F4 Investments, Business Combinations, and Goodwill

Question 1

Describe the financial instrument fair value option under U.S. GAAP?

Answer 1

On specified election dates, an entity may choose to measure eligible financial instruments at fair value with unrealized gains and losses reported in earnings. The fair value option is irrevocable.

Question 2

Describe the financial instrument fair value option under U.S. GAAP?

Answer 2

On specified election dates, an entity may choose to measure eligible financial instruments at fair value with unrealized gains and losses reported in earnings. The fair value option is irrevocable.

Question 3

On the balance sheet, debt securities classified as trading or available for sale are value how?

Answer 3

At fair value.

Question 4

How are unrealized gains/losses on debt securities classified as trading securities recognized?

Answer 4

Unrealized gains and losses on trading securities are recognized on the income statement.

Question 5

How are unrealized gains/losses on debt securities classified as available-for-sale recognized (assuming no expected credit loss)?

Answer 5

Unrealized gains and losses on available for sale securities with no expected credit loss are reported in other comprehensive income.

Question 6

On the balance sheet, debt securities classified as held to maturity are valued how (assuming no expected credit loss)?

Answer 6

At amortized cost

Question 7

List three conditions when losses on debt securities classified as available for sale are recognized in income.

Answer 7

-Sales of the security
- Transfer of the security to trading classification.
- When there is an expected credit loss on the available for
sale security. The credit loss reported in net income
cannot exceed the amount by which fair value is below
amortized cost.

Question 8

When a marketable debt security is transferred from trading to available for sale, or vice versa at what cost is it transferred?

Answer 8

• Transferred at fair value, which then becomes a new
  basis.
  
  • For a security transferred into the trading category, the
    difference is treated as a realized gain or loss and is
    recognized on the income statement.
  • For aa security transferred from the trading category, the
    unrealized holding gain or loss will already have been
    recognized in earnings.
    Note: Transfers to and from the trading category should be rare.

Question 9

When does credit loss have to be booked for debt investments?

Answer 9

A credit loss must be reported on an available for sale or held to maturity debt security when it is probable that the amounts due (principal and interest) will not be collected.

Question 10

How is a credit loss recognized for an available for sale or held to maturity debt security?

Answer 10

When there is an expected credit loss, the investment should be reported at the present value of the principal and interest that is expected to be collected. The credit loss is the difference between amortized cost and the presented value.

For an available for sale security, the credit loss cannot exceed the amount by which the fair value is below amortized cost, because the investor has the option to sell an available for sale investment if the loss on the sale will be less than the expected credit loss.

Question 11

How is the realized gain or loss calculated for trading and available for sale debt securities when they are sold?

Answer 11

Trading Securities:
Realized gain/loss = Selling price versus the adjusted cost
(Original cost +/- Unrealized gains or losses previously
recognized in net income)

Available for Sale Securities
Realized gain/loss = Selling price versus the original cost,
adjusted for any credit losses recorded on the income
statement from previous periods (note that any
unrealized gains or losses in AOCI must be reversed)

Question 12

How are equity securities typically valued?

Answer 12

Equity securities are typically carried at fair value through net income (FVTNI), with unrealized gains and losses included in earnings.

Question 13

Describe the “practicality exception” for equity securities.

Answer 13

For equity investments that do not have a readily determinable fair value, this exception allows an entity to measure equity investments at cost, less impairment, plus/minus observable price changes of identical or similar investments from the same owner.

Question 14

How are nonliquidating and liquidating dividends distributed by equity securities reported by the investor receiving them?

Answer 14

Nonliquidating dividends received by the investor are accounted for as dividend income.

Liquidating dividends received by the investor are accounted for as a return of capital.

Question 15

Describe the recognition of an impairment loss on equity securities if a qualitative assessment indicates that impairment exists.

Answer 15

Impairment losses apply to equity securities valued using the practicality exception. If impairment exists, the cost basis of the security will be written down to fair value with the write-down reflected as a realized loss and included in earnings.

Question 16

How is the realized gain or loss calculated for equity securities when they are sold?

Answer 16

Realized gain/loss=Selling price versus the adj. cost
(Original cost +/- Unrealized gains or losses previously recognized in net income)

Question 17

How is the year-end investment in investee reported on the balance sheet calculated under the equity method?

Answer 17

Beg. investment in investee
+ Investor’s share of investee earnings
- Investor’s share of investee dividends
- Amortization of FV differences
________________________________
End. investment in investee

Question 18

How is an investor’s equity method investment reported on the income statement?

Answer 18

Investor’s share of investee earnings
- Amortization of FV differences
_______________________________
Equity in earnings/investee income

Question 19

State the criteria to consolidate subsidiaries

Answer 19

• Consolidate when the parent is able to control the
  subsidiary. Usually this indicated by greater than 50%
  ownership of the voting stock of the subsidiary.
• Do not consolidate when control is not with owners ( as in
  bankruptcy of subsidiary).

Question 20

What is variable interest entity (VIE)?

Answer 20

A corporation, partnership, trust, LLC, or other legal structure used for business purposes that either does not have equity investors with voting rights or lacks sufficient financial resources to support its activities.

Question 21

What is variable interest entity (VIE)?

Answer 21

A corporation, partnership, trust, LLC, or other legal structure used for business purposes that either does not have equity investors with voting rights or lacks sufficient financial resources to support its activities.

Question 22

Who is the primary beneficiary of a VIE and how does the primary beneficiary account for its VIE investment?

Answer 22

The entity with the power to direct the activities of the VIE most significant impact the entity’s economic performance and:
1. Absorbs the expected VIE losses; or
2. Receives the expected VIE residual returns
The primary beneficiary must consolidate the VIE

Question 23

Who consolidate when one entity receives the expected returns from a VIE and another entity absorbs the expected losses?

Answer 23

The entity that absorbs the expected losses consolidates.

Question 24

In acquisition accounting, state the consolidating workpaper elimination entry:

CARINBIG

Answer 24

Dr: Common stock-subsidiary
Dr: Apic-subsidiary
Dr: Retained earnings-subsidiary
Cr: Investment in subsidiary
Cr: Noncontrolling interest
Dr: Balance sheet adj. to fair value
Dr: Identifiable intangible assets to fair value
Dr: Goodwill

Question 25

How are expenses relating to the combination treated under the acquisition method?

Answer 25

• Direct out-of-pocket costs are expensed.
  -Stock-related costs are a reduction in value of the stock issued (normally a debt to additional paid-in-capital)
  -Indirect costs are expensed.

Question 26

How is a noncontrolling interest (balance sheet) as of the acquisition date calculated under U.S. GAAP?

Answer 26

Noncontrolling Interest (NCI):
FV of subsidiary x NCI %

Question 27

How is noncontrolling interest on the income statement calculated?

Answer 27

Subsidiary net income
x Noncontrolling interest %
——————————————
NCI in net income

Question 28

In an acquisition, how are acquired identifiable intangible assets amortized?

Answer 28

Finite useful life:
Amortized to residual value over expected useful life. Subject to the two-step impairment test.

Indefinite useful life:
Do not amortize. Subject to the one-step impairment test.

Question 29

How is goodwill calculated under U.S. GAAP?

Answer 29

Goodwill:
Fair value of subsidiary-Fair value of subsidiary’s net assets

Question 30

In a business combination, what is the treatment of an acquisition in which the acquisition in which the acquisition cost is less than the fair value of 100% of the net assets acquiried?

Answer 30

The acquisition cost is allocated to the fair value of 100% of the balance sheet accounts and the fair value of 100% of the identifiable intangible assets. This creates a negative balance in the acquisition account, which is recorded as a gain.

Question 31

Name several simple workpaper elimination entries that are necessary to eliminate intercompany payable and receivable when producing consolidated financial statements.

Answer 31

Eliminate:
Accounts payable/accounts receivable
Bonds payable/bonds receivable
Accrued bond interest payable/accrued bond interest
receivable

Question 32

State the workpaper elimination entry for intercompany inventory transactions.

Answer 32

Dr: Retained earnings (intercompany profit in beg. inv.)
Dr: Intercompany sales
Cr: Intercompany cost of goods sold
Cr: Cost of goods sold (intercompany profit in goods sold)
Cr: End. inv. (intercompany profit in ending inventory)

Question 33

State the workpaper elimination entry for intercompany bond transactions.

Answer 33

Dr: Bonds Payable
Dr: Premium (or credit discount)
Cr: Investment in affiliates bonds
Cr: Gain on extinguishment of bonds (or debit loss on
extinguishment of bonds)

Question 34

State the workpaper elimination entry for intercompany land transactions.

Answer 34

Dr: intercompany gain on sale of land
Cr: Land

Question 35

State the workpaper elimination entries for intercompany depreciable assets transactions.

Answer 35

Elimination Entry 1
Elimination intercompany gain and adjust asset and
accumulated depreciation to original amounts:
Dr: Intercompany gain on sale of machinery
Cr: Machinery
Cr: Accumulated depreciation
Elimination Entry 2
Eliminate excess depreciation:
Dr: Accumulated depreciation
Cr: Depreciation expense

Question 36

When a parent company owns less than 100% of the stock of a subsidiary company, what amount of the subsidiary’s assets, liabilities, and equity are included on the consolidated balance sheet?

Answer 36

The consolidated balance sheet includes 100% of the parent’s subsidiary’s assets and liabilities, but does not include the subsidiary’s equity.
Noncontrolling interest is presented as part of equity, separately from the equity of the parent company.

Question 37

What three considerations must be taken into account when preparing consolidated statements of cash flow that are not present when preparing statements of cash flow for a nonconsolidated entity?

Answer 37

1. When reconciling net income to net cash provided by
   operating activities, total consolidated net income
   (including net income attributable to both the parent and
   the noncontrolling interest) should be used.
2. The financing section should report dividends paid by the
   subsidiary to noncontrolling shareholders. Dividends paid
   by the subsidiary to the parent company should not be
   reported.
3. The investing section may report the acquisition of
   additional subsidiary shares by the parent if the
   acquisition was an open-market purchase.

Question 38

Define goodwill

Answer 38

• Excess of the fair value of a subsidiary over the fair value of the subsidiary’s net assets.
• Costs of maintaining and/or developing goodwill cannot be capitalized.

Question 39

How is goodwill impairment analyzed under U.S. GAAP?

Answer 39

Goodwill impairment is analyzed by comparing the carrying value of the reporting unit (including goodwill) to the fair value of the reporting unit (including goodwill).

Fair value > Carrying value, then there is no impairment.

Fair value < Carrying value, then there will be an impairment charge equal to the difference between fair value and carrying value.

Note: The impairment charge cannot exceed the value of the goodwill allocated to the reporting unit.

Question 40

Under U.S. GAAP, a private company may elect to apply the alternative method of goodwill accounting.
Describe the steps of this method.

Answer 40

• Amortize goodwill on a straight-line basis over 10 years, or
  less than 10 years if the entity can demonstrate that
  another useful life is more appropriate.
• Make an accounting policy election to test goodwill for
  impairment at either the entity level or the reporting unit
  level when a triggering event occurs that indicate that the
  fair value of an entity (or reporting unit) may be below its
  carrying amount.
• This alternative method must be applied to all existing
  goodwill and any goodwill generated in future business
  combination.