized; 2,000 issued andoutstanding

Common stock, $1 par value, 150,000 shares authorized; 100,000 issued and outstanding

Additional paid-in capital

Retained earnings

Total stockholders' equity

$ 200,000

100,000

800,000

1,586,000

$2,686,000

Transactions during Year 2 and other information relating to the stockholders' equity accounts were as follows:

• February 1, Year 2 -Issued 13,000 shares of common stock to Ram Co. in exchange for land. On the date issued, the stock had amarket price of $11 per share. The land had a carrying value on Ram's books of $135,000, and an assessed value for propertytaxes of $90,000.

• March 1, Year 2 - Purchased 5,000 shares of its own common stock to be held as treasury stock for $14 per share. Kansas usesthe cost method to account for treasury stock. Transactions in treasury stock are legal in the state of incorporation.

• May 10, Year 2 - Declared a property dividend of marketable securities held by Kansas to common shareholders. The securitieshad a carrying value of $600,000; fair value on relevant dates were:

Date of declaration (May 10, Year 2)

Date of record (May 25, Year 2)

Date of distribution (June 1, Year 2)

$720,000

758,000

736,000

• October 1, Year 2 - Reissued 2,000 shares of treasury stock for $16 per share.

• November 4, Year 2 - Declarad a cash dividend of $1.50 per share to all common shareholders of record November 15. Thedividend was paid on November 25.

• December 20, Year 2 - Declared the required annual cash dividend on prefelT8d stock for Year 2. The dividend was paid onJanuary 5, Year 3.

• January 16, Year 3 - Before closing the accounting records for Year 2, Kansas became aware that no amortization had beenrecorded for the prior year for a patent purchased on July 1, Year 1. The patent was properly capitalized at $320,000 and had anestimated useful life of eight years when purchased. The company's income tax rate is 30%. The appropriate correcting entry wasrecorded on the same day.

• Adjusted net income for Year 2 was $838,000.

Calculate the following amounts as they would be reported on the Year 2 Statement ofRetained Earnings. Enter the appropriate valuesin the shaded cells.

~~fx II IPrior period adjustment.

Preferred dividends.

Common dividends - cash.

Common dividends - property.

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Solution I

1. $14,000; Prior period adjustment which reduces beginning retained earnings balance for prior year error, patentamortization not recorded:

Patent cost $320,000 I Useful life 8 years =$40,OOO/year x 1/2 year =

Less 30% income tax

Prior period adjustment (net of tax)

$20,000

(6,000)

$14,000

2. $12,000; Preferred dividends ($100 par value at 6% x 2,000 outstanding shares)

3. $165,000; Common dividends - Cash (110,000 common shares outstanding on Nov. 4 = $1.50)

4. $720,000; Common dividends - Property (fair market value of marketable securities on date of declaration)



TASK-BASED SIMULATION 2: Stockholders' Equity

Stoc:kho'dere' Equity Authorilative Literature I Help I

Kansas, Inc. is a publicly-held company whose shares are traded in the over-the-counter market. The stockholders' equity accounts atDecembar31, Year 1 of the prior year had the following balances:

Preferred stock, $100 par value, 6% cumulative; 5,000 shares authorized; 2,000 issued andoutstanding

Common stock, $1 par value, 150,000 shares authorized; 100,000 issued and outstanding

Additional paid-in capital

Retained earnings

Total stockholders' equity

$ 200,000

100,000

800,000

1,586,000

$2,686,000

Transactions during Year 2 and other information relating to the stockholders' equity accounts were as follows:

• February 1, Year 2 -Issued 13,000 shares of common stock to Ram Co. in exchange for land. On the date issued, the stock had amarket price 01 $11 pershare. The land had a carrying value on Ram's books 01 $135,000, and an assessed value for propertytaxes of $90,000.

• March 1, Year 2 - Purchased 5,000 shares of its own common s10ck to be held as treasury stock for $14 per share. Kansas usesthe cost method to account for treasury stock. Transactions in treasury stock are legal in the state of incorporation.

• May 10, Year 2 - Declared a property dividend of marketable securities held by Kansas to common shareholders. The securitieshad a carrying value 01 $600,000; fair value on relevant dates were:

Date of declaration (May 10, Year 2)

Date of record (May 25, Year 2)

Date of distribution (June 1, Year 2)

$720,000

758,000

736,000

• October 1, Year 2 - Reissued 2,000 shares of treasury stock for $16 per share.

• November 4, Year 2 - Declared a cash dividend of $1.50 per share to all common shareholders of record November 15. Thedividend was paid on November 25.

• December 20, Year 2 - Declared the required annual cash dividend on preferred stock for Year 2. The dividend was paid onJanuary 5, Year 3.

• January 16, Year 3 - Before closing the accounting records for Year 2, Kansas became aware that no amortization had beenrecorded for the prior year for a patent purchased on July 1, Year 1. The patent was properly capitalized at $320,000 and had anestimated useful life 01 eight years when purchased. The company's income tax rate is 30%. The appropriate correcting entry wasrecorded on the same day.

• Adjusted net income for Year 2 was $838,000.

calculate the following amounts as they would be reported on the Year 2 statement of Stockholders' Equity. Enter the appropriatevalues in the shaded cells.

~~fx II INumber of common shares issued at December 31, Year 2.

Amount of common stock issued.

Additional paid-in capital, including treasury stock transactions.

Treasury stock.



Solution I

1. 113,000

Date Transaction Issued Outstanding Months Weighted Average

End of prior year Balance 100,000 100,000 x 1 = 100,000

211Near 2 Shares for land 13,000 13,000

113,000 113,000 x = 113,000

3J1Near2 Purchase treasury stock -- (5,000)

113,000 108,000 x 7 756,000

10/1Near 2 Reissue treasury stock - 2,000--Balance 113,000 110,000 x .a = 330,000

Total 12 1,299,000

Weighted average 108,250

Alternative solution:

Date Transaction Outstanding Months Weighted Average

End of prior year Balance 100,000 x 12112 100,000

211Near 2 Shares for land 13,000

113,000 x 11/12 = 11,916

3J1Near2 Purchase treasury stock (5,000)

108,000 x 10/12 = (4,166)

10/1Near 2 Reissue treasury stock 2,000

Balance 110,000 x 3/12 500

Weighted average 108,250

2, $113,000

Balance (100,000 shares x $1 par) $100,000

land for shares (13,000 shares x $1) 13,000

$113,000

3. $934,000

Beginning balance, 12131Near 1 $800,000

land for shares (13,000 shares x $10) 130,000

2,000 shares treasury stock sold )( $16 $32,000

less cost of treasury stock (2,000 lC $14) 28,000

Excess (2,000 lC $2) 4,000

$934,000

4. $42,000

5,000 treasury shares lC $14 cost $70,000

(2,000) treasury shares lC $14 cost (28,000)

3,000 treasury shares lC $14 cost $42,000

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TASK-BASED SIMULATION 3: Stock Options

T Stock Options IAuthoritative literature I Help I

On January 2, Year 1, Gracie Corp. granted compensatory stock options exercisable beginning January 2, Year 3, to purchase100,000 shares of $2 par common stock for $6 per share. Using an acceptable valuation model, the options had a total fair valueof $150,000.

Complete the following journal entries, for each specific date, assuming all the options were exercised on January 2, Year 3.Double click in the shaded cells of Column A and select the appropriate account from the list provided. In addition, enter theappropriate amounts in the shaded cells of Columns B & C.

A

1. Record compensatory stock options at grant date

2. Record compensation expense for the year ended December 31, Year 1

3. Record compensation expense for the year ended December 31, Year 2

4. Record exercise of option at January 2, Year 3

B

DEBIT-,-

C

CREDIT-

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Additional paid-in capital CIS

Additional paid-in capital stock options

Cash

Common stock

Compensation expense

Deferred compensation

No entry required

Retained eamlngs


Solution I

1. January 2, Year 1

Not applicable.

No journal entry is required of the grant date of stock options.

2. December 31, Year 1

DR Compensation expense

CR Additional paid-in capital: stock options

$75,000

$75,000

Compensation expense is ratably allocated to the benefiting periods ($150,000/2 year service period).

3. December 31, Year 2

DR Compensation expense

CR Additional paid-in capital: stock options

$75,000

$75,000

Compensation expense is ratably allocated to the benefiting periods ($150,000/2 year service period).

4. January 2, Year 3

DR Cash

DR Additional paid-in capital: stock options

CR Common stock

CR Additional paid-in capital CIS

$600,000

150,000

$200,000

550,000

Exercise of the stock options is recorded as a charge to cash at the exercise price (100,000 shares at $6 per share),a reversal of the amounts recorded in APIC stock options and credit to shares purchased at par (100,000 shares at$2 per share), and a credit to APIC common stock for the difference.




Stockholders' Equity Authoritative literature I Help I

What is the treatment of purchased put options in the computation of diluted earnings per share? Find theproper citation that provides guidance to answer this question.



--FASB ASC I 1- C]- C]- c=J

Some examples of correctly formatted FASB ASC responses are205-10-05-1, 323-740-S25-1, 260-1 0-S0-1 A, 260-10-55-99 and

115-6G-35-128A

, R.search Authoritative literature I H~rp IBack J Home Recent Pia, ylslts

IEnter 'Se.a, ch Here ~5e.rch II 5e<!r<h With" I Advanced Search

iTable of Contents I Previous Mlltch II' Ne>:t Mlltch I I PrevJOUs Result II Ne>:tResult Iq;::J FASB L1terlIluro FASS Literature

l.k1 Original Pronouncements as A

!kI Current TextUniform CPA Examination Authoritative LiteraturefV Topical Index

ltJ FASB Import



OR


·1 I •

Solution I


FASB ASC 260-10-45-22

Keyword: Purchased put options



NOTES

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FINANCIAL 78Cash Flows

• Methods of Presentation

• Operating Activities - Indirect Method

• Operating Activities - Direct Method

• Investing Activities

• Financing Activities

• Non-Cash Investing and Financing Activities

• Cash Equivalents

.IFRSvs.U.S.GAAP

• Additional Supplemental Disclosures



NOTES



SUMMARY NOTES

I. METHODS OF PRESENTATION

The direct method and the indirect method are the two methods of presentation for the statement of cashflows. The two methods are identical except for the cash flows from operating activities and for somedisclosures.

A presentation of cash flow per share is prohibited. Both U.S. GAAP and IFRS encourage the use of thedirect method. Regardless of the method of presentation, the sections of the statement of cash flows are:

./ Operating activities (CFO)

./ Investing activities (CFI)

./ Financing activities (CFF)

./ Supplemental disclosures

Investing and financing activities are the same presentation for the direct and indirect methods. There aretwo approaches to presenting the operating activities but the results are the same. Under U.S. GAAP,operating activities require a reconciliation of "net income to net cash" for both methods. In addition, thedirect method requires a cash basis income statement.

II. OPERATING ACTIVITIES - Indirect Method (reconciliation ofnet income to net cash)

The indirect method begins with accrual net income and reconciles it to cash flow from operating activitiesby adding non-cash amounts, such as depreciation, amortization and losses on dispositions of assets andsubtracting gains on dispositions of assets.

Other adjustments to net income include changes in current assets and current liabilities, such as AIR, AlP,inventory, etc.

III. OPERATING ACTIVITIES - Direct Method (cash basis income statement)

These amounts are accrual amounts reported in the income statement and adjusted to the cash basis. A"reconciliation of net income to net cash" is required under U.S. GAAP. The totals for the "reconciliation"and "cash basis income statement" are the same. Operating activities include:

• Cash received from customers

• Cash paid to suppliers and employees

• Operating expenses paid in cash (excluding amounts such as depreciation and amortization)

• Interest received and paid

• Dividends received (not dividends paid)

• Taxes paid

• Purchase and sale of trading securities classified as current assets

IV. INVESTING ACTIVITIES

Investing activities generally involve changes in non-current assets, inclusive of the purchase or sale ofproperty, plant, investments, equipment and marketable securities (excluding trading securities classified ascurrent assets). Depreciation expense andlor the accumulated depreciation on assets disposed of, andgains/losses on assets disposed of are a few key accounts that must be considered in determining thebalance of the cash used or provided by the investing activities.

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V. FINANCING ACTIVITIES

Financing activities generally involve changes in non-current liabilities and stockholders' equity, includingpayment or retirement of long-term notes, long-term bonds, the issuance or re-acquisition of company stockand dividends paid.

VI. NON-CASH INVESTING AND FINANCING ACTIVITIES (supplemental)

Certain transactions do not affect cash: purchasing assets with a note, entering into a capital lease, orexchanging bonds for stock. Look for a transaction that is, in effect, a barter transaction. Thesetransactions are not included on the body of the statement of cash flows but are included in supplementaldisclosures.

VII. CASH EQUIVALENTS

Cash equivalents are short-term, highly-liquid investments (maturing 90 days or less from the date ofpurchase) that are readily convertible into cash or so near their maturity that the risk of changes in value isinsignificant. Cash equivalents are included with cash in the statement of cash flows.

VIII. IFRS VS. U.S. GAAP

IFRS allows more flexibility than U.S. GAAP in classifying cash flows related to interest, dividends, andincome taxes. The following table summarizes the classification differences between U.S. GAAP and IFRS:

Transaction U.S. GAAP IFRS

Interest received CFO CFO orCFI

Interest paid CFO CFO orCFF

Dividends received CFO CFO orCFI

Dividends paid CFF CFO orCFF

Taxes paid CFO CFO, CFI, CFF

IFRS classifies taxes paid as CFO, but allows allocation to CFI or CFF for portions specifically identifiedwith investing and financing activities.

IX. ADDITIONAL SUPPLEMENTAL DISCLOSURES

Interest paid and income taxes paid must be disclosed.


ILLUSTRATIONS:


DIRECT METHOD(preferred presentation)

Letterman, Inc.

STATEMENT OF CASH FLOWS

For the Year Ended 12/31/Year X

Cash flows from operating activities:

Cash received from customers

Cash paid to suppliers and employees

Income taxes paid

Net cash provided by operating activities

Cash flows from investing activities:

Cash paid to purchase equity securities

Net cash used in investing activities

$125,000

(30,OOO)

(4,000)

(3,000)

$ 91,000

(3,OOO)

";"'1Me "'S

1"..Ai.·edMei-ho..A

Cash flows from financing activities:

Cash dividends paid

Net cash used in financing activities

Net increase in cash and cash equivalents

Cash and cash equivalents at the beginning of the year

Cash and cash equivalents at the end of the year

Reconciliation of net income to net cash provided by operating activities:

(2,000)

(2,000)

86,000

99,000

$ 185.000

Net income

Adjustments to reconcile net income to net cash provided:

Decrease in accounts receivable

Increase in inventory

Increase in accounts payable

Increase in income taxes payable

Total adjustments

Net cash provided by operations

$ 25,000

(10,OOO)

20,000

6,000

$ 50,000

41,000

$ 91.000



INDIRECT METHOD

Letterman, Inc.

STATEMENT OF CASH FLOWS

For the Year Ended 12/31/Year X

Cash flows from operating activities:

Net income

Adjustments:


Increase in inventory

Increase in accounts payable

Increase in income taxes payable

Total adjustments


Cash flows from investing activities:

cash paid to purchase equity securities


Cash flows from financing activities:

cash dividends paid



Cash and cash equivalents at the beginning of the year

Cash and cash equivalents at the end of the year

$ 50,000

$25,000

(10,000)

20,000

6,000

41,000

91,000

(3,000)

(3,000)

(2,000)

(2,000)

86,000

99,000

$185.000




QUESTION 1

During Year 1, Brianna Company had the following transactions related to its financial operations:

Payment for the retirement of long-term bonds payable (carrying value $740,000)

Distribution in Year 1 of cash dividend declared in Year 0 to preferred shareholders

Carrying value of convertible preferred stock of Brianna converted into common shares

Proceeds from sale of treasury stock (carrying value at cost $86,000)

On its Year 1 statement of cash flows, net cash used in financing activities should be:

1. $717,000

2. $716,000

3. $597,000

4. $535,000

QUESTION 2

$750,000

62,000

120,000

95,000

In its year-end income statement, Black Knights Company reported cost of goods sold of $450,000. Changesoccurred in several balance sheet accounts during the year as follows:

Inventory

Accounts payable - suppliers

$160,000 decrease

40,000 decrease

What amount should the Black Knights Company report as cash paid to suppliers in its cash flow statement,prepared under the direct method?

1. $250,000

2. $330,000

3. $570,000

4. $650,000



NOTES




TASK-BASED SIMULATION 1: Cash Flows

Authoritative Literature I Help IBelow are the consolidated work paper balances of Marigold, Inc. and its subsidiary, Rose Corporation, as of December 31,Year 1 and Year 2:

Net changeincrease

Assets Year 2 Year 1 (decrease!

Cash $313,000 $195,000 $118,000

Mar1<etable equity securities for trading, at cost 175,000 175,000 -0-

Allowance to reduce marketable equity securitiee to market (13,000) (24,000) 11,000

Accounts receivable (net) 418,000 440,000 (22,000)

Inventories 595,000 525,000 70,000

Land 385,000 170,000 215,000

Plant and equipment 755,000 690,000 65,000

Accumulated depreciation (199,000) (145,000) (54,000)

Goodwill 57.000 60,000 (3,000)

Total assets $2.486,000 52.086.000

Liabilities and Stockholders' Equity

Current portion of long-term note $150,000 $150,000 $ -0-

Accounts payable and accrued liabilities 595,000 474,000 121,000

Note payable, long te"" 300,000 450,000 (150,000)

Deferred income taxes 44,000 32,000 12,000

Minority interest in net assets of subsidiary 179,000 161,000 18,000

Common stock par $10 580,000 480,000 100,000

Additional paid-in capital 303,000 180,000 123,000

Retained earnings 335,000 195,000 140,000

Treasury stock at cost 136.000) 36,000

Total liabilities and stockholders' equity 52,486,000 52.086.000

Additional information:1. On January 20, Year 2, Marigold, Inc. issued 10,000 shares of its common stock for land having a fair value of $215,000.

2. On February 5, Year 2, Marigold, Inc. reissued all of its Treasury stock for $44,000.3. On May 15, Year 2, Marigold, Inc. paid a cash dividend of $58,000011 its common stock.

4. On August 8, Year 2, equipment was purchased for $127,000.

5. On September 30, Year 2, equipment was sold for $40,000. The equipment cost $62,000 and had a carrying amount of $34,000 onthe date of sale.

6. On December 15, Year 2, Rose Corporation paid a cash dividend of $50,000 on its common stock,7. Deferred income taxes represent temporary differences relating to the use of methods for income tax reporting and the allowance for

financial reporting on accounts receivable,

8. Net income for Year 2 was as follows:Consolidated net income: $198,000

Rose Corporation: $110,0009. Marigold, Inc. owns 70% of its subsidiary, Rose Corporation. There was no change in the ownership interest in Rose Corporation

during Year 1 and Year 2. There were no intercompany transactions other than the dividend paid to Marigold, Inc. by its subsidiary.

10. Sales were $2,200,000.11. Purchases were $1,500,000.

12. Goodwill was determined to be impaired by $3,000.

(continued)



(continued)

For each account below, reconcile the beginning and ending balances to assist in determining the effect on cash flowsfor the year ended December 31, Year 2. Double-elick on the shaded cells of Column B and select from the listprovided. Enter the corresponding amounts in the shaded cells of Column C.

Marigold Inc. and Subsidiary

Consolidated Statement of Cash Flows

for the Year Ended December 31, Year 2

Cash Flows From Operating Activities:f----

f----

f----

f----

f----

f----

f----

f----

f----

f----

f----

f----

Total adjustments $0

Net cash provided by operating activities $0

Cash Flows From Investing Activities:f----

f----

Net cash used in investing activities $0

Cash Flows From Financing Activities:

f----

f----

f----



Cash and cash equivalents at beginning of year

Cash and cash equivalents at end of year $0

Supplemental Disclosure of Noncash Investing and Financing Activities:

n



Adjustments to reconcile net income tonet cash provided by operating activities

Capital expenditures for equipment

Cash dividend paid to minorityshareholder of subsidiary

Cash dividend paid by parent company

Cash paid to suppliers

Cash received from customers

Changes in current assets and liabilities


Decrease in allowance to reducemarketable securities to market

OK I ICancel I

II

III 1- Depreciation

Gain on sale of equipment

Impairment of goodwill

Increase in AlP and accrued liabilities

Increase in deferred income taxes

Increase in inventories

Interest paid

Interest received

Issuance of common stock to purchaseland for $215,000

Minority interest in net income ofsubsidiary

OK I ICancel I1

Net income

Principal payment on note payable

Proceeds from sale of equipment

Proceeds from sale of treasury stock

OK I ICancel I



Solution- ---

Marigold Inc. and Subsidiary

CONSOLIDATED STATEMENT OF CASH FLOWS

for the Year Ended December 31, Year 2

CASH FLOWS FROM OPERATING ACTIVITIES:

Net income

Adjustments to reconcile net income to net cash provided by operating activities:

Minority interest in net income of subsidiary

Depreciation

Impairment of goodwill

Gain on sale of equipment

Changes in current assets and liabilities:


Increase in inventories

Increase in AlP and accrued liabilities

Increase in deferred income taxes

Decrease in allowance to reduce marketable securities to market

Total adjusbnents


CASH FLOWS FROM INVESTING ACTIVITIES:

Proceeds from sale of equipment

capital expenditures for equipment


CASH FLOWS FROM FINANCING ACTIVITIES:

Proceeds from sale of treasury stock

cash dividend paid by parent company

Gash dividend paid to minority shareholder of subsidiary

Principal payment on note payable



cash and cash equivalents at beginning of year

cash and cash equivalents at end of year

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:

Issuance of common stock to purchase land for $215,000

78-12~ 2011 DeVryjBecker Educational Development Corp. All rights reserved,

$ 33,000

82,000

3,000

(6,000)

22,000

(70,000)

121,000

12,000

(11,000)

$198,000

$186,000

$ 384,000

$ 40,000

(127.000)

$ (87,000)

$ 44,000

(58,000)

(15,000)

(150.000)

$(179,000)

118,000

$ 195,000

$ 313,000


TASK-BASED SIMULATION 2: Rules

J'J Rul.. IAuthoritative Literature I Help I

From the following list of statements, select three that are true with regards to cash flows under U.S. GAAP. Only threeitems can be selected at a time.

o 1. Under either the direct or indirect method, cash flows from investing activities are reported the same.

o 2. Under the indirect method, the Statement of Cash Flows begins with Net Income.

o 3. Under the indirect method, a reconciliation of net income to net cash provided by operating activities is required tobe provided in a separate schedule.

o 4. Material non-cash investing and financing activities do not have to be disclosed under either the direct or indirectmethod.

o 5. Interest paid during the year is reported in the operating activities of the Statement of cash Flows under the direct

method.

o 6. Interest paid is a required additional disclosure for the Statement of Cash Flows under the direct method.

o 7. cash flows per share is a required disclosure under both the direct and indirect method of presenting the

Statement of Cash Flows.



Solution

1. True

The only section of the body of the Statement of Cash Flows that differs between the two methods is the section thatpresents operating activities. Under the direct method, this section shows the major classes of operating cash receiptsand disbursements directly. In contrast, the indirect method reports these cash flows by adjusting net income toreconcile it to net cash flows from operating activities.

2. True

Under the indirect method, net income is adjusted.

3. False

The reconciliation of net income to cash provided by operating activities is in the body of the statement under theindirect method. Under the direct method, it is provided in a separate schedule.

4. False

The disclosure of material non-cash investing and financing activities is required under both the direct and indirectmethods of presentation.

5. True

Interest paid is reported in the operating activities section of the body of the Statement of Cash Flows under the directmethod. Under the indirect method, the change in the interest payable is disclosed in the body, and the interest paid isa required disclosure.

6. False

Under the direct method, interest paid is shown in the operating activities section of the Statement of Cash Flows (I.e.,in the body of the statement, not as an additional disclosure). It is an additional disclosure under the indirect method.

7. False

Cash flows per share should not be reported.




Research Authoritative Literature I Help I

An entity presenting a statement of cash flows should disclose its policy for determining which items are cash equivalents.Find the citation that provides guidance on this disclosure.



--FASBASC I 1- CJ -CJ -c::::=J

Some examples of correctly formatted FASB ASC responses are

205-10-05-1, 323-740-S25-1, 260-1 0-60-1 A, 260-10-55-99 and115-6Q-35-128A

'I ReseMch Authortl:adve Ltlerature I Help II B3Ck 1l!2m! Rec.nt Pag' VI.lt!

IEnter Se~r(h Here - Seorch I St:~rchWlthin I Advanced Search

;fable of Contents I Pr"",,,,,, Match 11 ;·le>:!: ,••tch I I Pr"~OIl,Result II r'Jm Result I<V FASB Lnorolure FASS literature

tJ Original Pronouncement,.s A

fJ Current TextUniform CPA Examination Authoritative Literaturef] Topicel Index

IV FASB Import



OR

Perform a search for a particular topic by entering text in the text boxabove. Use the buttons to the right and the lin ks above the text box toperform more delailed or advance searches.

• •

Solution


FASS ASC 230-10-50-1

Keyword: Cash Equivalents Policy



NOTES



FINANCIAL 8Governmental Accounting

• Fund Structure

• Fund Accounting - Measurement Focus

• Fund Accounting - Basis of Accounting

• Fund Accounting - Mechanics

• Fund Accounting - Fund Balance Classifications

• GASB 34 Model - Government-wide Reporting

GASB 34 Model - Fund Financial Statements

GASB 34 Model - Infrastructure

• Reporting Units

• I nte rfu n d Activity

• Financial Statement Samples



NOTES



SUMMARY NOTES

I. FUND STRUCTURE

A fund is a sum of money or other resource segregated for the purpose of carrying on a specific activity orattaining certain objectives in accordance with specific regulations, restrictions or limitations and constitutingan independent fiscal and accounting entity. Each fund is a self-balancing set of accounts.

The basis of accounting and measurement focus contribute to the accountability objectives of each fundtype.

A. Fund Categories and Fund Types

Eleven fund types (GRSPP SE PAPI) are classified in the following three generic categories:

1. Governmental funds

• General- The general fund accounts for the ordinary operations of a governmental unitthat are financed from taxes and other general revenues. All transactions not accountedfor in some other funds are accounted for in this fund.

• Special Revenue - Special revenue funds account for revenues from specific taxes or otherearmarked sources that are restricted or committed to finance particular activities ofgovernment.

• Debt Service - Debt service funds account for the accumulation of resources and thepayment of interest and principal on all "general obligation debt."

• Capital Projects - Capital projects funds account for resources used for the acquisition orconstruction of major capital assets by a governmental unit.

• Permanent - Permanent funds are used to report resources that are legally restricted to theextent that income, and not principal, may be used for purposes that support the reportinggovernment's programs.

2. Proprietary funds

• Internal Service - Internal service funds account for goods and services provided bydepartments on a cost reimbursement fee basis to other departments.

• Enterprise - Enterprise funds account for the acquisition and operation of governmentalfacilities and services that are intended to be primarily (over 50%) self-supported by usercharges.

3. Fiduciary funds

• Pension - Pension trust funds account for resources of defined benefit and definedcontribution plans, as well as post retirement benefit plans.

• Agency - Agency trust funds account for resources temporarily in the custody of agovernmental unit.

• Private Purpose - Private purpose trust funds account for all other trust arrangementsunder which principal and income are for the benefit of specific individuals, privateorganizations, and other governments.

• Investment Trust - Investment trust funds account for external investment pools.



II. FUND ACCOUNTING - Measurement Focus

Measurement focus describes the reporting objective that the application of fund accounting is designed toachieve. There are two measurement focuses:

A. Current Financial Resources Measurement Focus

Financial statement readers are focused on the sources, uses and balances of current financialresources. The focus often includes a budgetary element. The Governmental Fund Types use thecurrent financial resources measurement focus.

1. Non-current assets and liabilities are NOT reported on the governmental fund types balancesheets.

2. Capital outlay expenditures are reported on the face of the governmental fund types operatingstatements.

3. Proceeds from long-term debt are recorded in the governmental funds as "other financingsources."

4. Payment of principal and interest are recorded as "expenditures."

B. Economic Resources Measurement Focus

Financial statement readers are focused on the determination of operating income, changes in netassets, financial position and cash flow. The Proprietary Fund and Fiduciary Fund Types use thisfocus. Accounting is nearly identical to commercial accounting used in "for profit" entities.

1. Non-current assets and non-current liabilities are recorded on the balance sheet. Depreciationexpense is recorded.

III. FUND ACCOUNTING - Basis ofAccounting

Basis of accounting describes the accounting principles used to accomplish the measurement focus ofeach fund category. There are two bases:

A. Modified Accrual Basis of Accounting

The current financial resources measurement focus is accomplished using the modified accrual basisof accounting. The difference between modified accrual and accrual primarily relates to the timing ofrevenue recognition.

Revenues are generally accrued when they are both measurable and available (due AND collectedwithin 60 days of year end). There are four classifications of non-exchange revenues that serve asthe basis for most governmental fund resources. There is no underlying exchange transaction thatproduces these revenues, the government does not provide a specific service in exchange for therevenue earned:

1. Derived Non-exchange Tax Revenues

A sales tax or an income tax is considered to be "derived" tax revenue; it is a tax that comes asa result of economic activity. Derived non-exchange tax revenues are accrued based on thetiming of receipt. Receipts due at year end and actually received within 60 days of year endare accrued and recognized as revenue.



2. Imposed Non-exchange Revenues

Fines and property taxes are imposed non-exchange revenues since the taxpayer's obligationis imposed by an enforceable claim by the government. Imposed non-exchange revenues aretypically accrued when billed since collection is not in doubt. Collection of fines is based uponenforcement of a penalty resulting from the violation of law (e.g., driver's licenses can berevoked, cars can be impounded, etc.). Leins on property (allowed by law) are used to enforceproperty tax collection.

3. Government Mandated Non-exchange Transactions

Grants are conveyed by one govemment to another, (a state, or a county) to mandate certainactivities.

Revenues are recognized when eligibility requirements are met and the revenues are bothmeasurable and available.

4. Voluntary Non-exchange Transactions

Resources are willingly conveyed by a govemment to another for a particular purpose or usewithout an equal exchange of value. Revenues are recognized when restrictions are met.

Modified accnJal also creates important expenditure recognition differences, including nointerest accnJal.

B. Accrual Basis of Accounting

The economic resources measurement focus is accomplished using the accrual basis of accountingwhere revenues are recorded when earned and expenses are recorded when incurred.

IV. FUND ACCOUNTING - Mechanics

Fund accounting mechanics generally focus on the accounting for the governmental funds and requireknowledge of the journal entries used to record the budget, actual activities, and encumbrances.

A. Budgetary Activity

To record the bUdget into the accounting records, the following entry is used. Any balancing amountsare posted to bUdgetary fund balance.

!!Iil Estimated revenue control

~ Appropriations control

~ Budgetary fund balance

xxxxxxXXX

BUdgetary fund balance can also be a debit. BUdgetary accounts are recorded at the beginning of theyear and are closed at the end of the year. Budgetary accounts are only impacted when establishing,amending or closing the budget.

B. Actual ActiVity

Actual activities are recorded as they happen throughout the year. Expenditures are typicallyrecorded as they are incurred.

Capital purchases are identified as capital outlay because of their long term nature but they areaccounted for as expenditures and they are not reported in the balance sheet. In addition, nodepreciation expense is recorded on govemmental fund financial statements. Generally, all spendingis recorded currently as "expenditures.·

!!Iil Capital outlay expenditures

~ Cash or vouchers payable

XXX

XXX



Principal payment on debt is displayed as an expenditure since there is no noncurrent debt recordedon the governmental fund financial statements.

!!rn Debt service - principal expenditure

~ Cash

xxxxxx

In addition, new debt proceeds are recorded as other financing sources, a resource inflow:

!!rn Cash

~ Other financing sources - debt proceeds

xxxxxx

The modified accrual basis of accounting records (accrues) revenue when it is measurable andavailable, generally collected within 60 days of year-end. Only the amount available is recorded asrevenue. Note the entry below to record property tax receivable (imposed non-eXChange revenue)and the related allowance for uncollectible taxes. Tax receivable is recorded when the tax is leviedbut only available revenue is recognized. No "bad debt expenditure" is recognized.

!!rn Property tax receivable - current XXX

~ Allowance for uncollectible taxes - current XXX

~ Property tax revenue XXX

c. Encumbrance Activity

Encumbrances are recorded when purchase orders are issued. The issuance of a purchase orderdoes not represent a liability, rather an encumbrance of appropriated funds. Entries to record theencumbrance of funds and the receipt of goods are as follows for internal accounting purposes(reserves are not used for external reporting):

To record the issuance ofa purchase order.

!!rn Encumbrances

~ Reserve for encumbrances. budgetaryfund balance

XXX

XXX

Upon receipt ofgoods the encumbrance offunds associated with the issued order is reversed and the relatedexpenditure ;s recorded.

!!rn Reserve for encumbrances. budgetaryfund balance XXX

~ Encumbrances XXX

!!rn Expenditure XXX

~ Vouchers payable XXX

D. Relationship Between Accounts at Year-end

Governmental funds record bUdget, actual, and encumbrance activities separately. Both bUdget andactual activities are recorded during the year and then closed at the end of the year.

Encumbrances are recorded and closed throughout the year. At year-end, if encumbrances are stilloutstanding, they are reported as a component of committed or assigned fund balance and disclosedif appropriations do not lapse.



E. Inventory of Supplies

When government bUys supply inventory two methods can be used for the transaction: Purchase andConsumption.

At the time ofpurchase

The Purchase method:

!!l2 Expenditures

Vouchers payable

5,000

5,000

The Consumption method:

!!l2 Inventory of supply

Si! Vouchers payable

5,000

5,000

At year-end (assumption: 1,DDD ofsupply is still on hand)

!!ru Inventory of supply 1,000 !!ru Expenditures 4,000

Nonspendable FB inventory 1,000 [ijil Inventory of supply 4,000

Under the purchase method the remaining inventory must be placed in the balance sheet (it was allexpensed at the beginning) and because it cannot be spent in that year, the fund balance should bereclassified as being non-spendable fund balance - inventory.

v. FUND ACCOUNTING - Fund Balance C/assfflcations

Governmental fund balances are classified in anyone of five ways:

A. Non..spendable

Non-spendable fund balances represent resources that are non-spendable because they are not inspendable form (e.g., inventories or prepaid expenditures) or legally or contractually required to bemaintained intact (e.g., permanent fund principal).

B. Restricted

Restricted fund balances represent resources whose use has been limited by such external sourcesas creditors (e.g., debt covenants), contributors, other governments, laws, constitutional provisions orenabling legislation.

C. Committed

Committed fund balances represent resources that can only be used for specific purposes pursuantto constraints imposed by formal action of the government's highest level of decision makingauthority.

D. Assigned

Assigned fund balances are constrained by the government's intent to be used for specific purposesbut are neither restricted nor committed.

E. Unassigned

Unassigned fund balances is the residual classification for the General Fund. This classificationrepresents fund balance that has not been assigned to other funds and that has not been restricted,committed or assigned to specific purposes within the general fund. The general fund should be theonly fund that shows a positive unassigned fund balance amount. Over expenditure of resources inother governmental funds may, however, result in a reported negative unassigned fund balance.



VI. GASB 34 MODEL - Government-Wide Reporting

The GASB 34 reporting model focuses the reader on both government-wide and fund financial statementsusing an integrated approach to hjghljght both the operational and fiscal accountability requirements of thegovernment.

The basic structure includes the presentation of:

• Basic financial statements (comprised of government-wide financial statements, fund financialstatements and notes to the financial statements)

• Required supplementary information

Fund financial statements emphasize fiscal accountability while government-wide financial statementsemphasize operational accountability. Financial presentations are integrated by the reconciliation of fundfinancial statements to government-wide presentations.

Government-wide financial presentations are prepared using the economic resources measurement focusutilizing the accrual basis of accounting. The government-wide financials include presentation ofgovernmental activities and business type activities such as the enterprise funds. Fiduciary funds areexcluded from the government-wide financial statements but are included as part of the fund financialstatements.

A matrix to keep in mind for GASB 34 reporting categorizes our fund structure mnemonic as follows:

Governmental

GRSPP S

Business TyPe

E

Excluded

PAPI

Government-wide financial statements are the:

./ Statement of Net Assets

./ Statement of Activities

• Required Supplementary Information (RSI) is presented both before and after the basic financialstatements.

• Preceding the basic financial statements is the management's discussion and analysis, a letter thatpresents a brief, objective and easily readable analysis of the government's activities.

• Following the basic financial statements is RSI that includes multi-year pension data, infrastructure datafor governments using the modified approach for infrastructure and budgetary disclosures.

• Other Supplementary Information (Optional) may be included. Optional information includes budgetvariances and individual financial statements for non-major funds.

• A Statement of Cash Flows is not prepared for government-wide presentations.



VII. GASB 34 MODEL - Fund Financial Statements

Fund financial statements are presented for all funds based on their applicable measurement focus andrelated basis of accounting. Only major funds are reported separately; non-major funds are reported in theaggregate. Individual non-major funds may be reported as optional supplementary information.

A. Governmental Fund Financial Statements Presented

• Balance Sheet

• Statement of Revenues, Expenditures, and Changes in Fund Balance. Included in this statementare also other financing sources (proceeds from debt and interfund transfers) and other financinguses.

B. Proprietary Fund Financial Statements Presented

• Statement of Net Assets

• Statement of Revenues, Expenses and Changes in Fund Net Assets

• Statement of Cash Flows

C. Fiduciary Fund Financial Statements Presented

• Statement of Fiduciary Net Assets

• Statement of Changes in Fiduciary Net Assets

D. Determination of Major Funds

GASB 34 emphasizes reporting by major fund rather than fund type. To qualify as a major fund thetwo following criteria must be met:

1. An individual fund's total assets, or liabilities or revenues, or expenditures/ expenses, are atleast 10% or more of the corresponding total assets, or liabilities or revenues, or expenditures/expenses of all governmental funds or enterprise funds (e.g., a special revenue fund's assetswould need to be 10% of the assets for the governmental fund financial statement category, aWater & Sewer fund's assets would need to be 10% of all enterprise funds' assets).

•2. The same individual fund's total assets, or liabilities or revenues, or expenditures/expenses, are

at least 5% or more of the corresponding total assets, or liabilities or revenues, orexpenditures/expenses of all govemmental funds and enterprise funds combined (e.g., aspecial revenue fund's assets would need to be 5% of the combined asset amounts forgovernmental and enterprise funds, a Water & Sewer fund's assets would need to be 5% of thecombined asset amounts for govemmental and enterprise funds).

E. Reconciliation of Fund Statements to Government-Wide Statements

Because of the different measurement focus and related basis of accounting used, the govemmentalfund balance as reported in the balance sheet must be reconciled to net assets of government-widestatements as reported in the statement of net assets.

1. The difference in measurement focus provides the following reconciling items:

a. Add non-current assets.

b. Subtract non-current liabilities.

c. Add internal service fund net assets.



2. The difference in basis of accounting produces the following reconciling items:

a. Adjust for accrual of revenue accounted for on the full accrual basis of accounting ratherthan the modified accrual basis of accounting.

b. Adjust for accrual of expenses accounted for on the full accrual basis of accounting ratherthan the expenditures accrued on the modified accrual basis of accounting.

3. The changes in fund balance displayed in the governmental fund statement of revenues,expenditures, and changes in fund balances must be reconciled to changes in net assets of thegovernmental activities column as reported in the statement of activities of the governmentwide statement.

4. The difference in measurement focus produces the following reconciling items:

a. Subtract debt proceeds (not accounted for as other financing sources in the governmentwide financial statements).

b. Add capital outlay (not accounted for as expenses in the government-wide financialstatements).

c. Add Internal Service Fund changes in net assets accounted for in the proprietary funds.

5. The difference in basis of accounting produces the following reconciling items:

a. Adjust for accrual of revenue accounted for on the accrual basis of accounting rather thanthe modified accrual basis of accounting.

b. Adjust for accrual of expenses accounted for on the accrual basis rather than theexpenditures accrued on the modified accrual basis.

Statement ofRevenues, Expenditures,

Balance Sheet and Changes in Fund Balance

@ GRASPP - Fund balance @ GRASPP - Net change in fund balance

@ Assets (non-current) ® Other financing sources

CD Liabilities (non-current) ® Expenditure - capital outlay (net of depreciation)

® Service (internal) fund net assets ® Service (internal) fund net income

® Basis of Accounting ® Basis of Accounting

@ Accrued @ Additional accrued

® Revenues and ® Revenues and

® Expenses ® Expenses

F. Statement of Cash Flows

The Statement of Cash Flows is only used for the proprietary funds. The direct method is requiredand it is prepared in a manner similar to the commercial version, with the following differences:

1. There are four categories (instead of the three) and the order of the categories is the following:

a. Operating activities.

b. Non-eapital financing activities.

c. Capital and related financing activities.

d. Investing activities.



2. Interest income/cash receipts are reported as "investing activities" (not as operating activities).

Interest expense/cash payments are either:

a. Capital and related financing, or

b. Non-capital financing.

3. Capital asset purchases are reported as "financing activities" (not as investing activities).

4. A reconciliation of operating income (instead of net income) to net cash provided by operationsis required.

VIII. GASB 34 MODEL - Infrastructure

Infrastructure can have an impact on both the statement of net assets and statement of activities. Includedamong the capitalized non-current assets on the government-wide statement of net assets should beeligible infrastructure, such as roads, drainage systems, and bridges. Consequently, depreciation of suchassets is required, and should be reported in the statement of activities.

However, if the government is unable to arrive at the cost data for its infrastructure, the use of a modifiedapproach (no capitalization needed) is acceptable, provided that supplementary information describing theinfrastructure, its condition and estimation of expenses needed to maintain condition, is included in the(RSI). A complete new professional assessment of the infrastructure condition is necessary every threeyears.

IX. REPORTING UNITS

Reporting units (the primary government and its component units) are the governmental version of"consolidations." When to consolidate and how to consolidate is important under the GASB 34 model.

A. Primary Governments and Component Units (When)

A government is viewed as a stand-alone or primary government if it has a separately electedgoverning board, it is a legal entity and it is financially independent.

A government that cannot stand by itself is a component unit of another government and shouldpresent its financial statements with the primary government.

B. Discrete vs. Blended Presentation (How)

Component units are presented either discretely or in a blended format. Generally, component unitsare presented as discrete (separate columns) on the primary government's financial statements.

Blended presentations are made when the component unit either exclusively serves the primarygovernment or when the component unit's governing body is substantially the same as the primarygovernment's governing body. Blending involves consolidation of activities.

X. INTERFUND ACTIVITY

Interfund activity is subject to specific requirements related to financial statement display and disclosure andcan be classified as follows:

• Reciprocal interfund activity

• Non-reciprocal interfund activity



A. Reciprocallnterfund Activity

• Includes exchange-type transactions between funds.

• Interfund Loans are expected to be repaid and are accounted for as interfund receivables andpayables (due from/due to).

• Unrealizable balances are reclassified as transfers.

• Interfund services provided and used represent sales and purchases between funds at externalpricing. Transactions of this type are accounted for as revenues and expenses.

B. Non-reciprocal Interfund Activity

• Represents non-exchange transactions between funds.

• Interfund transfers of assets between funds without the exchange of equivalent value representinterfund transfers. These are normally reported as other financing sources and uses after nonoperating revenues and expenses.

• Interfund payments of expenses made by one fund on behalf of another fund are accounted foras reimbursements. Interfund reimbursements are not displayed as interfund transactions.

C. Government-wide Financial Statement Displays of Interfund Activity

• Interfund activity within a particular column displayed on the governmental activities or businesstype activities financial statements (intra-activity transaction between governmental funds andinternal service funds) is eliminated prior to the preparation of governmental-wide financialstatements.

• Interfund activity between columns displayed on the governmental activities or business typeactivities financial statements (inter-activity transaction between governmental funds andenterprise funds) is reported as "internal balances" on statement of net assets and "transfers"(revenues or expenses), in the statement of activities. They are not eliminated.

• Interfund activity between the primary government and its fiduciary funds should be reported as ifbetween external parties.

• Disclosures specific to transfers include:

o Transfers that do not occur on a routine basis.

o Transfers that are not consistent with the activities of the fund making the transfer.

o Loans not expected to be repaid within a year.



XI. FINANCIAL STATEMENT SAMPLES

Progressive TownshipStatement of Net Assets

December 31, Year 1

PRIMARY GOVERNMENT

Governmental Business-type ComponentActivities Activities Total Units

ASSETS

Cash 4,000,000 2,000,000 6,000,000 520,000

Receivables 940,000 670,000 1,610,000

Internal balances 450,000 (450,000)

Inventories 96,000 127,500 223,500

Capital assets 2,827,000 2,975,000 5,802,000

Total assets 8,313,000 5,322,500 13,635,500 520,000

LIABILITIES

Accounts payable 1,104,000 400,000 1,504,000 130,000

Deferred revenue 95,000 95,000

Non-current liabilities

Due within one year 46,000 337,500 383,500

Due in more than one year 3,518,000 2,750,000 6,268,000

Total liabilities 4,763,000 3,487,500 8,250,500 130,000

NET ASSETS

Invested in capital assets net ofrelated debt 1,227,000 450,000 1,677,000

Restricted

Capital projects 1,074,000 1,074,000

Debt service 668,000 1,200,000 1,868,000

Unrestricted 581,000 185,000 766,000 390,000

Total net assets 3,550,000 1,835,000 5,385,000 390,000



Progressive TownshipStatement of Activities


PROGRAM REVENUES

NET {EXPENSES) REVENUES ANDCHANGES IN NET ASSETSPRIMARY GOVERNMENT

COMPONENTUNITS

Functions/Programs Expenses

IndirectExpense

AllocationChargesfor

Services

Operating Capital GrantsGrants and and

Contributions ContributionsGovernmental

ActivitiesBusiness-type

Activities Total Total

300,000

1,360,000

1,360,000

Primary government:Governmental activities:General government

Public safetyCulture and recreationOther functional classificationsInterest on long-term debt

Total governmental activities

Business-type activities:WaterSewerParking facilities

Total business-type activitiesTotal primary government

Component units:LandfillPublic school system

Total component units

563,000 215,0001,025,000 78,000

107,5002,147,000

246,0004,088,500 293,000

692,000 700,0001,038,000 1,050,000

465,000 650,0002,195,000 2,400,0006,283,500 2,693,000

300,000 500,0001,000,000 100,0001,300,000 600,000

1,360,000300,000300,000

(348,000)(947,000)(107,500)(787,000)(246,000)

(2,435,500)

(2,435,500)

8,000312,000185,000505,000505,000

(348,000)(947,000)(107,500)(787,000)(246,000)

(2,435,500)

8,000312,000185,000505,000

(1,930,500)

200,000(900,000)(700,000)

General revenuesTaxes:

Property taxesFranchise taxes

Investment earningsTransfers

Total general revenues, special items, and transfersChange in net assets

Net assets-beginningNet assets-ending

1,620,000835,000195,00081,000

2,731,000295,500

3,254,5003,550,000

60,000

60,000565,000

1,270,0001,835,000

1,620,000835,000255,00081,000

2,791,000860,500

4,524,5005,385,000

1,000,000

1,000,000300,000

90,000390,000



Progressive Township

Balance SheetGovernmental Funds

December 31, Year 1

Convention Convention Other TotalHUD Development Convention Center Governmental Governmental

General Fund Programs Tax Center Bonds Construction Funds Funds

ASSETS

Cash 800,000 80,000 250,000 450,000 2,100,000 270,000 3,950,000Receivables 162,000 162,000Due from other funds 450,000 60,000 510,000Receivables from other governments 620,000 50,000 83,000 753,000Inventories 55,000 6,000 61,000

Total assets 2,087,000 80,000 300,000 510,000 2,100,000 359,000 5,436,000

LIABILITIES AND FUND BALANCES

Liabilities:Accounts payable 250,000 20,000 56,000 600,000 100,000 1,026,000Due to other funds 50,000 60,000 110,000

Payable to other governments 65,000 65,000Deferred revenue 95,000 95,000

Total liabilities 460,000 20,000 116,000 600,000 100,000 1,296,000

Fund balances:Non-spendable Inventories 55,000 6,000 61,000Restricted for

Debt service 510,000 158,000 668,000Capital projects funds 1,500,000 74,000 1,574,000

Committed to urban renewal 60,000 184,000 244,000Assigned:

Sanitation 45,000 45,000Special revenue funds 28,000 28,000

Unassigned:General fund 1,527,000 1,527,000Special revenue funds (7,000) (7,000)

Total fund balances 1,627,000 60,000 184,000 510,000 1,500,000 259,0004,140,000J

Total liabilities and fund balances 2,087,000 80,000 300,000 510,000 2,100,000 359,000 5,436,000

Total governmental fund balances 4,140,000Capital assets used in governmental activities that are not reported in fund financial statementsOther long-term assets not available to defray the cost of current expenses and are not reported in fund financial

statementsLong-term liabilities including bonds payable not recorded in fund financial statements (3,420,000)Internal service fund used for governmental activities 163,000

Net assets from governmental activities 3,550,000

Note: This simplified example assumes no differences between fund financials and government-wide financials pertaining to the basis of accounting.




Statement of Revenues, Expenditures, and Changes in Fund BalanceGovernmental Funds


Convention Convention Other TotalGeneral HUO Development Convention center Governmental Governmental

Fund Programs Tax Center Bonds Construction Funds FundsREVENUES

Property taxes 1,620,000 1,620,000Fees and fines 120,000 120,000Intergovernmental 960,000 375,000 860,000 2,195,000Charges for services 78,000 78,000Interest earnings 55,000 18,000 36,000 40,000 40,000 189,000Total Revenues 1,795,000 960,000 393,000 36,000 40,000 978,000 4,202,000

EXPENDITURES

Current:General government 450,000 450,000Public safety 1,000,000 1,000,000Culture and recreation 80,000 17,500 97,500Other functional classifications 200,000 940,000 957,000 2,097,000

Debt service:Principal 250,000 110,000 360,000Interest and other charges 30,000 211,000 241,000

Capital outlay 25,000 600,000 162,000 787,000Total expenditures 1,755,000 940,000 17,500 280,000 600,000 1,440,000 5,032,500Excess (deficiency) of revenues over

expend itu res40,000 20,000 375,500 (244,000) (560,000) (462,000) (830,500)

OTHER FINANCING SOURCES (USES)

Proceeds of long-term capital-related debt 2,080,000 2,080,000Transfers in 85,000 370,000 10,000 465,000Transfers out (14,000) (250,000) (120,000) (384,000)Total other financing sources and uses 71,000 (250,000) 370,000 1,960,000 10,000 2,161,000

Net change in fund balances 111,000 20,000 125,500 126,000 1,400,000 (452,000) 1,330,500Fund balances-beginning 1,516,000 40,000 58,500 384,000 100,000 711,000 2,809,500Fund balances-ending 1,627,000 60,000 184,000 510,000 1,500,000 259,000 4,140,000




Reconciliation of Governmental Fund Operating Statements and the Statement of ActivitiesDecember 31, Year 1

Net change in fund balances - total governmental funds

Bond proceeds reflected as debt in excess of payments:

Bond proceeds

Payments

Capital outlay expense in excess of depreciation:

Capital outlay

Depreciation expense:

General government

Public safety

Culture and recreation

Other functional classifications

Revenues in the statement ofactivities that do not provide currentfinancial resources and are not reported in the funds

Net revenue (expense) of internal service funds

Change in net assets of governmental activities

1,330,500

(2,080,000)

360,000

787,000

(35,000)

(25,000)

(10,000)

(50,000)

*18,000

295.500

* Note: Our example includes the significant assumption that no reconciliation items resultfrom different bases of accounting.



NOTES




QUESTION 1

Property taxes for the Town of Farrell of $25,000,000 were assessed in October of Year 1 to fund budgetedoperations for the fiscal year ended September 30, Year 2. Some $24,000,000 are collected from NovemberYear 1 through March Year 2 with liens of $1 ,000,000 applied to properties with unpaid property tax bills in MayYear 2. Properties subject to delinquent property taxes were auctioned for taxes of $800,000. At September 30,Year 2, government would record property tax revenue of:

1. $25,000,000

2. $24,800,0003. $24,200,0004. $24,000,000

QU ESTION 2

The City of Lawrence has a $20,000,000 bond issue outstanding with a stated rate of 6% issued at .855 to yield7%. Interest is payable on April 1 and October 1. The City also had a master lease agreement with a balance of$200,000 yielding 6% that qualified for treatment as a capital lease to buy equipment used in generalgovernmental operations. Monthly interest had not been paid at year-end. The bond indenture required the usesof formal debt service fund accounting. Lease payments were made through the general fund. At December 31,the governmental funds of the City of Lawrence would display accrued interest payable of:

General Fund Debt Service Fund

1. $1,000 $300,0002. $1,000 $350,000

3. $1,000 $04. $0 $0

QUESTION 3

The Township of Thomasville recorded more appropriations than estimated revenues for the coming fiscal year.In integrating its adopted budget with its financial accounting records, the town would:

1. Debit budgetary fund balance.2. Credit budgetary fund balance.

3. Debit reserve for encumbrances.4. Credit reserve for encumbrances.

QUESTION 4

The County of Deutsch appropriated $45,000 in its General Fund for miscellaneous supplies for its fiscal yearended September 30, Year 1. The County found that it had paid $15,000 for miscellaneous supplies in NovemberYear 0 and issued a $30,000 PO to a sole source vendor for miscellaneous supplies in December Year O. ByAugust Year 1, the County had received $20,000 related to the order but did not pay the vendor until Octoberpending tax receipts. Appropriations do not lapse. For purposes of internal reporting, what was the County ofDeutsch's reserve for encumbrance at September 30, Year 1?

1. $45,000

2. $30,0003. $15,0004. $10,000



QUESTION S

The County of Deutsch appropriated $45,000 in its General Fund for miscellaneous supplies for its fiscal yearended September 30, Year 1. The County found that it had paid $15,000 for miscellaneous supplies in NovemberYear 0 and issued a $30,000 purchase order to a sole source vendor for miscellaneous supplies in DecemberYear O. By August Year 1, the County had received $20,000 related to the order but did not pay the vendor untilOctober pending tax receipts. Appropriations do not lapse. What was the County of Deutsch's availableappropriation at September 30, Year 1?

1. $0

2. $15,000

3. $10,000

4. $5,000

QUESTION 6

The City of Richardson reported a change in fund balances of $2,002,000 in its governmental funds Statement ofRevenues, Expenditures, and Changes in Fund Balances for the year ended December 31, Year 1. Additionalinformation:

1. Capital outlay expenditures amounted to $10,000,000 in the modified accrual statement. Generalgovernment fixed assets amounted to $160,000,000 excluding land and had an average life of 20 years.

2. The modified accrual statement reported proceeds from the sale of land in the amount of $1 ,000,000. Theland had a basis of $800,000.

3. Property taxes had been levied in the amount of $20,000,000. It was estimated that 3% would beuncollected, that $1,000,000 would be collected within 60 days of year-end, and that $400,000 would becollected more than 60 days from year-end. The City had recognized the maximum permitted under modifiedaccrual accounting.

4. $370,000 of property taxes had been deferred at the end of the previous year and was recognized undermodified accrual as revenue in the current year.

5. The modified accrual statement reflected debt service expenditures in the amount of $1 ,000,000 for interestand $1,500,000 for principal. No adjustment was necessary for interest accruals at year-end.

6. Compensated absences charges, on the full accrual basis, amounted to $100,000 more than under themodified accrual basis.

The change in net assets in the governmental column in the government-wide statement of activities for the yearended December 31, Year 1 is:

1. 4,602,000

2. 5,202,000

3. 3,832,000

4. 4,632,000



TASK-BASED SIMULATION

TASK-BASED SIMULATION: MFBA

MFBA IAuthoritative Literature I Help I

For each of the fund types listed below, identify the basis of accounting used in each instance by double-clicking on theshaded cells and selecting the appropriate response.

Generic or Specific Fund Types

1. Proprietary

2. General Fund

3. Permanent Fund

4. Private Purpose Fund

5. Fiduciary Fund

6. Internal Service Fund

.. ~

Modified accrual

Full accrual

Cash

Modified cash

Basis of Accounting



Solution

1. Full accrual

Proprietary funds (SE) use the full accrual basis of accounting, which both complements and facilitates theeconomic resources measurement focus.

2. Modified accrual

The General Fund is a Govemmental (GRSPP) Fund, which uses the modified accrual basis that bothcomplements and facilitates the financial resources measurement focus.

3. Modified accrual

The Permanent Fund is a Governmental (GRSPP) Fund, which uses the modified accrual basis that bothcomplements and facilitates the financial resources measurement focus.

4. Full Accrual

The Private Purpose Funds are Fiduciary (PAPI) Funds, which use the full accrual basis that bothcomplements and facilitates the economic resources measurement focus.

5. Full Accrual

Fiduciary funds (PAPI) use the full accrual basis of accounting, which both complements and facilitatesthe economic resources measurement focus.

6. Full Accrual

The Internal Service Funds are Proprietary (SE) Funds, which use the full accrual basis that bothcomplements and facilitates the economic resources measurement focus.



FINANCIAL 9Not-for-Profit

Required Financial Statements

• Net Asset Classification

• Statement of Cash Flows

• Revenue and Support Recognition

• Expense Classification and Display

Split Interest Agreements

• Special Rules for Donated Services and Works of Art

• Accounting for Marketable Securities

• Pass-through Contributions to Non-profit Beneficiary

• Industry Applications



NOTES



SUMMARY NOTES

Non-profit entities as described by the AICPA possess the following characteristics:

• Contributions of significant amounts of resources received from providers who do not expect commensurateor proportionate return.

• Operating purposes other than to provide goods or services at a profit.

• Absence of ownership interest.

The FASB has the primary responsibility of providing guidance on generally accepted accounting principles fornon-profit entities. The two major classifications are:

• Voluntary health and welfare organizations (VHWO)

• Other non-profit organizations (ONPO)

I. REQUIRED FINANCIAL STATEMENTS

All non-profit entities are required to prepare three basic financial statements on the full accrual basis:

./ Statement of Financial Position

./ Statement of Activities

./ Statement of Cash Flows

Voluntary Health and Welfare organizations (entities that are nearly entirely supported by contributions) arerequired to present the following additional financial statement, while all other non-profit organizations areencouraged to present it:

A. Statement of Functional Expenses

The objective of the statement of functional expenses is to present the programmatic and supportexpenses displayed horizontally on the Statement of Activities in separate columns and to analyzethe expenses by object (natural classifications).

II. NET ASSET CLASSIFICATION

The reporting objectives of non-profit organizations include presentation of the net assets at the balancesheet date and the components of the change in net assets on the Statement of Activities for the yearending on the balance sheet date. There are three net asset classifications:

A. Unrestricted

Net assets free of donor restrictions on usage.

B. Temporarily Restricted

Only donors may restrict assets. Management or Board can designate or identify assets to be usedfor a particular purpose. However, a designation is not a restriction. Net assets contributed withdonor-imposed temporary restrictions may be satisfied by fulfilling donor requirements as to:

• Purpose: The money must be spent as the donor stipulates (i.e., cancer research, youtheducation).

• Time: The donated assets are restricted until a fixed period passes (e.g., a gift of a CD that mustbe held until maturity and then can be spent as the organization wishes). Time restrictions mayalso be implied by availability; contributions receivable generally increase temporarily restrictednet assets.

• Acquisition of Plant: The donated assets are restricted until land is purchased and/or a facility isbuilt.



C. Permanently Restricted

Net assets contributed with restrictions, such as an endowment fund where the corpus must beretained in perpetuity and interest income can be used by the NPO in accordance with the donor'sstipulations.

III. STATEMENT OF CASH FLOWS

The Statement of Cash Flows is the same as the statement issued by commercial enterprises with a fewunusual features. Either the direct or indirect method can be used. There are three categories of cash flowactivities:

A. Operating Activities

• Include applicable agency transactions.

• Include receipts of unrestricted resources designated by the governing body to be used for longlived assets.

B. Investing Activities

• Include proceeds from the sale of works of art or purchases of works of art.

• Include investment in equipment.

• Include proceeds from the sale of assets that were received in prior periods and whose saleproceeds were restricted to investment in equipment.

C. Financing Activities

1. Proceeds from Restricted Contributions

• Include cash received with donor-imposed restrictions limiting its use to purchases oflong-term assets or annuity agreements.

• Disbursements of these restricted contributions for either temporary investments or thepurpose for which they were intended are classified as investing activities.

2. Other Types of Financing Activities

Include receipts and disbursements associated with borrowing and receipts of dividends andinterest restricted to reinvestment.

D. Cash and Cash Equivalents

Donor-restricted securities that may otherwise meet the cash equivalent criteria in commercialaccounting are excluded.

IV. REVENUE AND SUPPORT RECOGNITION

Non-profit accounting focuses on two terms (conditional and restricted) that are often used interchangeablyin conversation but that have two distinct accounting meanings.

• Classification of net assets relates to donor-imposed restrictions on contributions.

• Recognition of revenue relates to the treatment of gifts or promises to give. Conditional promises arenot recorded and conditional gifts received in advance of satisfying conditions are recorded as liabilities.

• Conditional is not the same as restricted.

Resource inflows in non-profit organizations are generally displayed in the financial statements as eitherrevenue or other support. Revenues typically represent exchange transactions in which the non-profitorganization earns resources in exchange for a service performed (e.g., fees). Support often representsunconditional contributions.



A. Cash Contributions and Unconditional Promises

Cash contributions and unconditional promises are displayed as support upon receipt or accrual.

B. Conditional Promises

Cash contributions that can only be used upon meeting a condition and conditional promises to giveare not recorded as revenue until the condition is met. Conditional contributions rgood faithdeposits") are displayed as a liability titled "Refundable Advance.II Conditional promises to give arenot recorded.

C. Multl-year Pledges

Unconditional promises receivable over a period of years are recognized as temporarily restrictedsince amounts have an implied time restriction. Receivables are recorded at their present value withthe difference between face and present value recognized as contribution revenue over time, notinterest.

D. Other Revenue Transactions and Issues

• Agency transactions relate to receipts of resources over which the non-profit organization hasno discretion or "variance power." The absence of variance power over the resources creates aliability rather than revenue.

• Gifts-in-kind represent non-cash contributions recorded as both support and an offsettingexpense.

• Exchange transactions represent the sale of goods or services in exchange for a fee.Exchange transaction revenue is unrestricted.

• Temporarily restricted donations for which restrictions will be satisfied within the year of receiptmay be classified as unrestricted in the event that the non-profit organization consistently appliesthis policy.

V. EXPENSE CLASSIFICATION AND DISPLAY

Expenses are defined as program or support services.

Program expenses relate to the mission of the organization while support services relate to theorganization's administrative, membership development and fund raising expenses. The total amount ofeach functional expense (the expenses by individual program or support service) is displayed on the face ofthe Statement of Activities or disclosed in the notes to the financial statement.

VI. SPLIT INTEREST AGREEMENTS

Agreements such as charitable remainder trusts represent donor contributions structured to simultaneouslydonate assets to the non-profit organization and share those assets with a beneficiary. Split interestagreements are displayed separately on the non-profit organization's financial statements, measured attheir fair value or present value at acquisition, and recorded as temporarily restricted unless otherwiserestricted by the donor.

i!Ii1 Assets held in trust

~ Liability to beneficiary

~ Contribution revenue (temporarily restricted)

xxxxxxXXX

Disbursements associated with split interest agreements are classified as financing activities on theStatement of Cash Flows. All expenses are presented in the unrestricted column in the Statement ofActivities.



VII. DONATED SERVICES AND DONATED WORKS OF ART

Contributions of services are recorded as revenue SOME of the time. The services must either enhance aphysical asset or meet the following criteria: they require specialized skills, are otherwise needed and aremeasured easily. Services that meet the criteria are recorded as revenues and assets or expenses at theirfair value as follows:

i!Ii1 Expense or asset

Si! Contributions - Non-operating revenue

xxxxxx

Donated works of art are NOT required to be recorded by the recipient if all of the following criteria are met:

A. The item is held for public viewing,

B. The work of art is cared for by the non-profit organization, and

C. Proceeds, if the art is sold, must be used to purchase other works of art.

VIII. ACCOUNTING FOR MARKETABLE SECURITIES

Investments in securities are displayed at their fair values and increases and decreases in the fair value ofsecurities are classified as Unrestricted in the Statement of Activities unless there are donor stipulatedrestrictions.

Losses on permanently restricted marketable securities have unusual rules. Typically eamings onpermanent endowments are temporarily restricted. Losses on investments of pennanent donor-restrictedendowments are first applied as a reduction of temporarily restricted net assets to the extent thatrestrictions on previously recognized gains have not been satisfied and remain classified in the temporarilyrestricted category. Any loss not absorbed by temporarily restricted balances is applied to unrestricted netassets.

Investment income (dividends and interest) are reported in the period earned in the net asset category aseither unrestricted or restricted as stipUlated by the donor.

IX. PASS·THROUGH CONTRIBUTIONS TO NON.PROFIT BENEFICIARY

FASB ASC 958-605 defines the manner in which separate organizations that either receive or benefit fromcontributions account for the donations. Principles are largely driven by application of the concept ofvariance power. The pronouncement considers the common situation of a foundation, the recipient, whichraises money for another non-profit organization, the beneficiary (e.g., a university). The statement alsoconsiders instances where the recipient is a federated or community-wide organization such as the UnitedWay. and the beneficiary is a smaller non-profit organization.

A. General Rule: Recipient (e.g., a Foundation)

1. Without Variance Power

If a recipient organization receives donations on behalf of another non-profit and does not haveany discretion with regard to the use of the contribution, the donation is recorded as a liability.

i!Ii1 Asset

Si! Refundable advance

xxxxxx



2. With Variance Power

If a recipient organization receives donations on behalf of another non-profit and has discretionregarding the use of the contribution, the donation is recorded as revenue.

!!l2 Asset

~ Revenue

xxxxxx

B. General Rule: Beneficiary (e.g., a University)

1. Without Variance Power

If a recipient organization receives donations on behalf of another non-profit and does not haveany discretion with regard to the use of the contribution, the donation is recorded as revenue onthe beneficiary's books.

!!l2 Receivable

~ Contribution revenue

xxxxxx

2. With Variance Power

If a recipient organization receives donations on behalf of another non-profit and has discretionwith regard to the use of the contribution, the donation is generally not recorded on thebeneficiary'S books unless a financial relationship exists.

C. Financially Interrelated Recipients (e.g., a Foundation) and Beneficiaries (e.g., a University)

Recipients and beneficiaries are deemed to be interrelated if one organization has the ability toinfluence the decisions of the other AND one organization has an ongoing interest in the other.

Beneficiaries recognize an interest in the net assets of the recipient when they are financiallyinterrelated with the recipient. The interest is adjusted for the beneficiary'S share of the change.

!!l2 Interest in net assets XXX

~ Equity transaction (Statement of Activities) XXX

Beneficiaries recognize a beneficial interest in an unconditional right to receive specified cash flowsfrom pools of assets. Changes in value are recorded on the beneficiary'S books as follows:

!!l2 Beneficial interest

~ Contribution revenue

XXX

XXX

x. INDUSTRY APPLICATIONS

A. Health Care Organization Revenue Recognition

Patient service revenue should be accounted for on the accrual basis at usual and customary fees,even if the full amount is not expected to be collected. Although patient service revenue is accountedfor on a gross basis. deductions are made from gross revenue for reporting purposes to displayrevenues net.

Charity care. the value of services that a health care organization gives away. is not displayed in thefinancial statements.

B. University and Institutions of Higher Learning Revenue Recognition

Student tuition and fees should be reported at gross amount. Scholarships. tuition waivers, andsimilar reductions are considered either expenditures or a separately displayed allowance reducingrevenue.



NOTES




QUESTION 1

The Felix Nursing Home, Inc. is a health care provider organized as a not-for-profit organization whose activitiesare regulated by State licensure rules. The financial statements that the Felix Nursing Home, Inc. is required toproduce are:

1.2.3.4.

Statement ofFinancial Position

YesYesYesYes

Statement ofActivitv

YesYesYesYes

Statement ofCash Flows

YesYesNoNo

Statement ofFuncilonalExpenses

YesNoNoYes

QUESTION 2

Walton Farms Boys Home, Inc is a not-far-profit organization that received marketable securities from a donorwith a fair value of $100,000 on July 1, Year 1. The securities were donated with the stipulation that proceedswould be used to build new dormitories. On January 8, Year 2, Walton Farms Boys Home elected to sell thesecurities for $110,000 and begin construction on the dormitories. On its Statement of Cash Flows for the yearended December 31, Year 2, the Walton Farms Boys Home would display cash flows from the securitiestransaction as:

1.2.3.4.

Operailng$110,000$0$10,000$0

Investing$0$110,000$100,000$0

Financing$0$0$0$110,000

QU ESTION 3

Balfour Animal Shelter, a non-profit organization, received $10,000 from Agnes Balfour to fund the acquisition ofgrooming equipment on December 1, Year 1. On February 2, Year 2, the Shelter used $5,000 to purchasegrooming equipment and on March 15, Year 2, used the remaining $5,000 to purchase more equipment asintended by the bequest. As a result of the above transaction, Balfour Animal Shelter would record the followingon its December 31, Year 1 financial statements:

1. Conditional restricted revenue of $10,000.2. Unrestricted revenue of $5,000 and Temporarily Restricted Net Assets of $5,000.3. Temporarily Restricted Net Assets of $10,000.4. Unrestricted Net Assets of $10,000.



QUESTION 4

On December 30, Year 1, Albert Altruistic donated $200,000 to the Carton Museum under the terms andconditions of a charitable remainder trust that guarantees Mr. Altruistic a life-time tax free annuity of $20,000 peryear and bequeaths the remainder to Carton for use in their operations in furtherance of the mission of themuseum. Independent actuaries have estimated that the museum's liability has a present value of $84,250. As aresult of his contribution, the Carton Museum would record the following on its December 31, Year 1 financialstatements:

1. An increase in unrestricted net assets of $200,000.2. An increase in temporarily restricted net assets of $200,000.3. An increase in unrestricted net assets of $115,750.4. An increase in temporarily restricted net assets of $115,750.

QUESTION S

Faith Church decided to replace their electric organ with a multiple rack pipe organ. The church purchased theorgan itself for $250,000 and a congregation member stepped forward to assemble the organ and perform thenecessary carpentry work for $5,000. The congregation member is a skilled craftsman that normally charges$40,000 for this work. Other congregation members stepped forward to help with general labor assistance valuedat $7,000. As a result of the transaction above, Faith Church should record revenues from contributed servicesof:

1. $35,0002. $40,0003. $42,0004. $47,000

QUESTION 6

The City of Lawrence's United Way received a donation of a vehicle from a concerned citizen on January 1, Year1 who directed that the vehicle was to be donated to the Lawrence Day Care Center, a non-profit organization,and went on to stipulate that the Lawrence United Way could use the vehicle for a period of one year prior to thetransfer. The vehicle had a fair value of $9,000 and a remaining useful life of three years. The Lawrence DayCare is a United Way organization but does not have the ability to influence United Way policy. The United Wayelects to use the vehicle. On their December 31, Year 1 financial statements, each organization should displaythe following Net Asset changes based on this transaction:

Lawrence United Way

Temporarily PermanentlyUnrestricted Restricted Restricted

1. $0 $0 $02. $3,000 $0 $03. $0 $9,000 $04. $3,000 $6,000 $0

Unrestricted$0$0$0$0

Lawrence Day Care

Temporarily PermanentlyRestricted Restricted

$0 $0$6,000 $0$0 $0$9,000 $0



FINANCIAL 10VIEs, Financial Instruments, and Other Topics

Variable Interest Entities (VIEs)

• Financial Instruments

• Derivatives

• Partnerships

• Contingencies

10-1(C) 2011 DeVry/Becker Educational Development Corp. All rights reserved.


NOTES



SUMMARY NOTES

I. VARIABLE INTEREST ENTITIES (VIEs)

A. Definition

A variable interest entity is a corporation, partnership, trust, LLC or other legal structure usedfor business purposes that either does not have equity investors with voting rights or lacksthe sufficient financial resources to support its activities.

B. Primary Beneficiary

The primary beneficiary is the entity that has the power to direct the activities of a variableinterest entity that most significantly impact the entity's economic performance, and:

1. Absorbs the expected VIE losses, or

2. Receives the expected VIE residual returns.

C. U.S. GAAP Consolidation Rule

Under U.S. GAAP, the primary beneficiary of a variable interest entity must consolidate thevariable interest entity.

Under U.S. GAAP, all consolidation decisions are evaluated first under the VIE model. Ifconsolidation is not required under the VIE model, then the investor (parent) companydetermines whether consolidation is necessary under the voting interest model (consolidatewhen ownership is >50% of the investee's voting stock, as previously covered).

D. IFRS Consolidation Rule

IFRS focus on the accounting for special purpose entities. A special purpose entity (SPE) isa specific type of VIE created by a sponsoring company to hold assets or liabilities, often forstructured financing purposes (e.g., sales of receivables, synthetic leases, securitization ofloans).

Under IFRS, a sponsoring company controls, and must consolidate, an SPE when thecompany:

1. Is benefited by the SPE's activities.

2. Has decision-making powers that allow it to benefit from the SPE.

3. Absorbs the risks and rewards of the SPE.

4. Has a residual interest in the SPE.



II. FINANCIAL INSTRUMENTS

A. Financial instruments are:

1. Cash, foreign currency, and demand deposits

2. Ownership interest in an entity (stock, partnership, LLC)

3. Contracts that both:

a. Impose on one entity a contractual obligation or duty

b. Convey to the second entity a contractual right to do the opposite.

4. Derivatives

B. Disclosure

Fair value must be disclosed for all financial instruments for which it is practicable toestimate that value together with the related carrying amounts.

Disclosure of concentrations of credit risk is required. Credit risk is the possibility of lossfrom the failure of another party to perform according to the terms of a contract. Disclosure ofmarket risk is encouraged but not required under U.S. GAAP. Under IFRS, disclosure ofmarket risk is required.

III. DERIVATIVES

Derivatives derive their value from other securities. A derivative must have all three of the followingcharacteristics:

A. One or more underlyings, and one or more notional amounts or payment provisions (orboth); and

B. No initial net investment (or smaller than would be expected); and

C. Its terms require or permit a net settlement.

• An underlying is a specified price, rate, or other variable, e.g., $10 a bushel.

• A notional amount is a specified unit of measure on which the derivative is valued, e.g.,10,000 bushels.

• The value or settlement amount is the amount determined by the multiplication of thenotional amount and the underlying, e.g., 10,000 bushels x $10 per unit = $100,000.

• Examples of common derivatives are forward contracts, futures, swaps, and options.

• Derivatives are reported as assets or liabilities and are measured at fair value just likeother financial instruments.

D. Hedging instruments:

• No hedge designation. Just speculation. Changes in fair value are fully included inincome.

• Fair value hedg&-A fair value hedge hedges an exposure to changes in fair value of arecorded asset or liability or recognized firm commitment. Changes in fair value areincluded in income but are offset by changes in the fair value of the hedged item.



• Cash flow hedge-A cash flow hedge hedges an exposure to variability in the cash flowsof a recognized asset or a forecasted transaction. Changes in fair value of theineffective portion of a cash flow hedge are included in income; changes in fair value ofthe effective portion of a cash flow hedge are included in the stockholders' equity aspart of other comprehensive income (OCI) until the related cash flows are realized.

ACCOUNTING FOR HEDGES: REPORTING GAINS AND LOSSES

Type of Hedge Instrument Accountingfor Changes in Fair Value

No hedge designation Income Statement

Fair value hedge Income Statement offset by changes in fairvalue of the hedged item

Cash flow hedge Ineffective portion Income Statement

cash flow hedge ~ffective portion (PUF~) In DCI then in Accumulated DCI in ~quity



IV. PARTNERSHIPS

Contributions to a partnership are recorded at fair value.

Land

Green, capital

5,000

5,000

Three basic methods are available for accounting for a new partner's contributions:

A. "Exact" Method

No goodwill or bonus is recorded. In the exact method, the exact amount that the newpartner contributes is the exact amount credited to his/her capital account.

CashGreen, capital

1,000

1,000

B. Bonus Method

The old capital plus the new partner's investment equals the total new capital. However, thenew partner's capital account is credited for an amount different than his/her investment. Anydifference between the new partner's contribution and the amount credited is a bonus to/fromthe new partner and is divided based on the old partner's profit/loss ratio.

CashX, capital (60%)

V, capital (40%)

Green, capital

1,000

120

801,200

C. Goodwill Method

Goodwill = Total new capital - (Old capital + New partner's investment). Any differencebetween the total new capital of the partnership and the total of the old capital plus theinvestment by the new partner is goodwill for the old partners and is allocated to their capitalaccounts in the old partnership profit/loss sharing ratio.

CashGoodwill

X, capital (60%)

V, capital (40%)

Green, capital

1,000

400

240

160

1,000

D. Division of Profits/Losses

For partnership operations, partnership income or loss is distributed among the variouspartners in accordance with their profit/loss sharing ratio. If the partnership agreement doesnot give a profit/loss sharing ratio, then the division is equal.

V. CONTINGENCIES

A. Contingent Losses

1. Probable: likely to occur. An adjusting entry and a note disclosure are required.

If a range of amounts is given, adjust for the smaller amount and disclose thedifference in the notes to the financial statements.

2. Possible: a note disclosure is required.

3. Remote: ignore (unless guarantee of indebtedness of others, then disclose).

B. Contingent Gains

Contingent gains that are probable or reasonably possible may be disclosed.



NOTES




QUESTION 1

Which of the following must be disclosed for most financial instruments?

1.2.3.4.

Carrying value

NoNo

YesYes

Fair value

NoYesNo

Yes

Market risk

QU ESTION 2

Disclosures about the following kinds of risks are required for most financial instruments.

Concentration ofcredit risk

1.2.3.4.

YesYesNoNo

YesNo

YesNo

QUESTION 3

A change in the fair value of a derivative qualified as a cash flow hedge is determined to be eithereffective in offsetting a change in the hedged item or ineffective in offsetting such a change. How shouldthe effective and ineffective portions of the change in value of a derivative which qualifies as a cash flowhedge be reported in financial statements?

Effective portion in

1. Current income2. Current income3. Other comprehensive income4. Other comprehensive income

Ineffective portion in

Current incomeOther comprehensive incomeCurrent incomeOther comprehensive income
