FAR - Conceptual Framework and Financial Reporting

Question 1

Financial accounting and reporting is concerned w/providing…

Answer 1

relevant information to external users (e.g. investors, creditors etc)

Question 2

3 aspects of financial reporting that GAAP addresses

Answer 2

1. Recognition: A recognized item is recorded in an account, which ultimately affects the financial statements
2. Measurement: Concerns the dollar amount assigned to an item
3. Disclosure: Many unrecognized amounts are reported in the footnotes to complete the portrayal of the firm’s financial position and performance

Question 3

3 accounting standard-setting mechanism in the US

Answer 3

1. Financial Accounting Foundation (FAF)
2. Financial Accounting Standard Board (FASB)
3. Financial Accounting Standards Advisory Council (FASAC)

Question 4

Financial Accounting Foundation (FAF)

Answer 4

The FAF:

• Appoints members of the FASB
• Ensures adequate funding for the FASB
• Exercises oversight over the FASB

Question 5

Financial Accounting Standards Board (FASB)

Answer 5

The FASB is 1 of the 3 parts of the current accounting standard-setting body in the US.

The FASB is an independent body, subject only to FAF

Question 6

Financial Accounting Standards Advisory Council (FASAC)

Answer 6

FASAC provides guidance on major policy issues, project priorities, and the formation of task forces

Question 7

The mission of the FASB

Answer 7

1. Improve the usefulness of financial reporting
2. Maintain current accounting standards
3. Promptly address deficiencies in accounting standards
4. Promote international convergence of accounting standards
5. Improve the common understanding of the nature and purposes of info in the financial reports

Question 8

Primary Qualitative Characteristics for information to be useful

Answer 8

1. Relevance
2. Faithful representation

For information to be useful for decision-making, it must be both relevant and a faithful representation of the economic phenomena that it represents

Question 9

Relevance

Answer 9

Information is relevant if it makes a difference to decision-makers in their role as capital providers

1. Predictive value
2. Confirmatory value
3. Materiality

Question 10

Relevance - predictive value

Answer 10

Information has predictive value if it helps you form expectations about future events

Question 11

Relevance - confirmatory value

Answer 11

Confirmatory value enables users to check and confirm earlier predictions or evaluations

Question 12

Relevance - materiality

Answer 12

Information that’s material will impact a user’s decision

Question 13

Faithful representation

Answer 13

Information is representationally faithful when it is:

1. Complete
2. Neutral
3. Free from error

Question 14

Faithful representation - completeness

Answer 14

Info is complete if it includes all data necessary to be faithfully representative

All of the information that a user needs in order to form a clear picture of the results, financial position, and cash flows of a business are included in the financial statements. This also means that no information is omitted that might have led a user to have a different opinion of the business.

Question 15

Faithful representation - neutral

Answer 15

Info is neutral when it’s free from any bias intended to attain a prespecificed result or to encourage/discourage certain behavior

Question 16

Faithful representation - free from error

Answer 16

Info is free from error if there are no omissions or errors

Question 17

Enhancing Qualitative Characteristics

Answer 17

1. Comparability
2. Verifiability
3. Timeliness
4. Understandability

Question 18

Enhancing characteristics - comparability

Answer 18

Comparability is the degree to which accounting standards and policies are consistently applied from one period to another.

Question 19

Enhancing characteristics - verifiability

Answer 19

Information is verifiable if different knowledgeable and independent observers could reach similar conclusions based on the information

Question 20

Enhancing characteristics - timeliness

Answer 20

Timeliness is how quickly information is available to external users. The less timely (thus resulting in older information), the less useful information is for decision-making.

Question 21

Enhancing characteristics - understandability

Answer 21

Information is understandable if the user comprehends it w/in the decision context at hand.

Note, users are assumed to have basic understanding of business and accounting

Question 22

Accounting Assumptions

Answer 22

1. Entity
2. Going-Concern
3. Unit-of-Measure
4. Time Period

Question 23

Entity Assumption

Answer 23

We assume that there is a separate accounting entity for each business organization

More practical: business owner’s transactions and company’s transactions are kept separate

Question 24

Going Concern Assumption

Answer 24

Organization is assumed to remain in business for the foreseeable future

Question 25

Unit-of-Measure Assumption

Answer 25

All transactions must be consistently recorded using the same currency of the country in which the business operates.

Question 26

Time Period Assumption

Answer 26

The accounting guideline that allows the accountant to divide up the complex, ongoing activities of a business into periods of a year, quarter, month, week, etc

Question 27

Accounting Principles

Answer 27

1. Measurement (typically historical cost)
2. Revenue Recognition - Revenues are recognized when performance obligation to customer has been met and the revenue is earned or realized; the related expenses are recognized (matching principle)
3. Expense Recognition
4. Full Disclosure Principle - financial statements should present all information needed by an informed reader to make an economic decision

Question 28

Cost of Goods Manufactured

Answer 28

Direct computation:

Direct materials + Direct labor + manufacturing overhead - ending work in process = cost of goods manufactured

Indirect computation:

Beg finished goods + cost of goods manufactured - ending finished goods = cost of sales

Question 29

Billings in excess of costs of long-term contracts is similar to unearned revenue and is always reported as…

Answer 29

Current liabilities

Question 30

Costs in excess of billings on long-term contracts should be reported on the balance sheet as

Answer 30

current assets

Question 31

Consignment goods should be included in

Answer 31

inventory at their cost

Question 32

Comprehensive income is defined as the change in

Answer 32

equity of a business during a period from transactions of nonowner sources

Comprehensive income is net income +/- unrealized gains and losses on debt securities classified as available-for-sale are recognized in comprehensive income for the period.

Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distributions to owners

Question 33

Accumulated other comprehensive income should be reported as a component of

Answer 33

Equity and separate from retained earnings or additional paid-in capital

Question 34

If debt security is available-for-sale, unrealized gains/losses prior to their sale are

Answer 34

not reported in net income

Question 35

Debt securities that are held-to-maturity are reported at amortized cost, which means

Answer 35

there are no holding gains. Any decreases or increases in fair value are reported neither in net income nor as part of other comprehensive income.

Question 36

Items typically included in other comprehensive income

Answer 36

• Unrealized gains/losses on debt securities classified as available-for-sale

- Unrecognized pension and postretirement benefit cost/gains

• Foreign currency translation adjustments
• Certain deferred gains/losses from derivatives

Question 37

Components of other comprehensive income can be shown either…

Answer 37

• net of tax-related effects
• before tax-related effects with the aggregate income tax effects shown as one amount.

Question 38

Comprehensive income can be displayed in the financial statements either…

Answer 38

• as a separate statement that begins with net income
• continuation of net income presented at the bottom of the income statement

Question 39

The correction of an error in the financial statements of a prior period is a prior period adjustment which is to be shown

Answer 39

net of tax as an adjustment to the beginning balance of retained earnings

Question 40

Beg. prepaid insurance + insurance payments − insurance expense = end. prepaid insurance

Question 41

Cash paid to suppliers

Answer 41

Cash paid to suppliers = COGS + (End. inv. − Beg. inv.) + (Beg A/P − End A/P)

Question 42

Per ASC Topic 230, investing and financing activities that do not affect cash but do affect recognized assets and liabilities should be presented in

Answer 42

a separate schedule to accompany the statement of cash flows.

Examples of such items include:

1. 1.Conversion of debt to equity
2. 2.Acquisition of assets by:

• Incurring a mortgage
• Entering into a capital lease
• Issuing stock

3. Exchange of noncash assets or liabilities for other noncash assets or liabilities.

Question 43

Cash Received from Customers

Answer 43

Cash Receipts from Customers = Net Sales + (Beginning Accounts Receivable − Ending Accounts Receivable)

Question 44

Cash payment to employees

Answer 44

Cash Payments to Employees = Salaries Expense + (Beginning Salaries Payable − Ending Salaries Payable

Question 45

Cash interest payments

Answer 45

Cash interest payments = Interest Expense + (Beg. interest payable - Ending interest payable)

Question 46

Income Tax Payments (Direct Method)

Answer 46

Income Tax payments = Income Tax Expense + (Beg. Income Tax payable - End Income Tax payable)

Question 47

Financing activities include the repayment of

Answer 47

debt principal

Therefore, payment of financial lease (principal) applies

Question 48

Dividends/interest revenue received is an… (for cash flow statement)

Answer 48

operating cash flow

Question 49

Cash flow from financing activities include all cash flows involving

Answer 49

liabilities and owner’s equity

Question 50

Cash paid for prepaid insurance (or any prepaid assets)

Answer 50

Cash paid for prepaid insurance (or any prepaid assets) = Insurance expense + (end prepaid insurance - beg prepaid insurance)

Question 51

Cash flows from available-for-sale and held-to-maturity investments are both included in

Answer 51

cash flow for investing activities

Question 52

Monetary asset

Answer 52

An asset, such as cash, A/R or a note receivable in which the amount is a fixed, stated amount.

Holding these assets during periods of inflation will result in a loss of purchasing power

Question 53

non-monetary items

Answer 53

non-monetary items = assets/liabilities whose amounts may change over time in a monetary unit (e.g. USD)

Examples: inventory, PP&E, obligations under warranties, accumulated deprecation etc.

Question 54

Required disclosures regarding risks and uncertainties include

Answer 54

• Nature of operations
• Use of estimates in the preparation of financial statements.
• Current vulnerabilities due to concentrations

Note: current vulnerability due to a possible recession is not a required disclosure

Question 55

current cost income from continuing operations

Answer 55

current cost income from continuing operations = revenue - COGS

Question 56

A company that wishes to disclose information about the effect of changing prices should report this information in

Answer 56

supplementary information to the financial statements

Question 57

The Consumer Price Index is used to compute information on a

Answer 57

constant dollar basis.

Question 58

When a component of a business has been discontinued during the year, this component’s operating losses of the current period should be included in the

Answer 58

Income Statement as part of the loss on disposal of the discontinued component

Question 59

to qualify as a cash equivalent, ASC Topic 305 requires the

Answer 59

original maturity date to be three months or less from the date of purchase

Therefore, certificates of deposit or any other instruments having an original maturity date greater than three months from the date of purchase are not considered cash equivalents

Question 60

Before recording an exit or disposal acitivity, you must record depreciation

Question 61

When the cash received from the sale > asset’s net book value (asset cost - accumulated depreciation), then

Answer 61

gain is recognized

Question 62

Gain on disposal

Answer 62

Actual gains on disposal (when the decision to discontinue the operation and the disposal occur in the same period) are recognized but estimated gains are not

A gain occurs when the net proceeds from the sale of the component > book value of the net assets of the component

Question 63

Loss on disposal

Answer 63

When the book value of the net assets of the component > (fair value - cost of disposal) -> loss is recognized

Question 64

If the actual disposal loss is different from the estimated loss recognized previously, then in the period of disposal, the difference is recognized as a gain or loss

Question 65

A discontinued operation is when a component or group of components of an entity are

Answer 65

1. Disposed for by sale or other than sale, or classified as held-for-sale and
2. The disposal represents a “strategic shift that has (or will have) a major effect on an entity’s operation and financial results”

A strategic shift includes the disposal of a major geographical area, a major line of business, a major equity method investment, or other major parts of the entity

Question 66

Impairment loss

Answer 66

Impairment loss = fair value - carrying value

First, you must apply the impairment test, which entails comparing the carrying value to the asset’s undiscounted expected net future cash flows.

If the undiscounted expected net future cash flows > asset’s carrying value -> asset is impaired

Question 67

Operating cycle

Answer 67

Operating cycle refers to the days required for a business to receive inventory, sell the inventory, and collect cash from the sale of the inventory. This cycle plays a major role in determining the efficiency of a business.

Operating cycle = inventory period + A/R period

Question 68

Combined financial statements are financial statements prepared for companies that are owned by the same parent company or other owner.

Combined financial statements are prepared by simply combining the subsidiaries’ financial statement classifications, with appropriate elimination of intercompany transactions, balances, and profit (loss).

Question 69

The excess of the equipment’s market value over its carrying amount is allocated to the equipment and amortized over the equipment’s useful life. The unamortized portion of the excess of the market value over the carrying amount of the equipment is then reported as part of plant and equipment. Only the excess of the acquisition cost over the market value of the net identifiable assets acquired is reported as goodwill. The excess of the market value over the carrying amount of the equipment is capitalized and subsequently amortized over the equipment’s useful life, not expensed on the date of the acquisition.

Question 70

When the fair value of a subsidiary’s assets is greater than book value, it is as though the parent paid more for the assets than the subsidiary paid for those assets. Using the equity method of accounting for the investment, the parent must depreciate the excess of fair value over book value. That equity entry would be: DR: Equity Revenue - to reduce it by the amount of depreciation on the excess of fair value over book value, and CR: Investment in Subsidiary - to offset a portion of the net income (or increase the amount of net loss) recognized from the subsidiary. Thus, both accounts would be decreased.

Question 71

On January 1, 20x6 Ritt Corp. purchased 80% of Shaw Corp.’s $10 par common stock for $975,000. On this date, the carrying amount of Shaw’s net assets was $1,000,000. The fair values of Shaw’s identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net) which were $100,000 in excess of the carrying amount. Those plant assets had a 10-year remaining life, depreciated on a straight-line basis. The fair value of the 20% noncontrolling interest in Shaw was properly determined to be $200,000 at that time. For the year ended December 31, 20x6, Shaw had net income of $190,000 and paid cash dividends totaling $125,000. Which one of the following is the amount of goodwill that should be recognized as a result of the business combination?

Answer 71

Answer: 75k

Goodwill is determined as the excess of investment value over the fair value of the subsidiary’s net assets. Investment value is the sum of the parent’s investment (which is the fair value of consideration paid) + the fair value of any noncontrolling interest, which in this question is $975,000 + $200,000 = $1,175,000. The fair value of Shaw’s identifiable net assets is book value $1,000,000 + write up in plant assets $100,000 = $1,100,000. Therefore, goodwill is investment value $1,175,000 - fair value of identifiable assets $1,100,000 = $75,000, the correct answer.

Question 72

The amount of an investment eliminating entry is the balance in the investment account as of the beginning of the period being consolidated.

Question 73

Intercompany Items

Answer 73

The primary types of intercompany transactions and related intercompany balances are:

• Receivables/payables
• Revenue/expenses
• Inventory
• Fixed assets
• Bonds

Question 74

Intercompany transactions

Answer 74

Include buying, selling, and transfers. They also include the profit/losses and the outstanding balances that result from these transactions

Question 75

Downstream transaction

Answer 75

A downstream transaction is when the parent sells to the subsidiary. Any intercompany profit that results from the sale will be on the books to the parent

Question 76

Upstream transaction

Answer 76

An upstream transaction is when the subsidiary sells to the parent. Any intercompany profit that results from the sale will be on the books of the subsidiary

Question 77

From the point of view of the consolidated entity, any intercompany receivables or payables from parent to subsidiary or vice versa are not payable to or receivable from any outside company.

In other words, the consolidated entity does not have a receivable or payable.

Question 78

When computing consolidated income, the objective is to restate the accounts as if the intercompany transactions had not occurred.

Question 79

When a subsidiary prepares separate financial statements, intercompany receivables (and payables) should be reported in the balance sheet as a separate line item.

When consolidated financial statements are prepared by the parent company, all intercompany receivables (and payables) should be eliminated to avoid overstating assets and liabilities.

Question 80

Par Corp. owns 60% of Sub Corp.’s outstanding capital stock. On May 1, year 2, Par advanced Sub $70,000 in cash, which was still outstanding at December 31, year 2. What portion of this advance should be eliminated in the preparation of the December 31, year 2, consolidated balance sheet?

Answer 80

Answer: 70k

Consolidated statements are prepared as if the acquirer and acquiree were one economic entity. From the point of view of the consolidated entity, the $70,000 is not payable to or receivable from any outside company. In other words, the consolidated entity does not have a receivable or payable. Therefore, the entire $70,000 payable on Sub’s books and the entire $70,000 receivable on Par’s books must be eliminated against each other. The level of ownership (60%) does not affect this elimination.

Question 81

Sun, Inc. is a wholly owned subsidiary of Patton, Inc. On June 1, year 1, Patton declared and paid a $1 per share cash dividend to stockholders of record on May 15, year 1. On May 1, year 1, Sun bought 10,000 shares of Patton’s common stock for $700,000 on the open market, when the book value per share was $30. What amount of gain should Patton report from this transaction in its consolidated income statement for the year ended December 31, year 1?

Answer 81

Answer: $0

The requirement is to determine the amount of gain to be reported on the consolidated income statement when a wholly owned subsidiary purchases parent company stock. A parent company reports no gain or loss when a wholly owned subsidiary purchases its common stock.

In effect, the consolidated entity is purchasing treasury stock when the purchase is made, and gains are not recognized on treasury stock transactions. The dividends paid by the parent to the subsidiary also do not affect income because such intercompany transactions are eliminated when consolidated financial statements are prepared. Therefore, $0 gain should be reported by the consolidated entity.

Question 82

Basic EPS

Answer 82

Basic EPS = (NI - preferred dividend)/weighted avg common shares outstanding

Question 84

Operating segments

Answer 84

Operating or business segments are identified in the same manner that mangement segments the company for purposes of making operating decisions

Question 85

Operating segments must have 3 characteristics

Answer 85

1. The segment is involved in revenue producing and expense incurring activities
2. The operating results of the segment are reviewed by the company’s chief operating decision maker on a regular basis
3. There is discrete financial info available for segment

Question 86

An operating segment becomes a reportable segment if it meets 1 or more of the following 3 quant tests

Answer 86

1. The operating segment’s revenue from all sources (internal and external) is 10% or more of the combined revenues of all of the company’s reported operating segments
2. The operating segment’s operating profit/loss is 10% or more of the greater of the following 2 amounts:
   
   1. The combined operating profit of all operaitng segments that didnt’ report an operating loss
      2.

Question 87

Earnings per share amounts must be presented for

(1) income from continuing operations, and

(2) net income.

Question 88

2 or more operating segments may be aggregated into a single operating segment if all of the aggregation criteria are met, or if after performing the 10% test a majority of the aggregation criteria are met.

Question 89

NFP: Contribution recognition

Answer 89

All unconditional contributions are recognized as contribution revenue in the period in which the contribution is made, regardless of whether it’s received in cash. Donations other than cash are recorded at fair value as of the date of the gift

Question 90

Conditional contributions revenue recognition

Answer 90

Conidition contributions depend on the occurrence of some future, uncertain events.

Thus, revenue recognition occurs when the condition is met or the chance of not meeting the conditions becomes remote

The NFP should account conditional contributions received (e.g. cash is deposited) as a refundable advance (liability) until the condition is met

Question 91

2 categories for revenue

Answer 91

1. Contributions with donor restrictions (4 categories)
   
   1. program or purpose restriction - resources restricted for specified operaitng purposes
   2. time restrictions - resources available after a specified time has elapsed
   3. capital restrictions - resources restricted for acquisition/construction of capital assets
   4. resources not available for expenditure at any time, although earnings on the resources may be expended -> “endowments”
2. Contributions w/out donor restrictions - these provide resources that are available for expenditure in the current period for any purpose

Question 92

Net patient service revenue is the amount charged to patients less the contractual adjustments and discounts.