FAR Module 12B Flashcards
Typically a servicing contract results in what (asset or liability)?
An asset because the benefits are more than adequate compensation for the cost of servicing.
Servicing of financial assets may involve one or all of the following activities
1) collecting payments
2) paying taxes and insurance
3) monitoring delinquencies
4) foreclosing
5) investing
6) remitting fees
7) accounting
What benefits are involved in a servicing contract?
Fees, late charges, float, and other income
How are assets accounted for under servicing contracts?
Assets are reported separately from liabilities. They are not netted
How do you measure servicing assets that are retained by the transferor
Initially measure servicing assets that are retained by the transferor by allocating the carrying amount based on relative fair values at the date of transfer
How do you measure all purchased assets, assumed liabilities, and liabilities undertaken in a sale or securitization?
Measure at fair value
T/F
Interest-only strips (future interest income from serviced assets that exceed servicing fees) should be accounted for separately
TRUE
Servicing assets and servicing liabilities should be measured using one of these two methods
1) amortization method
2) fair value method
T/F
An election must be made to use the fair value method for each class of servicing assets and servicing liability once elections made to value using the fair value method the election can be reversed
FALSE
the election cannot be reversed. Everything else is true.
You must report servicing assets and servicing liabilities on the balance sheet in one of these two ways:
1) display separate line items for amounts valued at fair value and amounts measured by amortization method
2) display aggregate amounts for all servicing assets and servicing liabilities and disclose parenthetically the amount that is measured at fair value that is included in the aggregate amount
Describe the amortization method of valuing servicing assets and servicing liabilities
This method requires servicing assets and servicing liabilities to be initially recorded at fair value.
Assets are then amortized in proportion to, and over the period of, receipt of estimated net servicing income or net servicing loss. At the end of each period the assets are assessed for impairment or increased obligation based on fair value. Over time, the asset is tested for impairment which is recognized in a valuation allowance account.
Liabilities are amortized in proportion to, and over the period of, net servicing loss. In cases where changes have increased the fair value above the book value, an increased liability and a loss should be recognized
Describe the fair value method when measuring servicing assets and liabilities
Servicing assets and servicing liabilities are initially recorded at fair value. The fair value is measured at each reporting date. Changes in fair value are reported in earnings in the period in which the change in fair value occurs
What are the required disclosures for all servicing assets and servicing liabilities
1) management’s basis for determining classes
2) a description of risks
3) any quantitative and qualitative information about assumptions used to estimate fair value
Define securitization
Securitization is the transformation of financial assets into securities (asset-backed securities)
T/F
various assets including mortgages, credit cards, trade receivables, loans, and leases cannot be grouped and securitized
FALSE
they can be grouped
What are the benefits of most securitizations?
lower financing costs, increased liquidity, and lower credit risk
Define a secured borrowing arrangement
Under this arrangement receivables are pledged as collateral for a loan
In a secured borrowing, the assets of the borrowing entity continue to be shown as assets in its financial statement, but must be identified as having been pledged. How is this identification accomplished?
Either parenthetically or by footnote disclosures
What are the three rules for accounting for collateral
1) ordinarily the transferor should carry the collateral as an asset and the transferee should not record the pledged asset
2) if the transferee has control of the asset, the secured party should record the asset at fair value and also the liability to return it. The transferor should reclassify the asset and report it separately in the balance sheet
3) if the transferor defaults and is not entitled to the return of the collateral, it should be derecognized. If not already recognized, the transferee should record collateral as an asset at fair value
Give examples of current liabilities (9)
1) trade accounts & notes payable
2) short term loan obligations
3) dividends payable
4) accrued liabilities
5) payroll
6) property taxes
7) bonus arrangements
8) fixed obligations
9) advances from customers
What are the entries to record prepayment
Debit prepaid asset
credit cash
Debit expense
credit prepaid asset
What are the two entries for payroll
Recording Payroll expense
Recording payroll tax expense
What are the two entries for setting up deferred expenses
Debit deferred expense
credit expense payable
Debit expense
credit deferred expense
Fixed obligations resulting from joint and several liability arrangements may be considered current liabilities under what requirements
1) the total obligation must be fixed at the reporting date, no measurement uncertainty (the obligation may change in value)
2) the amount to report includes the agreed-upon amount between the co-obligators
3) the amount to report must include the potential amounts the entity may be required to pay on behalf of the co-obligators
These liabilities exist when the amount of cash and time of payments are known and reasonably precise. Such liabilities are usually evidenced by written contracts but may also arise from implied agreements or imposed legal statutes
Determinable liabilities
These liabilities exist when obligations may exist but are dependent on uncertain future events.
Contingent liabilities
Define contingency
A contingency is when an existing condition, situation, or set of circumstances involve uncertainty as to possible gain or loss to an enterprise. This will ultimately be resolved when one or more future events occur or fail to occur
What are the three possible definitions for a contingency?
Probable
Reasonably possible
Remote
This is when future events are likely to occur
Probable
This is when there is a chance of occurrence that is more than remote but less than likely
Reasonably possible
This is when the chance of occurrence is slight
Remote
List examples of a loss contingency (6)
1) receivable collection
2) product warranty obligations
3) risk of property loss by fire or explosion
4) pending or threatened litigation
5) guarantees of indebtedness to others (for example factoring with recourse)
6) repurchase agreements
Estimated loss from contingencies should be accrued and charged to income when?
When it is probable and reasonably estimable
When the loss contingency is probable and reasonably estimable what do you do
Make a journal entry to record the estimated loss and provide a disclosure
When the loss contingency is reasonably possible what do you do
Just disclose
When the loss contingency has a remote chance what do you do
You do not need to disclose unless the loss contingency is one of four exceptions
What are the four exceptions where you will have to disclose even if there is only a remote chance of the loss contingency
1) guarantees of indebtedness to others
2) obligations of commercial banks under “standby letters of credit”
3) agreements to repurchase receivables or property
4) other agreements that in substance have the same characteristics
What is the rationale for accounting for loss contingencies
The rationale is that you want to look ahead at losses. You don’t really do this for gains. It is better to recognize gains only when we realize them. This follows the accounting principle of conservatism
If a loss contingency is probable and reasonably estimable and there is a range of possible losses what number do you use in the journal entry
Use the most likely amount
If a loss contingency is probable and reasonably estimable and there is a range of possible losses what number do you use in the journal entry when no number is better than any other under US GAAP? Under IFRS?
Use the minimum number in the range under US GAAP.
Use the midpoint of the range under IFRS.
If a loss contingency is probable and reasonably estimable and you have no idea of a number, not even a range, what number do you use in the journal entry
Do not make a journal entry, just disclose
What type of expense is a warranty expense
Selling expense
When do you recognize a warranty expense
You recognize the entire warranty expense in the year of sale. This follows the matching principle
When you hear “evenly during the year” what does that mean?
It means you need to take an average.
For example, if we are looking at revenue for recognition that was earned “evenly through the year” we will start recognizing the revenue in July (halfway through the year). Therefore our revenue recognition year will span from July-June rather than from Jan-Dec
Describe the warranty liability T account
On the right:
Beginning balance
+ warranty expense adjusting entry
On the left:
- expenditures
Both equal: ending balance
Asset retirement obligations may arise from…
1) existing or enacted law, statute, ordinance
2) written or oral contract
3) legal construction of a contract under the doctrine of promissory estoppel (inferred legal obligation)
An asset retirement obligation is recognized at what amount
It’s fair value in the period in which it is incurred providing that a reasonable estimate of fair value can be made
The best source of fair value of the liability would be provided by market determined values, but they will seldom be available
In the absence of a market expected present value of future cash flows should be used
How do you calculate expected present value for a liability when dealing with an asset retirement obligation
1) Use probability weighted present values in the range of the expected cash flows
2) the amount should be discounted to present value using a credit adjusted risk-free rate
Subsequent to the initial measurement of the liability, the obligation should be adjusted for what
1) The passage of time
2) revisions in estimates of timing or amounts of future cash flows
Upon initial recognition of a liability or upon revision of the liability what must you do to the related long-lived asset
Adjust the carrying amount of the related asset accordingly
Disclosures related to asset retirement obligations should include what
1) description of the obligation and related asset
2) description of how fair value is determined
3) the funding policy if any
4) reconciliation at the beginning and ending aggregate carrying value
