Far4 Flashcards
Contingent Liability
Potential Liabilities that a company is aware of, and depending on how probable they are, there are different requirements…
If the contingent liability is..
- “Probable” and can be estimated, then it should be recognized on the F/S
- “Probable” but cannot be estimated or reasonably possible, then a description of the contingency and a range of possible loss must be disclosed
- If the possibility is “Remote” then it does NOT need to be disclosed.
Merger
only 1 business lives
Consolidation
both businesses die, one new business is formed
Acquisition
Both businesses continue as SEPARATE LEGAL entities
Estimate Changes
When you change the estimated useful life of PPE or change Depreciation methods. This requires PROSPECTIVE application - so the new estimate is applied to the current and FUTURE years. It does not need to be applied to prior years. No F/S are restated.
Accounting Principle Changes
This is changing from one GAAP principle to another such as LIFO or FIFO. This requires retrospective application but is not considered restatement - go BACK in time
Error Correction
This is when an error is discovered that affects prior year income. This requires retrospective (GO BACK in time) AND needs a restatement.
whenever it is impossible to determine whether there is a change in accounting estimate or change in accounting principle…..
the change should be considered a change in ESTIMATE
If price paid for the business in a consolidation or business combination is greater than the FMV of the net assets, the difference is….
Goodwill
Costs that are associated with a business combination are
expensed as incurred. This includes legal fees, audit fees, etc.
Derivatives
A financial instrument with an underlying (Price $), a notional amount (# of shares), and a net settlement (shares X price) , like a stock option…..
An underlying is a specified unit of price or rate, such as stock price.
A notional amount is a specified unit of measure, such as a number of shares
The settlement amount is determined by the underlying being multiplied by the notional amount, such as 100 shares at $20/share
**Derivatives are recognized as either an asset or liability and they are measured at FV
Hedges
- At item that you would “Hedge” against is an asset or liability that is subject to a possible loss
- A “Hedging Instrument” is a contract or some other arrangement that mitigates the possible loss of the hedging item
**You use a “hedging instrument” to “hedge” against a “Hedging item”
-To qualify of hedge accounting, the hedge must be considered to be “highly effective” meaning it effectively offsets the changes in cash flows or fair value that is being hedged against
-Items you would use hedging for…
commodity price fluctuation risk, foreign exchange fluctuation risk, interest rate fluctuation risk, credit risk
Fair Value Risk
This is the risk of a loss due to a change in the FV of a hedged item. This converts a fixed risk into a floating risk
Cash Flow Risk
The risk of loss due to a change in cash flows from a hedged item. This converts a floating risk into a fixed risk. ex. a forecasted transaction- a transaction that is expected to occur. A cash flow hedge would be used.
foreign currency transactions
These are transactions that are done in another currency, but reported to the US dollar
*the issue is how to convert these transactions to USD and the related gains/losses
TERMS TO KNOW:
exchange rate direct rate indirect rate spot rate forward rate
KNOW
Exchange date
the price of one unit of one currency in term of another currency
Direct Rate
the domestic price of one unit of a foreign currency.
this would be 1 Euro=$1.57 or 1 peso=.32
Indirect Rate
this is the foreign price of 1 unit of domestic currency.
$1=.87 Euro, or $1 =3.2 pesos
Spot rate
the exchange rate at the current date
Functional currency
the currency of the primary economic environment that the business operates in: A Chilean company’s functional currency would be the Chilean peso.
when domestic currency WEAKENS
AR increase (gain), accounts payable decrease
when domestic currency STRENGTHENS
AR decrease (a loss), Accounts payable creates a gain
Forward rate
The exchange rate NOW, for a date in the future
Leases
There are two types of leases….
- Operating- this is basically a rental agreement
- Capital Lease-this is treated as if it were a sale
4 criteria for determining if lease is a capital lease instead of operating
- if ownership transfers at end of lease
- if there is a bargain price option
- if the lease term is greater or equal to 75% of the useful life of the lasted asset
- if the PV of the lease payments is greater than or equal to 90% of the cash price of the leased asset
Foreign currency Contracts
FX exchange contracts: an obligation to buy or sell a foreign currency
FX option contracts: this gives the right to buy or sell a foreign currency, but not an obligation to do so
- if instrument is used for speculation… then any gains or losses are recognized in CURRENT income
- if instrument is a fair value or cash flow hedge, then the gains or losses apply to the related rules
Terms to Know for Translating Foreign Financial Statements
Recording Currency: the currency that the foreign books and financial statements are in
Reporting Currency: The currency that the final financial statements will be in
Functional Currency: The currency of the primary economic environment that the entity operates in. Except when… the foreign operations could not operate without the U.S. entities operations, then the reporting currency is also the functional currency
Translation: Assets and liabilities are translated using the spot rate (current rate) at balance sheet date.
Remeasurement: A “remeasurement adjustment is needed to make it balance
Formula for Calculating the LEASE OBLIGATION
PV of minimal lease payments=
the PV of the rental payments + the PV of the guaranteed residual
OR
PV of minimal lease payments=
the PV of the rental payment + the Bargain Purchase Option (BPO)
Guaranteed Residual Value
is when the lessee guarantees a residual value, meaning that if the value of the asset is less than the guaranteed amount at the end of the lease, the lessee pays the lessor the difference.
The guaranteed residual value is included in calculated the lessee’s lease obligation at the beginning of the lease
**remember that an Unguaranteed residual is EXCLUDED from minimal lease payments
Bargain Purchase Option
Is an amount that the lessee will buy the asset for at the end of the lease.
By its definition, it will be LESS than the FV of the asset at the end of the lease. This BPO amount is included the lessees obligation at the beginning of the lease.
Operating Lease Accounting: things to know
- the average rental per period is used for the expense and revenue recognition. The Average rental per period is what is used as the lease expense
- when you CAPITALIZE lease payments- you EXCLUDE executory costs. Executory costs would be things like insurance, maintenance, or property taxes.
-the lessee’s interest rate on the lease will be the lower of the lessor’s implicit rate and the lessee’s incremental borrowing rate (which is the rate on similar debt) SO PICK THE LOWER OF THE TWO RATES
Lease Liability Account
Lease Asset Account
Non-Reciprocal Transfers
Conditional Vs. Unconditional Pledges
Conditional Pledges- the Non profit has to wait until the condition has been met to record the revenue.
Unconditional Pledges-the Non profit can recognize the revenue in the period the pledge is made
*The amount of revenue recorded is the net amount of the pledge EXPECTED to be collected within one year. for pledges that are expected to be collected more than a year are recognized as PV as temporarily restricted support
Donations on Behalf of a Beneficiary to a NFP
Sometimes a donation is made to a non for profit and the NFP agrees to use the donation on behalf of a beneficiary…
-if the donor grants the NFP variance power, which means they get to choose the beneficiary of the donation, then the NFP obviously records the donation at FAIR VALUE
- if the donor does NOT grant variance power to the NFP, then the NFP is just the intermediary and they record a liability until the donation is transferred to the beneficiary.
- if the donation is NOT a financial donation, such as materials or goods, then the NFP does NOT recognize the donation on its Financial Statements
Endowments to a Non-for-profit
A regular endowment is when an external party donates money with the stipulation that the endowment amount has to remain intact forever.
-This puts it into the category of Net Assets with donor restrictions
A term Endowment- is an endowment made to a nonprofit with the stipulation that it is invested for a specific period of time and can then be spent - this would also made it a net asset with a donor restriction
A Quasi endowment- is an amount set aside by the governing body of the Non profit. These are considered net assets with no donor restrictions because they can be spent by the governing body
*NON PROFITS ACCOUNT FOR ALL INVESTMENTS AT FAIR VALUE, gains and losses are reported as CHANGES in net assets with no donor restrictions unless there is a donor imposed restriction
Contributions to a NFP
Contributions can be Conditional on some event or other stipulation
- If a contribution is CONDITIONAL, the non profit has to wait until the condition has been met
- if a conditional contribution is received before the condition is met, then it is a liability until it is met
- collections of works of art or other treasures DO NOT have to be capitalized by an NFP if the items are held for public exhibition, education, or research and they are protected and reserved.
R &D Costs (Research and Development Costs)
-all research and development costs are EXPENSED. not capitalized.
R&D Activities are all in the
DEVELOPMENT PHASE:
they include….
- research aimed to discover new knowledge
-searching for ways to apply new research findings
-the formulation and design of possible products or process alternatives
-product testing or testing product alternatives
-the modification of the design of a product or process
-design, construction and testing of pre product prototypes
-the design of tools and molds for new technology
-engineering activity required to take a designed product to the manufacturing stage
AFTER the development phase… once it hits the commercial phase it is not r&d anymore
NOTHING related to the COMMERCIAL PRODUCTION PHASE… it would not be considered R&D at that point
- QUALITY CONTROL TESTING during commercial production is not an R&D expense
- LEGAL FEES for patent applications are not considered R&D
FOR R&D… Under IFRS…
Research costs are expensed, but development costs are capitalized
Software Costs
A firm can capitalize the costs related to the development of computer software, once the software has reached technological feasibility
-Before software being built is technology feasible, it is in the R&D stage, and therefor all costs are EXPENSED. Once software reaches technological feasibility, costs during this stage are then capitalized.
Then.. when the product is then on the market and being sold.. then the capitalized costs will start being amortized.
The Rate for yearly amortization is the GREATER OF
greater of:
- the ratio of software sales to expected total sales
- or the straight line method over the economic life of the software
-software that is INTERNAL USE ONLY, meaning it is being developed to be used internally and wont be sold commercially, is AMORTIZED STRAIGHT LINE OVER ITS USEFUL LIFE!
Cloud Computing Agreements
when a company enters a cloud computing agreement, it can take on of 2 treatments:
DEPENDING ON IF THERE IS A SOFTWARE LICENSE TRANSFERRED OR NOT….
1.IF THERE IS A TRANSFER OF A LICENSE.. THEN THE ACCOUNTING TREATMENT…
then the entire cost of the agreement is capitalized and then amortized
2.IF THERE IS NO TRANSFER OF A LICENSE, THEN IT IS JUST A SERVICE CONTRACT…
so cost is just expensed as incurred
An IFRS DIFFERENCE
under GAAP, software costs are expensed until technological feasibility is reached.
under IFRS- research costs for software costs are expensed but all DEVELOPMENT COSTS ARE CAPITALZIED.
Subsequent Events
These are events that occur after the B/S date but before the financial statements are issued.
There are basically 2 types:
1. Recognized Subsequent Events- these are items that did exist as of the B/S date that are somehow discovered AFTER the balance sheet date. These require recognition in the financial statements
2.Unrecognized Subsequent Events- these are items that did NOT exist at the balance sheet date BUT they DO REQUIRE DISCLOSURE in the Footnotes. These are obviously things that are MATERIAL.
Fair Value Measurements
Fair value is defined as the price that would be received if you sell an asset in an active market. The assumptions are that transactions take place in the most advantageous market to the entity that maximizes the selling price
Both the buyer and the seller act INDEPENDENTLY!
Different Approaches for Determining FAIR VALUE…
- Market Approach: prices are generated by real market transactions for identical or similar items
- Income Approach: discounts future amounts to current value
- Cost Approach: it uses the current amount that would be required to replace the service value of an existing asset
**The fair value option is not available for investments in entities that will be consolidated, obligations or assets related to pension or other employee related plans, lease related finaccial assets or liabilities, instruments that are components of shareholders equity
- fair value can only be elected when the item is FIRST RECOGNIZED, so when the firm first acquires it, or when the accounting treatment of an investment in another company changes
*the fair value treatment can be applied on an instrument by instrument basis, it does not have to be applied to all instruments issued or acquired in a single transaction
BUT *it must be applied to an entire instrument, not just a certain component of an instrument
The general procedure for FAIR VALUE ACCOUNTING
is that you determining the carrying value, which is something like at the balance sheet date, because the fair value fluctuates.
then you determine its current fair value..
then you determine the difference between the carrying value and fair value if there is a difference
you would recognize the difference as a write UP or a write DOWN, meaning a gain or a loss
you would recognize the increase, the gain, or decrease, the loss, in CURRENT INCOME
Fair Value Hierarchy- consists of inputs that are either
Observable or Unobservable
- Observable inputs: are derived from market data that are independent of the entity.
ex. stock exchange which gives real time market prices for stock. 1 share of Walmart compared to another share of Walmart is the exact same thing. you know the exact price at any given moment - Unobservable inputs: this is where the value is based on an entity’s assumptions. Internally generated data that is bases on the BEST INFORMATION THAT THEY HAVE.- essentially this is there best guess
* obviously observable inputs are much more accurate and valuable than unobservable.
3 levels of the fair value heirchy:
level 1: the highest quality. Quoted market prices in an active market for IDENTICAL items. ex. shares of stock publicly traded on exchanges
level 2: observable inputs that don’t meet all the requirements for level 1, quoted prices in active markets for SIMILAR items. ex. comparing recently sold homes that are similar to your home to come up with an approximate value
level 3: unobservable inputs for the level being valued. this is the lowest level with the least desirable inputs. based on the reporting firms internal data. it is essentially their best guess.
The disclosure requirements when using the FV option
- they must disclose the FV at the reporting date
- the valuation techniques used to determine the FV must be disclosed
- the inputs used to determine FV must be disclosed
- the items which the FV option have been applied to must be disclosed
- any gains or losses associated with the changes in FV must be disclosed
*MOST IMPORTANT GAAP VS. IFRS DIFFERENCES TO KNOW FOR EXAM
On the STATMENT OF CASH FLOWS..
How to classify dividends in interest paid or dividends in interest received?
under GAAP:
-Dividends PAID are in the Financing section
-Dividends RECEIVED and Interest PAID and Interest RECIEVED are in the Operating Section
under IFRS:
- Dividends and Interest PAID can be classified as either an OPERATING or FINANCING activity
- Dividends and Interest RECIEVED can either be classified as either OPERATING or INVESTING
With Inventory…..
- LIFO is not allowed at all under IFRS
- LIFO is allowed under GAAP
For write-downs on inventory…
- if an inventory value is written down, no reversals are allowed under GAAP.
- But, a subsequent reversal is allowed under IFRS (internationally), but it can never go above the original cost
For a measurement of inventory value..
- For IFRS, inventory is always going to be the lower of cost or NRV (Net realizable value = the selling price-any completion costs)
- Under GAAP, inventory using LIFO uses lower of cost or market, otherwise FIFO and the average costs uses the lower of cost or NRV
When using the EQUITY METHOD…
-when an investment is between 20-50% ownership but the investor does not have significant influence…. under GAAP- either the fair value method or the equity method can be used
under IFRS- the equity method must be used
For Intangible Assets..
-Intangible assets are carried at costs less amortization under GAAP
-IFRS allows for either historical cost or the revaluation model. the revaluation model is also allowed for PP&E. The revaluation model is basically the fair value option for PP&E.
Whenever there is a difference in the carrying amount and the FV of any PP&E or intangible assets, then the value is written up or down to whatever the FV is.
-if the value is written up, then the increase goes to OTHER COMPREHENSIVE INCOME,
-if the value is written down, then its is recognized in INCOME
