2. Measurement, Valuation and Disclosures - Short Term Items (AR, Inventory and Investments)

Question 1

Accounts Receivables

Answer 1

• They are classified as current and noncurrent. If current they should be recorded at NRV, if noncurrent they should be recorded at Net present value of future cash flow.
• Notes receivables are not part of AR. Also Rental income earned & accrued is not AR
• The direct write off method is not acceptable under GAAP, only used for tax purposes. Under GAAP Allowance method is used.
• Three types of AR Allowance methods used:
  1) Percentage of sales method - as a percentage of CREDIT gross sales and the bad debt expense is added to the current allowance balance (IS Approach)
  2) Percentage of receivables method - as a percentage of GROSS ending AR. Bad debt expense will be booked to reach the ending AR balance (BS Approach)
  3) Aging schedule - is used if the entity doesn’t have single rate of collectibility.
• Write off AR under allowance method does not affect IS NOR working capital NOR carrying amount of net AR
• Factoring of AR is a transfer of receivables to a third party who assumes responsibility of collection. Factoring AR have 2 methods:
  1) Sale WITHOUT recourse - the transferee assumes the risk and receives the rewards. This is considered as final sale and the seller has no further liability to the transferee.
  2) Sale WITH recourse - the transferor may be required to make payment to the transferee or buy back the receivables . It is not considered final sale and the receivables are still on the seller books and must recognize liability.
• Benefits of factoring:
  1) Buyer - Receives high financing fees and operates more efficiently as he is more specialized.
  2) Seller - Speed up collection, eliminate credit department and eliminate debt from FS

Question 2

Inventory - Fundementals

Answer 2

• Two inventory accounting systems:
  1) Perpetual inventory system - Update inventory after each purchase or sale. Used with expensive and heterogeneous products
  2) Periodic inventory system - Inventory and COGS are updated on specific intervals based on physical count. Used with inexpensive and homogeneous products
• Inventory physical count is necessary under both periodic and perpetual inventory accounting systems. Using perpetual system the difference between the physical count and the inventory in the books is recognized in COGS.
• Items to be included in entity inventory while physically it is not there:
  1) Goods in transit - included in inventory even if it is NOT on entity premises BUT the entity has legal title
  The entity might used FOB shipping point were the buyer must include the goods in inventory during shipping AND FOB destination were the seller must include inventory during shipping
  2) Goods out on consignment - Cost of transporting the goods to consignee are inventoriable cost
• Inventory estimation may be needed when:
  1) Exact count is not feasible
  2) For interim reporting purposes
  3) Records are destroyed
• If certain goods owned by an entity were not recorded as a purchase and were not counted in ending inventory, in error, then there will be no effect on cost of goods sold or profit for the period. Current assets and liabilities will be understated

Question 3

Inventory - Cost flow methods

Answer 3

1) specific identification - appropriate for items that are NOT interchangable and items that are segregated for specific project. Most accurate method but not feasible and expensive.
2) Average method used for homogeneous products. Moving avg used under perpetual inventory - new inventory cost after each purchase that will be used for the following sale transaction. Weighted avg used under periodic inventory - avg cost is determined ONLY at the end of the period.
3) FIFO - year end inventory and COGS will be the same regardless whether perpetual or periodic system is used, In period of inflation ending inventory will be high, lower COGS and higher profit
4) LIFO - year end inventory and COGS will differ if perpetual or periodic system is used. In period of inflation ending inventory will be low, higher COGS and lower profit. Most recent costs incurred will be allocated to COGS. If fewer units are purchased that sold, old costs are matches against current revenue

Question 4

Inventory - Initial and Subsequent recognition

Answer 4

• LCM rule is applied if LIFO is used
• LC or NRV is applied if FIFO and average cost is used
• Loss on write down of inventory to Market or NRV is presented as component of COGS but if loss is material it should be presented as a separate line in IS. A reversal of write down is prohibited under GAAP.
• Depending on the nature , write down may be applied either directly to each item (this will reduce inventory) OR total inventory.
• Applying LCM rule should choose the middle of:
  1) NRV (Ceiling)
  2) Floor - NRV minus Normal profit margin
  3) Replacement cost
• Evaluation of inventory under GAAP can only be done at ANNUAL FS unless it was Permanent it can be done at interim. Evaluation of inventory under IFRS can be done at ANNUAL FS or INTERIM.
• LC or NRV is also used with IFRS - any write down may be reversed up to the original cost. Any profit or loss should be recognized in IS.

Question 5

Classification of Investments

Answer 5

• Two types of investment:
  1) Investment in Debt Security - represents creditor relationship with the issuer. The accounting depends on the investor intent with respect to holding the securities
  2) Investment in Equity Security - Is an ownership interest in an entity. The accounting depends on the presumed influence based on the ownership interest held.
• Measurement in equity securities is measured at FV at each BS date, any unrealized gains and losses are reported in the IS. Measurement alternative for investment in equity securities WITHOUT readily determinable FV.
• Measurement alternative; This alternative is Cost Minus Impairment (if any), Plus or Minus changes resulting from observable price changes for the Identical or a Similar investment of the same issuer. To identify observable price change, a reasonable effort should be made to identify relevant transactions by the same issuer that occurred ON or BEFORE the BS date
• Qualitative assessment may consider many impairment indicators such as significant deterioration in earnings performance, credit rating or asset quality
• If the measurement alternative is selected, it must be applied until the investment has a readily determinable FV. It MUST be reassessed at EACH reporting period and when the FV is readily determinable the investment is measured at FV through Net Income.
• Under GAAP an investment in equity security that DOESN’T result in significant influence or control is measured at FV through IS or OCI. Under IFRS the measurement alternative is NOT an option and if an investment in equity security that DOESN’T result in significant influence or control is measured at FV ONLY
• Types of Investments securities:
  1) Held to maturity - Is a DEBT security, the holder must have the ability and intent to hold until maturity. Recorded at amortized cost (Carrying amount) and NO unrealized gains/losses are reported, realized are reported on IS. It should be presented net of any unamortized premium/discount. Held to Maturity are CURRENT or NONCURRENT assets
  2) Trading - is a DEBT and EQUITY security, bought and held to be sold in near future. Recorded at cost and remeasured and reported at FV. Trading securities are CURRENT Asset
  Unrealized/realized gain/losses are reported in IS.
  3) Available for sale - is a DEBT and EQUITY security. Recorded at cost and remeasured and reported at FV. Unrealized gain/loss is reported in OCI, realized gain/loss reported on IS. Tax effects are debited or credited directly to OCI. Available for sale securities are CURRENT or NONCURRENT assets

If a decline in FV of an hold to maturity or available for sale below its cost is permanent, it should be written down as a new cost basis. The impairment is a realized loss.

• Debt securities are impaired using Amortized Cost Basis if the decline is permanent
• Transfer between debt security categories are accounted for at Transfer Date FV: the following describes treatment of unrealized holding gains and losses
  1) From trading to any category - amounts ALREADY recognized in earning are NOT reversed
  2) To trading from any category - Amount NOT ALREADY recognized in earnings are recognized
  3) To available for sale from held to maturity - Amounts are recognized in OCI
  4) To held to maturity from available for sale - Amounts recognized in OCI are NOT reversed but are amortized is same way as premium or discount

Question 6

Equity Method

Answer 6

• An investment in voting stock the enables the investor to exercise significant influence over the invetsee. The influence is between 20-50%. The investor MUST HAVE SIGNIFICANT INFLUENCE on the investee
• If the company have between 20-50% of share but the invsetee is under bankruptcy we use LIQUIDATION method not EQUITY method.
• NO unrealized gain/loss recognized under equity method.
• It is initially recorded at cost. The investor recognize income in the share of invetsee earning or loss. In case of gain Investment (debit), Revenue share of earning (credit).
• Dividends from the investee are treated as a return on investment, they have NO effect on investors income. Dividends distributed increases cash and reduces investment Cash (debit), Investment (credit).
• Preferred stock does not apply on equity method, any dividends are treated as income.
• If the investment was purchased in half year, any income/dividend recognized should be treated as half year as well.
• Under IFRS when significant influence is lost, any retained investment is measured at FV. The gain/loss of the disposal of the investment equals FV of retained investment Plus proceed from disposal of Investment Minus Carrying amount of the investment at the date of significant influence lost

Question 7

Business combination and Consolidated FS

Answer 7

• A business combination must use acquisition method, involved identifying the acquirer and acquisition date.
• At the acquisition date the acquirer must recognize and measure the following at FV:
  1) Assets acquired
  2) Liabilities assumed
  3) Non controlling interest
  4) Goodwill or gain from bargain purchase
• Goodwill is recognized ONLY a business combination. It has indefinite useful time and must not be amortized, only subject to impairment.
• Bargain purchase gain is recognized s ORDINARY gain at acquisition date.
• Acquisition related cost are expenses as incurred. Issue cost of securities are reduced from additional paid in capital or reduced from the face amount of the debt.
• The purpose of consolidated FS is to present amount of the parent and its subsidiaries as single economic entity.
• Consolidated FS is not a legal requirement, it is an example of substance over form from accounting perspective.
• In the consolidated FS, the equity section represents parent accounts in addition to Non controlling interest portion from subsidiary equity plus their portion in subsidiary IS.
• In consolidation there are accounts in parent and subsidiary BS such as due to parent or due from subsidiary must be eliminated. Also accounts showing on parent BS related to investment in subsidiary.

Question 8

Different types of Expenses and Liabilities

Answer 8

• Purchase commitment recognize inventory when they are received not at the time of the agreement.
• The nature and terms of purchase commitment must be disclosed in the notes of the FS
• A loss must be recognized on the firm non cancelable purchase commitment if the current market market is lower than purchase pric. Unrealized holding loss (debit), Liability purchase commitment (credit)
• Warranty liability is a written guarantee of the integrity of the product or service
• Two types of warranties:
  1) Inseparable warranty also called expense warranty - Recognizes liability for warranty when related revenue is recognized.
  2) Separable warranty also called sales warranty - sold separately from the product, treated s deferred revenue and recognized on a straight line basis over the term contract
• Contingencies from book P.25

Question 9

Rules for calculation

Answer 9

• Cash Collection = Beg AR without reducing allowance + credit sales - AR write off - Ending AR without reducing allowance

* Ending AR balance =
Beg AR
\+ Net credit Sales 
- cash collection
- AR written off 

• Ending allowance for uncollectible accounts =
  Beg allowance
  + Bad Debt expense
• AR written off
  + Collection of AR previously written off
• Under allowance method the balance should be CREDIT, in case the questions says it is DEBIT this means the company written off debts more than the provision. To calculate the written off amount we ADD the CREDIT and DEBIT amounts
• Journal entry to record collection of written of debt using DIRECT METHOD, Cash (debit), Other Revenue (credit)
• Using factoring, what is the amount transferred to transferor = AR Submitted
  - Reserve %
  - factors fee
  = Amount accruing to the transferor
  - interest
  = Amounts to be received
• Purchases = Ending AP + cash Payments to supplier - beg AP
• If the question states that entity maintain markup of 25% based on cost, how much COGS= Sales / 1.25
• Ending inventory = Beg inventory + total production cost - COGS
• Weighted avg method = (Cost of Beg inventory + cost of purchases inventory ) / ( Unit beg inventory + units purchased )
• Historical cost for available for sale securities = FV + unrealized losses Or - unrealized gains
• Amortized Cost Basis = Cost + net unrealized holding gain or Cost - unrealized holding loss
• Goodwill = Purchase price + NCI > Net FV assets acquired - Net FV liabilities assumes
• Bargain purchase gain = Net FV assets - net FV liabilities - purchase price - non controlling interest
• Net income under consolidated FS =
  Income from parents
  Income of subsidiary as % of parent share(plus)
  Income of subsidiary as % of non controlling interest share (plus)
• NO journal entries will be recorded for consolidation purposes, only excel sheets should be prepared
• Warranty Expenses = Sales of current year * Estimated warranty cost % for all years
• Ending warranty liability =
  Beg warranty liability
  Warranty expense recognized during the period (plus)
  Warranty payment during current period (minus)