Adio book 3

Question 1

How to determine the value that you should record fixed asset.

Answer 1

When aquired it should reflect the cash or the amount of assets exchanged for it. when a short term not is used you would use the face value of the note interest expense would be expenses for the period. when the liability is long term then the cost would be the present value of the note again the interest is expended over the years. when equity securities are used to aquire the fixed asset then you would use the fv of the stock issued. if the fv cannot be determined than you would use the fv of the asset.

Question 2

When fixed asset is exchanged for another fixed asset and when a non monetary transaction happens.

Answer 2

when to assets are exchanged the rule is to use the fv of the asset that is more clearly depicted or if one of the options was to receive cash then you would use the cash as a measure of fv.

Question 3

exceptions for the fv treatment for non monetary transaction.

Answer 3

1 the fv is not determinable
2 the exchange is a transaction to facilitate sales to costumers,
3 the transaction lacks commercial substance (the future cash flow of the business will change due to the transaction).

Question 4

when the non monetary exchange meets one of the cafeterias listed above.

Answer 4

requires that the exchange be recorded at book value and not gain or loss be recognized. the new asset is recorded at the value of the old assetsIf cash or boot is GIVEN with the exchanged asset, the new asset is recorded at the book value of the old asset plus the cash given
The percent of the gain that is recognized can be computed by taking the cash received divided by the total fair value received of both the cash and the asset. This percentage is then multiplied by the total gain to determine recognized gain in the current period.

Question 5

capitalization of interest for self constructed fixed assets?

Answer 5

According to statement of financial standard #34, interest costs incurred during the construction period for self constructed fixed assets should be capitalized and included in the costs of the asset
The amount of interest cost that should be capitalized is equivalent to the interest that could have been avoided if the asset had not been constructed with the use of borrowed funds.

Question 6

interest is capitalized during construction of self constructed fixed assets when 3 conditions are satisfied:

Answer 6

1. Expenditures for the asset have been made
2. Activities intended to get the asset ready for use are in progress
3. Interest costs is being incurred

Question 7

Activities intended to get the asset ready for use includes both?

Answer 7

physical construction as well as getting building permits and architectural work.

Question 8

The amount of interest to be capitalized is the amount that could have been avoided if the project had not been undertaken. What is included

Answer 8

This amount includes the amortization of any discount or premium or interest cost that is imputed on non-interest bearing notes.

Question 9

The formula to calculate the amount of avoidable interest is ???

Answer 9

the average accumulated expenditures x the interest rate x construction period. However, the interest cost may not exceed the actual interest incurred during the period.

Question 10

Accounting for lump sump purchases

Answer 10

• These are often referred to as bundle or basket purchases
• 2 or more fixed assets for a single sum
• The accounting problem involved in determining value to assign to each asset
• formula is the fair value of the asset divided by the total fair value of all assets acquired x the amount paid.

Question 11

It is also the rationale for charging the demolition costs of dilapidated buildings to

Answer 11

the land account when the land is purchased for the construction of a new building

Question 12

What other cost should be capitalized and included in the land account?

Answer 12

When equipment is installed, the installation and test run costs should be capitalized and included in the equipment account. The costs of surveying land, the cost of title insurance, and the real estate broker’s commission should be capitalized and included in the land account. When land is acquired, any payment for delinquent property taxes should be capitalized and included in the and account. Finally, when a building is constructed the costs for the plans, blueprints, and architect fees should be capitalized and included in the land account.

Question 13

Depreciation ?

Answer 13

Depreciation is the systematic and rational allocation of an asset to the periods in which the firm is expected to benefit the use of the asset. Remember that depreciation is only an allocation. It is NOT intended to represent the decline in market value of the fixed asset. Any method of depreciation that is systematic and rational is acceptable for gaap.

Question 14

Straight line method is ?

Answer 14

• This method Allocates the costs of the asset evenly over its useful life.
• generates an equal amount of depreciation over the asset’s useful life. Straight line depreciation is calculated by the formula: the asset’s original cost minus residual value divided by the useful life of the asset.

Question 15

accelerated methods ?

Answer 15

If an asset is expected to contribute more to the firm’s revenue during the early stages of its useful life, the firm may select

Question 16

unit (?) of output method also referred to as the production method is ?

Answer 16

This method of depreciation calculates the expense based upon the actual usage of the asset. The depreciable cost of the asset costs less residual value is divided by the estimated total units of production or hours to arrive at the depreciation rate or depreciation per unit. Depreciation expense is calculated by multiplying the depreciation rate x the actual hours or production units for the period

Question 17

Sum of the years digit method?

Answer 17

• an accelerated method of depreciation
  Depreciation expense = (cost - residual value) x( asset useful life left in the asset/ sum of all the digits used in the useful life.
• sum of all the digits used in the useful life = 3 x (3+1)/2
  3 should represent a variable.

Question 18

declining balance method ?

Answer 18

another acceptable method of accelerated depreciation.
Depreciation expense= cost of asset/{(1/assets useful life)x}
x= the either 2 or 1. 5 depending how fast it is depreciating.
the asset may not be depreciated past the residual value of the asset.

Question 19

When the company has multiple group of fixed assets?

Answer 19

• it may depreciate them separate or it may depreciate them all at once
• if assets are identical depreciation rate is referred to as group rate.
• if assets are not identical then the rate is referred to as composite rate.

Question 20

When a company changes its accounting method for depreciation for an asset or it changes the useful life of an asset. How would it account for these changes?

Answer 20

It would account for it as prospective. the change for the period and future periods.

Question 21

Expenditures made during a useful life of a fixed asset. ?

Answer 21

Capital expenditures
- treated as an asset in balance sheet

Revenue expenditures

Question 22

Revenue expenditures

Answer 22

• treated as expense in income statement
• regular maintenance and repairs for the asset does not increase the useful life of the asset or increase the benefit of the fixed asset.

Question 23

Example of regular maintenance?

Answer 23

oiling machine
repainting
replacing tires on truck

Question 24

Capital expenditures

Answer 24

• treated as an asset in balance sheet
• expenses that would either increase the useful life or increase the benefits or production of the assets
• should be debited to the fixed asset account and deferred over the useful life of the asset.
• may be debited to the fixed assets accumulated depreciation account, decreasing this account would then increase the value of the asset.

Question 25

How should depreciation be recorded when the asset is disposed?

Answer 25

it should be recorded until the date the asset is disposed.
on the sale date asset and accumulated depreciation should be removed from the books and gain or loss would be recorded on the sale.
1st step: historical cost- accumulated depreciation
2nd step: Calculate gain or loss= fv- bv

Question 26

Date of acquisition and date of disposition

Answer 26

when acquired and when disposed.

Question 27

Now let’s review accounting for impaired assets

Answer 27

The rules of impairments are slightly different

depending upon on whether the asset is held for sale or held and used for productive purposes.

Question 28

Accounting for impaired assets held for sale.

Answer 28

Statement of financial accounting standard #144 requires that a long lived asset that is held for
sale should be measured at the lower of its carrying value or the fair value less cost to sale;
commonly referred to as net realizable value. If the carrying amount of the fixed assets
intended to be sold is less than their net realizable value, no loss is recognized. In this case, the
fixed assets would continue to be reported on the balance sheet at their carrying amount. On
the other hand, if the carrying amount of the fixed assets intended to be sold exceeds their net
realizable value, an estimated loss is reported on the income statement. The loss is calculated
as the excess of the carrying amount of the fixed assets over their net realizable value. On the
income statement, the loss is reported gross and included as ‘other loss or expense’ and
reported in income for continuum operations (???).

Question 29

Journal entry to record the loss in impaired assets.

Answer 29

The entry to record the loss would results in
removing the asset and related accumulated depreciation from the books at the carrying
amounts and debiting an account called equipment or other property to be disposed of.
equipment or other property to be disposed o xxx
fixed asset to be disposed xxx

classified as ‘other
assets’ on the balance sheet. Any losses on fixed assets to be disposed of can be recovered in
subsequent periods. However, the recovery of the loss or right of of the assets may NOT
exceed the carrying value of the assets prior to the impairment. A gain on disposal may NOT be
recognized until the asset is sold.

Question 30

Accounting for impaired assets that are intended to be held and used for productive purposes.

Answer 30

Assets that are intended to be held and used for productive purposes must be tested for
impairment. Impairment occurs when the carrying amount of a long-lived asset exceeds its fair
value. However, an impairment is only recognized if the carrying amount is not recoverable. The
recoverability test is used to determine if an impairment loss should be recognized. The
recoverability consists of estimating the net future cash inflows from using the fixed assets.
These future net cash inflows are not discounted. If the future net cash inflows, resulting from
using the fixed assets, are greater than the carrying amount of the fixed assets, no impairment
loss has been incurred. On the other hand, if the future net cash inflows from using the fixed
assets are less than the carrying amount of the fixed assets, an impairment loss has been
incurred and must be recognized. Once it has been determined that the asset’s value is not
recoverable, then the amount of the impairment must be measured by comparing the carrying
value minus the asset’s fair value. In determining fair value, the rules of PHAZ 157 (?) apply.
The fair value of the asset is determined by its highest and best use in the principle or most
adventageous market.

Question 31

What does an in-use evaluation premise do?

Answer 31

assumes the highest value of the asset is by using it in the

business with other assets.

Question 32

In exchange value premise(idea)

Answer 32

assumes that the highest value of the

asset is the amount received to sell the asset stand alone

Question 33

How to calculate impairment loss?

Answer 33

The impairment loss is recorded by impairment loss xxx
accumulated depreciation xxx

The impairment loss would be reported in the ‘other
expenses and losses’ section of the income statement. The loss is reported gross not net of
income tax. Once an impairment loss has been recognized, the reduced carrying amount
becomes the new cost basis for the fixed assets. This new cost basis is the amount that will be
depreciated in subsequent years.

Question 34

Can impairment loss for assets intended to be used be recovered.

Answer 34

Although circumstances may indicate that in subsequent years the impairment has been
partially or completely recovered, PHAZ 144 (???) specifically prohibits recording a recovery of
an impairment loss on assets to be held in use. Therefore, impairment loss is for assets to be
held in use may NOT be recovered in subsequent periods.

Question 35

depletion of natural resources

Answer 35

Depletion represents the cost of a wasting asset, an asset that is physically removed from the
surface of the earth, such as timber or beneath the earth such as petroleum and minerals.
When calculating a depletion rate per unit, you must first determine the cost that is subject to
depletion.

Question 36

This depletion cost is also called the depletion base the depletion base may consists of 3 elements:

Answer 36

1. the acquisition cost of the asset
2. exploration costs or the cost required if the company has to search for the natural resource
3. developmental cost or the cost incurred once it has been decided to remove the natural resource.

Question 37

Once the cost subject to depletion have been determined ?

Answer 37

you must estimate if the land will have any residual value after the resource has been exhausted. And you also have to estimate whether any expenditures will be necessary to restore the property to its original condition. The residual value of the land should be subtracted from the depletion base, while the expenditures to restore the property should be added to the depletion base.

Question 38

how to calculate depletion rate per unit

Answer 38

Once the depletion base has been determined, it is divided by the estimated total recoverable units. This gives us the

Question 39

How to calculate depletion cost?

Answer 39

depletion rate per unit x the amount of resources recovered during the period.Note the depletion cost becomes part of inventory cost. When the natural resource is sold, depletion is included in the costs of goods sold amount. On the balance sheet, the natural resource is shown net of its accumulated depletion.

Question 40

If the depletion rate per unit needs to be changed due to a revised estimate of the recoverable units, the new rate is determined as follows:

Answer 40

 Take the depletion base and subtract accumulated depletion up to the beginning of the year of the changed. Then divide this amount by the new estimate of recoverable units, also as of the beginning of the year. This figure will provide the revised estimate of depletion cost per unit.

Question 41

Intangible assets

Answer 41

Intangible assets are assets that have no physical substance. Intangible assets normally include: copyrights, lease holds, trademarks, franchises, patents, and goodwill.
• Purchased intangibles should be recorded at cost
• Internally developed intangibles are written off as research and development expense
• Goodwill is recorded only when an entire business is purchased
During an intangible asset’s economic life, its cost should be allocated to expense on a systematic and rational basis. This process is called amortization. The amortization cost is the intangible asset’s acquisition cost less any residual value. The method of amortization shall reflect the pattern in which the economic benefits of the intangible assets are consumed. If the pattern cannot be determined, the straight line method will be used. The estimate of the useful life for an intangible asset should be based upon the time period the asset is expected to contribute to the company’s revenues. An asset with a finite useful life is amortized. An asset with an indefinite useful life is NOT amortized. Goodwill is NOT amortized.

Question 42

Changing the estimated life for an intangible requires

Answer 42

asset requires that the unamortized balance of the asset at the beginning of the year of change, be allocated over the revised estimated useful life of the intangible asset. Research and development cost are to be expensed as incurred except intangibles or fixed assets purchased from others having alternative future uses. These should be capitalized and amortized over their useful life.

Question 43

The term current assets is used to ?

Answer 43

designate cash and other assets or resources that are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business. The normal operating cycle of a business is the period that it takes to move from a cash to cash position. In other words the operating cycle is the time it takes to purchase inventory, make the goods, sell the goods, collect [ and receivable???], and pay the supplier. If this period is less than 1 year, the operating cycle is assumed to be one year. However, if this period is longer than 1 year, the operating cycle is this longer period. Hence, current assets are those assets expected to be converted to cash or used within 1 year or the current operating cycle, whichever is longer. It is important to note that when a company has substantial amounts of installment sales, the operating cycle is usually longer than 1 year. Assets usually disclosed as current assets include cash which is available for current operations, accounts receivable, short-term investments, inventories, and prepaid expenses.

Question 44

What are the two issues when working with cash.

Answer 44

• determining which items are recognized as cash. the items that comprise cash must be readily available for the payment of current liabilities and operating expenses. Accordingly, cash consists of such items such as currencies and coins, demand and passbook balances at financial institutions, and items acceptable for deposit such as money orders, certified checks, cashier’s checks, personal checks, and petty cash
• Which items are cash equivalence. Cash equivalents are highly liquid with the maturity of 3 months or less from the date of purchase. Cash equivalents include certain investments such as certain treasury bills, money market funds, or commercial paper. Cash does NOT include accounts receivable, municipal bonds, investment in other corporations or any items not readily deposited.

Question 45

Additional info?

Answer 45

In addition, cash does NOT include items such as post-dated checks, NSF checks and IOUs, postage stamps, or employee travel advances. Post-dated checks, nonsufficient funds checks, and IOUs should be classified as receivables. Postage stamps and employee travel advances should be classified as pre-paid assets. Cash which is restricted as to use should be disclosed separately. This includes compensating balances, which is restricted amount of cash set aside as required by a loan agreement. Restricted cash is classified as a current asset if it is expected to be used within 1 year or the current operating cycle. Restricted cash that will not be used within 1 year should be reclassified as a non current asset.

Question 46

Trade Receivables

Answer 46

Trade receivables are accounts receivable that occur from regular sales to customers. To be classified in the current asset section, a receivable should be expected to be [realized] in cash during the normal operating cycle of the business or 1 year, whichever is longerNontrade receivables that are due from officers, employees, or affiliated companies or other entities should be disclosed separately from trade receivables. Trade receivables referred to as ‘accounts receivable’ should be disclosed at their net realizable value, which is the gross amount expected to be collected minus the allowance for uncollectable accounts. If the gross amount of the accounts receivable includes unearned interest in finance charges, these amounts should be deducted from accounts receivable on the balance sheet. These deductions would usually apply to installment accounts receivable which are collected over an extended period of time.

Question 47

Installment account receivables

Answer 47

Installments accounts receivable are usually disclosed in the current asset section because the operating cycle is usually extended when installments sales constitute a significant portion of sales.

Question 48

accounting for bad debt expense direct write off method.

Answer 48

1. The direct write-off method

Under the direct write-off method, bad debt expense should be recognized in the period in which the account receivable is determined to be uncollectable. The journal entry would
bad debt expense xxx
accounts receivables xxx

for the amount deemed uncollectable. This method is used only if the entity cannot estimate bad debt. It is also used for income tax reporting, however, the direct write-off method is NOT acceptable under GAAP.

Question 49

accounting for bad debt expense allowance method.

Answer 49

Bad debt expense is recognized in the period in which the related sales revenue are recognized. As a result, the allowance method produces a better matching of revenues and expenses than does the direct charge-off or write-off method. The journal entry should
bad debt expense xxx
allowance for uncollectable accounts xxx

for the amount estimated to be uncollectable. When an account is deemed to be uncollectable, the
allowance account xxx
accounts receivable xxx

If a previously written off account is collected, 2 entries should be made. First, re-instate the account receivable with a accounts receivable xxx
allowance account. xxx

Then make an entry for the cash collected by
cash xxx
account receivable xxx

for the amount collected. When the allowance method is used, bad debt expense must be estimated as of the balance sheet date.

Question 50

2 Ways to estimate bad debt expense?

Answer 50

There are 2 ways that bad debt expense can be estimated. The first is percent of credit sales method. Bad debt expense can be based upon a percentage of the years credit sales that are not expected to be collected. This percentage may change from year to year due to more experience and knowledge about previous estimates.

The other manor of estimating bad debt expense is called the aging method which is based upon an analysis of accounts receivable at year-end. With this approach, accounts receivable are analyzed according to their various ages, that is the various lengths of times the balances are uncollected. Percentages are then applied to these various amounts in the aging schedule to estimate the amount of accounts receivable that is not expected to be collected. The amount that is estimated to be uncollectable should be the ending balance in the account receivable. Therefore, bad debt expense is the adjustment needed to bring allowance for uncollectable accounts total to the amount of uncollectable accounts shown in the aging schedule.

Question 51

Differences between the two methods

Answer 51

The percentage approach emphasizes the income statement because it bases the estimate of bad debt expense upon credit sales. It focuses on matching the bad debt expense to the sales of the period. The percent of credit sales method places less emphases on the net realizable value of accounts receivable, which is a balance sheet value.

On the other hand, the aging of accounts receivable approach emphasizes the balance sheet. The aging approach’s main objective is the proper determination of the net realizable value for accounts receivable. The bad debt expense that results in the attainment of this objective is of less concern than accurately valuing the accounts receivable.

Question 52

accounting for pledging, assigning, and factoring accounts receivable

Answer 52

When accounts receivable are pledged or assigned, the accounts receivable provide collateral for a loan. In both pledging and assigning accounts receivable, the entity with the accounts receivable does not surrender control of the receivables. This means, that the accounts receivable remain as assets on the balance sheet and the entity borrows funds and incurs a note payable. As time goes by, the debt or enterprise collects the accounts receivable and remits the cash collected to pay the principle and interest on the amount borrowed. When accounts receivable are pledged, specific customer accounts are not designated as collateral. The accounts receivable remain on the entities balance sheet but must be identified as being pledged either parenthetically or by foot note.

Question 53

factoring accounts receivable

Answer 53

When accounts receivable are factored, they are sold to a finance company or a bank. A factoring arrangement represents a transfer of receivables which should be accounted for as a sale if the following three conditions are present:

1. The transferred assets have been isolated or put beyond the reach of the transferor and its creditors
2. The transferees have obtained the right to pledge or exchange either the transferred assets or beneficial interest in the transferred assets
3. The transferor does not maintain effective control over the transferred assets through an agreement to repurchase or redeem them before their maturity

Question 54

accounting for factoring account receivable.

Answer 54

In a factoring, the factor purchases the receivables for designated amount and the factor collects the payments directly from the customers. Receivables can be factored with and without recourse. If receivable are factored without recourse, the transferor, that is the enterprise selling the receivables should account for the transaction like any other sale of an asset. Cash should be debited for the amount received from the factor [ 36:24]. Accounts receivable should be credited for the amount of receivables transferred and a loss from sales of receivables should be debited for the excess of the receivable sold over the cash received. This loss represents the interest expense and factoring fees withheld by the lender and should be included in the amount reported for the income for continuing [?] operations on the income statement [36:44]. Specifically, the loss should be reported in the section with other expenses and losses. The factoring of receivables with recourse should be accounted for as a transfer of receivables. When receivables are transferred with recourse the transferor guarantees payment to the transferee that is, the party acquiring the receivables in the event the debtor fails to pay. Because the transferor is a guaranteeing payment, the transferor has a continuing involvement with the receivables transferred. This continuing involvement will be accounted for by recording a recourse liability on the date of the factoring.

Question 55

transfer and servicing the financial assets

Answer 55

A financial asset is viewed as a variety of components that can be controlled. When transferring financial assets, any interests that continue to be held should be measured at their carrying value before the transfer. The amount that continues to be held is reported on the balance sheet. The remaining portion of the financial asset is considered sold and a gain or loss on sale of the asset may be recognized.
Servicing financial assets includes collecting payments, paying taxes and insurance, monitoring delinquencies, foreclosures, investing, remitting fees or providing account services. Companies may have income from collecting fees, late charges, or managing float [?] [38:09]. If more than adequate compensation is expected for servicing financial assets than an asset may be recognized. If only adequate compensation is provided for servicing financial assets, then no asset or liability is recorded. If less than adequate compensation is provided for servicing the assets, a liability must be recognized. Servicing assets should be reported separately from servicing liabilities. In other words, the assets and liabilities may not be netted.

Question 56

amortization method for transferring and servicing the accounting method.

Answer 56

 The amortization method requires the servicing asset be initially recorded at its fair value. The servicing asset is amortized over the period of servicing. At the end of each period the asset is tested for impairment on increase and obligation. If the asset is impaired, a valuation account is used to recognize the impairment.

Question 57

fair value method for transferring and servicing the accounting method.

Answer 57

 The fair value method. The servicing asset is initially recorded at fair value. At the end of each reporting period, the servicing asset is remeasured to fair value. Any changes in fair value are reported as gains and losses from continuing operations in the income statement of the period. Servicing assets may be presented on the balance sheet as separate line [? 39:35] items for items valued at fair value and items that are accounted for using the amortization method or by disclosing the aggregate amount of all servicing assets with a parenthetical disclosure with the amount valued at fair value.

Question 58

Securitization

Answer 58

involves packaging financial assets and selling them. Securitization is widely used for mortgages, credit cards, and trade receivables. Similar to the sale of financial assets, each financial component is valued at fair value, any interest that continue to be held are recorded as assets or liabilities, recourse obligations are recorded as a liability, and a gain or loss can be recognized on the sale.

Question 59

Accounting for various types of current liability

Answer 59

According to ARB 43, term current liabilities is a term to principally describe obligations whose liquidation is expected to require the use of existing resources, properly classified as current assets or the creation of other liabilities. If the operating cycle of the business is less than 1 year, liabilities that will be paid within 12 months of the balance sheet date should be classified as current liabilities. If the operating cycle is longer than 1 year, liabilities that will be paid within this longer period should be classified as current liabilities.
Current liabilities by arise from many different transactions. Current liabilities result from activities that are directly associated with the operating cycle, trade accounts and notes payable, accrued liabilities for wages and payroll expenses, warranties, royalties, property taxes, and bonuses [41:15]. Current liabilities also include short-term debt as well as the current maturities of long-term debt. If a current liability is refinanced on a long-term basis, it should be reclassified to the long-term debt section. In addition, a short-term debt may also be classified to long-term if it is expected to be refinanced with long-term debt and if certain conditions are met.

Question 60

For a short term debt to be reclassified to long-term liabilities two conditions must be satisfied.

Answer 60

• First, the management of the entity must intend to refinance the short-term obligation on a long-term basis.
• Second, the entity must demonstrate an ability to consummate the refinancing. This can be done by actually refinancing the short term debt after the balance sheet date OR by entering into an agreement that permits it to refinance the short-term debt on a long-term basis.

Question 61

contingency ?

Answer 61

is an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise. The gain or loss will be ultimately resolved when one or more future events occur or fail to occur.

Question 62

When should the loss be disclosed: in the period the event occurred or in the period that the uncertainty is resolved?

Answer 62

The answer to this question depends on the likelihood of the loss and whether the loss is estimable. An estimated loss from a loss contingency should be accrued if both of the following conditions are met.

1. Information available prior to the issuance of the financial statements indicates that is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements.
2. The amount of the loss can be reasonably estimated

The loss is accrued by debiting a loss or expense and crediting a liability account. The loss or expense is then reported as loss on the income statement of the period. For contingencies involving lawsuits in which a loss is probable, it may be difficult to estimate with reasonable assurance the amount of damages. Arrange for the amount of the loss is sufficient to meet the condition that the loss can be estimated. If some amount within the range is a better estimate than any other amount, that amount should be accrued. When no amount in the range is a better estimate than any other amount, then the minimum amount in the range should be accrued and the additional loss that may be incurred should be disclosed in a footnote. If the loss is not probable or cannot be estimated, then no accrual entry is required.

Question 63

Examples to explain contingency

Answer 63

For example if the likelihood is probable but the amount cannot be estimated, then no entry can be made. In this situation, a footnote disclose is required. If the likelihood of the loss is reasonably possible, then a foot note disclosure for the loss contingency is also required. The footnote should disclose the nature of the contingency and should give an estimate of the possible loss, or range of loss, or state that such an estimate cannot be made. Finally, if the likelihood of the contingency occurring is remote, no disclosure is necessary.

Question 64

These contingencies should ALWAYS be disclosed in footnotes regardless of the likelihood of occurrence. Disclosures are required for for these 3 items

Answer 64

1. Guarantees of the debts of other entities
2. Standby letters of credit by banks
3. Agreements to purchase receivables

Question 65

compensated absences cover such things as???

Answer 65

vacations, illness, and holidays for which it is expected that employees will be paid. The employer should accrue a liability for employees compensation for future absences if all of the following conditions are met.
The employer’s obligation relating to the employees rights to receive compensation for future absences is attributable to employee services already rendered.
The obligation relates to rights that best [? 45:24] or accumulate
Payment of the compensation is probable
The amount can be reasonably estimated

If an employer meets conditions 1, 2, and 3, but does not accrue a liability because the amount cannot be reasonably estimated, that fact should be disclosed in the footnotes.
Note that enterprises that self insure from the risk of loss from firestorms and other hazards cannot accrue these losses. These losses must be charged to the period in which they occur. Finally, note that gain contingencies normally are recorded only when they are realized. In addition, if footnote disclosures are given to gain contingencies, care must be taken to avoid misleading implications as to the likelihood of their realization.

Question 66

Determination and disclosure of income tax expense and deferred taxes

Answer 66

Proper recording and disclosure of income taxes focuses on intra-period allocation and inter- period allocation.

Question 67

Intra-period allocation

Answer 67

tax allocation within a period. The objective is to properly disclose income tax expense on a particular period’s income statement. Proper disclosure of income tax expense requires that it be allocated to or associated with specific major items of income, gain, or loss that should be disclosed net of their related tax effects. For example: proper disclosure of income tax expense on the income statement requires that each of the following 3 categories of income, gain, or loss be reported net of their related income tax effects.
Income or loss from continuing operations
Income or loss from an operation of a discontinued segment
Extraordinary gains and losses

Question 68

Inter-period allocation

Answer 68

Financial accounting, or GAAP, is based upon accrual basis accounting concepts such as revenue recognition and matching. However, tax laws are based on economic and social considerations. Therefore, net income for financial, or book purposes, is rarely the same as taxable income. As a result, there is a difference between book and taxable income which gives rise to deferred taxes. Statement of financial accounting standard 109 uses an asset liability approach to account for income taxes. The two objectives are to:

Recognize the amount of taxes payable or refundable for the current year
Recognize deferred tax liabilities and assets that will have future tax consequences

For tax purposes, the goal is to calculate taxable income and the amount of tax due for the period. In order to calculate taxable income, you must understand what accounting rules are used for tax purposes. Then in order to calculate income tax expense for the gaap income statement, you must understand all of the items that give rise to book tax differences

Question 69

The differences in book income and taxable income can be attributable to two types of items

Answer 69

Permanent differences and temporary differences

Question 70

Permanent differences

Answer 70

Permanent differences are never deductible or never taxable on the tax return. However these items are included in net income for accrual basis gaap financial statements. Although there are many permanent differences, there are 7 that are most frequently tested. The most common permanent differences:
Interest revenue on state municipal bonds
Never taxable. This is because the federal government did not want to impinge on the state or local government’s ability to raise revenue and issue bonds. In other words, by allowing the state a municipal bonds to be tax-free, they can sell more bonds.
Premiums paid and proceeds from life insurance on key officers
Never included on tax return. As a general rule, life insurance proceeds are not
taxable. The government feels sad for you that the person has died, therefore the government is generous and does not tax life insurance proceeds. However, if the government does not tax the proceeds, they will also not allow a deduction for making the premiums
Payment of fines
Never tax deductible. The government does not want to encourage people to
break the law. Therefore, fines are never deductible
Income tax expense
Never deductible. Income tax expense is an accrual basis accounting type of
expense which is only reported on the gaap prepared income statement
Equity income from the equity method
Never taxed. One of the basic concepts of a good taxing system is the ability to
pay principle. If the taxpayer has the ability to pay, then it is appropriate to tax them. With the equity method, the company merely accrues their percentage of the investees net income for the year. The investor [? 51:58] may not have received any cash from the investee, therefore, using the ability to pay theory, the investor will not have the cash to pay the tax. Therefore, the code gives tax relief and does not tax income from the equity method.
80% of the dividends received deduction for equity investments
Although the equity income is not taxed because it is based on accrual
concepts and may not have been received, the dividends received are taxed. However, if all of the dividends were taxed, this would result in triple taxation. For example, Company A has an investment in B. Company B pays income tax on its net income. Form that net income, Company B pays a dividend to Company A. Now Company A must pay tax on the dividend income. When Company A distributes a dividend to their shareholders, the shareholders also pay tax on the dividends they receive. Therefore, if no tax relief were granted, the income from Company B would be taxed 3x. This helps mitigate this unfair tax situation by allowing the corporation who received the dividend to deduct either 75% or 80% of the dividend received and not included in taxable income. In the tax area, you will be tested on the 75% or 80% limit of this rule.
Percent depletion in excess of cost
This is a special interest legislation item that allows certain companies in
extractive industries to deduct depletion greater than the cost.

Question 71

Temporary differences

Answer 71

Occur due to differences in timing of when an item is recorded on the tax return vs when the item is recorded on the income statement. In order to understand temporary differences and calculate the deferred tax amounts that occur due to these temporary differences, you must first know the accounting rules used for book and tax reporting. For book or financial reporting purposes, revenue must be recorded on an accrual basis. This means we record revenue when we earn it. For book purposes, the percent of completion method is an acceptable method for calculating net income. If an company has rent revenue, it must be recorded on an accrual basis. Therefore, if rent is received in advance, no rent revenue is recognized until earned.

For tax, the rules can be very different. For tax purposes, revenues can be recorded on a cash basis, a hybrid basis, or the accrual basis. For constructions contracts, the completed contract method is required. For rent revenue, rent is taxable income when it is received.

Question 72

Rules for expenses and deductions

Answer 72

The word expense means an accrual base expense item recorded on the income statement reporting purposes. For tax purposes, we’ll refer to an item as deduction. For example, we have a depreciation expense on the income statement but a depreciation deduction on the tax return. Normally, these 2 numbers are different. For book purposes, any systematic and rational allocation method can be used to calculate depreciation. For tax purposes, most taxpayers use the modified accelerated cost recovery system, or M.A.C.R.S, because it yields more depreciation in the early years of the asset’s life. For book purposes, we may estimate warranty expense. For tax purposes, we can only deduct the warranties actually paid. For book purposes, we can estimate the bad debt expense for the period. For tax purposes, we only use the direct write-off method and deduct the debts that are actually not collected. frequently tested book/tax differences

Once you understand the methods used to calculate gaap net income and the methods used to calculate taxable income, the next goal is to calculate taxable income. In practice, an accountant would calculate taxable income by completing the tax return. However, for financial accounting purposes and for estimating deferred taxes, accountants use pre-tax accounting income and convert this number to taxable income by adjusting for permanent and temporary differences. Although the formula for determining income tax expense for a period is straightforward, the actual calculation of the number is a bit more challenging.

Question 73

Income tax expense .

Answer 73

Income tax expense = the sum of the current years tax liability from the tax return +/- the change in deferred income taxes for the period.

Question 74

Income tax expense .

Answer 74

Income tax expense = the sum of the current years tax liability from the tax return +/- the change in deferred income taxes for the period.

The current year tax liability is determined by multiplying the corporation’s taxable income by the appropriate tax rate

→ The calculation of the change in deferred income tax for the period requires that you measure the income tax effects of temporary differences.

According to statement of financial accounting standard 109, a temporary difference is a difference between the tax basis of an asset or liability and its reported amount in the financial statements that will results in taxable or deductible amounts in future years when the reported amount of an asset is recovered or the reported amount of the liability is settled.

The first goal in converting pre-tax accounting income to taxable income is to identify all permanent differences and remove their effects from income. For example, suppose $1000 of municipal bonds interest was included in book income, therefore since this $1000 is not taxable, we would subtract this amount from pre-tax income to arrive at taxable income. Once the effects of permanent differences are removed, then we look for the temporary differences. As we work the problem, we create a schedule of the temporary differences so that we can compute deferred taxes.

Question 75

Example

Answer 75

Suppose bad debt expense on the income statement was $1000 but the amount of debts that actually were written off was only $400. Tax laws allow a deduction for the actual amount of bad debts. Therefore, to convert pre-tax income to taxable income, we would have to add back the $600 difference that cannot be deducted in the current year. This means we will have a $600 deduction in later years when those debts are actually written off, given rise to a future deduction, which will lower our taxes at some point in the future. A future deduction creates a deferred tax asset. Because we did not get the entire $1000 deduction now, we must pay more taxes now in the current period.

Question 76

Tax expense for the period

Answer 76

To complete tax expense for the period, you must bill the deferred tax schedule. A nice deferred tax schedule lists a column for the book amount recorded, the tax amount recorded, the book tax difference, and then a schedule of future years for when the deferred item will reverse or turn around. On the far right, I always include a column to classify my deferred tax item. Deferred tax item should be classified as current deferred tax asset, non-current deferred tax asset, current deferred tax liability, and non-current deferred tax liability. Each individual deferred tax asset or liability is classified as current or non-current based on its related asset or liability account. If it cannot be linked to a related account, then it is classified as current or non-current by when it reversers.

Question 77

Tax liability

Answer 77

normally means the tax liability calculated on the tax return.
Taxes due or tax payable normally refers to the amount that is owed to the internal revenue service at the end of the year. In other words, if you made estimated payments, these estimated payments reduce the amount you owe the government at the end of the year.
Taxes due or taxes payable normally refers to the taxes payable account shown on the balance sheet as a current liability. remember that individuals in firms pay estimated taxes. So it is possible to have a prepaid tax on the balance sheet for these estimated payments. For example, if the total tax liability for the current year on the tax return is $10,000 and you have made estimated payments of $3,000 the taxes payable on the balance sheet will be $7,000. Assuming there are no deferred taxes, you would make the appropriate journal entry by debiting tax expense $10,000; crediting prepaid estimated taxes of $3,000; and crediting taxes payable by $7,000

Question 78

Tax expense

Answer 78

refers to total tax expense for the period. Tax expense is comprised of two amounts added together. The current portion of tax expense and the deferred portion of tax expense. Current portion of tax expense is calculated as current year taxable income x the current year tax rate. The deferred portion of tax expense is the sum of all the deferred tax journal entries netted. Although you may have a journal entry to deferred tax asset or a deferred tax liability, remember, if the question asks for what is the deferred tax liability on the balance sheet, you must post your entry to the deferred tax liability account to arrive at the end balance. When deferred taxes are displayed on the balance sheet, remember that we net current deferred tax asset against current deferred tax liability and show one amount as either a current deferred tax asset or a current deferred tax liability. Then we net the non current deferred tax asset and noncurrent deferred tax liability and show one amount for the noncurrent items.

Question 79

If there are several tax rates given in the problem

Answer 79

the enacted tax rates are used to calculate deferred taxes.