Financial Lecture 10

Question 1

Define fair value

Answer 1

Fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date.

Question 2

Describe the valuation techniques that can be used to measure the fair value of an asset or liability.

Answer 2

Market approach Income approach Cost approach

Question 3

Describe the hierarchy of fair value inputs. Which inputs have the highest priority?

Answer 3

Level 1 Inputs Level 2 Inputs Level 3 Inputs

Question 4

In creating a new partnership interest with an investment of additional capital, what three methods can be used?

Answer 4

Exact method Bonus method Goodwill method

Question 5

Describe the exact method of creating a new partnership interest with an investment of additional capital.

Answer 5

The purchase price equals the book value of the capital account purchased.

Question 6

Describe the bonus method of creating a new partnership interest with an investment of additional capital.

Answer 6

Bonus method

Question 7

Describe the goodwill method of creating a new partnership interest with an investment of additional capital.

Answer 7

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

Question 8

Describe the bonus method of withdrawal of a partner.

Answer 8

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.

Question 9

Describe the goodwill method of withdrawal of a partner.

Answer 9

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

Question 10

In liquidating a partnership, what is the order of preference?

Answer 10

Remember that all losses must be provided for before disposal; that is, maximum potential losses before distribution of cash.

Question 11

What is a variable interest entity (VIE)?

Answer 11

A corporation, partnership, trust, LLC, or other legal structure used for business purposes that either does not have equity investors with voting rights or lacks sufficient financial resources to support its activities.

Question 12

Who is the primary beneficiary of a VIE and how does the primary beneficiary account for its VIE investment?

Answer 12

The entity with the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and:

Question 13

Who consolidates when one entity receives the expected returns from a VIE and another entity absorbs the expected losses?

Answer 13

The entity that absorbs the expected losses consolidates.

Question 14

Define an asset retirement obligation (ARO).

Answer 14

A legal obligation associated with the retirement of a tangible long-lived asset that results from the acquisition, construction, development, and/or normal operation of a long-lived asset.

Question 15

How is an ARO initially measured?

Answer 15

At fair value (present value of the future obligation) as an asset (asset retirement cost) and a liability (asset retirement obligation).

Question 16

How is an ARO accounted for in periods after initial measurement?

Answer 16

The ARO liability is adjusted for accretion expense and the ARO asset is depreciated.

Question 17

Name four types of restructurings involving debt.

Answer 17

Transfer of assets

Question 18

How is the gain (loss) measured in a troubled debt restructuring involving the modification of terms?

Answer 18

It is the difference between the carrying value amount of the obligation prior to the restructuring and undiscounted total future cash flows required after restructuring, if undiscounted future cash flows are less than the carrying amount.

Question 19

How is the gain (loss) measured in a troubled debt restructuring involving a transfer of assets?

Answer 19

Restate the assets transferred to fair value and recognize a gain or loss in ordinary income.

Question 20

When is a gain (loss) not recognized on troubled debt restructuring?

Answer 20

For debtor, when there is a modification of terms and payment of the entire debt is not affected.

Question 21

When is a loan considered impaired?

Answer 21

Probable that all amounts due (principal and interest) will not be received.

Question 22

How is an impaired loan reported by the creditor?

Answer 22

Present value of the loan’s expected future cash flows discounted at the loan’s effective interest rate.

Question 23

What are the general disclosures for the debtor in a troubled debt restructuring?

Answer 23

A description of the main changes in term and/or features of settlements.

Question 24

What are the general disclosures for creditors in a troubled debt restructuring?

Answer 24

The creditor’s policy for recognizing interest income

Question 25

Explain the difference between the net method and gross method of recording accounts payable.

Answer 25

Gross Method Net Method

Question 26

How are notes receivable and payable recorded in the financial statements?

Answer 26

Notes receivables and payables (contractual rights to receive or pay money at a fixed or determinable rate) must be recorded at present value at the date of issuance.

Question 27

What is the effective interest rate method?

Answer 27

The effective interest rate method is a method under which each payment on a note (or other loan) would be divided between an interest component and a principal component as through the note had a constant effective stated rate (or adequate rate) of interest.

Question 28

How are premiums or discounts resulting from recording notes payable and receivable at present value presented in the financial statements?

Answer 28

The premium or discount that arises from the use of present value on cash and noncash transactions is inseparable from the related asset or liability. Therefore, such premium or discount valuation accounts are added to (or deducted from) their related asset or liability on the balance sheet.

Question 29

Premiums, warranties, and service contracts are examples of estimated liabilities. When are the liabilities for these types of expenses recorded and why?

Answer 29

Estimated liabilities for premiums, warranties, and service contracts are recorded in the same period as the revenue associated with the various transactions in order to accomplish matching of costs and revenues. Example: When a product is sold with a warranty, the future expense of satisfying the warranty is estimated and recorded as a liability in the same period of the sale.

Question 30

What is the difference between estimated liabilities and accrued liabilities?

Answer 30

Generally, estimated liabilities are for amounts that will be paid in the future where the amounts are not presently known precisely when the liability must be recorded. Estimated liabilities are recorded in the current period in order to match the expenses to be paid in the future to the revenue recorded in the current period. Example: Estimated liability for warranties.

Question 31

Identify the three ranges of likelihood that a future event will confirm a contingent liability.

Answer 31

Probable Reasonably possible Remote

Question 32

When are contingent liabilities accrued?

Answer 32

When the loss is both probable and can be reasonably estimated, then record and disclose.

Question 33

What is the accounting treatment of gain contingencies?

Answer 33

Gain contingencies are not reflected on the balance sheet but are disclosed at to their nature and amount if likelihood is probable and to do so would not be misleading.

Question 34

What is a subsequent event and what are the two categories of subsequent events?

Answer 34

An event or transaction that occurs after the balance sheet date but before the financial statements are issued or are available to be issued.

Question 35

What disclosures are required for subsequent events?

Answer 35

If an entity is not an SEC filer, the entity must disclose the date through which subsequent events have been evaluated.

Question 36

List the disclosure requirements for financial instruments under U.S. GAAP.

Answer 36

Fair value and related carrying amounts

Question 37

Describe the financial instrument fair value option under U.S. GAAP.

Answer 37

On specified election dates, an entity may choose to measure eligible financial instruments at fair value with unrealized gains and losses reported in earnings. The fair value option is irrevocable.

Question 38

Define derivative instrument.

Answer 38

A “derivative instrument” is a financial instrument (or other contract) that “derives” its value from the value of some other instrument and has all three of the following characteristics:

Question 39

Define underlying and notional amounts at they relate to a derivative financial instrument.

Answer 39

Underlying: A specified price, rate, or other variable (e.g., interest rate, security price, foreign exchange rate, index of prices or rates, etc.)

Question 40

Name four common derivative instruments.

Answer 40

Option contracts Future contracts Forward contracts Swap contracts

Question 41

Identify the three types of hedge designations.

Answer 41

Fair value hedge Cash flow hedge Foreign currency hedge

Question 42

Describe the accounting for changes in fair value associated with each type of hedge designation.

Answer 42

Fair value hedge Cash flow hedge Foreign currency hedge

Question 43

When should an entity prepare its financial statements using the liquidation basis of accounting?

Answer 43

When liquidation is imminent, an entity must prepare its financial statements using the liquidation basis of accounting.

Question 44

What are the criteria for “imminent liquidation”?

Answer 44

In order for liquidation to qualify as “imminent,” the following criteria must be met:

Question 45

Describe the proper accounting when the liquidation basis is initially applied.

Answer 45

On the effective date that the liquidation basis must be applied,

Question 46

Describe the measurement basis for assets and liabilities under the liquidation basis of accounting.

Answer 46

Assets must be measured and presented at the amount of cash proceeds expected from liquidation.

Question 47

Describe the accounting for costs expected to be incurred during and at the end of the liquidating process.

Answer 47

Costs that are expected to be incurred during and at the end of the liquidation process must be accrued,

Question 48

Describe the financial statements required under the liquidation basis of accounting.

Answer 48

An entity preparing financial statements under the liquidation basis of accounting must present both a Statement of Net Assets in Liquidation and a Statement of Changes in Net Assets in Liquidation.

Question 49

What are the disclosures required for a company that is applying the liquidation basis of accounting?

Answer 49

The plan for liquidation