FAR SEC 2 Flashcards
Are the financial statement formats required by GAAP?
No. Specific names and formats for these statements are not specified under GAAP. Instead, the formats of these statements have evolved to fulfill the requirements of GAAP
The left side of the accounting equation shows:
Assets (the entity’s resource structure)
The right side of the accounting equation shows:
Liabilities + Equity (the entity’s financing structure)
What are three items that primary users can assess about an entity based on the Balance Sheet?
Liquidity, Flexibility, Risk
Assets =
Liabilities + Equity
Assets are generally reported in order of:
Liquidity. Liquidity decreases moving from top to bottom on the assets section.
Current Assets
An asset is classified as current on the statement of financial position if it is expected to be realized within the entity’s operating cycle or 1 year, whichever is longer.
Operating Cycle
The operating cycle is the average time between the acquisition of resources and the final receipt of cash from their sale as the culmination of revenue generating activities. If the cycle is less than a year, 1 year is the period used for segregating current from noncurrent assets.
Operating Cycle = Inventory Period + Accounts Receivable Period
An asset is classified as current on the statement of financial position if
if it is expected to be liquidated or used up within the entity’s operating cycle or 1 year, whichever is longer.
Current assets include (6 elements)
1) Cash and cash equivalents;
2) Certain individual trading, available-for-sale, and held-to-maturity debt securities;
3) Certain individual investments in equity securities.
4) Receivables;
5) Inventories;
6) Prepaid expenses
Noncurrent Assets (basic definition, not examples)
Noncurrent assets are those not qualifying as current. Noncurrent assets are expected to be held for a longer period than 1 year or the length of the operating cycle.
What is the definition of Investments and Funds? Give the definition and four examples of types of Investments and Funds.
DEFINITION: NONOPERATING & NONCURRENT. Investments and funds include nonoperating items intended to be held beyond the longer of 1 year or the operating cycle. The following assets are typically included:
1) INVESTMENTS FOR CORPORATE EVENTS. Investments in equity securities made to control or influence another entity
2) NONCURRENT DEBT/EQUITY SECURITIES. Other noncurrent equity securities held as investments.
- Certain individual available-for-sale and held-to-maturity debt securities may be noncurrent.
3) NONOPERATING SPECIAL PUPROSE FUNDS. Funds restricted as to withdrawal or use for other than current operations, for example, to
- Retire long-term debt,
- Satisfy PENSION obligations, or
- Pay for the acquisition or construction of noncurrent assets
4) NONOPERATING CAPITAL ASSETS. Capital assets not used in current operations, such as
- Idle facilities or
- Land held for a future plant site
Noncurrent Assets (5 major categories)
Major categories of noncurrent assets include:
1) Investment and Funds,
2) Property, Plant, & Equipment (PPE),
3) Intangible Assets,
4) Other Noncurrent Assets,
5) Deferred Charges
Current Liabilities
Current liabilities generally are expected to be settled or liquidated in the ordinary course of business during the longer of 1 year or the operating cycle.
Current liabilities are “obligations whose liquidation is reasonably expected to require the use of existing resources properly classifiable as current assets, or the creation of other current liabilities.”
Current Liabilities include (5 elements):
1) Trade payables for items entering into the operating cycle, e.g., for materials and supplies used in producing goods or services for sale.
2) Other payables arising from operations, such as accrued wages, salaries, rentals, royalties, and taxes.
3) Unearned revenues (contract liabilities) arising from collections in advance of delivering goods or performing services, e.g., ticket sales revenue.
4) Other current liabilities include
Short-term notes given to acquire capital assets
Payments on the current portion of serial bonds or other noncurrent debt-
5) Noncurrent obligations callable by the creditor because of the debtor’s violation of the debt agreement at the balance sheet date are classified as current.
Working Capital =
Working Capital = Current Assets - Current Liabilities
Current liabilities do not include (2 elements):
Current liabilities do not include:
1) Current obligations if an entity (a) intends to refinance them on a noncurrent basis and (b) demonstrates an ability to do so.
- The ability to refinance may be demonstrated by
(i) Entering into a financing agreement meeting all conditions before the balance sheet is issued.
(ii) Issuing a noncurrent obligation or equity securities after the end of the reporting period but before issuance of the balance sheet.
- The amount excluded from current liabilities must not exceed the proceeds from the new obligation or equity securities issued.
2) Debts to be paid from funds accumulated in noncurrent asset accounts. Thus, a liability for bonds payable in the next period will not be classified as current if payment is to be from a noncurrent fund.
Noncurrent Liabilities (8 elements)
1) DEFINITION: Noncurrent liabilities are those not qualifying as current. The noncurrent portions of the following items are reported in this section of the balance sheet:
2) Noncurrent notes and bonds
3) Lease liability
4) Most postretirement benefit obligations
5) Obligations under product or service warranty agreements
6) Advances for noncurrent commitments to provide goods or services
7) Deferred revenue (payments collected for goods or services not yet earned)
8) Deferred tax liabilities arising from interperiod tax allocation are classified as noncurrent.
Noncurrent Liabilities (7 elements)
DEFINITION: Noncurrent liabilities are those not qualifying as current. The noncurrent portions of the following items are reported in this section of the balance sheet:
1) Noncurrent notes and bonds
2) LEASES. Long-term operating expense payment agreements, e.g., lease liability
3) PENSIONS. Most postretirement benefit obligations
4) WARRANTIES. Obligations under product or service warranty agreements
5) ADVANCES. Advances for noncurrent commitments to provide goods or services
6) Deferred revenue
7) ALL Deferred tax liabilities arising from interperiod tax allocation are classified as noncurrent.
Equity
Equity is the residual after total liabilities are subtracted from total assets.
Equity (4 major categories)
Equity consists of the following:
1) Capital contributed by owners (par value of common and preferred stock issued and additional paid-in capital)
2) Retained earnings (income reinvested)
3) Accumulated other comprehensive income (all comprehensive income items not included in net income)
4) The noncontrolling interest in a consolidated entity (covered in Study Unit 14)
Treasury Stock
Treasury stock is the entity’s own common stock that it has repurchased. Treasury stock is presented as a reduction of total equity (discussed in Study Unit 13).
Treasury Stock is a reduction of ___________.
Treasury stock is presented as a reduction of total equity.
Temporary vs. Permanent Accounts
The accounts presented on the balance sheet are real or permanent accounts. They report an entity’s resources and financing elements that exist from period to period. The accounts presented on the income statement are nominal or temporary accounts. They are reported for a period of time, closed at the end of the period, and reopened at the beginning of the next period with zero balances.
(Nominal) Temporary Accounts
The accounts presented on the income statement are nominal or temporary accounts. They are reported for a period of time, closed at the end of the period, and reopened at the beginning of the next period with zero balances.
(Real) Permanent Accounts
The accounts presented on the balance sheet are real or permanent accounts. They report an entity’s resources and financing elements that exist from period to period.
Permanent Accounts appear on the ________________.
Permanent accounts appear on the Balance Sheet.
Temporary Accounts appear on the _____________.
Temporary Accounts appear on the Income Statement.
What is reported on the Income Statement?
Revenues, Expenses, Gains, & Losses
Fundamental Equation of Net Income
Revenues - Expenses + Gains - Losses = Net Income
Should the accountant close each transaction in a temporary account directly to equity?
No. Income statement elements are reported in temporary (nominal) accounts that are periodically closed to permanent (real) accounts. The accountant need not close each transaction directly to equity.
What is the permanent accounting treatment of income or loss?
Income or loss is closed to retained earnings at the end of the period.
What are Discontinued Operations?
Discontinued operations is an accounting term for parts of a firm’s operations that have been divested or shut down.
Any recognized amounts not included in continuing operations are reported in a separate section for discontinued operations.
The term “continuing operations” is used only when a discontinued operation is reported.
The transactions not included in net income are (5 elements):
1) Transactions with owners (distributions/contributions)
2) Error corrections,
3) Items reported INITIALLY in other comprehensive income,
4) Transfers to and from appropriated retained earnings, and
5) Effects on prior periods of accounting changes.
What are the three Income Statement formats?
Single-step, Multiple-step, & Condensed
Define Single-step Income Statement
The single-step income statement provides one grouping for revenues and gains and one for expenses and losses. The single step is the one subtraction necessary to arrive at net income.
Define Multiple-step Income Statement
The multiple-step income statement reports operating revenues and expenses in a section separate from nonoperating items. It enhances disclosure by presenting subtotals.
Define Condensed Income statement
The condensed income statement is the most common method of presentation. It includes only the section totals of the multiple-step format. The enhanced disclosure of each line item is presented in the notes to the financial statements.
What is the most commonly used type of Income Statement?
Condensed Income Statement
Single-step Income Statement Formula
[Total Revenues & Gains] - [Total Expenses & Losses] = Net Income
Do all Income Statement formats end with earnings per common share?
Yes.
Multiple-step Income Statement Formula
Net Sales - COGS = Gross Profit
Gross Profit - Total Operating Expenses = Income from Operations
Operating Income + Other [Revenues/Gains - Expenses/Losses] = Income Before Taxes
Income Before Taxes - Tax Expense = Net Income
Gross Profit = ?
Gross Profit = Net Sales - COGS
Net Sales = ?
Net Sales = Gross Sales - Sales Discounts - Sales Returns & Allowances
Note: Allowances would mainly be the allowance for uncollectible accounts
COGS = ?
COGS = Beginning FG Inventory + Net Purchases + COGM - Ending FG Inventory
Operating Expenses = ?
Operating Expenses = Selling Expenses + General & Administrative Expenses
Condensed Income Statement
The condensed income statement is the most common method of presentation. It includes only the section totals of the multiple-step format. The enhanced disclosure of each line item is presented in the notes to the financial statements.
Define COGS
Cost of goods sold equals purchases for a retailer or cost of goods manufactured (COGM) for a manufacturer, adjusted for the change in finished goods (FG) in inventory. Beginning FG inventory + Purchases or COGM - Ending FG Inventory = COGS Beginning FG inventory + Purchases or COGM = Goods available for sale
Cost of Goods Manufactured
Adjusted COGM = Beginning FG Inventory + Period COGM - Ending FG Inventory
Cost of goods manufactured equals the period’s manufacturing costs adjusted for the change in work-in-process. It also may be stated as cost of goods sold adjusted for the change in finished goods inventory.
COGM Formulas
COGM = Beginning WIP + Periodic Manufacturing Costs - Ending WIP
COGM = Ending FG Inventory + COGS - Beginning FG Inventory
What is WIP?
WIP is work-in-process. May refer to work-in-process inventory.
Selling Expenses (Definition and 3 examples)
DEFINITION: Selling expenses are incurred in selling or marketing.
Examples include
1) Sales representatives’ salaries, commissions, and traveling expenses;
-Sales department rent, salaries, and depreciation; and
2) Communications (e.g., Internet) costs.
3) Shipping costs also may be classified as selling costs.
When should selling expenses be recognized (2 elements)?
1) GENERAL RULE: Advertising costs should be expensed either as incurred or when advertising first occurs.
2) SPECIAL RULE: COLLABORATIVE ADVERTISING: Sellers may agree to reimburse customers for the customers’ advertising costs (cooperative advertising). The revenues related to the transactions that created such obligations generally are recognized before reimbursement. Accordingly, the obligations must be accrued and the advertising costs expensed when the related revenues are recognized.
What is Cooperative Advertising?
Sellers may agree to reimburse customers for the customers’ advertising costs (cooperative advertising). The revenues related to the transactions that created such obligations generally are recognized before reimbursement, e.g., the revenue from cooperative advertising for sales from Auto manufacturer to Auto dealer are recognized immediately when the cars are sold to the dealer, so the expense from cooperative advertising is simultaneously recognized.. Accordingly, the obligations must be accrued and the advertising costs expensed when the related revenues are recognized.
General & Administrative Expenses (Definition and 6 examples)
DEFINITION: General and administrative expenses are incurred for the direction of the entity as a whole and are not related entirely to a specific function, e.g., selling or manufacturing. They include:
1) Accounting, legal, and other fees for professional services; 2) Officers’ salaries; 3) Insurance; 4) Wages of office staff; 5) Miscellaneous supplies; and 6) Office occupancy costs.
How is Interest Expense Recognized?
Interest expense is recognized based on the passage of time. In the case of bonds, notes, and finance leases, the effective interest method is used.
Effective Interest Method
Step (1) use annuity formula to find the effective interest rate.
Step (2) Interest Income (in current period) = Effective Interest Rate*Carrying Value
Step (3) Accreted Discount/Premium = Effective Interest - Coupon Payment
Step (4) Update the ending carrying amount at the end of each periodic application of the Effective Interest Method
Unusual or Infrequent Items (5 elements)
1) Material items that are unusual in nature, infrequent in occurrence, or both are reported as a separate component of income from continuing operations.
2) These items must not be reported net of taxes.
3) Gains or losses of a similar nature that are not individually material must be aggregated.
4) The nature and financial effect of each item is disclosed in the notes to the financial statements or reported in the income statement.
5) The effects of such items on earnings per share must not be presented on the income statement.
Discontinued Operations (3 elements)
1) REPORTED SEPARATELY NET OF TAX ON INCOME STATEMENT. The operating results of a discontinued operation are reported separately net of tax in the income statement. This section is presented after the results of continuing operations.
2) INCOME/LOSS REPORTED SEPARATELY FROM NET TAX BENEFIT/EXPENSE. The discontinued operations section presents separately the (a) income or loss from operations of the component and (b) income tax expense or benefit.
3) BASIC & DILUTED EPS AMOUNTS FOR DISCONTINUED OPERATIONS ARE REPORTED ON INCOME STATEMENT OR IN THE NOTES. If a discontinued operation is reported, basic and diluted earnings per share amounts for the discontinued operation are presented on the face of the income statement or in the notes (discussed in Study Unit 3, Subunit 2).
Gain or Loss on Disposal of Discontinued Operations
If a component of an entity (discontinued operation) is disposed of during the period, any gain or loss on disposal must be disclosed on the face of the income statement or in the notes.
Discontinued Operation Held for Sale (3 elements)
1) MEASUREMENT. When a component (discontinued operation) is classified as held for sale, it is measured at the lower of its carrying amount or fair value minus cost to sell (discussed in Study Unit 8, Subunit 9).
2) TIMEFRAME. Operating results reported in discontinued operations include any income earned or loss incurred during the entire reporting period (i.e., before and after the component was classified as held for sale).
3) INCLUDE ANY LOSS ON WRITE-DOWN TO FAIR VALUE FOR DISCONTINUED UNIT.
Operating results also include any loss for a write-down to fair value minus cost to sell recognized on the initial classification as held for sale and subsequently.
Discontinued Operations: Intraperiod Tax Allocation
Intraperiod tax allocation is required. Thus, income tax expense or benefit is allocated to
-Continuing operations,
–Discontinued operations,
Other comprehensive income, and
-Items debited or credited directly to other components of equity.
The operating results of a discontinued operation also must be reported in the comparative financial statements.
Comprehensive Income
Comprehensive Income = Net Income + OCI
Comprehensive Income excludes owner contributions/draws
Comprehensive income includes all changes in equity of a business during a period except those from investments by and distributions to owners. It includes all components of
Net income and
Other comprehensive income (OCI).
Other Comprehensive Income
OCI: Sum of: 1) unrealized holding gains/losses, 2) derivative cash flow hedges, 3) foreign currency adjustments, 4)credit risk adjustment for debt securities under fair value option.
OCI includes all items of comprehensive income not included in net income. Under existing accounting standards, items of OCI include, among others,
- Unrealized holding gains and losses on available-for-sale debt securities (Study Unit 5).
- Gains and losses on derivatives designated and qualifying as cash flow hedges (Study Unit 15).
- Certain foreign currency items (Study Unit 15).
- Changes in fair value attributable to instrument-specific credit risk of financial liabilities for which the fair value option is elected (Study Unit 5).
Each component of OCI must be presented net of tax, or one amount must be presented for the aggregate tax effect on the total of OCI. In either case, the tax effect on each component must be disclosed.
Must each component of Other Comprehensive Income be presented net of tax?
Yes.
Must an entity always report Other Comprehensive Income?
No. An entity that presents a full set of financial statements but has no items of OCI need not report OCI or Comprehensive Income.
What are the two options for reporting Other Comprehensive Income?
An entity that presents a full set of financial statements but has no items of OCI need not report OCI or comprehensive income. Otherwise, an entity must present all items of comprehensive income recognized for the period either
- In one continuous financial statement or
- In two separate but consecutive statements.
Note: In the continuous presentation, an Income Statement is merged with a statement of OCI. In two separate statements, the Income Statement is the first disclosure, followed immediately by a Statement of OCI where Net Income is the first line.
Reporting Other Comprehensive Income in one continuous statement
One continuous statement must have two sections: net income and OCI. It must include
A total of net income with its components,
A total of OCI with its components, and
A total of comprehensive income.
Reporting Other Comprehensive Income in separate but consecutive statements
Separate but consecutive statements must be presented as follows:
The first statement (the income statement) presents the components of net income and total net income.
The second statement (the statement of OCI) is presented immediately after the first. It presents
The components of OCI,
The total of OCI, and
A total for comprehensive income.
The entity must begin the second statement with net income.
How does the Statement of Other Comprehensive Income relate to the Income Statement?
The final component of the statement of net income is net income.
The first component of the statement of OCI is net income, and the final component is comprehensive income.
How is Other Comprehensive Income closed to a permanent account?
The components of OCI are recorded initially in a temporary (nominal) account. At the end of each reporting period, the total OCI for a period is closed to accumulated OCI, a permanent account that is reported in the equity section of the balance sheet.
Other comprehensive income for the period increases accumulated OCI.
Other comprehensive loss for the period decreases accumulated OCI.
Statement of Changes in Equity
A statement of changes in equity is presented as part of a full set of financial statements. This statement provides disclosure of changes during the accounting period in the separate equity accounts. These are retained earnings, common stock, preferred stock, additional paid-in capital, accumulated OCI, and noncontrolling interest.
What are the equity accounts shown on a Statement of Changes in Equity?
These are retained earnings, common stock, preferred stock, additional paid-in capital, accumulated OCI, and noncontrolling interest.
Is the Statement of Retained Earnings a separate financial statement?
No. The Statement of Retained Earnings is now a column of the Statement of Changes in Equity.
Statement of Retained Earnings
Statement of Retained Earnings
A statement of retained earnings reconciles the beginning and ending balances of the account. This statement is not separately reported. Instead, it is reported as part of the statement of changes in equity in a separate column.
The changes in retained earnings can result from the following adjustments:
Net income (loss) for the period;
Any prior-period adjustments, net of tax (discussed in Study Unit 3);
Dividends declared; and
Certain other rare items, e.g., reissuance of treasury stock under the cost method (discussed in Study Unit 13).
Retained earnings are sometimes appropriated (restricted) to a special account to disclose that earnings retained in the business (not paid out in dividends) are being used for special purposes (discussed in Study Unit 13).
Pension Plan
A pension plan is a separate legal entity to which a sponsoring employer makes contributions. It invests the assets and makes payments to beneficiaries.
Defined Contribution Pension Plan
A defined contribution plan provides an individual account for each participating employee. Pension benefits depend only on (a) the amount contributed to the plan by the employer and the employee and (b) the returns earned on investments of those contributions. Because the employer does not guarantee the amount of benefits that the employees will receive during retirement, employees bear the investment risk.
Defined Benefit Pension Plan
A defined benefit plan defines an amount of pension benefits to be provided to each employee. The employer is responsible for providing the agreed benefits and therefore bears actuarial risk and investment risk.
The benefits that the employer is required to pay are estimated by using actuarial assumptions. They depend on such factors as (1) how long an employee or any survivor lives, (2) how many years of service the employee renders, and (3) the employee’s compensation before retirement.
What is the purpose of a pension plan’s financial statements?
The primary objective of a pension plan’s financial statements is to provide financial information that is useful in assessing the plan’s present and future ability to pay benefits when they are due.
Which financial statements are required for a Defined Contribution Pension Plan?
1) Statement of Net Assets Available for Plan Benefits
2) Statement of Changes in Net Assets Available for Benefits
Statement of Net Assets Available for Plan Benefits
A statement of net assets available for benefits of the plan as of the end of the plan year. This statement should present the total assets, total liabilities, and net assets available for benefits.
Plan investments (e.g., equity or debt securities and real estate) should be reported at their fair value at the reporting date.
Statement of Changes in Net Assets Available for Benefits
A statement of changes in net assets available for benefits of the plan for the year then ended. This statement should present the effects of significant changes in net assets during the year and must present, at a minimum, all of the following:
- Net appreciation or depreciation of the fair value of investments. It includes (1) changes in the fair value of investments that were both purchased and sold during the period and (2) unrealized appreciation or depreciation of the investments held at year end.
- Contributions from employers, segregated between cash and noncash contributions.
- Contributions from participants or other identified sources.
- Benefits paid to participants.
- Administrative expenses.
- Payments to insurance entities to purchase contracts that are excluded from plan assets.
Is a Statement of Cash Flows required to be provided by the defined contribution plan entity or by the defined benefit plan entity.
No. For either a defined benefit pension or a defined contribution pension, the Statement of Cash Flows is not a required disclosure.
Which financial statements must be provided by a Defined Benefit Pension Plan?
1) Statement of Net Assets Available for Benefits. (similar in form to that required for a Defined Contribution Pension).
2) A Statement of Changes in Net Assets Available for Benefits of the plan for the year then ended (similar to a defined contribution pension plan).
3) Actuarial present value of accumulated plan benefits, which may be presented in a separate statement or in a combined statement with the statement of net assets available for benefits
4) Changes in the actuarial present value of accumulated plan benefits for the year then ended, which may be presented in a separate statement or in a combined statement with the statement of changes in net assets available for benefits
Other Bases of Accounting (Special Purpose Frameworks)
Other Bases of Accounting
Financial statements may be prepared using a comprehensive basis of accounting that is not in accordance with GAAP.
Common examples are the following:
The cash basis or modified cash basis
A basis used for tax purposes
A basis used to comply with the requirements of a regulator
Statements using a basis other than GAAP should include a summary of significant accounting policies that discusses the basis used and how it differs from GAAP.
Cash Basis
Under the strict cash basis of accounting, revenues and expenses are recognized when cash is received or paid, respectively, regardless of when goods are delivered or received or when services are rendered.
The cash basis ignores the revenue and expense recognition principles that are fundamental to the accrual basis.
This method may be appropriate for small businesses operated as sole proprietorships.
Modified Cash Basis
The modified cash basis uses the cash basis for typical operating activities with modifications having substantial support, for example, reporting inventory, accruing income taxes, and capitalizing and depreciating fixed assets.
This method often is used by professional services firms, such as physicians, realtors, and architects.
Income Tax Basis
This basis must be applied to calculate income tax liability.
Certain doctrines underlying the federal tax code differ significantly from those in the conceptual framework. For example, the code requires use of the modified accelerated cost recovery system (MACRS), a depreciation method not recognized under GAAP.
Par Value of Stock
The value per share of stock stated in the corporate charter; this has no relationship to the actual current market price of the shares.
Additional Paid-in Capital
The excess of the value paid for shares of stock over and above the par value during the initial public offering or later offerings of stock for sale to the public.
Par Value Common & Preferred Stock + Additional Pain-in Capital = Total Amount of Equity Financing from Sales of Stock
Available-for-Sale Securities
(Investopedia)
-Available-for-sale securities (AFS) are debt or equity securities purchased with the intent of selling before they reach maturity, or, if there is no maturation date, to be “held as a long-term investment” (not held-for-trading!).
-Available-for-sale securities are reported at fair value.
-Unrealized gains and losses are included in accumulated other comprehensive income within the equity section of the balance sheet.
-Investments in debt or equity securities purchased must be classified as held to maturity, held for trading, or available for sale.
An available-for-sale security (AFS) is a debt or equity security purchased with the intent of selling before it reaches maturity or holding it for a long period should it not have a maturity date. Accounting standards necessitate that companies classify any investments in debt or equity securities when they are purchased as held-to-maturity, held-for-trading, or available-for-sale. Available-for-sale securities are reported at fair value; changes in value between accounting periods are included in accumulated other comprehensive income in the equity section of the balance sheet.
Held-to-Maturity Securities
(Investopedia) Held-to-maturity (HTM) securities are purchased to be owned until maturity. For example, a company’s management might invest in a bond that they plan to hold to maturity. HTM securities are typically reported as a noncurrent asset; they have an amortized cost on a company’s financial statements. Amortization is an accounting practice that adjusts the cost of the asset incrementally throughout its life. HTM securities are only reported as current assets if they have a maturity date of one year or less. Securities with maturities over one year are stated as long-term assets and appear on the balance sheet at the amortized cost—meaning the initial acquisition cost, plus any additional costs incurred to date.
Held-for-Trading Securities
A held-for-trading security is a debt or equity investment that investors purchase with the intent of selling within a short period of time, usually less than one year. Within that time frame, the investor hopes to see appreciation in the value of the security and sell it for a profit. On the balance sheet, held-for-trading securities are considered current assets. Held-for-trading securities are reported at fair value, and unrealized/gains or losses are reflected in earnings.
Property, Plant, & Equipment (PPE)
Property, plant, and equipment (PPE) are tangible operating items recorded at cost and reported net of any accumulated depreciation. They include
Land and natural resources subject to depletion, e.g., oil and gas
Buildings, equipment, furniture, fixtures, leasehold improvements, land improvements, noncurrent assets under construction, and other depreciable assets
How are Property, Plant, & Equipment (PPE) reported?
They are recorded at cost and reported net of any accumulated depreciation.
Intangible assets
Intangible assets are nonfinancial assets without physical substance. Examples are patents and goodwill.
Other Noncurrent Assets
Other noncurrent assets include noncurrent assets not readily classifiable elsewhere. Examples are deferred tax assets and long-term receivables.
Deferred Charges
The category deferred charges (long-term prepayments) appears on some balance sheets.
How can violation of debt covenants change the status of noncurrent liabilities?
Noncurrent obligations callable by the creditor because of the debtor’s violation of the debt agreement at the balance sheet date are classified as current.
How does the intent & ability to refinance current liabilities on a long-term basis impact the status of liabilities?
Current obligations may not be recognized as current liabilities if an entity (a) intends to refinance them on a noncurrent basis and (b) demonstrates an ability to do so.
The ability to refinance may be demonstrated by
1) Entering into a financing agreement meeting all conditions before the balance sheet is issued.
2) Issuing a noncurrent obligation or equity securities after the end of the reporting period but before issuance of the balance sheet.
The amount excluded from current liabilities must not exceed the proceeds from the new obligation or
Current liabilities do not include
Current obligations if an entity (a) intends to refinance them on a noncurrent basis and (b) demonstrates an ability to do so.
Debts to be paid from funds accumulated in noncurrent asset accounts. Thus, a liability for bonds payable in the next period will not be classified as current if payment is to be from a noncurrent fund.
Material items that are unusual in nature, infrequent in occurrence, or both are ______________.
are reported as a separate component of income from continuing operations.
Material items that are unusual in nature, infrequent in occurrence, or both have the following four (4) properties:
These items must not be reported net of taxes.
Gains or losses of a similar nature that are not individually material must be aggregated.
The nature and financial effect of each item is disclosed in the notes to the financial statements or reported in the income statement.
The effects of such items on earnings per share must not be presented on the income statement.
Net Income + Other Comprehensive Income = ?
Comprehensive Income
Each component of OCI must be presented ____________.
net of tax. Or one amount must be presented for the aggregate tax effect on total OCI.
When can an entity avoid making a Statement of Comprehensive Income?
Only when there are no OCI items for the entity during the period.
Accumulated OCI
Accumulated OCI is a permanent account that is reported in the equity section of the balance sheet. The components of OCI in each period are temporary accounts that close to accumulated OCI.
Does a realized gain on sale of available-for-sale securities belong in other comprehensive income?
No, it belongs in net income.
Does a loss on write-down of inventory belong in other comprehensive income?
No, it belongs in net income.
Does a loss on early extinguishment of bonds belong in other comprehensive income?
No, it belongs in net income.
Should an adjustment to prior period profits due to an accounting error be included in net income?
No, it should be closed directly to retained earnings.
Should an adjustment to prior period profits due to an accounting error be included in net income?
No, it should be closed directly to retained earnings.
Are infrequently occurring gains included in net income?
Yes.
Which sections of the financial statements can have intraperiod tax allocation?
Continuing operations, discontinued operations, other comprehensive income, and items debited/credited directly to shareholders’ equity. Operating income is the section where no intraperiod tax allocation may be allocated.
Do administrative expenses effect changes in available pension plan benefits?
No. Changes in levels of administrative expenses are excluded from reporting the net changes in available pension plan benefits.
What is a discount on bonds payable from the perspective of the bond payer?
A discount on bonds payable is a reduction in the price of a bond below its face value. From the perspective of the bond payer, this is a contra liability account, so the amount of discounts on bonds payable should be subtracted when adding up the total liability balance.
What is Earnings per Share (EPS)?
Earnings per share (EPS) is the amount of current-period earnings that can be associated with a single share of a corporation’s common stock.
Who must follow the guidelines for reporting EPS?
The guidance regarding calculation and presentation of EPS must be followed by public entities and by other entities that choose to report EPS.
Is EPS calculated for preferred shares?
No. EPS is calculated only for common stock.
What is the formula for Basic Earnings per Share (BEPS)?
BEPS = [Income Available to Common Shareholders]/[Weighted-average Number of Shares Outstanding]
How many BEPS amounts is a corporation required to report?
All corporations must report at least two BEPS amounts on the face of the income statement. Their numerators are income from continuing operations and net income, respectively.
If there is a gain/loss from discontinued operations, this BEPS amount (and the corresponding diluted EPS amount) must also be reported either on the face of the income statement or in the notes.
How do discontinued operations affect the reporting of EPS?
If an entity has no discontinued operations, the income from continuing operations equals net income. Thus, one amount of BEPS for net income available to common shareholders is presented on the face of the income statement.
If a discontinued operation is reported, basic and diluted EPS amounts for the discontinued operation are presented on the face of the income statement or in the notes.
How is the BEPS numerator calculated?
Income available to common shareholders is the BEPS numerator.
Thus, neither BEPS amount (income from continuing operations or net income) is calculated directly from the amount reported for that line item on the income statement.
Income in the BEPS numerator is reduced by dividends
Declared in the current period on preferred stock (whether or not paid) and
Accumulated for the current period on cumulative preferred stock (whether or not declared).
Dividends paid in the current period for undistributed accumulated preferred dividends for prior years do not affect the calculation. They were included in BEPS of prior years.
The following calculation is performed for net income and income from continuing operations (or other number): [Income statement “amount”] - [Preferred stock dividend, current period] = Income Available to Common Shareholders
What is Cumulative Preferred Stock?
What Is Cumulative Preferred Stock?
Cumulative preferred stock is a type of preferred stock with a provision that stipulates that if any dividend payments have been missed in the past, the dividends owed must be paid out to cumulative preferred shareholders first. This is before other classes of preferred stock shareholders and common shareholders can receive dividend payments. Cumulative preferred stock is also called cumulative preferred shares.
What is Noncumulative Preferred Stock?
What Is Noncumulative?
The term “noncumulative” describes a type of preferred stock that does not pay stockholders any unpaid or omitted dividends. Preferred stock shares are issued with pre-established dividend rates, which may either be stated as a dollar amount or as a percentage of the par value. If the corporation chooses not to pay dividends in a given year, investors forfeit the right to claim any of the unpaid dividends in the future.
KEY TAKEAWAYS
Noncumulative stock does not pay unpaid or omitted dividends.
Cumulative stock entitles investors to missed dividends.
Cumulative preferred stock is more attractive to investors than noncumulative.
How is the BEPS Denominator calculated?
The weighted-average number of common shares outstanding is determined by relating the portion of the period that the shares were outstanding to the total time in the period.
Weighting is necessary because some shares may have been issued or reacquired during the period.
How do stock dividends or stock splits affect the BEPS denominator calculation?
Stock dividends and stock splits require an adjustment to the weighted-average of common shares outstanding.
EPS amounts for all periods presented are adjusted retroactively to reflect the change in capital structure as if it had occurred at the beginning of the first period presented.
Adjustments are made for such changes even if they occur after the end of the current reporting period but before issuance (or the availability for issuance) of the financial statements.
What are contingently issuable shares?
Contingently issuable shares are shares issuable for little or no cash consideration upon satisfaction of certain conditions.
Contingently issuable common shares are treated as outstanding and included in the calculation of the BEPS denominator from the date when the conditions for contingent issuance have been met.
Diluted Earnings per Share (DEPS)
An entity with only common stock outstanding (a simple capital structure) must report only BEPS amounts but not DEPS.
An entity that does not have a simple capital structure must report DEPS as well as BEPS. Thus, the DEPS calculation includes the effects of dilutive potential common shares (PCS).
PCS are securities or other contracts that may entitle the holder to obtain common stock.
PCS are included in the DEPS calculation only if they are dilutive.
Dilution is a reduction in BEPS (or an increase in loss per share) resulting from the assumption that
Convertible securities (preferred stock or debt) were converted;
Options, warrants, and their equivalents were exercised; or
Contingently issuable common shares were issued.
The conditions for contingent issuance may be satisfied by year end. The shares are then deemed to have been issued at the beginning of the period or date of the contingent stock agreement, if later.
However, the conditions may not have been met at year end. In this case, the shares included in the DEPS denominator equal those that would have been issued if the end of the year were the end of the contingency interval.
What corporate entities need not report DEPS?
An entity with only common stock outstanding (a simple capital structure) must report only BEPS amounts but not DEPS.
What are Dilutive Potential Common Shares (PCS)?
The DEPS calculation includes the effects of dilutive potential common shares (PCS).
PCS are securities or other contracts that may entitle the holder to obtain common stock.
PCS are included in the DEPS calculation only if they are dilutive.
What are the conditions for shares to be dilutive, i.e., eligible for inclusion in the calculation of PCS?
Dilution is a reduction in BEPS (or an increase in loss per share) resulting from the assumption that
Convertible securities (preferred stock or debt) were converted;
Options, warrants, and their equivalents were exercised; or
Contingently issuable common shares were issued.
The conditions for contingent issuance may be satisfied by year end. The shares are then deemed to have been issued at the beginning of the period or date of the contingent stock agreement, if later.
However, the conditions may not have been met at year end. In this case, the shares included in the DEPS denominator equal those that would have been issued if the end of the year were the end of the contingency interval.
Calculation of DEPS
DEPS measures performance after considering the effect on the numerator and denominator of dilutive PCS. DEPS is calculated as follows:
The BEPS denominator is increased to include the weighted-average number of additional shares of common stock that would have been outstanding if dilutive PCS had been issued.
The BEPS numerator is adjusted to add back any dividends on convertible preferred stock and the after-tax interest expense (an amount that includes amortization of discount or premium) related to any convertible debt.
DEPS = [(BEPS Numerator) + (Effect of Dilutive PCS)]/[(BEPS Denominator) + (Effect of Dilutive PCS)]
When calculating DEPS, why are any dividends on convertible preferred stock and after tax interest expense (including amortization of discount or premium) related to convertible debt added back to the numerator of BEPS?
If the PCS is truly dilutive, then the conversion of the PCS will occur, increasing the amount of funds available to holders of common shares in the BEPS Numerator.
On the CPA Exam, how do I know when the cumulative convertible stock dividend will be paid out?
Even if zero dividend is paid to common shareholders, assume that the cumulative convertible stock dividend will be paid out to preferred shareholders unless otherwise clearly stated in the question prompt.
For DEPS Numerator, how does adding back interest expense differ from adding back preferred dividends?
First, the interest expense is discounted by the reciprocal of the tax rate, whereas adding back preferred dividends does not require accounting for a tax effect (dividends come from after-tax income).
Second, the dividend amount for preferred shares may be calculated using the par value per share, e.g., for 10,000 shares of $20 par, 10%, cumulative, convertible preferred stock:
10,000 preferred shares × $20 par × 10% = $20,000
Add back $20,000 if the preferred shares are dilutive in the period.
How does DEPS calculation relate to the existence of antidilutive securities?
The calculation of DEPS does not assume the conversion, exercise, or contingent issuance of antidilutive securities, i.e., securities that increase EPS or decrease loss per share.
What are antidilutive securities?
Antidilutive securities increase EPS or decrease loss per share.
What are the three methods used to determine the dilutive effect of PCS?
Three methods are used to determine the dilutive effect of PCS: (1) the if-converted method for convertible securities, (2) the treasury stock method for call options and warrants, and (3) the reverse treasury stock method for put options.
How does the issuance of common shares and its effect on the BEPS denominator differ from the effect of dilutive PCS shares on the DEPS denominator?
Dilutive PCS issued during a period are included in the DEPS denominator for the period they were outstanding.
Moreover, dilutive convertible securities that were actually converted are included for the period before conversion. Common shares actually issued are included for the period after conversion.
How does variation in the share price effect reporting of DEPS after the time that a particular DEPS amount appears in the financial statements?
Previously reported DEPS is not retroactively adjusted for subsequent conversions or changes in the market price of the common stock.
The If-Converted Method
The if-converted method calculates DEPS assuming the conversion of all dilutive convertible securities at the beginning of the period or at the time of issue, if later.
The conversion of antidilutive securities (those whose conversion increase EPS or decrease loss per share) is not assumed. Thus, convertible PCS are antidilutive if the current dividend or after-tax interest per common share issuable exceeds BEPS.
The If-Converted Method is an iterative process. The initial control number is BEPS for the period (or BEPS from continuing operations if there were discontinued operations). Compute Earnings per Incremental Share (EIS) for each of the groups of PCS. Next, incorporate the number of dilutive shares from the PCS group with the lowest EIS value into the denominator for a trial calculation of DEPS; the result of this trial calculation is the control number for the subsequent iteration of the If-Converted Method if the trial value is less than the initial control value, which was BEPS for the period. In the subsequent iterations, the test calculations of DEPS use the number of convertible shares from the remaining PCS group with the least EIS value, computing test values that become the new control value is they are lower than the previous control value; if the test value is higher, the PCS group that was tested is rejected as antidilutive. It is crucial to remember that this process continues until all PCS groups have been tested. See Example 3-10 for more detail.
How does the If-Converted Method relate to DEPS for income from discontinued operations?
If a discontinued operation is reported, the same number of shares used to adjust the denominator for income from continuing operations is used to adjust the DEPS denominator for income from discontinued operations. This rule applies even if the effect on the other amounts is antidilutive. THIS MEANS THAT THE IF-CONVERTED METHOD RESULT FOR CONTINUING OPERATIONS DICTATES THE DENOMINATOR USED IN THE DEPS FOR DISCONTINUED OPERATIONS.
Under the If-Converted Method, what is the defining characteristic to differentiate dilutive from antidilutive securities?
The conversion of antidilutive securities (those whose conversion increase EPS or decrease loss per share) is not assumed. Thus, convertible PCS are antidilutive if the current dividend or after-tax interest per common share issuable exceeds BEPS. If there are multiple groups of PCS securities, an iterative process is used to determine which are dilutive or antidilutive.
When is the If-Converted Method used?
It is only used for convertible stocks and bonds.
Call Option
Call options are financial contracts that give the option buyer the right but not the obligation to buy a stock, bond, commodity, or other asset or instrument at a specified price within a specific time period. The stock, bond, or commodity is called the underlying asset. A call buyer profits when the underlying asset increases in price.
Put Option
A put option (or “put”) is a contract giving the option buyer the right, but not the obligation, to sell—or sell short—a specified amount of an underlying security at a predetermined price within a specified time frame. This predetermined price at which the buyer of the put option can sell the underlying security is called the strike price. Put options increase in value as the underlying asset falls in price, as volatility of the underlying asset price increases, and as interest rates decline.
Stock Warrants
Stock warrants are options issued by a company that trade on an exchange and give investors the right (but not obligation) to purchase company stock at a specific price within a specified time period. When an investor exercises a warrant, they purchase the stock, and the proceeds are a source of capital for the company. However, a warrant does not mean the actual ownership of the stocks but rather the right to purchase the company shares at a particular price in the future. Warrants are not popular in the United States, but they are common in other countries such as China.
A call warrant is the right to buy a specified amount of shares from a company at a certain price in the future. A put warrant is the right to sell back a specified number of shares to the issuing company at a specific price in the future.
Treasury Stock Method
The second method used to determine the dilutive effect of PCS is the treasury stock method, used to determine the dilutive effect of outstanding call options and warrants.
Call options and warrants are dilutive only if the average market price for the period of the common shares is greater than the exercise price of the options or warrants (they are in the money).
The treasury stock method assumes that
The options and warrants are exercised at the beginning of the period (or time of issuance, if later),
Common shares are issued, and
The proceeds of exercise are used to purchase common stock at the average market price for the period.
If the options or warrants are dilutive, their exercise affects only the denominator in the computation of DEPS. Any additional number of common shares outstanding (incremental shares) is added as an adjustment of the BEPS denominator.
Because the numerator in the computation of DEPS is not affected, the earnings per incremental share is $0. Thus, options and warrants are generally the most dilutive PCS. They should be included first (before other series of PCS) in the trial calculation of DEPS.
What are the most dilutive PCS?
Because the numerator in the computation of DEPS is not affected, the earnings per incremental share is $0. Thus, options and warrants are generally the most dilutive PCS. They should be included first (before other series of PCS) in the trial calculation of DEPS.
How does the Treasury Stock Method relate to If-Converted Method?
If options or warrants are found to be dilutive, they would be plugged into an If-Converted Method calculation of DEPS. Since the Earnings per Incremental Share (EIS) for options or warrants is always $0, all PCS groups with options or warrants would be tested prior to testing any PCS groups with nonzero EIS values.
How does the Treasury Stock Method contribute to a test calculation of DEPS under the If-Converted Method?
The number of incremental shares from dilutive call options or warrants that must be included in the denominator of the DEPS computation is determined by calculating the following:
Proceeds from exercising the options or warrants (Number outstanding × Exercise price).
Number of shares assumed purchased (Proceeds from exercise ÷ Average market price for the period of common shares).
Number of incremental shares (Number of common shares assumed issued – Number of common shares assumed purchased).
The number of common shares assumed issued is the amount of common shares that would have been issued assuming all the options or warrants were exercised.
Reverse Treasury Stock Method
The third method used to determine the dilutive effect of PCS is the reverse treasury stock method. It is used when the entity has entered into contracts to repurchase its own stock, for example, when it has written put options held by other parties.
When the contracts are in the money (the exercise price exceeds the average market price), the potential dilutive effect on EPS is calculated by
Assuming the issuance at the beginning of the period of sufficient shares to raise the proceeds needed to satisfy the contracts,
Assuming those proceeds are used to repurchase shares, and
Including the excess of shares assumed to be issued over those assumed to be repurchased in the calculation of the DEPS denominator.
Options held by the entity on its own stock, whether they are puts or calls, are not included in the DEPS denominator because their effect is antidilutive.
In the Money
A call option is in the money when the exercise price is less than the market price; a put option is in the money when the exercise price exceeds the market price.
When is the Reverse Treasury Stock Method used?
It is used when the entity has entered into contracts to repurchase its own stock, for example, when it has written put options held by other parties.
Are options held by the entity in its own stock dilutive?
No. Options held by the entity on its own stock, whether they are puts or calls, are not included in the DEPS denominator because their effect is antidilutive.
Revenue Recognition Over Time
For each performance obligation satisfied over time, an entity must recognize revenue over time. For this purpose, the entity measures the progress toward complete satisfaction using the output method or the input method.
- To determine the appropriate method, an entity must consider the nature of the good or service that it promised to transfer to the customer.
- The chosen method should describe the entity’s performance in transferring control of the promised asset to the customer.
What are the two methods for recognizing revenue over time?
Output Method and Input Method
How is the appropriate method of revenue recognition over time determined?
To determine the appropriate method, an entity must consider the nature of the good or service that it promised to transfer to the customer.
The chosen method should describe the entity’s performance in transferring control of the promised asset to the customer.
When is progress toward complete satisfaction of a performance obligation (revenue recognition) REMEASURED?
At the end of each reporting period, the progress toward complete satisfaction of the performance obligation must be remeasured and updated for any changes in the outcome of the performance obligation.
-Such changes must be accounted for prospectively as a change in accounting estimate.
How are remeasurements of partial satisfaction of a performance obligation accounted for?
Such changes must be accounted for prospectively as a change in accounting estimate.
Input Method
The input method recognizes revenue on the basis of (a) the entity’s inputs to the satisfaction of the performance obligation relative to (b) the total expected inputs to the satisfaction of that performance obligation.
Examples of input include Costs incurred, Labor hours expended, Resources consumed, Time elapsed, or Machine hours used.
Cost-to-Cost Method
In long-term construction contracts, costs incurred relative to total estimated costs often are used to measure the progress toward completion. This method is the cost-to-cost method.
Only costs that contribute to progress in satisfying the performance obligation are used in the cost-to-cost method. Thus, the following costs must not be included in measuring the progress:
Costs incurred that relate to significant inefficiencies in the entity’s performance (e.g., abnormal amounts of wasted materials or labor) that were not chargeable to the customer under the contract
General and administrative costs not directly related to the contract
Selling and marketing costs
The Cost-to-Cost Method is a subset of what family of methods?
Input Method
Which costs must be excluded from the basis for measuring progress under the Cost-to-Cost Method?
Costs incurred that relate to significant inefficiencies in the entity’s performance (e.g., abnormal amounts of wasted materials or labor) that were not chargeable to the customer under the contract
General and administrative costs not directly related to the contract
Selling and marketing costs
When is a straight-line basis used under the Input Method?
When an entity’s inputs are incurred evenly over time, recognition of revenue on a straight-line basis may be appropriate.
Output Method
The output method recognizes revenue based on direct measurement of (a) the value of goods or services transferred to the customer to date relative to (b) the remaining goods or services promised under the contract.
Examples of output methods include Appraisals of results achieved, Milestones reached, Units produced, and Units delivered.
An entity may have a right to consideration from a customer in an amount corresponding directly with the value to the customer of performance to date. Using a practical expedient, revenue may be recognized at the amounts to which the entity has a right to invoice the customer.
What is the key principle that distinguishes the Input Method from the Output Method.
The Input Method focuses on the value of input costs incurred to date, whereas the Output Method focuses on the value of outputs delivered to the customer that the firm should recognize as revenue during the period. Often, Output Method is used when the entity has the right to bill the customer for the value provided during the period.
Reasonable Measurement Rules for Revenue Recognition
An entity recognizes revenue for a performance obligation satisfied over time only if progress toward complete satisfaction of the performance obligation can be reasonably measured.
However, revenue can be recognized to the extent of the cost incurred (zero profit margin) when
- An entity is not able to reasonably measure the outcome of a performance obligation or its progress toward satisfaction of that obligation, but
- An entity expects to recover the costs incurred in satisfying the performance obligation.
Loss Recognition Rule
As soon as an estimated loss on any project becomes apparent, it must be recognized in full, regardless of the methods used.
An entity is calculating the income recognized in the third year of a 5-year construction contract. It uses the input method based on costs incurred to measure the progress toward completion. The ratio used in calculating income is
Total costs incurred to date to total estimated costs.
The entity is using a cost-to-cost accounting method. The input method based on costs incurred to measure the progress toward completion recognizes gross profit or revenue based on the ratio of costs to date to estimated total costs.
Appropriated Retained Earnings
Appropriated retained earnings are retained earnings that are specified by the board of directors for a particular use. Appropriated retained earnings can be used for many purposes, including acquisitions, debt reduction, stock buybacks, and R&D. There may be more than one appropriated retained earnings accounts simultaneously.
Appropriated retained earnings are given as a line item in the Equity section of the Balance Sheet.
Intraperiod Tax Allocation
What is an Intraperiod Tax Allocation?
An intraperiod tax allocation is the allocation of income taxes to different parts of the results appearing in the income statement of a business, so that some line items are stated net of tax. This situation arises in the following cases:
-Continuing operations (results of) are presented net of tax
-Discontinued operations are presented net of tax
-Prior period adjustments are presented net of tax
-The cumulative effect of a change in accounting principle is presented net of tax
Why is Intraperiod Tax Allocation Necessary
Intraperiod Tax Allocation is necessary to:
1) show tax allocation resulting from the existence of continuing and discontinued operations (present items net of tax).
2) to show the tax allocation in the event of an error correction (present items net of tax).
3) to show the tax allocation for the cumulative effect of a change in accounting principle (show items net of tax).
What is Reclassification of AOCI?
AOCI is Accumulated Other Comprehensive Income.
In the period when an AOCI component such as unrealized holding gain/loss is REALIZED, the income statement and/or OCI statement will show “gains from reclassification of AOCI” added back to Net Income and deducted from the OCI statement.
Where are unusual or infrequently occurring items reported on the income statement?
Material items that are unusual in nature, infrequent in occurrence, or both are reported as a separate component of income from continuing operations.
How are unusual or infrequent gains or losses of a similar nature that are not individually material treated?
Unusual or infrequent gains or losses of a similar nature that are not individually material must be aggregated if they are material in aggregate.
Are unusual or infrequent items reported net of taxes?
No. These items must not be reported net of taxes.
Can the effects of unusual or infrequent items on earnings per share be reported on the income statement?
No.
Are the operating results of discontinued operations reported net of tax?
Yes. The operating results of a discontinued operation are reported separately net of tax in the income statement.
What are the specific items presented under the heading for income from discontinued operations on the income statement? (2 elements)
The discontinued operations section presents separately the (a) income or loss from operations of the component and (b) income tax expense or benefit.
What is financial flexibility?
Financial flexibility means that a firm “can avoid financial distress in times of negative shocks
and readily fund investment when profitable opportunities arise”. Financially flexible firms are
characterized as having greater cash holdings and easier or less costly access to external debt
financing. Financial flexibility is ascertainable from the balance sheet.
What criteria demonstrate the ability to refinance current debt on a long-term basis? (3 elements)
- The ability to refinance may be demonstrated by
(1) Entering into a financing agreement meeting all conditions before the balance sheet is issued.
(2) Issuing a noncurrent obligation or equity securities after the end of the reporting period but before issuance of the balance sheet.
(3) The amount excluded from current liabilities must not exceed the proceeds from the new obligation or equity securities issued.
What is the Operating Cycle Equation?
Operating Cycle = Inventory Period + Accounts Receivable Period
What are nonoperating capital assets? (definition and give 2 examples)
NONOPERATING CAPITAL ASSETS. Capital assets not used in current operations, such as
- Idle facilities or
- Land held for a future plant site
What are nonoperating special purpose funds? (definition and give 3 examples
NONOPERATING SPECIAL PUPROSE FUNDS. Funds restricted as to withdrawal or use for other than current operations, for example, to
- Retire long-term debt,
- Satisfy PENSION obligations, or
- Pay for the acquisition or construction of noncurrent assets
What is the cost of goods sold adjusted for the change in finished goods inventory?
It is the Adjusted Cost of Good Manufactured
Cost of goods manufactured equals the period’s manufacturing costs adjusted for the change in work-in-process.
Adjusted COGM = ?
Adjusted COGM = Beginning FG Inventory + Period COGM - Ending FG Inventory
What is Period Cost of Goods Manufactured?
This is the COGM incurred during a period without adjustment for change in FG inventory.
Period COGM = Adjusted COGM - Beginning FG Inventory + Ending FG Inventory
Are the effects on earnings per share of unusual or infrequently occurring events reported on the income statement?
No. The effects of such items on earnings per share must not be presented on the income statement. The nature and financial effect of each item is disclosed in the notes to the financial statements or reported in the income statement.
Where is the nature and effect of each unusual or infrequently occurring item reported?
The nature and financial effect of each item is disclosed in the notes to the financial statements or reported in the income statement. The effects on earnings per share are not reported in the income statement.
Are the effects of unusual or infrequently occurring items reported net of tax?
These items must not be reported net of taxes.
How are gains or losses from unusual or infrequently occurring items that aren’t individually material reported?
Gains or losses of a similar nature that are not individually material must be aggregated.
Are unusual or infrequently occurring items always expenses , losses?
No. Unusual or infrequently occurring items could be revenues, expenses, gains, or losses.
How is a discontinued operation held for sale measured?
1) When a component (discontinued operation) is classified as held for sale, it is measured at the lower of its carrying amount or fair value minus cost to sell (discussed in Study Unit 8, Subunit 9).
What is the definition of intraperiod tax allocation? What are the four main cases where intraperiod tax allocaiton occurs? What is the purpose of intraperiod tax allocation?
DEFINITION: An intraperiod tax allocation is the allocation of income taxes to different parts of the results appearing in the income statement of a business, so that some line items are stated net of tax. This situation arises in the following cases:
1) Continuing operations (results of) are presented net of tax
2) Discontinued operations are presented net of tax
3) Prior period adjustments are presented net of tax
4) The cumulative effect of a change in accounting principle is presented net of tax
PURPOSE: The intraperiod tax allocation concept is used to reveal the “true” results of certain transactions net of all effects, rather than disaggregating them from income taxes. The reason for using intraperiod tax allocations is to improve the quality of information presented to the readers of a company’s financial statements.
