FAR Chapter# 4

Question 1

FAR 4-1 - WORKING CAPITAL AND ITS COMPONENTS | Define working capital.

Answer 1

Current assets - Current liabilities

Question 2

FAR 4-2 - WORKING CAPITAL AND ITS COMPONENTS | How is the current ratio computed?

Answer 2

Current assets / Current liabilities

Question 3

FAR 4-3 - WORKING CAPITAL AND ITS COMPONENTS | How is the quick ratio computed?

Answer 3

Cash + Net receivables + Short-term investments / Current liabilities

Question 4

FAR 4-4 - WORKING CAPITAL AND ITS COMPONENTS | Current assets are defined as?

Answer 4

Those resources that are reasonably expected to be realized in cash, sold, or consumed (prepaid items) during the normal operating cycle of a business or one year, whichever is longer.

Question 5

FAR 4-5 - WORKING CAPITAL AND ITS COMPONENTS | Current liabilities are defined as?

Answer 5

Obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities.

Question 6

FAR 4-6 - WORKING CAPITAL AND ITS COMPONENTS | When can a short-term obligation be included in noncurent liabilities?

Answer 6

If the enterprise intends to refinance the debt on a long-term basis and the intent is supported by the ability to do so as evidenced by:

• Actual refinancing prior to the issuance of the financial statements, or
• Existence of a noncancelable financing agreement from a lender having the finanical resources to accomplish the refinancing.

Question 7

FAR 4-7 - WORKING CAPITAL AND ITS COMPONENTS | Define cash and cash equivalents.

Answer 7

Cash includes both currency and demand deposits with banks and/or other financial institutions.

Cash equivalents include short-term, highly liquid investments that are both readily convertible to cash and so near their maturity when acquired by the entity (90 days or less from the date of purchase) that they represent insignificant risk of changes in value.

Question 8

FAR 4-8 - WORKING CAPITAL AND ITS COMPONENTS | Name two methods of accounting for uncollectible accounts.

Answer 8

Direct Write-Off:
Dr. Bad debt expense
Cr. Accounts receivable
Weakness: Bad debts are not matched to sales and accounts recievable are overstated. Not GAAP.

Allowance Method:
Dr. Allowance for uncollectible accounts
Cr. Accounts receivable
Strengths: Matches bad debts with credit sales. A/R fairly stated. Required by GAAP.

Question 9

FAR 4-9 - WORKING CAPITAL AND ITS COMPONENTS | Name three methods of estimating uncollectible accounts.

Answer 9

Percentage of credit sales

Percentage of accounts receivable at year-end

Aging of accounts receivable at year-end

Question 10

FAR 4-10 - WORKING CAPITAL AND ITS COMPONENTS | Using the allowance method, give the two journal entries to provide for and then to write off an uncollectible account.

Answer 10

Provide for:
Dr. Bad debt expense
Cr. Allowance for uncollectible accounts

Write-off:
Dr. Allowance for uncollectible accounts
Cr. Accounts receivable

Question 11

FAR 4-11 - WORKING CAPITAL AND ITS COMPONENTS | What is the difference between factoring with recourse and without recourse?

Answer 11

With Recourse:
The factor may return the account to the company if it proves to be uncollectible. Potential liability and risk of loss remains with the company.

Without Recourse:
The factor assumes the risk of loss if the account is uncollectible.

Question 12

FAR 4-12 - WORKING CAPITAL AND ITS COMPONENTS | State the three conditions that must exist for control of financial asset to be considered surrendered.

Answer 12

The transferred assets have been isolated from the transferor;

The transferee has the right to pledge or exchange the assets; and

The transferor does not maintain control over the transferred assets under a repurchase agreement.

Question 13

FAR 4-13 - WORKING CAPITAL AND ITS COMPONENTS | If control of financial asset is surrendered, what is the accounting treatment of the transfer?

Answer 13

No Continuing Involvement
Recorded as a sale with appropriate reduction in receivables and recognition of any gain or loss.

Continuing Involvement:

• Asset for which there is no retained interest is recorded as a sale using the financial-components approach.
• Assets for which there is retained interest is carried on the books of transferor and allocated a book value based on relative value of all transferred assets at the date of transfer.

Question 14

FAR 4-14 - WORKING CAPITAL AND ITS COMPONENTS | If control of financial asset is not surrendered, what is the accounting treatment of the transfer?

Answer 14

Account for transfer as a secured borrowing with pledged collateral.

Recognize the appropriate asset/liability amounts and interest revenue/expense amounts.

Question 15

FAR 4-15 - WORKING CAPITAL AND ITS COMPONENTS | At what value should non-interest bearing promissory notes be recorded?

Answer 15

At the present value of all future payments required by the note. The payments should be discounted at the market interest rate.

Question 16

FAR 4-16 - WORKING CAPITAL AND ITS COMPONENTS | Notes receivable may be discounted “with” or “without” recourse. What is the difference?

Answer 16

Discounting with Recourse:
The holder remains contingently liable.

Discounting without Recourse:
The holder assumes no further liability after discounting.

Question 17

FAR 4-17 - WORKING CAPITAL AND ITS COMPONENTS | Describe the computational steps required in “discounting a note”.

Answer 17

1. Compute maturity value (remember to include interest to maturity).
2. Compute the “discount” (remember to use maturity value).
3. Get proceeds by subtracting discount from maturity value.
4. Compute interest income as difference between proceeds and face of note.

Question 18

FAR 4-18 - INVENTORIES | When does the title of goods pass for FOB Destination, FOB Shipping Point, COD, Consigned goods?

Answer 18

FOB destination - When received by buyer
FOB shipping point - When given to a common carrier.
COD - When received and paid for by buyer.
Consigned goods - When sold to a third party by consignee.

Question 19

FAR 4-19 - INVENTORIES - LCM (U.S. GAAP) | How is market calculated in the U.S. GAAP lower-of-cost-or-market method?

Answer 19

Market generally means current replacement cost, provided the current replacement cost does not exceed the market ceiling or fall below the market floor.

• Ceiling - Net realizable value (estimated net selling price less completion and disposal costs).
• Floor - Net realizable value minus normal profit margin.

Question 20

FAR 4-20 - INVENTORIES - LOWER OF COST OR NET REALIZABLE VALUE (IFRS) | How is net realizable value calculated in the IFRS lower-of-cost-or-net-realizable-value method?

Answer 20

Net realizable value is the net selling price less completion and disposal costs.

Question 21

FAR 4-21 - INVENTORIES | Explain the difference between periodic and perpetual inventory methods.

Answer 21

Periodic:

• The quantity of inventory is determined only by physical count.
• Ending inventory is physically counted and priced.

Perpetual

• Inventory is updated for each purchase and for each sale.
• Keeps a running total of inventory balances.

Question 22

FAR 4-22 - INVENTORIES | Name several cost flow methods for inventory.

Answer 22

Specific identification
FIFO
LIFO (unit and dollar value)
Averaging
          Weighted average (associated with periodic)
          Moving average (associated with perpetual)
Gross profit
Retail
          Conventional retail
          Cost retail
          FIFO/Cost
          LIFO/Cost
          Dollar value LIFO/Cost

Question 23

FAR 4-23 - INVENTORIES | Name several retail inventory methods.

Answer 23

Conventional retail

Cost retail

FIFO/Cost

LIFO/Cost

Dollar value LIFO/Cost

Question 24

FAR 4-24 - INVENTORIES | When are losses on firm purchase commitments recognized?

Answer 24

Losses are recognized in the period when the price declines.

Dr. Estimated loss on purchase commitment
Cr. Estimated liability on purchase commitment

Question 25

FAR 4-25 - INVENTORIES | Describe an inventory consignment arrangement. Also, how are the consigned goods carried on the parties’ balance sheets?

Answer 25

Consignor gives goods to consignee for sale to third parties. Title to the goods remains with the consignor; therefore the consigned items stay on the balance sheet of the consignor.

Question 26

FAR 4-26 - INVENTORIES | During periods of rising prices, the use of LIFO verses FIFO has what effect on the valuation of ending inventory and reported net income? Which inventory method is prohibited under IFRS?

Answer 26

Both ending inventory and net income will be lower when LIFO is used during a period of rising prices.

LIFO = Lowest

LIFO is prohibited under IFRS.

Question 27

FAR 4-27 - FIXED ASSETS | Give some examples of capitalizable costs for acquisition of equipment and acquisition of buildings.

Answer 27

Acquisition of Equipment:
Purchase price, freight-in, installation, testing, taxes, less any cash discounts allowed.*

Acquisition of Building:
Purchase price, deferred maintenance, alterations, improvements, architect’s fees.*

• If equipment or building is constructed by company, capitalized cost could include construction period interest.

Question 28

FAR 4-28 - FIXED ASSETS | How is fixed-asset carrying value computed under U.S. GAAP and IFRS?

Answer 28

U.S. GAAP:
Carrying Value = Historical Cost - Accumulated Depreciation - Impairment

IFRS:

     - Under IFRS, carrying value can be calculated using the U.S. GAAP method above or can be calculated using the revaluation model.
     - Revaluation Model Carrying Value = Fair Value on Revaluation Date - Subsequent Accumulated Depreciation - Subsequent Impairment.
       - Revaluation gains are reported in OCI.
       - Revaluation losses are reported on the income statement.

Question 29

FAR 4-29 - FIXED ASSETS | Describe the proper accounting for ordinary versus extraordinary repairs.

Answer 29

‘Ordinary repairs are expensed as repair and maintenance. They do not increase the life or utility of the asset. Extraordinary repairs either increase the life or utility of the asset. If the extraordinary repair increases the life of the asset, it is recorded by reducing accumulated depreciation. If the extraordinary repair increases the utility of the asset, it is capitalized to the fixed asset account.

Question 30

FAR 4-30 - DEPRECIABLE ASSETS & DEPRECIATION | Give examples of costs to be capitalized as land.

Answer 30

Acquistion price

Closing costs, such as real estate broker commissions, legal fees, escrow fees, title guarantee insurance

Any mortgages, liens, or encumberances on the land which the buyer assumes

Preparation costs, such as surveying costs, leveling costs, tree removal

Cost of razing an existing building, in getting land into condition for inteded use

Improvements with indefinate life

Less: Proceeds from sale or assets on land

Note: Excavating costs for a building and cost of improvements with a definate life are not included in land.

Question 31

FAR 4-31 - INVESTMENT PROPERTY | How is investment property defined and reported under IFRS?

Answer 31

Investment Property - Land and/or buildings held to earn rental income or for capital appreciation is reported using one of two models:

Cost Model
Carrying Value = Historical Cost - Accumulated Depreciation

Fair Value Model
Reported at fair value and not depreciated. Gains and losses from fair value adjustments are reported on the income statement.

Question 32

FAR 4-32 - DEPRECIABLE ASSETS & DEPRECIATION | State two rules concerning capitalizing interest.

Answer 32

Only capitalize interest on money actually spent, not on amount borrowed.

The amount of capitalized interest is the lower of:

• Actual interest cost incurred, or
• Computed capitalized interest (avoidable interest).

Question 33

FAR 4-33 - DEPRECIABLE ASSETS & DEPRECIATION | For capitalizing interest, when does the capitalization period begin?

Answer 33

Begins when three conditions are met:

• Expenditures for the asset have been made.
• Activities that are necessary to get the asset ready for its intended use are in progress.
• Interest cost is being incurred

Ends when the asset is substantially complete and ready for its intended use.

Question 34

FAR 4-34 - DEPRECIABLE ASSETS & DEPRECIATION | Name the most common depreciation methods. Give the basic formula for calculating each method.

Answer 34

Straight Line:
(Cost - Salvage)/ useful life

Sum-of-Years’ Digits:
Sum of years = n(n+1)/2
(Cost - Salvage) x (Years remaining)/ (Sum of years)

Double-Declining Balance:
2 x Straight line rate x net book value of asset*
* No deduction for salvage to determine depreciable base. Depreciate down to salvage value.

Units of Production:
(Cost - Salvage) / estimated hours x Actual hours for period.

Question 35

FAR 4-35 - DEPRECIATION: IFRS vs. GAAP | Explain the diffent approaches to depreceiation under IFRS and U.S. GAAP.

Answer 35

Under IFRS, the depreciation method used should match the expected pattern of fixed asset consumption. (Not required under U.S. GAAP.)

Under IFRS, component depreciation is required. (Not required under U.S. GAAP.)

Question 36

FAR 4-36 - DEPRECIABLE ASSETS & DEPRECIATION | State the rules for computing depletion of natural resources. Remember it is REAL property.

Answer 36

R - residual value (subtract)
E - extraction/development cost
A - anticipated restoration cost
L - land purchase price

(cost of land + extraction + restoration - residual value)/ (estimated recovery) * units extracted = Depletion

Question 37

FAR 4-37 - IMPAIRMENT | What assets are subject to the impairment test?

Answer 37

Long lived assets, specific identifiable intangibles, and related goodwill to be held and used.

Long lived assets and specific indentifiable intangibles slated for disposal.

Certain assets of a rate-regulated entity.

Note: Test must be done at least annually

Question 38

FAR 4-38 - IMPAIRMENT | Describe the impairment test for recoverability under U.S. GAAP.

Answer 38

If the sum of the undiscounted expected future cash flows is less than the carrying amount, an impairment loss needs to be recognized.

Question 39

FAR 4-39 - IMPAIRMENT | Name the two rules for performing impairment calculations under U.S. GAAP.

Answer 39

Determining impairment:
Use the undicounted future net cash flows. An impairment loss exists if total undiscouned cash flows are less than the carrying value.

Amount of Impairment:
Use the fair value of asset: Impairment loss = fair value - carrying value

Question 40

FAR 4-40 - IMPAIRMENT - IFRS | How is impairment evaluated under IFRS?

Answer 40

Under IFRS, impairment exists if the carrying value of the fixed asset exceeds the higher of:

• Fair value - Costs to sell
• Value in use (present value of future cash flows)

Question 41

FAR 4-41 - IMPAIRMENT | How is the impairment loss reported in the financial statements?

Answer 41

As a component of income from continuing operations before income taxes.

The carrying amount of the asset is reduced.

Question 42

FAR 4-42 - IMPAIRMENT | Is restoration of impairment losses permitted under U.S. GAAP and IFRS?

Answer 42

U.S. GAAP
Restoration (reversal of impairment losses) is permitted for assets held for sale. Restoration is prohibitied for assets held for use.

IFRS
Restoration is always permitted.