FAR Chapter# 2

Question 1

FAR 2-1 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | In general, what are the criteria for revenue recognition under U.S. GAAP?

Answer 1

Earned and realized or realizable. The following four criteria must be met before revenue can be recognized:

1. Persuasive evidence of an arrangement exists.
2. Delivery has occurred or services have been rendered.
3. The price is fixed and determinable.
4. Collection is reasonably assured.

Question 2

FAR 2-2 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | What are the four categories of revenue transactions under IFRS and what are the common revenue recognition criteria for those categories?

Answer 2

1. Sale of goods
2. Rendering of services
3. Revenue from interest, royalties, and dividends
4. Construction contracts

Common revenue recognition criteria include:
- Revenues and costs can be reliably measured.
- It is probable that economic benefits will flow to the entity.
Each category has additional critera.

Question 3

FAR 2-3 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | When should revenue from the performance of services be recognized under U.S. GAAP and IFRS?

Answer 3

U.S. GAAP:
In the period in which the services have been rendered and are able to be billed.

IFRS:
Using the percentage of completion method when the outcome of the transaction can be estimated.

Question 4

FAR 2-4 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | What are the conditions for revenue recognition when the right of return exists?

Answer 4

The sales price is substantially fixed at the time of sale.

The buyer assumes all risks of loss because the goods are considered in the buyer’s possesion.

The buyer has paid some form of consideration.

The product sold is substantially complete.

The amount of future returns can be reasonably estimated.

Question 5

FAR 2-5 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | Name an example of both 1) accelerated and 2) deferred revenue recognition relative to normal recognition when revenue is recognized at the time goods are transferred.

Answer 5

The percentage-of-completion method of long-term construction accounting is an example of accelerated revenue recognition.

The installment method (or cost recovery method) is an example of deferred revenue recognition.

Question 6

FAR 2-6 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | How are purchased intangible assets and internally developed intangible assets recorded under U.S. GAAP and IFRS?

Answer 6

Purchased intangible assets:
Recorded at cost, including legal and registration fees, under U.S. GAAP and IFRS

Internally developed intangible assets:
- Legal fees, costs of successful defense, registration fees, consulting fees, and design fees can be capitalized under U.S. GAAP and IFRS.

Under U.S. GAAP, research and development costs must be expensed. Under IFRS, research costs must be expensed, but development costs may be capitalized if they meet certain criteria.

Question 7

FAR 2-7 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | How are intangible assets reported under U.S. GAAP and IFRS?

Answer 7

U.S. GAAP:
Reported at cost less amortization (finite life intangibles only) and impairment.

IFRS:
Reported using the cost model (same as U.S. GAAP) or the revaluation model. Under the revaluation model, reported at fair value on revaluation date less subsequent amortization and impairment.

Question 8

FAR 2-8 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | How should the contractual amounts of future services to be performed under a franchise agreement be accounted for by 1) the franchisor and 2) the franchisee?

Answer 8

They should be recorded at their present value as unearned revenue by the franchisor until earned and as an intangible asset by the franchisee.

Question 9

FAR 2-9 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | Define start-up costs. What is the accounting treatment of start-up costs?

Answer 9

Costs incurred for one-time activities to start a new operation. Start-up costs include costs incurred in the formation of a corporation.

Start-up costs are expensed in the period incurred.

Question 10

FAR 2-10 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | Define goodwill.

Answer 10

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 11

FAR 2-11 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | What is the maxiumum period over which an indentifiable intangible asset (not goodwill) should be amortized?

Answer 11

The shorter of its estimated useful economic life and its legal life (as in a copyright, franchise, or patent).

Goodwill is not amortized, but must be tested at least annually for impairment.

Question 12

FAR 2-12 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | What is the proper treatment of research and development costs under U.S. GAAP and IFRS?

Answer 12

U.S. GAAP:
Research and development costs should be expensed as incurred unless an expenditure is for capital assets that have alternative future uses, or for research and development undertaken on behalf of others under a contractual arrangement.

IFRS:
Research costs must be expensed. Development costs may be capitalized if they meet certain criteria.

Question 13

FAR 2-13 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | List some items not considered reasearch and development costs.

Answer 13

Routine periodic design changes

Marketing research

Quality control testing

Reformulation of a chemical compound

Question 14

FAR 2-14 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | When should the costs of developing computer software for resale, lease, or licensing be capitalized under U.S. GAAP?

Answer 14

After technological feasibility has been established and before the product is released for sale.

Question 15

FAR 2-15 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | How should the costs of capitalized computer software developed for resale be amortized under U.S. GAAP?

Answer 15

Annual amortization is the greater of:

Percent of Revenue Method:
Total capitalized amount x Current gross revenue for the period/ Total projected gross revenue for product

Straight-line:
Total capitalized amount / Estimate of economic life

Question 16

FAR 2-16 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | Outline the treatment of computer software developed internally or obtained for internal use only under U.S. GAAP?

Answer 16

Expense costs incurred in the preliminary project state and costs incurred in training and maintenance

Capitalize costs incurred after preliminary project state and for upgrades and enhancements

Capitalized costs should be amortized on a straight-line basis

Question 17

FAR 2-17 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | What is the test of recoverability for the impairment of long-lived assets other than goodwill under U.S. GAAP?

Answer 17

Finite Life:
If undiscounted future cash flows expected from use of asset and eventual disposal is less than the carrying value, recognize loss on impairment.

Indefinite Life:
If fair value is less than carrying value, recognize loss on impairment.

Question 18

FAR 2-18 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | How is impairment of long-lived assets other than goodwill analyzed under IFRS?

Answer 18

Compare the carrying value of the asset to the asset’s recoverable amount.

The recoverable amount is the greater of the asset’s fair value less costs to sell and the asset’s value in use (PV of future cash flows).

Question 19

FAR 2-19 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | What is the calculation for impairment loss under U.S. GAAP and IFRS?

Answer 19

U.S. GAAP:
The amount by which the carrying amount exceeds the fair value of the asset.

IFRS:
The amount by which the carrying amount exceeds the asset’s recoverable amount.

Question 20

FAR 2-20 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | How is goodwill impairment analyzed under U.S. GAAP?

Answer 20

Goodwill impairment is analyzed at the reporting unit level using a two-step process:

1. Identify potential impairment by comparing the fair value of each reporting unit with its carrying value, including goodwill.
2. Measure the amount of goodwill impairement by comparing the implied fair value of the reporting unit’s goodwill to its carrying amount.

Question 21

FAR 2-21 - TIMING ISSUES: MATCHING OF REVENUE AND EXPENSES, CORRECTING AND ADJUSTING ACCOUNTS | How is goodwill impairment analyzed under IFRS?

Answer 21

Goodwill impairment testing is done at the cash generating unit (CGU) level using a one-step test that compares the carrying value of the CGU to the CGU’s recoverable amount.

Impairment losses are the first allocated to goodwill and then allocated on a pro rata basis to the other CGU assets.

Question 22

FAR 2-22 - LONG-TERM CONSTRUCTION CONTACTS | identify two methods of revenue recognition for long-term construction-type contracts under U.S. GAAP and IFRS.

Answer 22

U.S. GAAP:

• Percentage of completion
• Completed-contract

IFRS:

• Percentage of completion
• Cost recovery

Question 23

FAR 2-23 - LONG-TERM CONSTRUCTION CONTACTS | For long-term construction-type contracts, when are losses recognized?

Answer 23

Immediately when discovered, regardless of the method used for revenue recognition.

Question 24

FAR 2-24 - LONG-TERM CONSTRUCTION CONTACTS | State the formula for recognizing the gain/loss on long-term construction-type contracts under the percentage-of-completion method.

Answer 24

Total cost to date / Total estimated cost of contract x Test est. gross profit

• Gross profit recognized to date

Question 25

FAR 2-25 - ACCOUNTING FOR INSTALLMENT SALES | State the formula for calculating the gross profit realized on installment sales.

Answer 25

Cash received x Total gross profit/ sales price

Question 26

FAR 2-26 - ACCOUNTING FOR INSTALLMENT SALES | When are profits recognized under the cost recovery method?

Answer 26

Profits are recognized only after all costs have been recovered.

Question 27

FAR 2-27 - ACCOUNTING FOR NONMONETARY TRANSACTIONS | How are gains/losses on nonmonetary exchanges recognized under U.S. GAAP?

Answer 27

Exchange has commercial substance - always recognize gains and losses on the exchange equal to the differencve between the FV of what is given up.

Exchange does not have commercial substance or the new asset’s fair value is not determinable (and the FV of the asset is given up is unknown) - NO GAIN on exchange is recognized UNLESS BOOT IS RECEIVED, and losses are recognized in full (if losses exist because an impairment loss was not previously recognized).

If boot received is greater than 25% of total consideration, gain is recognized just as in monetary transaction that has commercial substance.

Question 28

FAR 2-28 - ACCOUNTING FOR NONMONETARY TRANSACTIONS | How are gains/losses on nonmonetary exchanges recognized under IFRS?

Answer 28

Exchange of similar assets - No gains recognized. Losses recognized in full.

Exchange of dissimilar assets - All gains and losses recognized.

Question 29

FAR 2-29 - ACCOUNTING FOR NONMONETARY TRANSACTIONS | When will an asset exchange have commercial substance under U.S. GAAP?

Answer 29

An asset exchange generally has commercial substance when the entity expects a change in future cash flows as a result of the exchange and that expected change is material relative to FV of the assets exchanged.

[Note that FASB has not provided specific guidance, nor has it provided examples of transactions that would meet the criteria for commercial substance. Although it is not certain what will occur on the CPA Exam, it is suspected that it will be clear in the question whether an exchange has or lacks commercial substance.]

Question 30

FAR 2-30 - ACCOUNTING FOR NONMONETARY TRANSACTIONS | In a nonmonetary exchange, what is the basis of the new asset under U.S. GAAP?

Answer 30

In an exchange that has commercial substance (or an exchange when boot received exceeds 25% of the total consideration), record at fair value of asset given up + cash paid (or - cash received), or the fair value of the asset received if it is more clearly evident.

In an exchange that lacks commercial substance, record at the net book value of the asset given up + cash paid (or -cash received), unless adjustments are needed for gain recognized (if boot is received).

Question 31

FAR 2-31 - CHANGING PRICES | What are monetary items?

Answer 31

Assets and liabilities that are fixed in amount by contract or in terms of number of dollars.

Examples include cash, accounts and notes receivables, accounts and notes payable.

These items are already stated in constant dollars.

Question 32

FAR 2-32 - FOREIGN CURRENCY | What are nonmonetary items?

Answer 32

All assets and liabilities that are not monetary.

Examples are inventories, property, plant and equipment, and capital stock. These items need to be restated to constant dollars.

Question 33

FAR 2-33 - FOREIGN CURRENCY | Identify the two foreign currency activities.

Answer 33

Foreign currency translations

Foreign currency transactions

Question 34

FAR 2-34 - FOREIGN CURRENCY | What is an entity’s functional currency under U.S. GAAP?

Answer 34

The functional currency is the currency of the primary economic environment in which the entity operates. All of the following conditions must be met:

• The foreign operations are relatively self-contained and integrated within the country.
• The day-to-day operations do not depend on the parent’s or investors functional currency.
• The local economy of the foreign entity is not highly inflationary.

Question 35

FAR 2-35 - FOREIGN CURRENCY | When is the translation method used?

Answer 35

Translation is used to restate financial statements denominated in the functional currency to the reporting currency.

Question 36

FAR 2-36 - FOREIGN CURRENCY | When is the remeasurement method used?

Answer 36

Remeasurement is used to restate financial statements from the foreign currency to the entity’s functional currency when:

• The reporting currency is the functional currency.
• The financial statements must be restated in the entity’s functional currency prior to translating from the functional currency to the reporting currency.

Question 37

FAR 2-37 - FOREIGN CURRENCY | Identify the exchange rate to be used when translating different components of the balance sheet and income statement.

Answer 37

Assets and Liabilities:
Current exchange rate

Common Stock and APIC
Historical rate

Revenue and Expenses
Weighted-average exchnages rate for the period

Question 38

FAR 2-38 - FOREIGN CURRENCY | Identify the exchange rate to be used when remeasuring different components of the balance sheet and income statement.

Answer 38

Balance Sheet:

• Monetary - current exchange rate
• Nonmonetary - historical rate

Income Statement

• Balance sheet related - historical rate
• Non-balance sheet related - weighted-average

Question 39

FAR 2-39 - FOREIGN CURRENCY | Where are reameasurement gains/losses reported in the financial statements?

Answer 39

Remeasurement gains or lossess are recognized on the income statement.

Question 40

FAR 2-40 - FOREIGN CURRENCY | Where are translational adjustments reported in the financial statements?

Answer 40

Translation gains or losses are reported in other comprehensive income. They are treated as unrealized gains and losses.

Question 41

FAR 2-41 - FOREIGN CURRENCY | State two types of foreign currency transactions.

Answer 41

Operating transactions, such as importing, exporting, borrowing, lending, and investing transactions

Forward exchange contracts, which are agreeements to exchange two different currencies at a specific future date and at a specific rate

Question 42

FAR 2-42 - FOREIGN CURRENCY | Where are foreign currency transaction gains or losses reported in the financial statements?

Answer 42

Foreign currency transaction gains or losses are included in determining net income for the period.

Question 43

FAR 2-43 - FOREIGN CURRENCY | For operating transactions in foreign currency, detail the recording process.

Answer 43

Record original transaction at the exchange or spot rate on date of transaction.

At balance sheet date, compute gain/loss on the transaction by recalculating using the current exchange or spot rate.

On payment date, compute gain/loss on the transaction by using the exchange rate on payment date.

Question 44

FAR 2-44 - OTHER FINANCIAL STATEMENT PRESENTATIONS | What are the general guidelines for OCBOA financial statement reporting?

Answer 44

Different titles from accural basis financial statements.

Required financial statements are the equivalent of the accrual basis balance sheet and income statement.

Financial statements should explain changes in equity accounts.

A statement of cash flows is not required.

Disclosures should be similar to GAAP financial statement disclosures.