60 VOCABULARY

Question 2

Acquisition

Answer 2

An acquisition is a business combination in which one entity achieves control over another, thus requiring combined financial statement presentation using “consolidated financial statements.” Control is direct or indirect power over the management of another entity. An acquisition can occur when one company acquires a majority share in the voting stock of another enterprise but both entities continue their legal existence. Each company retains its legal existence in a parent-subsidiary relationship.

Question 3

Acquisition Method

Answer 3

To apply the acquisition method, one must:

• identify the acquirer,
• determine the acquisition date,
• recognize and measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquire, and
• recognize and measure goodwill or a gain from a bargain purchase.
  The acquirer is an entity that receives control of another entity by giving up consideration.

The acquisition date is the date on which the acquirer obtains control of the entity.

FASB ASC 805-10-05-2 requires that as of the acquisition date, the acquirer shall recognize, separately from goodwill, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree.

To qualify for recognition as part of applying the acquisition method, the identifiable assets acquired and liabilities assumed must meet the definitions of assets and liabilities in FASB Concepts Statement (SFAC) 6, Elements of Financial Statements, at the acquisition date.

• In addition, to qualify for recognition as part of applying the acquisition method, the identifiable assets acquired and liabilities assumed must be part of what the acquirer and the acquiree (or its former owners) exchanged in the business combination transaction rather than the result of separate transactions.

Question 4

Amortization

Answer 4

Amortization is an accounting process for reducing an asset or liability by periodic payments or writedowns that are distributed across the time the organization gains a value from or has obligation for the item. Specifically, it is the process of reducing a liability recorded as a result of a cash receipt (e.g., unearned revenue) by recognizing revenues or reducing an asset recorded as a result of a cash payment (e.g., prepaid expenses) by recognizing expenses or costs of production.

SFAC 6.142

Amortization is an allocation process to orderly reduce bond premium, bond discount, and bond issue costs by allocating the cost of an intangible asset to expense over time.

Question 5

Carrying Amount (Book Value)

Answer 5

The carrying amount or book value is the net amount at which an item is reported in the financial statements of the enterprise. For a receivable, the FASB ASC Glossary indicates the carrying amount is the “face amount increased or decreased by applicable accrued interest and applicable unamortized premium, discount, finance charges, or issues costs and also an allowance for uncollectible amounts and other valuation accounts.”

For a payable, the FASB ASC Glossary indicates the carrying amount is the “face amount increased or decreased by applicable accrued interest and applicable unamortized premium, discount, finance charges, or issue costs.”

Question 6

Cash Dividend

Answer 6

Question 7

Combined Financial Statements

Answer 7

Combined financial statements are the financial statements of a combined group of commonly controlled entities or commonly managed entities presented as those of a single economic entity. The combined group does not include the parent.

Question 8

Common Stock

Answer 8

Common stock is ownership interest that is subordinate to all other classes of stock (and to all creditors) of the issuing corporation in participation rights and in dividend and liquidation preferences (i.e., holders of common stock are paid after debt and preferred stock obligations have been met). Common stock is also known as residual ownership interest and usually carries voting rights (at stockholders’ meetings), although some classes of common stock may be nonvoting. Common stock is often called common shares.

Question 9

Consolidation

Answer 9

Consolidation is a reporting procedure in which the financial statements of the parent and the subsidiary are combined. The financial statements are prepared by the parent, not by the subsidiary. Consolidation is a reporting procedure only. It does not affect the accounting records of either the parent or the subsidiary.

All majority-owned subsidiaries must be consolidated with the parent unless control does not rest with the majority owner (e.g., if the subsidiary is in legal reorganization or bankruptcy).

Question 10

Cost of Goods Sold

Answer 10

The cost of goods sold is all costs that were included in the value of the units of finished product sold during the period.

Beginning finished goods inventory + Cost of goods manufactured = Cost of goods available for sale - Ending finished goods inventory = Cost of goods sold

Question 11

Customer

Answer 11

A customer is a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities in exchange for consideration.

FASB ASC Glossary

Question 12

Depreciation

Answer 12

Question 13

Dividends

Answer 13

Dividends are the distributions of cash, other corporate assets or property, or the corporation’s own stock to stockholders in proportion to the number of outstanding shares held. Accounting for dividends represents a debit to retained earnings and the establishment of a liability at the date of declaration. Dividends must meet the preferences of preferred stock first and then may be extended to common stock.

There are two types of dividends:

Common, such as cash, stock (treasury or newly issued shares), and property
Special, such as scrip and liquidating
Four dates are relevant to dividends: date of declaration, record, ex-dividend, and distribution (payment).

Date of declaration is the date whereby the dividend amount is decided by the board of directors for those shareholders owning stock on the date of record (usually 1 month later) and to be paid on the date of distribution. Ex-dividend date is a date prior to the date of record (see ex-dividend date).

Question 14

Equity

Answer 14

Equity is ownership interest. It is the residual interest in the business entity that remains after deducting its liabilities. Equity is affected by all events that increase or decrease total assets by a different amount than they increase or decrease total liabilities.

SFAC 6.49–.65 and 6.212–.214

Distinctions within equity (common, preferred, etc.) are matters of presentation and display, not of definition.

Equity stems from ownership rights and involves a relation between the enterprise and its owners as owners rather than as employees, lenders, suppliers, customers, or other nonowner roles. Stockholders, partners, proprietors, investors, and participants are also terms used in defining owners.

The distinction between liability and equity depends on the nature of the claim, not the identity of the claimant—equity ranks after liabilities as a claim to or interest in the assets of the enterprise (the residual interest). Generally, the enterprise is not obligated to transfer interest to owners except under liquidation. Distributions to owners are at the discretion of the owners or their representatives.

The distinguishing characteristic of the equity of a business (compared to the equity of not-for-profit entities, termed “net assets”) is that it may be increased through investments by owners and decreased by distributions to owners.

See SFAC 6.64–.65 for details regarding changes in equity.

Question 15

Fair Value

Answer 15

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date.

Question 16

Goodwill

Answer 16

Goodwill is an asset that represents a future economic benefit arising from other assets acquired in a business combination or an acquisition by a not-for-profit entity that are not individually identified and separately recognized. Goodwill is generally calculated as the difference between the amount paid for a business minus the fair market value (FMV) of the net assets acquired.

Question 17

Gross Margin

Answer 17

Gross margin is the sales minus cost of goods sold, the “first stage” profit from the manufacture of goods for sale, and profit before selling and administrative expenses. Gross margin results from using absorption costing. It is also known as gross profit.

Gross margin analysis involves the evaluation of the gross margin variance (the difference between actual and budgeted gross margin). Gross margin variance can be caused by the following:

Sales price variance: The difference between planned sales price and the actual sales price
Sales mix variance: The difference between the planned sales mix and the mix actually achieved
Sales volume variance: The difference between the planned volume of sales and the actual volume achieved
Cost price variance: Differences between planned and actual manufacturing costs

Question 18

Impairment

Answer 18

Impairment is the condition that exists when the amount of a long-lived asset (asset group) carried on an organization’s books exceeds its fair value. An impairment loss shall be recognized only if the carrying amount of a long-lived asset (asset group) is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset (asset group) is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group). That assessment is based on the carrying amount of the asset (asset group) at the date it is tested for recoverability, whether in use or under development. An impairment loss is measured as the amount by which the carrying amount of a long-lived asset (asset group) exceeds its fair value.

FASB ASC 360-10-35-15; GASB 1100.107

Question 19

Income Statement

Answer 19

The income statement is a financial statement that shows an organization’s revenues and expenses for a defined period of time. The income statement is the financial statement used most often by investors as it provides information concerning the firm’s ability to sustain ongoing operations profitably. The income statement is also the statement that is most readily understood.

The single-step income statement displays the net income from ordinary operations without intermediate calculations. The multi-step income statement uses intermediate steps such as gross profit in displaying the net income from ordinary operations.

Question 20

Intercompany

Answer 20

An intercompany transaction occurs between members of the same commonly controlled group of entities (e.g., sales or loans made between parent and subsidiary or between two subsidiaries of the same parent). Intercompany transactions and profits must be eliminated from consolidated financial statements.

Question 21

Intercompany

Answer 21

An intercompany transaction occurs between members of the same commonly controlled group of entities (e.g., sales or loans made between parent and subsidiary or between two subsidiaries of the same parent). Intercompany transactions and profits must be eliminated from consolidated financial statements.

Question 22

Intercompany

Answer 22

An intercompany transaction occurs between members of the same commonly controlled group of entities (e.g., sales or loans made between parent and subsidiary or between two subsidiaries of the same parent). Intercompany transactions and profits must be eliminated from consolidated financial statements.

Question 23

Intercompany Profit

Answer 23

Intercompany profits are financial statement amounts that arise from transactions between members of the same commonly controlled group of entities (parent-subsidiary, subsidiary-subsidiary), i.e., transactions between two entities that are related parties. They may be receivables/payables or profit/expense from the sale of merchandise, or loan receivable/payable. Intercompany profits must be eliminated from consolidated financial statements.

Question 24

Intracompany

Answer 24

An intracompany transaction or event occurs between components (segments, divisions, locations, departments) of a single entity and does not involve another entity. For example, a transfer of merchandise between two store locations owned by the same entity is an intracompany transfer.

Question 25

Liabilities

Answer 25

Liabilities are probable future sacrifices of economic benefits arising from present obligations of the entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. (SFAC 6.35–.42 and .192–.211)

Essential characteristics, all three of which must be present, are as follows:

• A present duty or responsibility to one or more other entities entails settlement by probable future transfer or use of assets at a specified determinable date, on occurrence of a specified event, or on demand.
• The duty or responsibility obligates the entity, leaving it little or no discretion to avoid the future sacrifice.
• The transaction or event obligating the entity has already occurred.

Most liabilities stem from human inventions—financial instruments, contracts, laws—that are commonly embodied in legal obligations and rights with no existence apart from them. Liabilities permit delay—delay in payment, delay in delivery, etc.

Liabilities are changed both by the entity’s transactions and activities and by events that happen to it.

“Valuation accounts,” which increase or decrease the carrying value of assets, are part of the related asset and are not liabilities, or assets, in their own right.

In governmental accounting: Liabilities are defined as present obligations to sacrifice resources that the government has little or no discretion to avoid. (GASB Concepts Statement 4.17)

Question 26

Noncontrolling Interest

Answer 26

A noncontrolling interest is the portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to a parent. A noncontrolling interest is sometimes called a minority interest. For example, 80% of a subsidiary’s ownership (equity) interests are held by the subsidiary’s parent, and 20% of a subsidiary’s ownership interests are held by other owners. The ownership interests in the subsidiary that are held by owners other than the parent are a noncontrolling interest. The noncontrolling interest in a subsidiary is part of the equity of the consolidated group.

FASB ASC 805-10-20

Question 27

Outstanding

Answer 27

Outstanding refers to the number of shares of capital stock that have been issued and are currently owned by stockholders. Treasury stock is not considered to be “outstanding” since it is owned by the issuing corporation, not by outside shareholders. Outstanding is an important aspect of earnings per share calculations.

The number of bonds that have been issued and are currently owned by bondholders and accounts receivable that have not been collected are both examples of outstanding numbers.

Question 28

Parent

Answer 28

A parent is the investor company that owns over 50% of the outstanding voting stock of another (investee) company, the majority interest, or the controlling interest.

In a parent-subsidiary relationship, both corporations continue to exist as separate legal (accounting) entities. The financial statements of the parent and the subsidiary are usually consolidated and viewed as a single economic unit for reporting purposes only.

Question 29

Purchase

Answer 29

A purchase is the acquisition of goods and service by paying for them.

“Purchase” is a term formerly used for a method of accounting for a business combination in which one company, the parent, acquires voting stock from the stockholders of another company by paying cash, transferring noncash assets, or incurring debt. Purchase resulted in new ownership of the acquired entity.

The purchase method of accounting for business combinations and consolidations has been superseded by the acquisition method, which differs in some respects.

The acquiring company records as its investment the fair value of the acquired net assets (assets acquired minus liabilities assumed). The difference between the fair value of the acquisition and the sum of the fair values of identifiable tangible and identifiable intangible assets less liabilities is recorded as goodwill. Occasionally, the fair value received exceeds the consideration given in an acquisition, leading to recognition of a gain on bargain purchase. Acquisition accounting is appropriate when the parent company exercises control over the subsidiary. If the parent does not hold 100% of the subsidiary equity, then a noncontrolling interest also exists. The fair values of the assets and liabilities of the subsidiary are consolidated with the book values of the parent in preparing financial statements.

Reported income of an acquiring corporation includes the parent’s share of the acquired entity’s net income adjusted for the amortization of any revaluations of subsidiary assets and liabilities to fair value.

FASB ASC 805-10

Question 30

Retained Earnings

Answer 30

Retained earnings are an increase in net assets from results of operations, retained by the corporation for use in the enterprise. They are internally generated financing or the corporation’s undistributed earnings. They are accumulated earnings, less accumulated losses and dividends paid, from inception. Retained earnings are a major source of owners’ equity and can be viewed as additional investments by the owners as foregone dividends.

Negative balance is called a deficit.

Retained earnings may also be decreased by purchase of treasury stock at a price higher than the amount originally received for the stock.

Retained earnings may be appropriated (i.e., restricted as to use) by:

• contractual specification (e.g., bond covenants),
• legal requirement (e.g., by state law), or
• management discretion (e.g., for future expansion).

Retained earnings are increased by net income, prior-period adjustments, and quasi-reorganization. Retained earnings are decreased by net loss, prior-period adjustments, cash, property, scrip, stock dividends, and treasury stock and stock retirement transactions.

Question 31

Salvage Value

Answer 31

Salvage value is the amount estimated to be recoverable on disposal (by sale, trade-in, or other means) or retirement from service of an operational asset (net of any costs of disposal, such as dismantling and selling expenses). The remaining carrying amount, after deduction of salvage value, is then fully depreciated (depreciated to the end of the asset’s useful life).

Question 32

Significant Influence

Answer 32

Significant influence refers to the ability to exert substantial control over the management or operating and financial policies such that the entity might be prevented from fully pursuing its separate interests. It is the ability to direct or cause the direction of the management and policies of an enterprise even though the investor may own less than 50% of the voting stock of the enterprise. Significant influence is defined with respect to investment in equity securities as ownership of 20% or more of the voting stock. It is also evidenced (in cases of less than 20% ownership) by such circumstances as representation on the board of directors, participation in policymaking processes, material intercompany transactions, interchange of managerial personnel, or technological dependency. (FASB ASC 323-10-15-6)

Significant influence is presumed in cases of 20% or more ownership unless proven not to exist because of the following:

Opposition of investee (e.g., litigation)
By written, signed agreement between the investor and investee
Majority ownership is concentrated among a small group that operates the investee without regard to the views of the investor.
The investor tries and fails to obtain additional information not made available to other investors.
The investor tries and fails to obtain representation on the board of directors.
FASB ASC 323-10-15-10

Question 33

Stockholders’ Equity

Answer 33

Question 34

Straight-Line Method

Answer 34

The straight-line method is a depreciation method based on an equal allocation of the cost of operational assets with the passage of time. It assumes that the useful life of the asset is used up evenly over time and charges a fixed amount per period to expense.

The computation for the straight-line (SL) method is:

• Straight-line depreciation expense per year = (Cost - Residual value) ÷ Useful life (years)

The advantage of the straight-line method is that it is simple to compute. The disadvantage is that the passage of time may not be representative of the use of the asset’s benefits and may not match cost to revenue.

• Straight-line rate = 1 ÷ Useful life (years)

The straight-line method is a method of allocation such that a constant dollar amount is recognized as revenue or expense each period. The straight-line method is commonly used for depreciation.

Example: An asset costing $100,000, with a salvage value of $5,000, to be depreciated over 10 years by the straight-line method of depreciation would be depreciated at $9,500 per year (($100,000 - $5,000) ÷ 10).

Question 35

Subsidiary

Answer 35

A subsidiary is a corporation controlled, directly or indirectly, by another (parent) corporation where the control is usually by ownership of a majority (greater than 50%) of the outstanding voting stock. Power to control may also exist with a lesser percentage of ownership (i.e., by contract, lease, agreement with other stockholders, or court decree). A subsidiary may be consolidated or unconsolidated with the parent for reporting purposes (FASB ASC 810-10-20) but is usually accounted for by the parent by the equity method.

Question 36

Transportation Out

Answer 36

“Transportation out” is the expense of shipping goods to customers in the normal course of business. It is a selling expense and the opposite of “transportation in.”

Question 37

Purchase

Answer 37

A purchase is the acquisition of goods and service by paying for them.

“Purchase” is a term formerly used for a method of accounting for a business combination in which one company, the parent, acquires voting stock from the stockholders of another company by paying cash, transferring noncash assets, or incurring debt. Purchase resulted in new ownership of the acquired entity.

The purchase method of accounting for business combinations and consolidations has been superseded by the acquisition method, which differs in some respects.

The acquiring company records as its investment the fair value of the acquired net assets (assets acquired minus liabilities assumed). The difference between the fair value of the acquisition and the sum of the fair values of identifiable tangible and identifiable intangible assets less liabilities is recorded as goodwill. Occasionally, the fair value received exceeds the consideration given in an acquisition, leading to recognition of a gain on bargain purchase. Acquisition accounting is appropriate when the parent company exercises control over the subsidiary. If the parent does not hold 100% of the subsidiary equity, then a noncontrolling interest also exists. The fair values of the assets and liabilities of the subsidiary are consolidated with the book values of the parent in preparing financial statements.

Reported income of an acquiring corporation includes the parent’s share of the acquired entity’s net income adjusted for the amortization of any revaluations of subsidiary assets and liabilities to fair value.

FASB ASC 805-10