FAR Lecture 2

Question 1

In general, what are the criteria for revenue recognition under U.S. GAAP?

Answer 1

Earned and realized or realizable. The following four criteria must be met before revenue can be recognized:

1. Persuasive evidence of an arrangement exists.
2. Delivery has occurred or services have been rendered.
3. The price is fixed and determinable.
4. Collection is reasonably assured.

Question 2

What are the four categories of revenue transactions under IFRS and what are the common revenue recognition criteria for those categories?

Answer 2

1. Sales of goods
2. Rendering of services
3. Revenue from interest, royalties and dividends
4. Construction contracts

Common revenue recognition criteria include:

• Revenues and costs can be reliably measured.
• It is probable that economic benefits will flow to the entity.

Each category has additional criteria.

Question 3

When should revenue from the performance of services be recognized under U.S. GAAP and IFRS?

Answer 3

U.S. GAAP

In the period in which the services have been rendered and are able to be billed.

IFRS

Using the percentage of completion method when the outcome of the transaction can be estimated reliably.

Question 4

What are the conditions for revenue recognition when the right to return exists?

Answer 4

• The sales price is substantially fixed at the time of sale.
• The buyer assumes all risks of loss because the goods are considered in the buyer’s possession.
• The buyer has paid some form of consideration.
• The product sold is substantially complete.
• The amount of future returns can be reasonably estimated.

Question 5

Name an example of both 1) accelerated and 2) deferred revenue recognition relative to normal recognition when revenue is recognized at the time goods are transferred.

Answer 5

• The percentage-of-completion method of long-term construction accounting is an example of accelerated revenue recognition.
• The installment method (or cost recovery method) is an example of deferred revenue recognition.

Question 6

How are purchased intangible assets and internally developed intangible assets recorded under U.S. GAAP and IFRS?

Answer 6

Purchased intangible assets:

Recorded at cost, including legal and registration fees, under U.S. GAAP and IFRS.

Internally developed intangible assets:

• Legal fees, costs of successful defense, registration fees, consulting fees and design fees can be capitalized under U.S. GAAP and IFRS.
• Under U.S. GAAP, research and development costs can be expensed. Under IFRS, research costs must be expensed, but development costs may be capitalized if they meet certain criteria.

Question 7

How are intangible assets reported under U.S. GAAP and IFRS?

Answer 7

U.S. GAAP:

reported at cost less amortization (finite life intangibles only) and impairment.

IFRS:

Reported using the cost method (same as U.S. GAAP) or the revaluation method. Under the revaluation model, reported at fair value on revaluation date less subsequent amortization and impairment.

Question 8

How should the contractual amounts of future services to be performed under a franchise agreement be accounted for by 1) the franchisor and 2) the franchisee?

Answer 8

They should be reported at their present value as unearned revenue by the franchisor until earned and as an intangible asset by the franchisee.

Question 9

Define start-up costs.

What is the accounting treatment of start-up costs?

Answer 9

• Costs incurred for one-time activities to start a new operation. Start-up costs include costs incurred in the formation of a corporation.
• Start-up costs are expensed in the period incurred.

Question 10

Define goodwill.

Answer 10

• Excess of the fair value of a subsidiary over the fair value of the subsidiary’s net assets
• Costs of maintaining and/or developing goodwill cannot be capitalized.

Question 11

What is the maximum period over which an identifiable intangible asset (not goodwill) should be amortized?

Answer 11

• The shorter of its estimated useful economic life and its remaining legal life (as in copyright, franchise, or patent).
• Goodwill is not amortized, but must be tested at least annually for impairment.

Question 12

What is the proper treatment of research and development costs under U.S. GAAP and IFRS?

Answer 12

U.S. GAAP

Research and development costs should be expensed as incurred unless an expenditure is for capital assets that have alternative future uses, or for research and development undertaken on behalf of others under a contractual agreement.

IFRS

Research costs must be expensed. Development costs may be capitalized if they meet certain criteria.

Question 13

List some items not considered research and development costs.

Answer 13

• Routine periodic design changes
• Marketing research
• Quality control testing
• Reformulation of a chemical compound

Question 14

When should the costs of developing computer software for resale, lease, or licensing be capitalized under U.S. GAAP?

Answer 14

After technological feasibility has been established and before the product is released for sale.

Question 15

How should the costs of capitalized computer software developed for resale be amortized under U.S. GAAP?

Answer 15

Amount amortization is the greater of:

Percent of Revenue Method

Total capitalized amount x

Current gross revenue for the period
Total projected gross revenue for the product

Straight-Line

Total capitalized amount x

1
Estimate of economic life

Question 16

Outline the treatment of computer software developed internally or obtained for internal use only under U.S. GAAP.

Answer 16

• Expense costs incurred in the preliminary project state and for costs incurred in training and maintenance.
• Capitalize costs incurred after preliminary project state and for upgrades and enhancements.
• Capitalized costs should be amortized on a straight-line basis.

Question 17

What is the test of recoverability for the impairment of long-lived assets other than goodwill under U.S. GAAP?

Answer 17

Finite Life

If undiscounted future cash flows expected from use of asset and eventual disposal is less than the carrying value, recognize loss on impairment.

Indefinite Life

If fair value is less than carrying value, recognize loss on impairment.

Question 18

How is impairment of long-lived assets other than goodwill analyzed under IFRS?

Answer 18

• Compare the carrying value of the asset to the asset’s recoverable amount.
• The recoverable amount is the greater of the asset’s fair value less costs to sell and the asset’s value in use (PV of future cash flows).

Question 19

What is the calculation for impairment loss under U.S. GAAP and IFRS?

Answer 19

U.S. GAAP

The amount by which the carrying amount exceeds the fair value of the asset.

IFRS

The amount by which the carrying amount exceeds the asset’s recoverable amount.

Question 20

How is goodwill impairment analyzed under U.S. GAAP?

Answer 20

Goodwill impairment is analyzed at the reporting level using a two-step process:

1. Identify potential impairment by comparing the fair value of each reporting unit with its carrying value, including goodwill.
2. Measure the amount of goodwill impairment by comparing the implied fair value of the reporting unit’s goodwill to its carrying amount.

Note: Under U.S. GAAP, the goodwill impairment test has been simplified by allowing companies to test qualitative factors first to determine whether it is necessary to perform the two-step goodwill impairment test.

Question 21

How is goodwill impairment analyzed under IFRS?

Answer 21

Goodwill impairment testing is done at the cash-generating unit (CGU) level using a one-step approach that compares the carrying amount of the CGU to the CGU’s recoverable amount.

Impairment losses are first allocated to goodwill and then allocated on a pro rata basis to the other CGU assets.

Question 22

Under U.S. GAAP, a private company may elect to apply the alternative method of goodwill accounting. Describe the steps of this method.

Answer 22

• Amortize goodwill on a straight-line bases over 10 years, or less than 10 years if the entity can demonstrate that another useful life is more appropriate.
• Make an accounting policy election to test goodwill for impairment at either the entity level or the reporting unit level when a triggering event occurs that indicates that the fair value of an entity (or reporting unit) may be below its carrying amount.
• This alternative method must be applied to all existing goodwill and any goodwill generated in future business combinations.

Question 23

Identify two methods of revenue recognition for long-term construction-type contracts under U.S. GAAP and IFRS.

Answer 23

U.S. GAAP

• Percentage-of-completion
• Completed-contract

IFRS

• Percentage-of-completion
• Cost recovery

Question 24

For long-term construction-type contracts, when are losses recognized?

Answer 24

Immediately when discovered, regardless of the method used for revenue recognition.

Question 25

State the formula for recognizing the gain/loss on long-term construction-type contracts under the percentage-of-completion method.

Answer 25

Total estimated gross profit x

Total cost to date
Total estimated cost of contract

• Gross profit recognized to date

Question 26

State the formula for calculating the gross profit realized on installment sales.

Answer 26

Cash received x

Total gross profit
Sales price

Question 27

When are profits recognized under the cost recovery method?

Answer 27

Profits are recognized only after all costs have been recovered.

Question 28

How are gains/losses on nonmonetary exchanges recognized under U.S. GAAP?

Answer 28

Exchange has commercial substance–always recognize gains and losses on the exchange to the difference between the FV of what is given up and the carrying value of what is given up.

Exchange does not have commercial substance of the new asset’s fair value is not determinable (and the FV of the asset given up is unknown)–no gain on exchange is recognized unless boot is received, and losses are recognized in full (if losses exist because an impairment loss was not previously recognized).

If boot received is greater than 25% of total consideration, all gains and losses are recognized by both parties to the exchange just as in a monetary transaction that has commercial substance.

Question 29

How are gains/losses on nonmonetary exchanges recognized under IFRS?

Answer 29

• Exchange of similar assets–No gains recognized. Losses recognized in full.
• Exchange of dissimilar assets–All gains and losses recognized.

Question 30

When will an asset exchange have commercial substance under U.S. GAAP?

Answer 30

An asset exchange generally has commercial substance when the entity expects a change in future cash flows as a result of the exchange and that expected change is material relative to the FV of the assets exchanged.

[Note that the FASB has not provided specific guidance, nor has it provided examples of transactions that would meet the criteria for commerial substance. The exam should be clear if an exchange has or lacks commercial substance.]

Question 31

In a nonmonetary exchange, what is the basis of the new asset under U.S. GAAP?

Answer 31

In an exchange that has commercial substance (or an exchange when boot received exceeds 25% of the total consideration), record at fair value of the asset given up + cash pair (or - cash received), or the fair value of the asset received if it is more clearly evident.

In an exchange that lacks commercial substance, record at the net book value of the asset given up + cash paid (or - cash received), unless adjustments are needed for gain recognized (if boot is received).

Question 32

What are monetary items?

Answer 32

• Assets and liabilities that are fixed in amount by contract or in terms of numbers of dollars.
• Examples include cash, accounts and notes receivable, and accounts and notes payable.
• These items are already stated in constant dollars.

Question 33

What are nonmonetary items?

Answer 33

• Assets and liabilities that fluctuate in value with inflation/deflation
• Examples are inventories; property, plant and equipment; and capital stock. These items need to be restated to constant dollars.

Question 34

Identify the two foreign currency activities.

Answer 34

• Foreign currency translations
• Foreign currency transactions

Question 35

What is an entity’s functional currency under U.S. GAAP?

Answer 35

The functional currency is the currency of the primary economic environment in which the entity operates. All of the following conditions must be met:

• The foreign operations are relatively self-contained and integrated within the country.
• The day-to-day operations do not depend on the parent’s or investor’s functional currency.
• The local economy of the foreign entity is not highly inflationary.

Question 36

When is the translation method used?

Answer 36

Translation is used to restate financial statements denominated in the functional currency to the reporting currency.

Question 37

When is the remeasurement method used?

Answer 37

Remeasurement is used to restate financial statements from the foreign currency to the entity’s functional currency when:

• The reporting currency is the functional currency.
• The financial statements must be restated in the entity’s functional currency prior to translating from the functional currency to the reporting currency.

Question 38

Identify the exchange rate to be used when translating different components of the balance sheet and income statement.

Answer 38

Assets and Liabilities
Current exchange rate

Common Stock and APIC
Historical rate

Revenues and Expenses
Weighted average exchange rate for the period

Question 39

Identify the exchange rate to be used when remeasuring different components of the balance sheet and income statement.

Answer 39

Balance Sheet

• Monetary–current exchange rate
• Nonmonetary–historical rate

Income Statement

• Balance sheet related–historical rate
• Non-balance-sheet related–weighted average

Question 40

Where are remeasurement gains/losses reported in the financial statements?

Answer 40

Remeasurement gains or losses are recognized on the income statement.

Question 41

Where are translation adjustments reported in the financial statements?

Answer 41

Translation gains or losses are reported in other comprehensive income. They are treated as unrealized gains and losses.

Question 42

State two types of foreign currency transactions.

Answer 42

• Operating transactions, such as importing, exporting, borrowing, lending, and investing transactions.
• Forward exchange contracts, which are agreements to exchange two different currencies at a specific future date and at a specific rate.

Question 43

Where are foreign currency transaction gains or losses reported in the financial statements?

Answer 43

Foreign currency transaction gains or losses are included in determining net income for the period.

Question 44

For operating transactions in foreign currency, detail the recording process.

Answer 44

• Record original transaction at exchange or spot rate on date of transaction.
• At balance sheet date, compute gain/loss on the transaction by recalculating using the current exchange or spot rate.
• On payment date compute gain/loss on the transaction by using the exchange rate on payment date.

Question 45

What are the general guidelines for OCBOA financial statement presentation?

Answer 45

• Different title from accrual basis financial statements.
• Required financial statements are the equivalent of the accrual basis balance sheet and income statement.
• Financial statements should explain changes in equity accounts.
• A statement of cash flows is not required.
• Disclosures should be similar to GAAP financial statement disclosures.