Final Chapter 10

Question 1

Fair value

Answer 1

FV is the price that would be recevied to sell an asset or paid to transfer a liability in an orderly transactions between market participants in the principle market at the measurement date under current market condition

FV is an exist price, FV does not include transactions cost but it may include transportation cost if location is an attribute of the asset or liability

Question 2

Principle Market

Answer 2

The principle market is the market with the greatest volume or level of activity for the asset or liability. If there is a principle market for an asset or liability , the price in that market will be the FV measurement, even if there is a more advantage price in a different market

Question 3

Most advantage market

Answer 3

The most advantage market is the market with the best price for the asset or liability, after considering transactions costs. Note that although transactions costs are used to determine the most advantageous market , transactions costs are not included in the final FV measurement. The price in the most advantageous market will the fair value measurement only if there is no principle market.

Question 4

Valuation Techniques

Answer 4

Entities can use the market approach, the income approach, the cost approach, or a combination of these, as appropriate when measuring the FV of an asset or a liability

Market approach - use prices and other relevant information from market transactions involving identical or comparable assets or liabilities to measure FV

Income approach - converts future amounts, including cash flows or earnings to single discounted amount to measure FV. This method can be applied to assets or liabilities

Cost Approach - uses current replacement cost to measure the fair value of assets

Question 5

Formation of a partnerships

Answer 5

Contributions to a partnerships are recorded as follows

1. Assets are valued at fair value
2. Liabilities assumed are recorded at their PV
3. Partner’s capital account therefore equals the differences between the fair value of the contributed assets less the present value of liabilities

Question 6

Creation of a new partnership interest with investment of additional capital

Answer 6

When a new partnership interest is created by the investment of additional capital into the partnership, the total capital of partnership does change, and the purchase price can be equal to , more than, or less than BV

Exact method - when the purchase price is equal to the BV of the capital account purchased, no goodwill or bonuses are recorded

Question 7

Bonus Method of partnership

Answer 7

when the purchase price is more or less than the book value of the capital account purchased, bonuses are adjusted between the old and new partner’s capital accounts and do not affect partnership assets

Bonus method recognize inter-capital transfer

B= Bonus = Balance in total capital accounts controls the capital alloaction

Question 8

Goodwill Method of partnership

Answer 8

Goodwill is recognized based upon the total value of the partnership implied by the new partner’s contribution

Rules

1. Compute new net assets before goodwill after admitting new partner
2. Compute new capitalized net assets and compare Capitalized net assets with net assets before Goodwill
3. The difference is goodwill to be allocated to the old partners according to their old partnership ratios

Question 9

Profit and loss distribution

Answer 9

Income and loss distributed among the partners in accordance with their agreement, and in absence of an agreement all partners shear equally irrespective of what their capital account reflect or the time each partner spends on partnership affairs

unless the partnership agreement provides otherwise, all payments for interest on capital, salaries, and bonuses are deducted prior to any distribution in the profit or loss , such payments are provided in full

Question 10

Withdrawal of a partner

Answer 10

Bonus Method

The difference between the balance of the withdrawing partner’s capital account and the amount that person is paid is the amount of the bonus. The bonus is allocated among the remaining partners capital accounts in accordance with their remaining profit and loss ratio.

Question 11

Withdrawal of a partner

Answer 11

Goodwill Method

The partners may elect to record the implied goodwill in the partnership baed on the payment to the withdrawing partner. The amount of the implied goodwill is allocated to all of the partners accordance with their profit and loss ratio.

Question 12

Variable Interest Entities

Answer 12

Primary beneficiary
The entity that is required to consolidate the VIE , the primary beneficiary is the entity that has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performances

1. Absorbs the expected VIE losses or
2. Receives the expected VIE residual returns

note once a company has established that has a variable interest in a business entity that is a VIE, the primary beneficiary must be determined. The primary beneficiary must consolidate the VIE

Question 13

IFRS Special purpose entities

Answer 13

A special purpose entity is a specific type of VIE created by a sponsoring company to hold assets or liabilities, often for structured financing purposes . Under IFRS a sponsoring company controls and must consolidate an SPE when the company

1. Is benefited by the SPE activities
2. Has decision making powers that allow it to benefit for the SPE
3. Absorbs the risk and rewards of the SPE
4. Has a residual interest in the SPE

Question 14

Asset Retirement Obligation

Answer 14

An asset retirement obligation is a legal obligation associated with the retirement of a tangible long lived asset that results from the acquisition, construction, or development and or normal operation of long lived asset , except for certain lease obligation

US GAAP and IFRS require a balance sheet approach to recognizing ARO

ARO qualifies for recognition when it meets the definition of a liability

1. Duty or responsibility
2. Little or no discretion to avoid
3. Obligation event

Question 15

Troubled debt re-structuring

Answer 15

Transfer of assets
The debtor will recognize gain in the amount of the excess of the carrying amount of the payable ( face amount of payable plus accrued interest , premiums) over the fair value of the assets given up.

Transfer of equity interest

The difference between the carrying amount of the payable and the fair value of the equity interest may be recognized as an extraordinary gain under US GAAP, if it meets the requirement.

Question 16

Modification of Terms

Answer 16

In a modification, effects of the restructuring done prospectively. The debtor does not change the carrying amount unless the carrying amount exceeds the total future cash payment specified by the new terms.

The total future cash payments are the principle and any accrued interest at the time of the restructuring that continues to be payable by the new terms. If the future payments are less than the carrying amount, the debtor should reduce the carrying amount and recognize the difference as a gain

Question 17

Accounting and Reporting by creditors

Answer 17

When the creditor receives either assets or equity as full settlement of a receivable, these are accounted for at the FV at the time of restructuring.

Modification of terms ( use PV)
Impairment should be measured based on the loan’s PV of expected future cash flows discounted at the loan’s historical effective interest rate

Question 18

Trade Accounts payable

Answer 18

Trade accounts payable are amounts owed for goods, raw materials, and supplies that not evidenced by a promissory note.

Sales taxes are not an expense of the company collecting the sales from customers

Unemployment taxes and the employers share of taxes should be accrued by the employer as an expense

Question 19

Transactions not requiring PV

Answer 19

Receivables and payables generally do not require
PV and are required to be recorded as FV

1. Arising in the ordinary course of business, the terms of which do not exceed approximately one year (short term notes )
2. Paid in property or services (not in cash)
3. Representing security or retain age deposits
4. Bearing an interest rate determined by a governmental agency
5. Arising from transactions between a parent and its subsidiaries

Question 20

Estimated Liabilities

Answer 20

An estimated liability represents recognition of probable future charges that results from a prior act, such as estimated liability for warranties, trading stamps, or coupons

Warranties are a seller’s promise to correct any product defects. Sellers offering warranties must create a liability account if the cost of the warrant can be reasonably estimated

The accrual should take place even if part of the warranty expenditure will be incurred in a later year

Question 21

Loss is probable and can be reasonably estimated

Answer 21

The amount of loss can be reasonably estimated, in the even that range of probable losses is given , GAAP require that the best estimated of be accrued. If no amount in the range is a better estimate than any other amount within the range, the minimun amount in the range should be accrued and disclose possibility any additional amount.

Note if the loss contingency is reasonably possible, disclosure is required. If the loss contingency is remote, then disclosure is NOT required however disclosure should be made for guarantee type remote loss contingencies

Question 22

Subsequent event

Answer 22

Recognized subsequent events
Subsequent events that provide additional information about condition that existed at the balance sheet date. Entities must recognize the effect of all recognized subsequent events in the F/S

Non-recongized subsequent events
Subsequent event that provide information about condition that occurred after the balance sheet date and did not exist at the balance sheet date. Entities should not recognized non-recongized subsequent events in the F/S

Question 23

IFRS Subsequent events

Answer 23

Under IFRS subsequent event referred as “Events after there reporting period” Recognized subseqnent events = Adjusted events after reporting period , Non-reconzied subsequent events = non adjusted event after the reporting period. IFRS specially address going concern issue in the guidance on events after the reporting period, stating that an entity can not prepare its F/S on a going concern basis if management determine after year end it intend to liquidate the company or ceae treading

Question 24

Financial Instruments

Answer 24

Entities may choose to measure eligible instrument at FV. Under the FV option, Unrealized gains and losses are reported in earnings. The FV option is irrevocable and is applied to individual financial instrument. Entities may elect the fair value option for recognized financial assets and liabilities.

Financial instrument not eligible for the fair value option include investment in subsidiaries or VIE

Question 25

IFRS Financial instrument

Answer 25

under IFRS the FV can only be elected for financial assets if doing so eliminates or significantly reduces a measurement or recognition inconsistency otherwise different basis

The FV option can be elected for financial liabilities if either

1. Doing so eliminates or significantly reduces a measurement or recognition inconsistency
2. A group of financial assets and liabilities is managed and its performance is evaluated on a fair value basis in accordance with policy or key management personnel.

Question 26

Fair value disclosure required for financial instrument

Answer 26

Fair value must be disclosed for all financial instrument for which it is practicable to estimate that value, together with the related carrying amount showing clearly whether the amounts represent assets or liabilities.

A concentration of credit risk occurs when an entity has contracts of material value with one or more parties in the same industry or region or having similar economic characteristics. Entities must disclose all significant concentration of credit risk arising from all financial instrument , whether from a single party or a group of parties engaged in similar activities and that have similar economic characteristics.

Question 27

FV disclosure under IFRS

Answer 27

IFRS require disclosure of the nature and extent or risks arising from financial instrument , including disclosure of credit risk for each class of financial instrument, disclosure of liquidity risk, and disclosure of market risk. The market disclosure is not optional under IFRS

Question 28

Derivate Instrument

Answer 28

A derivative instrument is a financial instrument that derives it’s value from the value of other instrument and has all three of the following characteristic

1. One or more and one or more notional amounts or payment provision ( or both)
2. It require no initial net investment or one that is smaller that would be required for other types of similar contracts and
3. Its terms require or permit net settlement in lieu of physical delivery. It can be readily be settled net outside the contract or by delivery of an asset that gives substantially the same results.

Question 29

Hedging

Answer 29

Hedging is the use of a derivative to offset anticipated losses or to reduce earnings volatility. When a hedge is effective, the change in the value of the derivatives offsets the change in value of a hedged item or the cash flow of the hedged item.

Question 30

Common Derivatives

Answer 30

Option contract
A contract between two parties that gives one party the right, but not the obligation, to buy or sell something to the other party at a specified price (the strike price or exercise price ) during a specified period of time.

A call option gives the holder the right to buy from option writer at a specific price during a specific period of time. A put option gives the holder the right to sell to the option writer at a specified price during a specified period of time

Common Derivatives NMONIC - OFFS

Question 31

Future Contract

Answer 31

An agreement between two parties to exchange a commodity or currency at a specified price on a specified future dates. One party takes a long position and agrees to buy a particular item while other party takes a short position and agrees to sell that item. Unlike option, both parties are obligated to perform according to the term of the contract. Future contract are made through a clearinghouse and have standardized notional amount and settlement dates

Question 32

Forward Contract

Answer 32

Forward contract are similar to futures contracts, except that they are privately negotiated two parties with the assistance of an intermediary, rather through a clearinghouse. Forward contract do not have standardized notional amount or settlement dates. The term of forward contract are established by the parties to the contract.

Question 33

Swap Contracts

Answer 33

A private agreement between two parties, generally assisted by an intermediary, to exchange future cash payment. Common swaps includes interest rate swaps, currency swaps and commodity swaps. A swap agreement is equivalent to a series of forward contract.

Question 34

Derivaties Risk

Answer 34

Market risk and credit risk are the inherent risk of all derivative instrument

Market risk that entity will incur a loss on a the derivate contract. As demonstrated in the example above =, derivatives are a Zero sum Game . Every derivate has a winner or loser

Credit risk the risk that other party to the derivative contract will not perform according to term of contract. for example, in the interest swaps the lose company will refuse to pay net settlement.

Question 35

Accouting for derivatives

Answer 35

All derivative instrument are recognized in the balance sheet as either assets or liabilties, depending on the rights or obligation under the contract. All derivative instrument measured at fair value

Gain/losses on a derivatives instrument not designated as a heding instrument are recognized currently in earnings, similar to the accouting for trading securities.

Question 36

Derivative Disclosure

Answer 36

If derivative information is presented in more than one footnote, then the footnotes should be cross -referenced as for the IFRS.

A descripton of the entity’s objective for holding or issuing derivatives and it’s strategies to acheive those objective.

The location and amount of the gains and losses reported on the I/S and OCI

Question 37

Accounting for Financail instruments under IFRS

Answer 37

Under IFRS, Financail assets are initailly recongized at fair value and then subsequently measured at either amortized cost or FV. Financail assets that are debt instruments are reported at amortized cost or fair value.

A financail asset that is an equity instrument is reported at FV with gains and losses recognized in earning unless

1. It is a part of hedging relationship
2. The entity makes an irrevocable election on initial recognition to present gains or losses in OCI

Question 38

Fair Value Hedge

Answer 38

A Fair value hedge is an instrument designated as hedge of the exposure to changes in FV of recongized asset or liability. Gains/losses on such instrument as well as offsetting gain/loss on the hedge item are recognized in earning in the same accounting period. The derivative must be expected to be highly effective in offsetting the FV change of the hedged item

No hedge designation - included in current earnings.