FAR Lecture 4

Question 1

Define working capital.

Answer 1

Current assets - Current liabilities

Question 2

How is the current ratio computed?

Answer 2

Current assets
Current liabilities

Question 3

How is the quick ratio computed?

Answer 3

Cash + Net receivables + Short-term investments
Current liabilities

Question 4

Current assets are defined as . . .

Answer 4

Those resources that are reasonably expected to be realized in cash, sold, or consumed (prepaid items) during the normal operating cycle of a business or one year, whichever is longer.

Question 5

Current liabilities are defined as . . .

Answer 5

Obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities.

Question 6

When can a short-term obligation be included in noncurrent liabilities?

Answer 6

If the enterprise intends to refinance the debt on a long-term basis and the intent is supported by the ability to do so as evidenced by:

• Actual refinancing prior to the issuance of the financial statements, or
• Existence of a noncancelable financing agreement from a lender having the financial resources to accomplish the refinancing.

Question 7

Define cash and cash equivalents.

Answer 7

• Cash includes both currency and demand deposits with banks and/or other financial institutions.
• Cash equivalents include short-term, highly liquid investments that are both readily convertible to cash and so near their maturity when acquired by the entity (90 days or less from date of purchase) that they represent insignificant risk of changes in value.

Question 8

Name two methods of accounting for the write-off of uncollectible accounts.

Answer 8

Direct Write-Off

Bad debt expense

Accounts receivable

Weaknesses: Bad debts are not matched to sales and accounts receivable are overstated. Not GAAP.

Allowance Method

Allowance for uncollectible accounts

Accounts receivable

Strengths: Matches bad debts with credit sales. Accounts receivable fairly stated. Required by GAAP.

Question 9

Name three methods of estimating uncollectible accounts.

Answer 9

• Percentage of credit sales
• Percentage of accounts receivable at year-end
• Aging of accounts receivable at year-end

Question 10

Using the allowance method, give the two journal entries to provide for and then to write off an uncollectible account.

Answer 10

Provide For

Bad debt expense

Allowance for uncollectible accounts

Write-Off

Allowance for uncollectible accounts

Accounts receivable

Question 11

What is the difference between factoring with recourse and without recourse?

Answer 11

With Recourse

The factor may return the account to the company if it proves to be uncollectible. Potential liability and risk of loss remains with the company.

Without Recourse

The factor assumes the risk of loss if the account is uncollectible.

Question 12

State the three conditions that must exist for control of a financial asset to be considered surrendered.

Answer 12

• The transferred assets have been isolated from the transferor;
• The transferree has the right to pledge or exchange the assets; and
• The transferor does not maintain control over transferred assets under a repurchase agreement.

Question 13

If control of a financial asset is surrendered, what is the accounting treatment of the transfer?

Answer 13

No Continuing Involvement

Recorded as a sale with appropriate reduction in receivables and recognition of any gain or loss.

Continuing Involvement

• Assets for which there is no retained interest are recorded as a sale using the financial-components approach.
• Assets for which there is retained interest are carried on the books of transferor and allocated a book value based on relative value of all transerred assets at the date of transfer.

Question 14

If control of a financial asset is not surrendered, what is the accounting treatment of the transfer?

Answer 14

• Account for transfer as a secured borrowing with pledged collateral.
• Recognize the appropriate asset/liability amounts and interest revenue/expense amounts.

Question 15

At what value should non-interest bearing promissory notes be recorded?

Answer 15

At the present value of all future payments required by the note. The payments should be discounted at the marked interest rate.

Question 16

Notes receivable may be discounted “with” or “without” recourse. What is the difference?

Answer 16

Discounting With Recourse

The holder remains contingently liable.

Discounting Without Recourse

The holder assumes no further liability after discounting.

Question 17

Describe the computational steps required in “discounting a note.”

Answer 17

1. Compute maturity value (remember to include interest to maturity).
2. Compute the “discount” (remember to use maturity value).
3. Get the proceeds by subtracting discount from maturity value.
4. Compute the interest income as difference between proceeds and face of note.

Question 18

When does the title to goods pass for each of the following?

FOB destination

FOB shipping point

Consigned goods

Answer 18

• FOB destination–When received by buyer
• FOB shipping point–When given to a common carrier
• Consigned goods–When sold to a third party by consignee.

Question 19

How is market calculated in the U.S. GAAP lower-of-cost-or-market method?

Answer 19

Market generally means current replacement cost, provided the current replacement cost does or exceed the market ceiling or fall below the market floor.

• Ceiling–Net realizable value (estimated net selling price less completion and disposal costs).
• Floor–Net realizable value minus normal profit margin.

Question 20

How is net realizable value calculated in the IFRS lower-of-cost-or-net-realizable-value method?

Answer 20

Net realizable value is the net selling price less completion and disposal costs.

This is the market ceiling under U.S. GAAP.

Question 21

Explain the difference between periodic and perpetual inventory methods.

Answer 21

Periodic

• The quantity of inventory is determined only by physical count.
• Ending inventory is physically counted and priced.

Perpetual

• Inventory is updated for each purchase and for each sale.
• Keeps a running total of inventory balances.

Question 22

Name several cost flow methods for inventory.

Answer 22

• Specific identification
• FIFO
• LIFO (unit and dollar value)
• Averaging
  
  • Weighted average (associated with periodic)
  • Moving average (associated with perpetual)

Question 23

When are losses on firm purchase commitments recognized?

Answer 23

Losses are recognized in the period when the price declines.

Estimated loss on purchase commmitment

Estimated liability on purchase commitment

Question 24

Describe an inventory consignment arrangement. Also, how are the consigned goods carried on the parties’ balance sheets?

Answer 24

Consignor gives goods to the consignee for sale to third parties. Title to the goods remains with the consignor; therefore the consigned items stay on the balance sheet of the consignor.

Question 25

During period of rising prices, the use of LIFO versus FIFO has what effect on the valuation of ending inventory and reporting net income? Which inventory method is prohibited under IFRS?

Answer 25

Both ending inventory and net income will be lower when LIFO is used during a period of rising prices.

LIFO = Lowest

LIFO is prohibited under IFRS.

Question 26

Give some examples of capitalization costs for:

–Acquistion of equipment

–Acquisition of building

Answer 26

Acquistion of Equipment

Purchase price, freight-in, installation, testing, taxes, less any cash discounts allowed.*

Acquisition of Building

Purchase price, deferred maintenance, alterations, improvements, architect’s fees.*

*If equipment or building is constructed by the company, capitalized cost could include construction period interest.

Question 27

How is fixed-asset carrying value computed under U.S. GAAP and IFRS?

Answer 27

U.S. GAAP

Carrying value = Historical cost - Accumulated depreciation - Impairment

IFRS

• Under IFRS, carrying value can be calculated using the U.S. GAAP method above or can be calculated using the revaluation model.
• Revaluation model carrying value = Fair value on revaluation date - Subsequent accumulated depreciation - Subsequent impairment
• Revaluation gains are reported in OCI.
• Revaluation losses are reported on the income statement.

Question 28

Describe the proper accounting for ordinary versus extraordinary repairs.

Answer 28

Ordinary repairs are expenses as repair and maintenance. They do not increase the life or utility of the asset.

Extraordinary repairs either increase the life or utility of the asset. If the extraordinary repair increases the life of the asset, it is recprded by reducing accumulated depreciation. If the extraordinary repair increases the utility of the asset, it is capitalized to the fixed asset account.

Question 29

Give examples of costs to be capitalized as land.

Answer 29

• Acquisition price
• Closing coses, such as real estate broker commissions, legal fees, escrow fees, title guarantee insurance
• Any mortgages, liens, or encumbrances on the land which the buyer assumes.
• Preparation costs, such as surveying costs, leveling costs, tree removal
• Cost of razing an existing building, in getting land into condition for intended use
• Improvements with indefinite life
• Less: Proceeds from the sale of assets on land.

Note: excavating costs for a building and cost of improvements with a definite life are not included in land.

Question 30

How is investment property defined and reported under IFRS?

Answer 30

Investment Property–Land and/or buildings held to earn rental income or for capital appreciation is reporting using one of two models:

Cost Model

Carrying value = Historical cost - Accumulated depreciation

Fair Value Model

Reported at fair value and not depreciated. Gains and losses from fair value adjustments are reported on the income statement.

Question 31

State two rules concerning capitalizing interest.

Answer 31

• Only capitalize interest on money actually spent, not on amount borrowed.
• The amount of capitalized interest is the lower of:
  
  • Actual interest cost incurred, or
  • Computed capitalized interest (avoidable interest).

Question 32

For capitalizing interest, when does the capitalization period begin?

Answer 32

Begins when three conditions are met:

• Expenditures for the asset have been made.
• Activities that are necessary to get the asset ready for its intended use are in progress.
• Interest cost is being incurred.

Ends when the asset is substantially complete and ready for its intended use.

Question 33

Name the most common depreciation methods. Give the basic formula for calculating each method.

Answer 33

Straight-Line

(Cost - Salvage) / Useful life

Sum-of-the-Years’ Digits

Sum of years = n(n+1)/2

(Cost - Salvage) x (Years remaining) / (Sum of the years)

Double-Declining Balance

2 x Striaght-line rate x Net book value of asset*

*No deduction for salvage to determine the depreciable base. Depreciate down to salvage value.

Units of Production

(Cost - Salvage) / Estimated hours x Actual hours for period.

Question 34

Explain the different approaches to depreciation under IFRS and U.S. GAAP.

Answer 34

Under IFRS, the depreciation method used should match the expected pattern of fixed asset consumption. (Not required under U.S. GAAP)

Under IFRS, component depreciation is required. (Not required under U.S. GAAP)

Question 35

State the rules for computing depletion on natural resources.

[Remember it is REAL property.]

Answer 35

Residual value (subtract)

Extraction/development cost

Anticipated restoration cost

Land purchase price

Divide that amount by Estimated recoverable units to get rate.

Rate x Units extracted = Depletion

Question 36

What assets are subject to the impairment test?

Answer 36

• Long-lived assets, specific identifiable intangibles, and related goodwill to be held and used.
• Long-lived assets and specific identifiable intangibles slated for disposal.
• Certain assets of a rate-regulated entity.

Note: The test must be done at least annually.

Question 37

Describe the impairment test for recoverability under U.S. GAAP.

Answer 37

If the sum of the undiscounted expected future cash flows is less than the carrying amount, an impairment loss needs to be recognized.

Question 38

Name the two rules for performing impairment calculations under U.S. GAAP.

Answer 38

Determining Impairment

Use the undiscounted future net cash flows. An impairment loss exists if total undiscounted cash flows are less than the carrying value.

Amount of Impairment

Use the fair value of asset:

Impairment loss = Fair value - Carrying value.

Question 39

How is impairment evaluated under IFRS?

Answer 39

Under IFRS, impairment exists if the carrying value of the fixed assets exceeds the higher of:

• Fair value - Costs of sell (NRV)
• Value in use (present value of future cash flows)

Question 40

How is the impairment loss reported in the financial statements?

Answer 40

As a component of income from continuing operations before income taxes.

The carrying amount of the asset is reduced.

Question 41

Is restoration of impairment losses permitted under U.S. GAAP and IFRS?

Answer 41

U.S. GAAP

Restoration (reversal of impairment losses) is permitted for assets held for sale. Restoration is prohibited for assets held for use.

IFRS

Restoration is always permitted.