AICPA OBJECTIVES COVERED

Question 1

Recall the purpose and characteristics of the conceptual framework for state and local governments.
*R&U

Objectives of Financial Reporting - GASB Concept Statement #1 (unique characteristics/purpose of gov’t and characteristics of financial reporting)

Answer 1

*Note this is not authoritative guidance, but rather the conceptual framework GASB uses in developing new standards

The unique characteristics of the governmental environment and the two main purposes of financial reporting by governments.

1) Unique characteristics:
- relationship of taxpayers to services received is not a direct relationship
- control aspects is the budget - it is an expression of public policy, a financial plan, a form of control of law, and evaluates performance
- users of the financial reports include the citizenry, legislative & oversight bodies, investors and creditors
- 2 Purposes - accountability, inter-period equity

Characteristics of Financial reporting (TRUCCR)

1) Timeliness
2) Relevance
3) Understandability
4) Comparability
5) Consistency
6) Reliability

Question 2

Recall the purpose and characteristics of the conceptual framework for state and local governments.
*R&U

Describe the Elements of Service Efforts & Accomplishments (SEA) - GASB Concept Statement #2

Answer 2

GASB believes that service effort and accomplishment (SEA) information assists users in assessing accountability and making better informed decisions. SEA is voluntary.

Elements of SEA Performance:

1) Measures of service efforts (inputs) - amount or resources spent on a service
2) Measures of service accomplishments (Output measures) and (Outcome Measures)
3) should meet TRUCCR
4) Context should be provided

GASB states that SEA performance information should focus on measures of service accomplishments (outputs and outcomes) and measures that relate service efforts and service accomplishments (efficiency)

Question 3

Recall the purpose and characteristics of the conceptual framework for state and local governments.
*R&U’’

Communication Methods in General Purpose External Financial Reports that Contain Basic Financial Statements - GASB Concept Statement #3

Answer 3

Hierarchy:

1) Recognition in basic F/S
2) Disclosure in notes to basic F/S
3) Presentation as RSI
4) Presentation as OSI

Question 4

Recall the purpose and characteristics of the conceptual framework for state and local governments.
*R&U

Elements of Financial Statements - GASB Concept Statement #4

Answer 4

Elements of Net Position: 
1) Assets 
2) Liab
3) Deferred outflow of resources
4) Deferred inflow of resources
5) Net position
Elements of Resource Flow Statements:
1) Outflow of resources
2) Inflow of resources

Question 5

Recall the purpose and characteristics of the conceptual framework for state and local governments.
*R&U

How to measure Assets & Liabilities?

Answer 5

Two ways to measure Assets and Liab:

1) Initial Amount - when acquired/incurred
2) Remeasured amounts - at date of F/S

Four Measurement Attributes:

1) Historical Cost
2) Fair Value
3) Replacement Cost
4) Settlement Amount/acquisition value

Question 6

Recall the measurement focus, basis of accounting, and accounting objective used by state and local governments for fund and government-wide financial reporting.
*R&U

Answer 6

Measurement focus: Flow of financial resources
Basis of Accounting: Modified Accrual Basis
Accounting Objective: Sources & uses of current financial resources

Measurement focus: Flow of economic resources
Basis of Accounting: Accrual Basis
Accounting Objective: Net Income

Question 7

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Answer 7

C-PIPP are the fiduciary funds:
Custodial funds
Pension trust funds (aka Post-employment trust funds)
Investment trust funds Private-Purpose trust funds;

DRIP: 
Debt service funds
Special Revenue funds 
Internal service funds
Permanent funds

CEG:
Capital project funds
Enterprise funds
General fund

Consonants D,R,P,C,G are Governmental
Vowels E,I are Proprietary

Question 8

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe the General Fund

Answer 8

Principal Operating Fund for all governmental entities.

Characteristics -

1) Fund is required in governmental accounting
2) There is ONLY ONE General Fund
3) Modified Accrual Basis
4) Budgetary & Encumbrance Accounting
5) Accounts for current items only
6) Finances the funds through “Other Financial Uses/Sources - Transfers (not expected to be repaid) Out/In” and loans

Question 9

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe the Special Revenue Fund

Answer 9

Account for monies restricted or “earmarked” for specific types of general government expenditures (except if money is restricted for debt, capital projects, or permanently restricted)

Characteristics -

1) Modified Accrual Basis
2) Budgetary & Encumbrance Accounting
3) Accounts for current items only
4) Only accounts for restricted resources

Receive $ from:

1) General Fund (recorded as “Other Financing Sources - Transfers In”)
2) Intergovernmental Transfers (grants, entitlements, shared revenues) - usually from large gov’t entities to small/ subject to eligibility and time restrictions
3) Voluntary grants

Question 10

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe the Debt Service Fund

Answer 10

Used to make interest and principal payments on general long-term debt.

Characteristics:

1) DO NOT make payments on ST liabilities or Specific Debt
2) DO NOT record/report LT Debt they just service the Debt (unless debt matured - aka “current” or “due”)
3) Modified Accrual Basis (interest expense recorded when due, not accrued)
4) Budgetary & Encumbrance Accounting
5) JE’s record:
a. Receipt of resources to pay interest and principal
b. Investments of those resources and recognition of investments earnings
c. Liabilities related to matured interest and principal
d. Payment of Matured Interest and Principal (Both recognized as expenditures (require an outflow of financial resources). GASB requires separate reporting of each type of expenditure: Expenditures—Interest and Expenditures—Principal)

Question 11

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe the Capital Project Fund

Answer 11

Funds that are used to facilitate resource accumulation and manage expenditures for major capital projects.

Characteristics:

1) Modified Accrual Basis
2) Recognized Encumbrances
3) Limited Life Funds - only exist for a specific project
4) Money left over in fund transferred to debt service or general fund
5) Assets Constructed are reported on Gov’t wide F/S - not in this fund. This fund is solely a CIP.
6) JE’s record:
a. Receipt of resources for project
b. Expenditures to construct/acquire asset
c. Transfers of excess resources when project complete

Question 12

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe the Permanent Fund

Answer 12

Account for the principal and earnings of endowments (contributions/bequest from a private individual or organization) that must be used for the support/benefit of governmental programs. Accepting the endowment, means the government agrees to invest & maintain the principal intact, usually in perpetuity, and to expend the net earnings on the investment for the purposes stated in the agreement.

• Note if the money can be spent for the governmental purpose this should be in the Special Rev. Fund
• Note if the money is for a non–gov’tal purpose or benefits a specific person this should be in the Private Purpose Trust Fund

Characteristics:

1) Modified Accrual Basis
2) Do NOT account for related expenditures of the endowment (net transferred in from special revenue fund)
3) JE’s record:
a) Receipt of the endowment principal (recognize as revenue when received)
b) Receipt of investment earnings
c) Transfer of net expendable earnings

Question 13

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe the Internal Service Fund

Answer 13

Characteristics:

1) Full Accrual Accounting
2) Purpose - Measure Profit, Maintain Capital
a. Carry their own FA & LT Debt
b. Record Depreciation Exp
c. Use standard accounting terms (i.e. expenses, net position)
3) GASB this fund is only used if the government is the customer and
4) COMBINED with governmental funds on Gov’t Wide F/S
4) User Charge based on - Cost Reimbursement
5) Receive transfers/subsidies from General Fund for capital and initial start up (Transfers (in)) - closed at YE to Net position account
6) Revenue aka “Billings to Department”
7) Probably will be on Fund F/S as Other SI

Question 14

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe the Enterprise Fund

Answer 14

Provides G&S to public

Activity recorded if:

1) financed with debt secured solely by a pledge of net revenues from fees and charges of the activity (revenue bonds)
2) Laws & Regulations establish fees/charges
3) *Pricing policy of activity establishes fees and charges designed to MAINTAIN CAPITAL MAINT

Revenue aka “Charges for Services”
Included on Gov’t Wide F/S
Included in Basic F/S (Fund Statements)

Characteristics:

1) Frequently have restricted assets (ex. customer deposits)
2) Utility Ent. Funds commonly report utility plant assets & construction WIP
3) Utilities commonly require customer advances for cost of construction projects that occur at the request of its customers
4) Long-Term liabilities - Bonds (if being serviced by enterprise fund than it is reported as a liability)

Question 15

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe the Custodial Funds

Answer 15

Purpose is to be a custodian - to make disbursements from one gov’t entity to the next in accordance to predetermined instructions or formulas

1) Fully Accrual Basis
2) Prepare a Statement of Net Positions and a Statement of Changes in Net Position - even though this fund is basically an increase in Liability when money is received and a decrease in the Liability when money is given away

It is common that tax levies from multiple governments in the same area be collected together and then distributed to the applicable government.
Ex. lets say a county collects all the taxes - in its custodial fund it would make this entry:
Dr. Taxes Receivable (total amount collected)
Cr. Due to other Governments
Cr. Due to General Fund

Question 16

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe the Investment Trust Funds

How are securities reported? When/how is money distributed?

What happens if there isn’t a legal/formal trust agreement established between entities pooling money together?

Answer 16

Used to maximize the governments earnings on their investments, by pooling or commingling idle cash from many funds into one account / can include external entities

1) Securities in the pool are reported at FV (revalued when income distributed to participants or there is a withdrawal
a. distribution happens on monthly/quarterly basis
b. distribution based on % share of investment

If no formal trust, use a custodial fund. When reporting Investment Pools in the Custodial Fund need to keep them in there own column.

Question 17

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe a Pension Trust Fund & Other Post employment Benefit Plan Trust Fund (2 types of pension plans)

What are the required ratios/disclosures?

Answer 17

2 types of pension plans:

1) Defined Contribution plans = contributions by employee and employer are invested to earn a return, at retirement receive defined contributions but benefit are determined by the performance of the investment
2) Defined Benefit Plans - employer promises the retiree a defined future benefit over a future time period and the employer bears the risk associated with unknown future economic factors - thus actuarial calculations are required to determine the PV of benefits to know the amount of contributions needed

Required Supplemental Info:

1) Schedule of Funding Progress
2) Schedule of Employee Contributions
3) Actuarial Info
4) 10 year schedules

Ratios:

1) Funded Ratio = Plan Fiduciary Net Position/Total Pension Liability
2) Net Pension Liability/Covered Payroll
3) Contributions/Covered Payroll

Question 18

Determine the appropriate fund(s) that a state or local government should use to record its activities.
*App

Describe a Private Purpose Trust Fund

Answer 18

Used to account for any resources managed in trust by the governmental entity, where the beneficiaries are outside of the governmental entity itself. The beneficiaries may be individuals, private organizations or businesses, or other governmental entities.

Maybe Expendable or NonExpendable (e.g. endowments, where the principal must be retained and only earnings may be expended)

Question 19

Identify and recall basic concepts and principles associated with government-wide financial statements (e.g., required activities, financial statements and financial statement components)
*R&U

Government-wide financial statements:

Answer 19

Government-wide financial statements:
1) Statement of Net Position - has government-wide balance sheet, it’s on the accrual basis, ‘net position’ is the last part of this statement

2) Statement of Activities: has government-wide statement of operations. It’s prepared on the accrual basis. The sections include:
a. Program expenses
b. Program revenues
c. Net program (expense) or revenue
d. General revenues

Both Statements separate Governmental activities and business-type activities and both DO NOT fiduciary funds either - remember that these are funds being held in custodial capacity, so they aren’t resources for the government’s use. The measurement focus for the government wide financial statements is the economic resources focus (prepared on accrual basis).

Question 20

Identify and recall basic concepts and principles associated with government-wide financial statements (e.g., required activities, financial statements and financial statement components)
*R&U

Governmental Activities Accounting Equation

Describe how fund F/S roll up into Gov’t Wide

3 Categories of Net Position/Equity on Gov’t wide and Fund Level F/S

Answer 20

Governmental Activities Accounting Equation on Gov’t Wide:

CA
\+ Capital Assets
\+ Deferred Outflows 
- Current Liab
- LT Liab
- Deferred Inflows
- Deferred Revenues 
= Net Position

TOTAL of Governmental Funds
+ TOTAL of Enterprise Funds
+/- Adjustments to Dissolve ISF
= Governmental Activities on the Gov’t Wide F/S

3 Categories of Net Position/Equity on Gov’t wide and Fund Level F/S:

1) Net Investment in Capital Assets
2) Restricted Net Positions @ fund level
3) Unrestricted - won’t be used for the general operations of fund

*BOARD DESIGNATED FUND is UNRESTRICTED

Question 21

What are the governmental fund F/S?

Answer 21

Fund F/S:
Balance Sheet
Statement of Rev, Expenditures, & Changes in Fund Bal

Question 22

Identify and recall basic concepts and principles associated with proprietary fund financial statements (e.g., required funds, financial statements and financial statement components)
*R&U

Name the statements and their sections

Orientation of accounting and reporting

Answer 22

1) Statement of Revenues, Expenses, and Changes in Fund Net Position
2) Statement of Net Position
3) Statement of CF’s - Operating (based on Operating Income not NI; excludes Interest Rev & Exp), Noncapital Financing, Capital Financing, Investing/Direct Method Required/Non-cash transactions must be on the Face (ex. Donated Assets, Capital Assets, Unrealized G/L on Inv, Debt Issued to acquire capital asset)

*Major fund reporting doesn’t apply to internal service funds; therefore they are usually reported in a single column (F/S will have columns for each major enterprise fund, 1 column for non-major enterprise funds in aggregate, and 1 column for internal service funds in aggregate)

Orientation of accounting and reporting = Income Determination

Question 23

Recall the objectives and components of management’s discussion and analysis in the comprehensive annual financial report for state and local governments.
*R&U

Answer 23

The MD&A in the CAFR discusses the current year’s results compared to prior years.

It provides and explanation of the included financial statements and how the different statements relate to each other.

It will also discuss overall financial position, reasons for any major changes in fund balances, deviations from the budget, etc.

*Note MD&A is RSI in financial section of the CAFR

Question 24

Recall the criteria for classifying an entity as a component unit of a state or local government and the financial statement presentation requirements (discrete or blended).
*R&U

Recap of the combinations of criteria of a potential component unit that should be included in the primary gov’t reporting entity.

Answer 24

1) Appointment Authority + Financial Benefit or Burden

2) Financial Accountability Appointment Authority +
Ability to Impose Will

3) Fiscal Dependence + Financial Benefit or Burden

Question 25

Statement of Changes in Net Position Fiduciary Funds

Answer 25

Statement of Changes in Net Position Fiduciary Funds
(For the Year Ended…) - column for each type of fund

Additions 
-Deductions 
= Change in Net position
Net Position - Beg
Net Position - Ending

Question 26

Statement of Net Position Fiduciary funds

Answer 26

Statement of Net Position Fiduciary funds
Month Date, Year
-column for each type of fund (*if there was an investment pool not subject to a trust arrangement it would be in a separate column under custodial funds)

Assets 
Receivables 
Investments @FV
Liabilities
Payables
= Net Position

Question 27

Prepare worksheets to convert the governmental fund financial statements to the governmental activities reported in the government-wide financial statements.
*App

Answer 27

Conversion worksheet: Starts with total of Gov’t Funds + to simplify the example capital assets are added in the worksheet as a single amount net of accumulated depreciation in adjustment (1) and long-term liabilities are added in total in adjustment (2). It highlight the
adjustment for internal service funds adjustment (3) is shown in a separate column. All other adjustments appear in the
“Other Items” column with the appropriate reference in the “#” column = Total Gov’t Wide

Question 28

Prepare the schedule to reconcile the total fund balances and the net change in fund balances reported in the governmental fund financial statements to the net position and change in net position reported in the government-wide financial statements.
*App

Answer 28

Reconciliation of Fund Balances to Net Assets:

Beg. Fund Balances - Total Governmental Funds
+Capital Assets (net A/D)
-LT Liabilities
+Unamortized balance of debt refunding costs reported when refunding occurred by the governmental refunding occurred
+ISF CA and A/P
+Internal Balances between gov’tal activities and business activities
-Interest is not accrued on LT Debt
+Deferred Revenue
+Equity Investment in JV
= Net Position of Gov’t Activities

Question 29

Prepare the government-wide statement of net position for a state or local government from trial balances and supporting documentation.
*App

Answer 29

Assets (add in capital assets)
= Total assets 
\+ Deferred changes on refundings
\+Liabilities 
= Net positions 
Restricted for: Debt Service, Capital Projects, Special Rev
=Unrestricted

Question 30

Prepare journal entries to record encumbrances of state and local governments.

JE’s for:

1) When PO prepared
2) When G/S received
3) At YE when you still have outstanding PO’s you are waiting to be filled

Answer 30

1) Dr. Encumbrances
         Cr. Budgetary Fund Balance - Assigned
2) Reverse entry above
Dr. Expenditures (Actuals)
      Cr. Cash/Vouchers Payable
3) Reverse entry above
Dr. Unassigned Fund Bal
      Cr. Fund Balance - Assigned/Committed

Question 31

Calculate the fund balances (assigned, unassigned, nonspendable, committed and restricted) for state and local governments and prepare journal entries.

5 Fund Balance Classifications

Answer 31

1) Nonspendable (can’t be spent - not liquid; or legally/contractually obligated to keep) - General Fund/Permanent
2) Spendable
a. Restricted (should be positive) - Special Revenue, Capital Project, Debt Service, Permanent
b. Committed (highest level of authority; should be positive)
c. Assigned (should be positive) - General Fund
d. Unassigned - ONLY THE GENERAL FUND HAS A POSITIVE BALANCE HERE - other funds can only have a negative balance

Question 32

• *Calculate the net position balances (unrestricted, restricted and net investment in capital
  assets) for state and local governments and prepare journal entries.

Classification of Net Position (Equity) and formula

Answer 32

Note this is the last section of the Statement of Net Position (Gov't Wide) 
It goes in this order: 
1) Net Investment in Capital Assets 
2) Restricted 
3) (Unrestricted)
4) Total Net Position

Formula for #1: 
Historical Cost of Capital Assets
-A/D
=NBV
- Capital asset related debt of the fund
(*non-expended portion of debt not included here)
=Net Investment in Capital Assets

Question 33

What are infrastructure Assets?

Identify capital assets reported in the government-wide financial statements of state and local governments.

Answer 33

Infrastructure assets are capital assets that are normally stationary and can be preserved for a longer time than most capital assets. Common infrastructure assets include roads, bridges, sewer systems, lighting systems, and drainage. Buildings & Equipment are not infrastructure assets.

Question 34

**Prepare journal entries to record budgets (original and final) of state and local governments.

Answer 34

Estimated Revenue (Dr) - Actual Revenue (Cr) = 
Revenue to still be recognized

Appropriations (CR) -
Actual Expenditures (Dr) -
Encumbrances
= Appropriations (aka funds available) not expended or encumbered

Example Original:
*has to reverse at the end of year 
Dr. Estimated Revenues $500,000
        Cr. Appropriations (est. 
        expenditures) $450,000
        Cr. Fund Balance $50,000

Example - ordered a new machine - record to “Encumbrances” to restrict the money needed to pay for machine
Dr. Encumbrances (decrease equity)
Cr. Reserve for Encumbrances (increase equity)

YOU ALSO HAVE TO CLOSE REVENUES, ENCUMBRANCES, & EXPENDITURES - plug is the FUND BALANCE (unassigned)

OR YOU CAN CLOSE LIKE THIS:

Dr. Rev
Cr. Est Rev
Cr. Fund Bal

Dr. Appropriations
Cr. Expenditures
Cr. Encumbrances
Cr. Fund Bal

Question 35

Name purpose of financial reporting, the primary qualitative characteristics and their components, and the enhancing characteristics

Recall the purpose and characteristics in the conceptual framework for business and nonbusiness entities.

Answer 35

The conceptual framework is the “guiding principles” of GAAP and for FASB when setting new standards. The main idea behind the framework is to provide financial reporting useful for making decisions.

Another key idea is that the benefits of financial reporting should outweigh the costs.

There are two primary qualitative characteristics and their components (know which components go with each characteristic):

1) Faithful Representation
a. Completeness: Are all necessary facts included in the information
b. Neutral: The information is free from bias
c. Free from error: Info doesn’t contain any material errors
2) Relevance
a. Predictive value: Does it help make predictions about future events?
b. Confirmatory value: Does it provide information about earlier expectations or predictions?
c. Material: Does the information matter to the user? (from a size/scope standpoint)

There are four enhancing characteristics:

1) Comparability: Can the info be used to compare to other companies in the same industry(consistency)
2) Verifiability: Independent observers would reach the same conclusion
3) Timeliness: The info is recent enough to make a decision with
4) Understandability: A user with a reasonable understanding of business can understand and draw conclusions from the information

Question 36

Recall the due process steps followed by the FASB to establish financial accounting and reporting standards.

Answer 36

The FASB Uses the Following Process when Issuing an Accounting Standard:

1) Considers whether to add a project to its agenda, in consultation with the FAF—the FASB receives many requests from its constituencies including the SEC, auditing firms, investors, and reporting firms to address new financial reporting issues and clarify existing standards
2) Conducts research on the topic and issues a Discussion Memorandum detailing the issues surrounding the topic
3) Holds public hearings on the topic
4) Evaluates the research and comments from interested parties and issues an Exposure Draft—the initial accounting standard
5) Solicits additional comments, modifies the Exposure Draft if needed
6) Finalizes the new accounting guidance and approves with a majority vote (4 of 7 affirmative votes) and issues an Accounting Standards Update (ASU)
* *FASB’s Emerging Issues Task Force (EITF)—This group was formed to consider emerging reporting issues and to accelerate the process of establishing rulings on such issues. In this sense, the EITF acts as a “filter“ for the FASB, enabling the FASB to focus on more pervasive issues. When a consensus of the 15 members is reached on an issue, no further action by the FASB is required. EITF pronouncements are included in GAAP. If the EITF is unable to reach a consensus, the FASB may become involved, ultimately revising an existing standard or adopting a new one.

Question 37

Prepare financial statements using the cash basis of accounting.
Prepare financial statements using a modified cash basis of accounting.

Answer 37

Remember
In converting accrual basis to cash basis use the accounting equation:

Change in Cash = Change in Liab + Change in Equity - Change in Assets
Ex - an increase in A/R would be subtracted, while an increase in unearned revenue would be added

Start with Accrual basis NI -/+ all the adjustments = Cash Basis NI

In converting cash basis to accrual basis use the accounting equation:
Change in Equity = Change in Assets - Change in Liabilities

Question 38

List and describe the accounting assumptions & principals in the conceptual framework (4 each)

Recall the purpose and characteristics in the conceptual framework for business and nonbusiness entities.

Recall concepts of accounting for revenue

Answer 38

Accounting Assumptions
1) Entity Assumption—a separate accounting entity for each business organization.

2) Going-Concern Assumption (aka continuity assumption) -a business is assumed to have an indefinite life, that is, it will continue to be a going concern.
3) Unit-of-Measure Assumption—Assets, liabilities, equities, revenues, expenses, gains, losses, and cash flows are measured in terms of the monetary unit of the country in which the business is operated. Price level changes cause the application of this assumption to weaken the relevance of certain disclosures.
4) Time Period Assumption—The indefinite life of a business is broken into smaller time frames, typically a year, for evaluation purposes and reporting purposes. For accounting information to be relevant, it must be timely. The reliability of the information often must be sacrificed to provide relevant disclosures. The use of estimates is required for timely reporting but also implies a possible loss of reliability.

Accounting Principles
1) Measurement—At the time of origination, assets and liabilities are recorded at the market value of the item on the date of acquisition, usually the cash equivalent. This origination value is referred to as historical cost. valuation.

2) Revenue Recognition Principle—This principle addresses three important issues related to revenues.
i. Revenue Defined—What revenue is: Revenue refers to increases in assets or the extinguishment of liabilities stemming from the delivery of goods or the provision of services—that is, the main activities of the firm.
ii. When to Recognize Revenue—Revenues are recognized when the entity completes its performance obligation to a customer and the revenue is earned and realized (or realizable). The performance obligation is completed when the goods or services are delivered (revenue is earned) and cash or promise of cash is received (realized).
iii. Measure Revenue—How to measure revenue: Revenues are measured at the cash equivalent amount of the good or service provided.

3) Expense Recognition Principle—This principle addresses when to recognize expenses and is sometimes referred to as the matching principle.

The matching principle says: Recognize expenses only when expenditures help to produce revenues. Revenues are recognized when earned and realized or realizable; the related expenses are recognized, and the revenues and expenses are “matched“ to determine net income or loss. Expenses that are directly related to revenues can be readily matched with revenues they help produce.
(ex. COGS/sales commissions). Other expenses are allocated based on the time period of benefit provided (ex. depreciation/amortization). Such expenses are not directly matched with revenues. Still other expenses are recognized in the period incurred when there is no determinable relationship between expenditures and revenues. (ex. advertising costs).

4) Full Disclosure Principle (aka adequate disclosure principle) —F/S should present all information needed by an informed reader to make an economic decision.

Question 39

5 steps to allocate the components of revenue.

Recall concepts of accounting for revenue

Answer 39

a. Identify the contract with the customer (promise to deliver a good or service)
b. Identify if there is more than one performance obligation
c. Determine the transaction price
d. Allocate the transaction price to the separate performance obligations (if there is more than one performance obligation)
e. Recognize revenue when each performance obligation is satisfied.

Question 40

List and describe the constraints in the conceptual framework.

Answer 40

1) Cost Constraint:
a. limits recognition and disclosure if the cost of providing the information exceeds its benefit. Firms may not omit disclosures if they are material and mandated by GAAP.
b. Conservatism (aka prudence) is the reporting of less optimistic amounts (lower income, net assets) under conditions of uncertainty or when GAAP provides a choice from among recognition or measurement methods.
* It should be noted that overly conservative estimates can be misleading and cause over reporting in subsequent periods.

Question 41

Practical Expedient Exception

Identify investments that are eligible or required to be reported at fair value in the financial statements.

Answer 41

Investments

Note: An entity can apply the FV option to an investment when it becomes subject to the equity method or to a VIE that is no longer consolidated.

ASC 820 allows a company to use a “practical expedient“ to measure the fair value of an investment that does not have a quoted market price but reports a net asset value per share (NAV). These investment vehicles are often referred to as alternative investments.

Examples: 
hedge funds
private equity funds
real estate funds
venture capital funds
common/collective funds
offshore funds

For example, a private equity fund (PE) may invest in start-up companies, rare archeological artifacts, artwork, and real estate. The PE fund most likely reports the investment in these items at fair value or investment value. The PE fund may report NAV to the investors; if the PE fund meets the criteria as an alternative investment, the investor can use NAV as a practical expedient to measure fair value.

The structure of an alternative investment:

Investors provides $$ > go into “Alternative Investment”
then, the “Alternative Investment” > invests in start-ups, rare artifacts, art, real estate

Alternative investments must meet the criteria in order to use NAV as the practical expedient:

1) Does not have a “readily determinable fair value.”
2) The investment meets the criteria for an investment company as stipulated in ASC 940-10-15-2 or does not meet the criteria to be an investment company but follows industry practice and issues financial statements consistent with the measurement principles for an investment company.

Question 42

Calculate gains and losses to be recognized in net income or other comprehensive income for investments measured at fair value and prepare journal entries.

Answer 42

Only a note need to finish card still.

If the FV option elected for HTM securities, those securities will be treated as trading securities:

1) G/L from change in FV will not be reported in OCI
2) G/L from changes in FV will be reported in current income.

Investments

Question 43

Identify the valuation techniques used to measure fair value.

Answer 43

Measurement Techniques

1) Market approach— uses prices and other relevant information generated by market transactions involving assets or liabilities that are identical or comparable to those being valued.
2) Income approach—converts future amounts to a single present amount. Discounting future cash flows would be an income approach to determining fair value.
3) Cost approach—uses the amount that currently would be required to replace the service capacity of an asset (i.e., current replacement cost), adjusting for obsolescence.

Which approach is used will depend on the circumstances, including the availability of sufficient data for the respective approaches, and will maximize the use of relevant observable inputs and minimize the use of unobservable inputs.

Note that:

• Valuation techniques should be consistently applied.
• Changes in fair value resulting from changes in valuation techniques or applications are treated as changes in accounting estimates.

Question 44

Use the fair value hierarchy to determine the classification of a fair value measurement.

Answer 44

FV Hierarchy:

1) Level 1 - inputs are unadjusted quoted prices in active markets
2) Level 2 - inputs are observable, either directly or indirectly (quoted prices for similar assets/liab)
3) Level 3 - inputs are unobservable

Note: Alternative investments that are reported at NAV as a practical expedient are NOT categorized in the fair value hierarchy (Level 1, 2, or 3) but are separately reported in the footnotes with disclosures that indicate that NAV is being used and these disclosures must reconcile to the amounts reported on the balance sheet.
Companies that use NAV as a practical expedient for measuring fair value must disclose sufficient information so that financial statement users understand the nature and the risks of the investment. The disclosure must include information about the terms and conditions in which the company can redeem its investments.
There are other instances where practical expedient is allowed. An entity is allowed to use a practical expedient in other circumstances, such as in the valuation of benefit plans or for a private company’s measurement of share-based payments.

Question 45

Use the fair value concepts (e.g. highest and best use, market participant assumptions, unit of account) to measure the fair value of assets and liabilities.

What are inputs?

Answer 45

Inputs refer to the various assumptions that market participants would use in determining FV (ex. risk assumptions - on the valuation technique or the inputs)

Inputs are either:

1) Observable— inputs used in pricing an asset, liability, or equity item that are developed based on market data obtained from sources independent of the reporting entity
2) Unobservable—Inputs that reflect the reporting entity’s own assumptions that are developed based on the best information available in the circumstances.

Question 46

Difference between Entry and Exit Price

Answer 46

Entry Price - paid to acquire the asset or the price received to assume the liability (which may not equal the FV) 
Exit Price (aka FV) - price that would be received to sell an asset or paid to transfer a liability

Question 47

What is the Fair Value Option?

Answer 47

The alternative for a business to record its financial instruments at their fair values.

Irrevocable option, applied to entire instrument, applied on an Instrument to Instrument basis

Question 48

How is NAV reported/presented on F/S if its used as a practical expedient to determine fair value?

Answer 48

Separately disclosed in the footnotes of the financial statements - not included in hierarchy

• Alternative investments that are reported at NAV as a practical expedient are NOT categorized in the fair value hierarchy (Level 1, 2, or 3) but are separately reported in the footnotes with disclosures that indicate that NAV is being used and these disclosures must reconcile to the amounts reported on the balance sheet.
• Companies that use NAV as a practical expedient for measuring fair value must disclose sufficient information so that financial statement users understand the nature and the risks of the investment. The disclosure must include information about the terms and conditions in which the company can redeem its investments.

Question 49

Disclosure requirements for Assets and Liabilities That Are Measured at Fair Value on a Recurring Basis?

Answer 49

These disclosures are required for each interim and annual period:

1) For each class of assets/liabilities, the FV measurements either on the B/S or in the FN at the reporting date
2) Segregated into each of the 3 levels of hierarchy
4) If Level 2 or 3, describe the valuation techniques and inputs used and a discussion of changes in valuation techniques during the period, if any
5) If Level 3, must disclose the unobservable inputs, a reconciliation of the beginning and ending balances, separately presenting changes during the period attributable to the following:
a. G/L recognized, showing separately those included in earnings and those included in other comprehensive income, and the line item(s) in which they are recognized in the respective statements
b. Purchases, sales, issuances, and settlements, disclosed separately
c. Transfer in and/or out of Level 3 disclosed separately, the reasons for such transfers
6. If Level 3, a narrative description of the uncertainty of the fair value measurement to changes in unobservable inputs
7. Total G/L for period attributable to the change in unrealized G/L relating to assets and liabilities still held at the reporting date and a description of where those unrealized amounts are reported in the I/S or statement of comprehensive income.
8. For nonfinancial assets, disclose if highest and best use differs from current use and why.

Question 50

Disclosure requirements for Assets and Liabilities That Are Measured at Fair Value on a NONRecurring Basis?

Answer 50

Measured at FV on a nonrecurring basis because that asset or liability is impaired or there is other evidence that FV measurement must be used.

The disclosures are the same as the disclosures on a recurring basis, but, in addition, the following also must be disclosed:

1) The reasons for the measurement and if the measurement estimate is at a date that is not at the end of the reporting period, the entity must disclose the date for the measurement
2) If Level 3, unobservable inputs, a description of the valuation process used and quantitative information about the unobservable inputs used

Other Disclosure Issues
1) Quantitative disclosures must be in a tabular format.

Question 51

Required Disclosures for Interim and Annual Income Statements

Answer 51

• For each line item in the Statement of Financial Position (Balance Sheet), gains and losses from fair value changes included in earnings for the period and in which line in the Income Statement those gains/losses are reported/how were they determined/and reason for changes
• a description of how interest and dividends are measured and where they are reported in the Income Statement

Other Disclosure Requirements
-In annual reports only, the methods and significant assumptions used to estimate fair value (of items for which the fair value option has been elected) must be disclosed.
-If an entity elects the fair value option at the time an investment becomes subject to the equity method of accounting or when it ceases to consolidate a subsidiary, it must disclose:
Information about the nature of the event, and
Where the effect on earnings shows in the Income Statement.

Question 52

Describe how cash flow and present value are used in accounting measurements.

Answer 52

The concepts statement addresses the use of present-value measurements. Like all concepts statements, it does not constitute GAAP but is used in the development of GAAP.

Measurement Issues

1) This Statement addresses only measurement issues, not recognition. The statement applies to initial recognition, fresh-start measurements, and amortization techniques based on future cash flows. A fresh-start measurement establishes a new carrying value after an initial recognition and is unrelated to previous amounts (e.g., mark-to-market accounting and recognition of asset impairments).
2) If the fair value of an asset or liability is available, there is no need to use present-value measurement. If not, present value is often the best available technique to estimate what fair value would be if it existed in the situation.

Present Value Measure—When a present-value measure is used:

1) Result should be as close as possible to fair value if such a value could be obtained.
2) The expected cash flow approach is preferred, because present-value measurements should reflect the uncertainties inherent in the estimated cash flows.

Capture Economic Differences—A present value measurement that fully captures the economic differences between various estimates of future cash flows would include the following:

1) An estimate of future cash flows
2) Expectations about variations in amount or timing of those cash flows
3) Time value of money as measured by the risk-free rate of interest
4) The price for bearing the uncertainty inherent in the asset or liability
5) Any other relevant factors

Two Approaches—The statement contrasts two approaches to computing present value:
**Note - The risk and uncertainty is incorporated into either the discount rate or the cash flows—not both!

1) The traditional approach (referred to as discounted cash flows) incorporates factors 2–5 above in the discount rate and uses a single most-likely cash flow in the computation. The traditional approach uses the interest rate to capture all the uncertainties and risks inherent in a cash flow measure. This is the approach that continues to be applied in some present value applications in financial accounting.
2) The expected cash flow approach uses a risk-free rate as the discount rate. That is, factors 2–5 are incorporated into the risk-adjusted expected cash flow and the discount factor is the risk-free rate.

Question 53

Prepare the sections of a multiple-step income statement (including operating, nonoperating, discontinued operations) from a trial balance and supporting documentation.

*The presentation below income from continuing operations is mandated by U.S. GAAP and is the same regardless of how the top portion is presented.

Answer 53

Company Name
Income Statement
For the Year Ended Dec. 31, 20xx

Sales Revenue 
-Less Sales Returns and Allowances
= Net Sales 
- COGS
=Gross Margin 
- Operating Expenses
=Operating Margin 
\+Other Rev. and Gains
\+/-Unusual or Infrequent Gains and Losses: 
(ex. Casualty Loss, Gain on Real Estate)
= Pretax Income from Continuing Operations 
-Income Tax Expense
=Income from Continuing Operations
\+/- Income from Discontinued Operations
(ex. Results of Operations (net tax), Loss on Disposal of Business Segment) 
=Net Income

Earnings per Share:
Income from Cont. Ops
Income from Discont. Ops
Net Income (per Share)

Question 54

Prepare a single-step income statement from a trial balance and supporting documentation.

*The presentation below income from continuing operations is mandated by U.S. GAAP and is the same regardless of how the top portion is presented.

Answer 54

Company Name
Income Statement
For the Year Ended Dec. 31, 20xx

Revenues and Gains: 
Expenses and Losses:
Unusual or Infrequent Gains and Losses: 
(ex. Casualty Loss, Gain on Real Estate)
= Pretax Income from Continuing Operations 
-Income Tax Expense
=Income from Continuing Operations
*the rest is the same as multi step

Question 55

Difference between Accounting Income and Economic Income

Answer 55

GAAP, takes an objective, arm’s length transaction approach to measurement and recognition, as it is concerned with the RELIABILITY of the info. (uses Accounting Income = Revenue - Expenses plus G/L).
-Acct. Income reflects recorded transactions, events, and adjustments

Economic Income is the change in net worth of a business during an accounting period (aka FV of net assets) =

Beg. FV of NA
\+Net Income (including increases in FV)
\+Owner Investments
-Dividends and Stock Repurchases 
=Ending FV of NA

*the use of FV and other price level changes takes into account the changes in the firm’s assets and liabilities that goes beyond the recording of transactions

Question 56

Prepare a classified balance sheet from a trial balance and supporting documentation.

*only statement dated as of a point-in-time (“As of 12/31/2021”)

Answer 56

Assets = Liabilities - Shareholders Equity

Current Assets (presented in order of liquidity)
LT Assets
ST Liab (presented in order of maturity)
LT LIab
Shareholders' Equity (Statement of Changes in equity usually 3 years):
P/S
C/S
T/S
APIC
RE
AOCI

Question 57

Ratio for liquidity

Important Valuations

Answer 57

1) Current Ratio/Working Capital = CA/CL
2) Quick/acid-test = (Cash + ST Investments + AR)/CL - more rigorous test of liquidity
3) Securities Defensive-Interval Ratio = (Cash + (Net) Receivables + Marketable Securities) / Average Daily Cash Expenditures
4) Times Interest Earned Ratios = (Net Income + Interest Expense + Income Tax) / Interest Expense
5) Times Preferred Dividend Earned Ratio = Net Income / Annual Preferred Dividend Obligation

*Debt to Equity Ratio = Total Liab/Shareholders’ Equity (aka owed vs. owNed)

1) Total OE/Net Assets
2) Market Value of net identifiable assets/”Split up”/Liquidation Value (aka the cash left after selling all identifiable assets/intangibles and paying all liabilities - assets need to be appraised)
3) Total Value of a Firm/Market Capitalization - the total value of the firm’s Outstanding Stock

Question 58

2 types of Owner’s Equity

Answer 58

1) Contributed Capital (CS, PS, T/S)

2) Retained Earnings = Beg. RE - NI - Dividends

Question 59

Common Ratios to analyze the I/S

Answer 59

Gross Margin = Gross Profit/Net Sales
Profit Margin = NI/Net Sales
EPS = NI/WACSO

AR Turnover = (Net) Credit Sales / Average (Net) AR (e.g., Beginning + Ending/2)

# of Days' Sales in Average Receivables = (300 or 360 or 365 (or other measure of business days in a year)) / 
AR Turnover (computed above)

Inventory same formulas - but for turnover use COGS

Operating Number of Cycle = Days in Operating = Number of Days’ Sale in A/R + Length Cycle Number of Days’ Supply in Inventory

Question 60

Prepare a statement of changes in equity from a trial balance and supporting documentation.

Answer 60

Note this is not one of the required F/S under GAAP - it reconciles all of the beginning and ending balances in the equity accounts

3 years are required to be presented - same with I/S and CFs

Company Name
Statement of Changes in Equity
For the Year Ended December 31, 20XX

Format #1
Vertical Columns: Common Stock, Contributed Capital in Excess of Par, AOCI, RE, T/S, Total OE

Horizontal Columns: Beginning Balance, Issued Stock, Issued Stock Dividend, Purchased T/S, Declared cash dividend, Preferred Stock, Contributed capital in excess of par - preferred, Equity attributable to NCI (minority interest), Equity attributable to the shareholders of the parent, Net Income, OCI, Ending Balance

Format #2 Horizontal Ex.

Common stock, Beg Balance
Issued Stock
Issued Stock Dividend
Common stock, Ending Balance

Other Events on the Statement:
Retrospective Change in accounting principle affecting prior earnings - prior period adj
Restatement of I/S for an error affecting prior earnings - prior period adj
Contributed capital from conversion of bonds
Contributed capital from stock options and stock award plans

Question 61

Statement of Cash Flows

Answer 61

Operating Activities
Investing
Financing
Effect of Exchange Rate changes on Cash & Cash Equiv.

Net increase (decrease) during the year
Balance at beginning of the year
Balance at the end of the year

Other Information Required on SCF:

• Effects of foreign currency translation on CFs
• If direct method used, report a recon of accrual NI to CF from operations
• Significant non-cash transactions (must be reported on a supplemental schedule - examples: Purchase of Equip. with a note payable, Settle a liab. by paying with C/S vs. cash)

Question 62

Direct vs. Indirect Method on SCF’s

Answer 62

-Direct Method reports the actual operating cash inflows and outflows in the operating section.
-Indirect Method reports the reconciliation of NI and Net operating cash flow in operating section.
Both lead to “Net Operating Cash Flow”

The other sections are the same for both methods.
Reconciliation is required - so most companies use the Indirect Method.

Question 63

Operating Activities - Direct Method SCF

Answer 63

Directly showing all the cash inflows (these are items that are on the Income Statement (trading securities unrealized g/l on I/S):

• From customers
• Interest income or dividend income (on I/S) - but dividend paid is not on the I/S it is a direct reduction in RE - so that is a Financing Activity
• Sale of debt trading securities

Cash outflows:
-to suppliers, employees, to the government, or interest paid, income taxes, operation expenses, or purchases of debt trading securities

*If you present using the direct method need to present a reconciliation of Net income to net cash provided by operating activities

Ex.
Cash from from operating activities:
Cash Collected from customers $910,000
Less: Cash Payments: To suppliers, employees, operating expense, interest (assumed), Income Taxes
= Total cash Payments
= Net Cash provided by Operating Activities

Question 64

Investing Activities

Answer 64

LT Assets/Investments

Cash Inflows:

• Sale of PPE
• Sale of Debt/Equity Securities of other entities (HFS/AFS)
• Collection of Loan principal (if you finance your products to customers)
• Sale of productive assets (patent/equipment)

Cash Outflows:

• Purchase of PPE/LT Assets
• Purchase of Debt/Equity Securities of other entities (HFS/AFS)
• Lending (others)
• Purchase of other productive assets (e.g., patent or equipment; but not Inventory)

Question 65

Financing Activities

Answer 65

C/S, APIC, notes payable

Cash Inflows:

• From sale of equity securities/own stock
• Proceeds from borrowing (bond/notes)

Cash Outflows:

• To Stockholders as dividends
• To redeem long-term debt
• To re-acquire capital stock (buying treasury stock)

Question 66

What is at the bottom of SCF?

Answer 66

A reconciliation:

Net increase (decrease) of cash during the year
+/- impact of foreign currency translation
Balance at Beginning of year
=Balance at the end of the year

Should tie to the “Cash and cash equivalents” amount on the B/S

Question 67

Reconciliation of Net Cash Flow from Operating Activities with Net Income - Example

Answer 67

Net Income $110,000
Adjustment to Reconcile Net Income to Net Cash provided by Operating Activities:
ADD: Depreciation Expense (or other non cash
expenses found on the I/S) $150,000
ADD: Loss on Equipment Sale 5,000
LESS: GAINS
Undistributed Equity Revenue (28,000)
Amortization of Premium on Bond Investment
3,000
Increase in Accounts Receivable (above) (15,000)
Increase in Inventory (above) (20,000)
Decrease in Prepaid Expense (above) 5,000
Increase in Accounts Payable (above) 10,000
Increase in Expense Payable (above) 15,000
Increase in Unearned Revenues (above)* 25,000
Total Adjustments 150,000
Net Cash Provided by Operating Activities $260,000

Question 68

Significant noncash investing and financing activities must be reported.

Answer 68

Noncash activities must be presented at the bottom of the SCF or in a disclosure

Question 69

Operating Activities - Indirect Method SCF (Accrual Reconciliation)

Answer 69

Have to adjust Net Income by
- adding back non-cash charges (reductions) examples:
Depreciation/Amortization/Depletion Expense
Losses (from sale of assets)
Loss under equity method of accounting for
Investments.
Amortization of premium on bond investment
Amortization of discount on bond payable
Decreases in CA (A/R, Inv, Prepaids)
Increases in CL (A/R, Deferred taxes)
Increases in unearned Rev

• subtracting out non-cash credits (increases) examples:
  Gains (from sale of assets)
  Amort. of discount on bond investment
  Amort on premium on bond payable
  Undistributed income under equity method of
  investments
  Increases in CA
  Decreases in CL
  Decrease in unearned Rev

When using the indirect method, you are taking net income (accrual basis) and converting it to cash basis.
• A change in assets means cash moved in the opposite direction.
• A change in liabilities means cash moved in the same direction.

Question 70

Indirect Method - Additional Disclosures

Answer 70

Payments for Interest

Payments for Income Tax

Question 71

Describe the reason for footnote disclosures.

Answer 71

Disclosures are a key part of the financial statements in that they provide info about assumptions and estimates.

Question 72

List the disclosures required in the footnotes.

Answer 72

Managements’ Discussion and Analysis - discusses operations, liquidity, and capital resources.

• narrative on management’s view of the firm’s financial condition, changes in financial condition, and results of operations through analysis of the financial statements.
• Forward-looking information is provided that is not reflected in the financial statements - future sales, effects of competition, and expected effects of general macroeconomic conditions.

Significant Accounting Policies and how they are applied:

• A company’s revenue recognition policies
• How a company determines what investments are cash equivalents
• How a company prices/values their inventory
• Methods for amortizing intangibles
• The chosen depreciation method
• The basis for consolidation

Other Disclosures:

• During times of price instability, a disclosure is required discussing the effects of the instability on the company’s business.
• Related party transactions: Any significant related party information would be discussed in the notes.
  - The nature of the relationship
  - A description of all related-party transactions
  - $$ amounts of the transactions
  - any receivables or payables from or to related parties
• Concentration of credit risk: If a business and most of its customers/suppliers all operate in the same industry, then a concentration of credit risk needs to be disclosed in the notes.

-Contingent liabilities: Remember that possible liabilities that are not both probable and can be reasonably estimated (if it was both it would be on the balance sheet) would be discussed in the notes instead being accrued on the balance sheet.

• Noncurrent Liability Disclosures:
  - Combined aggregate amount of maturities on
  borrowings for each of the 5 years following the
  B/S
  - Sinking fund requirements
  - The aggregate amount of payments for
  unconditional obligations to purchase fixed or
  minimum amounts of goods or services
  - FV of each financial debt instrument
  - nature of the firm’s liabilities, interest rates, maturity
  dates, conversion options, assets pledged as
  collateral, and restrictions
• Capital Structure Disclosures:
  - Rights and privileges of outstanding securities
  - # of shares issued during the annual fiscal period
  and any subsequent interim period presented
  - Liquidation preference of preferred stock
  - Aggregate or per-share amounts at which
  preferred stock can be called or is subject to
  redemption through sinking fund operations
  - Aggregate or per-share amounts of arrearages for
  cumulative preferred stock
  - Redeemable preferred stock—For each of the five
  years following the balance sheet date, the amount
  of redemption requirements for all types of
  redeemable capital stock must be disclosed in the
  notes to the financial statements.
• Errors and Irregularities—
  Errors are unintentional.
  Irregularities are intentional.
  Both require footnote disclosure.
• Illegal Acts—Examples include illegal contributions and bribes. The Foreign Corrupt Practices Act was passed by the US Congress to discourage such acts. The nature and impact of illegal acts on the financial statements should be disclosed fully in the notes.

Question 73

Explain the scope of the required disclosures and the kinds of risks and uncertainties that are required to be disclosed.

Identify the five areas of required disclosure.

Answer 73

Info on the R&U - enhances the ability of FS users to predict the future CFs and operations of the firm. R&U that are required to be disclosed are limited to matters that materially affect a particular entity.

The required disclosures involve the following sources of risk and uncertainty.

1) Nature of the entity’s operations
2) Use of estimates in financial statements
3) Certain significant estimates
4) Current vulnerability due to significant concentrations in certain aspects of operations
5) Their is substantial doubt about the entity’s ability to exist as a going concern (management’s assessment should be based on facts and circumstances that are “known or reasonably knowable“ as of the date the financial statements are issued.)

Question 74

Define a subsequent event.

Answer 74

Events or transactions that have a material effect on the financial statements. Subsequent events occur after the date of the financial statements but before the statements are issued or are available to be issued.

Question 75

If conditions Existed at the Balance Sheet Date

Requires Recognition?
Disclosure?

Answer 75

• Requires recognition in the financial statements and includes all events that provide evidence about conditions existing at the balance sheet date including estimates used in the process of preparing the statements.
• Disclosure/Footnotes (optional) may be included to supplement and explain the recognition.

Question 76

If conditions Did Not Exist at the Balance Sheet Date

Requires Recognition?
Disclosure?

Answer 76

• Requires only footnote disclosure of events that have material effects on the financial statements (disclosure should include a description of the nature of the event and an estimate of the financial effect, or a statement that an estimate cannot be made).
• NO Recognition because the condition existed after the balance sheet date

Question 77

Calculate the gain or loss on the disposal or involuntary conversion of a plant asset.

Complete the journal entry to record the disposal or involuntary conversion of a plant asset.

Answer 77

The gain or loss is the net proceeds from sale of the component less book value of the component’s net assets. Net proceeds are equal to the gross amount received on sale less the cost to dispose of the assets.

If asset is abandoned/involuntary conversion because asset destroyed - no cash is received and the gain or loss equals the NBV of the asset on the date of the abandonment or conversion. The loss on abandonment or conversion is an ordinary loss and part of continuing operations on the income statement.

Example of JE:
Purchased Asset for $20,000/10yr life on January 1, 20X0.
On July 1, 20X8, sold the asset for $5,000.

*the asset must be depreciated up to the date of the disposal - so first step is to record depreciation:

Dr. Depreciation expense $1,000
Cr. Accumulated depreciation $1,000
(to record 6 months of depreciation in the year of sale — (20,000/10 years) × 6/12)

Dr. Cash $5,000
Dr. Accumulated depreciation $17,000*
Cr. Plant Asset $20,000
Cr. Gain on sale of plant asset $2,000
(to record the gain on the sale of the plant asset)

Question 78

Define what is meant by a “component of an entity.”

Answer 78

A discontinued operation is when a component or group of “components of an entity” are 1) disposed for by sale or other than sale, or classified as held-for-sale, and 2) the disposal “represents a strategic shift that has (or will have) a major effect on an entity’s operation and financial results.“ (ASU 2014-08).

A strategic shift includes the disposal of a major geographical area, a major line of business, a major equity method investment, or other major parts of the entity.

Question 79

Calculate the gain or loss on a discontinued operation.

Answer 79

Ex. 
Component data: 
Assets (net depreciation) = $400
Liabilities = $150 
Amount received on sale = $220
Costs to sell = $20

Book value of net assets = $400 − $150 = $250. Proceeds = $220 − $20 = $200.
Loss on disposal = $250 − $200 = $50.

Question 80

Complete the financial statement presentation of a discontinued operation.

Answer 80

Income from Continuing Operations
Income from DOP
Loss on disposal of DOP
Net Income

The following are separately disclosed and computed in the I/S below “Income from continuing operations:”

1) Income from the discontinued operation (DOP)
2) Gain or Loss—On disposal of the operation.
3) All items reported for DOP are net of tax (after tax).
4) *gain or loss recognized for individual assets is included in income from continuing operations whereas the gain or loss from DOP is reported as discontinued operations below income from continuing operations.
5) Estimated Gain on Disposal not recognized, but actual gains on disposal (when the decision to discontinue the operation and the disposal occur in the same period) are recognized
6) Estimated Loss on Disposal is recognized, when the BV of the net assets of the component exceeds the component’s fair value less cost of disposal at year-end, then the component assets are written down to fair value less cost of disposal. The latter amount (fair value less cost of disposal) is estimated at the end of the year, and the loss is recognized even though disposal or sale has not taken place.

Ex: If the previously recognized estimated loss was $40,000 and the actual loss in the year of disposal was $30,000, then in the year of disposal a $10,000 gain is recognized and reported in the DOP section of the income statement.

Disposal loss or gain is a separate line item in the DOP section of the I/S in addition to the separate operating income of the component during the period. Alternatively, the two amounts can be netted with footnote disclosure showing them both.

The assets are separated from the others in the BS when disposal takes place after the decision to eliminate the component.

Question 81

Disclosures for:

(1) disposals that meet the criteria for a discontinued operation and
(2) individually significant disposals that do not meet these criteria.

Answer 81

2) For disposal of an individually significant component that does not meet the definition of a discontinued operation, the entity must disclose pretax profit or loss reported in the income statement for the period in which the disposal group is sold or is classified as held for sale.

1) For a disposal that meets the criteria of a discontinued operation the entity must disclose the following:
- Fact and circumstances leading to the disposal and reasons for the strategic shift and the effect of the strategic shift on operations
- For the initial period in which the disposal group is classified as held for sale and for all prior periods presented in the statement of financial position, a reconciliation of (1) TA and TL of the discontinued operation that are classified as held for sale in the notes to the financial statements to (2) TA and TL of the disposal group classified as held for sale that are presented separately on the balance sheet
- Operating and investing cash flows for the periods for which the discontinued operation’s results of operations are reported in the income statement
- Depreciation and amortization, capital expenditures, and significant operating and investing non-cash items for the periods for which the discontinued operation’s results of operations are reported in the income statement
- Entities that have significant continuing involvement with a discontinued operation after the disposal date must provide additional disclosures regarding the nature of activities, including cash flows from or to the discontinued operation.

Question 82

Types of Exit or Disposal Activities

Answer 82

1) those disposals that occur in the normal course of business that are disposals of individually insignificant assets,
2) disposals that meet the criteria of a discontinued operation, and
3) individually significant disposals that do not meet the criteria of a discontinued operation.

Question 83

Calculate and interpret profitability ratios.

Answer 83

1) Profit Margin (on Sales) = Net Income / (Net) Sales
2) Return on Total Assets = (Net Income + (add back) Interest Expense (net of tax effect)) / Average Total Assets
3) Return on Common Stockholders’ Equity = (Net Income—Preferred Dividend (obligation for the period only)) / Average Common Stockholders’ Equity (e.g., (Beginning + Ending)/2)
4) Return on Owners’ (all Stockholders’) Equity = Net Income / Average Stockholders’ Equity (e.g., (Beginning + Ending)/2)
5) EPS—Basic Formula = (Net Income—Preferred Dividends (obligation for the period only)) / Weighted Average Number of Shares Outstanding
6) Price-Earnings Ratio (P/E Ratio) = Market Price for a Common Share / Earnings per (Common) Share (EPS)

7) Common Stock Dividends Pay Out Ratio
Total Basis = Cash Dividends to Common Shareholders / Net Income to Common Shareholder

8) Per Share Basis = Cash Dividends per Common Share / Earnings per Common Share
9) Common Stock Yield = Dividend per Common Share / Market Price per Common Share

Question 84

Calculate and interpret equity ratios.

Answer 84

1) Debt to Equity Ratio =
Total Liabilities / Total Shareholders’ Equity

2) Owners’ Equity Ratio =
Shareholders’ Equity / Total Assets

3) Debt Ratio = Total Liabilities / Total Assets

4) Book Value per Common Stock =
Common Shareholders’ Equity / Number of Outstanding Common Shares

5) Book Value per Preferred Share = Preferred Shareholders’ Equity (including dividends in arrears) / Number of Outstanding Preferred Stocks

Question 85

What accounting methods can a parent use to carry an investment in a subsidiary on its books?

Answer 85

A Parent records a subsidiary on its books as an investment (in Subsidiary), using one of the following methods:
Cost method;
Equity method;
Any other method it chooses.

Method chosen will not affect final resulting Consolidated Statements

Question 86

When are consolidated financials required?

Answer 86

Consolidated financials are required when one entity has effective control over another entity.

1) Controlling interest is usually present when an entity (investor/parent) has a greater than 50% ownership (directly or indirectly) of another entity (investee/subsidiary) and, therefore, can direct the activities of the investee/subsidiary; or
2) Control is also evident when an entity (variable-interest holder) is the principal beneficiary of a variable-interest entity.

In either of the foregoing cases, the entities are separate legal entities, but are under common economic control.
The shareholders of the parent entity control that entity, which, in turn, has control of the subsidiary entity.
The shareholders of the variable-interest holder entity control that entity, which, in turn, has control of the variable-interest entity.

Because the entities are under common economic control, GAAP requires consolidated financial statements.

Question 87

What are the information requirements to consolidate financials of 2 or more entities?

Answer 87

1) Financial statements (or adjusted trial balances) of the separate affiliated entities to be consolidated
2) Data as of the date of a business combination (i.e., acquisition date):
- Book values of assets acquired and liabilities assumed as of the acquisition date
- Fair values of assets acquired and liabilities assumed as of the acquisition date
- Fair value of any NCI interest in the acquired entity as of the acquisition date
- Fair value of any equity interest in the acquired entity owned by the parent prior to the acquisition date
3) Intercompany (i.e., between the companies being consolidated) transaction data (for the operating period) and intercompany balances (as of period end)

Question 88

Where is the consolidating process is carried out?

List the basic sequence of steps used in carrying out the consolidating process.

Answer 88

Consolidating Process is carried out on a consolidating worksheet, not on the books of any entity.

The basic information for the worksheet comes from the account balances of the separate entities.

The consolidating process is primarily concerned with adjusting and eliminating those balances to develop information that would report the separate entities as though they were a single entity.

The basic sequence of steps in carrying out the consolidating process are (each of these requirements is covered in detail in the following lessons):
1) Record trial balances—Record account titles and balances of the separate entities on the consolidating worksheet from the adjusted trial balances, separate statements, or other sources.
2) Record adjusting entries—Develop and post to the worksheet consolidating adjusting entries, if any.
3) Record eliminating entries—Develop and post to the worksheet consolidating eliminating entries; these entries are likely to include:
Investment eliminating entry (always required)
Intercompany receivables/payables elimination(s)
Intercompany revenue/expense elimination(s)
Intercompany profit elimination(s)
Complete consolidating worksheet.
4) Prepare formal consolidated financial statements from worksheet.

Question 89

Identify the specific circumstances that affect how the consolidating process is carried out.

Answer 89

The following alternatives will affect the specific adjustments and eliminations made during the consolidating process:

• Is the consolidation process being carried out at the date of the business combo or subsequent date?
• Does the parent owns 100% (all) of the voting stock of a subsidiary or less than 100% of the voting stock?
• Whether on its books the parent carries its investment in a subsidiary using the cost or equity method of accounting
• Whether transactions between the affiliated entities (parent and its subsidiaries) originate with the parent or with a subsidiary