FAR Chapter 2

Question 1

Summary of significant accounting policies

Answer 1

• Usually the first or second note to the financials

- If you use IFRS then everything must be IFRS and needs to explicit on the notes, GAAP does not have this requirement

Question 2

Going concern

GAAP: use liquidation basis of accounting if the entity is a going concern

IFRS: does not really say what basis to use

Answer 2

• If liquidation is for sure, then prepare financial statements using liquidation basis of accounting
• Going concern evaluation is done by managers on a yearly and interim basis
• If management is implementing a plan to avoid closing down the entity, then management has to evaluate if the plan will be implemented and if it will be successful. If there is no doubt that it will continue then no disclosure, otherwise it must be disclosed.

Question 3

Subsequent events: recognized and not recognized

If only re-issuing statements disregard what happened between prior issuance date and updated issuance date (unless this violates other requirements)

Answer 3

Recognized: record journal entry and disclose if condition existed at B/S date, such as settlement of litigation and loss on uncollectible receivable.

Non-recognized: did not exist at B/S date, therefore just disclose.

Events for public company must be evaluated through the date of issuance, date NOT required to be disclosed. Private MUST disclose evaluation date and issuance or available date.

Question 4

Fair Value - note that transaction costs are used to determine the best option but not considered in final FV

Answer 4

FV level (1,2, or 3) must be disclosed.
Valuation Techniques:
-market approach: uses prices and data from markets
-income approach: uses future cash flows
-cost approach: uses current replacement cost

Question 5

Segment Reporting

If one segment is more than 90% of revenue, then no segment reporting needed

Report segments starting with 10% of revenue and must report up to 75%

Compile all other remaining segments and report as one

Answer 5

Transactions between segments are not eliminated for consolidation purposes

IFRS requires disclosure of segment liabilities, GAAP doesn’t

An operating segment is a component that has business activity, has its operating results reviewed, and discrete financial information. Components such as corporate headquarter and pension plan are not considered operating segments

Question 6

SEC Reporting Requirements

11K - employee benefit plans
20F Non-US annual form
40F Canadian annual form
6K semianual (foreign) unaudited
8K major event
3,4,5 are filed by 10% owners

Answer 6

Form 10-K (annual)

• Large 60 days
• Accelerated 75 days
• Other 90 days

Form 10-Q (quarterly)

• Large 40 days
• Accelerated 40 days
• Other 95 days

Question 7

Requirements for Annual F/S

Answer 7

2 B/S
3 I/S and 3 cash flow

IFRS:
2 B/S
2 statements of comprehensive income
2 statements of changes in equity
2 cash flow

Question 8

Liquidity Ratios : the higher the better

Measure the ability to pay current obligations

Balance sheet accounts only

Focus on short term risk

Answer 8

working capital = CA - CL

current ratio (working capital) = CA / CL

Acid test (quick ratio) = (CA - inventory) / CL

Cash ratio = (cash, equivalents, mark. securities) / CA

Question 9

Activity Ratios: the higher the better

How effectively do you use your assets?

I/S in numerator
B/S in denominator

Answer 9

AR Turnover = net credit sales / average net A/R

AR Turnover in days = avg. net receivable /
(net credit sales / 365)

Inv. Turnover = COGS / Avg. Inventory

Inv. Turnover in days = avg. inventory /
(COGS / 365)

Question 10

Operating cycle = A/R turnover in days + inventory turnover in days

You want it to be less than the standard

Answer 10

working capital turnover = sales / avg. working capital

total asset turnover = net sales / avg. total assets

Question 11

Profitability ratios

You want it to be greater or = to standard

Answer 11

net profit margin = net income / net sales

return on total assets = net income / average total assets

return on common equity = (NI - Preferred Dividend) /
Avg. common equity

Question 12

Coverage ratios = focus on long term

Debt to equity (the lower the better) = total liabilities / common stockholder equity

Answer 12

Debt to asset ratio = total liabilities / total assets

times interest earned = EBIT / interest expense