Recognition, Measurement, Valuation, Disclosure - Part 2 Flashcards
What is an impaired asset?
If the asset’s book value > future cash flows, then the asset is considered to be impaired. An impaired asset is written down to its fair value. The amount by which the asset is written down is reported as a loss during that period.
What is a patent and how is a patent accounted for?
A patent is the right of exclusive use granted by the U. S. Patent Office. Previously patents were valid for 17 years, but the length of time is now 20 years for all new patents. Patents are amortized over the shorter of the patent’s legal life or the economic useful life of the patent. It is very possible that the economic useful life of the patent will be shorter than the legal life of the patent because of changing technologies. For patents that are purchased, the patent should be recorded on the books at the purchase price. The purchase price is also the amount that should be amortized over the useful life of the patent. For internally developed patents, the capitalized and amortized amount is generally limited to registration fees and legal fees for filing the patent. This accounting treatment is related to the accounting treatment for research and development. Research and development costs are generally expensed as incurred and thus they cannot be capitalized and amortized.
What are leasehold improvements and how are they accounted for?
Leasehold Improvements are improvements that:Are made by a lessee to a building or property that the lessee is leasing. Cannot be removed by the lessee when the lease period is over. The cost of leasehold improvements should be amortized over the shorter of the remaining lease term or the useful life of the improvements.
What is a trademark and how is accounted for?
A trademark or trade name is a distinctive sign, word or symbol. Trademarks can be registered for 20 years and renewed for longer time periods. The costs that should be capitalized include legal and registration fees, design costs and any cost of successfully defending the name. The trademark should be amortized over its useful life, but the amortization period should not exceed 40 years. Trademarks are identified with the symbol ®.
What is a copyright and how is it accounted for?
A copyright is granted for intellectual property consisting of original works and is effective for the life of the author plus 70 years. Copyrights are identified with the symbol ©. As with patents, if a copyright is purchased, it is recorded at its purchase price. An internally generated copyright can be recorded at its registration costs only. Capitalized costs for copyrights are amortized over the useful life of the copyright if less than its legal life. Any research and development costs that lead to a copyright must be expensed as they are incurred and thus are not capitalized or amortized.
What is goodwill and how is it accounted for?
Goodwill is defined as the amount that a purchaser has paid for a company that is greater than the fair value of the net identifiable assets. Purchased goodwill must be reported as a separate line item on the balance sheet. Generally, other intangibles are combined and reported as one figure on the balance sheet. Goodwill can be acquired or developed internally, but the only goodwill recognized in the accounting records is purchased goodwill. The amount of goodwill purchased is equal to the difference between the purchase price paid for a business and the fair value of the net assets received.
What is a warranty and what are the two types of warranties?
A warranty is a promise that a company makes to a buyer that if the product breaks during a specific time period, the company will pay to fix or replace the defective product. Warranties can be of two types:An expense warranty is a manufacturer’s warranty given along with the sale of the product, without any additional payment being required from the customer. A sales warranty is an extended warranty that is sold separately from the product. Sales warranties may be offered by the manufacturer but also may be offered by either the reseller or by a third party.
What is off-balance sheet financing?
Off-balance sheet financing is any form of funding that avoids placing owners’ equity, liabilities or assets on a firm’s balance sheet. Off-balance sheet financing can be accomplished through the use of:Operating leasesSale of receivables (factoring), Joint ventures, Non-consolidated subsidiaries, Variable interest entities
What is book income and what is taxable income?
Book income is the pre-tax financial income reported in the financial statements calculated using the rules of GAAP. Book income is the “correct” income because it is calculated according to GAAP. Taxable income is a tax accounting term and it is used for the amount upon which the company’s income tax payable is computed. Taxable income is calculated by following the tax code of the IRS.
What are some examples of reasons that book and taxable income differ?
For financial reporting, the full accrual method is used to report revenues, whereas for tax purposes a modified cash basis is used. For tax purposes, expense accrued for financial reporting for estimated liability for warranties is not allowed as a tax deduction until the amounts are paid. For tax purposes, expense accrued for financial reporting for estimated liability for pending litigation is not allowed as a tax deduction until the amounts are paid. By using accelerated depreciation methods for fixed assets for tax purposes, depreciation expense for tax purposes can be greater than depreciation expense for financial reporting purposes, leading to a lower taxable income in the early years of the assets’ lives as compared with pretax financial income for the same years.
What are four potential events that will cause a difference between book and taxable income?
An income item is recognized as taxable income before it is recognized in the accounting records as revenue. An expense item is deductible from taxable income before it is deducted in the accounting records as an expense. An income item is recognized in the accounting records as a revenue before it is recognized as taxable income on the tax return. An expense item is deducted in book income as an expense before it is deductible in taxable income.
What is a deferred tax asset and how is one created?
A deferred tax asset is created by an item that causes taxable income in the current period to be higher than book income in the current period. Because taxable income is higher, the company has had to pay more in taxes than its book income indicates it should have paid. Therefore, for book purposes this is a prepaid tax, or a deferred tax asset. A deferred tax asset is created by either:A revenue that is taxable in the current period but is not included in book income for the current period. For example, a deposit received for work to be performed in the future, rental income received in advance of the period covered, or subscription payments received in advance. Or an expense that is included in book income but is not deductible for tax purposes in the current period. For example, warranty expense debited to the income statement and credited to estimated warranty liabilities.
What is a deferred tax liability and how is one created?
A deferred tax liability is created by an item that causes taxable income in the current period to be lower than book income in the current period. Because taxable income is lower, the company does not pay as much as its book income indicates it should pay in taxes in the current period. However, because the company knows that these temporary timing differences will reverse, it understands that the tax that was not paid this year will need to be paid in the future. Therefore, for book purposes this difference is recorded as a deferred tax liability. A deferred tax liability is created by either: A revenue that is included in book income but not in taxable income in the current period. For example, interest income accrued monthly for book purposes on a debt security investment when the interest is received only semi-annually. Or an expense that is deductible for tax purposes but is not an expense for book purposes in the current period. For example, payment of an insurance premium in advance for insurance coverage during the coming year or the early years of an asset’s life when accelerated depreciation is used for tax purposes while straight-line depreciation is used for book purposes.
What are permanent timing differences with regards to income tax?
Permanent timing differences are items that cause differences between taxable income and book income but do not reverse over time. Permanent differences do not give rise to deferred tax assets or liabilities because of the fact that by definition a permanent timing difference is something that will be recognized for either book or tax purposes, but not both.
What is contributed capital?
Contributed capital consists of the assets that are put into the company by the owners in return for their share of ownership of the company. The fair value of what is received in exchange for the shares (whether it is cash or another asset) will be recorded in two different equity accounts.
What is retained earnings?
Retained earnings represent the undistributed profits of the company that have been reinvested in the company. These may also be called undistributed profits or undistributed earnings. We will use the term “retained earnings” in this book.
What is the par value of stock?
Par value is the specified value printed on the share itself. Par value is the maximum amount of a shareholder’s personal liability to the creditors of the company, because as long as the par value has been paid in to the corporation by the shareholders, the shareholders obtain the benefits of limited liability, and their potential for loss is limited to the amount they paid for their shares.
What are dividends?
Dividends are the distribution of current profits and/or the retained earnings of the company to its owners. The declaration of cash or property dividends reduces total stockholders’ equity as a result of either the distribution of an asset (cash or other property) or the incurrence of a liability (dividends payable if the dividend is not immediately distributed).
