Cpa Exam Prep – Far

CPA EXAM PREP – FARAccounting Standards and Conceptual Framework  SEC has the legal authority to establish US GAAP o Deferred to FASB Authoritative Literature Included in the Codification (FED PRIA)  FASB  Emerging Issues Task Force (EITF)  Derivative implementation group issues  Accounting Principles Board opinions (APB)  Accounting Research Bulletins (ARB)  Accounting Interpretations  AICPA International Financial Reporting Interpretations Committee (IFRIC)  IFRIC provides guidance on newly identified financial reporting issues not addressed in IFRSs and assists IASB in achieving convergence Convergence  A single set of high quality, international reporting standards that companies can use for both domestic and cross-border financial reporting Conceptual Framework – Basis of All FASB Pronouncements  SFAC #8: Objective of financial reporting (disclose entity’s performance)  SFAC #6: Elements of Financial Statements (REGL ALE needs ID) o Revenues o Expenses o Gains o Losses o Assets o Liabilities o Equity o Investments by owners o Distributions to owners Presentation order of major components of Income and Retained Earnings (IDEA)  Income from continuing operations  Discontinued operations (net of tax)  Extraordinary items (net of tax)  Accounting principle change – RETAINED EARNINGS (net of tax) Account Receivable Account Analysis A/R Beginning Balance + Credit Sales (Write-offs) (Convert to note) (Cash Collected) Ending Balance Objective of Financial Reporting  Provide financial information about the reporting entry that is useful to the primary users (investors, creditors, and other lenders) Fundamental Qualitative Characteristics of Financial Statements  Relevance  Faithful Representation Components of Relevance (Passing Confirms Money)  Predictive value  Confirming value  Materiality  Makes a difference in decision making Components of Faithful Representation (Completely neutral is free from error)  Completeness  Neutrality  Freedom from error Enhancing Qualitative Characteristics of Financial Statements  Enhance the usefulness of info that is relevant and faithfully represented  Comparability (current year to prior year, for example)  Verifiability  Timeliness  Understandability Fundamental Characteristics of Financial Statements Relevance Predictive Value Materiality Confirming Value Faithful Representation Completeness Neutrality Freedom From Error Fundamental Recognition Criteria  Definitions  Measurability  Relevance  Reliability Fundamental Assumptions  Entity  Going concern  Monetary unit  Periodicity  Revenue recognition  Matching  Accrual accounting  Full disclosure  Conservatism Income Statement  Performance for a period of time Discontinued Operations  Component of an entity held for sale  Reported net of tax o Can consist of:  Impairment loss (in period when it occurs)  Gain / loss from operations (in period when it occurs)  Gain / loss on disposal (in period when it occurs)  Gain recognized for any subsequent increase in FV (not in excess of cumulative loss)  Assets of component no longer depreciated or amortized Exit or Disposal Activities  Recognize a liability for costs associated with exit or disposal when: o An event has occurred that o Creates an obligation to transfer assets/services in the future and o The obligation cannot be avoided  Measured at FV in the period incurred Extraordinary Items  Unusual AND infrequent  Reported net of tax  Not allowed under IFRS Change in Accounting Estimate  Prospective approach  Changes in accounting principle inseparable from a change in estimate (i.e. from installment method to immediate recognition) should be handled prospectively as well Change in Accounting Principle  Adjust RE in earliest period presented o Non-comparative statements: cumulative effect = beg. Retained earnings – correct retained earnings o Comparative statements: cumulative effect = beg. Retained earnings in 1 st period shown – correct retained earnings Changes to LIFO or in Depreciation Method  Prospective approach Changes in Accounting Entity + Error Correction  Restate financials  Non-GAAP to GAAP: an example of an error  No change in accounting entity under IFRS Comprehensive Income  Non-owner transactions  Net income per income statement + other comprehensive income = comprehensive income Other Comprehensive Income (PUFE R)  Pension adjustment  Unrealized gains and losses on available for sale securities  Foreign currency items  Effective portion of cash flow hedge  Revaluation surplus – IFRS only!!! Accumulated OCI  A component of equity that includes the total of OCI for the period and previous periods (like RE) Full Set of Financial Statements  Balance sheet  Income statement  Comprehensive income  Cash flows  Changes in owner’s equity Reclassification Adjustments  Avoids double counting  Moves OCI items from AOCI to the income statement  Displayed in net income for the current year Interim Financial Reporting  Not required under GAAP / IFRS o Considered an integral part of annual financial statements  Revenues and expenses matched by quarter  Unaudited  Permanent inventory losses from market declines should be reflected in the period in which they occur o Temporary losses that are expected to reverse before the end of the period should not be recognized  Income tax rate = estimated effective tax rate for the year o If changes during year, calculate as: Total net income for all periods * new effective tax rate – income tax expense reported for the year Segment Reporting  Required for all public companies o Operating segments o Products and services o Geographic areas o Major customers  Use the same principles as main statements  Intercompany transactions are not eliminated Materiality Tests for Reportable Segments  10% or more of: o Revenues (internal and external) o Combined reported profit o Combined reported loss o Combined assets of all operating segments  AND 75% of external revenue must be included in reportable segments (if not, add segments until 75% is reached) Segment Profit and Loss Defined  Revenues (for that segment – internal and external)  (Directly traceable costs)  (Reasonably allocated costs – by CFO)  Operating Profit (Loss) – for that segment o Items normally excluded: general corporate revenues and expenses Development Stage Enterprises (GAAP only)  Start-up, organizational costs are immediately expensed  Disclosure of cumulative net losses in balance sheet, income statement, and cash flows First-time Adoption of IFRS  Required to present 3 balance sheets and 2 income statements  Explanation of transition required SEC Reporting Requirements (common)  Form 10-K: US annual report  Form 10-Q: US quarterly report  Form 20-F and Form 40-F: Foreign annual report  Form 6-K: Foreign semi-annual report  Forms 3, 4, 5: directors, officers, owners of 10% or more equity XBRL  Data tags to describe financial information for business and financial reporting XBRL Tag  Tags provide contextual information that allow data to be recognized and processed by software SEC Interactive Data Rule  Requires U.S. public companies and foreign private issuers that use GAAP to present financial statements and schedules in an exhibit prepared using XBRL Assets + Liabilities  Assets = probable future economic benefits, Liabilities = probable future sacrifices Revenue Recognition Criteria  Persuasive evidence of an arrangement exists (signed contract)  Delivery occurred / services rendered (transfer risks and rewards)  Price is fixed and determinable (no contingencies)  Collection is reasonably assured Revenue Recognition Categories – IFRS  Sale of goods  Rendering of services  Revenue from interest, royalties, dividends  Construction contracts Basic Revenue Recognition Criteria – IFRS  Measured reliably  Economic benefits will flow to the entity Franchises  Initial franchise fee: revenue when substantially performed  Continuing franchise fees: revenue when earned o Franchisor accounting:  Unearned revenue => initial franchise fee (not yet earned) and prepaid franchise fee o Franchisee accounting:  Initial franchise fee => intangible asset (amortize)  Continuing franchise fee => expense as incurred Purchased Intangible Assets  Record at Cost Internally Developed Intangible Assets  Expense as incurred Costs to Capitalize – Intangible Assets  Legal fees and other costs for successful defense (unsuccessful = expense)  Registration and consulting fees  Design costs  Direct costs to secure the asset What to Capitalize – Assets, Liabilities, and C/S  Assets: cash paid or FV of other assets distributed  Liabilities: PV of amounts to be paid  Stock: FV of consideration received Patent Amortization  Amortized over the shorts of its estimated life or legal life IFRS – Intangible Asset Valuation  Cost model: cost – amortization – impairment  Revaluation model: FV on revaluation date – subsequent amortization – subsequent impairment R&D Costs – US GAAP  DO NOT EXPENSE: o Machines and equipment with alternate future uses (capitalize and depreciate) o R&D performed for others  NOT R&D: o Periodic design changes o Marketing research o Quality control testing o Reformulation Computer Software to be Sold (not internal use)  Expense costs until technological feasibility has been established, then:  Capitalize costs until released for sale Amortization of Capitalized Software Costs  The greater of: o % of revenue = Total capitalized amount * (Current revenue / Total projected revenue) o S/L depreciation = Capitalized amount / Economic life Computer Software Costs – Internal Use  Expense costs incurred for the preliminary project state and training and maintenance  Capitalize after the preliminary project state and for upgrades and enhancements o Amortize S/L Impairment of Intangible Assets, Finite Life (2-Step Method)  Compare CV to undiscounted future cash flows o CV>UFCF, impairment, then  Amount of Impairment loss = CV – FV Impairment of Intangible Assets, Indefinite Lives (1 Step Method)  Compare CV to FV o CV>FV, impairment, then  Amount of Impairment loss = CV – FV  Note: same as step 2 above only!!! Goodwill Impairment – US GAAP  Tested at the reporting unit level  Compare the FV of the reporting unit (including goodwill) to the CV o If CV>FV, then:  Goodwill impairment = CV of goodwill – implied FV of goodwill Completed Contract Method (GAAP ONLY!!!)  Income recognition at completion of contract  Losses recognized in full in year of discovery Completed Contract Method – Balance Sheet Presentation  Current Asset Accounts o Due on accounts (receivable) o Costs of uncompleted projects in excess of billings (construction in progress) OR  Current Liabilities o Progress billings in excess of cost Percentage of Completion Method (GAAP + IFRS)  Recognize profit based on amount of contract completed o % of job earned = (Actual costs incurred / Total expected costs)  Loss on entire contract recognized immediately (adjust any previous gross profit recognized as well) Percentage of Completion Method – Calculation of Recognized Gross Profit  Total GP = Contract price – estimated total costs  % of job earned = (Actual costs incurred to date / Total estimated costs)  Step 1 * Step 2 = Total profit to date  Profit to date – prior profit recognized = current period gross profit Percentage of Completion Method – Balance Sheet Presentation  Current Asset Accounts o Due on accounts (receivable) o Costs and estimated earnings in excess of billings (construction in progress) OR  Current Liability Account o Progress billings in excess of cost and estimated earnings Accounting for Installment Sales  Only used when there is no reasonable basis for estimating the degree of collectability  Revenue is recognized when cash is actually collected Installment Sales – Problem Solving Formulas  Gross Profit = Sales – COGS  Gross Profit % = GP / Sales  Earned Gross Profit = Cash collections * GP%  Deferred Gross Profit = Installment Accounts Receivable * GP% Cost Recovery Method  Expected profit reported as deferred profit at the time of sale  Cash collection first applied to the recovery of costs; after all costs recovered, other collections are recognized as revenue Exchanges with Commercial Substance (ANY CHANGE IN CASH FLOWS)  Future cash flows change because of transaction  Under IFRS, exchange of similar assets => no gain recognized o Dissimilar accounted for in the same manner as those having commercial substance under GAAP Exchanges with Commercial Substance – Journal Entry Framework  New asset (FV of consideration given)  Accumulated depreciation of asset given up  Cash received  Loss (if any) o Old asset at historical cost o Cash given o Gain (if any) Exchanges without Commercial Substance (NO CHANGE IN CASH FLOWS)  No change in future cash flows  Always recognize a loss  Gain recognition is conditional: o No boot received: do not recognize any gain o Boot paid: do not recognize any gain o Boot received: recognize gain proportional to consideration (25% rule)  If (Boot received / consideration received) > 25%, recognize the entire gain  If (Boot received / consideration received) < 25%, recognize gain proportional to (boot received/consideration received)*Gain Measurement Methods and Current Cost Determination – Effect of Changing Prices  Historical cost / nominal dollar: no adjustment necessary  Historical cost / constant dollar: adjust for inflation  Current cost / nominal dollar: adjust for appreciation  Current cost / constant dollar: adjust for both inflation and appreciation o Monetary assets and liabilities are fixed o Non-monetary assets and liabilities fluctuate with inflation and deflation Foreign Currency Transactions  Transactions with a foreign entity denominated in a foreign currency Functional Currency  The currency of the primary economic environment in which the entity operates, usually the local currency or the reporting currency Foreign Currency Translation (Functional)  The restatement of financial statements denominated in the functional currency to the reporting currency using appropriate rates of exchange Foreign Currency Remeasurement (Dysfunctional)  The restatement of foreign financial statements from the foreign currency to the entity’s functional currency when: o The reporting currency is the functional currency o The statements must be restated in the entity’s functional currency prior to translating from the functional to the reporting Remeasurement (Temporal) Method  In order: 1) Start with Balance sheet: a. Monetary items – use current rate b. Non-monetary items – historical rate 2) Income statement: a. Non-balance sheet items – weighted average rate b. Balance sheet items – historical rate 3) Remeasurement G/L goes to Income Statement a. Plug a G/L required to for Net Income necessary for RE in Step 1 to balance the balance sheet Translation (Current Rate) Method  In order 1) Start with Income statement: a. Everything at the weighted average rate b. Transfer Net income to retained earnings on balance sheet 2) Balance sheet: a. Assets and liabilities: current rate b. Common stock and APIC: historic rate c. Retained earnings: roll forward i. Retained earnings: beginning translation retained earnings + net income calculated in step 1 – translated dividends 3) Translation G/L in OCI a. Plug a G/L to OCI to get RE to balance General OCBOA Guidelines  Titles should differentiate OCBOA statements from accrual basis statements  Should explain changes in equity accounts  Cash flow statement not required Cash Basis Statements  Cash is the only Asset, no liabilities, and equity = cash Income Tax Basis Statements  Nontaxable revenues and expenses may be reported as: o Separate line items in the statement of revenues and expenses o Additions and deductions to net income o A disclosure Personal Financial Statements  Statement of financial condition => balance sheet  Assets are reported at estimated current fair value  Liabilities are reported at estimated current amount  Assets and liabilities are listed in order of liquidity Trading Securities  Current assets  Debt or equity bought and held for purpose of selling in the near term Available For Sale Securities  GR: Noncurrent assets  Debt or equity not meeting the definitions of the other two classifications  Can be reported as current assets or noncurrent assets depending on the intent of the corporation Held to Maturity Securities  Debt ONLY  GR: Noncurrent assets  Classified as HTM only if the corporation has the intent and the ability to hold these securities to maturity Trading and Available For Sale Securities: Valuation  Fair value (mark to market) o Unrealized gain/loss of trading securities: recognized in Income Statement o Unrealized gain/loss of available for sale securities: recognized in Other Comprehensive Income o All realized gains/losses are recognized on the income statement Reclassifications Between Categories  From Trading to any other category: no adjustment necessary  Any other category to Trading: recognize unrealized G/L in earnings immediately  From HTM to AFS: record unrealized G/L in OCI  AFS to HTM: amortize the unrealized G/L over the remaining life of the security Consolidated Statements  Consolidated financial statements ignore important legal relationships and emphasize substance over form When to Consolidate Statements  Majority-owned subsidiaries have one management and economic entity  If there are different year ends, it is still OK to consolidate  DO NOT CONSOLIDATE: o When control is NOT with the owners Cost Method  There is NO significant influence  Generally between 0-20% ownership  DO NOT consolidate statements Equity Method  There IS significant influence  Generally between 20-50% ownership (presence of significant influence is the still the determining factor!!)  DO NOT consolidate statements Acquisition Method (Consolidation)  When there is CONTROL  Generally 50%+ ownership Cost Method – Balance Sheet Journal Entries  Record initial investment at cost: o Investment in entity  Cash  Unrealized gains/losses recorded in OCI (marketable securities): o Investment in entity  Unrealized gain  Reduce share of entity for dividends received in EXCESS of investor’s share of retained earnings: o Cash  Investment in entity Cost Method – Income Statement Journal Entries  Record income for dividends received that are NOT in excess of investor’s share of earnings: o Cash  Dividend Income  DO NOT RECOGNIZE STOCK DIVIDENDS o Increase number of shares held only! o Memo entry only! Equity Method – Balance Sheet Journal Entries  Record initial investment at cost: o Investment in entity  Cash  Increase investment by investor’s share of entity earnings (income/loss) o Investment in entity  Equity in entity o Note: same entry for the income statement  Decrease investment for share of dividends received: o Cash  Investment in entity o Stock dividends = memo only!! Equity Method – Simple Account Calculation (BASE)  Beginning balance  Add: investor’s share of earnings  Subtract: investor’s share of dividends  Ending balance Equity Method – Income Statement Journal Entries  Record equity for share of entity earnings o Investment in entity  Equity in entity o Note: same entry for balance sheet Equity Method – Recording a Premium Paid and Goodwill  Any premium paid: amortized over the life of the asset (except land) o Journal entry to record amortization:  Equity in entity  Investment in entity  Goodwill: not amortized, not tested for impairment Changing from Cost to Equity Method  Apply the equity method using the prior period’s old percentage o DO NOT apply the new percentage to the prior periods Acquisition Method  When there is control (50%+ ownership, generally)  Consolidate the sub at 100% of its fair value at the acquisition date, even if less than 100% is acquired Acquisition Method – Initial Journal Entry  Acquired for cash: o Investment in entity  Cash  Acquired for stock (measure the value of the stock as of the TRANSACTION date) o Investment in entity  Common stock  APIC Calculating Consolidated Amounts  Always value at 100% Consolidating Workpaper Eliminating Journal Entry (CAR IN BIG)  Common stock – subsidiary  APIC – subsidiary  Retained Earnings – Subsidiary o Investment in subsidiary o Noncontrolling interest (create if not 100% owned)  Balance Sheet adjustments to FV  Identifiable intangible assets to FV  Goodwill Business Combination Costs  EXPENSE: legal costs, finder’s fees, indirect and direct costs  CAPITALIZE AND AMORTIZE: bond issue costs  REDUCE APIC OF PARENT: stock issuance costs, registration costs Subsidiary Acquired • 4 - Goodwill • 3 - Identified Intangible Assets at Fair Value • 2 - Balance Sheet adjustments at Fair value • 1 - Book Value of subsidiary acquired Consolidating Acquirer • 2 - Non-controlling interest if less than 100% is acquired • 1 - Investment in subsidiary (price paid) Acquired R&D  Expense continuing R&D to complete a project o Project success: amortize IP R&D o Project failure: impair/write-off IP R&D Partial Goodwill Method – IFRS ONLY  Goodwill = acquisition cost – FV of sub’s net assets acquired  “Plug” non-controlling interest Intercompany Transactions  Eliminate 100% for external reporting Intercompany Profit on Inventory  Calculate Intercompany Profit on sale  Allocate Intercompany profit between COGS and ending inventory: o Beginning inventory o + Purchases o = Cost of goods available for sale o – Ending Inventory o = Cost of Goods Sold  (COGS / Purchases) * Profit = Correction necessary to COGS  (Ending inventory / Purchases) * Profit = Correction necessary to ending inventory Intercompany Bond Transactions  If one member of the group acquires affiliate’s debt from an outsider, the debt is considered retired and gain/loss recognized on consolidated income statement  Only considered extraordinary if unusual and infrequent Intercompany Sale of Land  Eliminate any G/L and restore land to original carrying amount Intercompany Profit on Fixed Assets  Eliminate gain  Restore asset and accumulated depreciation to correct amounts  Fix depreciation to original amount Combined Financial Statements  A group of related companies, not consolidated because there is no parent o Under common control and management Push Down Accounting  Reports assets and liabilities at fair value in separate financial statements of the subsidiary o In essence, consolidation adjustments are pushed down into the records of each sub Working Capital  The ability to pay debt as due to short-term financial risk  Working capital = Current assets – current liabilities  Current ratio = Current assets / Current liabilities  Quick ratio = (Cash + net receivables + Marketable securities) / Liabilities o (Current Assets – Inventory) / Current Liabilities Current Assets  Resources that are reasonably expected to be realized in cash/sold/consumed during the normal operating cycle or one year, whichever is longer Current Liabilities  Obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities o Includes estimates or accrued amounts that are expected to be required to cover expenditures within the year for know obligations Classification of Short-term Obligations to be refinanced  GAAP: may be excluded from current liabilities and included in noncurrent debt if the company intends to refinance it on a long-term basis and the intent is supported by the ability to do so  IFRS: must wait until actually refinanced to classify as noncurrent Cash Equivalents  Short-term, highly liquid investments that are both readily convertible to cash and so near their maturity when acquired by the entity that they present insignificant risk of changes in value o Original maturity date 90 days or less  Time certificates of deposit (COD’s) are NOT cash equivalents  Legally restricted deposits are NOT cash equivalents Restricted Cash  Cash that has been set aside for a specific use or purpose o If restriction is associated with a current asset or liability, classify it as a current asset but separate from unrestricted cash Simple Reconciliation  Goal – calculate the true balance Simple Reconciliations – Bank Adjustments  Add: deposits in transit  Subtract: outstanding checks Simple Reconciliations – Book Adjustments  Add: bank collections, interest income  Subtract: service charges, nonsufficient funds Net Realizable Value – Accounts Receivable  Accounts receivable balance (gross) is adjusted for o Allowance for uncollectible accounts o Sales discounts o Sales returns and allowances Sales / Cash Discounts  The discount is generally based on a percentage of the sales price o Example: 2/10, n/30 => 2% discount within 10 days, net amount due in 30 days Gross Method – Sales Discounts  Records a sale without regard to the available discount  If payment is received within the discount period, a sales discount account is debited to reflect the sales discount o Record Sale:  Accounts Receivable (gross amount)  Sales (gross amount) o If payment is received within the discount period  Cash  Sales discounts taken  Accounts Receivable o If payment is not received within the discount period  Cash  Accounts Receivable Net Method – Sales Discounts  Records ales and accounts receivable net of the available discount  If payment is received after the discount period, a sales discount not taken account must be credited o Record Sale:  Accounts Receivable (net amount)  Sales (net amount) o If payment is received within the discount period  Cash  Accounts Receivable o If payment is not received within the discount period  Cash  Accounts Receivable  Sales discounts not taken Trade (Quantity) Discounts  Revenue and Accounts Receivable reported net of discounts o Apply sequentially (DO NOT combine) Sales Returns and Allowances  Expected exchanges DO NOT affect sales, inventory, or COGS  Journal entry to record a sales return: o Sales returns and allowances  Accounts receivable Estimating Uncollectible Accounts Receivable  Direct Write-Off Method – the account is written off and the bad debt is recognized when the account becomes uncollectible o NOT GAAP  Allowance Method - estimate and book uncollectible Accounts Receivable now o GAAP – 3 allowable methods:  Percent of sales method  Percent of Accounts Receivable  Aging of Accounts Receivable Percent of Sales Method  Bad Debt Expense = % estimated * credit sales Allowance for Uncollectibles Beginning Balance (Write-Offs) + Bad Debt Expense Directly Calculated Ending Balance Percent of Accounts Receivable Method  Ending Allowance Balance = % estimated * ending Accounts Receivable balance  Bad Debt Expense is a “plug” amount allowing the account to arrive at the correct ending balance Allowance for Uncollectibles Beginning Balance (Write-Offs) + Bad Debt Expense “Plug” amount Ending Balance Aging of Accounts Receivable  Ending Allowance Balance = Sum of the product of each gaining category  Bad Debt Expense is a “plug” amount allowing the account to arrive at the correct ending balance Allowance for Uncollectibles Beginning Balance (Write-Offs) + Bad Debt Expense “Plug” amount Ending Balance Subsequent Collection of Previously Written-Off Receivable  Journal entry to restore the account: o Accounts Receivable  Allowance for Uncollectibles  Journal entry to record cash collection: o Cash  Accounts Receivable Pledging  The company uses existing accounts receivable as collateral for a loan o Requires only note disclosure Factoring Accounts Receivable  The company can convert its receivables into cash by assigning them to a factor either without or with recourse Factoring Without recourse  The sale is final and the factor assumes risk of any losses on collections  Journal entry to factor accounts receivable without recourse o Cash o Due from factor (factors margin) o Loss on sale of receivables  Accounts receivable Factoring With recourse  The factor has an option to re-sell any uncollectible receivables back to the seller  Can be either a sale (same journal entry as without recourse) or loan (footnote) Discounting Notes Receivable  When the holder endorses the note to a third party and receives cash  Without recourse: the holder assumes no further liability; it’s a true sale  With recourse: holder remains liable, remains on Balance Sheet Discounting a Note at a Bank  Compute the Maturity Value of the note by adding the interest to the face amount of the note o Face value of the note + interest on note to maturity = payoff value of note at maturity  Compute bank discount on the payoff value at maturity o Bank discount rate * payoff value at maturity  Determine the amount paid by the bank for the note (Cash Received) o Payoff value at maturity – bank discount = amount paid by bank for the note  Derive the interest income (or expense) by subtracting the face value of the note from the amount paid by the bank for the note o Amount paid by bank for the note – face value of the note = interest income to company FOB Shipping Point  With terms of FOB shipping point the title to the goods usually passes to the buyer at the shipping point. This means that goods in transit should be reported as a purchase and as inventory by the buyer o Buyer’s inventory at shipment o Freight-in added to cost (buyer’s) FOB Destination  With terms of FOB destination the title to the goods usually passes from the seller to the buyer at the destination. This means that goods in transit should be reported as inventory by the seller, since technically the sale does not occur until the goods reach the destination o Seller’s inventory o Freight-out = selling expense o Non-conforming goods = seller’s inventory Consigned Goods  The seller delivers the goods to an agent to hold and sell on the consignor’s behalf  Revenue will be recognized when the goods are sold to a third party o Sales – COGS = Gross Profit o GP – Commission – Advertising = Net Income  Until the sale, the goods remain in the consignor’s inventory Lower of Cost or Market (US GAAP)  Market = Replacement Cost  Cannot be higher than the ceiling: Net Realizable Value o NRV = Selling Price – Costs to complete/dispose  Cannot be lower than the floor: Net Realizable Value less a normal profit margin o Based on selling price  Between all three values (RC, NRV, NRV-PM), pick the one in the middle; that is the market Lower of Cost or Net Realizable Value (IFRS)  Net Realizable Value = Selling Price – Costs to complete/dispose o Same as US GAAP ceiling  The reversal of inventory write-downs for subsequent recoveries is allowed; however, the reversal is limited to the amount of the original write-down and is recorded as a reduction of total inventory costs on the statement (COGS) Periodic Inventory System (Use Purchases)  Quantity determined by physical count o Beginning inventory o + Purchases o = Cost of Goods Available for Sale o – Ending Inventory o = Cost of Goods Sold Perpetual Inventory System (No Purchases)  COGS determined and recorded with each sale (a running total) FIFO  Start with oldest costs – first in, first out  Ending inventory is the same whether a periodic or perpetual system is used  In a period of rising prices, COGS decreases, NI increases and ending inventory increases Weighted Average Method  Calculate weighted-average cost per unit: total units purchased / total cost  Multiply units sold by rate for COGS, units remaining for ending inventory Moving Average Method  Perpetual weighted average method o Average computed after each purchase LIFO (GAAP ONLY)  Use most recent costs – last in, first out  LIFO periodic IS NOT the same as LIFO perpetual  In a period of rising prices, COGS increases, NI decreases, and ending inventory decreases Dollar-Value LIFO  Price Index = Total ending inventory at Current Year cost / Total ending inventory at Base Year cost  LIFO layer in the current year = Current year layer at base year cost * Price Index Valuation of Fixed Assets – US GAPP  Historical Cost Valuation of Fixed Assets – IFRS  Cost Model o Carry value = historical cost – accumulated depreciation – impairment  Revaluation model o Carry value = fair value at revaluation date – subsequent accumulated depreciation – subsequent impairment o Revaluation losses – income statement o Revaluation gains - OCI Cost of Equipment  Invoice price (taking into account any cash discounts)  + Freight-in  + Insurance  + Installation Charges  + Sales and federal tax  + Construction period interest Cost of Equipment – Capitalize  Additions  Improvements  Replacements  Extraordinary repairs that increase the assets life or usefulness Cost of Land  All costs up to excavation LESS proceeds from sale of existing buildings, standing timber  Basket purchase: Allocate the purchase price of land and a building based on the ratio of appraised values of the individual items Investment Property (IFRS ONLY)  Land or buildings held by an entity or by a lessee under a finance lease to earn rental or for capital appreciation are classified and reported as investment property (rental or flip property)  Can be reported under the fair value model or cost model o Fair value model: Reported on balance sheet at fair value and not depreciated o Cost model: Reported on the balance sheet at historical cost less accumulated depreciation Capitalization of Construction Period Interest  Only capitalize interest on money actually spent, NOT total amount borrowed  Amount to capitalize is the lower of: actual interest costs OR computed capitalized interest Computing Capitalized Interest  Weighted average of accumulated expenditures & applicable interest rate = amount to be capitalized o If less than actual interest, capitalize the full amount o Any remaining amount is expensed Sum-of-the-Years Digits Depreciation  SYD = (Cost – salvage value) * (Remaining Life / sum of years digits)  Quick computation of sum of years digits: (N*(N+1)) / 2 Declining Balance Depreciation (Can Be Double Declining (200%) or Less (150%))  1/N * Cost – accumulated depreciation (carrying value) o If 200% or 150%, multiply by 2 or 1.5  DO NOT depreciate below the salvage value Units of Production  Rate = (cost – salvage value) / estimated units or hours  Rate * units or hours = depreciation expense Depletion  Depletion Base = cost of land + development costs + restoration – residual value  Depletion Rate = Depletion Base / Estimated Recoverable Units  Rate * units extracted = depletion, Rate * units sold = COGS Definition of Annuity  A large number of business transaction involve multiple payments or receipts  Bond interest payments and lease rental payments are two examples Types of Annuities  Ordinary annuity (or annuity in arrears): payments start later o Number of payments = number of interest periods  Annuity due: payments start immediately o Number of interest periods is one less than the number of payments  Annuity due – 1 = ordinary annuity Present Value of $1  Amount that must be invested now at a specific interest rate so that $1 can be paid or received in the future  Examples: o Capital lease buyout at the end of the lease o Bond principal payoff at the end of the term o U.S. savings bond Future Value of $1  The amount that would accumulate at a future point in time if $1 were invested now  Example: o Bank savings account Present Value of an Ordinary Annuity  The current worth of a series of identical periodic payments to be made in the future  Examples: o Periodic lease payments o Periodic bond payments o Winning the lottery Future Value of an Ordinary Annuity  The sum to be received at some point in the future of identical periodic investments made from the present until that future point  Example: o Investing in an IRA Present and Future Value of an Annuity Due  The only difference between an ordinary annuity and annuity due is the timing of the payments  By adding 1 to the PV of an ordinary annuity, the PV of an annuity due can be found Operating Lease  There is no transfer of ownership or any risk/benefit of ownership o Lease does not meet the capital lease criteria  A rental agreement Operating Lease Accounting – Lessee (Renter)  Lease rent expense: Rent expense is recorded over the lease term, usually on a straight-line basis unless other methods are warranted o Rent expense  Cash/rent payable  Lease bonus: Any prepayment for future expenses (commission paid to rental agent) should be classified as an asset (deferred charge) and amortized using the straight-line method over the life of the lease  Leasehold improvements: An improvement that is permanently affixed to the property and reverts back to the lessor at the termination of the lease o Capitalize any leasehold improvements AND o Depreciate over the LESSER of the lease life or the asset/improvement life  Rent kicker: Any premium rent payment required for specific events is a period expense  Refundable security deposit: Reported as an asset until refunded by the lessor  Free or reduced rent consideration: Must take the total rent expense to be paid for the entire lease term and divide it evenly over each period Operating Lease Accounting – Lessor (Owner)  Fixed asset: the cost of the property remains on the owner’s books and is depreciated over the asset’s useful life  Rental income: reported using the straight-line method (matches with lessee’s rental expense) o Cash/rent receivable  Rental income  Security deposits: o Nonrefundable: deferred by the lessor (unearned revenue) and capitalized by the lessee (prepaid rent expense) until it is considered earned o Refundable: treat as a receivable by the lessee and a liability by the lessor until the deposit is refunded to the lessee  Cash  Refundable deposit  Lease bonus: deferred and amortized over the life of the lease (into income)  Free or reduced rent: lessor must take the total rental income to be received over the entire lease term and divide it evenly over each period Capital (US GAAP) / Finance (IFRS) Lease  Transfers substantially all of the benefits and risks inherent in ownership of the property of the lease Capital Lease Criteria – Lessee (Buyer) – US GAAP (OWNS)  Must meet just one condition to capitalize: o Ownership transfers at the end of the lease o Written option for bargain purchase o Ninety percent of leased property fair value LESS THAN OR EQUAL TO the present value of the lease payments o Seventy-five percent or more of the assets economic life is being committed in the lease term Finance Lease Criteria – Lessee (Buyer) – IFRS (OWES FACS)  Generally defined as a lease in which substantially all the risks and rewards inherent in ownership are transferred to the lessee  List of non-exhaustive situations that would lead to a lease being classified as a finance lease under IFRS o Ownership is transferred o Written bargain purchase option contained o Economic life for a major part of the asset is covered by the lease term o Fluctuation gains/losses due to changes in the fair value of the asset accrue to the lessee o Ability to continue the lease for a secondary period at a rent substantially below market rent o Cancelation of lease losses are borne by the lessee o Specialized nature of the leased asset such that only the lessee can use it without modification Sales-Type / Direct Financing Lease Criteria – Lessor (Seller) – US GAPP (LUC)  If the lease meets ALL 3 of the following conditions, it should be classified as a sales-type lease or direct financing lease, whichever is appropriate: o Lessee “OWNS” the leased property (meets any of the 4 criteria) o Uncertainties do not exist regarding any unreimbursable costs o Collectability of the lease payments is reasonably predictable  Note: under GAAP, it is possible for the lessee to classify a lease as capital and a lessor to classify it as operating Sales-type Lease – 2 Profits  The fair value of the leased property at the inception of the lease differs from the cost/carrying amount to the lessor o Gives rise to a manufacturer’s profit/loss  The 2 profits on the lease: o Gain on the sale o Interest income Direct Financing Lease – 1 Profit  The fair value of the leased property at the inception of the lease is the same as the cost/carrying amount  1 profit on the lease o Interest income Capital Lease (Finance Lease) Accounting – Lessee (Buyer)  Recording the lease: the lessee records as an asset and liability the LESSER of: o Fair value of the asset at the inception of the lease o Cost => Present value of the minimum lease payments  End of period – PV of an ordinary annuity (annuity in arrears)  Beginning of period – PV of an annuity due o Include in this amount:  Required Payments  Bargain purchase option (PV of $1)  Guaranteed Residual value (PV of $1) o EXCLUDE from this amount:  Executory costs – insurance, maintenance and taxes paid by the lessee  Optional buyout o Interest rate: when calculating the present value of the minimum lease payments, the lessee uses the LOWER of:  Rate implicit in the lease  Lessee’s incremental borrowing rate o Under IFRS, the cost of any initial indirect costs are added to the asset, but NOT the obligation:  Leased equipment  Obligations under lease  Cash (amount of initial indirect costs paid)  Depreciation – period of benefit (US GAAP) o If the lease qualifies as a capital lease using Ownership transfer or Written Bargain:  Depreciate over the estimated economic life of the asset o If the lease qualifies as a capital lease using Ninety % of fair value or Seventy-five percent of economic life:  Depreciate over the lease term o Summary: OW = economic life, NS = lease term o If the lease meets more than one criteria, the order of priority is: O-W-N-S  Depreciate – period of benefit (IFRS) o Depreciate over the LESSER of: lease term and the useful life of the asset Lease Liability and Asset Amortization – Lessee 1 2 3 4 Annual Lease Payments Interest on Unpaid Obligation (Interest rate * 4) Reduction of Lease Liability (1 – 2) Carrying Amount of Lease Obligation (Prior period 4 – 3) **Note: 1 st payment of an annuity due is ALL PRINCIPAL** Sales-Type Lease Accounting – Lessor  Gross Investment (lease receivable): the minimum lease payments plus any unguaranteed residual value o Lease Payments o + Unguaranteed residual value o = Gross Investment  Net investment: Gross investment * present value  Unearned Interest Revenue (contra-lease receivable): gross investment – net investment  Cost of Goods Sold: o Cost of asset o – PV of unguaranteed residual value  Sales Revenue: present value of the minimum lease payments Direct Financing Lease Accounting – Lessor  Gross Investment (lease receivable): the minimum lease payments plus any unguaranteed residual value o Lease Payments o + Unguaranteed residual value o = Gross Investment  Net investment: Gross investment * present value  Unearned Interest Revenue (contra-lease receivable): gross investment – net investment  NO COGS OR SALES REVENUE Sale-Leaseback  The owner of the property sells the property and simultaneously leases it back from the purchaser-lessor  Selling Price: the negotiated price in the agreement  Profit or Loss: the amount that would have been recognized by the seller assuming there’s no leaseback  Excess Profit: o Operating lease: the amount of profit that exceeds the minimum lease payments: Sales price – net book value = tentative gain – PV of minimum lease payments o Capital lease: the amount of profit that exceeds the recorded amount of the asset: Sales price – net book value = tentative gain – leaseback asset Sales-Type Lease Accounting – Seller/Lessee  Amount of deferred gain is determine by the retained rights to remaining use of the leaseback property o Substantially all rights retained (+90% of the sales price): the present value of the rent payments is greater than or equal to 90% of the fair value of the property  Defer all gain and amortize with leased asset o Rights retained are less than substantially but greater than minor (between 90% and 10%): the present value of the rent payments are less than 90% but greater than 10% of the fair value of the property  Defer gain up to the present value of the minimum payments. Anything in excess is recognized immediately o Minor portion of rights retained (less than 10%): the present value of the rent payments is 10% or less of the fair value of the property  Recognize gain or loss at the time of the sale-leaseback – gains are NOT deferred  ANY REAL ECONOMIC LOSS MUST BE RECOGNIZED IMMEDIATELY (when FV < BV)  Amortization of deferred gain: o Capital leaseback: amortized in proportion to the amortization of the leased asset o Operating leaseback: any deferred gain or loss is amortized in proportion to the gross rental expense of the leased asset Convertible Bonds  Convertible into common stock generally at the option of the bondholder o Non-detachable warrants: convertible bond itself is converted into common stock o Detachable warrants: the bond is not surrendered upon conversion, only the warrants plus cash representing the exercise of the warrants Term Bonds  Bonds that have a single fixed maturity date – the entire principal is paid at the end of the term Serial Bonds  Pre-numbered bonds that the issuer may call and redeem a portion by serial number Overview of Bond Terms  Usually denominated in $1000  Price is always quoted in 100’s (i.e. 106 = 1060)  Indenture: contract for purchase of a bond  Coupon rate: stated interest rate on the bond o Used to calculate the face coupon  Bond interest (check amount): coupon * face  Effective interest rate: market rate  Principal payoff is always full face value  Premium / discount adjusts coupon to market rate Bond Valuation  PV of principal (PV of $1)  + PV of interest (PV of an ordinary annuity)  = Fair Value of bond (cash received) o Can be either a premium or a discount Bonds Issued at Par value  When the market rate = coupon rate Bond Issued at a Discount  When the stated rate (coupon) on the bonds is less than the market rate  The unamortized discount is a contra-account to bonds payable (a direct reduction)  Amortization of the discount INCREASES interest expense each period Bond Issued at a Premium  When the stated rate (coupon) on the bonds is greater than the market value  The unamortized premium is a direct addition to bonds payable  Amortization of the premium DECREAES interest expense each period Bond Issue Costs  Examples: legal fees, accounting fees, underwriting, and commissions  Deferred charges (an asset) and amortized using the straight line method into expense  Under IFRS, bond issue costs are deducted from the carrying value and amortized using the effective interest method Bond Amortization – Straight Line Method (NOT GAAP BUT ALLOWED)  Yields a constant dollar amount of interest each period  Periodic amortization = premium or discount / number of periods bond is outstanding Effective Interest Method  Required by both GAAP and IFRS  Interest expense = carrying value at the beginning of the period * effective interest rate (market rate)  Amortization of the discount = interest expense – cash paid at the coupon rate  Amortization of the premium = cash paid at the coupon rate – interest expense 1 2 3 4 5 6 Beginning Period Carrying Value Semi-Annual Amortization Interest (using MARKET rate) Effective Carrying Value (1*2) Face Coupon (using COUPON rate) Amortization - (3-4) = positive, discount and add - (3-4)= negative, premium and subtract Ending Period Carrying Value (1 – 5) Bond Sinking Fund  Used to avoid a cash shortage at the time of debt repayment  The sinking fund is generally a non-current (restricted) asset Determination of Sinking Fund Payments  Use the future value of an ordinary annuity Serial Bonds  Principal matures in installments Non-detachable Warrants  Convertible bonds are often issued at more than face value because of the value of the conversion feature. Under GAAP, the issuance price is allocated to the bonds with NO RECGONITION of the conversion feature because it is difficult to assign a specific value to the conversion feature  EVERYTHING GOES TO THE BOND AT ISSUANCE Conversion of the Bonds to Stock  Can be done using either the book value method (GAAP) or market value method (NOT GAAP)  Book value method: No gain or loss is recognized, bond payable and any premium/discount are written off and common stock/APIC are credited for the value of the stock o Bond payable o Premium on bond payable  Common stock  APIC  Market value method: gain or loss is recognized as the difference between the market value of the stock and the book value of the bonds o Bond payable o Premium on bond payable o Loss  Common stock  APIC Detachable Warrants  A conversion feature that is separate from a security should be accounted for separately at its relative fair value at the time of issue  This amount is credited to APIC – warrants o Cash  Bonds Payable  APIC – warrants  Can be recorded at issuance using either the warrants only method or the market value method o Warrants only method: use if the fair value of the warrants is known  Issuance:  Cash  Discount (plug) o Bond payable o APIC – warrants (FV)  Warrants exercised:  Cash  APIC – warrants (removed) o Common stock o APIC  Warrants expire:  APIC – warrants o APIC o Market value method: use if the fair value of the warrants AND the bonds is known  Issuance: allocate the sales price to the bonds and warrants based on relative market value  Cash  Discount (plug) o Bond payable (FV) o APIC – warrants (FV)  Warrants exercised:  Cash  APIC – warrants (removed) o Common stock o APIC  Warrants expire:  APIC – warrants o APIC Defined Contribution Plan  This type of plan specifies the periodic amount of contributions to the plan  Like a 401(k) Defined Benefit Plan  This type of plan defines the benefits to be paid to employees at retirement. Contributions are computed using actuarial assumptions of future benefit payments Accumulated Benefit Obligation (ABO)  The actuarial present value of benefits attributed by a formula based on CURRENT and past compensation levels.  Differs from PBO only in that it includes no assumption about future compensation levels Projected Benefit Obligation  The actuarial present value of all benefits attributed by the plan’s benefit formula to employee service rendered prior to that date  Only uses an assumption as to FUTURE compensation levels  Under IFRS, DBO (defined benefit obligation) and PBO are calculated in a similar manner Prior Service Cost  The cost of benefits based on past service granted for: o Service prior to the initiation of a pension plan that employees receive retroactive credit for o Subsequent plan amendment, reflecting new or increased benefits that is also applied to service already provided  Increases the PBO in the period of plan initiation or amendment and should be amortized to pension expense over the future service periods of the affected employees Calculating the PBO  Beginning PBO  + Service cost  + Interest Cost  + Prior service cost from current period plan amendments  + Actuarial losses incurred in the period  - Actuarial gains incurred in the period  - Benefits paid to retirees  = Ending PBO Calculating Plan Assets or Actual Return on Plan Assets  Beginning fair value of Plan Assets  + Contributions  + Actual return on plan assets  - Benefits paid to retirees  = Ending fair value of plan assets Income Statement Expense Formula (SIR AGE)  Service cost (current period)  + Interest cost  - Return on plan assets  + Amortization of Prior Service Cost  - Gains (+Losses)  + Amortization of Existing net obligation or net asset  = Net Periodic Pension Cost o Under GAAP, must be aggregated and presented as one number; no such requirement under IFRS o A-G-E: anything unamortized is in OCI  Net Periodic Pension Cost o Pension Benefit Liability o OCI Current Service Cost (S)  This cost is provided by the actuary Interest Cost (I)  Beginning of period PBO * Discount rate Return on Plan Assets (R)  GAAP allows the use of either actual return or expected return on plan assets o Actual return: can be calculated by looking at the plan assets account for the period o Expected return: Beginning FV of plan assets * expected rate of return  When companies use expected return, the difference between the actual and expected return must be recognized in OCI each period and amortized to pension expense over time with any actuarial gains or losses Amortization of Unrecognized Prior Service Cost (A)  The unrecognized prior service cost in Accumulated OCI is amortized to pension expense over the plan participant’s remaining years of service  Beginning unrecognized prior service cost / average remaining service life Gains and Losses (G)  Gains and losses arise from two sources: o The difference between the expected and actual return on plan assets when the expected return on plan assets is used to calculate pension expense o Changes in actuarial assumptions (actuarial gains and losses)  Under GAAP, there are two choices for when to account for gains and losses: o Recognize on the income statement in the period incurred OR o In OCI in the period incurred and amortize unrecognized gains and losses over time using the corridor approach  Corridor approach: the unrecognized gain/loss is amortized over the employee’s remaining service period ONLY IF it exceeds 10% of the greater of: o Beginning balance in plan assets OR o PBO o Unamortized belongs in AOCI Amortization of Existing Net Obligation or Net Asset at Implementation (E)  PBO – FV of plan assets  = Initial Unfunded obligation  / 15 years OR average employee job life (greater of)  = Minimum amortization Pension Plan Contributions  Pension benefit asset/liability o Cash  Funded status = FV of plan assets – PBO o Pension plan asset: overfunded, always a noncurrent asset o Pension plan liability: underfunded, current to the extent that the benefit obligation payable in the next 12 months exceeds the FV of plan assets Postretirement Benefits Other than Pensions / Other Deferred Compensation  Must be accrued if: o Attributable service is already rendered o Obligation relates to rights that vest or accumulate o Payment of the compensation is probable o The amount can be reasonably estimated Permanent Differences  DO NOT affect the deferred tax computation o Affect current, not deferred, taxes  Examples of permanent differences: o Tax-exempt interest (muni, state) o Life insurance proceeds on an officer’s policy o Life insurance premiums when the corporation is the beneficiary o Certain penalties, fines, kickbacks o Nondeductible portion of meals and entertainment expense (50%) o Dividends received deduction for corporations o Excess percentage depletion over cost depletion Temporary Differences  Affect current and deferred taxes Accounting for Interperiod Tax Allocation  Total income tax expense = Current income tax expense/benefit + Deferred income tax expense/benefit o Current income tax expense/benefit is equal to the income taxes payable or refundable for the current year as determined on the corporate tax return o Deferred income tax expense/benefit is equal to the change in deferred tax liability or asset account from the beginning to the end of the year Deferred Tax Liabilities  Created when temporary difference results in future tax income being GREATER than future accounting income (tax deductible first or tax income later)  Examples of deferred tax liabilities o Installment sales (tax income later) o Contractors accounting (tax income later) o Equity method (undistributed dividends – tax income later) o Depreciation expense (tax deductible first) o Amortization of franchise (tax deductible first) o Prepaid expenses (tax deductible first)  When the difference between taxable income and financial statement income is negative, a deferred tax liability is created Deferred Tax Assets  Created when temporary difference results in future tax income being LOWER than future accounting income (tax income first or tax deductible later)  Example of deferred tax assets o Bad debt expense (tax deduct later) o Estimated liability/warranty expense (tax deduct later) o Start-up expenses (tax deduct later) o Prepaid rent, royalties, interest (tax income first)  Valuation allowance: if it is more than likely that part of a DTA will not be realized, a valuation allowance is recognized so that the net DTA equals the portion that will likely be realized (for amount expected not to be used) o Not permitted under IFRS  When the difference between current taxable income and financial statement income is positive, a deferred tax asset is created Tax Rate  Use the tax rate IN EFFECT when the temporary difference reverses itself to calculate the DTA or DTL  IFRS permits the use of enacted or substantially enacted Net Temporary Adjustment  The deferred income tax expense/benefit is the difference between the beginning balance in the deferred tax account and the computed ending balance o Beginning temporary differences o + Current period temporary difference o Total temporary differences o * Enacted tax rate o = Required Ending Balance o – Beginning balance o = Required adjustment (deferred income tax expense) Balance Sheet Presentation  All deferred tax assets and liabilities classified as current must be netted and presented as one amount (net current deferred tax asset/liability)  All deferred tax assets and liabilities classified as noncurrent must be netted and presented as one amount (net noncurrent deferred tax asset/liability)  Under IFRS, all DTA and DTL are noncurrent Operating Loss Carrybacks  100% collectible – no valuation allowance necessary  Can be carried back 2 years Operating Loss Carryforwards  If an operating loss is carried forward, the tax effects are recognized to the extent that the tax benefit is likely to be realized o Valuation allowance may be necessary Calculating the Carryback and Carryforward  Net Operating Loss o - Carryback: Income from prior 2 years o = Net Carryforward  Calculate income tax refund receivable from prior years (100% of income tax paid)  Net Carryforward * Enacted rate = Deferred Tax Asset  Valuation allowance (if necessary): o Net Carryforward – any future income = What Will Not Be Used o Net Carryforward not used * enacted rate = Valuation Allowance Book Value Per Common Share  Book value per common share = common shareholders’ equity / common shares outstanding  Common shareholders’ equity = Total shareholders’ equity – preferred stock outstanding (at greater of call or par value) – cumulative preferred dividends in arrears Cumulative Preferred Stock  All or part of the preferred dividend not paid in any year accumulates and must be paid in the future before dividends can be paid to common shareholders Participating Preferred Stock  Preferred shareholders share with common shareholders in dividends in excess of a specific amount o Fully participating – preferred shareholders participate in excess dividends without limit o Partially participating – there is a percentage limit in the excess Convertible Preferred Stock  May be exchanged for common stock at a specified conversion rate Callable Preferred Stock  May be called at a specific price Mandatorily Redeemable Preferred Stock (Liability)  Must be bought back by the company on the maturity date  Classified as a liability Calculation of Retained Earnings  Net Income/Loss  - Dividends declared  +/- Prior period adjustments (i.e. correction of error), net of tax  +/- Accounting changes reported retrospectively, net of tax  + Adjustment from quasi-reorganization  = Change in retained earnings Quasi-Reorganization  An accounting adjustment that revises the capital structure of a corporation as though it had been legally reorganized  Allows a corporation with a significant deficit in retained earnings to eliminate that deficit  Purpose: restate overvalued assets to their lower fair values o NO CHANGE in total equity Treasury Stock  Reduces stockholders’ equity (normal debit balance)  Methods of accounting: cost or par Treasury Stock – Cost Method  The treasury shares are recorded and carried at their reacquisition cost  Gain/loss is recognized at REISSUE  Journal Entries: o Buyback:  Treasury stock (at COST)  Cash o Reissue above cost:  Cash  Treasury stock  APIC – T/S o Reissue below cost:  Cash  APIC – T/S  Retained Earnings  Treasury Stock Treasury Stock – Par Method  The treasury shares are recorded and carried at par value  Gain/loss is recognized at BUYBACK  Journal Entries: o Buyback above issue price:  Treasury stock (at PAR)  APIC – C/S (note – must be at original APIC amount)  Retained earnings  Cash o Buyback below issue price:  Treasury stock (at PAR)  APIC – C/S (note – must be at original APIC amount)  Cash  APIC – T/S (Plug) o Reissue:  Cash (amount received)  Treasury Stock  APIC – C/S Dividends  A distribution to shareholders based on earnings  Date of declaration: Create a liability and reduce retained earnings  Date of record: NO JOURNAL ENTRY Cash Dividend  Dividends are only paid on authorized, issued and outstanding shares Property (In-Kind) Dividend  On the date of declaration, the property should be restated to fair value and any gain or loss should be recognized in income Scrip Dividends  A form of notes payable whereby a corporation commits to paying a dividend at a later date o Typically when there is a cash shortage Liquidating Dividends  When dividends to shareholders exceed retained earnings Stock Dividends  Distribute additional shares of stock to shareholders  Not dividend income to the shareholder o Small stock dividend (less than 20% of previously outstanding shares issued): reduce retained earnings by the FMV of the stock  Retained earnings (FMV)  Common Stock  PIC o Large stock dividend (greater than 25% of previously outstanding shares issued): reduce retained earnings by PAR value of the stock  Retained Earnings (at par)  Common stock distributable  Note: there is no change to total shareholders’ equity Stock Splits  No journal entry  Increase the number of share outstanding and reduce the par value o I.E. 2-for-1 stock split: double number of shares, cut par value in half Noncompensatory Stock Option/Purchase Plan  No journal entry until the stock is purchased; then, regular stock issuance entry Compensatory Stock Option/Purchase Plan  Valued at the fair value of the options issued Option Price  The price at which the underlying stock can be purchased pursuant to the option contract Exercise Date  The date by which the option holder must use the option to purchase the underlying Fair Value of an Option  Typically determined by an option pricing model Grant Date  The date the option is issued Vesting Period  Compensation expense is recognized over the service period, which typically is the vesting period Compensation Cost  Determined by the fair value of the options and recognized over the service period o Compensation expense  APIC – stock options  On exercise date: o APIC – stock options  Common stock  APIC  Expiration: o APIC – stock options  APIC – expired stock options Earnings Per Share  Under GAAP and IFRS, all public entities are required to present earnings per share on the face of the income statement Simple Capital Structure – Report BASIC EPS ONLY  A company that only has common stock outstanding has a simple capital structure  Basic EPS is calculated as follows: o (Net Income – Preferred Dividends) / Weighted-Average Number of Shares Outstanding (WACSO) o Preferred dividends includes:  Dividends declared in the period on non-cumulative preferred stock AND  Dividends accumulated in the period on cumulative preferred stock WACSO  Treat stock dividends and stock splits as though they occurred at the beginning of the period  Time weight all other securities Complex Capital Structure – Report BASIC AND DILUTED EPS  An entity has a complex capital structure when it has securities that can potentially be converted to common stock and would therefore reduce (dilute) EPS  Both basic and diluted EPS must be presented  Diluted EPS is calculated as follows: o (Net Income – Preferred Dividends) + interest on dilutive securities / WACSO assuming all dilutive securities are converted to common stock Dilution from Options, Warrants, and their equivalents  NO CHANGE IN THE NUMERATOR  Apply the treasury stock method: o Formula to compute additional shares: Number of shares issued – ((# of shares * exercise price)/average market price) = additional shares outstanding Dilutive vs. Anti-dilutive  Options are only dilutive when the average market price is GREATER than the strike price Dilution from Convertible Bonds  Add to the numerator the interest expense, net of tax, due to assumed conversion of the bonds to common stock o Interest expense * (1 – tax rate) => add to numerator  Add to the denominator the number of common shares associated with the assumed conversion Anti-dilutive  Use the results of each assumed conversion only if it results in dilution  Each issue should be considered separately from most to least dilutive Dilution from Convertible Preferred Stock  Adjust the numerator – preferred stock dividends removed as if they no longer existed  Add to the denominator the number of shares associated with the conversion  Anti-dilution rules apply Statement of Cash Flows  A required part of a full set of financial statements for all business enterprises Operating Cash Flows  Cash receipts and disbursements from: o Transactions reported on the income statement o Current assets and liabilities (excluding current notes payable and current portion of long-term debt – financing activities) Investing Cash Flows  Cash receipts and disbursements from: o Noncurrent Assets Financing Cash Flows  Cash receipts and disbursements from: o Debt o Equity Operating Activities – Direct Method  Cash received from customers (+) o Revenues o – Increase in receivables o + Decrease in receivables o + Increase in unearned revenue o – Decrease in unearned revenue o = Cash received from customers  Interest received (US GAAP) (+)  Dividends received (US GAAP) (+)  Other operating cash receipts such as the receipt of insurance proceeds and lawsuit settlements (+)  Cash received from the sales of securities classified as trading securities, if classified as current assets (+)  - Cash paid to suppliers o COGS o + Increase in inventory o – Decrease in inventory o – Increase in accounts payable o + Decrease in accounts payable o = Cash paid to suppliers  - Cash paid to employees o Salaries and wages expense o – Increase in wages payable o + Decrease in wages payable o = Cash paid to employees  - Interest paid (US GAAP)  - Income taxes paid (US GAAP)  - Cash paid to acquire securities classified as trading securities, if classified as current assets  - Other operating cash payments o Other operating expenses o – Decrease in prepaid expenses o + Increase in prepaid expenses o + Decrease in accrued liabilities o – Increase in accrued liabilities o = Cash paid for other expenses Operating Activities – Indirect Method  Net Income per income statement  + Depreciation / amortization expense  + Losses  - Gains / amortization of premium  - Earnings of equity affiliate  - Increase in operating assets  + Decrease in operating assets  + Increase in operating liabilities  - Decrease in operating liabilities Investing Activities  The change in non-current assets such as: o Making loans to other entities o Purchasing / disposing of trading (noncurrent), AFS, and HTM securities o Acquiring / disposing of PP&E o Acquiring another entity under the acquisition method using cash Financing Activities  The change in interest-bearing debt and equity  Equity activities: o Issuing stock o Paying dividends or repurchasing stock  Non-current liability activities: o Issuing bonds, notes, and other borrowings o Payment of principal (note: INTEREST IS IN OPERATING ACTIVITIES) IFRS Differences in Reporting Cash Flow  Interest received – operating or investing  Interest paid – operating or financing  Dividends received – operating or financing  Dividends paid – operating or financing  Taxes paid – operating, investing, or financing Dual Objective of Governmental Accounting  Demonstrate operational accountability for the entity as a whole  Demonstrate fiscal accountability for specific funding Purpose of Fund Accounting  Enables service and mission-driven organizations to easily monitor and report compliance with spending purposes, spending limits, and other fiscal accountability objectives  Funds = legal restrictions Governmental Accounting Principals and Standards  GASB establishes accounting and reporting standards for governments o Note: FASB establishes accounting and reporting standards for Not-For- Profit organizations  GAO prescribes government audit standards Definition of a Fund  A fund is a sum of money or other resource segregated for the purpose of carrying on a specific activity or attaining certain objectives in accordance with specific regulations, restrictions, or limitations, constituting an independent fiscal and accounting entity. Each fund is a self-balancing set of accounts Fund Structure – Government  Governmental funds  Proprietary funds  Fiduciary funds Government-Wide Presentations (Consolidated Financial Statements)  Full accrual basis of accounting  Economic resources measurement focus  Classified in two categories: o Government activities (GRaSPP + S) o Business-type activities (E) Major Fund Statements (like segment reporting)  Major funds are presented using the basis of accounting and measurement focus unique to each category of fund. Only major funds are presented Governmental Funds (no profit motive)  Modified accrual basis of accounting  Current financial resources measurement focus (no fixed assets or long-term debt)  Governmental fund types (GRaSPP): o General Fund o Special Revenue Fund o Debt Service Fund o Capital Projects Fund o Permanent Fund  Balance Sheet: o Current assets and deferred outflows = o Current liabilities and deferred inflows of resources o + Fund balance  Statement of Revenues, Expenditures, and Changes in Fund Balance o Revenues o – Expenditures o + Other financing sources (uses) o = Net change in fund assets Proprietary Funds (treat like customer / not citizen)  Full accrual accounting  Economic resources measurement focus (carry everything – fixed assets and long term debt)  Proprietary fund types (SE): o Internal Service Fund o Enterprise Fund  Statement of Net Position: o All assets and deferred outflows of resources o – All liabilities and deferred inflows of resources o = Net Position  Statement of Revenues, Expenses, and Changes in Net Fund Position o Operating revenue o – Operating expenses o + Non-operating revenues (expenses) o = Change in net position Fiduciary Funds (trust accounts)  Full accrual accounting  Economic resources measurement focus (carry everything – fixed assets and long term debt)  Fiduciary fund types (PAPI): o Pension Trust Fund o Agency Trust Fund o Private Purpose Trust Fund o Investment Trust Fund  Statement of Fiduciary Net Position: o All assets and deferred outflows of resources o – All liabilities and deferred inflows of resources o = Net position  Statement of Changes in Fiduciary Net Position o Additions o – Deductions o = Changes in net position Balance Sheet – Measurement Focus  Current Financial Resources (GRaSPP Funds) o Modified accrual accounting o No fixed assets are reported o No no-current liabilities are reported  Economic Resources (SE-PAPI Funds) o Full accrual accounting o Fixed assets are reported o Non-current liabilities are reported Income Statement – Basis of Accounting  Modified accrual (GRaSPP Funds) o Revenue is recognized when measurable and available  Available = collectible within the current period or soon enough thereafter to be used to pay liabilities in the current period (60 days) o Expenditures are generally recorded when the related fund liability is incurred  Full accrual (SE-PAPI Funds) o Revenue is recognized when earned o Expenses are recognized when incurred Classification of Governmental Fund Balances (NU CAR) – ON BALANCE SHEET  There are five degrees of constraint associated with the current equity of the fund o Non-Spendable Fund balance: current assets that cannot be spent o Restricted Fund balance: assets restricted by external authorities o Committed Fund balance: assets obligated by a formal action of the government’s highest decision making authority o Assigned Fund balance: assets the government intends to obligate but has not formally committed o Unassigned fund balance: spendable assets neither restricted, committed, nor assigned  Only the general fund should have a positive unassigned balance Modified Accrual Accounting (GRaSPP Funds)  Budgetary accounting is emphasized in order to control spending  Activity emphasizes flow of current financial resources  Encumbrance accounting is used to record purchase orders o Book and Close the Budget-Activity-Encumbrance for the same amount o BAE-BAE Budgetary Accounting  Budgetary accounting is used by the GRaSPP funds  It is used to control expenditures and to account for the levy of taxes sufficient to cover estimated expenditures Budgetary Accounting – Journal Entries  Budgetary accounts are posted only twice during the year – beginning and end  Beginning – budgetary control entry: o Estimated revenue control o Estimated other financing sources o Budgetary control (negative / deficit)  Appropriations control (approved spending)  Estimated other financing uses  Budgetary control (positive / surplus)  Ending – the budget is reversed and closed for the SAME AMOUNTS as those recorded in the beginning of the period: o Appropriations o Estimated other financing uses o Budgetary control (positive / surplus)  Estimated revenue control  Estimated other financing sources  Budgetary control (negative) Activity Accounting  Emphasis is on the flow of current financial resources, not profit and loss  There is no application of the matching principle Activity – Revenue  Government fund revenues are recorded when measurable and available – this usually means the collection period does not exceed 60 days after fiscal year end o Derived Tax revenues – taxes imposed on or derived from exchange transactions (sales tax and income tax)  Revenue when measurable and available o Imposed non-exchange revenues – taxes imposed on non-exchange transactions (fines or property taxes)  Revenue when billed o Government mandated non-exchange transactions – instances in which a higher level of government provides funds and mandates certain activities by another level of government  Revenue when earned o Voluntary Non-exchange transactions – instances in which the government receives resources and does not provide equal value (grant agreements)  Revenue when earned Activity – Expenditures  Options for expenditure recognition: o Purchase method: expenditure current assets when purchased and reverse (set up current asset) for items not used during the period  Buying: Expenditures  Vouchers payable  Year end: Supplies inventory  Non-spendable fund balance – inventory o Consumption method: set up as a current asset when purchased and expenditure as consumed  Buying: Supplies inventory  Voucher payable  Use of item: Expenditure  Supplies inventory  Transfers between funds: although not an expenditure, transfers out represent the use of financial resources o Other financing uses – transfers out  Cash  Classification of governmental expenditures: o Functional or program o Organizational unit o Activity o Character o Object classes  Fixed Assets: the acquiring of a fixed asset is not capitalized on the funds books. Instead, it is considered an expenditure of the funds o Fixed assets are reported on the government-wide statements  Long term debts: proceeds from long-term debts are recorded in the governmental funds as “other financing sources”. The governmental funds do not record or carry long-term debt o Repayments of long-term debt are recorded as expenditures of both principal and interest o Long-term debt is carried on the government-wide financial statements Encumbrances  Not a GAAP expenditure  Open purchase order represent an encumbrance or commitment of the available appropriations of a government o Set up the budgetary control:  Encumbrances  Budgetary control o Reverse estimated encumbrances (SAME AMOUNT):  Budgetary control  Encumbrances o Record actual expenditures:  Expenditures  Vouchers payable  Outstanding encumbrances at year-end will be carried forward within the appropriate fund balance classification with a corresponding reduction of unassigned fund balance, if the appropriations do not lapse Deferred Outflows and Deferred Inflows of Resources  Service concession arrangements  Derivative instruments and hedge accounting General Fund  Accounts for the general activities of a government that are not accounted for by any other fund Special Revenue Fund  Accounts for revenue and expenditures that are legally restricted or committed for specific purposes other than debt service or capital projects  Expendable trust activities should be reported in the special revenue fund (scholarship and endowment funds)  Grants that are monitored belong in the special revenue fund Debt Service Fund  Accounts for the accumulation of resources and the payment of currently due interest and principal on long-term general obligation debt by setting aside cash and cash equivalents o Only pays off the debt of the GRaSPP funds o Encumbrances are not used – interest payments are considered expenditures Capital Projects Fund (Purchasing department)  Established for the construction, purchase, or leasing of significant fixed assets used by GOVERNMENTAL FUNDS ONLY  The life of the capital projects is short and limited to a construction period of 1-3 years  Special assessments: when the government is primarily or potentially liable, report in the capital project fund o If NOT liable, report in the agency fund  Bond Issue proceeds: other financing sources on the income statement Permanent Funds  Used to report resources that are legally restricted to the extent that only earnings (and not principal) may be used for the purposes that support the reporting government’s programs  Does NOT record encumbrances Internal Service Fund (customer / not citizen)  Established to finance and account for services and supplies provided exclusively to other departments within a government unit or to other governmental units, typically on a cost-reimburse basis  Use accrual accounting o Record long-term liabilities and fixed assets o Fixed assets are depreciated  Net Position (RUN) o Restricted o Unrestricted o Net Investment in capital assets Enterprise Fund (customer / not citizen)  Used to account for operations that are financed and operated in a manner similar to private business enterprise  Use accrual accounting o Record long-term liabilities and fixed assets o Fixed assets are depreciated  Net Position (RUN) o Restricted o Unrestricted o Net Investment in capital assets  Municipal Landfills – Cost components o Cost of equipment expected to be installed and facilities expected to be constructed near or after the date the landfills stops accepting waste o Cost of gas monitoring and collection system o Cost of final cover (capping) o A portion is recognized as an expense and a liability each period according to use Pension Trust Funds  Account for government sponsored defined benefit and defined contribution plans and other employee benefits such as post retirement healthcare benefits  Use accrual accounting  Changes in net pension liability are typically included in the pension expense o Certain changes in the liability that are not included in pension expense are required to be reported as deferred outflows or deferred inflows of resources  Statement of cash flows NOT required (true for all Fiduciary – PAPI – funds) Agency Trust Fund (mailman)  An agency fund collects cash to be held temporarily for an authorized recipient to whom it will later be disbursed – may be another fund / individual / firm / government  No liability or monitoring of funds – report in the agency fund  Current assets = current liabilities  Statement of cash flows NOT required Private Purpose Trust (NOT general public use)  The designated fund for reporting all other trust arrangements under which principal and income are for the benefit of one of the following: o Specific individuals o Private organizations o Other governments  Use accrual accounting Investment Trust Funds  Reports any external investment pool that is sponsored by the government Government-wide Financial Statements (Operational Accountability)  The focus of the government-wide financial statements is to report the extent to which the government has met its operating objectives efficiently and effectively Fund Financial Statements (Fiscal Accountability)  The focus of the fund financial statements is to demonstrate that the government entity’s actions in the current period have complied with public decisions concerning the raising and spending of the public funds in the short term Reporting For General Purpose Governmental Units  Required reports: o Management’s Discussion and Analysis (MD&A) – Before Financial Statements o Government-wide Financial Statements  Statement of Net Position  Statement of Activities o Fund Financial Statements – major funds shown individually; nonmajor in total  Governmental Funds  Balance Sheet  Statement of Revenues, Expenditures, and Changes in Fund Balance  Proprietary Funds  Statement of Net Position  Statement of Revenues, Expenses, and Changes in Fund Net Position  Statement of Cash Flows  Fiduciary Funds  Statement of Fiduciary Net Position  Statement of Changes in Fiduciary Net Position o Notes to Financial Statements o Required Supplementary Information (RSI) other than MD&A – After the Financial statements  Pension  Budget – comparison schedules  Infrastructure  Optional Reporting: o Comprehensive Annual Financial Report (CAFR)  Intro Section  Basic Financial Statements and RSI (Includes all required reports)  Statistical Section Primary Government  The primary government consists of all organizations that make up the legal government entity Primary Government Entities (SELF)  State governments  Local governments  Special purpose local governments that meet ALL of the following criteria: o Separately-Elected governing body o Legally separate o Fiscally independent of other state and local governments  Primary government reports by it-SELF Component Unit  A component unit of the primary government is usually an organization for which the elected officials of the primary government are financially accountable  By its nature, it cannot be excluded from the primary government’s financial statements without making the primary government’s financial statements misleading or incomplete Blended Presentation  The blended method is used when: o A board of the component unit is substantively the same as that of the primary government OR o The component unit serves the primary government exclusively or almost exclusively OR o The component unit is not a separate legal entity  The blended presentation combines financial information with the primary government Discrete Presentation (Separate Presentation)  Discrete presentation is used when the criteria for blended presentation are not met  Displays component units in separate columns Management’s Discussion and Analysis (MD&A)  Does NOT contain variance analysis or reconciliation of fund financials to government-wide financials Government-Wide Financial Statements  Use full accrual accounting  Economic resources measurement focus o Report all assets and liabilities Statement of Net Position  Assets – Liabilities = Net Position (RUN) o Not necessary to capitalize construction period interest  Required and Modified approach o Required: all assets meeting capitalization requirements should be recorded and depreciated o Modified: eligible infrastructure assets are not required to be depreciated if it meets two requirements:  The government’s asset management system meets certain conditions  Government documentation should include data on asset preservation  Artwork and Historical Treasures (SAME RULES AS NOT FOR PROFITS) o Governments may elect not to capitalize works of art when the collection meets the following conditions  Collection is held for public exhibition  Collection is protected  Collection is subject to an organizational policy that requires the proceeds from sales of collection items to be used to acquire other items for collections Statement of Activities  The net expense or revenue for each function or program is classified into one of these categories: o Governmental activities (GRaSPP + S) o Business-type activities (E) o Component units (rescue squad or board of education)  Expenses are reported by function on the full accrual basis  Program revenues are directly associated with the function or program on the full accrual basis Program Revenue Categories (SOC)  Service charges – revenues based on exchange-like transactions  Operating grants and contributions – mandatory and voluntary non-exchange transactions with other governments, organizations, or individuals restricted for use in a particular program  Capital grants and contributions Fund Financial Statements  Financial statements are required for the governmental, proprietary, and fiduciary funds Major Fund Reporting Criteria  The GRaSPP funds and enterprise funds are individually compare to the total governmental and enterprise funds (respectively) and must meet two criteria: o 10% or more of the revenues/expenditures, assets/liabilities of all governmental funds OR all enterprise funds AND o 5% or more of the revenues/expenditures, assets/liabilities of all governmental funds AND all enterprise funds Reconciliation of Fund Financials to Government-Wide Statements (GRaSPP + S)  Balance Sheet (GALS BARE) o GRaSPP Fund Balance o + Assets (non-current) o – Liabilities (non-current) o + Service (internal) fund net position o Basis of accounting (adjustments) o Accrued o Revenues and o Expenses  Statement of Revenues, Expenditures, and Changes in Fund Balance (GOES BARE) o GRaSPP net change in fund balance o – Other financing sources o + Expenditure – capital outlay (net of depreciation) o +Service (internal) fund net income o Basis of accounting (adjustments) o Accrued o Revenues and o Expenses Proprietary Funds – Statement of Cash Flows  Direct method is required  Reconciliation of operating income to net cash provided by operations required  Four categories: o Operating activities o Capital and related financing activities o Non-capital financial activities o Investing activities  Capital assets are financing activities  Interest expense/payments are financing activities Fiduciary Funds (PAPI)  NOT INCLUDED IN GOVERNMENT-WIDE STATEMENTS Industries that Frequently Use Not-For-Profit Accounting  Health care organizations  Educational institutions  Voluntary health and welfare organizations  Other private, non-governmental not for profits NFP – Required Financial Statements  Statement of Financial Position (balance sheet)  Statement of Activities (income statement)  Statement of Cash flows  Statement of functions expenses o Required for voluntary health and welfare organizations o Optional for the rest NFP – Statement of Financial Position  Assets, Liabilities, and Net Assets (equity) o Net Assets (PUT)  Unrestricted net assets – not permanently or temporarily restricted, internal-board designated funds  Temporarily restricted net assets – donor-imposed stipulations either expire by passage of time or can be fulfilled and removed by actions of the organization  Permanently restricted net assets – limited by donor-imposed stipulations that neither expire by passage of time NOR can be fulfilled or otherwise removed by actions of the organization NFP – Statement of Activities  Classification of Revenue, Gains, and Other Support (PUT) o Unrestricted net assets – not permanently or temporarily restricted, internal-board designated funds o Temporarily restricted net assets – donor-imposed stipulations either expire by passage of time or can be fulfilled and removed by actions of the organization o Permanently restricted net assets – limited by donor-imposed stipulations that neither expire by passage of time NOR can be fulfilled or otherwise removed by actions of the organization  Timing of Reclassification of Restrictions o Donor-imposed restrictions are recorded as restricted revenue in the period received o When satisfied, a reclassification is reported o If met in the same period received, may be recorded as unrestricted support if the policy is applied consistently and disclosed  Classification of Expenses o Expenses are reported as decreases in unrestricted net assets ONLY  Program services – activities for which the organization is chartered  Support services – include everything not classified as a program service  Combined costs – if fundraising costs are combined with educational services, should be allocated NFP – Statement of Cash Flows  Either the direct or the indirect method may be used  Operating activities o Include applicable agency transactions o Under the direct method, should be reported by major class of cash receipts  Financing activities – include the cash transactions related to borrowing and cash transactions related to certain restricted contributions o Increases to an endowment, purchases of assets, annuity agreements  Investing activities o Include proceeds from the sale/purchase of works of art o Include investment in equipment o Proceeds from the sale of assets that were received in prior periods and whose sale proceeds were restricted to investment in equipment  Cash and cash equivalents o Exclude donor-restricted securities NFP – Statement of Functional Expenses  Required for voluntary health and welfare organizations  Classification of expenses: o Program support expenses o Fund-raising expenses o Management and general costs o Multiple cost items Contributions and Recognition  Cash contributions – should be recognized as revenue when received o Asset at FV  Contribution support revenue  Pledge – should be recognized as revenue when the promise is made  Conditional pledge – should be recognized when the conditions are substantially met  Multi-year pledge – recorded at the Net Present Value when the pledge is made o Future collections are considered temporarily restricted  Allowance for uncollectible pledges – allowance should be setup for the pledges net realizable value Donated Services (SOME)  Should be recorded as contribution revenue AND expense at FV if it meets the following criteria: o Specialized skills are required and possessed by the donor o Otherwise needed by the organization o Measureable o Easily (fair value)  Volunteer assistance – a fundraising expense Donated Collection Items (SAME AS GOVERNMENT)  Do not need to be recorded at all when the collection meets the following conditions o Collection is held for public exhibition o Collection is protected o Collection is subject to an organizational policy that requires the proceeds from sales of collection items to be used to acquire other items for collections Donated Materials  Record at fair value Promises to Contribute  Unconditional promises to contribute in the future are reported as temporarily restricted support  Donor-imposed restrictions are recognized as revenue/gain in the period received and classified as temporarily or permanently restricted Exchange Transactions (Buyer and Seller)  Reciprocal transfers in which each party receives and sacrifices something of approximately equal value are termed exchange transactions o Amount transferred – FV Dues/Purchase = contribution revenue Recipient Accounting  WITHOUT VARIANCE POWER (NFP acts as agent/no benefit or power) o Assets are recognized at fair value o Assets are recognized as a liability to the beneficiary  Asset  Refundable advance  GRANTED VARANCE POWER (NFP acts as agent/has power) o Assets are recognized at fair value o Assets are recognized as contribution revenue when received  Asset  Contribution revenue  FINANCIALLY INTERRELATED o Assets are recognized at fair value o Assets are recognized as contribution revenue when received  Asset  Contribution revenue Beneficiary Accounting  Specified beneficiaries recognize their rights to assets held by others unless the recipient is explicitly granted variance power Investments in Securities  Measured at fair value  Gains and losses are reported as increases/decreases in unrestricted net assets unless their use is restricted by donor stipulations or law NFP – Fund Accounting  Only appropriate for internal reporting purposes!!  Types of funds used by non-profits: o Unrestricted current funds o Restricted current funds o Plant funds o Loan funds o Endowment funds o Annuity and life income funds o Agency funds Colleges and Universities  Revenues o Student tuition and fees (reported at gross) o Government aid, grants, contracts o Gifts and private grants  Gross revenue from tuition and fees = assessed student tuition and fees – cancelled classes  Expenses o Scholarship and fellowship Health Care Organization  Revenues o Patient service revenue (reported at gross)  Charity care is not reported as revenue  Gross patient service revenue – charitable services = patient service revenue  Net patient service revenue = patient service revenue – contractual adjustments – policy discounts – administrative adjustments o Other operating revenue – can include tuition from schools, revenues from educational programs, donated supplies and equipment, cafeteria and gift shop revenue o Non-operating revenue – any unrestricted income and donated services Voluntary Health and Welfare Organizations  Income - largely contributions and pledges from the general public Fair Value (exit price)  The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants  DOES NOT INCLUDE TRANSACTION COSTS o Used to calculate most advantageous market  FV of non-financial assets assumes highest and best use Principal Market  The market with the greatest volume or level of activity Most Advantageous Market  The market with the best price for the asset or liability after considering transaction costs Valuation Techniques  Market approach – used for prices and other relevant information from market transactions involving identical or comparable assets or liabilities  Income approach (PV of discounted cash flows) – converts future amounts to a single amount to measure fair value  Cost approach – uses current replacement cost to measure fair value Hierarchy of Inputs  Level 1 – quoted prices in active markets for identical assets or liabilities on the measurement date  Level 2 – inputs other than quoted market prices that are directly or indirectly observable for the asset or liability  Level 3 – unobservable inputs for the asset or liability (discounted cash flows) o Only used when there are no Level 1 or Level 2 inputs or when undue cost/effort is required to obtain observable inputs  If multiple levels are used, the fair value is classified as the lowest level used (the weakest link) Admission of a Partner By Sale of Existing Partnership Interest  Outside partnership transaction, no journal entry needed Formation of a Partnership  Assets are valued at fair value  Liabilities assumed are recorded at their present value Creation of a New Partnership Interest with Additional Investment of Capital  Exact method (equal to book value) – when the purchase price is equal to the book value of the capital account purchased, no goodwill or bonuses are recorded o Use “finger math” – get ¼ share, divide by 3  Bonus Method – 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 partners’ capital accounts and do not affect partnership assets o BALANCE in total capital accounts controls the allocation:  Total existing capital  + New partner contribution  BALANCE in total capital accounts  / new partner’s share %  = Amount of Capital attributed to new partner  - New partner contribution (Step 2 above)  = Bonus o Bonus attributed to existing partners when new partner contributes MORE than their capital share  Split based on partnership agreement o Bonus attributed to existing partners when new partner contributes LESS than their capital share  Goodwill method – goodwill is recognized based upon the total value of the partnership implied by the new partner’s contribution o GOING IN INVESTMENT controls the allocation”  Implied value going in (new partner contribution * share denominator)  - Book value of partnership (total partners capital accounts, including new partner)  = Goodwill o Always allocated to old partners:  Cash  Goodwill  A  B  C Profit and Loss Distribution  Start with total profit (or loss), then: o Subtract any bonus, interest, or salary FIRST  Remaining balance after bonus, interest, and salary is distributed based on the partnership agreement Withdrawal of a Partner  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 o Bonus is allocated to the remaining partners based on the partnership agreement o Goodwill IS NOT recognized o Step 1: Revalue assets to fair value  Asset adjustment  A  B  C o Step 2: pay off withdrawing partner  A  B  C  Cash  Goodwill Method – the amount of the implied goodwill is allocated to ALL of the partners based on the profit and loss ratios o Step 1: Revalue assets to fair value o Step 2: Record goodwill so that the withdrawing partners capital account equals the amount of their payoff  Goodwill  A  B  C o Step 3: Pay off withdrawing partner  C  Cash Liquidation of a Partnership  Creditors must be paid before the noncreditor partners receive any payments  All possible losses must be provided for in a liquidation before any distribution is made  Steps: 1. Convert non-cash asset to cash 2. Gain or loss on realization (of conversion) 3. If there is a capital deficiency in a partners account, the other partners must cover (offset) based on their profit/loss ratios 4. Distribute any remaining cash based on profit/loss ratios Variable Interest Entities (VIEs)  Consolidation required – even if the company owns no stock – if 3 conditions are met: o Variable interest – there is a financial stake in the company o Variable interest entity – that company’s equity is “strange” o Primary beneficiary – we have the power over the company and get P/L  Variable interest entity (strange equity) – company either does not have equity investors with voting rights or lacks sufficient financial resources to support its activities  Primary beneficiary – the entity that is required to consolidate the VIE o Power to direct VIE activities o Absorbs expected VIE losses o Receives expected VIE profits  Under IFRS = Special Purpose Entity (SPE), similar determination process Asset Retirement Obligations (AROs)  A legal obligation associated with the retirement of a tangible long-term assets  Measured at present value Asset Retirement Cost (ARC)  The ARC is the amount capitalized that increases the carrying amount of the long- lived asset when a liability for a ARO is recognized: o ARC (asset at present value)  ARO (liability at present value) ARO – Subsequent Measurement  Accretion expense (interest expense) – the increase in the ARO due to the passage of time calculated using the accretion rate o Accretion expense  ARO  Depreciation expense (every year on the ARC) – decreases the ARC asset on the balance sheet o Depreciation expense  Accumulated depreciation (ARC) Troubled Debt Restructurings  The creditor allows the debtor certain concessions to improve the likelihood of collection that would not be considered under normal circumstances Accounting by Debtors  Transfer of assets – recognize a gain in the amount of the excess of the carrying amount of the payable over the fair value of the assets given up o FV assets transferred o – NBV asset transferred  Transfer of assets – recognize a rain on the amount of debt discharge (could be considered extraordinary if it meets requirements) o Carrying amount of the payable o – FV of assets transferred  Transfer of equity interest – recognize a gain on the difference between the carrying amount of the payable and the fair value of the equity interest o Carrying amount of the payable o – FV of equity transferred  Modification of terms – handled PROSPECTIVELY o If future cash payments are less than current book value, debtor should recognize a gain Accounting by Creditors  Receipt of assets or equity – account for at fair value on date received o The excess of debt forgiven over the fair value is a loss  Modification of terms – impairment is recorded by creating a valuation allowance with a corresponding charge to bad debt expense Trade Accounts Payable  Cash discounts on accounts payable can be recorded gross or net: o Gross method – record the purchase without regard to the discount; if discount is taken, credit purchase discounts take o Net method – record purchases and accounts payable net of the discount; if payment is made after the discount period, purchase account lost is debited Sales Taxes Payable  Should be credited to a payable account after collection and until remitted  NOT an expense of the company collecting sales taxes from customers Payroll Deductions  Deductions for social security, Medicare, and income taxes are withheld from employees out of the gross pay on their paychecks  NOT an expense to the employer Unemployment Taxes and Employer’s Share of Payroll Taxes  Unemployment taxes and the EMPLOYER’s share of payroll taxes should be accrued by the employer as an expense Low or Absent Interest Rate – Notes Payable and Receivable  Record the receivable/payable at its face amount  Record the sale of the asset at the present value of the obligation  Difference between the face amount and present value is a discount/premium that is amortized over the life of the note  Use the effective interest method to calculate interest and note carrying value Payment Interest Principal Balance Coupon Balance * Eff. Rate Difference between Payment and Interest Prior balance - principal Estimated Liabilities (Guessing – looking forward)  An estimated liability represents recognition of a probable future charge that results from a prior act, such as estimated liability for warrants, trading stamps, or coupons  Premiums: offers to customers for stimulating sales (box tops, for instance) o Total number of coupons issued * Estimated redemption rate = Total estimated coupon redemptions o Must accurately reflect the current liability at the end of each period  Warranties: must create a liability account if the cost of the warranty can be reasonably estimated  Service contracts: treated as unearned revenue and estimated and accrued in the financial statements Accrued Liabilities (Looking back)  An accrued liability represents an expense recognized or incurred but not yet paid  Bonus: easiest method of solving – select the middle answer and work backwards Contingencies (GAAP)  Probable – likely to occur  Reasonably possible – more than remote but less than likely  Remote – slight chance of occurring Loss is Probably and Can Be Reasonably Estimated  Record Journal Entry o Expense  Liability  Provision for a loss contingency should be accrued by a charge to income, providing that both of the following conditions exist: o It is probable o The amount of the loss can be reasonably estimated  GAAP – use minimum amount in range  IFRS – midpoint in the range Loss is Reasonably Probable  Disclose (DO NOT record journal entry or accrue) Loss is Remote  Ignore and disclose o Debts of others guaranteed o Obligations of commercial banks o Guarantees to repurchase receivables Subsequent Events  An event or transaction that occurs after the balance sheet date but before the financial statements are issued  Recognizable / Type 1: relate to pre-existing item (journal entry and disclose) o Provide additional information about conditions that existed at the balance sheet date  Non-recognizable / Type 2: important new event (disclose) o Provide information about conditions after the balance sheet date and did not exist at the balance sheet date Gain Contingencies  DO NOT record journal entry  Not reflected on the financial statements  Disclose nature and amount Reissuance of Financial Statements  The entity should NOT recognize events that occurred between the date of the original financial statements and the reissue date unless the adjustment is required by GAAP or other regulatory requirements Types of Financial Instruments  Cash, foreign currency, and demand deposits  Evidence of an ownership interest in an entity (stock certificate, partnership interests)  Contracts (bonds) which result in an exchange of cash or ownership interest in an entity  Derivatives – financial instruments whose value or settlement amount is derived from the value of another unity of measurement (OFFS) o Options o Futures o Forwards o Swaps Fair Value Option  On specified election dates, entities may choose to measure eligible financial instruments at fair value. Under the fair value option, unrealized gains and losses are reported in EARNINGS.  The fair value option is irrevocable and is applied to individual financial instruments  Disclosures required: o Fair value for all financial instruments together with related carrying amounts showing clearly weather the amount represents an asset or liability Concentration of Credit Risk – Disclosures  Credit risk is the possibility of loss or default from the failure of the other party  Concentration of credit risk occurs when an entity has contracts of material value with one or more parties in the same industry/region/similar economic characteristics  Entities must disclose all significant concentrations of credit risk Market Risk (Beta) – Disclosures  GAAP – entities are encouraged but not required to disclose quantitative information  IFRS – entities are required to disclose information about market risk, credit risk, and liquidity risk Derivative Instrument  A financial instrument that derives its value from the value of some other instrument and has all three of the following characteristics: o One or more underlyings and one or more notional amounts/payment provisions o Requires no initial net investment o Terms require or permit net settlement  Underlying – a specified rate, price or other variable (what we are gambling on)  Notional amount – specified unit of measure (used to calculate gain/loss)  Value/Settlement amount – Notional amount * Underlying  Payment provision – a specified settlement that is to be made if the underlying behaves in a specified way  Hedging – the use of a derivative to offset anticipated losses or to reduce earnings volatility o When effective, the change in the value offset the change in value of the hedged item or cash flows of the hedged item Common Derivatives (OFFS)  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 (strike/exercise price) during a specified period of time o Call option – the right to buy (hope price goes up) o Put option – the right to sell (hope price goes down) o Gain/Loss = (Underlying – FV) * number of shares – cost (initial net investment)  Futures Contract – an agreement between two parties to exchange a commodity or currency at a specified price on a specified future date o Long position (buy – profit when price goes up) o Short position (sell – profit when price goes down) o Profit/loss = (FV – underlying) * notional amount  No cost to enter futures contract  Forward Contract – similar to futures contracts except that they are privately negotiated between two parties rather than on a clearing house  Swap Contract – a private agreement between two parties to exchange future cash payments o Hope that what you get is greater than what you receive Accounting for Derivative Instruments  All derivative instruments are recognized in the balance sheet as either assets or liabilities (depending on the rights/obligations of the contract) and measure at fair value  Gains and losses: o No hedging destination – recognized in earnings o Fair value hedge – designed as a hedge to changes in fair value of an asset/liability  Recognized in earnings o Cash flow hedge – hedges the exposure to variability in expected future cash flows  Ineffective (within 1/5) recognized in earnings  Effective recognized in OCI until the transaction impacts earnings o Foreign currency hedge – designated as hedging the exposure to variability in foreign currency  FC fair value hedge – income statement  FC cash flow hedge – ineffective in IS, effective in OCI  FC net investment hedge – OCI Liquidation Basis of Accounting  When liquidation is imminent, the liquidation basis is applied prospectively Criteria for Imminent Liquidation  The likelihood of the entity returning from liquidation is remote AND  A liquidation plan is approved by the individuals who have authority OR  A liquidation plan is imposed by other forces Liquidation – Measuring Assets, Liabilities, and Accruals  Assets – the amount of cash proceeds expected from liquidation  Liabilities – according to the GAAP that otherwise applies to them  Accruals – must be presented separately and at non-discounted values