FAR F4 Flashcards
How should a short-term loan that is refinanced into long-term debt after year-end but before the issuance of financial statements be recorded in the balance sheet?
Answer:
- Accounts payable or other short-term obligations: Report as current liabilities.
- Short-term loan refinanced with long-term debt: Reclassify as long-term liabilities if the refinancing occurs before the financial statements are issued.
Key Concept:
If a short-term liability is refinanced on a long-term basis before the financial statements are issued, it should be classified as a long-term liability on the balance sheet.
How should a short-term loan that is partially prepaid and refinanced into long-term debt after year-end but before the issuance of financial statements be recorded in the balance sheet?
Answer:
- Accounts payable or other short-term obligations: Report as current liabilities.
- Short-term loan:
1- Prepaid portion: Report as current liability (because it has been settled during the subsequent event period).
2- Remaining portion refinanced with long-term debt: Reclassify as a long-term liability if the refinancing occurs before the financial statements are issued.
Key Concept:
If a short-term liability is partially prepaid during the subsequent event period and the remaining portion is refinanced on a long-term basis, only the remaining portion should be classified as a long-term liability on the balance sheet. The prepaid portion should be adjusted to reflect its settlement as a current liability.
How should a business account for sales tax collected from customers?
Answer:
Sales tax collected is recorded as a liability (Sales Tax Payable) because it must be paid to the government.
Example:
If a business collects $40,000 in sales tax and starts with $4,500 from the prior year, and then pays $39,500 to the state, the remaining liability would be $5,000.
Key Concept:
Sales tax is not revenue or expense; it’s a liability that needs to be paid to the government.
How should a company calculate the accrued liability for unemployment claims under the options provided by the state?
Option 1: Pay a fixed percentage (e.g., 3%) of eligible gross wages, which is typically defined as the first portion of wages per employee (e.g., the first $10,000).
Option 2: Reimburse the state based on estimated actual claims (e.g., 2% of eligible gross wages).
Key Concept:
Eligible gross wages refer to a capped amount of wages per employee, as defined by state law (e.g., the first $10,000 of each employee’s wages).
What are the key costs associated with exit and disposal activities?
Answer:
- Involuntary employee termination benefits (e.g., severance pay).
- Costs to terminate a contract that is not a lease (e.g., breach of contract).
- Other costs include consolidating facilities, relocating employees, and moving property, plant, and equipment (PPE).
Key Concept:
Exit and disposal activities involve costs related to terminating contracts, employee severance, and operational relocations and consolidations.
How should a company account for exit and disposal costs?
Answer:
1- Recognize a liability for the costs when a formal plan is communicated, and there is a reasonable expectation that the plan will be implemented.
2- Measure the liability at fair value, typically the present value of the expected future cash flows.
3- Expense the costs in the period the liability is recognized, unless they are directly related to a future benefit (e.g., asset retirement obligations).
4- Disclose the nature and amount of the costs in the financial statements, including details about the expected timing of payments and any revisions to the original estimate.
Key Concept:
Exit and disposal costs are recognized as liabilities and expensed when the company is committed to a formal plan and can reasonably estimate the costs.
Where are exit and disposal costs reported in the income statement?
If related to a discontinued operation, the costs are reported within the discontinued operations section, net of tax. If not related to a discontinued operation, they are reported as part of non operating expenses.
What is an Asset Retirement Obligation (ARO)?
An Asset Retirement Obligation (ARO) is a legal obligation to dismantle, remove, or restore a long-lived asset at the end of its useful life. This obligation is recorded as a liability in the financial statements and is often associated with industries like oil and gas, mining, and energy. A decommissioning liability is a common term used interchangeably with ARO, particularly when referring to the costs of decommissioning assets like oil rigs or mines.
How should contingent gains be reported in financial statements?
Answer:
Contingent gains should be disclosed in the financial statement notes when the gain is probable but not yet realized. The full range of possible outcomes should be disclosed if they are equally likely. Contingent gains are not recognized as revenue until they are realized or certain.
Key Concept:
Contingent gains are only recognized as revenue when realized or certain. If they are probable or possible, they must be disclosed; if remote, no disclosure is needed.
How should contingent liabilities be accounted for in financial statements?
Answer:
Probable and Estimable: Accrue the lowest amount in the range if all outcomes are equally likely, and disclose the range in the notes.
Probable but Not Estimable: Disclose the nature of the contingency and the range of potential outcomes in the notes without accruing.
Reasonably Possible: No accrual, but disclose the range of possible outcomes and any best estimates in the notes.
Remote: No accrual or disclosure is required.
Key Concept:
The treatment of contingent liabilities depends on the likelihood and estimability of the outcome. Accrue and disclose when probable and estimable, disclose only when probable but not estimable or reasonably possible, and do nothing when remote.
Why is pending or threatened litigation considered a loss contingency?
Answer:
Pending or threatened litigation is considered a loss contingency because there is a possibility that it could result in a future loss. Although the outcome is uncertain, the potential for a loss (such as damages or settlement payments) creates a situation that must be evaluated and possibly disclosed in the financial statements.
Key Concept:
Loss contingencies involve uncertain future events, like litigation, where there is a possibility of a future obligation and outflow of resources.
How should contingent liabilities be accounted for in a business acquisition?
Answer:
In a business acquisition, contingent liabilities (e.g., lawsuits) that are probable and reasonably estimable must be recorded at their fair value as of the acquisition date. This fair value represents the best estimate of the amount needed to settle the obligation, even if it differs from the total claim amount.
Key Concept:
When acquiring a company, recognize contingent liabilities at their fair value on the acquisition date if they are probable and can be reasonably estimated.
Why should the acquiring (parent) company record contingent liabilities on its books during an acquisition?
Answer:
The acquiring (parent) company records contingent liabilities because, upon acquisition, it assumes responsibility for the acquired company’s obligations. These liabilities are recorded at fair value as they represent future obligations that the parent company is now accountable for.
Key Concept:
In an acquisition, the parent company must recognize all identifiable liabilities of the acquired company, including contingent liabilities, because it now holds responsibility for settling those obligations.
How are purchase commitments with a price decline accounted for?
Answer:
When a purchase commitment is made and the market price drops below the committed price:
No entry is made when the contract is signed.
A liability is recognized for the loss if the market price drops below the committed price. This loss is the difference between the contract price and the market price.
At purchase, the liability is settled, and the raw materials are recorded at the market value.
Key Concept:
Only the loss (difference between contract and market price) is recorded as a liability, not the total purchase commitment amount.
How should warranty liabilities be accounted for under the expense warranty accrual method?
Answer:
Under the expense warranty accrual method, the full estimated warranty cost is accrued in the year of sale. This creates a liability for future warranty expenses. As actual warranty costs are incurred, they reduce the liability.
Key Concept:
Accrue the total estimated warranty costs at the time of sale and adjust the liability as actual warranty expenses are paid.
How are changes in warranty estimates accounted for under U.S. GAAP, and how do they impact both expenses and liabilities?
Answer:
When a company changes its estimate for warranty costs (e.g., from 2% to 1%), the change is applied prospectively.
Expense: The new estimate is used to calculate warranty expenses for the current and future periods. Previous periods are not adjusted.
Liability: The existing liability for past warranty obligations remains unchanged. The liability for warranties issued in the current period is calculated using the new estimate.
Key Concept:
Changes in estimates affect current and future periods only. Both the warranty expense and liability are adjusted prospectively based on the new estimate, without altering previous years’ amounts.
How should a company report cash received from coupon sales when the coupons haven’t been redeemed yet?
Answer:
The cash received from coupon sales should be recorded as unearned revenue at the amount received (e.g., $10 per coupon). Revenue is only recognized when the coupons are redeemed, and the merchandise is provided.
Key Concept:
Unearned revenue represents cash received for obligations that haven’t been fulfilled yet. It is recorded at the cash received amount until the company delivers the promised goods or services.
How to Adjust Present Value Factors for Annuity Due?
Method 1: Add 1
If you have the present value factor for n periods of an ordinary annuity, just add 1 to get the present value factor for an annuity due for n+1 periods.
Note: You can’t add more than 1. This only works when adjusting by one period. For multiple periods, use a financial calculator or annuity due tables.
Example:
Ordinary annuity (2 periods) = 1.8334
Annuity due (3 periods) = 1.8334 + 1 = 2.8334
Method 2: Multiply by 1 + r
If you have the present value factor for n periods of an ordinary annuity, multiply it by 1 + r (interest rate) to adjust the factor for an annuity due for the same number of periods. This accounts for payments being made at the beginning of each period.
Example:
Ordinary annuity = 4.5
Interest rate (r) = 10%
Annuity due = 4.5 × 1.10 = 4.95
Key takeaway:
Add 1 for more periods, multiply by 1 + r for the same periods.
What is the difference between Effective Interest and Imputed Interest?
Effective Interest:
The actual interest rate earned or paid, accounting for compounding.
Based on cash flows (payments/receipts).
Used for loans, bonds, and investments with compounding interest.
Imputed Interest:
The assumed or estimated interest when no interest is stated or when the stated rate is below market.
Applies a market rate to estimate interest.
Used in non-interest-bearing loans or related-party transactions.
