FAR Module 12B

Question 0

Typically a servicing contract results in what (asset or liability)?

Answer 0

An asset because the benefits are more than adequate compensation for the cost of servicing.

Question 1

Servicing of financial assets may involve one or all of the following activities

Answer 1

1) collecting payments
2) paying taxes and insurance
3) monitoring delinquencies
4) foreclosing
5) investing
6) remitting fees
7) accounting

Question 2

What benefits are involved in a servicing contract?

Answer 2

Fees, late charges, float, and other income

Question 3

How are assets accounted for under servicing contracts?

Answer 3

Assets are reported separately from liabilities. They are not netted

Question 4

How do you measure servicing assets that are retained by the transferor

Answer 4

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

Question 5

How do you measure all purchased assets, assumed liabilities, and liabilities undertaken in a sale or securitization?

Answer 5

Measure at fair value

Question 6

T/F

Interest-only strips (future interest income from serviced assets that exceed servicing fees) should be accounted for separately

Answer 6

TRUE

Question 7

Servicing assets and servicing liabilities should be measured using one of these two methods

Answer 7

1) amortization method

2) fair value method

Question 8

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

Answer 8

FALSE

the election cannot be reversed. Everything else is true.

Question 9

You must report servicing assets and servicing liabilities on the balance sheet in one of these two ways:

Answer 9

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

Question 10

Describe the amortization method of valuing servicing assets and servicing liabilities

Answer 10

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

Question 11

Describe the fair value method when measuring servicing assets and liabilities

Answer 11

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

Question 12

What are the required disclosures for all servicing assets and servicing liabilities

Answer 12

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

Question 13

Define securitization

Answer 13

Securitization is the transformation of financial assets into securities (asset-backed securities)

Question 14

T/F

various assets including mortgages, credit cards, trade receivables, loans, and leases cannot be grouped and securitized

Answer 14

FALSE

they can be grouped

Question 15

What are the benefits of most securitizations?

Answer 15

lower financing costs, increased liquidity, and lower credit risk

Question 16

Define a secured borrowing arrangement

Answer 16

Under this arrangement receivables are pledged as collateral for a loan

Question 17

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?

Answer 17

Either parenthetically or by footnote disclosures

Question 18

What are the three rules for accounting for collateral

Answer 18

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

Question 19

Give examples of current liabilities (9)

Answer 19

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

Question 20

What are the entries to record prepayment

Answer 20

Debit prepaid asset
credit cash

Debit expense
credit prepaid asset

Question 21

What are the two entries for payroll

Answer 21

Recording Payroll expense

Recording payroll tax expense

Question 22

What are the two entries for setting up deferred expenses

Answer 22

Debit deferred expense
credit expense payable

Debit expense
credit deferred expense

Question 23

Fixed obligations resulting from joint and several liability arrangements may be considered current liabilities under what requirements

Answer 23

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

Question 24

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

Answer 24

Determinable liabilities

Question 25

These liabilities exist when obligations may exist but are dependent on uncertain future events.

Answer 25

Contingent liabilities

Question 26

Define contingency

Answer 26

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

Question 27

What are the three possible definitions for a contingency?

Answer 27

Probable
Reasonably possible
Remote

Question 28

This is when future events are likely to occur

Answer 28

Probable

Question 29

This is when there is a chance of occurrence that is more than remote but less than likely

Answer 29

Reasonably possible

Question 30

This is when the chance of occurrence is slight

Answer 30

Remote

Question 31

List examples of a loss contingency (6)

Answer 31

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

Question 32

Estimated loss from contingencies should be accrued and charged to income when?

Answer 32

When it is probable and reasonably estimable

Question 33

When the loss contingency is probable and reasonably estimable what do you do

Answer 33

Make a journal entry to record the estimated loss and provide a disclosure

Question 34

When the loss contingency is reasonably possible what do you do

Answer 34

Just disclose

Question 35

When the loss contingency has a remote chance what do you do

Answer 35

You do not need to disclose unless the loss contingency is one of four exceptions

Question 36

What are the four exceptions where you will have to disclose even if there is only a remote chance of the loss contingency

Answer 36

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

Question 37

What is the rationale for accounting for loss contingencies

Answer 37

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

Question 38

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

Answer 38

Use the most likely amount

Question 39

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?

Answer 39

Use the minimum number in the range under US GAAP.

Use the midpoint of the range under IFRS.

Question 40

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

Answer 40

Do not make a journal entry, just disclose

Question 41

What type of expense is a warranty expense

Answer 41

Selling expense

Question 42

When do you recognize a warranty expense

Answer 42

You recognize the entire warranty expense in the year of sale. This follows the matching principle

Question 43

When you hear “evenly during the year” what does that mean?

Answer 43

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

Question 44

Describe the warranty liability T account

Answer 44

On the right:
Beginning balance
+ warranty expense adjusting entry

On the left:
- expenditures

Both equal: ending balance

Question 45

Asset retirement obligations may arise from…

Answer 45

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)

Question 46

An asset retirement obligation is recognized at what amount

Answer 46

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

Question 47

How do you calculate expected present value for a liability when dealing with an asset retirement obligation

Answer 47

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

Question 48

Subsequent to the initial measurement of the liability, the obligation should be adjusted for what

Answer 48

1) The passage of time

2) revisions in estimates of timing or amounts of future cash flows

Question 49

Upon initial recognition of a liability or upon revision of the liability what must you do to the related long-lived asset

Answer 49

Adjust the carrying amount of the related asset accordingly

Question 50

Disclosures related to asset retirement obligations should include what

Answer 50

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