FAR Deck 1

Question 1

What are the 10 key elements of financial statements

Answer 1

1. Assets
2. Liabilities
3. Equity
   4. Investments by owners
   5. Distributions to owners
   6. Comprehensive Income
   7. Revenues
   8. Expenses
   9. Gains
   10. Losses

Question 2

What makes up Other Comprehensve Income (OCI)

DENT

Answer 2

D : Derivative cash flow hedges

E : Excess adjustment of Pension PBO and FV of plan assets at year end

N : Net unrealized holding gains and losses on available-for-sale debt securities

T : Translation adjustments from foreign currency

*OCI includes changes in equity (DENT) and are excluded from net income because they are primarily related to fair value gains/losses and are not effective indicators of business performance.

Question 3

What is comprehsive income

Answer 3

Comprehensive income includes changes in an entitys equity from the two nonowner sources:

Net Income
and
Other Comprehensive Income (OCI)

Question 4

What are the fair value measurement techniques (MIC)

Answer 4

Market : compares an item to actual market data

Income : equates expected future amounts (eg cash flows) into a current value

Cost : Involves the items current replacement cost

Question 5

Bank Reconcilation Calculation for Book

Answer 5

Cash balance per books

+ Interest paid by bank

+ Deposits not yet recorded in books

• Bank charges
• Returned checks (e.g. for insufficient funds)
• Withdrawls not yet recorded in books

+ /- Recording errors

=

Net cash balance

Question 6

Bank reconciliation Calculation Per Bank

Answer 6

Bank statement balance

+ Deposits in transit

• Checks outstanding

+ / - Bank errors

=

Bank errors

Question 7

increases/Decreases current ratio

Answer 7

If current current ratio and quick ratio are less than 1, decreasing both CA and CL by the same amount decreases the ratios.

If these ratios are greater than 1, decreasing both CA and CL by the same amount increases the ratios.

Question 8

Realization

Answer 8

Realization is the process of exchanging noncash resources (eg depreciated equipmnet) for cash, a claim to cash ( ie. note receivable), or noncash asset convertible to a known amount of cash.

Realization occurs when the purchaser and seller agree to terms and enter into a sales agreement.

Question 9

Writing off an Accounts Receivable

Answer 9

Allowance for credit losses  (decreases) (contra-asset account)      XXX
       Accounts receivable (decreases) (asset)                          XXX

Question 10

How are Available-for-sale (AFS) securites recorded and carried

Answer 10

AFS are initally recorded at cost, but are carried at Fair Value (FV).

Unrealized gains or losses resulting from fluctuations in FV (ie market value) must be evaludated to determine what portion, if any, is due to credit losses (reported on the income statement).

Any remaining change is considered a noncredit-related market risk holding gain (loss) and is reported in Other Compreshensive Income (OCI).

Note: Electing the FV option for AFS alows unrealizable holding gains or losses due to market risk to be recongized in net income.

These are all securities not classifed as trading or held-to-maturity.

Question 11

What are trading securities?

Answer 11

Trading securities are investments in marketable debt securities (bonds, commercial paper) that an investor acquires with the intent to make a profit by buying and selling within a short period of time (day, months).

Also called marketable debt securities

They are adjusted to market value at the end of each period.

Unrealized gains and losses are reported in net income in each period.

Realized gains and losses from the sale or disposal are reported in net income as incurred.

Question 12

How are Held-to-maturity securites recorded and carried?

Answer 12

Helt-to-maturity securities are initally recorded at cost and then carried at amortzed cost.

Question 13

What are amortized costs?

Answer 13

Amortized costs = the face amount of the bond plus or minus unamortizied premiums or discounts.

Question 14

When is OCI transferred to Accumulated Other Comprehsive Income (ACOI)

Answer 14

OCI is transferred at the end of the period to AOCI in the stockholders equity section of the balance sheet.

Question 15

What is goodwill and how is it recroded?

Answer 15

Goodwill is when the purchase price of an investments exceeds the FV of the net assets. When this occurs, goodwill is recorded.

When the equity method is used to account for investments, any excess purchase price over the investors share of carrying value of net assets is allocated to specifically identified assets.

Question 16

Construction in Progress (CIP) Formula

Answer 16

Construction in Progress = Construction expenses + Gross profit/loss

Question 17

What are the 2 fundamental characteristics of useful information

Answer 17

Relevance

 - Predictive value
 - Confirmatory value

And

Faith Representaton

 - Completeness 
 - Neturality
 - Free from error

Question 18

What are the 4 enchancing characteristics?

Answer 18

• Comparabaility
• Understandability
• Timeliness
• Verifability

Question 19

Goodwill – how to report in income statement when it exists

Answer 19

Under the equity method, if the purchase price exceeds the fair value (FV) of the investor’s share of the investee’s equity, certain adjustments to equity are required.

The excess is allocated first to assets with FV’s greater than carrying values.

For depreciable assets, the excess is amortized over the assets remaining life and deducted from reported investee income; inventory access is deducted as sold.

Remember: Under the equity method dividends received reduce the investment account on the balance sheet (NOT in the income statement).

Question 20

What is a hedge?

Answer 20

A hedge is a mechanism to reduce risk.

A hedge involves the use of a derivative to reduce or eliminate a risk that an entity is subject as a result of a recoginzed asset or liability or a future transaction.

Hedging can reduce or eliminate the risk of an adverse change in circumstances (i.e sudden shortage of natural resources); it also eliminates the opportunity to take advantage of a favorable change.

Question 21

What is a fair value hedge?

Answer 21

A fair value hedge can be used to mitigate the exposure to changes in fair value of a recognized asset or liability.

For example, the purchase of put options (i.e. the hedge) may protect against a possible decline in market price of a stock portfolio (the hedged item).

A FV hedge is reported at FV with unrealized gains/losses recognized in net income in the period of change.

The gain/loss from the hedge is reported together with the corresponding gain/loss of the hedged item in the income statement.

Question 22

Option Valuation: time value + Instrinsic value Formula

Answer 22

Intrinsic value (call options) = [(market price - exercise price) x number of shares

Cannot be less than zero because an option holder would not exercise an option that would result in a loss.

An instrinsic value of $0 means the options exercise price is equal to or greater than the stock’s market value, therefore providing no benefit to the option holder.

Question 23

What is an option?

Answer 23

An option contract is when the buyer/owner has the right but not the obligation to buy (CALL option) or sell (PUT option) an underlying asset (i.e. common stock) at a predetermined price (exercise price) within a specific timeframe.

They can be used to reduce risk (hedging) or to profit from price changes in the underlying asset (i.e speculation).

Question 24

What are the 2 parts of option valuation?

Answer 24

1. Instinsic value
2. Time value

For Call Options (Buy), intrinisc value is the current market price of the underlying asset less the option exerice price multiplies by the # of shares.

Time value is based on the amount of time the option has until it expires; it decreases as an option approaches expiration.

Question 25

What is a derivative?

Answer 25

A derivative is a type of financial instrument (i.e. contract) whose value is derived from an underlying asset. Investors generally purchase derivative for hedging (reducing risk), arbitrage (taking advantage of market pricing differences), or speculation (betting on the market).

They are always reported at fair value.

They have the following characteristics (NUNS)

1. N - No net investment : there is either no initial investment or an initial investment that is smaller than would normally be required for a similar market instrument.
2. U - An Underlying and a Notional amount : The notional amount is the # of units and the underlying is the factor that affects the derivatives value (price, interest rate, exchange rate).
   * For example, in a foreign exchange, the notional amount would be the # of foreign units (FCU’s) and the underlying would be the future exchange rate.
3. S: Net Settlement : The derivative is settle in a net amount. A holder of a forward exchange contract does not actually buy or sell the FCUs, but instead receives or pays the difference between the contracted exchane rate and the market rate.