F4 Flashcards
Fair Value Option
Entities can choose whether or not to measure certain instruments at fair value.
Eligible instruments are AFS and equity method debt investments
Unrealized gains and losses are reported in earnings
Classifications of debt securities
- Trading security- generally a current asset, valued at fair value, G/L go to I/S, cash flows from operations
- Available For Sale security- valued at fair value, cash flow from investments
- Held to maturity- cash flows from investing, valued at amortized cost
Accounting for Unrealized G/L when switching debt security classification
Transfer from Trading: No adjustment necessary
Transfer to Trading: Recognized in current earnings
HTM to AFS: Record in OCI
AFS to HTM: Amortize gain or loss with bond discount
Practicability exception
Allows an entity to measure an equity investment at cost less impairment +/- observable price changes on market with similar investments.
Applicable to nonpublic entities that cannot easily determine fair value
Realized gains and losses
Recognized when a debt security is sold
Impairment (loss) on AFS security or nonpublic securities
Recognized credit loss
Derivative financial instrument
A contract between parties based on an underlying financial asset.
Ex. options, forwards, futures, swaps
Debt security
A security representing a creditor relationship with an entity: Corporate bonds Redeemable preferred stock Government securities Convertible debt Commercial paper
Exceptions to Consolidation (US GAAP and IFRS)
US GAAP: Subsidiaries are in legal reorganization, declared bankruptcy, or have foreign restrictions
IFRS: Parent itself is a subsidiary, parent is not publicly traded, AND Parent of the parent produces consolidated statements
Variable Interest Entity (VIE)
A business entity that does not have equity investors with voting rights, or lacks financial resources
A primary beneficiary that financially supports the VIE is required to consolidate the VIE
Examples: Long-term liabilities, forward contracts to sell assets, options to acquire a leased asset
Exclusions from VIEs
Nonprofit organizations Employee benefit plans Registered investment companies Accounts of life insurance companies Governmental organizations
A company has variable interest in an entity when all these conditions are met
Company and business entity have an arrangement
Business entity is a legal entity
Entity is not one of the exclusions
Company has more than insignificant interest in entity, explicit or implicit
An entity is a VIE when it meets any of these conditions
Insufficient Equity Investment (Can’t operate on its own)
Inability to make decisions or direct activities
No obligation to absorb losses
No right to receive residual returns
Disproportionate voting rights
Acquisition method
Used when 100% of net assets are acquired.
Subsidiary’s entire equity, common stock, retained earnings, is eliminated
Partial Goodwill Method
Option under IFRS, calculates non-controlling interest by only using the fair value of the subsidiary’s net identifiable assets (excludes goodwill)
Non-controlling interest = FV of net identifiable assets x (1- ownership %)
Identifiable Intangible Assets in acquisition
Agreements/contracts Rights Permits Patents/ copyrights/ trademarks Franchises Computer software licenses Technical drawings Customer lists Unpatented technology In process R&D Noncompete agreements
Simple Intercompany Transactions
Fixed asset sales = Gain on sale / Depreciation expense
Inventory transactions = Sales / COGS
Bonds = Interest expense/ Interest Income
Goodwill presentation on FS
Acquisition method- Reported as a seperate asset on consolidated balance sheets
Equity method- Embedded in inventory account (Stock price - FV of net assets)
Consolidation Adjustment for External Reporting
DR Common Stock (acquired company) DR Additional Paid In Capital (acquired company) DR Retained Earnings (acquired company) CR Investment in Subsidiary CR Non-controlling interest DR Balance Sheet Adjustments to FV DR Identifiable Intangible Assets DR Goodwill
JE to eliminate intercompany bond transactions
DR Bonds Payable (Face value)
DR Premium
DR Loss on Extinguishment of Bonds (Face value > Intercompany price)
CR Investment in [Company’s] bonds
CR Discount
CR Gain on Extinguishment of Bonds (Intercompany price > Face value)
JE to eliminate intercompany fixed asset sales
DR Intercompany gain on sale
DR or CR Fixed Asset (Original cost - Intercompany price)
CR Accumulated Depreciation (at time of sale)
When is the equity method required?
When investor has “ability to excercise significant influence” over the investee.
If this is not directly stated, entities with ownership of 20-50% are assumed to have significant influence.
When is the equity method not appropriate?
Subsidiary is bankrupt
Investment in sub is temporary
Lawsuit/complaint has been filed
Another small group has majority ownership (>50%)
