F2 - Financial Reporting & Disclosures

Question 1

Summary of Significant Accounting Policies

Answer 1

Focuses on measurement bases used in preparing the financial statements. Specific accounting principles and methods used during the period including:

• Basis of consolidation
• Depreciation methods
• Amortization of intangibles
• Inventory pricing
• Use of estimates
• Fiscal year definition
• Special revenue recognition issues (e.g., long-term construction contracts, franchising, leasing operations, etc.)

Question 2

Fair Value Defined

Answer 2

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the principal (or most advantageous) market at the measurement date under current market conditions.

• FV does NOT include transaction costs but may include transportation costs if the location is an attribute of the asset or liability.
• FV is an EXIT price (the price to sell an asset or transfer a liability), not an entrance price (the price to acquire an asset or assume a liability).

Question 3

Hierarchy of Inputs

Answer 3

Level 1 Inputs = Quoted prices in active markets for identical assets or liabilities that the reporting entity has access to on the measurement date.

Level 2 Inputs = Inputs other than quoted market prices (Level 1) that are directly or indirectly observable for the asset or liability. These include: Quoted prices for similar assets or liabilities in active markets; Quoted prices for identical or similar assets in markets that are not active. Inputs other than quoted prices that are observable for the asset or liability.

Level 3 Inputs = Unobservable inputs for the asset or liability. Unobservable inputs reflect the reporting entity’s assumptions and should be based on the best available information.

Question 4

Market Approach (FV Valuation)

Answer 4

Uses prices and other relevant information from market transactions involving identical or comparable assets or liabilities to measure fair value.

Question 5

Income Approach (FV Valuation)

Answer 5

Converts future amounts, including cash flows or earnings, to a single discounted amount to measure fair value.

Question 6

Cost Approach (FV Valuation)

Answer 6

Uses current replacement cost to measure the fair value of assets.

Question 7

Principal Market

Answer 7

The market with the greatest volume of activity for the particular asset for which FV is being determined.

Question 8

Most Advantageous Market

Answer 8

The market offering the best price after subtracting transaction costs.

Question 9

“Major” Customers (Segment Reporting Disclosure)

Answer 9

An entity that generates 10% or more of its revenue from sales to a single customer must disclose that fact, the total amount of revenues from each such customer, and the identity of the segment or segments reporting the revenues.

The identity of the major customer need not be disclosed.

Question 10

Form 10-K

Answer 10

A form that must be filed ANNUALLY by U.S. registered companies (issuers). The filing deadline for the form 10-k is:

• 60 days for large accelerated filers,
• 75 days for accelerated filers,
• 90 days for all other registrants.

These forms contain financial disclosures, including a summary of financial data, management’s discussion and analysis (MD&A), and audited financial statements prepared using U.S. GAAP.

Question 11

Form 8-K

Answer 11

Filed to report MAJOR CORPORATE EVENTS such as:

• corporate asset acquisitions or disposals,
• changes in securities and trading markets, changes to accountants or financial statements,
• changes in corporate governance or management.

Question 12

Form 10-Q

Answer 12

A form that must be filed QUARTERLY by U.S. registered companies (issuers). The filing deadline for the form 10-Q is:

• 40 days for large accelerated filers,
• 45 days for accelerated filers,
• 45 days for all other registrants

These forms contain unaudited financial statements prepared using U.S. GAAP, interim period management’s discussion and analysis (MD&A), and certain disclosures.

Question 13

CPA-00237: During the second quarter, Buzz Company sold a piece of equipment at a $12,000 gain. What portion of the gain should Buzz report in its income statement for the second quarter?

Answer 13

RULE: The entire amount of the gain or loss from the sale of a fixed asset should be reported during the period (quarter) incurred.

Question 14

Form 6-K

Answer 14

A form filed semiannually by foreign private issuers. This form is similar to the Form 10-Q and contains unaudited financial statements, interim period MD&A, and certain disclosures.

Question 15

Forms 3, 4, and 5

Answer 15

These forms are required to be filed by directors, officers, or beneficial owners of more than 10% of a class of equity securities of a registered company.

Question 16

Forms 20-F and 40-F

Answer 16

These forms must be filed annually by foreign private issuers. Form 40-F is filed by specific Canadian companies registered with the SEC and Form 20-F is filed by other non-U.S. registrants. These forms are similar to Form 10-K and contain financial disclosures, including a summary of financial data, MD(and)A, and audited financial statements.

Question 17

OCBOA Converting Cash Basis to Accrual Basis

Answer 17

• A decrease in PREPAID interest is added when calculating accrual basis interest expense because a decrease in prepaid interest expense increases interest expense.
• A decrease in interest PAYABLE is subtracted when calculating accrual basis interest expense because a decrease in interest payable implies that cash interest payments exceeded accrual basis interest expense.
• An increase in PREPAID Expenses represents operating expenses that have been paid but not yet used or incurred.
• An increase in Accrued Liabilities represents operating expenses which have been incurred or used but not yet paid. This amount must be subtracted from operating expenses.
• A net decrease in A/R means cash collected exceeds revenue recognized on the accrual basis. This would mean higher cash basis income than accrual basis income.
• A net decrease in Accrued Expenses means cash paid to reduce accrued expenses was more than the accrual basis expense recorded. This would mean a higher expense under the cash basis than under the accrual basis.

Question 18

CPA-05450: Savor Co. had $100,000 in ash-basis pretax income for Year 2. At December 31, Year 2 accounts receivable had increased by $10,000 and accounts payable had decreased by $6,000 from their December 31, Year 1, balances. Compared to the accrual basis method of accounting, Savor’s cash pretax income is:R

Answer 18

Answer: (C) $16,000 decrease
A $10,000 increase in A/R means that $10,000 of sales revenue recorded using the accrual basis during the year has not been paid by the customers. Under cash basis of accounting, revenue is not recorded until the cash has been received, so this amount must be deducted to arrive at cash basis income.

The $6,000 decrease in A/P means that total cash payments to vendors during the year exceeded the current period’s accrual basis expenses. Under the cash basis, expenses are recorded when payment is made, so the $6,000 must be deducted to arrive at cash basis income.

If cash basis pretax income is $100,000, then accrual basis pretax income must be $116,000 ($100,000 cash basis income = $116,000 accrual basis income - $10,000 increase in A/R - $6,000 decrease in A/P.)

Question 19

CPA-06396: Which of the following is not a common modification used to prepare modified tax basis financial statements?

(A) Capitalizing inventory
(B) Recognizing revenues when earned
(C) Recording long-term liabilities
(D) Accrual of income taxes

Answer 19

Answer: (B) Recognizing revenues when earned

If revenues were recognized when earned, rather than when received, then the financial statements are prepared using the accrual basis. Recording long-term liabilities, accrual of income taxes, and capitalization of inventory are all common modifications made to cash basis financial statements.

Question 20

Liquidity Ratios

Answer 20

Measure of a firm’s short term ability to pay maturing obligations.

Question 21

Working Capital

Answer 21

Current Assets - Current Liabilities

Question 22

Current Ratio

Answer 22

Current Assets / Current Liabilities

Question 23

Acid Test (Quick) Ratio

Answer 23

(Current Assets - Inventory) / Current Liabilities

Question 24

Cash Ratio

Answer 24

(Current Assets - Inventory - A/R) / Current Liabilities

Question 25

Activity Ratios

Answer 25

Measure of how effectively an enterprise is using its assets.

Question 26

A/R Turnover

Answer 26

Net Credit Sales / Average Net Receivables

This ratio indicates the receivables’ quality and indicates the success of the firm in collecting outstanding receivables. Faster turnover gives credibility to the current and acid-test ratios.

Question 27

A/R Turnover in Days

Answer 27

365 / A/R Turnover

This ratio indicates the average number of days required to collect A/R.

Question 28

Inventory Turnover

Answer 28

COGS / Average Inventory

This measure of how quickly inventory is sold is an indicator of enterprise performance. The higher the turnover, in general, the better the performance.

Question 29

Inventory Turnover in Days

Answer 29

365 / Inventory turnover

This ratio indicates the average number of days required to sell inventory.

Question 30

Operating Cycle

Answer 30

A/R turnover in days + Inventory turnover in days

The operating cycle indicates the number of days between acquisition of inventory and realization of cash from selling the inventory.

Question 31

Total Asset Turnover

Answer 31

Net Sales / Average total assets

This ratio is an indicator of how a company makes effective use of its assets. A high ratio indicates effective asset use to generate sales.

Question 32

Profitability Ratios

Answer 32

Measure of the success or failure of an enterprise for a given time period.

Question 33

Return on Total Assets

Answer 33

Net Income / Average Total Assets

Question 34

Du Point Return on Assets

Answer 34

Net Profit Margin x Total Asset Turnover

• SAME calculation as the Return on Total Assets *

Question 35

Return on Common Equity

Answer 35

(Net Income - Preferred Dividends) / Average Common Equity

Question 36

Coverage Ratios

Answer 36

Measure of security or protection for long-term creditors/investors.

Question 37

Debt-to-Equity Ratio

Answer 37

Total Liabilities / Common stockholders’ equity

This ratio indicates the degree of protection to creditors in case of insolvency. The lower this ratio the better the company’s position.

Question 38

Debt-to-Assets Ratio

Answer 38

Total Liabilities / Total Assets

Question 39

Times Interest Earned

Answer 39

Recurring income before taxes and interest (EBIT) / Interest

This ratio reflects the ability of a company to cover interest charges. It uses income before interest and taxes to reflect the amount of income available to cover interest expense.