CPA FAR - In My Words - Set3

Question 1

Calculating depletion amount
(Per ton of coal—Using mine and tons of coal as an example)

Answer 1

Add the cost of preparing the mine AND the purchase price together THEN subtract the amount that the property will be sold for at the end of the useful life THEN divide that number by the estimated number of tons of coal

Question 2

What happens to the interest expense when calculating a firms diluted earnings per share, if the firm has convertible bonds that are dilutive

Answer 2

The interest expense (net of the tax effect) is added back to the net income!

• Example: if the convertible bonds had an interest expense of $100,000 and the tax rate was 25% then $75,000 would be added back to the net income as part of the calculation

Question 3

The underlying concept that governs gain contingencies under GAAP is

Answer 3

The rationale for accounting for contingencies according to Accounting Standards Codification (ASC) Topic 450, Contingencies, includes reflecting conservatism in the reporting of transactions

This means that losses should be recognized immediately (if probable and reasonably estimable), but gains recognized only when realized. Applying conservatism in the reporting of transactions prevents assets and/or net income from being overstated

Thus, when selecting accounting principles in accordance with US GAAP, the method that is less likely to overstate assets and understate liabilities should be chosen according to the rule of conservatism

Question 4

What should a company use to account for a contingent liability when the loss is probable but not reasonably estimated?

Answer 4

The liability should only be disclosed in the notes to the financial statements.

• Contingent losses on purchase commitments are recorded as a liability in the period the expected loss is identified if the loss is both probable and estimable.
• If the liability is probable but not estimable, the liability is not accrued in the financials, though footnote disclosure would be needed.

Question 5

Contingent gains

Answer 5

GAAP does not recognize any estimated future gain relating to an asset until the gain has actually occurred. The estimated contingent gain should only be noted in the comments of the financial statements.

The estimated contingent gain should be noted in the comments of the financial statements and only recognized when occurs.

• Using the principle of conservatism, GAAP says to never recognize contingent gains until they are realized though disclosure is required.

Contingent gains:
*Record only when realized
*Disclosure is required

Question 6

Valuation techniques for fair value

Answer 6

Fair value estimates estimate the value of an asset or liability using three approaches:

*market approach using market-based assumptions
*the cost approach, which estimates the replacement cost of an asset.
*the income approach estimates projected income via the present value of future cash flows.

The most common method for estimating fair value is the market approach, which uses quoted prices from similar or identical assets in active markets. However, if a market for the particular asset is not active, then other techniques may be used.

-Summary-
Market: value of the market price
Income: value using projected income
Cost: cost to replace the asset

Question 7

What would be the condition that must be present for a contract modification to be accounted for as a separate contract

Answer 7

The scope of the original contract increases when you add distinct goods or services.

-The scope of the original contract increasing through the addition of distinct goods or services is a justification for a contract modification to be accounted for as a separate contract

Question 8

Gem of the question for contract modifications

Answer 8

Multiple performance obligations in a contract:

*E.g., contract includes equipment, installation service, training service
*Each obligation allocated a portion of the total transaction price

Revenue recognition for separate performance obligations: Identify elements in a contract that has:
*Its value on a standalone basis
*Can be sold separately

Contract modification:

If additional goods or services are distinct from the original contract and consideration reflects standalone prices:
- Will not affect the accounting for the original contract

If additional products or services covered are the same as original contract:
- Use prospective approach

Question 9

Changing from one accounting method to another - how should the cumulative effect of change in accounting principle be reported?

Answer 9

The cumulative effect adjustment is recognized by adjusting beginning retained earnings, net of tax. (increase to beginning retained earnings balance)

Question 10

What would be reported as adjustments to the beginning balance­ of retained earnings for the earliest period presented?

Answer 10

• Correction of an error in a period that is not being presented
• Cumulative effect of a change in inventory from FIFO to weighted average

FYI:
- Correction of an error from a prior period is reported as a prior period adjustment, and as a result, an adjustment is made to the opening balance of retained earnings for the earliest period presented.

• The cumulative effect of a change in accounting principle is shown as an adjustment to beginning retained earnings for the earliest period presented.

Question 11

Cost of goods available for sale: for inventory methods

Answer 11

Note that cost of goods available for sale would be identical regardless of using LIFO, FIFO, or average cost. Cost of goods available for sale would be identical using perpetual or periodic inventory.

Question 12

Periodic method: journal entry for making a purchase and doing a return

Answer 12

Example- bought inventory for $10,000 on account

Purchases 10,000 (DR)
Accounts payable 10,000 (CR)

*Returning inventory
Accounts payable 10,000 (DR)
Purchases 10,000 (CR)

Question 13

Perpetual method: journal entry for making a purchase and doing a return

Answer 13

Example- bought inventory for $10,000 on account

Inventory 10,000 (DR)
Accounts payable 10,000 (CR)

*Returning inventory
Accounts payable 10,000 (DR)
Inventory 10,000 (CR)

Question 14

PPE Impairment

Answer 14

1. If undiscounted future cash flows are less than carry value (CV), an impairment loss must be recognized
2. Calculate impairment loss:
   a. Difference between FV or PV of future cash flows (fair value) and the net CV = impairment loss to be recognized
   b. Write down to fair value
   c. Depreciate new cost
   d. Restoration not permitted

Question 15

Which of the following is considered nonmonetary rather than monetary?

• Equipment
• Accumulated depreciation-equipment (contra account)

Answer 15

BOTH!!

• Equipment is a nonmonetary asset. Nonmonetary assets fluctuate in value; they are not fixed like cash and receivables are.

Nonmonetary assets include equipment, buildings, inventory, common and preferred stock investments, patents, and trademarks.

• A contra account is classified as monetary or nonmonetary based upon the classification of the related account. Equipment is nonmonetary; therefore, accumulated depreciation-equipment is nonmonetary also.

A contra account is classified as monetary or nonmonetary based upon the classification of the related account.

Question 16

Periodic inventory system

Answer 16

A periodic inventory system is an accounting system in which the inventory of a business is counted and recorded only at specific intervals. The most common type of periodic inventory system is the physical count method, in which the physical quantity of each item on hand is counted and recorded.

The company does not know what they have in inventory until the end of the period.

When the company purchases inventory they would debit purchases and credit AP or cash. At the end of the period, they can figure out the cost of goods sold (COGS).

Debit ending inventory (asset) by counting it. This is the inventory still in stock. And they would credit purchases to reverse the inventory purchases account at COST.

COGS would be the plug at the end of the period as it would represent the COST of the items sold in the period. So, under the periodic method, COGS is only known at the end of the period.

Question 17

Perpetual inventory system

Answer 17

A perpetual inventory system is an accounting system in which the inventory of a business is continually updated as items are bought and sold. The most common type of perpetual inventory system is the computerized method, in which each sale and purchase is recorded by the computer.

When the company purchases inventory, they debit inventory (not purchases) and credit accounts payable (AP) or cash.

When they sell the inventory, they record two entries:

1) debit accounts receivable (AR) or cash and credit revenue for the SALE price and

2) debit COGS and credit inventory for the COST.

So, under the perpetual method, COGS is known at the date of sale.

Question 18

In addition to LIFO and FIFO costing methods there are two “average methods” for inventory cost of goods sold:

Answer 18

Weighted average uses the periodic method. Tally all the purchases during the period at cost divided by the units purchased during the period. Multiply by units sold.

Moving average uses the perpetual method. Tally cost of goods sold (cost/units) prior to each sale. Multiply by units sold.

Question 19

If cash dividends are paid from a company’s earnings, how will an investor’s investment account be affected by the dividends under the fair value method vs equity method?

Answer 19

*No effect under the fair value method and decrease the investment account under equity method

Under the FV method, dividends are income to the investor and does not effect the investment account

Under the equity method , dividends paid from current earnings will reduce the investor’s investment account in the company

Question 20

Under US GAAP, nonmonetary exchanges that lack commercial substance could possibly result in which of the following NOT being recognized immediately?

-Losses
-Gains

Answer 20

• Gains

Under US GAAP, nonmonetary exchanges that lack commercial substance could possibly result in a portion of the gain being deferred.

If the exchange is said to lack commercial substance and the amount of cash received in the transaction is less than 25% of the total consideration received, then a proportional amount of the gain is recognized.

Question 21

A company uses a periodic inventory system and has its cost of ending inventory understated by $4,000. What’s the effect of this error on the company’s current year’s cost of goods sold and net income, respectively?

Answer 21

The formula for COGS is: beginning inventory plus purchases less the physical count of ending inventory.

COGS = BEG + PUR − END

Based on this formula if ending inventory is undervalued, COGS is overstated. And the inverse is true when ending inventory is overvalued then COGS is understated

Now COGS is a cost that lowers net income. If COGS is too high, income will be too low.

Gem of the question
Knowing these COGS formulas and relationships is the key to this question!

COGS = BEG + PUR − END
COGS and ending inventory are affected inversely.
COGS and income are affected inversely.

Question 22

Capitalized Interest

Answer 22

The amount of capitalized interest is the lower of actual interest cost incurred or computed capitalized interest.

Compute the capitalized interest by multiplying the appropriate interest rate by the weighted average accumulated expenditures. If the weighted average calculated amount does not exceed the total interest cost incurred, the amount calculated is capitalized.

Question 23

Misc info:
Purchase returns and freight in
(figuring out COGS)

Answer 23

Beg inventory + purchases - purchase returns + freight in = Total available for sale - Ending inventory = COGS

Question 24

Recording Inventory:

Answer 24

Recording Inventory:

*FOB Shipping: considered a sale, title transfers when inventory is shipped out
*FOB Destination: considered a sale, title transfers when inventory is received
*Consignee: does not record consigned inventory on their books
*Consignor: records consigned inventory on their books

Consignment is the arrangement of consigning goods (from consignor) to someone else’s care (consignee) with the agreement that the consignee will purchase the goods only upon sale to a third party.

While the goods are consigned, the consignor has ownership but is not in possession. The consignee does not book the consigned inventory until sold to a third party. Inventory remains on the consignor’s sub-ledger until sold.

Example:
Goods held on consignment by Super Toy Store, not included: 75,000 in inventory on hand

Super Toys (consignee) does not include items they hold on consignment $75,000 in their inventory.

Question 25

Pledging Accounts Receivable

Answer 25

*Rights to receivables are not delivered as collateral
*Accounts Receivable is not reclassified
*Accounting for the receivables or the loan is not affected by the pledge
*Receivables transferred to a trustee used to pay the loan in case of default
*Cash flows from the receivables are used to pay the loan.
*Footnote disclosure of the pledge is required.

Additional Info:
Pledging accounts receivable is when the rights to specific receivables are not delivered as loan collateral, and the accounts receivable are not reclassified.

Accounting for the receivables or the loan is not affected by the pledge. The receivables are transferred to a trustee, and they can be used to pay the loan in case of default by the borrower (the original creditor for the accounts receivable). The cash flows from the receivables are used to pay the loan. Footnote disclosure of the pledge is required.

Question 26

SEC Reporting deadlines

Answer 26

10K
Large accelerated $700mm+ in assets: 60 days
Accelerated $75mm+ in assets: 75 days
Small <$75mm in assets and <$100 in revenue: 90 days

10Q
Large accelerated: 40 days
Accelerated: 40 days
Small: 45 days
8K - 4 days

Question 27

Government uses three categories of funds:

Answer 27

(1) Governmental (budgetary) - modified accrual; current financial resources

5 governmental funds
-General (catch-all, licenses, fees, permits)
-Special revenue (earmarked for gas tax, tolls)
-Capital projects (construction-related, proceeds from bonds or grants)
-Debt Service (for principal and interest of bonds)
-Permanent (endowment doesn’t spend the principal, just the interest)

(2) Proprietary (operations) - accrual; economic resources

2 proprietary funds:
-Enterprise fund (run like a regular business)
-Internal service fund (purpose for inside the government)

(3) Fiduciary (as trustee) - accrual; economic resources
4 Fiduciary funds

Question 28

Which of the following funds is a proprietary fund?

A. General fund
B. Permanent fund
C. Enterprise fund
D. Special revenue fund

Answer 28

C. Enterprise fund

An enterprise fund is one of the proprietary funds. Proprietary funds include activities of a government that have a user charge (such as a bus system or a municipal airport).

A proprietary fund such as an enterprise fund uses fund accounting but also uses accrual accounting, almost like a for-profit business. A fund set up as a proprietary fund has an actual profit motive.

Net income is a measurement focus of a proprietary fund. Other than the fact that they use fund accounting and for-profit companies do not, proprietary funds are accounted for much like a for-profit business using the full accrual method of accounting.

Question 29

Accrual accounting VS modified accrual accounting

Answer 29

Under accrual accounting, all assets and liabilities appear on the balance sheet for proprietary funds. This is different than accounting for governmental type funds, which follow modified accrual accounting.

Under modified accrual accounting, only current assets and current liabilities appear on the balance sheet for governmental funds in the fund-based financial statements.

Question 30

Internal service fund

Answer 30

An internal service fund is a type of proprietary fund in which the services are provided to other agencies of the local government for a fee on a cost reimbursement basis, but the internal service fund typically does not offer those same services to the public.

(purpose for inside the government)

An example of an internal service fund would be a motor pool to store township cars. Proprietary funds use the full accrual basis of accounting and the economic resource focus, as opposed to the financial resource focus.

All assets and liabilities are included in the fund-based financial statements of an internal service fund, not just the current assets and current liabilities.