NINJA CPA REVIEW®
NINJA Notes
Financial Accounting & Reporting 2018
January 2018 – June 2018 Exams
The 2018 CPA Exam
(Source: AICPA)
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2018 FAR Exam
(Source: AICPA)
3
4
Table of Contents
The N.I.N.J.A. Framework
I. IFRS 11
II. Accounting Changes 23
III. Financial Reporting 24
IV. Bonds & Debt Restructure 53
V. Consolidations 61
VI. Deferred Taxes 64
VII. Investments & Derivatives 66
VIII. Fixed Assets 72
IX. Governmental Accounting 78
X. Segments & Interim Reporting 91
XI. Partnership Accounting 93
XII. Inventory 96
XIII. Leases 102
XIV. Current Assets & Liabilities 106
XV. Not-For-Profit Accounting 109
XVI. Pensions 116
XVII. Statement of Cash Flows 118
XIII. Stockholders’ Equity 121
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The N.I.N.J.A. Framework
NAIL THE CONCEPTS
Watch your CPA Review videos first – before working any
assigned homework questions.
The CPA Review industry says to watch a section of CPA
Review video and then work the accompanying MCQs. This
perspective stems from the old-school approach to the paper
and pencil exam where you had to sit in a live classroom and
learn from an instructor on weekends.
Today, there is a smarter way to study. You don’t have to go
to a weekend live course. You can fire up the laptop on a
Tuesday morning and knock out two hours of material
before you even brush your teeth. If you work MCQs in week
one over your week one topic, guess what? You will work
them again in week 5 or 6 when you review because you will
forget what you learned.
If you watch a video in week one and score an 85 on the
corresponding MCQs, will you be able to score an 85 four
weeks later? Not likely. You will need to work them again
anyway, and it’s not a smart use of study time.
Instead, let the N.I.N.J.A. Framework guide you.
INTENSE NOTES
Repeat after me: “PUT THE HIGHLIGHTER DOWN.”
Which method do you think will help you learn the material
better – painting printed words in a book with pretty
florescent colors or writing them down on a legal pad and
thinking about the information?
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Grab a stack of legal pads, put the highlighter down, and
start writing.
Many people have said that instead of taking their own notes,
they just re-write the material inside of this study guide,
which is fine too.
NON-STOP MCQS
Now is the time to start working NINJA MCQ and do them
with a focused frenzy. Do so many MCQs that you’re
absolutely sick of them. As you encounter little “fact nuggets”
that you didn’t know or are prone to forget, write it down
and add it to your voluminous stack of notes.
JUST RE-WRITE IT
This is where it gets tedious. This is also where the payoff
happens. You may be familiar with the fact that if you had a
choice between $3 Million and 1¢ doubled daily for 31 days,
the penny doubled for 31 days ends up tripling the $3 Million.
The payoff, however, doesn’t happen until the 31st day. The
road is long, but ends up being worth it in the end.
The same goes for re-writing your study notes. The thought
of grabbing that stack of legal pads and going to town rewriting what you’ve already written may sound like a
ridiculous suggestion at first, but I am a firm believer in its
impact.
Merely writing down your notes and then reviewing them
before your exam doesn’t have near the impact as taking
your furious scribbles and converting them into re-packaged,
easily digestible “fact nuggets.”
Not only will your notes mean more when you’ve whittled
away the non-essentials, but you are actually learning the
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material twice. Re-processing the material by re-writing your
notes is like letting the information marinade in your mind.
Just like a well-prepared steak, you will taste the payoff of
this extra step.
Don’t like taking notes? No problem. Re-write these
NINJA Notes instead. You will absorb the material better
vs. reading only.
Plan wisely because this will likely take a week to
complete.
“I have found this to be unbelievably helpful! This is now my
second section that I have followed this piece of advice and,
once again, I am amazed at how much the material "clicks"
as I review and write the notes a second time.
Sure, it's time-consuming, but for me, it is worth it. No
questions asked. Not only does it help with processing and
understanding the material, but it also results in a better,
more organized set of study notes to use for review up until
exam date.” – Sandy
ALL COMES TOGETHER
You have watched the videos. You’ve taken ridiculous notes
and have done hundreds (thousands?) of multiple-choice
questions. You’ve re-written your notes.
Now, study that stack of review Gold in your hands multiple
times, aim for a NINJA MCQ Trending Score of 85%
heading into exam day, study your notes even more, and
then go in and PASS the CPA Exam.
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How to use NINJA Notes
READING
You've invested in the NINJA Notes, now let it go to battle
for you. You should read them as many times as possible.
Carry it with you wherever you go.
Do you have an iPhone®, iPad®, or similar device(s)?
Simply load the PDF onto the device, and if you have 5
minutes of downtime, you have 5 minutes of study
time.
It is recommended that you read the NINJA Notes at least
five times leading up to your final two weeks of exam prep.
If you have 6 weeks to study, then you need to complete
this in 4 weeks. 5 weeks to study, then complete it in 3.
4 weeks = 2 weeks. You get the picture. The point is: plan,
plan, plan and budget, budget, budget, budget because
exam day is looming.
6-Week Plan: Approx. 112 pages x 5 reads /4 weeks
/ 7 days per week = Approx. 20 pages per day
5-Week Plan: Approx. 112 pages x 5 reads /3 weeks
/ 7 days per week = Approx. 27 pages per day
4-Week Plan: Approx. 112 pages x 5 reads /2 weeks
/ 7 days per week = Approx. 40 pages per day
3-Week Plan: Approx. 112 pages x 5 reads /1 weeks
/ 7 days per week = Approx. 80 pages per day
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RE-WRITING
This step is optional, but it won over a lot of skeptics with its
results. This is not mainstream advice. This is the NINJA
way. The mainstream way of studying for the CPA Exam is
old-fashion and outdated.
Forget the old way. You are a NINJA now.
Now is the time to either
1. Re-write your own CPA Exam notes or
2. Re-Write the NINJA Notes.
Plan on investing a week doing this and you should expect to
get through 16 pages a day (Approx. 112 pages / 7) in order
to stay on track.
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I. IFRS
BASIC ACCOUNTING CONCEPTS (IFRS)
Ø International Accounting Standards Board (IASB)
o Issues IFRS
o Most Authoritative & first place management looks
for guidance accounting policies
Ø IASB Framework helps to develop standards
o Is not a standard itself
o Does not supersede any standard’s authority
Ø Objective of IFRS Framework
o Provide users with information
Ø Assumption
o Entity uses the Accrual basis of accounting
Ø Qualitative Characteristics
o Relevance
§ Makes a difference to user
§ Predictive Value – Predicts Future
§ Confirmatory Value – Evaluates Past
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o Faithful Representation
§ Complete
§ Neutral
§ Free from Error
Ø Enhancing Characteristics
o Comparability
§ Allows users to compare different items
among various periods
o Understandability
§ Easy to use and understand
o Verifiability
§ Different people would reach same conclusion
o Timeliness
§ Information is available in time to make a
decision
Ø Pervasive Constraint of IFRS
o Cost vs. Benefit
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Ø Recognition for Balance Sheet & Income Statement
o Must meet the criteria for an “element”
§ Asset
§ Liability
§ Equity
§ Income
§ Expense
o Must meet the criteria for recognition
§ Probable future economic benefit
§ Can be measured reliably
§ Cost Recovery Method required if value
or outcome cannot be measured reliably
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IFRS vs. GAAP
Comparative Financial Statements Required
No Completed Contract
No LIFO
Statement of Comprehensive Income Required
Statement of Changes in Equity Required
"Income" instead of Revenue
• Gains not displayed separately
• Losses same as expense, but ARE displayed separately
"Profit" instead of Net Income
Contracts - Customer Controls Asset Before Delivery?
• IFRS - Performance Obligation classification mandatory
• GAAP - Optional
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Ø IFRS Transitioning
o Date of Transition is the first reporting period that
an entity produces full comparative financial
statements using IFRS
§ If IFRS was implemented June 2010 for use in
the December 31, 2010 financial statements,
then the Date of Transition is actually January 1,
2009 because a full year of comparative
statements is required from the previous year
o For Property Plant & Equipment, the Fair Value
election is the most efficient method for
converting assets to IFRS
o Adjustments made for adopting IFRS get made in
the entity’s retained earnings or equity
CURRENT ASSETS & LIABILITIES (IFRS)
Ø Current Assets
Ø Current Liabilities
o Can be refinanced into a non-current liability if the
refinancing agreement is executed before the
Balance Sheet Date
§ GAAP only requires intent, not execution
Ø Contingent Liability
o Contingencies are uncertain future events
o GAAP – Probable, Reasonably Possible, or Remote
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o IFRS
§ If “Probable” and “Measurable”
§ Classified as a Provision
§ Payment is uncertain in Timing or
Amount
FINANCIAL ASSETS (IFRS)
Ø Recorded on the Statement of Financial Position using
one of three methods
o Amortized Cost
§ Objective: Collect Cash Flows
§ Uses Effective Interest Method
o Fair Value through OCI
§ Objective: Sell Financial Assets
§ Gain or Loss recognized in OCI
o Fair Value through Profit or Loss
§ Objective: Everything Else
§ Gain or Loss recognized in Profit or Loss
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DEFERRED TAXES (IFRS)
Ø Uses the “Liability Method”
o All Deferred Tax Liabilities must be reported
o Only “probable” Deferred Tax Assets can be
reported
Ø Deferred Tax Assets and Liabilities are non-current on
the Statement of Financial Position
Ø Deferred Tax Assets and Liabilities can be netted ONLY
if they are related to the same country/taxing authority
o China Deferred Tax Assets can’t offset Japan
Deferred Tax Liabilities
Ø Tax Rates
o IFRS - Enacted Tax Rate or Substantially Enacted
Tax Rate
o GAAP – Enacted Tax Rate only
FINANCIAL REPORTING (IFRS)
Ø Income Statement
o Income
o Finance Costs
o Tax Expense
o Discontinued Ops
o Profit/Loss
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o Non-controlling interest in Profit/Loss
o Net profit/loss attributable from equity
Ø Comprehensive Income
o Two statements allowed
§ Income Statement
§ Statement of Comprehensive Income
Ø Investment in Subsidiaries – Valued at
o Cost
o Fair Value
o Equity Method
FIXED ASSETS (IFRS)
Ø PP&E Valuation
o Recorded at Cost
o Valued using one of two options
§ Cost Model
§ Asset carried at Cost less Accumulated
Depreciation and Impairment Loss
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§ Revaluation Model
§ Asset is adjusted to Fair Value, less
Accumulated Depreciation
§ Increases in value from the adjustment
are reported in the current period as
Other Comprehensive Income
§ Decreases in value from the adjustment
are treated as an expense
§ Asset must be able to be reliably
measured
§ Must be applied to whole class of assets,
not just one asset
§ No guidance on how often assets should
be revalued under IFRS
Ø Investment Property
o Does not include property used in the course of
business
o Initially recorded at cost
o Revalued using
§ Fair Value Model
§ Property is revalued to fair value
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§ Profit or Loss is recorded in current
period on the Income Statement
§ Investment P/L = IS
§ PP&E P/L = OCI
§ Cost Model
§ Carried at (Cost – Accum. Depreciation)
§ Fair Value must still be disclosed in the
notes to the financial statements
o Leases
§ Operating Leases can be recorded as
Investment Property if measured at Fair
Value
§ All other investment property must use Fair
Value Model if one asset uses it
Ø Intangible Assets
o Valued using one of two options
§ Cost Model
§ Asset carried at Cost less Accumulated
Depreciation and Impairment Loss
§ Revaluation Model
§ Asset is adjusted to Fair Value, less
Accumulated Depreciation
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§ Increases in value from the adjustment
are reported in the current period as
Other Comprehensive Income
§ Decreases in value from the adjustment
are treated as an expense
§ Asset must be able to be reliably
measured
§ Must be applied to whole class of assets,
not just one asset
§ No guidance on how often assets should
be revalued under IFRS
o Internally generated Goodwill is not recognized
o Amortization
§ Intangible Asset has Finite Life
§ Amortized over Useful Life
§ Intangible Asset has Indefinite Life
§ Not Amortized
§ Tested for Impairment at Reporting
Date
LEASES (IFRS)
Ø If the substantial risks of ownership have passed to the
Lessee, then the Lease must be accounted for as a
Finance Lease
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PENSIONS (IFRS)
Ø Defined Benefit Plans
o Project-Unit-Credit Method calculates the PV of
the defined benefit obligation
STATEMENT OF CASH FLOWS (IFRS)
Ø Interest Expense or Finance Costs can be classified as
either Operating or Financing
o Once a classification is chosen, all future costs
must be classified there
Ø Significant non-cash transactions
o Must be included in notes to financial statements
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II. Accounting Changes
Change in Accounting Principle
• Retrospective Application
• Prior Periods adjusted
• Retained Earnings adjusted
• Ex: LIFO to FIFO
Change in Entity
• Retrospective Application
• Prior periods adjusted
• Included in footnotes
• Ex: Change to Consolidated Statements
Change in Accounting Estimate
• Prospective Application
• Going-Forward adjustment
• Ex: Straight Line to DDB Depreciation
Error Correction
•
•
•
•
Prior Periods adjusted
Beginning balances of earliest period adjusted
Included in footnotes
Ex: Non-GAAP to GAAP
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III. Financial Reporting
ACCOUNTING CONCEPT BASICS
Ø Primary Objective of Accounting: Measure Income
o Income measures a firm’s efficiency
Ø Monetary Units are the basis of all economic activity
Ø The FASB Codification
o The most authoritative set of accounting
pronouncements. All pronouncements fall under
the Codification “umbrella.”
Ø Codification (Two levels of GAAP)
o Authoritative
o Non-authoritative
Ø Financial vs. Managerial Accounting Comparison
o Managerial Accounting = “Timeliness” focus
o Managerial Accounting does not follow GAAP
FINANCIAL REPORTING BASICS
Ø Financial Reports are used for
o Providing financial information that is useful to
§ Existing and potential investors
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§ Lenders and other creditors
Ø Filed with SEC
o Form 10K (Annual and Audited)
o Form 10Q (Quarterly and Reviewed)
Primary Constraints of Financial Reporting
• Cost vs. Benefit
• Materiality
Secondary Constraints of Financial Reporting
• Consistency - Year vs.Year
• Comparability - Company vs. Company
Ø Qualitative Characteristics of Financial Reporting
o Relevance - Makes a difference to the user
§ Predictive Value – Future Trends
§ Confirming Value – Past Predictions
§ Materiality – Could affect User Decisions
o Faithful Representation
§ Completeness
§ Nothing omitted that would impact the
decision-making of a user
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§ Neutrality
§ Information presented is without bias
§ Freedom from Error
§ No material errors or omissions
Ø Enhancing Qualitative Characteristics
o Comparability
§ Allows users to compare different items
among various periods
o Verifiability
§ Different people would reach a similar
conclusion on the information presented
o Timeliness
§ Information is made available early enough
to impact the decision making of users
o Understandability
§ Information is easy to understand
Ø Accrual vs. Deferral
o Accrual – Earned (Revenue) or Incurred (Expense),
but no Cash Receipt/Outlay yet
§ Revenue Example: Sell an item on credit
§ Expense Example: Monthly rent expense for
December not paid until January
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o Deferral – Cash Receipt/Outlay, but not Earned
(Revenue) or Incurred (Expense)
§ Revenue Example: Customer pre-pays for a
repair done to their car (Liability)
§ Expense Example: Company pre-pays
insurance premiums and is amortized (Asset)
Ø Recognition
o When an item is recorded and included in the
financial statements
Ø Conservatism
o When an estimate is necessary due to uncertainty,
conservatism chooses the best option that won’t
overstate the financial position of the company
Ø Fair Value
o The price you would receive if you sold the asset
o Assumes asset is at its highest and best value
o Market Assumes
§ Asset is sold in its most advantageous
market to get the best price possible
§ Buyer and Seller are not Related
§ Buyer and Seller are Knowledgeable
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§ Buyer and Seller are able to transact
§ This isn’t a hypothetical transaction for
Fair Value measurement purposes
§ Buyer actually has $10M to purchase
§ Buyer and Seller are motivated to buy/sell
Ø Fair Value Hierarchy
o Level 1 – Top Level
§ Uses price quotes or market prices
§ NYSE or NASDAQ
o Level 2 – Mid Level
§ Interest Rates
§ Prime Rate
o Level 3 – Lowest Level
§ Unobservable
§ Uses assumptions or forecasts
Ø Acceptable Valuation Techniques
o Market Approach
§ Market transactions/prices value asset
o Income Approach
§ Present value discounts earnings
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o Cost Approach
§ Replacement cost values the asset
ASSETS
Ø Current Assets
o Cash
o Inventory or assets expected to be converted or
consumed during a business’ operating cycle
o Receivables expected to be collected < 12 months
LIABILITIES
Ø Current Liabilities
o Will use Current Assets during the present
operating cycle
Ø Accrued Liability vs. Current Liability
o Accrued Liability
§ Expense that has been incurred, but not paid
§ Rent Payable
o Current Liability
§ Payments that have been received but
cannot be recorded as revenue yet
§ Tenant pre-pays rent – Landlord must still
“perform” to earn
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REVENUE (Updated for FASB ASC 606)
Ø Revenue from Contracts with Customers
o Excludes
§ Insurance Contracts
§ Lease Contracts
§ Financial Instruments
§ Contracts with Non-Customers
Ø Revenue Recognition Steps (COPAS)
o Identify the Contract with a Customer
o Identify Separate Performance Obligations
o Determine Transaction Price
o Allocate Transaction Price to the Separate
Performance Obligations
o Recognize Revenue when/as the entity Satisfies a
Performance Obligation
o
o
o
o
o
Contract
Obligations
Price
Allocation
Satisfaction
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Ø Contracts
o Commercial Substance
o Rights to Goods/Services Identified
o Approval & Commitment by Each Party
o Payment Terms Identified
o Collection is Probable
o Consideration Received – But Not a Contract?
§ Liability to Entity
§ Recognize Revenue When
• No Further Obligation to Perform &
Consideration is Non-Refundable or
• Contract Terminated & Consideration
Non-Refundable
o Combine Multiple Contracts if
§ Same Customer
§ Same Time
§ Same Commercial Objective
§ Same Performance Obligation
§ Contracts Co-Dependent
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o Obligations to Transfer
§ Goods/Services
§ Must Be Distinct
• Has Standalone Value
• Doesn’t Include Administrative Activities
• Not Distinct?
o Bundle Until Becomes Distinct
§ Shipping / Handling
• Customer Controls After Delivery
o No Performance Obligation
• Customer Controls Before Delivery
o GAAP – Optional
§ Performance Obligation or
§ Activity to Fulfill Contract
o IFRS – Not Optional
§ Performance Obligation
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o Price - Consideration Received from Customer
§ Allocated to Performance Obligations
§ Reasonably Estimable
§ Excludes Taxes
§ May Contain Variable Consideration
• Included only if Reversal not Expected
o Rebates & Incentives
o Discounts & Price Adjustments
o Refunds
o Bonuses
o Non-Cash Consideration
§ Valuation Methods for Variable Consideration
• Expected Value Method
o Probability-Weighted
• Most-Likely Value Method
o Most-Likely Amount
• Must Be Applied Consistently
§ Refund Liabilities
• Recognize each Reporting Period
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o Amount Expected to be Returned
• Example:
o 100 Home Theater Receivers sold
at $1,000 each
o 10% Expected to be Returned
o Cash 100,000
§ Revenue 90,000
§ Refund Liability 10,000
§ Significant Financing Component
• Does Financing Affect Transaction Price?
•
Promised Consideration
<Cash Price of Goods/Services>
• Can Be Explicitly Stated or Implicit
• Discount Rate Should Be the Rate Used
If the Entity and Customer Entered Into
Separate Financing Arrangement
o Accounts for Credit/Collateral
o Rate NOT Updated Once In Place
• Excludes
o Payments in Advance By Customer
o Payment Terms That Protect Entity
or Customer
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o Time between Customer payment
and transfer of Goods/Services is
less than 1 year
• Financial Statement Presentation of
Significant Financing Component
o Interest Income or Expense
o Separately Presented on Statement
of Comprehensive Income
• Price may contain Non-Cash
Consideration
o Measured at Fair Value as of
Contract Date
o Use Standalone Selling Price if Fair
Value Not Determinable
• Consideration Payable
o Cash, Credit, Etc. Owed to
Customer
o Reduces Transaction Price
§ Unless for Distinct
Good/Service
o Allocation of Price to Performance Obligations
§ Based on Standalone Selling Price (SPP)
§ Approaches for Estimates instead of SPP
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• Market Assessment
o Base Price on Market / Competitors
• Expected Cost + Margin
o Cost of Product + Desired Margin
• Residual
o Price – SPP of other known items
§ Allocation of Discounts
• Allocate Based on SPP
• Discounts Must Be Allocated to Entire
Contract Before Residual Approach Used
§ Allocation of Variable Consideration
• Allocated to One or More Obligations
• Allocated to One or More
Goods/Services that Form a
Performance Obligation
• Criteria
o Variable Amount related to
Satisfaction of Performance
Obligation
o Application Objective of Variable
Amount Consistent with other
Payments in Contract
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§ Allocation of Warranties
• Customer Has Option to Purchase?
o Classified as a Distinct Service
o Performance Obligation
§ Allocate Transaction Price
• No Option to Purchase?
o Not a Performance Obligation
Ø Satisfaction of Performance Obligations: Revenue
Recognition - Point in Time vs Over Time
o Revenue Recognition: Point in Time (Default)
§ Revenue recognized at a Point in Time unless
it meets the criteria to be recognized Over
Time
o Revenue Recognition: Over Time
§ Customer simultaneously receives/consumes
benefits of asset as entity performs
• Marketing Agency (Entity) creates and
tests online ad campaign for Client
§ Entity performance enhances an asset that
customer already controls
• Website Developer (Entity) makes
programming improvements to a Client
website
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§ Entity has no alternative use for asset
• Website Developer (Entity) writes
custom script to show new visitors a
pop-up ad on Client’s website
§ Entity entitled to payment for work
performed
§ Output Method of Recognition (Value)
• Recognition based on value transferred
to Customer to date
§ Input Method of Recognition (Costs)
• Recognition based on internal costs of
assets transferred to Customer to date
o Goods/Services Transferred to Customer
§ Customer gains Control of goods/services at
Point in Time or Over Time
• Ability to use, consume, benefit, etc.
§ Criteria for Control of Asset
• Entity – Right to Payment
• Entity – Transferred Possession
• Customer – Right to Title
• Customer – Risks/Rewards of Ownership
• Customer – Accepts
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Ø Contract Modifications
o New (Distinct) Goods/Services Added +
Consideration Increase
§ Create New Contract
o New (Distinct) Goods/Services Added + No
Consideration Increase
§ Replace Contract
o New (Not Distinct) Goods/Services Added
§ Use the Same Contract
Ø Royalty Income – Sales-Based & Usage-Based
o Recognize when (Later of …)
§ Subsequent Sale/Usage Occurs
§ Performance Obligation allocated to royalty
has been satisfied
o If the Royalty % is applied to Net Sales
§ (Gross Sales – Estimated Returns) x %
Ø Revenues vs Gains
o Revenues
§ Inflows of assets from central/main activities
of the business
§ Company makes machines for $1,000 and
sells them for $2,000
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• $1,000 Gross Profit
o Gains
§ Increase in equity from an activity or event
that is not central to the main activities of
the business
§ Company buys a $2,000 machine and fully
depreciates it – later sells it for $1,000
• $1,000 Gain
§ Can be operating or non-operating
Ø Losses
o Decrease in equity from an activity or event that is
not central to the main activities of the business
§ Can be operating or non-operating
Ø Operating Cycle
o Average time to turn materials/services to cash
Ø Asset Measurement & Valuation Methods
o Present Value of Future Cash Flows
§ Current value of a Future Amount of Money
§ Uses Specific Interest Rate
o Historical Cost
§ Asset Cost – (Net of Depr. & Amortization)
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o Replacement (Entrance) Cost
§ Cost to re-acquire an asset
o Market (Exit) Cost
§ Sale Price of an Asset
o Net Realizable Value
§ Sale Price of an Asset – Selling/Disposal Fee
Ø Revenue: Cash to Accrual Basis (SPEAR-BAR)
Sales (i.e. Customer Payments)
+Ending Accounts Receivable
–Beginning Accounts Receivable
Sales Revenue on an Accrual Basis
Ø COGS from Cash Basis (CRAP-I)
Cash Remitted (i.e. paid – made acronym easier)
+Increase in Accounts Payable
–Increase in Inventory
COGS on an Accrual Basis
Ø Discontinued Operations
o Company ceases operating a business segment
§ Must represent a strategic shift
• Major effect on operations and financials
o Disposal Assets must be
§ Held for Sale
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§ Sold
§ Disposed of another way
o Includes
§ Income (or Loss) from the period
§ + Gain (or Loss) from disposal
o Reported
§ Net of Tax after Continuing Operations in
the period it’s classified as held for sale and
all prior periods presented in the financial
statements
Ø Unusual or Infrequent Items
o Formerly Extraordinary Items
o Two Options for Reporting
§ Income Statement
• Above Income from Continuing
Operations
§ Footnotes to Financial Statements
o Change: No longer net-of-tax
o Treatment in Financial Statements
§ Retrospective or Prospective Treatment
• Additional disclosures required for
previous extraordinary classifications
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Ø Constant Dollar Accounting
o Uses CPI to adjust assets to reflect a consistent
level of purchasing power due to inflation
EXPENSE
Ø Recognized when incurred; Accrue if not yet paid
Ø Product Costs
o Expenses matched with associated revenues
§ Ex: Sales commission on a used car sale
Ø Period Costs
o Expenses amortized & recognized with the
passage of time
Ø Impaired assets are written down and expensed
Ø General and Administrative (G&A) Expense
o Office staff salaries, rent, and supplies
§ Sales staff salaries and portions of the
building assigned to Sales should be allocated
to Selling Expense, not G&A
Ø Business Start-up Costs
o One-time costs for opening a new business
o Expensed as they are incurred
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Ø Interest Expense
o Interest on projects (software) for internal use is
not expensed, but is instead capitalized
COMPREHENSIVE INCOME
Ø Net Income + Other Comprehensive Income (OCI)
o Revenues/Expenses
o Gains/Losses
§ Comprehensive Income includes some Gains
and Losses that are not a part of Earnings
o Cumulative Accounting adjustments
§ Foreign Currency Translation Adjustments
§ Minimum Pension Liability adjustment for
Defined Benefit Plans
Ø Non-owner changes in Equity
o Investment by owners is not included
Ø Reported in a Single or Combined Income Statement
o Earnings Per Share is not required for OCI
FINANCIAL STATEMENT DISCLOSURES
Ø Revenue Recognition Disclosures (ASC 606)
o Contracts with Customers
§ Contract Balances
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• Opening/Closing Balances
o Receivables
o Contract Asset
o Contract Liabilities
• Changes in Contract Asset/Liability
Balances due to
o Business Combinations
o Catch-Up Adjustments
o Impairment
o Time Frame Changes
o Performance Obligations
§ Typical Contract Satisfaction
• At Shipment?
• At Arrival?
• As Services Rendered?
• At Service Completion?
• Bill-and-Hold Policies?
§ Significant Payment Terms
§ Nature of Goods/Services Promised
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§ Obligations
• Refunds
• Warranties
• Returns
o Significant Judgments
§ Judgments made in applying Standard
§ Changes in Judgements
o Costs to Obtain/fulfill Customer Contracts
§ Assets Created/Recognized
• Include Closing Balances
§ Judgments Made
§ Amortization Method
§ Amount of Amortization & Impairment Losses
Ø Accounting Policy Disclosures
o Includes
§ Accounting Principles used
§ Basis of Consolidation
§ Inventory Pricing Methods
§ Depreciation Method
46
§ Amortization of Intangibles
Ø Risk and Uncertainty Disclosures
o Nature of Operations
o Use of Estimates & listing of Significant Estimates
o Concentration vulnerability
Ø Going Concern Doubts
o Management must evaluate whether the entity will
continue to operate as a going concern within 1
year of financial statement issuance
o Substantial Doubt Raised – Alleviated
§ Management has a plan to alleviate threat
§ Disclosures Required
• Events that led to GC Doubt
• Management evaluation of event
• Management plans to alleviate
o Substantial Doubt Raised – Not Alleviated
§ Management plan – doubtful success
§ Statement Required
• There is substantial doubt that entity
will continue as GC within 1 year of
financial statement issuance date
47
§ Disclosures Required
• Events that led to GC Doubt
• Management evaluation of event
• Management plans to alleviate
SPECIAL PURPOSE FRAMEWORKS
Ø Alternatives to GAAP Accounting
o Cash Basis
o Modified Cash Basis
o Incomes Tax Basis
o FRF for SMEs
o Public Business Entities Framework
Ø Cash Basis Accounting
o Revenue Recognized with Cash Inflow
o Expense Recognized when Cash Outflow
o OK for Tax Returns
o Not GAAP
Ø Modified Cash Basis Accounting
o Avoids GAAP complexities while providing more
information than Cash Basis Accounting
o Not GAAP
48
Ø Income Tax Basis Accounting – 3 Options
o Cash Basis
o Accrual Basis
o Hybrid Method (Cash + Accrual for Inventory)
Ø Financial Reporting Framework for Small & Medium
Sized-Entity Framework (FRF for SME)
o Developed by the AICPA
o Not GAAP
o Has No Authoritative Status
o Simplifies reporting for small companies
§ Uses Historical Cost as measurement basis
(instead of Fair Value)
§ Targeted/Relevant Disclosures only
o Provides efficiency and flexibility
o Reduces Book vs. Tax Differences
o Income Taxes – Two Options
§ Deferred Taxes Method
§ Taxes Payable Method
49
o Startup Costs – Two Options
§ Expensed
§ Amortized (15 years)
o Goodwill
§ Amortized (15 years)
Ø Public Company Framework
o Developed by the FASB
o GAAP
o Small Company Lease Accounting
§ Private companies can bypass Variable
Interest Entity rules for Leases
§ Instead, Lease disclosures are made
o Accounting for Goodwill
§ Amortize Goodwill over 10 years
• Will reduce impairment likelihood
• Less than 10 if more appropriate
§ Must test for impairment – Two Options
• Entity-Level
• Reporting Unit Level
50
o Interest Rate Swaps
§ Simplified Hedge Accounting approach
• Simplifies the process of moving from a
variable-rate borrowing + interest rate
swap to a fixed-rate borrowing
REGULATION S-K
Ø Under the Securities Act of 1933
Ø When an issuer issues an IPO, they must adhere to
Regulation S-K
Ø Included in Regulation S-K (note: Registration S-K
contains a lot of information and sub-topics. For
purposes of passing the CPA Exam, this list is general
in nature.)
o General Business & Securities information
o Financial information
o Management and security holder information
o Registration Statement and Prospectus provisions
o Industry Guides, Exhibits & Asset-backed
securities
o Roll-Up Transactions & Mergers
o Oil and Gas disclosures, if applicable
51
DEVELOPMENT STAGE ENTITIES
Ø A DSE is a company that is still in the formation stage
and hasn’t yet begun principal operations or produced
significant revenue
Ø New GAAP rules relax the reporting requirements for a
DSE by removing the need for
o Incremental Financial Reporting
o Data Maintenance
o Inception-to-Date Reporting
o Attaching the DSE label to the F/S
o Disclose descriptions of DSE Activities
o Disclose first-year entity is no longer a DSE
Ø Benefit: Cost savings without sacrificing F/S usefulness
52
IV. Bonds & Debt Restructure
Serial Bond
• Matures in Installments
Term Bond
• Matures on a Single Date
Debenture Bond
• Unsecured
Sinking Fund Bonds
• Cash held for Bond Repayment
• 5 years of Disclosures
BOND CALCULATIONS
Ø Bond Proceeds Formula
Present Value of the Principal Payment at Maturity
+ Present Value of Interest Payments made
= Market Value of Bond Proceeds
Ø Present Value of a Bond
Step 1: PV of $1 @ Yield Rate (not Stated Rate)
x Bond Face Value
PLUS
Step 2: PV of an Ord. Annuity of $1 for Term
@Yield
x (Stated Rate x Face)
53
Application:
Face Amount: $1,000
Stated Interest Rate: 6%
Yield Interest Rate: 9%
Bond Term: 10 periods
PV $1 for 10 periods @ 6% = .558
PV $1 for 10 periods @ 9% = .422
PV of an OA of $1 @ 9% for 10 periods = 6.418
(Remember: always ignore the stated rate for PV
calculations)
Step 1: $1,000 x .422 = $422
Step 2: $1,000 x 6% = $60 (the only time you
use the stated rate) x 6.418 = $385
Carrying Amount of Bond: $422 + $385 = $807
Ø Bond Issuance Costs
o Third Party debt issuance costs (Engraving,
Printing, Legal, Underwriter, Registration, etc)
o Reduces Carrying Amount of Liability
§ Key: Increases Effective Interest Rate
o Disclosures: Same as a Change in Accounting
Principle
o Retrospective Treatment to all prior periods
presented in the financial statements
54
Ø Bonds Classified as Trading Securities
o Reported at FMV with unrealized gains and losses
being included in earnings
Ø Bond Amortization: Interest Method
o Both discount and premium amortization amounts
increase each year
Ø Bond to Stocks: Book Value Method
o No gain or loss recognized
o APIC is the plug for the difference between the
Bond’s Book Value and the Par Value of the
Common Stock
Application:
Bond Payable 1,000,000
Bond Premium 300,000
Common Stock (Par) 50,000
APIC (plug)
1,250,000
55
BOND RATES
Ø Stated Rate: Rate on the face of the bond
Ø Market Rate: Rate that bonds are currently selling for
Ø Market Rate > Stated Rate?
o Bond will need to sell at a discount for buyers to
be interested. The difference in market rate vs.
the stated is made up by the buyer purchasing the
bond for less than par value
§
§
§
§
Market Rate: 12%
Stated Rate: 10%
Par Value: $100
Purchase Price: $98
Ø Market Rate < Stated Rate?
o Bond will need to sell at a premium in order for
sellers to be interested. The difference in market
rate vs. the stated is made up by the buyer
purchasing the bond for more than par value
§
§
§
§
Market Rate: 8%
Stated Rate: 10%
Par Value: $100
Purchase Price: $102
BOND JOURNAL ENTRIES - ISSUER
Ø Bond Issuance on Interest Date
Dr. Cash 102
Cr. Premium
2
Cr. Bond Payable 100
Dr. Cash 98
Dr. Discount 2
Cr. Bond Payable 100
56
Ø Bond Issuance between Interest Date
Dr. Cash 102
Dr. Cash Interest*
Cr. Premium 2
Cr. Bond Payable 100
Cr. Interest Payable*
Dr. Cash 98
Dr. Cash Interest*
Dr. Discount 2
Cr. Bond Payable 100
Cr. Interest Payable*
* Face x Stated Rate x Interest Accrued since last date
o If a company issues bonds between interest dates,
then the total cash that they receive will be MORE
than they normally would (set aside any
considerations for premium or discount, they are
irrelevant for this point).
o Purchaser of the bonds must give the bond issuer
the amount of accrued interest up front
§ Why? Because if the bonds are issued on
March 1 and the next interest payment date
is July 1, then when the buyer of the bonds
gets the full interest payment on July 1, it
will be for the full six months (Face x Stated
Rate).
§ To account for the buyer getting money that
wasn’t earned in July, then the buyer
essentially pays them back for those two
months up front.
57
$100,000 Bonds
10% Stated Rate
Sold at Par on March 1
January 1 & July 1 interest dates
100,000 x 2/12 x 10% = $1,667
Cash $101,667
Bonds Payable $100,000
Interest Expense $1,667 ß Note: Credit
Ø Interest Expense
o Interest Expense starts accruing when the bonds
are issued – not with the face amount of the
bonds
o Remember – when doing a Journal Entry on Bonds
for Interest payments
§ The amount of cash that is credited for the
payment = Stated Rate x Face Amount
§ The amount of interest expense debited is
the Effective Yield x Carrying Value
Ø Remember: Interest Paid vs. Interest Expense
o Interest Paid depends on the amount/rate on the
bond – it has nothing to do with Premiums or
Discounts
o Interest Expense depends on the carrying amount
[(Bond amount +/- Premium or Discount), minus
amortization)] x Effective (Market) Interest Rate
58
BOND AMORTIZATION
Ø Bond Sold at a Discount
$10,000 Face
Bond Discount $635 (PV table not used for illustration)
5% Stated Interest
6% Yield
Date
1-1
7-1
1-1
Coupon Expense Discount
Bond
Carrying
@ 2.5% @ 3%
Amortization Discount Amount
635
9,365
250
281
31
604
9,396
250
282
32
572
9,428
Ø Bond Sold at a Premium
$10,000 Face
Bond Premium $635 (PV table not used for illustration)
5% Stated Interest
4% Yield
Date
1-1
7-1
1-1
Coupon Expense Premium
Bond
Carrying
@ 2.5% @ 2%
Amortization Premium Amount
635
10,635
250
213
37
598
10,598
250
212
38
560
10,560
Ø Effective Interest Method of Amortization as shown in
above two examples is GAAP
o Straight Line Amortization is not GAAP
59
DEBT RESTRUCTURE - DEBTOR
Ø Modification of Terms
o If future payments are now less than the carrying
amount of the debt, then a Gain is recognized
Ø Settlement
o Gain recognized
§ Cash Paid - Carrying Amount
§ Difference between non-cash asset given and
re-valued at FMV and debt carrying amount
DEBT RESTRUCTURE - CREDITOR
Ø Loan Impairment
o Future Cash Flows discounted at loan’s Effective
Interest Rate < Carrying Value
§ Effective Rate calculated using Original Rate,
not Modified Rate
60
V. Consolidations
FINANCIAL REPORTING METHODS
Ø Fair Value – 20% Ownership or Less
o Accounted for as a “purchase”
o If amount paid < Fair Value = Bargain Purchase
§ Results in a Gain in current period
Ø Equity Method – 21-50% Ownership
o Gives “Significant Influence”
o Purchase Price - Par Value = Good Will
§ Fair Value of Assets = $100,000
§ Purchase Price of Shares = $33,000
§ Shares Purchased = 30%
§ $100,000 x 30% = $30,000
§ $33,000 - $30,000 = $3,000 Goodwill
o Dividends received from Investee reduce the
Investment account and are not income
o Changing to Equity Method
§ New with Simplification Initiative
§ Recognize Unrealized Holding G/L in Earnings
61
§ Prospective F/S Treatment
Ø Consolidation – > 50% Ownership
o Investment account eliminated
o Exceptions for consolidation
§ Majority owner does not “Control”
§ Bankruptcy
§ Foreign Bureaucracy
o Only parent company prepares consolidated
statements, not subsidiary
o Majority shares are purchased, but separate legal
entities continue to exist
o Acquired assets and liabilities are recorded at their
Fair Value on the Acquisition Date
o Eliminating Entries
§ Intercompany Sales
§ Inventory
§ PP&E
§ Note: Under Newly-Tested ASU 2016-16,
the tax effects of Intercompany Sales,
except Inventory, must be recognized
immediately
62
o Subsidiary A has a Gain upon
Sale/Transfer to Subsidiary B
§ Sub A = Current Tax Expense
§ Sub B = Deferred Tax Asset
§ Intercompany Investments
Ø Step Acquisition
o Acquirer held previous shares accounted for under
Fair Value Method or Equity Method, and are now
re-valued to Fair Value
§ Results in a Gain or Loss in current period
Ø Acquisition vs. Merger
o Acquired companies continue to exist as a legal
entity – their books are just consolidated with the
parent company in the parent’s financial
statements
o Merged companies cease to exist and only the
parent remains
Ø Acquisition Costs
o Expensed in period incurred – i.e. NOT capitalized
§ Accounting
§ Legal
§ Valuation
§ Consulting
63
§ Professional
o Netted against Stock Proceeds
§ Stock registration and issuance costs
VI. Deferred Taxes
DIFFERENCES BETWEEN BOOK AND TAX INCOME
Ø Temporary Differences
o GAAP says to recognize a revenue/expense in one
period and tax laws say to recognize it in another
§ Ex: Dividends from a subsidiary accounted
for using the Equity Method
§ Tax Income, but not Book Income
o Deferred Tax Asset
§ Deduction will reduce future income taxes
expense
o Deferred Tax Liability
§ Income will be taxable in a future period and
will increase future tax expense
o Note: Deferred Tax Assets and Liabilities are
calculated using the FUTURE enacted tax rate,
not the current one
§ Never discounted to Present Value
64
o Valuation Allowance
§ If it is “probable” that not all of a Deferred
Tax Asset (Debit) will be realized, then the
Deferred Tax Asset account must be written
down (Credit) to reflect this probability
Ø Permanent Differences
o Have no Tax Impact
§ When calculating the total differences
between book and tax income, subtract the
Permanent Differences from the total before
applying a Future Enacted Tax Rate
o Ex: Tax-free Bond Interest
Ø Deferred Income Tax Expense
o The sum of Net Changes in Deferred Tax Assets
and Deferred Tax Liabilities
o GAAP Method for calculating is the “Asset and
Liability Approach”
§ Note: IFRS uses the “Liability Approach” only
Ø Balance Sheet
o Deferred Tax Assets and Liabilities are noncurrent only (Simplification Initiative)
o Deferred Tax Assets and Liabilities can be netted
ONLY if related to same country/taxing authority
§ China Deferred Tax Assets can’t offset Japan
Deferred Tax Liabilities
65
VII. Investments & Instruments
EQUITY SECURITIES
Ø Excludes
o Equity Method Investments
o Consolidations
Ø No longer categorized as AFS/Trading
o Debt Securities still categorized as AFS/Trading
Ø Recorded
o Fair Value
o Cost <Net of Impairment>
§ If Value Not Determinable
§ Qualitative Assessment required to
Determine Impairment
Ø Unrealized Gains/Losses
o Income Statement
Ø Disclosures
o Fair Value Disclosures Based on Exit Price
§ Price received if you sold the asset
66
HELD-TO-MATURITY (DEBT) SECURITIES
Ø Recorded at Amortized Cost
o Classified as Current or Non-Current Asset
Ø Unrealized Gains/Losses
o N/A
Ø Reclassified?
o Available-for-Sale
§ Unrealized G/L go to Stockholder’s Equity
o Trading Securities
§ Unrealized G/L recognized in Current Period
Ø Balance Sheet Requirements
o Separate Presentation
§ Financial Assets
• Securities
• Loans
§ Financial Liabilities
• Securities
• Loans
67
DERIVATIVES
Ø Recorded at Cost when acquired
Ø Re-valued to Fair Value each period on Balance Sheet
Ø Equity Securities
o Unrealized Gains and Losses
§ Income Statement
HEDGING
Ø Fair Value Hedge
o Offsets exposure to changes in the value of a
recognized asset/liability or of an unrecognized
commitment
o Ex: Interest Rate Swap that offsets risk that
changes in interest rates will materially change a
company’s risk with respect to debt
o Recorded on Balance Sheet at Fair Value
o Gain or Loss
§ Income Statement
Ø Cash Flow Hedge
o Hedges exposure to fluctuations in cash flows
o Ex: A cereal company knows that it will be
purchasing grain 10 months from now. To offset
the risk that grain will go up in price 10 months
from now, they enter into a futures contract
68
o Recorded on Balance Sheet at Fair Value
o Gains or Loss
§ OCI
Ø Foreign Currency Hedge
o Gain or Loss
§ OCI
Ø Required Disclosures
o Objectives and Strategies
o Context to help investor understand instrument
o Risk Management Policies
o Complete List of Hedged Instruments
FOREIGN CURRENCY TRANSACTIONS
Ø Used for transactions denominated in something other
than a company’s functional currency
o A US firm purchases goods on account from a
company located in Japan
o Agrees to pay the amount owed in yen
o The Payable is denominated in a foreign currency
(yen), and the transaction is a Foreign Currency
Transaction.
69
Ø A change in exchange rates between the functional
currency and the currency in which a transaction is
denominated occurs
o This increases or decreases the expected amount
of functional currency cash flows upon settlement
of the transaction
o Resulting in a Foreign Currency Transaction G/L
o The G/L goes to the Income Statement
FOREIGN CURRENCY TRANSLATION
Ø US corporation has a subsidiary in a foreign country
o Functional/Reporting currency is the US dollar
o The translation issue then revolves around
translating the foreign subsidiary’s financial
statements into the reporting currency of the
parent for purposes of preparing consolidated
financial statements
o G/L goes to OCI
Ø If Functional Currency = Local Currency
o Asset and Liability Translation
§ Use Current Rate as of Balance Sheet date
o Revenue and Expense Translation
§ Use the Weighted Average Exchange Rate for
the current year
70
Ø If Functional Currency = Reporting Currency
o Foreign Currency Financial Statements are remeasured into the Reporting Currency (Dollar)
using the weighted-average exchange rate
§ Historical Exchange Rates (Weighted Avg)
§ Inventory @ Cost
§ Prepaid Assets & PP&E
§ Current Exchange Rates (Weighted Avg)
§ Monetary Assets & Liabilities
§ Inventory @ Market
§ Trading Securities
§ Deferred Taxes
71
VIII. Fixed Assets
CAPITALIZED ACQUISITION COSTS - EQUIPMENT
Ø Includes all expenditures to get the asset into “working
condition” and ready for use
o Purchase Price + Liabilities Assumed
o Shipping
o Taxes
o Insurance
o Installation
o Testing
o Legal fees
o Construction Loan Interest
o Any alterations to existing facilities or equipment
necessary for the new purchase and installation
that extend the life or increase efficiency of these
assets are capitalized
Ø R&D Costs are expensed in the period incurred and are
not capitalized
CAPITALIZED ACQUISITION COSTS - BUILDINGS
Ø Includes all expenditures to get the asset into “working
condition” and ready for use
72
CAPITALIZED ACQUISITION COSTS - LAND
Ø Includes all expenditures to get the land ready for its
intended use
o Title & County Fees
o Clearing of Land - Dirt Work, etc.
o Demolition and Removal of Buildings (minus any
scrap or salvage)
Ø Remember – Capitalized land costs are not depreciated
NON-MONETARY EXCHANGES
Ø If non-monetary assets are exchanged, no gain can be
recognized if the cash flows are not significantly
different – i.e. it lacks commercial substance
o The asset acquired is recorded at the book value
of the asset given up
o The only gain that can be recognized is any boot
(cash) received from the transaction
Ø If non-monetary assets are exchanged and the cash
flows are significantly different, then it has commercial
substance and a gain/loss can be recorded on the
exchange
o New asset is recorded at the fair value of the
assets given up, unless the asset acquired has a
fair value that is easier to determine
73
Ø Recap:
o Transaction Lacks Commercial Substance
§ Cash Flows are not different
§ New Asset = Book Value of Old Asset
o Transaction Has Commercial Substance if …
§ Cash Flows are different
§ New Asset = Fair Value of Old Asset
§ Exam Tip – Transactions that have
Commercial Substance are arms-length and
are “fair” and use “fair value”
Ø Donated Property (Non-Reciprocal Transfer) - Donee
o Recorded at Fair Value + costs associated with
getting the property into working condition for its
designed purpose
o Exam Tip - Think of a charity holding a “fair” and
then donating the property which is then recorded
at “fair value”
Ø Donated Property (Non-Reciprocal Transfer) – Donor
o Recorded at Fair Value of asset given up
o Gain or Loss recorded
74
DEPRECIATION
Ø Double-Declining Balance (DDB)
o 1/(Useful Life) x 2 x Book Value
o Ignore Salvage Value
o Exam Tip: Be sure to know how to calculate DDB
Equipment costs $10,000
10-Year Useful Life
$1,000 Salvage Value
What is DDB for Year 1 and Year 2?
Straight Line = 1/10 = 10%
DDB = S/L x 2 = 20%
Year
Year
Year
Year
Year
1:
2:
3:
4:
5:
$10,000 x 20%
($10,000 - $2,000) x 20%
($10,000 - $3,600) x 20%
($10,000 - $4,880) x 20%
(10,000 - $5,904) x 20%
= $2,000
= $1,600
= $1,280
= $1,024
= $819.20
Note: Since Year 5 drops below S/L, then you
continue to depreciate using S/L and abandon
DDB.
Ø Sum of Year’s Digits (SYD)
o Deducts Salvage Value
= Remaining Useful Life / SYD
10-Year Useful Life
75
What is the SYD for Year 3?
Year 1 = 10
Year 2 = 9
Year 3 = 8
=8 / (10+9+8+7+6+5+4+3+2+1) = 8/55 = 14.5%
(Cost – Salvage Value) x 8/55 = Depreciation
Expense for Year 3
Ø Straight Line (S/L)
o Deducts Salvage Value
$10,000 Asset
10-Year Useful Life
$100 Salvage
$10,000-$100 = $9,900
$9,900 / 10 = $990 per year
IMPAIRMENT
Ø Undiscounted Future Cash Flows < Carrying Value
Ø Carrying Value – Fair Value = Impairment Loss
o Impaired Assets that recover their value can’t be
written back up once written down
o Deducts Salvage Value
76
INTANGIBLE ASSETS
Ø Patents
o Legal fees to successfully defend a patent are
amortized over the patent’s economic life
Ø Goodwill
o Tested for impairment at the level of the Reporting
Unit – never tested at the Entity Level
o Two Steps for Testing Goodwill Impairment
§ Compare the CV to the FV. If FV>CV, no
impairment exists, you’re done.
§ If impairment appears to exist, the assets
and liabilities should be compared to the total
value of the reporting unit. The difference is
Goodwill. Compare this amount to the CV of
the Goodwill and write it down accordingly.
SOFTWARE EXPENSES
Ø Prior to Technological Feasibility - Expense as R&D
Ø After Feasibility but prior to Production - Capitalize
Ø Expenses incurred during production
o Inventory
Ø During training on internal use software – Expensed
77
IX. Governmental Accounting
GOVERNMENTAL ACCOUNTING BASICS
Ø Primary Objective
o Provide information that is useful and benefits a
wide range of users including
§ Cost of Services provided
§ Sufficiency of Revenues to cover costs
§ Financial Position of the Entity
Ø GAAP Hierarchy for State & Local Governments
o Authoritative
§ Category A
§ GASB Statements
§ Category B
§ GASB Technical Bulletins
§ GASB Implementation Guides
§ GASB-Approved AICPA Literature
o Non-Authoritative
§ GASB Concepts Statements
§ FASB Pronouncements / Other
78
Ø Fund Types
o Governmental Funds
o Proprietary Funds
o Fiduciary Funds
Ø Fund Accounting - Two Types
o Accrual Basis
§ Current Economic Resources Focus
§ Revenues recognized when earned
o Modified Accrual Basis
§ Current Financial Resources Focus
§ Revenues recognized when available &
measurable
Ø Budget Estimates
o Appropriation
§ Highest amount allowed for an expenditure
o Encumbrance
§ Records purchases & reserves it
Ø Budget Actuals
o Expenditure
§ The actual cost of something
79
Ø Opening Budgetary Entry
Dr Estimated Revenues Control
Cr Appropriations Control
Dr/Cr Budgetary Fund Balance (plug)
Ø Closing Budgetary Entry
Dr Appropriations Control
Dr/Cr Budgetary Fund Balance (plug)
Cr Estimated Revenues Control
GOVERNMENTAL FUNDS (GSP-CD)
Ø Use Modified Basis of Accounting
Ø Have a Current Financial Resource Focus
Ø Revenue Recognized when available and measurable
o Sales tax revenue to be received within 60 days of
the fiscal year-end that will be used to fund
expenditures made prior to year-end are treated
as revenue in the current fiscal year
Ø General Fund
o The “Operating” fund of the governmental unit
§ Records Significant Revenues
§ Taxes
§ Tickets
80
§ Fines
§ Licenses
§ Records Significant Expenditures
§ Police
§ Education
§ Fire Dept.
Ø Special Revenue Fund
o Restricted for a specific purpose such as street
repair
Ø Permanent Fund
o Legally restricted
o Only earnings can be used to fund programs
o Principal remains intact
Ø Capital Projects Fund
o Used to acquire and build facilities
Ø Debt Service Fund
o Handles repayment of long-term debt and related
interest
Ø Governmental Fund Balance Types
o Restricted – Restricted by Contributor (Strict)
81
o Committed – Restricted by Government (Less
strict because they can undo the restriction)
o Assigned – Intended to be used for a purpose
o Unassigned – Available to be spent
o Non-Spendable – isn’t in a “spendable” state
(Inventory)
Ø Governmental Fund Statements
o Balance Sheet
o Statement of Revenues, Expenditures, and
Changes in Fund Balance
Ø Revenue Recognition
o Is it available?
o Is it measurable?
o If yes – it’s revenue, regardless of when it is spent
Ø Derived Tax Revenue
o Collected by people “doing” things
§ Buying cars
§ Sales Tax
§ Going to work
§ Income Tax
82
Ø Imposed Tax Revenue
o Assessed just because things “exist”
§ Property Tax on car
§ Your car could sit in the driveway all
year and never move. The fact that it
exists means it gets taxed
§ Real Estate Tax
o Recorded as Revenue when Budgeted
PROPRIETARY FUNDS
Ø Use Accrual Basis of Accounting
o Orientation is Income Determination
Ø Have an Economic Resource Focus
Ø Revenue Recognized when earned and measurable
Ø Internal Service Fund
o Serves the needs of other governmental units
o Example: Motor Pool fixes government vehicles
Ø Enterprise Fund
o Provides goods or services to external users
o Example: Post Office
Ø Proprietary Fund Financial Statements
83
o Statement of Net Position
o Statement of Revenues, Expenses, and Changes in
Net Assets
o Statement of Cash Flows
FIDUCIARY FUNDS
Ø Use Accrual Basis of Accounting
Ø Have an Economic Resource Focus
Ø Agency Fund
o Government acts as an “agent” or custodian
Ø Pension Trust Fund
o Government is a trustee for a pension plan
Ø Investment Trust Fund
o Government is trustee over a series of
investments
Ø Private Purpose Trust
o Trust that benefits various individuals and entities
Ø Fiduciary Fund Financial Statements
o Statement of Net Position
o Statement of Changes in Net Position
84
INVESTMENT & LIABILITY VALUATION
Ø Fair Value
o Price received to sell an Investment
§ Held for Income or Profit
o Price paid to transfer a liability
Ø Valuation Approaches
o Market Approach
§ Price from similar transactions
o Cost Approach
§ Price to replace similar asset
o Income Approach
§ Converts future cash flows to current
amounts
§ Example: Present Value Technique
Ø Fair Value Hierarchy
o Level 1 (Best)
§ Quoted Prices for Same Assets & Liabilities
o Level 2
§
Quoted Prices for Similar Assets & Liabilities
85
o Level 3
§ Best Data Available
Ø Acquisition Value
o Price paid if purchased instead of donated
§ Donated Assets
§ Donated Art
Ø Investment & Liability Disclosures
o Organized by Asset & Liability Type or Class
o Fair Value Measurement
§ Valuation Technique
§ Change in Valuation Technique?
§ Level of FV Hierarchy used
GOVERNMENT-WIDE FINANCIAL STATEMENTS
Ø Statement of Net Position & Statement of Activities
o Prepared on an Accrual Basis
o Focus is on Economic Measurement
o Purpose is to provide Operational Accountability
86
Ø Statement of Net Position
o Assets (Current & Non-Current)
§ Ordered by Liquidity
o Deferred Outflows of Resources
§ Future use of Net Assets
§ Exam Tip – Which MCQ option is an example
of cash leaving the entity?
§ Exam Tip – D. Outflows follows Assets in
presentation (Assets – Outflows – Liabilities –
Inflows) because it’s going to use those
assets.
o Liabilities (Current & Non-Current)
§ Ordered by Liquidity
o Deferred Inflows of Resources
§ Future increase in Net Assets
§ Exam Tip – Which MCQ option is an example
of cash entering the entity?
§ Exam Tip – D. Inflows follows Liabilities in
presentation … think of it as bringing in
money (Inflow) and now owing a service
o Restricted Net Assets
o Unrestricted Net Assets
87
o Capital Assets
§ Net of debt
o Divided into
§ Government Activities
§ Business Activities
o Capital Assets are shown Net of Debt
Asset Cost
-Accumulated Depreciation
-Asset Liabilities
Net Assets
o Infrastructure
§ Modified Approach
§ Reported at Cost
§ No Accumulated Depreciation
Ø Statement of Activities
o Government activities divided by function
o Revenues
§ General Revenues
§ Program Revenues
88
Ø Notes to Financial Statements
o Notes are considered part of Financial Statements
Ø Presentation
o If the activities of a component are distinguishable
from the rest of the governmental entity, then
Discrete Presentation is required
o If the activities of the component cannot be
identified and separated from the rest of the
governmental activities, then Blended
Presentation is warranted.
o Component units are reported in the Entity-Wide
Financial Statements and not the Fund Financial
Statements.
DEFINED BENEFIT PENSION PLANS
Ø Financial Statements Required
o Statement of Fiduciary Net Position
§ Assets
§ Deferred Outflows
§ Liabilities
§ Deferred Inflows
§ Fiduciary Net Position
89
o Statement of Changes in Fiduciary Net Position
§ Additions
§ Contributions
§ Net Investment Income
§ Deductions
§ Benefit Payments
§ Admin Expense
§ Net Change in Fiduciary Net Position
Ø Financial Statement Notes
o Types of Benefits Provided
o Plan Member Classes
o Board of Directors Information
o Investments
§ Policies
§ Fair Value Determination
90
X. Segments & Interim Reporting
INTERIM REPORTING
Ø Short-term Financial Statements for periods < 1 year
Ø Same accounting principles used for annual reporting
purposes should be applied to interim periods
Ø Discrete View
o Interim period is a separate accounting period
o Not GAAP
Ø Integral View
o Interim period is part of the annual period
o GAAP
Ø Interim Reporting rules that differ from normal GAAP
o Gross Profit Method may be used to estimate
COGS and Ending Inventory
o Temporary declines in Inventory aren’t recognized
Ø Discontinued Operations & Unusual/Infrequent Items
o Aren’t prorated
o Fully recognized in Interim Period as incurred
o If it occurs in Q3, it’s recognized in Q3
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Ø Cumulative Gains and Losses
o Reported as if they occurred in the first quarter
Ø Inventory Valuation
o If inventory experiences a decline in value during
an interim period, the loss is recognized in the
interim period
§ If the loss is expected to be only temporary,
no loss is recognized
Ø Problems with Interim Reporting
o The matching principle gets messed up –
Expenses incurred in one period may benefit
future periods
SEGMENT REPORTING
Ø Required by publicly traded companies
Ø Test of Significance for a Segment (must meet one of
these requirements)
o Revenue of segment is 10% or more of total
o Profit is 10% or more of total
o Segment assets are 10% or more of total
o 75% Test
§ All segment revenues must equal 75% of
total external revenues
92
Ø Disclosure Requirement
o If 10% or more of enterprise revenue comes from
one customer, the segment making the sales must
be disclosed
XI. Partnership Accounting
FORMATION OF A NEW PARTNERSHIP
Ø Contributed Assets should be recorded at Fair Value
Ø Liabilities assumed by the partnership should be valued
at the Present Value of the remaining Cash Flows.
Ø Capital Contributions with a Mortgage
o Unlike in Regulation where the partner’s tax basis
is reduced by the amount of the mortgage that
the other partners absorb, calculating the capital
balance when property contributed has a
mortgage results in the FV of the Asset being
netted against the Liability
o If you contribute a $100,000 building with a
20,000 loan, your capital account is increased by
$80,000, instead of allocating the liability to the
other partners according to their ownership %.
93
ADMISSION OF A NEW PARTNER
Ø Bonus Method
o If no Goodwill is recorded, then use Bonus Method
Old Partnership Equity
+ New Partner Contribution
New Partnership Equity
New Partnership Equity
x New Partner %
New Partner Equity Amount
New Partner Contribution
- New Partner Equity Amount
= Bonus to Prior Partners using same allocation as P/L
Current Capital (A,B,C): 60,000
New Capital (D): 30,000
20% interest purchased
60,000 + 30,000 = 90,000 total capital
20% x 90,000 = 18,000 capital for D
Cash from New Partner $$
New Partner Capital
$$
Old Partner’s Capital (Bonus) $$
94
Ø Goodwill Method
New Contribution/New Equity % = Partnership Value
Implied Value of Partnership
-Capital Accounts of all partners
= Goodwill to Old Partners
Under the Goodwill Method, the new Partner is paying
an amount for a certain percentage stake in the
partnership. For instance, if they pay $1000 for a 25%
stake, then it is assumed that the Partnership is worth
$4,000 ($1,000/25%)
If the partnership is worth $4,000 and the new partner
paid $1,000, that leaves $3,000 left over. If the old
partners’ capital accounts add up to $2,500 + the new
partner’s account of $1,000 = $3,500
$4,000 - $3,500 means there is $500 of “goodwill” to
split between the old partners based on their
Profit/Loss ratios.
95
XII. Inventory
INVENTORIABLE COSTS
Ø Purchases
o Recorded Net of Discounts
Ø Freight
o FOB Shipping Point puts the inventory into the
hands of the buyer from the loading dock
o FOB Destination keeps the items in the seller’s
inventory until it reaches the buyer
Ø Warehouse Expenditures
NON-INVENTORIABLE COSTS
Ø Sales Commissions
Ø Interest on Liabilities to Vendors
Ø Shipping Expense to Customers
INVENTORY DISCOUNTS
Ø Gross Method
o Records discounts only when used
Ø Net Methods
o Records discounts whether used or not
o Unused discounts allocated to financing expense
96
INVENTORY MARGINS
Ø Gross Margin = Sales – COGS (BI + P – EI)
INVENTORY ACCOUNTING SYSTEMS
Ø Periodic - Counted at certain times
o Weighted-Average Cost Flow Method
Ø Perpetual – Continually updated
o Moving-Average Cost Flow Method
Ø In periods of Rising Prices, Ending Inventory under
Periodic and Perpetual Methods are identical under
FIFO
RATIOS
Inventory Turnover
• COGS / Average Inventory
Average Day's Sales
• 365 / Inventory Turnover
CONSIGNMENTS
Ø Consignor
o Sends their inventory to be sold by someone else
o Include consignment items in inventory count
o Include shipping to consignee
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Ø Consignee
o Sells someone else’s inventory in their store and
they get a cut of the revenue
o Don’t include consignment inventory held as part
of their inventory
ABNORMAL INVENTORY COSTS
Ø Not included in inventory – Includes Waste
ERRORS
Ø For Exam purposes, just remember
o Beginning Inventory Over/Under stated has no
effect on Ending Retained Earnings (E.RE)
o EI Over = COGS Under = E.RE Over
o EI Under = COGS Over = E.RE Under
o On the CPA Exam, you can pick up quick points if
you have this relationship memorized
CALCULATIONS
Ø FIFO
o The first (oldest) inventory you have in stock is
the first inventory you record for COGS purposes.
o If your oldest inventory on the shelf cost you $1
when you bought it, COGS is $1
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o This is just for inventory pricing. It has nothing to
do with physically selling the oldest item on the
shelf - It is purely for accounting purposes
Ø LIFO
o The last (newest) inventory you have in stock is
the first inventory you record for COGS purposes.
o If your newest inventory on the shelf cost you
$1.50 when you bought it, COGS is $1.50
Ø Weighted Average Method
Cost of Goods Available for Sale (COGAS)
• Beginning Inventory + Purchases
Weighted Average Cost per Unit
• COGAS / Total Units
• Use this x Units Sold for COGS
Inventory: Beginning + Net Purchases – COGS = Ending
Very Important: Know how to find COGS using FIFO, LIFO,
and Weighted Average to solve any inventory problem
FIFO VS. LIFO IN PERIODS OF CHANGING PRICES
Ø A quick way to remember the relationship between
FIFO/LIFO and Rising/Falling Prices in relation to COGS
and Ending Inventory (EI)
o If you can remember FIFO and COGS, you’ll
know LIFO because it’s the opposite
99
o Just remember that you learned FIFO because it’s
FIRST. Picture a little cat named FIFO.
Ø Rising Prices
o FIFO has the Lowest COGS
o FIFO (cat) sees a mouse…starts Low and is Rising
o If COGS is Low, that means EI is High
Ø Falling Prices
o FIFO has the Highest COGS
o FIFO, high from Catnip is Falling off the couch
o If COGS is High, that means EI is Low
MEASUREMENT OF INVENTORY
Ø Two Methods
o Lower of Cost or Market
§ LIFO & Retail Method
o Lower of Cost or Net Realizable Value (NRV)
§ FIFO & Average Cost
§ All other Methods besides LIFO & Retail
100
Ø Lower of Cost or Market (LIFO & Retail Method)
o How to Find Market - 3 Variables:
§ Market Ceiling (NRV)
• NRV = Selling Price – Selling* Costs
§ Inventory Replacement Cost
§ Market Floor (NRV – Profit Margin)
§ The “middle” number is Market
*Includes Disposal, Completion, Transportation Costs
Example: Lower of Cost or Market (LCM)
Cost: $50
Replacement Cost: $55
Selling Price: $75
Selling (including Disposal) Cost: $2.50
Normal Profit Margin: 25%
NRV = $75 - $2.50 = $72.50
Replacement Cost = $55
NRV – Normal Profit Margin = $53.75
[$72.50 – ($75 x 25% = $18.75)]
NRV = $72.50
Replacement Cost = $55 (Market)
NRV – Normal Profit Margin = $53.75
$50 Cost vs. $55 Market
LCM = $50
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Ø Lower of Cost or NRV (FIFO & Weighted Avg*)
o How to Find Net Realizable Value:
§
Selling Price
<Selling** Costs>
Net Realizable Value
*Includes all Inventory Measurement methods other
than LIFO & Retail Method
**Includes Disposal, Completion, Transportation Costs
Example: Lower of Cost or NRV (LCNRV)
Cost: $50
Selling Price: $75
Selling (including Disposal) Cost: $2.50
NRV = $75 - $2.50 = $72.50
Cost= $50
LCNRV = $50
XIII. Leases
CAPITAL LEASE - LESSEE
Ø Risk of ownership passes by (Must meet one)
o Title
o Bargain Purchase Option (BPO)
o Substance
§ 75% Test - Lease term > 75% of useful life
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§ 90% Test - PV of Min. Lease Payments >
90% of Fair Value
Ø Capitalize at Cost
o Asset & Liability Recorded
o Present Value of Future Lease Payments
o Discount Rate – Lesser of
§ Implicit Rate in the Lease
§ Market Rate
Ø Footnotes
o Future minimum rental commitments
o By year – for 5 years
o All remaining years as a group
Ø Journal Entry – Lease Payments
Dr. Interest Expense
Cr. Cash or Lease Payable
CAPITAL LEASE - LESSOR
Ø Requirements:
o Lessee must meet one of the above criteria
o Collectability of lease payments is predictable
103
o No uncertainties about the lessor reimbursing the
lessee for costs incurred
Ø Journal Entry – Initial Lease
Dr. Lease Receivable
Cr. Asset
Cr. Unearned Income
Ø Journal Entry – Lease Payments
Dr. Cash
Cr. Lease Receivable
Dr. Unearned Income
Cr. Interest Income
OPERATING LEASE - LESSEE
Ø Risk of ownership does not pass
Ø No asset or liability is recorded in financial statements
Ø Leasehold Improvements
o Capitalizes and depreciated over the lesser of
Lease Life or Leasehold Improvements Life
Ø Journal Entry – Lease Payments
Dr. Rent Expense
Cr. Cash or Rent Payable
OPERATING LEASE - LESSOR
Ø Rent Revenue recorded
104
Ø Remains an asset and depreciated
Ø Journal Entry – Lease Payments
Dr. Cash or Rent Receivable
Cr. Rent Revenue
Ø If payments fluctuate over the term of the lease
o Rent Revenue recognized on a S/L basis
Year 1: $4,000
Years 2-5: $12,500
Rental Revenue Per Year = $10,800
[($12,500*4)+$4,000]/5
DIRECT FINANCING LEASE
Ø Interest Revenue decreases with passage of time
o Principal amount increases with each payment
o Carrying amount of Lease decreases
SALE-LEASEBACK
Ø Any profit on the sale is deferred and amortized
Ø Exception:
o If PV of Lease Payments is 10% or less of the
asset’s FMV
§ Gain is Recognized
o If PV of Lease Payments is greater than 10% of
FMV and the lease is operating
105
§ Gain is recognized except the amount of the
PV of the lease payments
$100,000 Gain
PV of Lease Payments: $25,000
$75,000 of Gain: Recognized
$25,000 of Gain: Deferred
LEASE PAYMENTS
Ø Annuity Due
o Payments begin at the start of the lease
o Think: Rent is Due at the first of the month
Ø Ordinary Annuity
o Payments begin after the end of the first year
o Think: An annuity that pays you at end of the year
XIV. Current Assets & Liabilities
CURRENT ASSETS
Ø Cash plus other assets that are expected to be sold or
converted to cash during the current operating cycle
o Includes
§ Demand Deposits
§ Cash Equivalents
• Short Term
106
• Very Liquid
• Original maturity < 3 months
• Exam Tip: Don’t let the exam trip you
up with some 9-month bond that
matures in 2 months – not a cash
equivalent
§ Accounts Receivable
§ Inventory
§ Prepaids
§ Short-term Investments
CURRENT LIABILITIES
Ø Expected to be paid within 12 months or less
107
RATIOS
Note: “Turnover” Ratios have the average of what is
being turned over in the denominator
Quick Ratio
•(Cash + A/R + Trading Securities)/Current Liabilities
Current Ratio
•Current Assets/Current Liabilities
Working Capital
•Current Assets - Current Liabilities
A/R Turnover
•Credit Sale/Average A/R
Inventory Turnover
•COGS/Average Inventory
Day Sales in Inventory
•365/Inventory Turnover
Days to Collect A/R
•Avg A/R / Avg Sales Per Day
GAIN CONTINGENCIES
Ø Don’t Accrue due to Conservatism
LOSS CONTINGENCIES
Ø Remote – Don’t Accrue or Disclose
108
Ø Reasonably Possible – Disclose
Ø Probable – Accrue (if Estimable) and Disclose
XV. Not-For-Profit Accounting
NON-GOVERNMENTAL NOT-FOR-PROFITS
Ø Private colleges and hospitals that are not governmentsupported like a public university
Ø Financial Statements Required
o Statement of Financial Position
§ Similar to Balance Sheet
§ Assets
§ Liabilities
§ Net Assets
§ With Donor Restrictions
o “Temporarily” & “Permanently” SubClassifications No Longer Used
o Nature of Restrictions still disclosed
§ Without Donor Restrictions
o Statement of Activities
§ Similar to an Income Statement
§ Organization-wide
109
§ Revenues
§ Expenses
§ ONLY deducted from Unrestricted
Revenues
§ Report
o Functional Expense Classification
§ Groups by Purpose
• Program Services
• Support Services
o Natural Expense Classification
§ Groups by Economic Benefits
• Salaries
• Rent
• Utilities
• Supplies
§ Gains & Losses
§ Changes in Net Asset Classes
§ With Donor Restrictions
§ Without Donor Restrictions
110
§ Investment Returns
o Net of Investment Expense
o Statement of Cash Flows
§ Both Direct & Indirect Methods OK
§ Operating Activities
§ Unrestricted Revenues & Expenses
§ Investing Activities
§ Financing Activities
§ Endowments
§ Restricted Contributions
Ø New Financial Disclosures Required
o Qualitative - Management of Liquid Resources
o Qualitative & Quantitative – Ability of organization
to meet short-term cash expenditures
Ø Non-governmental Hospitals
o Balance Sheet
o Statement of Operations
o Statement of Changes in Net Assets
o Statement of Cash Flows
o Financial Statement Notes
111
Ø Revenues and Net Assets
o Accrual basis of accounting is used
o Only external parties can restrict the use of assets
§ Assets earmarked internally by management
still classified as unrestricted
o Unrestricted Assets/Revenue
§ No restrictions or conditions placed on entity
to use the resources
§ Revenues on contributions are recognized in
the year received, not the year the
contribution is spent and are recorded at Fair
Value on the date received
§ Services rendered are contributions
§ If the organization would have otherwise
paid for or they increase the value of a
non-monetary asset
§ Hospital Charity Care is NOT revenue
§ Disclosed in the notes to the financial
statements only
§ Unconditional pledges to contribute are
classified as revenue
§ Current year only – multi-year future
contributions fall under Restricted
112
§ Expenses ONLY deducted from Unrestricted
Revenues, not Restricted Revenues/Assets
o Restricted Assets & Revenue
§ Use is restricted to by Donor
§ Unrestricted contributions promised
(including multi-year contributions), but not
yet received are actually restricted by “time”
and are therefore classified as Restricted
Assets
§ Multi-year contributions recorded at the
present value of the future contributions
§ Initially, the JE to record the Restricted
Contribution looks like this:
Cash - RA 500
Contributions 500
§ Once the terms of the restrictions are met,
the funds can be reclassified
Reclass 500
Cash –RA 500
Cash – Unrestricted 500
Reclass 500
113
§ Later, when an expense arises
Expense 500
Cash – Unrestricted 500
o Endowments
§ Use of investment is restricted, but income
from investment could be either restricted or
unrestricted
§ Must be under control of receiving entity
(Quasi Endowment) in order to be recorded
in unrestricted net assets
§ Otherwise, memo entry recorded
§ Underwater Endowments
§ Value dropped below Gift Amount
§ Disclosure Requirements
§ Fair Value of Funds
§ Original Gift Amount or Required
§ Funding Level
§ Deficiency Amount
§ Governing Board Policies
o Art Collections
§ Not recognized as assets or contribution
revenue if they are held for display or
114
education – or their sale results in the
purchase of similar items
§ When both Restricted Assets and Unrestricted
Assets are available for use, Restricted
Assets are used first
o Refundable Advance
§ Classified as a Liability
§ Promise to contribute assets pending on
certain conditions being met
§ Becomes unconditional once the possibility
that it won’t happen is remote
o Investments
§ Fair Value mostly used
§ Exception – Equity Method used when
significant influence exists
o Scholarships
§ Reduction of revenue & Netted against
college’s tuition
o Depreciation Expense
§ Allocated proportionately to various functions
115
XVI. Pensions
NET PERIODIC PENSION COST
Ø Projected Benefit Obligation (PBO)
o Reflects future compensation levels
Ø Accumulated Benefit Obligation
o PV of Pension Benefits accrued based on
present compensation levels
Ø PRIUS: Net Periodic Pension Cost
PRIUS
+ Prior Service Cost Amortization
- Return on Plan Assets (Estimated)
+ Interest
+ Unexpected Loss (Gains)
+ Service Cost
116
+
Prior Service Cost Amortization
-
Return on Plan Assets (Estimated)
+
Interest
o Beginning PBO x Interest Rate
o Increase of PBO due to time
+
Unexpected Losses or (-) Gains
+
Service Cost
o As employees work, the Projected Benefit
Obligation increases
o (New) Only Component of NPBC allowed as
an Operating Expense on Income Statement
=
Net Periodic Pension Cost
Ø Fair Value of Plan Assets – PBO
o Overfunded (Asset) = Non-Current only
o Underfunded (Liability) = Current & NonCurrent
o Gains/Losses go to OCI
§ Net of Tax
Ø Financial Statement Disclosures
o Pension Funding Policies
117
o Types of Assets Held
o 5 Year Benefits to be paid
o 5 Year Benefits in aggregate after that
o Estimated Pension Contribution for next period
Ø Vested Benefits
o Owed to employee regardless of continuance of
employment via the Full Eligibility Date
XVII. Statement of Cash Flows
STATEMENT OF CASH FLOWS
Ø Shows changes in
o Cash
o Cash Equivalents
o Restricted Cash (New in ‘18)
o Restricted Cash Equivalents (New in ’18)
OPERATING ACTIVITIES
Ø Cash Received:
o Customers
o Interest & Dividends
o Trading Securities
118
Ø Cash Paid:
o Vendors
o Suppliers
o Interest
§ Includes Zero-Coupon debt instrument
payment attributable to Interest
o Taxes from Operating Activities
o Asset Retirement Obligation settlement
INVESTING ACTIVITIES
Ø Cash Received:
o Sale of PP&E
o Sale of Investments
o Loan Principal
Ø Cash Paid:
o Loans
o Acquisitions
o Equity or HTM Securities
o Taxes from Investing Activities
119
FINANCING ACTIVITIES
Ø Cash Received:
o Issuance of Stock
o Issuance of Debt
Ø Cash Paid:
o Dividends
o Distributions to Owners
o Debt
§ Debt Issue Costs
§ Debt Re-Payment
• Includes principal of Zero-Coupon
Debt Instruments
o Note: Interest portion classified
as Operating Activity
§ Debt Pre-Payment
• Includes Pre-Payment Fees
INDIRECT METHOD
Ø Starts with Net Income
Ø Disclosure Requirements
o Interest Paid
120
§ Including zero-coupon debt interest
o Taxes Paid
DIRECT METHOD
Ø Starts with Income from Continuing Operations
Ø Adjusts for changes in accounts like A/R, A/P,
Inventory and non-cash revenues, expenses, gains,
losses
Ø If used, the Indirect Method must also be shown
XIII. Stockholders’ Equity
COMMON AND PREFERRED STOCK
Ø When common stock and preferred stock are issued in
a lump sum purchase
o APIC for each is allocated by its respective % of
the total FMV of the shares x the proceeds.
FMV of C/S = 36,000 (36 per share x 1000 shares)
FMV of P/S = 54,000 (27 per share x 2000 shares)
Total Proceeds = 80,000
Proceeds attributable to P/S = 54,000/90,000
(54k+36k) x 80,000
Ø Stock Subscriptions
o APIC increases on date subscription is recorded –
not on the date paid for or issued
121
TREASURY STOCK - COST METHOD
6,000 shares of Treasury Stock purchased at $36 per share:
Treasury Stock 216,000
Cash 216,000
Scenario 1:
3,000 shares re-issued at $50 per share:
Cash 150,000
T/S 108,000 (36 x 3,000)
APIC 42,000
Scenario 2:
3,000 shares re-issued at $30 per share:
Cash 90,000
APIC 18,000 (if no APIC exists to exhaust, then RE is
debited)
T/S 108,000
If Retained Earnings is legally restricted due to T/S, it will be
to the extent of the balance in the T/S account.
122
TREASURY STOCK – PAR VALUE METHOD
Ø Common Stock – Par Value of Shares
Ø APIC – The amount of APIC connected to the par value
of shares you’re debiting
Cash
PIC – T/S (plug) *or* a debit to RE (plug) if cash
paid exceeds C/S and APIC
Ø Dividends in Arrears for Cumulative Preferred Stock
o Not accrued until declared
Ø If a year passes and no Cumulative Preferred Stock
dividends are declared, then the dividends in arrears
are included as a disclosure – not an accrual in the
financial statements
Ø A transfer of a non-monetary asset to a shareholder
o You give them stock of another company
o Results in a Gain/Loss situation
Ø The gain or loss is the difference between the FMV of
the asset distributed at the date of distribution and its
carry amount on the company’s books
Ø The effect on Retained Earnings is the Carrying Amount
of the asset
o RE will be debited when the dividend is declared
for the FMV of the asset, which is more (or less)
than the carrying amount
123
o Gain/Loss recorded when the asset is distributed
will offset the original effect of the debit to RE and
will be a wash
o The net effect of the entry is that RE will decrease
by the CV of the asset
RE 78,000
Div Payable 78,000
Div Payable 78,000
Asset, CV 60,000
Gain
18,000
STOCK DIVIDENDS
Ø Stock Dividend < 25% of C/S Outstanding
o
Debit RE for FMV of stock
Ø Stock Dividend > 25% of C/S outstanding
o
Debt RE for Par Value
Example:
%: 10…FMV: 15,000…Par Value: 10,000
%: 28…FMV: 40,000…Par Value: 30,800
Debit RE for 45,800
Ø Stock dividends and stock splits both have no effect
on Total Shareholder Equity
124
Ø Stock splits only affect par value
o APIC remains the same
STOCK OPTIONS
Ø Compensation expense is recorded at the time of grant
if options are exercisable immediately
o They are based on past service
Ø Expense recognized = FV Stock Option x # of Shares
Example: Option Granted
Deferred Comp 28,000 (FV of option x 1,000 shares)
APIC – stock options 28,000
Example: Option Exercised
Compensation Expense 28,000
Deferred Comp 28,000
Cash 20,000 (option price x shares)
APIC – Stock Options 28,000
C/S 10,000 ($10 par x 1,000)
APIC 38,000 (plug)
Ø The interest rate used to discount stock options is the
risk-free interest rate
Ø The measurement date for share-based payments
classified as liabilities is the settlement date
125
Ø Compensation costs for share-based payments
classified as liabilities are measured by the change in
the fair value of the instrument for each reporting
period
REORGANIZATIONS
Ø In a reorganization where a company pays cash and
issues stock to satisfy unsecured creditors
o The net increase to SHE is equal to:
Gain on settlement of debt
+ Credit to SHE from stock issuance
FV of liability to Unsecured Creditors
1,200,000
Cash Paid
<400,000>
Common Stock issued (80,000 x 1.25)
<100,000>
Gain on Settlement of Debt
700,000
Increase in SHE = 800,000
(700,000 gain to RE + 100,000 from C/S)
Ø The primary purpose of a quasi-reorganization is to
eliminate a deficit balance in RE by restating its assets
to fair value
o It does not directly protect a company from its
creditors.
Ø Return on Common Stockholders’ Equity
(Net Income – P/S Dividends) / Average CSE
126
Note: Average CSE = Common Stock + RE
Ø Book Value Per Share of C/S
Total Stockholders’ Equity
<Total Preferred Stock>
<P/S Dividends in Arrears>
<P/S Liquidation Premium>
=Total Book Value
BV/Share: Total Book Value / Shares outstanding
Ø Dividend Per Share Payout Ratio
Dividends Per Share / Earnings Per Share
EARNINGS PER SHARE
Ø Basic EPS
(Net Income – Preferred Dividends) / Avg C/S Outstanding
Ø Note – If Cumulative, subtract the P/S dividend
regardless of whether or not they’re declared.
Ø If dividends are in arrears from a prior year on P/S,
don’t subtract that amount.
Ø The prior year P/S cumulative dividend reduces that
year’s EPS. Only deduct the current year.
127
Ø For EPS purposes, treat C/S stock splits or stock
dividends as if they occurred at the beginning of the
year, regardless of when actually issued during the
year
1/1: 20,000
2-for-1 split 4/1: 20,000
Shares issued 7/1: 10,000
Average C/S for EPS purposes: 45,000 (20k+20k+5k)
Ø EPS is only required to be shown for Income from
Continuing Operations and Net Income
o All others (Discontinued Operations) can be shown
on the financial statements or in the notes
DILUTED EPS
Ø Stock options increase shares outstanding only if they
are dilutive
o Their exercise price is less than market value
o If not, you ignore them in the calculation
Ø Treasure Stock Method of calculating the effect of stock
options on denominator in diluted EPS calculation:
o Assume stock options were exercised (40k shares
at $15 exercise price) = $600k
o Stock issued was 40,000 shares (from above)
o Stock reacquired calc: ($600k proceeds/$20
current mkt price) = (30,000 shares)
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o Shares issued, not reacquired from Stock Option =
10,000
o 325,000 average C/S + 10,000 from options =
335,000 Avg share
CONVERTIBLE P/S
Ø Net Income – P/S dividend + P/S dividend that
wouldn’t be paid if converted (wash)
Ø Weighted average common stock + convertible
equivalents
Ø Basic EPS must be calculated first and then compared
with Diluted EPS.
Ø If Diluted EPS is not less than Basic EPS, then it is antidilutive and the security should not be included
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