F10 Flashcards
Fair Value
is the price that would be received to sell an asset or paid to transfer a liability at the measurement date under current market conditions
- exit price*
- market based measure, not entity based
- does not include transactions costs, EXCEPT used to calculated most advantageous market (but not included in FV measurement)
- includes transportation costs, but not transaction costs
~
- FV of liab should include nonperformance risk
Orderly Transaction
asset or liab exposed to market for period before measurement date long enough to allow for marketing activities that are usual and customary
- cannot be a forced transaction
Principal Market
market w greatest volume or level of activity for the asset or liab
- 1st option even if more advantageous market available
Most Advantageous Market
market w best price for asset or liab, after considering transaction costs
- use transaction costs to determine most advantageous market, but not included in FV measurement
- 2nd option if no principal market
Highest and Best Use
applies to Nonfinancial Assets
- doesnt apply to Liabilities and Financial Assets
Valuation Techniques
FV Measurement Framework
should be appropriate and should maximize use of observable inputs and minimize use of unobservable inputs
- change in valuation technique is change in accounting estimate
- Market Approach
- uses prices and other relevant info from comparable market transactions to measure FV
- can be used for assets or liabs - Income Approach
- PV discounted cash flows - Cost Approach
- current replacement cost to measure FV of assets
Hierarchy of Inputs
FV Measurement Framework
if multiple levels (1, 2, 3) are used, FV is classified as “lowest level” used- the weakest link
- Level 1
- quoted prices in active market for identical assets or liabs as of measurement date
- identical items - Level 2
- other that quoted market prices that are directly or indirectly observable for the asset or liab
- similar items
- identical items not in active markets - Level 3
- unobservable inputs for asset or liab
- assumptions based on best available info
- used only when no observable inputs or when undue cost and effort is required to obtain observable
- discounted cash flows
Admission of a Partner
Partnerships
- By Purchase or Sale of Existing Partnership Interest
- consent of all partners
- no JE, just change of name on capital acct - Formation of a Partnership
- assets are valued at FV (tax uses NBV), net of any related liabilities
- liabilities recorded at PV - Creation of a New Partnership Interest w Investment of Add. Capital
- total capital of partnership changes and purchase price can be equal to, more than, or less than book value
a) Exact Method
- when purchase price = book value of capital acct, no goodwill or bonuses are recorded
- old partners’ capital acct “dollars” stay the same, just % ownership changes
- *finger math? (get 1/4 = 4 - 1 = divide by 3)
b) Bonus Method
- when purchase price is more or less than book value of capital acct purchased
- bonuses are adj. b/w old and new parters’ capital accts and do not affect partnership assets
- recognize intercapital transfers
1. determine total capital and interest to new partner
2. if interest is less than amt contributed, bonus to old partners
3. if interest is more than amt contributed, bonus to new partner
c) Goodwill Method
- goodwill recognized based on total value of partnership implied by new partner’s contribution
1. compute new “net assets before GW” before goodwill after admitting new partner
2. memo: compute new “capitalized” net assets and compare w net assets before GW
3. difference is “Goodwill” to be allocated to old partners according to partners profit ratios
Profit and Loss Distribution
Partnerships
interest on capital, salaries, and bonuses are deducted from total profit before profit and loss distributions
- provided for in full, even in loss situation
Withdrawal of a Partner
Partnerships
- Bonus Method
- bonus = diff b/w balance of capital acct and amt the person paid
- bonus allocated among remaining partners’ capital accts in accordance w remaining profit and loss ratios
- partnership’s identifiable assets may be revalued to FV at date of withdrawal, but any goodwill implied by excess payment to retiring partner is NOT recorded - Goodwill Method
- may elect to record implied goodwill in partnership based on payment to withdrawing partner
- amt of implied goodwill is allocated to ALL partners in accordance w profit and loss ratios
- get him to exact amt of buyout
Liquidation of a Partnership
Partnerships
Order of Preference for Distribution of Assets
- Creditors, including partners who are creditors
- Partner’s Capital
Losses Consideration
- all possible losses must be provided for in a liquidation before any distribution is made to partners
- losses in accordance w partnership agreement, if none then equally
Convert Noncash Assets
- all liabs are paid, and if any remainder distribute to partners
Gain or Loss on Realization
- liquidation may result in: gain on realization, loss, or loss resulting in capital deficiency
Capital Deficiency
- a debit balance in partner’s capital acct indicating partnership has claim against partner for amt of deficiency
1. Right of Offset - if partner w capital deficiency has a loan account (partnership has payable to partner), can offset to satisfy capital deficiency
2. Remaining Partners Charged - if deficiency still exists, remaining partners must absorb according to respective remaining profit and loss ratios
Variable Interest Entities
consolidation required (even if comp owns no stock) if 3 conditions met
- variable interest
- we have financial stake in another company
- most liabilities, excluding ST payables (accts payable), represent variable interests* - Variable Interest Entities (VIEs)
- either does not have equity investors w voting rights or lacks sufficient financial resources to support activities
- equity/characteristics are strange - Primary Beneficiary
- has power to direct activities and get profits and losses (not all but some)
- the entity required to conslidate the VIE
- first identify whether to consolidate under VIE, then if meets 50%+ sub
- Identifying a Variable Interest in a Business Entity
Variable Interest Entities
company has variable interest when all are met:
- Company and Business Entity Have an Arrangement
- financial stake in another company
- F10-16 - Business Entity is a Legal Entity
- Business Entity Fails to Qualify for Exclusion
- nonprofit, employee benefit plans, registered investment comp, separate accts of life insurance companies, gov. orgs - Interest is more than Insignificant
- Comp has Explicit or Implicit Variable Interest in Entity
- absorb portion of business entity’s losses or
- receive portion of residual returns
- Business Entity is a Variable Interest Entity
Variable Interest Entities
VIE if following characteristics
- company’s equity characteristics are strange: didn’t put in money, get the gains and losses
- Insufficient Level of Equity Investment at Risk
- needs outside financial support for activities - Inability to Make Decisions or Direct Activities
- equity holders dont have power to direct activities that most significantly impact economic performance - No Obligation to absorb’s entity’s Expected Losses
- No Right to Receive Expected Residual Returns/Profits
- Disproportional Voting Rights
- entity is automatically deemed to be VIE when all 3 conditions are present:
1) substantially all activities of the entity are conducted on behalf of an equity investor or involving an equity investor
2) voting rights of that equity investor are small in comparison w focus of the equity on that investor and
3) voting rights of 1 or more equity investors, including that equity investor, are out of line w investor’s obligation to absorb expected losses, the investor’s right to receive expected residual returns, or both
- Primary Beneficiary Consolidates
Variable Interest Entities
company is primary beneficiary if it has power to direct activities of a VIE that most sig. impact the entity’s economic performance and:
- absorbs expected VIE losses or
- receives expected VIE residual returns/profits
- if one part receives profits and another absorbs losses, party that absorbs losses consolidates
- it’s possible for an entity to be a VIE, but no primary beneficiary so no consolidation
IFRS SPE*
Variable Interest Entities
IFRS focuses on accting for special purpose entities, a specific type of VIE created by a sponsoring comp to hold assets and liabs, often for structure financing purposes
- under IFRS, sponsoring comp controls and must consolidate an SPE when:
1. benefited by SPE’s activities
2. has decision-making powers
3. absorbs risks and rewards
4. has residual interest
Private Company Accounting Alternative
Variable Interest Entities
under GAAP, a private comp may elect to aply accounting alternative for consolidation of a VIE for common control lease arrangements if all 4 are met:
- lessee and lessor are under common control
- lessee has leasing arrangement w lessor
- substantially all activities b/w lessee and lessor are related to leasing activities
- lessee explicitly guarantees or collateralizes any obligation of the lessor, then the principal amt of the obligation at inception of such guarantee or collateral agreement doesn’t exceed value of asset leased by private comp from lessor
- elected by lessee and applies to all current and future leasing arrangements
- applied using full retrospective approach to all periods presented
- disclosures required
Asset Retirement Obligations (AROs)
ARO Recognition when meet def. of a liability:
- duty or responsibility
- little or no discretion to avoid
- obligating event
Initial Measurement
- Asset Retirement Obligations (ARO)
- fair value: PV
- liability
- if reasonable estimate of FV cannot be made, liab and asset are recognized when it can be
- *IFRS, ARO is called decommissioning liability- initially measured at best est. of expenditure required to settle the obligation - Asset Retirement Cost
- amt capitalized (asset) that increases carrying amt of the asset when liab. ARO is recognized
- dr: asset retirement cost, cr: asset retirement obligation
Subsequent Measurement
- Accretion and Depreciation
- Accretion Expense: “interest expense” every year on ARO
- dr: accretion expense (IS), cr: ARO (liab. inrease)
- Depreciation Expense: every year decreases ARC asset
- dr: depreciation expense (IS), cr: accum. depr (ARC)
- cumulative accretion expense + cumulative depr expense = ARO
- * use credit-adjusted risk free interest rate - Revision to Cash Flow Estimates
- changes in value of the liab after the property has been fully depreciated will be recognized in profit or loss*
- upward revisions are new liabilities- use current discount rate
- downward revisions are removal of old liabilities- use historical (or weighted avg) discount rate
- *IFRS, decommissioning obligation is remeasured each period for changes in amt, timing of cash flows, and changes in disc. rate
- GAAP, obligation is only adjusted for changes in amt or timing of cash flows
ARO Accounting and Leases
- Lessees
- if ARO is included in min. lease payments, no separate ARO accting req.
- ARO is imposed otherwise, ARO accting applies - Lessors
- ARO accting applies
Troubled Debt Restructurings
creditor allows debtor certain concessions to improve likelihood of collection that would not be considered normally
- reduced interest rates, extension of maturity dates, reduction of face amt, etc
- often result of legal proceedings or negotiation
Accounting and Reporting by Debtor
Troubled Debt Restructurings
Transfer of Assets
- ordinary gain/loss on: FV asset transfer - NBV asset transferred
- recognized ordinary gain on: carrying amt of payable - FV asset transferred = gain
- gain on amt of debt discharged
Transfer of Equity Interest
- recognize gain: carrying amt of payable - FV asset transferred
- gain on amt of debt discharged
Modification of Terms
- debtor usually accounts for effects of restructuring prospectively
- when total future cash payments < carrying amt, debtor should reduce carrying amt and recognize difference as a gain
Accounting and Reporting by Creditor
Troubled Debt Restructurings
Measurement of Impairment
- Receipt of Assets or Equity
- accounted for at FV at time of restructuring
- excess of recorded receivable over the FV of asset received is recognized as an ordinary loss - Modification of Terms
- use PV of expected future cash flows discounted at historical effective interest rate (or market rate if more readily available)
- any costs to sell should be estimated and reduce cash flows
- impairment recorded by creating a valuation allowance w corresponding charge to bad debt expense
(dr: bad debt expense, cr: allowance for credit losses)
*^ those are for if foreclosure is not probable, but if it is probable then impairment must be measured using FV of collateral (1) hw
Exceptions
- troubled debt restructuring accting by creditors does not apply to
- groups of loans collectively evaluated for impairment
- loans measured at market value
- leases
- held to maturity debt securities
Debt Covenants
creditors use debt covenants in lending agreements to protect their interest by limiting or prohibiting actions of debtors
common debt covenants
- limitations on issuing add. debt
- restrictions on payment of dividends
- limitations on disposal of certain assets
- min. working capital requirements
- collateral requirements
- limitations on how borrowed money can be used
- maintenance of specific financial ratios
Violation
- when violated, debtor is in technical default and creditor can demand repayment
- most of the time concessions are negotiated and real default is avoided
- concessions can result in violated covenants being waived and change in interest rate or other terms of debt
Debt Covenants
creditors use debt covenants in lending agreements to protect their interest by limiting or prohibiting actions of debtors
common debt covenants
- limitations on issuing add. debt
- restrictions on payment of dividends
- limitations on disposal of certain assets
- min. working capital requirements
- collateral requirements
- limitations on how borrowed money can be used
- maintenance of specific financial ratios
Violation
- when violated, debtor is in technical default and creditor can demand repayment
- most of the time concessions are negotiated and real default is avoided
- concessions can result in violated covenants being waived and change in interest rate or other terms of debt