FAR Lecture 3

Question 1

On the balance sheet, marketable securities classified as trading or available-for-sale are valued . . .

Answer 1

At fair value

Question 2

On the balance sheet, marketable securities classified as held-to-maturity are valued . . .

Answer 2

At amortized cost

Question 3

How are unrealized gains/losses on trading securities recognized?

Answer 3

Unrealized gains and losses on trading securities are recognized on the income statement.

Question 4

How are unrealized gains/losses on available-for-sale securities recognized?

Answer 4

Unrealized gains and losses on available-for-sale securities are reported in other comprehensive income.

Question 5

List three conditions when losses on marketable securities as available-for-sale are recognized in income.

Answer 5

• Sale of the security
• Transfer of the security to trading classification
• Other than temporary decline of individual security below cost (impairment)

Question 6

When a marketable equity security is transferred from trading to available-for-dale, or vice versa, at what cost is it transferred?

Answer 6

• Transferred at fair value, which then becomes new basis.
• For a security transferred into the trading category, the difference is treated as a realized gain or loss and is recognized on the income statement.
• For a security transferred from the trading category, the unrealized holding gain or loss will already have been recognized in earnings.

Note: Transfers to and from the trading category should be rare.

Question 7

How are gains and losses on financial instruments that hedge trading securities reported?

Answer 7

Reported in earnings, consistent with reporting unrealized gains and losses on trading securities.

Question 8

How are gains and losses on financial instruments that hedge available-for-sale securities reported?

Answer 8

Reported in earnings together with the offsetting gains or losses on the available-for-sale securities attributable to the hedged risk.

Question 9

What disclosures should be made for available-for-sale and held-to-maturity securities?

Answer 9

• Aggregate fair value
• Gross unrealized holding gains and losses
• Amortized cost basis by type
• Information about the contractual maturity of debt securities

Question 10

State the criteria to consolidate subsidiaries.

Answer 10

• Consolidate when the parent is able to control the subsidiary. Usually this is indicated by greater than 50% ownership of the voting stock in the subsidiary.
• Do not consolidate when control is not with owners (as in bankruptcy of subsidiary).

Question 11

Identify the three levels of control and the appropriate accounting method for each.

Answer 11

No Significant Influence

Cost method: Trading or available-for-sale securities, at fair value

Signficant Influence by 50% or Less Ownership

Equity Method

Control

• Cost of equity method (internal accounting)
• Consolidated financial statements (external reporting)

Question 12

When is the cost method of accounting for investments used?

Answer 12

• The cost method, also known as the fair value method or the available-for-sale method, should be used when the investor owns less than 20% of the investee’s voting stock and does not exercise significant influence.
• Lacking evidence to the contrary, it is assumed that no significant influenced can be exercised from 0%-20%
• The original investment under the cost method is accounted for in the same manner as marketable equity securities, generally as an available-for-sale investment.

Question 13

How are dividends distributed by the investee treated by the investor receiving them?

Answer 13

Stock dividends issued by the investee are not recognized by the investor.

Cash dividends received by the investor are accounted for as dividend income.

Question 14

How is the year-end “investment in investee” report on the balance sheet calculated under the equity method?

Answer 14

Beginning investment in investee

+Investor’s share of investee earnings

-Investor’s share of investee dividends

-Amortization of FV differences

Ending investment in investee

Question 15

How is an investor’s equity method investment reported on the income statement?

Answer 15

Investor’s share of investee earnings

-Amortization of FV differences

Equity in earnings / investee income

Question 16

How are joint ventures accounted for under IFRS and U.S. GAAP?

Answer 16

Joint ventures are accounted for using equity method under both U.S. GAAP and IFRS.

Question 17

In a step-by-step acquisition, what is the accounting treatment when significant influence is acquired?

Answer 17

• Going from the cost method to the equity method is handled like a change in accounting principle–retroactively.
• Go back retroactively with the equity method but not with the new ownership percentage.
• Prior period financial statements are restated.

Question 18

When are consolidated financial statements prepared?

Answer 18

When the parent company has control over the subsidiary company. Control is achieved when more than 50% of the voting stock of the subsidiary is owned directly or indirectly by the parent and no other factors are present that would indicate a lack of control (bankruptcy, reorganization).

Question 19

In acquisition accounting, state the consolidating workpaper elimination entry.

[CAR IN BIG]

Answer 19

Common Stock–Subsidiary

APIC–Subsidiary

Retained earnings–Subsidiary

Investment in subsidiary

Noncontrolling interest

Balance sheet adjustments for fair value

Identifiable intanglible assets to fair value

Goodwill

Question 20

How are expenses related to the combination treated under the acquisition method?

Answer 20

• Direct out-of-pocket costs are expensed.
• Stock-related costs are reduction in value of the stock issued (normally a debit to additional paid-in-capital)
• Indirect costs are expensed.
• Bond issue costs are capitalized and amortized.

Question 21

In an acquisition, how are acquired identifiable intangible assets amortized?

Answer 21

• Finite useful life: Amortized to residual value over expected useful life.
• Indefinite useful life: Do not amortize.

Question 22

How is goodwill calculated under the U.S. GAAP acquisition method?

Answer 22

U.S. GAAP

• Goodwill is the excess of the fair value of the subsidiary (acquisition cost plus noncontrolling interest) over the fair value of the subsidiary’s net assets, including identifiable intangible assets at FV.
• Goodwill = Fair value of subsidiary - Fair value of subsidiary’s net assets.
• Goodwill recorded in a business combination is not amortized. The entire investment is subject to the impairment test.

Question 23

How is goodwill calculated under the IFRS acquisition method?

Answer 23

IFRS

• Goodwill is recognized using the full goodwill method (same as U.S. GAAP) or the partial goodwill method.
• Under the partial goodwill method, goodwill is the excess of the acquisition cost over the fair value of the subsidiary’s net assets acquired.
• Partial goodwill = Acquisition cost - Fair value of subsidiary’s net assets acquired.

Question 24

How is noncontrolling interest (balance sheet) calculated under U.S. GAAP?

Answer 24

Noncontrolling interest (NCI) = FV of subsidiary x NCI %

Question 25

How is noncontrolling interest (balance sheet) calculated under IFRS?

Answer 25

IFRS permits the use of the full goodwill method or the partial goodwill method.

Full Goodwill Method (Same as U.S. GAAP)

NCI = FV of the subsidiary x NCI%

Partial Goodwill Method

NCI = FV of subsidiaryis net identifiable assets x NCI%

Question 26

How is noncontrolling interest on the income statement calculated?

Answer 26

Subsidiary net income

x Noncontrolling interest %

NCI in net income

Question 27

In a business combination, what is the treatment of an acquisition in which the acquisition cost is less than the fair value of 100% of the net assets acquired?

Answer 27

The acquistion cost is allocated to the fair value of 100% of the balance sheet accounts and the fair value of 100% of the identifiable intangible assets. This creates a negative balance in the acquisition account, which is recorded as a gain.

Question 28

Name several pro forma workpaper elimination entires when producing consolidated financial statements.

Answer 28

Eliminate:

• The effects of intercompany dividends
• Parent’s investment in sub account
• The entire stockholder’s equity section of the sub.
• The effects of the gain or loss and adjust for the excess depreciation on the dale of property, plant and equipment between affiliates.
• All intercompany sales and purchases.
• All other intercompany balance sheet and income statement accounts.
• Intercompany profit in cost of goods sold, and in beginning and ending inventories relating to an intercompany sale of merchandise between affiliates.

Adjust:

• Recognize noncontrolling interest.
• Adjust the balance sheet if the sub to fair value.
• Establish goodwill.

Question 29

State the workpaper elimination entry for intercompany inventory transactions.

Answer 29

Retained earnings (intercompany profit from beginning inventory)

Intercompany sales

Intercompany cost of goods sold

Cost of goods sold (intercompany profit in goods sold)

Ending inventory (intercompany profit in ending inventory)

Question 30

State the workpaper elimination entry for intercompany bond transactions.

Answer 30

Bonds payable

Premium (or credit discount)

Investment in affiliates bonds

Gain on extinquishment of bonds (or debit loss on extinguishment of bonds)

Question 31

State the workpaper elimination entry for intercompany land transactions.

Answer 31

Intercompany gain on sale of land

Land

Question 32

State the workpaper elimination entry for intercompany depreciable assets transactions.

Answer 32

Elimination Entry 1–Eliminate intercompany gain and adjust asset and accumulated depreciation to original amounts.

Intercompany gain on sale of machinery

Machinery

Accumulated depreciation

Elimination Entry 2–Eliminate excess depreciation:

Accumulated depreciation

Depreciation expense

Question 33

When are combined financial statements prepared?

Answer 33

• Companies under common control
• Companies under common management.
• Unconsolidated subsidiaries are combined.

Question 34

When preparing combined financial statements, identify the requirements.

Answer 34

• Intercompany transactions and balances among these companies are eliminated.
• Noncontrolling interests treated like consolidated financial statements.
• Capital stock and retained earnings are added across, not eliminated.
• Income statements are added across.

Question 35

Describe push down accounting.

Answer 35

Reports assets and liabilities at fair value in separate financial statements of subsidiary. In effect, consolidation adjustments are “pushed down” into the records.

• Assets and liabilities are adjusted to fair value at date of acquisition.
• Retained earnings of the subsidiary are transferred to paid-in capital.
• Net income of each subsidiary includes depreciation, amortization, and interest expense based on fair values rather than historical cost.
• The SEC requires push down accounting for each “substantially wholly owned subsidiary.”