Upload
others
View
5
Download
0
Embed Size (px)
Citation preview
FAR_Participant_Part1 1 23 December 2017 4:01 AM
1
FASB andStandard Setting
Lesson OverviewIn this lesson we will cover the primary purpose of financial accounting.
The professional organizations that are an integral part of the financial accounting environment
Primary PurposeFinancial accounting and reporting provides information to aid the decision making of the users of the financial statements—primarily the external users need this information to:
Make investment and credit decisions.Assess amount and timing of cash flows.Assess economic resources and obligations.
Conceptual Framework and Financial ReportingFinancial Accounting Standards Board (FASB)Overview of US GAAPFASB and Standard Setting
COPYRIG
HTED M
ATERIAL
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 2 23 December 2017 4:01 AM
2
Generally Accepted Accounting Principles (GAAP)
GAAP addresses three aspects of financial reporting:
1. Recognition—when recorded on financial statements
2. Measurement—how recorded on financial statements
3. Disclosure—anything that is not on the financial statements
Organizations The Financial Accounting Standards Board (FASB)
The Securities and Exchange Commission (SEC)
The American Institute of Certified Public Accountants (AICPA)
The Private Company Council (PCC)
FASBThe private sector body that establishes GAAP
Seven full time members—Effective
Mission to improve the usefulness of financial reporting
Address deficienciesPromote international convergence
FASB and Standard Setting
FAR_Participant_Part1 3 23 December 2017 4:01 AM
3
FASBFinancial Accounting Foundation (FAF) appoints Board members and advisory councils, ensures funding, and exercises oversight
Financial Accounting Standards Advisory Council (FASAC) advises the FASB on current and possible new agenda items, policy issues, or formation of task forces
Emerging Issues Task Force (EITF) provides implementation guidance within GAAP
FASB Structure
FASBFASB
FASACProvides guidance on policy, priorities, etc
FASACProvides guidance on policy, priorities, etc
FAFProvides funding
FAFProvides funding
Standard-Setting Process
Adds Project to
Agenda
Adds Project to
Agenda
Conducts Research and
IssuesDM
Conducts Research and
IssuesDM
Public HearingPublic
Hearing
Issues EDIssues EDModifies EDModifies EDFinalizes
and Issues ASU
Finalizes and Issues
ASU
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 4 23 December 2017 4:01 AM
4
SEC Formed by Congress in the 1933 Act
Authority to establish GAAP—but SEC relinquished that task to the private sector (FASB)
Enforcement authority
AICPA
Professional Organization for practicing CPAs
Substantial input into the standard-setting process
All past standard-setting bodies were created by the AICPA
GAAPAuthoritative GAAP
FASB Accounting Standards Codification (ASC)ASC is a compilation of pronouncements issued by FASB, APB, and CAP
Non-authoritative
FASB Concepts, AICPA Issues Papers, IFRS
SEC Guidance—considered part of authoritative GAAP for public companies
FASB and Standard Setting
FAR_Participant_Part1 5 23 December 2017 4:01 AM
5
SummaryMake sure you are comfortable with the main organizations that make up the financial accounting environment.
FAR_Participant_Part1 6 23 December 2017 4:01 AM
6
Accrual Accounting
Accrual Accounting
MUST know for the CPA exam!
Tested frequently andconsistently!
Types of Exam QuestionsConvert cash basis income to accrual basis income.
Convert accrual basis income to cash basis.
Given accrued expense or revenue and solve for cash paid or received (and vice versa).
Given deferred expense or revenue and solve for cash paid or received (and vice versa).
Accrual Accounting
FAR_Participant_Part1 7 23 December 2017 4:01 AM
7
Accrual Basis AccountingAccrual basis accounting recognizes and reports the economic activities of an entity in the period the economic activity was incurred, regardless of when the cash activity takes place.
The Heart of Financial
Accounting and Reporting
Accrual Accounts
• Good or service received from vendor
Event
• Good or service provided to a customer
Event
• Accounts Payable(liability)
Accrual Account
• Cash ReceivedCash
• Accounts Receivable
(asset)
Accrual Account
• Cash PaidCash
Deferral Accounts
• Cash ReceivedCash
• Unearned Revenue (liability)
Deferral Account
• Good or service used
Event• Cash PaidCash• Prepaid
Expense (asset)
Deferral Account
• Good or service delivered
Event
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 8 23 December 2017 4:01 AM
8
Theme of Accruals and DeferralsThe common theme for accruals and deferrals:
When the economic event occurs first you create an accrual account (you are accruing the cash to be received or to be paid as an asset or liability).
When the cash activity occurs first you create a deferral account (you are deferring the recognition of an expense or revenue as an asset or liability).
Tools The Accounting Equation: A = L + E
Use to reconcile accrual basis net income to cash basis net incomeUse to reconcile cash basis net income to accrual basis net income
T-accountsUse to solve for accrual basis revenue or
expense Use to solve for cash received or paid
Use accounting equation to determine change in working capital accounts
1) A = L + E
2) ∆A = ∆L + ∆E
3) ∆Cash + ∆OA = ∆L + ∆E
4) ∆Cash = ∆L + ∆E – ∆OA
Accrual Net Income to Cash Net Income
Accrual Accounting
FAR_Participant_Part1 9 23 December 2017 4:01 AM
9
Accrual to CashJ&L Pecans maintain accounting records on an accrual basis. J&L decided to convert to cash basis accounting. During the year J&L reported $95,178 of net income. On January 1, 20X5 and December 31, 20X5 J&L had the following amounts:
January DecemberAccounts receivable 9,250 15,927Unearned revenue 2,840 4,111Accrued expenses 3,435 2,108Prepaid expenses 1,917 3,232
Conversion of Accrual Basis to Cash Basis∆Cash = ∆L + ∆E – ∆OA
Net Income on accrual basis $95,178
increase in accounts receivable ($9,250 – $15, 927) (6,677)
increase in unearned service revenue ($2,840 – $4,111) 1,271
decrease in accrued expense ($3,435 – $2,108) (1,327)
increase in prepaid expenses ($1,917 – $3,232) (1,315)
Net income on a cash basis 87,130
Use accounting equation to determine change in working capital accounts (signs are opposite!)
1) A = L + E
2) ∆A = ∆L + ∆E
3) ∆A – ∆L = ∆E
4) ∆E = ∆A – ∆L
Accrual basis net income is essentially the change in equity (retained earnings)
Cash Net Income to Accrual Net Income
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 10 23 December 2017 4:01 AM
10
Cash to AccrualJ&L Pecans maintain accounting records on a cash basis. Assume J&L decided to convert to accrual basis accounting. During the year J&L reported $87,130 of cash basis income. On January 1 and December 31 J&L determined they had the following amounts:
January DecemberAccounts receivable 9,250 15,927
Unearned revenue 2,840 4,111Accrued expenses 3,435 2,108
Prepaid expenses 1,917 3,232
Conversion of Cash Basis to Accrual Basis∆E = ∆A – ∆L
Net income on a cash basis $87,130
increase in accounts receivable ($9,250 – $15, 927) 6,677
increase in unearned service revenue ($2,840 – $4,111) (1,271)
decrease in accrued expense ($3,435 – $2,108) 1,327
increase in prepaid expenses ($1,917 – $3,232) 1,315
Net income on an accrual basis 95,178
Cash Received or Revenue RecognizedUse T-accounts
Accounts receivableBeginning balanceRevenue (sales) Cash collectionsEnding balance
Unearned RevenueBeginning balance
Revenue (sales) Cash collectionsEnding balance
Accrual Accounting
FAR_Participant_Part1 11 23 December 2017 4:01 AM
11
Solving for Cash CollectedA company has the following activity with respect to unearned consulting fees during the year.
Unearned consulting fees, Dec 31 2,000
Unearned consulting fees, Jan 1 3,500
Consulting fee revenue 25,000
How much cash was collected for consulting fees?
Solving for Cash CollectedInformation given on unearned revenue:
Unearned Revenue
Beginning balance 3,500
Revenue 25,000 Cash collections 23,500
Ending balance 2,000
Solving for Cash CollectedWhat if the information was accounts receivable?
Accounts Receivable
Beginning balance 3,500
Revenue 25,000 Cash collections 26,500
Ending balance 2,000
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 12 23 December 2017 4:01 AM
12
Cash Paid or Expense RecognizedUse T-accounts
Prepaid ExpenseBeginning balanceCash paid ExpensesEnding balance
Accounts PayableBeginning balance
Cash paid Expenses Ending balance
Solving for Cash PaidA company has the following activity with respect to prepaid insurance expense during the year.
Prepaid expense, Dec 31 2,000
Prepaid expense, Jan 1 3,500
Insurance expense 25,000
How much cash was paid during the year?
Solving for Cash Paid Information given on prepaid expense:
Prepaid Expense
Beginning balance 3,500
Cash paid 23,500 Expense 25,000
Ending balance 2,000
Accrual Accounting
FAR_Participant_Part1 13 23 December 2017 4:01 AM
13
Solving for Cash Paid What if the information was on accounts payable?
Accounts Payable
Beginning balance 3,500
Cash paid 26,500 Expense 25,000
Ending balance 2,000
SummaryConvert cash basis income to accrual basis income or accrual basis income to cash basis.
Given accrued expense or revenue and solve for cash paid or received (vice versa).
Tools:
The Accounting Equation: A = L + E
T-accounts
FAR_Participant_Part1 14 23 December 2017 4:01 AM
14
Financial Statements
Financial Statements
Income Statement Reports accrual-based performance over a
period of time. It is dated as fiscal year ended (FYE). For example, December 31
Captures all revenues, expenses, gains and losses that were incurred during the period
Certain items are excluded from the income statement but included in comprehensive income.
Statement of Comprehensive IncomeReports non-owner changes to equity over a period of time. It is dated as FYE. For example, December 31 includes:
Unrealized gains/losses on investments in AFS securitiesCertain pension adjustmentsForeign currency translation adjustmentsCertain hedge accounting adjustments
Financial Statements
FAR_Participant_Part1 15 23 December 2017 4:01 AM
15
Balance SheetReports economic resources and obligations as of a specific date. It is dated as of December 31:
Assets presented in order of liquidity
Liabilities presented in order of maturity
Current/long-term designation
Various measurement attributes
Exam Question HintThe CPA exam tends to emphasize sections of the balance sheet, such as PPE or Equity.
As we cover the balance sheet items, make sure to understand not only the accounting, but also the reporting of these items.
Statement of Stockholders’ EquityReports the changes related to owners’ equity over a period of time. It is dated as FYE, for example, December 31.Owners’ Equity is presented in order of permanence:
1. Contributed capital is shown first, because it will not be returned to shareholders.
2. RE is shown last because it is less permanent because dividends are paid from RE.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 16 23 December 2017 4:01 AM
16
Statement of Cash FlowsReports changes in cash over a period of time. It is dated as FYE, for example, December 31.
Operating—cash flows related to income statement transactions
Investing—cash flows related to long-term assets and investments
Financing—cash flows related to liabilities and owners’ equity
Footnotes and OpinionFootnote disclosures and supplementary schedules:
Footnotes are an integral part of the financial statements.Footnotes present information not captured on the statements.
Auditor’s opinion:Opinion on the statements in conformance with GAAP
FAR_Participant_Part1 17 23 December 2017 4:01 AM
17
Financial Accounting Standards Codification
Financial AccountingStandards Codification
What is the Codification?
The Codification is a compilation and organization of all GAAP sources.
Accounting Standards Codification (ASC) is the official name of the Codification.
Accounting Standards Updates (ASU) are how updates to GAAP are communicated. ASUs are not GAAP.
Example: Accounting Standard Update
Source: FASB .org
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 18 23 December 2017 4:01 AM
18
Goals of CodificationThe FASB Codification Research System is a online, real-time, searchable data base in order to:
Simplify structure and accessibility of GAAP.
Place all authoritative literature in one place.
Reduce time and effort to research an issue.
Facilitate updating GAAP.
Assist with IFRS convergence.
Codification Structure
AreasAreas
TopicsTopics
SubtopicsSubtopics
SectionsSections
Paragraphs
Subsections
Areas and Topics
Area 100: General Topic 105: GAAPGeneral
Area 200: Presentation Topic 210: Balance SheetPresentation
Area 300: Assets Topic 305: CashArea 400: Liabilities Topic 405: LiabilitiesArea 500: Equity Topic 505: Equity
Balance Sheet
Financial Accounting Standards Codification
FAR_Participant_Part1 19 23 December 2017 4:01 AM
19
Areas and Topics
Area 800: Broad Transactions Topic 805: Business CombBroad Transactions
Area 900: Industry Topic 905: AgricultureIndustry
Area 600: Revenue Topic 605: Recognition Area 700: Expenses Topic 705: Cost of SalesIncome Statement
Illustration of the Hierarchy
Topic Accounts Receivable
Subtopic Overall Nonrefundable Fees and Other Costs
Securities with Deteriorated Credit
Quality
Section Recognition Initial Measurement Recognition Initial
Measurement Recognition Initial Measurement
Subsection General: Factoring
General: Notes for Cash
General: Origination
Fees
General: Origination
Fees
General: Collateral
Ownership
General: Valuation
Allowances
Structure of the Classification SystemXXX = Topic, YY = Subtopic, ZZ = Section, PP = Paragraph (XXX-YY-ZZ-PP) For example, the classification codes for Receivable are as follows (Assets are 300):310 = Receivables (Topic)310-10 = Overall (Subtopic)
310-10-25 = Recognition (Section)310-10-30 = Initial Measurement (Section)
310-20 = Nonrefundable Fees and Other Costs (Subtopic)310-20-25 = Recognition (Section)310-20-30 = Initial Measurement (Section)
310-30 = Loans and Debt Securities Acquired with Deteriorated Credit Quality (Subtopic)310-30-25 = Recognition (Section)310-30-30 = Initial Measurement (Section) Source: FASB Accounting Standards Codification
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 20 23 December 2017 4:01 AM
20
Assets: Accounts Receivable
Source: FASB Codification
Accounts Receivable: 310-10
Topic
Source: FASB Codification
Subtopic
Section
Source: FASB Codification
References that begin with an “S” are SEC requirements
Accounts Receivable: 310-10-30
Financial Accounting Standards Codification
FAR_Participant_Part1 21 23 December 2017 4:01 AM
21
Subsection
Source: FASB Codification
Accounts Receivable: 310-10-30
Accounts Receivable: 310-10-30-2
Paragraph
Source: FASB Codification
Sections Are Uniform
Source: FASB Codification
Sections are organized the same
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 22 23 December 2017 4:01 AM
22
Practice!
Practice using the software provided by NASBA.
You get a free six-month access when you have “Notice to Schedule” (NTS) from NASBA.
Practice using the research questions in the AICPA practice test.
Practice using the software in Wiley CPAexcel.
Access to Professional Literature
Source: NASBA .org/proflit
FAR_Participant_Part1 23 23 December 2017 4:01 AM
23
Conceptual Framework of Financial Reporting by Business EnterprisesObjectives and Qualitative Characteristics
Objectives, Qualitative Characteristics
OverviewThe Conceptual Framework guides the standard-setting process so that the resulting GAAP is cohesive and internally consistent.
Purpose of ConceptsThe Conceptual Framework is based on the overriding objective of financial reporting—decision usefulness.
The Conceptual Framework describes two primary qualitative characteristics of the information that will be decision useful.
There are four enhancing qualitative characteristics.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 24 23 December 2017 4:01 AM
24
Decision Usefulness
Primary Characteristics
Faithful Representation
Completeness Neutrality Free from error
Relevance
Predictive Value
Confirmatory Value Materiality
Primary Characteristics
Faithful Representation
+Relevance
=
FaRR
Faithful RepresentationCan I Depend on it?
Complete
Are all facts embedded in the information?
Neutral
The information is free from bias; no one interest group is favored; focus is on objectivity and balance.
Free from error
Would a sufficiently knowledgeable third party derive the same result?
Objectives and Qualitative Characteristics
FAR_Participant_Part1 25 23 December 2017 4:01 AM
25
RelevanceDoes it Relate to my decision?
Helps me Predict
Helps form a prediction about future events; prediction is best formed from elements in the financial statements expected to persist into the future
Helps me Confirm
Provides information about earlier expectations or predictions; either as a confirmation or disconfirmation; helps understand how past actions have affected current financial position
RelevanceDoes it Relate to my decision?
The information is Material
This is information that could influence my decision.
FaRRDecision—useful information
Relevance• Relates to my decision,
helps me predict and confirm predictions. Is material to my decision
Faithful Representation• I can depend on the
information; it is complete, neutral, and free from error.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 26 23 December 2017 4:01 AM
26
Enhancing Characteristics• Between companies• Non uniformityComparability
• Independent observers would reach similar conclusionVerifiability
• Recent enough to make a differenceTimeliness
• Comprehensible by a user with reasonable understanding of business
Understandability
Example QuestionWhat are the Accounting Concepts intended to establish?A. Generally accepted accounting principles in financial
reporting by business enterprisesB. The meaning of "Presented fairly in accordance with
generally accepted accounting principles”C. The objectives and concepts for use in developing
standards of financial accounting and reportingD. The hierarchy of sources of generally accepted accounting
principles
AnswerAnswer: C
Here is where careful reading will pay off!
The concepts assist the development of the standards, but they are not GAAP!
Don't fall for the GAAP answers in A, B, or D.
Objectives and Qualitative Characteristics
FAR_Participant_Part1 27 23 December 2017 4:01 AM
27
Example QuestionAccording to the FASB's Conceptual Framework, predictive value is an ingredient of:
FaithfulRepresentation Relevance
A. Yes YesB. Yes NoC. No NoD. No Yes
AnswerAnswer: D
Faithful representation answers the question “Can I depend on it?” Faithful representation is completeness, neutral, and free from material error.
Relevance answers the question “Does it relate to my decision?” Predictive value relates to the relevance of information. Relevant information contains predictive value and feedback value.
ConclusionNow you are ready to complete some questions on your own in study mode. Once you feel comfortable, continue on to the next lesson on the Conceptual Framework.
Study hint: If you had trouble with the terminology in this section, try the flash cards to help you learn the definitions. We strongly recommend that you understand the definitions—it will serve you well and take you farther than just memorization.
You can do it—once you put your mind to it!
FAR_Participant_Part1 28 23 December 2017 4:01 AM
28
Assumptions and Accounting Principles
Assumptions, AccountingPrinciples
Acronym for AssumptionsAssumptions come “Entirely from your GUT”
The four assumptions are: 1. Entity2. Going Concern3. Unit of measurement4. Time period
Entity AssumptionThe entity is separate and distinct from its owners.
Example: The owners of the corporation are separate from the corporation itself. The assets of the corporation do not belong to the owners, but to the corporation.
Assumptions and Accounting Principles
FAR_Participant_Part1 29 23 December 2017 4:01 AM
29
Going Concern AssumptionA business has an indefinite life that extends beyond the life of the owners.
Absent evidence to the contrary (such as imminent bankruptcy), a business will continue on.
Assets would not be recorded unless we assumed that the business will be there in the next period to use these assets.
Unit of Measurement AssumptionEverything is measured in terms of a stable monetary unit of measure.
Values are not adjusted for inflation
1. Example: Land purchased in 1960 is added to land purchased in 2015 even though the value of the dollar in 1960 is different than the value in 2015.
2. We do not adjust the 1960 dollars to the 2015 equivalent.
Time Period AssumptionIndefinite life is broken into timeframes, such as a year, a quarter, a month, etc.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 30 23 December 2017 4:01 AM
30
PrinciplesThere are four Accounting Principles:
1. Revenue Recognition
2. Expense Recognition (matching)
3. Measurement
4. Full Disclosure
Revenue Recognition PrincipleRevenue is recognized when realized and earned.
Recognized = Recorded on the financial statementsRealized = Cash or near cash (AR) receivedEarned = Goods or service has been delivered
Much more on revenue recognition in separate lesson
Expense Recognition PrincipleOften referred to as the matching principle
Addresses when to recognize expenses
Recognizes expenses when they produce revenues
Assumptions and Accounting Principles
FAR_Participant_Part1 31 23 December 2017 4:01 AM
31
MeasurementAssets and liabilities are recorded at the value at the time of origin.Historical cost: LandAmortized cost: Plant and EquipmentNet realizable value: Accounts ReceivableReplacement cost: InventoryNet present value: BondsFair value: Investments
Full Disclosure PrincipleNot all information can be recognized on the financial statements.
Example: Operating lease obligationsDisclosures are needed to help the financial statement user assess financial obligations of the business.
Example: The future minimum lease payments are disclosed in the footnotes.
FAR_Participant_Part1 32 23 December 2017 4:01 AM
32
Constraints and Present Value
Constraint and Present Value
88
ConstraintCost-benefit
Cost of providing the information should not outweigh the benefit.
Using Cash Flow and PVThis concept refers to measurement when the present value of cash flows are used to estimate fair value.
Governs measurement not recognition
When using cash flows to determine present value, there are two ways to incorporate the risk associated with the cash flows:
1. Discounted cash flows: single cash flow value is discounted using the risk adjusted rate
2. Expected cash flows: probability weighted cash flows is discounted using the risk-free rate
Constraints and Present Value
FAR_Participant_Part1 33 23 December 2017 4:01 AM
33
ExampleA cash flow of $200,000 may be received in one year, two years, or three years, with probabilities of 20%, 50%, and 30%, respectively. The rate of interest on default risk-free investments is 5%. The PV factors are:
PV of 1, at 5%, for 1 year is 0.95238PV of 1, at 5%, for 2 years is 0.90703PV of 1, at 5%, for 3 years is 0.86384
Solution$200,000 × 0.2 = $ 40,000 × 0.95238 = $38,095
$200,000 × 0.5 = $100,000 × 0.90703 = $90,703
$200,000 × 0.3 = $ 60,000 × 0.86384 = $51,830
Total $180,628
Example QuestionWhich of the following is not addressed in the concept statement on cash flows and fair value accounting measurements?
A. Measurement methods at initial recognitionB. Interest method of amortizationC. Expected cash flow approachD. Determining when fresh-start measurements are
appropriate
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 34 23 December 2017 4:01 AM
34
AnswerAnswer: D
The concept statement governs how to measure not when to measure items at present value.
Answers A, B, and C were all how to measure.
ConclusionThis concludes the third lesson on the FASB’s Conceptual Framework.
Make sure to be comfortable with the terminology and concepts presented in the Conceptual Framework lessons.
This material is integral to all other FAR topics.
Best of luck as you continue with your studies!
FAR_Participant_Part1 35 23 December 2017 4:01 AM
35
Fair Value FrameworkFair Value Framework—Introduction and Definitions
Fair Value Framework—Introduction and Definitions
Introduction
Use of fair value is pervasive in financial accounting and reporting.
In an information economy, today’s value is more useful than yesterday’s value.
1960 – Industrial Economy 2016 – Information Economy
adempercem/Shutterstock
CPA Exam Coverage
Must know:
Definition of “fair value”
Fair value at initial recognition and subsequent measurement
Approaches to determining fair value
Inputs used in determining fair value and input hierarchy
Disclosure requirements any time fair value is used
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 36 23 December 2017 4:01 AM
36
Fair Value Defined
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Dblight/iStockphoto
Entry Price ≠ Exit Price
Entry price and exit price are conceptually different:
Different markets Related party transactionDistressed saleDifferent unit of account
At initial recognition of an item, the entry price and exit price may or may not be the same value.
Adam Kazmierski/iStockphoto
Buying new car – Entry Price
Selling new car –Exit Price
Kzenon/Shutterstock Gunter Nezhoda/Shutterstock
Fair Value Framework—Introduction and Definitions
FAR_Participant_Part1 37 23 December 2017 4:01 AM
37
Exit Price
Exit price = Amount received to sell an asset or paid to transfer a liability
Eric Isselee/Shutterstock
Orderly transaction
Occurs at the measurement date.
Occurs under current market conditions.
Not a forced liquidation or distressed sale.
Orderly transaction is a hypothetical transaction because an actual transaction may not have occurred or the actual transaction is not orderly.
denis_pc/iStockphoto
Principal or Most Advantageous Market
An orderly transaction is assumed to occur in the principal market or most advantageous market to which the entity has access:
Principal market is the market available to the entity with greatest volume and level of activity for the item.
Most advantageous market is the market available to the entity that maximizes selling price or minimizes transfer price.
Determination of the most advantageous market would include the costs to transact in that market.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 38 23 December 2017 4:01 AM
38
Determination of Fair Value
Once the principal or most advantageous market is identified, the fair value from that market:
Should not be adjusted for transaction cost—incremental direct cost to execute sale or transfer—which do not measure a characteristic of the asset, liability, or equity item
Should be adjusted for cost of transporting item to market (the location characteristic)
Market Participants
“Market participants” are buyers/sellers that are:
Independent of the reporting entity
Acting in their economic best interest
Knowledgeable of the item or transaction
Able and willing to enter a transaction, but not compelled to do so
Fair Value Is a Market-Based Measurement
Fair value not based on buyer’s unique perspective and is applied to:
A single item (e.g., a bond)
A group of related items (e.g., a business)
Should consider attributes of the specific item being measured:
Condition, location, restrictions on use
Fair Value Framework—Introduction and Definitions
FAR_Participant_Part1 39 23 December 2017 4:01 AM
39
Fair Value Is a Market-Based Measurement
Assumes the highest and best use by market participants, even if it will be used in some other way by the reporting entity.
Highest and best use considers what is:
Physically possible
Legally permissible
Financially feasible
Application of Fair Value Definition
Assume you own a share of Smith Company. Smith trades on two different exchanges and neither is your principal market. Which market is your most advantageous market?
Answer: The NYSE is the most advantageous because the net price (after transaction cost) is $105.
Market Share Price Transaction CostNY Stock Exchange $112 $7London Stock Exchange $115 $11
Application of Fair Value Definition
What is the fair value you should use to report your investment in Smith Company?
Market Share Price Transaction CostNY Stock Exchange $112 $7London Stock Exchange $115 $11
Answer: The fair value of Smith Company is $112 per share - the fair value does not include transaction cost.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 40 23 December 2017 4:01 AM
40
Net Asset Value (NAV) as Practical Expedient
Practical expedient is allowed when there is no readily determinable fair value and the investee reports net assets value at fair value.
NAV as Practical Expedient
NAV = $1,500,000(Assets less liabilities)
InvestorsReal Estate Fund
Investor owns 10% of Real Estate Fund.
FV of Investment = 10% $1,500,000 =
$150,000
FV = $2,000,000Real Estate
Canadastock/Shutterstock
Showshill/Getty Images
dan_prat/Getty Images
Tsuji/Getty Images
FAR_Participant_Part1 41 23 December 2017 4:01 AM
41
Recognition and Measurement
Recognition and Measurement
Recognition and Measurement of Fair Value
This lesson will provide an overview of the techniques used to measure fair value and the fair value option.
The CPA exam will ask about the various techniques and you will frequently see reference to the fair value option.
Recognition and Measurement of Fair Value
“Recognition” refers to what is recorded on the financial statements.
“Measurement” refers to what amount is recorded on the financial statements.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 42 23 December 2017 4:01 AM
42
Fair Value Defined
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Dblight/iStockphoto
Approaches to Determine Fair Value
Market Approach: Use prices generated by real market transactions for identical or similar items
Income Approach: Discount future amounts to a current present value
Cost Approach: Use the value required to replace the asset
Approaches to Determine Fair Value
Sometimes a single approach to determining fair value may be appropriate and adequate.
Quoted market prices in active markets
Sometimes multiple approaches are used to determine fair value.
Valuing an entire business
Professional judgment required if assessing multiple outcomes
Recognition and Measurement
FAR_Participant_Part1 43 23 December 2017 4:01 AM
43
Quiz
Huskie Co. holds an investment in a bond of Shephard Co. that is not publicly traded. To determine the fair value of the bond, Huskie uses the fair value of a similar bond that is traded on an exchange and adjusts that price for characteristics in Shephard’s bond. What type of valuation approach is Huskie using?
A. Market approach
B. Income approach
C. Cost approach
D. Residual value approach
Fair Value Option
Entities can elect to measure the following at fair value:
Recognized financial assets and financial liabilities (with few exceptions)
Firm commitments not otherwise recognized and that involve only financial instruments
Written loan commitments
Rights/obligations under warranties and insurance contracts that can be settled by paying a third party
Items Not Available for Fair Value Option
Entities may not elect to measure the following at fair value:
Investments in entities to be consolidated
Obligations or assets related to pension or other employee-oriented plans
Lease-related financial assets or liabilities
Demand deposits of financial institutions
Instruments that are components of shareholders’ equity
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 44 23 December 2017 4:01 AM
44
Fair Value Option Election Dates
Fair value option can be elected only:
When the item is first recognized
When an eligible firm commitment occurs
When the accounting treatment of an investment in another entity changes
Fair Value Option Application
Fair value option may be applied on an instrument-by-instrument basis.
Does not have to be applied to all instruments issued or acquired in a single transaction.
Must be applied to an entire instrument, not just to specific elements of an instrument.
Fair value option is irrevocable, except when a new election date for a specific item occurs.
Accounting at Eligible Election Date
Determine carrying value (CV).
Determine fair value (FV).
Determine difference between CV and FV.
Recognize difference:
Write item up or down.
Recognize increase (gain) or decrease (loss) in current income.
Recognition and Measurement
FAR_Participant_Part1 45 23 December 2017 4:01 AM
45
Illustration—FV Option
Assume the eligible date for electing the FV option is January 2, 20X1, and the CV of the asset is $100,000 and the FV is $110,000.
FV > CV (Difference) = $ 10,000
Entry on January 1, 20X1:
DR: Investment in Equity Investee $ 10,000
CR: Unrealized Gain—FV Option $ 10,000
Accounting After Election
At each subsequent reporting date adjust the item to new fair value.
Recognize difference as:
Write item up or down.
Recognize increase or decrease in current earnings.
FAR_Participant_Part1 46 23 December 2017 4:01 AM
46
Inputs and Hierarchy
Inputs and Hierarchy
Inputs and Hierarchy
This lesson will provide an overview of the inputs used to measure fair value and the hierarchy of those inputs.
The CPA exam will ask about inputs and frequently asks you to classify the inputs into the hierarchy.
Side note: If NAV is used as a practical expedient, it is NOT classified into the fair value hierarchy, but disclosures about the use of NAV are required.
Fair Value Inputs
Inputs are assumptions and data used in valuation techniques:
Observable Inputs: Derived from market data from sources independent of the reporting entity
Unobservable Inputs: Entity’s assumptions based on best information available in circumstances
Use of observable inputs should be MAXIMIZED.
Use of unobservable inputs should be minimized.Robyn Mackenzie/Shutterstock
pavlen/iStockphoto
Inputs and Hierarchy
FAR_Participant_Part1 47 23 December 2017 4:01 AM
47
Hierarchy
Fair Value Hierarchy Level 1
Observable quoted prices at measurement date in active markets for identical items.
Highest level with most desirable inputs Most reliable evidence of fair valueUse whenever availableSometimes adjustments are proposed
Liquidity discount—permittedControl premium—not permittedBlockage discount—not permitted
Fair Value Hierarchy Level 2
Directly or indirectly observable but do not meet all conditions for Level 1
Quoted prices in active markets for similar items
Quoted prices in inactive markets for similar (or identical)
Observable inputs other than market prices that are relevant to an item being valued
Inputs derived from or corroborated by observable market data using correlation or other means
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 48 23 December 2017 4:01 AM
48
Fair Value Hierarchy Level 3
Unobservable inputs for the item being valued:
Lowest level with least desirable inputs
May use reporting firm’s internal data
Based on assumptions or inferences that market participants would make
Example: Determining fair value of closely-held stock
Quiz
Huskie Co. holds an investment in a bond of Shephard Co. that is not publicly traded. To determine the fair value of the bond, Huskie uses the fair value of a similar bond that is traded on an exchange and adjusts that price for characteristics in Shephard’s bond. What level in the fair value hierarchy should Huskie classify this valuation?
A. Level 1
B. Level 2
C. Level 3
D. Puppy level
FAR_Participant_Part1 49 23 December 2017 4:01 AM
49
Disclosure Requirements
Disclosure Requirements
Disclosure Requirements
Disclosure requirements depend on whether fair value is used:
On a recurring basis—Fair value is determined and applied to an item period after period.
On a nonrecurring basis—Fair value is determined and applied only when certain conditions or situations occur.
For both, the fair value at reporting date, valuation techniques, and inputs used in those techniques must be disclosed.
Coca-Cola, Inc.—Footnote Excerpt
Coca-Cola Company, 2015 10k
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 50 23 December 2017 4:01 AM
50
Disclosures when Fair Value Is on Recurring Basis
Table showing items at each level of the fair value hierarchy.
Transfers into and out of each level of the hierarchy
For measurements in Level 3:
A reconciliation of beginning and ending balances
Description of the valuation process and significant assumptions
Coca-Cola, Inc.—Footnote Excerpt
Coca-Cola Company, 2015 10k
Disclosure Requirements when Fair Value Is on Nonrecurring Basis
In interim and annual statements, for each major category of asset or liability measured at fair value:
Reasons for the fair value measurement
Level of the fair value hierarchy within which measurements fall
For measurements in Levels 2 and 3, a description of any changes in techniques
Disclosure Requirements
FAR_Participant_Part1 51 23 December 2017 4:01 AM
51
Disclosure Requirements when Fair Value Is on Nonrecurring Basis
For measurements that fall in Level 3, unobservable inputs:
The effect of the measurement on earnings or OCI
Quantitative information about the unobservable inputs used
If highest and best use of nonfinancial assets differs from current use, disclose that fact and why.
Coca-Cola, Inc.—Footnote Excerpt
Coca-Cola Company, 2015 10k
Coca-Cola, Inc.—Footnote Excerpt
Coca-Cola Company, 2015 10k
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 52 23 December 2017 4:01 AM
52
Disclosure for Fair Value Option
Identify items to which the fair value option is applied and reasons for electing the fair value option.
Information to enable users to understand how fair value is applied for each item (methods and assumptions).
The amount of gains and losses associated with the fair value changes.
Wrap-up
Must know:
Definition of “fair value”
Fair value at initial recognition and subsequent measurement
Approaches to determining fair value
Inputs used in determining fair value and input hierarchy
Disclosure requirements any time fair value is used
FAR_Participant_Part1 53 23 December 2017 4:01 AM
53
International Financial Reporting Standards (IFRS)IASB Accounting Standards
IASB Accounting Standards
How IFRS are Tested
Typically as an application of the measurement or recognition related to inventory, intangibles, fixed assets, etc.
Must have basic knowledge and understanding of U.S. GAAP and the differences under IFRS.
Expect one or two MC questions that require application of IFRS.
How to Study IASB/IFRS
Understand the differences in vocabulary or definitions.
Understand the differences related to recognition and measurement.
Be aware of presentation and disclosure differences.
Work through IFRS examples in the study text and MC questions.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 54 23 December 2017 4:01 AM
54
International Accounting Standards Board (IASB)
Establishes IFRS
IFRS based on framework
No enforcement power
Enforcement is the responsibility of the securities regulators in national jurisdictions
IASB 2001–present
The International Accounting Standards Committee (IASC): 1973–2001
Objectives of IASB
To develop a single set of high quality, understandable, enforceable and globally accepted financial reporting standards.
To promote the use and rigorous application of IFRS.
To consider the needs of a range of size and type of entities.
To promote and facilitate adoption of IFRS through convergence.
IFRS: Principles-Based Standards
Less detailed than U.S. GAAP
Fewer rules
Requires more professional judgment
Less literature to address exceptions
IASB Accounting Standards
FAR_Participant_Part1 55 23 December 2017 4:01 AM
55
International Financial Reporting Standards (IFRS) Structure
Source: www.ifrs.org
IFRS Hierarchy
Level 1IFRSs and implementation guidance dealing with specific issue or similar situations.
Level 2Definitions, recognition criteria, and measurement concepts for A, L, income, and expenses in the framework.
Level 3Pronouncements from other standard-setting bodies using a similar framework.
Standard-Setting Process
Source: www.ifrs.org
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 56 23 December 2017 4:01 AM
56
Accounting Standards Convergence
Norwalk agreement in 2002 formalized the FASB and IASB commitment to convergence.
Many differences have been eliminated, but many remain.
SEC eliminated the requirement to reconcile from international GAAP to U.S. GAAP in 2007—making it easier for foreign companies to list on U.S. exchanges.
Conclusion
Expect to have a question on the application of IFRS.
There are many similarities to U.S. in the structure and process related to setting accounting standards.
The convergence of the IFRS and FASB standards is ongoing.
FAR_Participant_Part1 57 23 December 2017 4:01 AM
57
IASB Framework
IASB Framework
IASB FrameworkThe IASB Framework is similar to the FASB’s as it is used to develop GAAP
Under IFRS the Conceptual Framework is a point of reference for preparers in the absence of specific guidance in IFRS
In contrast—in US GAAP the Conceptual Framework is non-authoritative and is not referred to by preparers of financial reporting
Objective of IFRS is to provide financial statements that present a “true and fair” view of the entitie’s performance
IASB Framework
Primary Characteristics
Faithful Representation
Completeness Neutrality Free from error
Relevance
Predictive Value
Confirmatory Value Materiality
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 58 23 December 2017 4:01 AM
58
DifferencesThere are some differences in the identification and definitions of the elements of the financial statements—refer to the study guide for more details.
The IASB Framework has only two assumptions:1. The accrual method is used.2. The entity is a going concern.
ConclusionThe convergence of the IASB and FASB Conceptual Framework is ongoing.
Refer to the study text for the most recent status in the convergence of the IASB and FASB Conceptual Framework.
FAR_Participant_Part1 59 23 December 2017 4:01 AM
59
IFRS for SMEs
IFRS for SMEs
Simplified financial reporting guidance for small and medium-sized entities (SMEs)
Similar to “little GAAP” issued by the FASB via the Private Company Council (PCC)
IFRS does not have Other Comprehensive Basis of Accounting (OCBOA)
International Financial Accounting Standards (IFRS)
FrameworksFinancial Accounting Standards Board
(FASB)International Accounting Standards Board
(IASB)American Institute of
Certified Public Accountants (AICPA)
ApplicableFinancialReporting Framework
U.S. Generally Accepted Accounting Principles (GAAP): U.S. GAAP–based financial statements for nongovernmental entities
Private Company Council accounting alternative: U.S. GAAP–basedfinancial statements with modifications/simplifications
International Financial Reporting Standards: GAAP–based financialstatements for foreign private issuer
IFRS for Small- and medium-sized entities (SMEs):GAAP–based financial statements with modification/simplification of full IFRS
Special purpose frameworks (SPF): Non-GAAP financial statements prepared using a type of SPF such as FRF for SMES, cash basis, modified cash basis, tax basis, regulatory basis, contractual basis
Applicability Mandatory for public business entities
May be elected by private, for-profit entities
Required unless entity meets eligibility for accounting alternative
Small- and medium-entities without public accountability
FRF for SMEs may be usedby smaller- to medium-sized for-profit private entities when U.S. GAAP-based financial statements are not required
Authoritative Guidance
FASB Accounting Standards Codification (ASC) and Accounting Standards Updates (ASU)
ASC/ASU with modifications for simplicity
IFRS IFRS with modifications for simplicity
FRF for SMEs
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 60 23 December 2017 4:01 AM
60
What You Need to KnowWhy IFRS for SMEs?
Who uses this guidance?
When is this guidance considered GAAP?
What are the major differences in IFRS for SMEs versus regular IFRS?
Why IFRS for SMEs?Millions of companies
Europe has roughly 28 million private sector enterprises (SMEs)
USA has about 25 millionUK: 4.7 millionBrazil: 6 million
Why IFRS for SMEs?IFRS for SMEs—230 pages of guidance2,500 pages for IFRS 25,000+ pages for US GAAPSimplified IFRSs, but built on an IFRS foundation and Conceptual Framework
IFRS for SMEs
FAR_Participant_Part1 61 23 December 2017 4:01 AM
61
Who Can Report under IFRS for SMEs?Any entity that does not have public accountability...
securities not publicly tradednot a financial institution
... and is required or chooses to produce General Purpose Financial Statements
to present fairly financial position, results of operations, and cash flows
IFRS for SMEs Considered to be GAAP?Yes The AICPA recognizes the IASB as an accounting body for purposes of establishing international financial accounting and reporting principlesIFRS for SMEs is not considered OCBOA
Yes—if meet the criteria
Simplified and less complicated compared to voluminous US GAAP
Can Private US Entities Use IFRS for SMEs?
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 62 23 December 2017 4:01 AM
62
Who CANNOT Use IFRS for SMEs?Entities that issue instruments in a public market—required to file financial statements
Entities that hold assets in a fiduciary capacity:BanksInsurance companiesMutual funds, etc.
Not-for-profits and governmental entities
Major Differences from IFRS1. Disclosures are simplified in a number of
areas including pensions, leases and financial instruments
2. Goodwill and indefinite life intangible assets are amortized over a period not exceeding ten year.
3. A simplified temporary difference approach to income tax accounting
Major Differences from IFRS4. Accounting for financial assets and
liabilities makes greater use of cost5. No disclosures for Earnings Per Share and
Segment Disclosures
FAR_Participant_Part1 63 23 December 2017 4:01 AM
63
IFRS—General-Purpose Financial Statements
IFRS—General Purpose Financial Statements
Heineken—Assets
Heineken—Liabilities and Stockholders’ Equity
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 64 23 December 2017 4:01 AM
64
Major Differences—Balance Sheet
US IFRS
Comparative periods are required.
Comparative periods are not required (unless
SEC registrant).
Major Differences—Statement of Shareholders’ Equity
US IFRS
Changes in owners’ equity can be
presented in the footnotes.
Changes in owners’ equity must be presented in a
separate statement.
Heineken—Income Statement
IFRS—General-Purpose Financial Statements
FAR_Participant_Part1 65 23 December 2017 4:01 AM
65
Major Differences—Income Statement
US IFRSReporting special items prescribed
Dividends per share not required
No requirement on reporting special items
Dividends per share require disclosure
Heineken—Statement of Comprehensive Income
Major Differences—Statement of Comprehensive Income
US IFRS
No revaluation of PPE through OCI
Per share measures are prohibited.
Permits revaluation of PPE through OCI
NOTE: Reclassification of PPE revaluation must also flow
through OCI and not NI.
Per share measures are not prohibited.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 66 23 December 2017 4:01 AM
66
Heineken—Operating Activities
Heineken—Investing Activities
Heineken—Financing Activities
IFRS—General-Purpose Financial Statements
FAR_Participant_Part1 67 23 December 2017 4:01 AM
67
Major Differences—Statement of Cash Flows
US IFRS
Interest paid Operating only Operating or financing
Interest received Operating only Operating or investing
Taxes paid Operating onlyOperating—In financing or
investing if specifically identified with an item
Dividends received Operating only Operating or investing
Dividends paid Financing only Operating or financingCash and cash equivalents
Bank overdrafts not allowed May include bank overdrafts
FAR_Participant_Part1 68 23 December 2017 4:01 AM
68
General-Purpose Financial StatementsBalance Sheet/Statement of Financial Position
Balance Sheet/Statement of Financial Position
Balance SheetStatement of Financial Position
Measured at one point in time
Assets = Liabilities + Equity = Contra and adjunct accounts
Measurement AttributesHistorical cost—Land, prepaid insurance
Amortized historical cost—Fixed assets
Fair Market value —Marketable securities, derivatives
Net realizable value—Accounts receivable
Present value—Bonds
Balance Sheet/Statement of Financial Position
FAR_Participant_Part1 69 23 December 2017 4:01 AM
69
Contra and Adjunct AccountsContra accounts are subtracted from the balance sheet accounts.
Adjunct accounts are added to the balance sheet account.
Current AssetsAssets expected to be realized in cash or consumed within one operating cycle or year
Examples: accounts receivable, prepaid expenses, and investments (short-term)
Current LiabilitiesLiabilities expected to be extinguished with current assets or another liability within one operating cycle or year
Examples: accounts payable, accrued expenses
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 70 23 December 2017 4:01 AM
70
NoncurrentBy default accounts that are not current are classified as noncurrent.
Noncurrent asset examples: PPE, long term investments, and intangibles
Noncurrent liability examples: notes payable, bonds payable, and pension liabilities
Equity AccountsContributed Capital:
The amount contributed by ownersExample: Common stock, preferred stock, additional paid-in capital
Retained Earnings:
The amount of earnings retained by the entityCumulative net income less dividends paid
Coca-Cola, Inc.—Assets
Balance Sheet/Statement of Financial Position
FAR_Participant_Part1 71 23 December 2017 4:01 AM
71
Coca-Cola, Inc.—Liabilities and Shareholders’ Equity
FAR_Participant_Part1 72 23 December 2017 4:01 AM
72
Income Statement
Income Statement
DefinitionsRevenues—increases in net assets or settlement of liabilities from PRIMARY activities—providing goods or servicesDR: Cash or AR
CR: Revenue or SalesorDR: Unearned Revenue
CR: Revenue or Sales
DefinitionsExpenses—decreases in net assets or incurrence of liabilities from PRIMARY activities—providing goods or servicesDR: Expense
CR: Cash or APorDR: Expense
CR: AP or Accrued Liabilities
Income Statement
FAR_Participant_Part1 73 23 December 2017 4:01 AM
73
DefinitionsGains—increases in net assets from incidental activities
Losses—decreases in net assets from incidental activities
Examples: sale of assets, interest income, and interest expense
Multi-step Income StatementABC Company
FYE December 31SalesCost of Goods SoldGross profitOperating expenses+/– Other income/expensesIncome from continuing operations before taxIncome taxesIncome from continuing operations+/– Discontinued operationsNet Income
Coca-Cola, Inc.—Income Statement
FAR_Participant_Part1 74 23 December 2017 4:01 AM
74
Statement of Comprehensive Income
Statement of Comprehensive Income
Need to Know for the CPA Exam
Definitions
Components
Presentation formats
Disclosures
Definition
Comprehensive Income
Other Comprehensive
Income (OCI)
NetIncome
Statement of Comprehensive Income
FAR_Participant_Part1 75 23 December 2017 4:01 AM
75
Components of Other Comprehensive Income
Unrealized gains and losses on available-for-sale debt securities
Certain gains and losses from pension costs
Foreign currency translation adjustments
Unrealized gains and losses from certain derivative transactions
Presentation
Comprehensive income can be presented in one of two ways:
One-statement approach:
In combination with the income statement
Two-statement approach:
A separate statement of income and
A separate statement of comprehensive income
One-Statement ApproachStatement of Net Income and Comprehensive Income
FYE December 31Revenues $1,000Expenses (900)Net Income 100
Other comprehensive income items (net of tax):
Unrealized G/L foreign currency translation (2)Unrealized G/L AFS debt securities 14
Other comprehensive income 12
Comprehensive Income $ 112
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 76 23 December 2017 4:01 AM
76
Two-Statement Approach
Statement of IncomeFYE December 31
Revenues $1,000
Expenses (900)
Net Income m
Statement of Comprehensive IncomeFYE December 31
Net Income $ 100Other comprehensive income items(net of tax):
Unrealized G/L foreign currencytranslation (2)
Unrealized G/L AFS debtsecurities 14
Other comprehensive income 12Comprehensive Income
$ 112
Coca-Cola, Co.—Statement of Comprehensive Income
Coca-Cola Company, 2016 10k
Accumulated Other Comprehensive IncomeStatement of Shareowners’ Equity
Coca-Cola Company, 2016 10k
Statement of Comprehensive Income
FAR_Participant_Part1 77 23 December 2017 4:01 AM
77
Accumulated Other Comprehensive IncomeStatement of Shareowners’ Equity
Coca-Cola Company, 2016 10k
Accumulated Other Comprehensive IncomeEquity Section of Balance Sheet
Coca-Cola Company, 2016 10k
Coca-Cola, Co.—Other Comprehensive Income Disclosure
Coca-Cola Company, 2016 10k
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 78 23 December 2017 4:01 AM
78
Accumulated Other Comprehensive IncomeFootnote Disclosure
Coca-Cola Company, 2016 10k
Quiz
Choose the correct equation from the following:
A. Net income + Comprehensive income = Other comprehensive income
B. Comprehensive income = Net income + Prior-period adjustments + Accounting principle changes
C. Comprehensive income = Net income + Other comprehensive income
D. Comprehensive income = Total change in owners’ equity –Dividends declared
What did we do?
Definitions
Components
Presentation formats
Disclosures
FAR_Participant_Part1 79 23 December 2017 4:01 AM
79
Statement of Changes in Equity
Statement of Changesin Equity
Changes in Owners’ EquityThis statement provides beginning balances, changes during the year and ending balances for the following items:
Stock (common and preferred)APICRetained EarningsTreasury StockAOCI
PresentationChanges in owners’ equity can be presented in the footnotes, supplemental schedules or as a separate statement.
Most large companies present changes in owners’ equity in a separate statement.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 80 23 December 2017 4:01 AM
80
Coca-Cola, Inc.—Statement of Shareowners’ Equity
Coca-Cola, Inc.—Statement of Shareowners’ Equity (continued)
FAR_Participant_Part1 81 23 December 2017 4:01 AM
81
Statement of Cash FlowsSources and Uses of Cash
Sources and Uses of Cash
Overview
The purpose of a Statement of Cash Flow
What is cash, cash equivalents, and restricted cash
The categories of the sources and uses of cashTsuji/Getty Images
Types of Exam Questions
What is cash?
Classification of an item as operating, investing, or financing
Calculation of cash flows from operating, investing, or financing
Should changes be added or deducted to derive cash flows from operations
Tested VERY
frequently!
JUAWA/Shutterstock
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 82 23 December 2017 4:01 AM
82
Purpose of Statement of Cash Flows
The purpose of the SCF is to provide information so that users can:
Assess past ability to generate and control cash inflows and outflows.
Assess probable future ability to generate cash inflows sufficient to meet future obligations.
Assess the likelihood of future borrowing.
A Required Statement
The SCF is a basic statement like the income statement and statement of financial position.
SCF is required for all business enterprises that report both a statement of financial position and income statement.
The SCF complements the information presented in the other statements to help the user assess the entities operations.
What Is Cash?
Cash
Coin, currency, foreign currency
Cash equivalents
Are short-term, highly liquid investments
Are readily convertible to known amount of cash
Bear no interest rate risk
Examples: T-bills, and money market funds
Maksim Shmelijov/ShutterstockTorsakarin/Depositphotos
Sources and Uses of Cash
FAR_Participant_Part1 83 23 December 2017 4:01 AM
83
What Is Cash?
Restricted Cash
Cash that is held for special purposes and is not freely available for the entities use
Designated for special projects
Compensating balance account
Collateral accounts
Information Reported
The total change in all cash is represented in the SCF
Cash flows related to operating activities
Cash flows related to investing activities
Cash flows related to financing activities
Acronym to Remember
Operating Ohhhhhhh
Investing
Financing
AND when I pass the CPA Exam , I am going to …..
IF. . .
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 84 23 December 2017 4:01 AM
84
wavebreakmedia/Shutterstock
Mauricio Graiki/Shutterstock
Sergey Nivens/Shutterstock
Sources and Uses of Cash
FAR_Participant_Part1 85 23 December 2017 4:01 AM
85
Creativa Images/Shutterstock
Other Information Reported on SCF
Effects of foreign currency translation on cash flows
Reconciliation of cash at the beginning of the year to cash at the end of the year
If direct method is used must report a reconciliation of accrual net income to cash flow from operations
Significant non-cash transactions
Noncash Transactions
A supplement schedule must be provided to present significant non-cash transactions.
Examples:
Purchase of equipment with a note payable
Settle a liability by paying with common stock and not cash
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 86 23 December 2017 4:01 AM
86
Colin Anderson/Getty Images
FAR_Participant_Part1 87 23 December 2017 4:01 AM
87
Operating, Investing, and Financing Activities
Operating, Investing, andFinancing Activities
Categories
Cash flows from operating activities – direct method
Cash flows from investing activities
Cash flows from financing activities
Types of Exam Questions
Categorize a transaction or event into operating, investing or financing.
Complete one (or more) sections of the SCF.
Complete the reconciliation of beginning to ending cash.
What cash to include?
JUAWA/Shutterstock
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 88 23 December 2017 4:01 AM
88
Operating Activities—Direct Method
Cash inflows: From customers Interest income or dividend incomeSale of debt securities classified as trading
Cash outflows: To suppliers To employeesTo government For interest or other operational expensesPurchase of debt securities classified as trading
EMC Corp. —Statement of Cash Flows: Operating Activities –Direct Method
EMC Corp.—Statement of Cash Flows: Reconciliation Operating Activities
Operating, Investing, and Financing Activities
FAR_Participant_Part1 89 23 December 2017 4:01 AM
89
Investing Activities
Cash inflows:
Sale of property, plant or equipment
Sale of debt or equity securities of other entities
Collection of loan principal
Cash outflows:
Purchase of property, plant or equipment
Purchase of debt or equity securities of other entities
Coca-Cola, Inc. Statement of Cash Flows: Investing Activities
Year Ended December 31, 2015 2014 2013
Financing Activities
Cash inflows:
From sale of equity securities
From issuance of debt (bonds and notes)
Cash outflows:
To stockholders as dividends
To redeem long-term debt
To re-acquire capital stock
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 90 23 December 2017 4:01 AM
90
Coca-Cola, Inc. Statement of Cash Flows: Financing Activities
Year Ended December 31, 2015 2014 2013
Coca-Cola, Inc. Statement of Cash Flows
Year Ended December 31, 2015 2014 2013
Coca-Cola, Inc. Balance Sheet
Operating, Investing, and Financing Activities
FAR_Participant_Part1 91 23 December 2017 4:01 AM
91
Question - Classification
Which of the following items is included in the financing activities section of the SCF?
A. Cash effects of transactions involving making and collecting loans.
B. Cash effects of acquiring and disposing of investments and PPE.
C. Cash effects of transactions obtaining resources from owners and providing them with a return on their investment.
D. Cash effects of transactions that enter into the determination of net income.
Question - Analysis
In an SCF, if used equipment is sold at a loss, the amount shown as cash inflow from investing activities equals the carrying amount of the equipment
A. Less the loss and plus the amount of tax attributed to the loss
B. Less both the loss and the amount of tax attributable to the loss
C. Less the loss
D. With no additional addition or subtraction
Conclusion
The sources and uses of cash are categorized into operating, investing, and financing activities.
Complete the practice questions in this lesson—it will really help reinforce what transactions go into each category.
FAR_Participant_Part1 92 23 December 2017 4:01 AM
92
Operating Cash Flows—Indirect Method
Operating Cash Flows—Indirect Method
Operating Cash Flows
Cash flow from operations can be presented in one of two ways:
1. Direct method—This method directly shows the amount of cash inflows and outflows from operations. It shows cash received from sales and cash paid in operations.
2. Indirect method—This method is a reconciliation of the accrual-based net income to derive cash flows from operations.
Types of Exam Questions
Calculate cash flows from operating activities.
Both quantitative and qualitative.
Need to know what should be added or deducted to derive cash flows from operations.
JUAWA/Shutterstock
Operating Cash Flows—Indirect Method
FAR_Participant_Part1 93 26 December 2017 11:01 PM
93
TOOLS
chictype/Getty Images
Operating Activities—Indirect Method
Most recordkeeping is done on an accrual basis.
The indirect method is a reconciliation of net income to cash flows from operations.
Net income is adjusted for changes in working capital.
Net income is adjusted for “noncash” income/expenses such as depreciation.
Ivsigns/iStockphoto
Accounting Equation as a Tool
The accounting equation can be used to determine whether to add or subtract changes in working capital accounts to reconcile accrual-based net income to CF from operations.
A = L + E
∆A = ∆L + ∆E
∆ Cash + ∆ Other assets = ∆L + ∆E
∆ Cash = ∆L + ∆E – ∆ Other assets
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 94 23 December 2017 4:01 AM
94
Using the Accounting Equation as a Tool
The equation is to adjust net income to CF from operations.
∆ Cash = ∆L + ∆E – ∆ Other assets
If you are asked to convert cash flows from operations to net income you must switch the signs!
∆ Cash = –∆L + ∆E + ∆ Other assets
If you are asked to convert an expense from accrual to cash you must switch the signs because expenses reduce net income.
If you are asked to convert an expense from cash to accrual you do NOT need to switch the signs.
Noncash Expenses
Any noncash expenses or losses on the income statement need to be ADDED back to net income to derive cash flows from operations
Examples: depreciation or amortization expense and losses
Any noncash gains on the income statement need to be SUBTRACTED from net income to derive cash flows from operation
Examples: Gains
Coca-Cola, Inc.—Statement of Cash Flows: Operating Activities
Operating Cash Flows—Indirect Method
FAR_Participant_Part1 95 23 December 2017 4:01 AM
95
Coca-Cola, Inc.—Footnote Excerpt: Net Change in Operating Assets and Liabilities
Question—Adjusting Net Income
Kresley Co. has provided the following 20X5 current account balances for the preparation of the annual statement of cash flows:
Kresley's 20X5 net income is $75,000. What would be reported as net cash provided by operating activities in the statement of cash flows?
December 31 January 1Accounts receivable $11,500 $14,500Allowance for uncollectible 400 500Prepaid rent 6,200 4,100Accounts payable 9,700 11,200
Question - Qualitative
Dee's inventory and accounts payable balances at December 31, 20X5, increased over their December 31, 20X4, balances. Should these increases be added to or deducted from cash payments to suppliers to arrive at 20X5 cost of goods sold?
Increase in inventory Increase in accounts payable
a. Added to Deducted fromb. Added to Added toc. Deducted from Deducted fromd. Deducted from Added to
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 96 23 December 2017 4:01 AM
96
Bartosz Hadyniak/iStockphoto
FAR_Participant_Part1 97 23 December 2017 4:01 AM
97
Notes to Financial StatementsNotes to Financial Statements
Notes toFinancial Statements
DisclosuresFootnote disclosures are an integral part of the financial statements.
Remember disclosures are part of GAAP
Provide information about assumptions and estimates
Provide information that cannot be captured quantitatively
Basic DisclosuresSummary of Significant Accounting PoliciesRelated Party TransactionsLiability DisclosuresCapital Structure Errors and IrregularitiesIllegal Acts
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 98 23 December 2017 4:01 AM
98
Management’s Discussion and Analysis
Required narrative for publicly held firms
Includes a discussion about operations, liquidity and capital resources
Forward-looking information can be provided by management
Effects of Changing PricesDuring times of price instability and high levels of inflation firms were required to disclose the effect of changing prices.
There are currently no required disclosures.
Review the study text—this material has a low probability of being tested.
FAR_Participant_Part1 99 23 December 2017 4:01 AM
99
Risks and Uncertainties
Risks and Uncertainties
Areas of ConcernRequired disclosure of vulnerability to conditions and events capable of materially affecting financial statements in the near term (one year).
Sources of risk and uncertainty:
Nature of the entity's operations
Use of estimates in financial statements
Certain significant estimates
Areas of ConcernVulnerability to significant concentrations
NEW! Going-concern assessment
The FASB now requires disclosures if conditions give rise to substantial doubt about the entities ability to continue as a going concern!
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 100 23 December 2017 4:01 AM
100
Nature of OperationsInformation about the firm's products and services, geographical location, and principal markets
Relative importance of each type of business
Need not be quantitative
Use of EstimatesDisclose that estimates:
Are required for many financial statement itemsAre approximationsRequire assumptions about future events
Certain Significant EstimatesEstimates for which there is a reasonable chance of change such that its effect could be material.
Disclosures:Nature of the uncertaintyEstimated effect of the change in estimate
Risks and Uncertainties
FAR_Participant_Part1 101 23 December 2017 4:01 AM
101
Certain Significant Estimates (continued)The standard provides examples of areas susceptible to estimate changes including:
Fair valuation
Inventory
Equipment obsolescence
Valuation allowances for deferred tax assets
Impairment testing
Contingencies
Vulnerability Due to Significant Concentrations
Example: A firm with 60% of revenues derived from one entity is vulnerable to the loss of that revenue stream.
Concentrations are aspects with insufficient diversification.
Vulnerability Due to Significant Concentrations
Disclosures are required only for concentrations in:1. Volume of business with a particular customer,
supplier, lender, grantor or contributor2. Revenue from specific products, services, or
fundraising sources3. Specific sources (suppliers) of services, materials,
labor, licenses or other rights used in operations4. Market or geographic area of operations
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 102 23 December 2017 4:01 AM
102
Vulnerability Due to Significant Concentrations (continued)
Disclosure is required for concentrations meeting the following three criteria:1. The concentration exists at the balance sheet date.2. The entity is vulnerable, because of the concentration,
to the risk of a "severe impact" that could cause significant financial disruption to the firm, in the near term.
3. It is reasonably possible (less than probable) that events causing a severe impact will occur in the near term.
Vulnerability Due to Significant Concentrations (continued)
Required disclosures for concentrations meeting the above criteria include information enabling users to assess the risk and its possible outcomes.
FAR_Participant_Part1 103 23 December 2017 4:01 AM
103
Subsequent Events
Subsequent Events
Events that occur after the balance sheetdate, but before the financial statementsare issuedExamples: uncollectibility of accounts
receivable, lawsuits, issuance of debt orsecurities, major acquisitions
Embodies the Full Disclosure principle!
Subsequent Events
Subsequent EventsConditions that existed at the balance sheet date:
Require recognition in the financial statements
Conditions that did not exist at the balance sheet date:
Require disclosure in the footnotes
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 104 23 December 2017 4:01 AM
104
Major Differences
US
The cut-off date is when the financial
statements are issued or available to be
issued
IFRSCut-off date for
subsequent events is the date the financial
statements are considered
authorized for issuance
Major Differences
US
Requires adjustment for share splits after
the balance sheet date and before
statement are issued
IFRS
Does not require adjustment for share
splits after the balance sheet date
and before statement are issued
Major Differences
USRefinancing,
amendments and waivers are considered
in determining the classification of debt as current or noncurrent
IFRSRefinancing,
amendments and waivers are not considered in
determining the classification of debt as current or noncurrent
FAR_Participant_Part1 105 23 December 2017 4:01 AM
105
Evaluating Financial StatementsRatios—Liquidity/Solvency and Operational
Ratios—Liquidity/Solvencyand Operational
Categories of RatiosLiquidity/Solvency
Measures the ability to meet maturing obligations
OperationalMeasures the efficiency of operations
ProfitabilityMeasures operational results
EquityMeasures sources of equity
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 106 23 December 2017 4:01 AM
106
This Lesson Covers…Liquidity/Solvency
Measures the ability to meet maturing obligations
OperationalMeasures the efficiency of operations
Purpose of Ratio AnalysisRatio analysis quantifies the relationship between various elements of the financial statements.
Ratio analysis enables comparisons between entities.
Ratio analysis strips the information of magnitude and unit of measure.
Ratios Permit ComparisonAssume you want to compare the performance of a US-based company and a Japanese-based company.
Calculating the profit margin ratio will permit this comparison:
US: NI ÷ Sales = $100 ÷ $2,500 = 4%
Japan: NI ÷ Sales = ¥4,000 ÷ ¥65,000 = 6%
Ratios—Liquidity/Solvency and Operational
FAR_Participant_Part1 107 23 December 2017 4:01 AM
107
Liquidity/Solvency RatiosWorking CapitalCurrent Assets (CA) – Current Liabilities (CL)Measures the extent to which CA exceed CLIf positive, then there are more CA than CLExample: 100 – 80 = 20If negative, then there are more CL than CA80 – 100 = (20)
Liquidity/Solvency RatiosCurrent Ratio (CR)CA ÷ CLStates working capital (WC) in a ratio formIf WC is positive, then the CR > 1Example: 100/80 = 1.25 If WC is negative, then the CR < 1Example: 80/100 = .8
Liquidity/Solvency RatiosAcid or Quick Ratio
Cash + AR + Marketable Securities Current Liabilities
Uses the most “liquid” assets to measure the ability to meet maturing obligationsWill always be less than the current ratio because the numerator excludes CA like inventory
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 108 23 December 2017 4:01 AM
108
Liquidity/Solvency RatiosTimes Interest Earned
NI + Interest Expense + Income Tax Exp
Interest Expense
Measures the ability of current earnings to cover interest costs for the period
Example: 1,000 + 50 + 300 = 27 times50
Current earnings can cover interest 27 times.
Operational RatiosAccounts Receivable (AR) turnover
Net credit sales ÷ Average AR
Example: 1,000 ÷ {(80 + 90) ÷ 2} = 11.76
Number of days in AR = 365 ÷ AR turnover
Example: 365 ÷ 11.76 = 31 days
Measures the average number of days required to collect receivables
Operational RatiosInventory turnover
Cost of Goods Sold ÷ Average Inventory
Example: 800 ÷ {(75 + 85) ÷ 2} = 10
Number of days in Inventory = 365 ÷ Inventory turnover
Example: 365 ÷ 10 = 36.5 days
Measures the average number of days inventory is sold or used
Ratios—Liquidity/Solvency and Operational
FAR_Participant_Part1 109 23 December 2017 4:01 AM
109
Example QuestionTod Corp. wrote off $100,000 of obsolete inventory at December 31, 20X5. The effect of this write-off was to decrease:
A. Both the current and acid-test ratios
B. Only the current ratio
C. Only the acid-test ratio
D. Neither the current nor the acid-test ratios
AnswerThe acid ratio includes only the most liquid assets, cash, AR and marketable securities.
The current ratio included inventory and prepaid assets.
Therefore writing off inventory will effect only the current ratio.
Answer: B
FAR_Participant_Part1 110 23 December 2017 4:01 AM
110
Ratios—Profitability and Equity
Ratios—Profitabilityand Equity
Categories of RatiosLiquidity/Solvency
Measures the ability to meet maturing obligations
OperationalMeasures the efficiency of operations
ProfitabilityMeasures operational results
EquityMeasures sources of equity
Ratios—Profitability and Equity
FAR_Participant_Part1 111 23 December 2017 4:01 AM
111
This Lesson Covers…Profitability
Measures operational resultsEquity
Measures return on equity and degree of equity financing
Purpose of Ratio AnalysisRatio analysis quantifies the relationship between various elements of the financial statements.
Ratio analysis enables comparisons between entities.
Ratio analysis strips the information of magnitude and unit of measure.
Profit MarginNet Income (NI)
Sales
Measures net profitability on sales
Example: 100 ÷ 1,000 = 10%There is a 10% net profit on sales orFor every dollar of sales there is 10¢ of net profit.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 112 23 December 2017 4:01 AM
112
Return on AssetsNet Income
Average Total Assets
Measures the rate of return on total assets; how effectively total assets generate NI
Example: 100 ÷ {(3,000 + 3,500) ÷ 2} = 3.08%
There is a 3.08% return on assets or
For every dollar of assets, 3¢ of NI is produced.
Return on Equity
Net Income
Average Common Stockholders’ Equity
Measures the rate of earnings on common shareholders’ investment
Example: 100 ÷ {(600 + 700) ÷ 2} = 15.38%There is a 15.38% return on CSE orFor every dollar of CSE, 15¢ of NI is produced.
Earnings Per ShareNet Income – Preferred Dividends
Weighted Avg. Common Shares Outstanding
Measures the income per share of common stock (see EPS lessons!)
Example: 100 ÷ 500 = $0.20
For each share of common stock, there was $.20 of net income.
Ratios—Profitability and Equity
FAR_Participant_Part1 113 23 December 2017 4:01 AM
113
Price–Earnings RatioStock price per share
Earnings per share
Measures the price of stock relative to its earnings per share; indicates how the market values the stock
Example: $2.50/$0.20 = 12.5 times
The market has priced this stock at 12.5 times earnings.
Debt–Equity or Leverage RatiosAll are measures of leverage because
A = L + E
L / E, E / A, or L / A
Example: 100 = 60 + 40
L / E = 60 / 40 = 150%: L is 1.5 times E
E / A = 40 / 100 = 40%: 40% financed by E
L / A = 60 / 100 = 60%: 60% financed by L
FAR_Participant_Part1 114 23 December 2017 4:01 AM
114
Consolidated Financial StatementsIntroduction to Consolidated Financial Statements
Introduction to ConsolidatedFinancial Statements
Consolidated Financial Statements
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventory Fixed assets Bonds
IFRSCombined financial statementsVariable interest entities
zager/Getty Images
HIGHLY TESTED TOPIC
Types of CPA Exam Questions
Qualitative
Terminology, definitions, and concepts
Quantitative
What should be reported on consolidated statements?
What should be eliminated?
Task-Based Simulations
Higher-order thinking analysis of a fact pattern
Introduction to Consolidated Financial Statements
FAR_Participant_Part1 115 23 December 2017 4:01 AM
115
Consolidated Statements
Objective is to present the financial statements of entities under common control as if one economic entity.
An entity has control when:
It is the primary beneficiary of a variable interest entity.
It has greater than 50% ownership of another entity.
Consolidation
Pretty Tall Swiss Shalet
Consolidated Financial StatementsBalance SheetIncome StatementStatement of Shareholders’ EquityStatement of Cash Flows
Pretty Tall
Mlenny Photography/Getty Images
Swiss Shalet
Alexander Chaikin/Shutterstock
Mateusz Zagorski/Stockphoto
Benefits of Consolidated Financial Statements
Consolidated financial statements:
Present all economic resources and obligations of the economic entity.
Present economic substance over legal form.
Are more useful to decision makers than separate financial statements.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 116 23 December 2017 4:01 AM
116
Exceptions to Consolidation
Consolidation is not required when the parent cannot exercise control.
There is no effective control when the:
Foreign subsidiary is controlled by foreign government.
Domestic subsidiary is in bankruptcy.
Circumstances that Affect Consolidation
Date the consolidation occurs
Date of business combination or a subsequent date
Percentage ownership
Parent owns 100% or less than 100% of the subsidiary
The type of accounting used by the parent
Cost, equity, or other method
Intercompany transactions between the parent and subsidiary
Hang in there with me. We will make it through the maze!
JuSun/Stockphoto
FAR_Participant_Part1 117 23 December 2017 4:01 AM
117
Consolidating ProcessConsolidation at Acquisition
Consolidation at Acquisition
Consolidated Financial Statements
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventory Fixed assets Bonds
IFRSCombined financial statementsVariable interest entities Vladimir Gjorgiev/Shutterstock
Types of Questions
Amounts reported on the consolidated statements at date of acquisition:
Balance Sheet (P + S + fair value increment)
Income Statement (P entire year)
Statement of Retained Earnings (P only)
Statement of Cash Flows (P entire year)
ALMAGAMI/Shutterstock
Read the question carefully!
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 118 23 December 2017 4:01 AM
118
chictype/Getty Images
TOOL S
Diagrams
T-accounts
Decomposition at acquisition
CPAexcel candidate’s toolbox
Consolidation at Acquisition
Company P
January 1
Statements at the date of acquisition
Acquisition July 1
Company S
Decomposition Tool for Acquisition
Price Paid
Goodwill
Net FV Assets and Liabilities
Unidentifiable asset
Plant assets
Intangible assets
Identifiable assets revalued to FV
(tangible and intangible)
Net BV (Assets – Liabilities)
Valu
e of
S C
ompa
ny
Consolidation at Acquisition
FAR_Participant_Part1 119 23 December 2017 4:01 AM
119
Example 1
Assume Passing (P) purchased 100% of Score (S) for $200,000 on January 1, 20X1. On that date, the book value of S was $150,000, which equals the fair value of all of S’s assets and liabilities except for equipment, which had a FV of $100,000 (the carrying value was $80,000). Any excess price is attributed to goodwill.
Also assume that P owes S $10,000 and S has a receivable from P of $10,000.
Potential question:
Calculate the value of specific (or total) assets, liabilities (or total), or equity (or total) reported on the consolidated balance sheet on the date of acquisition.
Example 1: Decomposition Tool
Price Paid 200,000
Goodwill
Net FV
30,000
170,000
Unidentifiable asset
Equipment 20,000 Identifiable assets revalued to FV
Net BV 150,000
Example 1: Consolidated Balance Sheet Date of Acquisition
Passing Score Elimin Consolidated
Debit Credit Debit Credit Debit CreditCurrent assets 80,000 30,000 100,0001
Inventory 150,000 350,000 500,000Equipment (net) 430,000 80,000 530,0002
Investment in S 200,000 0Goodwill - - 30,000Current liabilities 150,000 110,000 250,0003
Long-term debt 460,000 200,000 660,000Common stock 200,000 140,000 200,0004
Retained earnings 50,000 10,000 50,0004
Totals 860,000 860,000 460,000 460,000 1,160,000 1,160,000
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 120 23 December 2017 4:01 AM
120
Example 1: Calculations
1 P’s current assets 80,000S’s current assets 30,000Less interco accounts rec (10,000)
Consolidated current assets 100,000
2 P’s equipment 430,000S’s equipment 80,000Plus FV adjustment 20,000
Consolidated equipment 530,000
Example 1: Calculations
4 All equity accounts are only P’s.
3 P’s current liabilities 150,000S’s current liabilities 110,000Less interco accounts pay (10,000)
Consolidated current liabilities 250,000
Example 2
Passing Score
Current assets 70,000 20,000
Noncurrent assets 190,000 140,000
Total assets 260,000 160,000
Current liabilities 30,000 10,000
Long-term debt 50,000 -
Stockholders’ equity 180,000 150,000
Totals 260,000 160,000
On January 2, 20X8, Passing (P) borrowed $200,000 and used the proceeds to purchase 100% of the outstanding common shares of Score (S). The principal plus interest is payable in 10 annual installments, beginning December 30, 20X8. The excess cost of the investment over S’s book value of acquired net assets was allocated 60% to inventory and 40% to goodwill.
At the end of business on January 1, 20X8, P and S had condensed balance sheets as follows:
Note: The balance sheet is as of January 1 (preacquisition) and the consolidated balance sheet is January 2 (postacquisition).
Consolidation at Acquisition
FAR_Participant_Part1 121 23 December 2017 4:01 AM
121
Example 2: Potential Questions
Calculate the value reported on the consolidated balance sheet on the date of acquisition:
Assets (components or totals) or
Liabilities (components or totals) or
Equity (components or totals).
Example 2: Decomposition Tool
Price Paid 200,000
Goodwill
Net FV
20,000
180,000
Unidentifiable asset(50,000 × .4)
Inventory 30,000 Identifiable assets revalued to FV
(50,000 × .6)
Net BV 150,000 From the balance sheet
Example 2: Consolidated Balance Sheet January 2, 20X8
Passing Score Consolidated
Current assets 70,000 20,000 120,0001
Noncurrent assets 190,000 140,000 350,0002
Total assets 260,000 160,000 470,000
Current liabilities 30,000 10,000 60,0003
Long-term debt 50,000 - 230,0004
Stockholders’ equity 180,000 150,000 180,0005
Totals 260,000 160,000 470,000
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 122 23 December 2017 4:01 AM
122
Example 2: Calculations1 P’s current assets 70,000
S’s current assets 20,000Inventory revaluation 30,000
Consolidated current assets 120,000
2 P’s noncurrent assets 190,000S’s noncurrent assets 140,000Plus goodwill 20,000
Consolidated noncurrent assets 350,000
Note: The “Investment in S” is not in P’s noncurrent assets because the balance sheet is pre-acquisition.
Example 2: Calculations3 P’s current liabilities 30,000
S’s current liabilities 10,000New debt–current portion 20,000
Consolidated current liabilities 60,000
4 P’s noncurrent liabilities 50,000S’s noncurrent liabilities 0New debt–noncurrent portion 180,000
Consolidated noncurrent liabilities 230,000
5 Only P’s equity.
Total debt 200,000Current portion (20,000)Noncurrent debt 180,000
Consolidating Entries
Eliminate the equity investment in S and the equity reported by S.
Record the incremental revaluation to FV (including goodwill).
Eliminate intercompany payables and receivables.
Eliminate intercompany sales and expenses.
Eliminate intercompany profits.
Consolidation at Acquisition
FAR_Participant_Part1 123 23 December 2017 4:01 AM
123
Consolidating Entries
Investment eliminating entry
Basic to all consolidating processes
Eliminates: Investment in S account on Parent’s booksShareholders’ equity of SubsidiaryRecognizes noncontrolling interest in Subsidiary’s net assets
Avoids multiple counting of same “value”Investment Subsidiary's equity Subsidiary’s assets less liabilities
Consolidating Entries
One version of the entry to eliminating the investment:
The most important thing to know is the balances reported!
DR: Common Stock—Subsidiary DR: Additional Paid-in Capital—Subsidiary DR: Retained Earnings—Subsidiary DR: Differential (if any)
CR: Investment in SubsidiaryCR: Noncontrolling interest (if any)
Hang in there with me. The maze is easier when you have a path!
JuSun/Stockphoto
FAR_Participant_Part1 124 23 December 2017 4:01 AM
124
Consolidation Subsequent to Acquisition
Consolidation Subsequentto Acquisition
Consolidated Financial Statements
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventory Fixed assets Bonds
IFRSCombined financial statementsVariable interest entities
Douglas Allen/iStockphoto
Types of Questions
Amounts reported on the consolidated statements
Balance Sheet (P + S + fair value increment – intercompany balances)
Income Statement (P entire year + S since acquisition – depreciation fair value increment)
Equity accounts (common stock of P only)
Retained earnings of P only, if P used full equity method
ALMAGAMI/Shutterstock
Watch for midyear acquisitions!
Consolidation Subsequent to Acquisition
FAR_Participant_Part1 125 23 December 2017 4:01 AM
125
Midyear Acquisition
Company P
January 1 December 31
S Corporation
July 1July 1
Illustration: Midyear Acquisition
Assume P Company acquired S Corporation on July 1. S Corp earned $400,000 evenly throughout the year and paid dividends on December 31 of $300,000.
What is included in consolidated retained earnings as of December 31?
December 31July 1
,$200,000
$200,000
January 1
Dividends
Net Income
$300,000
Example
Passing (P) purchased 100% of Score (S) for $200,000 on January 1, 20X8. S’s book value of $150,000 equaled the fair value (FV) of all of S’s assets and liabilities except for equipment, which had a FV of $100,000 (the carrying value is $80,000). Any excess price is attributed to goodwill. The equipment has a remaining life of four years.
Calculate the amounts reported on the Consolidated Statements.Balance Sheet (P + S + fair value increment – intercompany balances)Income Statement (P entire year + S since acquisition – depreciation fair value increment)Equity accounts (common stock of P only)
Retained earnings of P only, if P used full equity method
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 126 23 December 2017 4:01 AM
126
Example: Decomposition Tool
Price Paid 200,000
Goodwill
Net FV
30,000
170,000
Unidentifiable asset
Equipment 20,000 Identifiable assets revalued to FV
Net BV 150,000
Example: Consolidated Trial Balance December 31, 20X8Passing Score Elim Consolidated
Debit Credit Debit Credit Debit CreditCurrent assets 80,000 30,000 110,000Inventory 150,000 350,000 500,000Equipment (net) 430,000 80,000 525,0001
Investment in S 245,000 0Goodwill - - 30,000Current liabilities 150,000 110,000 260,000Long-term debt 255,000 150,000 405,000Common stock 200,000 140,000 200,0003
Retained earnings 50,000 10,000 50,0003
Sales 500,000 75,000 575,000Income from S 45,000 0Expenses 295,000 25,000 325,0002
Totals 1,200,000 1,200,000 485,000 485,000 1,490,000 1,490,000
Example: Calculations
1 P’s equipment 430,000S’s equipment 80,000FV adjustmentAccum depr of FV adjust
20,000(5,000)
Consolidated equipment 525,000
2 P’s expenses 295,000S’s expenses 25,000Depreciation of FV adjustment 5,000
Consolidated expenses 325,0003Only P’s Equity
($20,000 / 4 years)
Consolidation Subsequent to Acquisition
FAR_Participant_Part1 127 23 December 2017 4:01 AM
127
Qualitative Question
On January 1, 20X1, Prim, Inc. acquired all the outstanding common shares of Scarp, Inc. for cash equal to the book value of the stock. The carrying amount of Scarp's assets and liabilities approximated their fair values, except that the carrying amount of its building was more than fair value. In preparing Prim's 20X1 consolidated financial statements, which of the following adjustments would be made?
A. Depreciation expense would be decreased, and goodwill would be recognized.B. Depreciation expense would be increased, and goodwill would be recognized.C. Depreciation expense would be decreased, and no goodwill would be
recognized.D. Depreciation expense would be increased, and no goodwill would be
recognized.Copyright © 2007 by the American Institute of Certified Public Accountants, Inc., is reprinted and/or adapted with permission.
Qualitative Answer: A
Use simple numbers to answer abstract questions.
Price Paid 100
Goodwill
Net FV (Assets – Liabilities)
?
90
Building (10)
Net BV (Assets – Liabilities) 100Copyright © 2007 by the American Institute of Certified Public Accountants, Inc., is reprinted and/or adapted with permission.
Quantitative Quiz
On January 1, 20X9, Prairie Corp. purchased all of Shade Co.'s common stock for $1,200,000. On that date, the fair values of Shade's assets and liabilities equaled their carrying amounts of $1,420,000 and $220,000, respectively. During 20X9, Shade paid cash dividends of $20,000.
Prairie Shade
Investment in Shade 1,320,000 -
Retained Earnings 1,240,000 560,000
Total Equity 2,620,000 1,320,000
Operating Income 420,000 200,000
Equity Earnings of Shade
140,000 -
Net Income 400,000 140,000
What should be reported as retained earnings on the consolidated balance sheet?
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 128 23 December 2017 4:01 AM
128
Quantitative Answer
Prairie uses fully adjusted equity method because the equity investment and equity earnings equals what is reported by Shade.
Therefore, consolidated retained earnings will equal $1,240,000.
Investment in ShadePurchase 1/1/X9 1,200,000Net Income 140,000 20,000 DividendsBalance 12/23/X9 1,320,000
Shade’s Equity1,200,000 Bal 1/1/X9
Dividends 20,000 140,000 Net Income1,320,000 Bal 12/23/X9
Quantitative Quiz TwistPrairie Shade
Investment in Shade 1,200,000 -
Retained earnings 1,120,000 560,000
Total Equity 2,620,000 1,320,000
Operating Income 420,000 200,000
Dividend Income 20,000 -
Net Income 280,000 140,000
If Prairie used cost method, then the balance in the equity investment would be $1,200,000 and only dividends would have been recorded by Prairie as income.
ANSWER:P’s Retained Earnings 1,120,000S’s Net Income 140,000S’s Dividends (20,000)Consolidated RE 1,240,000
P S1,200,000 ≠ 1,320,000
20,000 ≠ 140,000
Tips and Hints
Read what the question is asking first.
Watch out for midyear acquisitions.
If full equity method is used, consolidated RE equals P’s!
Don’t let irrelevant information throw you off.
ALMAGAMI/Shutterstock
Consolidation Subsequent to Acquisition
FAR_Participant_Part1 129 23 December 2017 4:01 AM
129
Hang in there. You are gaining the tools to success!
JuSun/Stockphoto
Creativeye99/Getty Images
Use Your Toolbox!
chictype/Getty Images
Diagrams
T-accounts
Decomposition at acquisition
CPAexcel candidate's toolbox
FAR_Participant_Part1 130 26 December 2017 11:01 PM
130
Consolidation Less than 100% Ownership
Consolidation Less Than100% Ownership
Consolidated Financial Statements
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventory Fixed assets Bonds
IFRSCombined financial statementsVariable interest entities
Snvv/Shutterstock
Noncontrolling Interest
When P owns > 50% of S, P controls S, and consolidation is required.
When P owns > 50% but < 100% of S, 100% of S is still consolidated; the portion not acquired by P is owned by the noncontrolling interest.
Sashkin/Shutterstock
Noncontrolling interest of S
P’s ownership of S is controlling interest
Consolidation Less than 100% Ownership
FAR_Participant_Part1 131 23 December 2017 4:01 AM
131
The Coca-Cola Company Noncontrolling Interest: Income Statement
The Coca-Cola Company, 2016 10K
The Coca-Cola Company Noncontrolling Interest: Balance Sheet
The Coca-Cola Company, 2016 10K
ExampleP (Passing) purchased 80% of S (Score) for $200,000 on January 1, 20X8. On that date, the net book value of S was $150,000, which equaled the fair value (FV) of all of S's assets and liabilities except for equipment. Equipment had a FV of $100,000 and carrying value of $80,000. Any excess price was attributed to goodwill. The remaining life of the equipment was four years. The fair value of the noncontrolling interest was $50,000.
Calculate the amounts reported on the Consolidated StatementsBalance Sheet (P + S + fair value increment – intercompany balances)Income Statement (P entire year + S since acquisition – depreciation FV increment)Equity accounts (P only)Net income to noncontrolling interestNoncontrolling interest equity
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 132 23 December 2017 4:01 AM
132
Example: Decomposition
100% 80% 20%Price Paid 250,000 200,000 50,000
Goodwill 80,000 64,000 16,000
Net FV 170,000 136,000 34,000
Equipment 20,000 16,000 4,000
Net Book Value 150,000 120,000 30,000
Example: Consolidated Trial Balance December 31, 20X8Passing Score Elim Consolidated
Debit Credit Debit Credit Debit CreditCurrent assets 80,000 30,000 110,000Inventory 150,000 350,000 500,000Equipment (net) 430,000 80,000 525,0001
Investment in S 236,000 0Goodwill 0 0 80,0002
Current liabilities 150,000 110,000 260,000Long-term debt 260,000 150,000 410,000Common stock 200,000 140,000 200,0003
Retained earnings 50,000 10,000 50,0003
NCI Equity 0 0 59,0005
Sales 500,000 75,000 575,000Income from S 36,000 0Expenses 300,000 25,000 330,0004
Income to NCI 0 0 9,0006
Totals 1,196,000 1,196,000 485,000 485,000 1,554,000 1,554,000
Example: Equity Method Accounting
Equity Investment in S Equity Income from SCost 200,000 0 Dividends
Depr of equip 4,000(80% × 5,000)
40,000 P’s share of S’s NI (80% × 50,000)
P’s % S’s NI 40,000 (80% × 50,000)
4,000 Depr of equip(80% × 5,000)
Ending Bal 236,000 36,000 Ending Bal
Consolidation Less than 100% Ownership
FAR_Participant_Part1 133 23 December 2017 4:01 AM
133
Example: Calculations
1 P’s equipment 430,000S’s equipment 80,000FV adjustmentAccum depreciation of FV
20,000(5,000)
Consolidated equipment 525,000
2 Goodwill 80,000Impairment 0
Consolidated goodwill 80,000
3 Only P’s equity
4 P’s expenses 300,000S’s expenses 25,000Depreciation of FV adjustment 5,000
Consolidated expenses 330,000
Example: NCI Calculations5 S’s Net book value *200,000
+ FV adjustment 80,000― Depreciation FV adjustment― Goodwill impairment
(5,000)0
S’s adjusted Net book value 295,000× NCI percentage .20
NCI Equity 59,000
S’s Beginning NBV 150,000 S’s NI 50,000
S’ Ending NBV *200,000
6 S’s Net Income 50,000― Depreciation of FV adjustment (5,000)― Goodwill impairment 0
S’s adjusted Net Income 45,000NCI percentage .20
Income to NCI 9,000
Calculation of Noncontrolling Interest Equity
S’s net book value (at end of the year)
Plus: 100% of the FV increment
Less: accumulated depr/amort of FV increment
Less: goodwill impairment loss
S’s adjusted NBV
NCI % ownership of S
NCI Equity
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 134 23 December 2017 4:01 AM
134
S’s Net Income
Less: depreciation / amortization of differential
Less: goodwill impairment loss
S’s adjusted net income
NCI % ownership of S
Income to NCI
Calculation of Income to Noncontrolling Interest
Example Quantitative QuestionOn January 1, 20X6, Ritt Corp. purchased 80% of Shaw Corp.'s $10 par common stock for $940,000. On this date, the carrying amount of Shaw's net assets was $1,000,000.
The fair values of Shaw's identifiable assets and liabilities were the same as their carrying amounts except for plant assets (net), which were $100,000 in excess of the carrying amount. Those plant assets had a 10-year remaining life, depreciated on a straight-line basis.
The fair value of the 20% noncontrolling interest in Shaw was properly determined to be $235,000 at that time. For the year ended December 31, 20X6, Shaw had net income of $190,000 and paid cash dividends totaling $125,000.
1. What would be reported as noncontrolling interest in a consolidated balance sheet prepared December 31, 20X6?
2. What is the income to the noncontrolling interest that would be reported on the consolidated income statement for the year ended December 31, 20X6?
Copyright © 2007 by the American Institute of Certified Public Accountants, Inc., is reprinted and/or adapted with permission.
Example: Decomposition
100% 80% 20%Price Paid 1,175,000 940,000 235,000
Goodwill 75,000 60,000 15,000
Net FV 1,100,000 880,000 220,000
Equipment 100,000 80,000 20,000
Net Book Value 1,000,000 800,000 200,000
Note: 10-year life
Consolidation Less than 100% Ownership
FAR_Participant_Part1 135 23 December 2017 4:01 AM
135
S’s Net book value (at end of the year)* 1,065,000
Plus: 100% of FV increment 175,000
Less: accumulated depr/amort FV incr (10,000)
S’s adjusted NBV 1,230,000
NCI % ownership of S .20
NCI Equity 246,000
Calculation of Noncontrolling Interest Equity
S’s Beg NBV 1,000,000
S’s NI 190,000
S’s Dividends (125,000)
S’s End NBV *1,065,000
S’s Net Income 190,000Less: depr/amort FV increment (10,000)
S’s adjusted net income 180,000NCI % ownership of S .20
Income to NCI 36,000
Calculation of Income to Noncontrolling Interest
Hang in there. The path is becoming clearer!
JuSun/Stockphoto
Courtney Keating/Getty Images
FAR_Participant_Part1 136 23 December 2017 4:01 AM
136
Intercompany (I/C) Transactions and BalancesIntercompany I/C Transactions and Balances—Introduction
Intercompany (I/C)Transactions and
Balances—Introduction
Consolidated Financial Statements
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventory Fixed assets Bonds
IFRSCombined financial statementsVariable interest entities
Liliya Kandrashevich/Shutterstock
Intercompany (I/C) Transactions and Balances
All intercompany transactions and balances must be removed (eliminated) as if they never occurred.
You cannot have a transaction with yourself!
The Parent and Subsidiary are one economic entity.
Transactions reported by the consolidated entity are only those with outside third parties.
Intercompany I/C Transactions and Balances—Introduction
FAR_Participant_Part1 137 23 December 2017 4:01 AM
137
Exam Pointers
Carefully read the problem to make sure you answer the question asked.
The question will ask either:
What should be on the consolidated statement? or
What amount needs to be eliminated?
chictype/Getty Images
TOOL S
Diagrams
Journal entries
Should be-is-difference table
CPAexcel candidate’s toolbox
Downstream
Outsidethird party
Upstream
Outsidethird party
Tools: Diagrams
P S
Economic Entity
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 138 23 December 2017 4:01 AM
138
Tools: Journal Entries AR / AP
PDownstream
S
Assume P sells consulting services to S for $10,000 and S owes P $3,000 for the services.
DR: Cash 7,000
DR: Accounts Rec 3,000
CR: Other income 10,000
DR: Expense 10,000
CR: Cash 7,000
CR: Accts Payable 3,000
Consolidating Entries
DR: Other Income 10,000
CR: Expense 10,000
DR: Accts Payable 3,000
CR: Accts Receivable 3,000
PUpstream
S
Tools: Journal Entries AR / APAssume S sells consulting services to P for $10,000 and P owes S $3,000 for the services.
DR: Expense 10,000CR: Cash 7,000CR: Accts Payable 3,000
DR: Cash 7,000
DR: Accts Receivable 3,000
CR: Other Income 10,000
Consolidating Entries
DR: Other Income 10,000
CR: Expense 10,000
DR: Accts Payable 3,000
CR: Accts Receivable 3,000
Qualitative Question
Which one of the following is not a characteristic associated with intercompany transactions?
A. Intercompany transactions must be eliminated in the consolidating process.
B. Intercompany gains and losses must be eliminated in the consolidating process.
C. Transactions that originate with a subsidiary must be eliminated in the consolidating process.
D. Transactions between two subsidiaries to be consolidated with the same parent do not need to be eliminated.
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., is reprinted and/or adapted with permission.
Intercompany I/C Transactions and Balances—Introduction
FAR_Participant_Part1 139 23 December 2017 4:01 AM
139
Qualitative Answer
When a question is stated in the null form, “which of the following is not”—read through each response to determine if it is true or false.
Answer D is a false statement.
Quantitative Quiz
In order to carry out its operations, each subsidiary of Plumber Corp. has a specialization. The following intercompany balances are on Plumber’s trial balance for the fiscal year ended June 30.
On the June 30 consolidated balance sheet, what amount should Plumber report as intercompany receivables?
Debit CreditAccounts receivable from Sewer Co. 105,000Notes receivable from Sewer Co. 6,150Cash advance to Construction, Inc. 452,600Cash advance from Jetting Co. 157,000Accounts payable to Jetting Co. 411,230
Quantitative Answer
Zero intercompany receivables would be reported. All intercompany accounts will be eliminated.
If any of these subsidiaries were not controlled or if control was temporary, then they would not be consolidated and the payable or receivable would not be eliminated.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 140 23 December 2017 4:01 AM
140
Making our way!
VLADGRIN/Getty Images
FAR_Participant_Part1 141 23 December 2017 4:01 AM
141
Intercompany (I/C) Inventory Transactions
Intercompany (I/C) InventoryTransactions
Consolidated Financial Statements
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventoryFixed assets Bonds
IFRSCombined financial statementsVariable interest entities
George Dolgikh/Shutterstock
Types of Questions
Questions usually ask either:
What should be on the consolidated statement? or
What amount needs to be eliminated?
Carefully read the problem to make sure you answer the question asked!.
rSnapshopPhotos/Shutterstock
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 142 23 December 2017 4:01 AM
142
chictype/Getty Images
TOOL S
Diagrams
Journal entries
Should be-is-difference table
CPAexcel candidate’s toolbox
Tools: Diagram
Downstream
Upstream
P SOutsidethird party
Outsidethird party
Cost
CostSelling Price
Selling Price
NOTE: The arrows depict the flow of goods, not cash.
Tools: Table
Should be(If interco
transaction had not occurred)
What is (on the general ledger of P and S)
P S
Difference(Eliminating
entry)
Sales
CGS
Inventory
Intercompany (I/C) Inventory Transactions
FAR_Participant_Part1 143 23 December 2017 4:01 AM
143
16,000 20,000 0P S
Outsidethird party
Outsidethird party
P purchased inventory for $16,000 and sold it to S for $20,000. S held the inventory at year-end.
20,000
Example: Downstream 100% of Inventory Held
Example: Downstream100% of Inventory Held
Should be What is P S
Difference
Sales 0 20,000 0 20,000 dr
CGS 0 16,000 0 16,000 cr
Inventory 16,000 0 20,000 4,000 cr
16,000 20,000 0P S
Outsidethird party
Outsidethird party20,000
Example: Downstream 30% of Inventory Held
16,000 20,000 14,000
P SOutside
third partyOutside
third party
P purchased inventory for $16,000 and sold it to S for $20,000. S held 30% of the inventory at year-end.
6,000
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 144 23 December 2017 4:01 AM
144
Example: Downstream30% of Inventory Held
Should be What is P S
Difference
Sales ? 20,000 ? 20,000 dr
CGS 11,200(16,000 × .7)
(16,000 + 14,000) 18,800 cr
Inventory 4,800(16,000 × .3)
0 6,000 1,200 cr
16,000 20,000 14,000P S
Outsidethird party
Outsidethird party
6,000
Example: Upstream 100% of Inventory Held
0 38,00020,000
P S
Outsidethird party
Outsidethird party
S purchased inventory for $20,000 and sold to P for $38,000. P held the inventory at year-end.
38,000
Example: Upstream100% of Inventory Held
Should be What is P S
Difference
Sales 0 0 38,000 38,000 dr
CGS 0 0 20,000 20,000 cr
Inventory 20,000 38,000 0 18,000 cr
0 38,000 20,000P S
Outsidethird party
Outsidethird party
38,000
Intercompany (I/C) Inventory Transactions
FAR_Participant_Part1 145 23 December 2017 4:01 AM
145
Example: Upstream 30% of Inventory Held
26,600 38,000 20,000P S
Outsidethird party
Outsidethird party
S purchased inventory for $20,000 and sold to P for $38,000. P held 30% of the inventory at year-end.
11,400
Example: Upstream30% of Inventory Held
Should be What is P S
Difference
Sales ? ? 38,000 38,000 dr
CGS 14,000(20,000 × .7)
(26,600 + 20,000) 32,600 cr
Inventory 6,000(20,000 × .3)
11,400 0 5,400 cr
26,600 38,000 20,000P S
Outsidethird party
Outsidethird party
11,400
Example Question
During the year, Papa Company sold inventory, which cost $18,000, to its subsidiary Sonny for $30,000. At the end of the year, Sonny held $10,000 of the intercompany goods. The balance had been resold to unaffiliated customers for $24,000. What should be reported as:
inventory on the consolidated financial statements?sales on the consolidated financial statements ?cost of sales on the consolidated financial statements?intercompany profit to be eliminated?
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., is reprinted and/or adapted with permission.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 146 23 December 2017 4:01 AM
146
Example Question Diagram
18,000 30,00024,000 selling price
20,000 CGSP S
Outsidethird party 10,000
Outsidethird party
Example Question: Table
Should be What is P S
Difference
Sales 24,000 (30,000 + 24,000) 30,000 dr
CGS 12,000(18,000 × 2/3)
(18,000 + 20,000) 26,000 cr
Inventory 6,000(18,000 × 1/3)
0 10,000 4,000 cr
18,000 30,000 24,000 SPP S
Outsidethird party
Outsidethird party10,000
Practice!
Don’t let information overwhelm you.
Practice using tools.
Read strategically.
Don’t let distractors get to you.
Intercompany (I/C) Inventory Transactions
FAR_Participant_Part1 147 23 December 2017 4:01 AM
147
On our way out of the maze!
VLADGRIN/Getty Images
FAR_Participant_Part1 148 23 December 2017 4:01 AM
148
Intercompany (I/C) Fixed Asset Transactions
Intercompany (I/C) FixedAsset Transactions
Consolidated Financial Statements
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventory Fixed assets Bonds
IFRSCombined financial statementsVariable interest entities 5PH/Shutterstock
Intercompany (I/C) Fixed Asset Transactions
A gain or loss cannot be recognized on the intercompany sale/purchase.The asset’s carrying value, depreciation expense, and accumulated depreciation must be adjusted to the original cost from an outside third party.
Questions usually ask either:
What should be reported on the consolidated financial statements? or
What should be eliminated?
Intercompany (I/C) Fixed Asset Transactions
FAR_Participant_Part1 149 23 December 2017 4:01 AM
149
chictype/Getty Images
TOOL S
Diagrams
Journal entries
Should be-is-difference table
CPAexcel candidate’s toolbox
Example: Sale of Land
On December 31, P sold land to S for $150,000. The land originally cost P $130,000. S still holds the land.
130,000P S
Outsidethird party
150,000
Outsidethird party150,000
Example: Sale of Land
To understand the transaction, it helps to first evaluate the journal entries each company made at the date of the sale. Here are the entries that P and S would have made on December 31.
On P’s Books On S’s BooksDR: Cash 150,000 DR: Land 150,000
CR: Land 130,000 CR: Cash 150,000CR: Gain on sale 20,000
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 150 23 December 2017 4:01 AM
150
Example: Land
To help keep straight what the consolidated amount should be, prepare a table that compares the original asset basis to the intercompany asset basis.
Should be What is Difference
Land 130,000 150,000 20,000 cr
Gain on sale 0 20,000 20,000 dr
Example: Depreciable Asset Diagram
Now suppose on December 31, P sold equipment to S for $7,000. The equipment originally cost $9,000. The equipment had an original life of 10 years, and P held the equipment for 3 years before the sale to S.
9,000P S
7,000
9,000 / 10 yrs = 900 depr 7,000 / 7 yrs =
1,000 depr
Example: Depreciable Asset Calculate Gain or Loss
9,000P S
7,000
9,000 / 10 yrs= 900 depr 7,000 / 7 yrs
= 1,000 depr
Gain on date of saleCost 9,000Accumulated depr 2,700Net book value 6,300Selling price 7,000Gain 700
Tip: The gain or loss divided by remaining life equals the difference in depreciation! 700 / 7 years = 100!
Intercompany (I/C) Fixed Asset Transactions
FAR_Participant_Part1 151 23 December 2017 4:01 AM
151
Example: Depreciable Asset Transaction Entries
The journal entries each company made at the date of the sale:
On P’s Books On S’s BooksDR: Depreciation expense 900
CR: Accum depreciation 900
DR: Cash 7,000 DR: Equipment 7,000DR: Accum deprecation 2,700 CR: Cash 7,000
CR: Equipment 9,000CR: Gain on sale 700
Example: Depreciable Asset—Year 1
Should be What is Difference
Equipment 9,000 7,000 2,000 dr
Accumulated depreciation 2,700 0 2,700 cr
Depreciation expense 900 900 0
Gain on sale 0 700 700 dr
Example: Depreciable Asset—Year 2
Should be What is Difference
Equipment 9,000 7,000 2,000 dr
Accumulated depreciation 3,600 1,000 2,600 cr
Depreciation expense 900 1,000 100 cr
Retained earnings (plug) - - 700 dr
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 152 23 December 2017 4:01 AM
152
Quantitative Quiz
Pug Corp. (P) owns 80% of Sheltie Co.'s (S) common stock. On January 2, Year 1, P sold to S for $245,000, machinery with a carrying amount of $210,000. S is depreciating the acquired machinery over the remaining 7-Year life by the straight-line method. The net adjustments to compute Year 1 and Year 2 consolidated income before income tax would be an increase (decrease) of:
Year 1 Year 2A. ($30,000) $5,000B. ($30,000) $4,000C. ($35,000) $5,000D. ($35,000) $4,000
Quantitative SolutionAnswer: A
35,000 gain / 7 years = 5,000 difference in depreciation
Year 1: The sale occurred at the beginning of the year, so the impact on net income is a debit to remove the 35,000 gain, less the credit for the 5,000 depreciation adjustment (net 30,000). The percentage ownership (80%) is not relevant 100% is eliminated.
Year 2: The only impact on consolidated net income is the 5,000 depreciation adjustment.
Book value 210,000Selling price 245,000Gain 35,000
Qualitative Question
An intercompany depreciable fixed asset transaction resulted in an intercompany gain. Which one of the following is least likely to be reflected in the consolidated financial statements prepared at the end of the period in which the intercompany transaction occurred?
A. Consolidated income will be less than the sum of the incomes of the separate companies being combined.
B. Consolidated assets will be less than the sum of the assets of the separate companies being combined.
C. Consolidated depreciation expense will be more than the sum depreciation expense of the separate companies being combined.
D. Consolidated accumulated depreciation will be more than the sum of accumulated depreciation of the separate companies being combined.
Copyright © 2009 by the American Institute of Certified Public Accountants, Inc., is reprinted and/or adapted with permission.
Intercompany (I/C) Fixed Asset Transactions
FAR_Participant_Part1 153 23 December 2017 4:01 AM
153
Qualitative Answer: C
SB Is Diff
Equipment 10,000 8,000 2,000 dr
Accum depr 4,000 0 4,000 cr
Depr exp ? ?
Gain on sale 0 2,000 2,000 dr
The question is in null form; find the false statement. Use simple numbers to answer the question.
Consolidated assets
Consolidated income
Almost there!
photosindia/Getty Images
FAR_Participant_Part1 154 23 December 2017 4:01 AM
154
Intercompany (I/C) Bond Transactions
Intercompany (I/C) BondTransactions
Consolidated Financial Statements
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventory Fixed assets Bonds
IFRSCombined financial statementsVariable interest entities
Branislav Senic/Alamy Stock Photo
Intercompany (I/C) Bond Transactions
When an entity purchases the bonds issued by an affiliate that is consolidated, the purchase is a constructive retirement of the bonds.
Investment in Bonds/Bonds Payable is overstated by face amount of the bonds.
Premium/Discount on Investment in Bonds/Bonds Payable is overstated. Interest Income/Interest Expense is overstated by amounts related to I/C bonds.Interest Receivable/Interest Payable is overstated by amounts related to I/C bonds.
Intercompany (I/C) Bond Transactions
FAR_Participant_Part1 155 23 December 2017 4:01 AM
155
Illustration: Intercompany Bond Elimination
P’s Books S’s Books EliminationBonds Payable 100,000 cr 100,000 drPremium on Bonds Payable 3,000 cr 3,000 drInvestment in Bonds 100,000 dr 100,000 crPremium on Investment in Bonds 6,000 dr 6,000 cr
Gain or Loss on Retirement of Bonds 3,000 dr
Assume S purchased $100,000 of P’s bonds on the market for a premium of $6,000. P originally issued the bonds for a premium, and $3,000 is unamortized on the date of S’s purchase.
Eliminations in Subsequent Periods
Interest Revenue/Interest Expense on I/C Bonds:
Interest Payable/Interest Receivable on I/C Bonds:
DR: Interest RevenueCR: Interest Expense
DR: Interest PayableCR: Interest Receivable
You can always do more than you think you can.
Tischenko Irina/Shutterstock
FAR_Participant_Part1 156 23 December 2017 4:01 AM
156
IFRS—Consolidations
IFRS—Consolidations
Consolidated Financial Statements
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventory Fixed assets Bonds
IFRSCombined financial statementsVariable interest entities
Viktor1/Shutterstock
U.S. GAAP IFRS Differences
U.S. IFRS
Control defined as > 50% ownership. Control can be obtained with < 50% ownership in certain circumstances (i.e., potential rights or decision-making rights).
Defines variable interest entities. Does not define variable interest entities but has similar concept with special-purpose entities.
Accounting policies of P and S do not have to align.
Accounting policies of P and S have to align.
IFRS—Consolidations
FAR_Participant_Part1 157 23 December 2017 4:01 AM
157
U.S. GAAP IFRS Differences
U.S. IFRS
Accounting periods can be up to three months apart.
Accounting periods should have the same end date; if not, adjust for transactions during gap period.
Noncontrolling interest is assigned its percentage of goodwill at date of acquisition.
Parent has a choice at acquisition date whether or not to assign goodwill to noncontrolling interest (NCI).
Noncontrolling Interest U.S. GAAP and IFRS
Goodwill is assigned to the noncontrolling interest.
100% Parent share 80%
NCI share 20%
Total FV 200 160 40
Goodwill 25 20 5
FV net assets 175 140 35
FV increment 75 60 15NBV 100 80 20
100% Parent share 80%
NCI share 20%
Total FV 195 160 35
Goodwill 20 20 0
FV net assets 175 140 35
FV increment 75 60 15NBV 100 80 20
Noncontrolling Interest Option under IFRS
Goodwill is not assigned to the noncontrolling interest.
FAR_Participant_Part1 158 23 December 2017 4:01 AM
158
Combined Financial Statements
Combined FinancialStatements
Combined Financial Statements
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventory Fixed assets Bonds
IFRSCombined financial statementsVariable interest entities
pick/Shutterstock
Combined vs. Consolidated Financial Statements
Combined statements appropriate when:
Common control—one individual owns two or more entities
Common management—two or more entities under common
management
Unconsolidated subsidiaries—combine results of two or more
unconsolidated subsidiaries
FAR_Participant_Part1 159 23 December 2017 4:01 AM
159
Office buildings Retail buildings Restaurant buildings
Super CPA
Colin Anderson/Getty Images
Office buildings
Retail buildings
Restaurant buildings
Super CPA Management
Rawpixel.com/Shutterstock
Combined Financial Statements
The process of combining financial statements includes:Eliminating intercompany transactions/balances
Intercompany receivables/payablesIntercompany revenues/expensesIntercompany gains/lossesIntercompany ownership/equity, if any
There is no goodwill or bargain purchase.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 160 23 December 2017 4:01 AM
160
Mr. Allen owns all of the common stock of Astro Company and 80% of the common stock of Bio Company. Astro owns the remaining 20% interest in Bio's common stock, for which it paid $8,000, and which it carries at cost, because there is no ready market for Bio's stock. The condensed balance sheets for Astro and Bio as of December 31 were:
What would be reported as equity on the combined financial statements of Astro and Bio?
Astro BioAssets 300,000 120,000Liabilities 100,000 60,000Common Stock 50,000 40,000Retained Earnings 150,000 20,000
Copyright © 2008 by the American Institute of Certified Public Accountants, Inc., is reprinted and/or adapted with permission.
Example Question
Copyright © 2008 by the American Institute of Certified Public Accountants, Inc., is reprinted and/or adapted with permission.
Answer
Astro's investment in Bio would be eliminated.
Astro's equity 200,000
Bio's equity 60,000
less Astro's investment in Bio (8,000)
252,000
FAR_Participant_Part1 161 23 December 2017 4:01 AM
161
Variable Interest Entities (VIEs)
Variable Interest Entities(VIEs)
Variable Interest Entities (VIEs)
IntroductionConsolidating process
At acquisition Subsequent to acquisition Less than 100% ownership
Intercompany transactionsIntroductionInventory Fixed assets Bonds
IFRSCombined financial statementsVariable interest entities
Monkey Business Images/Shutterstock
Voting and VIE Model for Consolidation
Is the entity a variable interest entity (VIE)?
If yes, is the investor the primary beneficiary?
Yes = Consolidate VIE.
If no, does the investor have > 50% voting ownership?
Yes = Consolidate.
No = Do not consolidate; report as investment.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 162 23 December 2017 4:01 AM
162
Variable Interest Entity (VIE) Defined
A VIE is a legal entity which by design:
Cannot finance its activities without additional subordinated financial support, or
Expected losses exceed its total equity investment at risk, or
Its equity holders, as a group, do not have the direct or indirect ability to make decisions about the VIE’s activities, or
Shareholders do not control the entity.
VIE Characteristics
May be a partnership, joint venture, legal trust, or corporation
Set up for a well-defined, limited purpose
Sponsor or sponsors provide most of its resources
Activities are governed largely by contract or agreement and rest with sponsors, not shareholders.
Risks and rewards are largely attributable to sponsors.
Value of sponsor interest increases/decreases with changes in net asset value of the VIE.
Consolidation of VIEs
The primary beneficiary of a VIE will consolidate the VIE.
Primary beneficiary must meet two conditions:
Power criterion—power to direct the activities of VIE that significantly impact the VIE’s economic performance, and
Losses/benefits (or risk/rewards) criterion—has obligation to absorb losses from or right to receive benefits of the VIE.
Variable Interest Entities (VIEs)
FAR_Participant_Part1 163 23 December 2017 4:01 AM
163
Example VIE Fact Pattern
VIEco was established to construct and lease the office building that houses Pamco’s headquarters. Pamco then leases the building from VIEco. VIEcoobtains long-term financing from Bankco using the building as collateral.
Pamco and Bankco share gains and losses of VIEco 60% and 40%, respectively. Pamco enjoys the use of the building without carrying the asset or debt. VIEco carries the building as an asset and uses the lease payments collected from Pamco to pay the debt to Bankco.
Example: VIE Illustration
Example: VIE
The primary beneficiary of VIEco is Pamco.
Power criterion—Pamco has the power to direct the activities of VIEcothat impact VIEco’s economic performance, and
Losses/benefits (or risk/rewards) criterion—Pamco has obligation to absorb losses from or right to receive benefits of VIEco.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 164 23 December 2017 4:01 AM
164
Pedro Nogueira/Shutterstock
CPA Exam
FAR_Participant_Part1 165 23 December 2017 4:01 AM
165
Exit or Disposal Activities and Discontinued Operations
Exit or Disposal Activities and
Discontinued Operations
Exit or DisposalA company may sell, dispose, abandon or involuntarily convert a plant assetRecord depreciation up to the date of saleCalculate a gain or loss
Asset cost– Accumulated depreciation
Asset net book value– Cash received
Gain or loss
Exit or Disposal—DisclosuresDescription of the facts and circumstances
Expected manner and timing of the disposal
Gain or loss on disposal
Where gain is reported on the income statement
If held-for-disposal present separately on the balance sheet
Segment in which the asset belongs
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 166 23 December 2017 4:01 AM
166
Discontinued OperationsDisposal of a component of a business is a discontinued operation only if it represents a “strategic shift” that will have a major impact on the entity’s operating results.
Examples of Strategic ShiftDisposal of
A major geographic area
A line of business
An equity method investment
Income Statement ReportingThese amounts are reported below Income from Continuing Operations, on an after-tax basis, in a separate section labeled Discontinued Operations
Earnings per share for Discontinued Operations is presented.
Discontinued Operations is the only item separated from Continuing Operations.
Exit or Disposal Activities and Discontinued Operations
FAR_Participant_Part1 167 23 December 2017 4:01 AM
167
Income Statement ReportingThe operating income (loss) of the discontinued component is reported as discontinued for all periods presented.
If a component is discontinued in 20X8, the income statement reports the operating income of the component for 20X6 and 20X7 in the discontinued operations section for comparative purposes.
Balance SheetThe carrying amount of major classes of assets and liabilities included as part of a discontinued operations are classified as Held-for-Sale.
The disposal group held for sale should be remeasured at the lower of its carrying value or fair value less selling costs. The resulting gain or loss is included in the income or loss from discontinued operations.
All prior periods are also adjusted.
Comparative StatementsPrior year financial statements are always reported comparatively with the current year.
The component in discontinued operations must be segregated in the previous years.
Although the component was not discontinued in those years, financial results for all years presented should be on the same basis.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 168 23 December 2017 4:01 AM
168
DisclosuresFor disposals that meet the criteria for a discontinued operation and for individually significant disposals that do not meet the criteria:
Facts and circumstances leading to the disposal
Expected manner and timing of the disposal
Information about continuing involvement after the disposal date
Disclosures (continued)Major line items of income (revenue, cost of sales, depreciation, etc.)
The total operating and investing cash flows of the discontinued operation
The depreciation, amortization, capital expenditures, and significant noncashoperating and investing items
Two CasesReporting is affected by whether the decision to discontinue, and the discontinuation itself, take place in the same period:
1. Decision and discountinue occur in the same period
2. Discontinuation occurs in a later period. In this case, estimated disposal losses are estimated and recognized (but not gains). No estimate of operational income or losses in future periods.
Exit or Disposal Activities and Discontinued Operations
FAR_Participant_Part1 169 23 December 2017 4:01 AM
169
Case 1 ExampleIncome from continuing operations is $10,000 for the current year. On December 1, the company discontinued a business component and sold the entire component for $14,000:
1. The loss from operating the component for the current year was $700 (net of tax).
2. The net book value (assets less liabilities) of the component is $13,000 on Dec 1.
3. The tax rate is 40%.
Reporting FormatIncome from continuing operations $10,000Discontinued operations:– Loss from operation of discontinued component (net of tax) (700)+ Gain on the disposal of discontinued component (net of tax) 600*
(100)Net Income $ 9,900* ($14,000 – $13,000)(1 – .40)
Comparative StatementsPrior year financial statements are always reported comparatively with the current year.
The component in discontinued operations must be segregated in the previous years.
Although the component was not discontinued in those years, financial results for all years presented should be on the same basis.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 170 23 December 2017 4:01 AM
170
Case 2 Example Income from continuing operations is $10,000 for the current year. The company decided to discontinue a component.
Actual disposal is expected next year. The fair value of the component is $11,000 (after estimated cost to sell):
1. The loss for operating the component for the current year was $700 (net of tax).
2. The net book value of the component was $13,000.
Reporting FormatIncome from continuing operations $10,000Discontinued operations:– Loss from operation of discontinued component (net of tax) (700)– Estimated loss on the disposal of discontinued component (net of tax) (1,200)*
(1,900) Net Income $ 8,100* ($11,000 – $13,000)(1 – .40)
Next YearIf the actual loss is not equal to the estimated amount, the difference is reported in next year’s discontinued operations section.
In this example, if the actual loss in year 2were only $1,000, a $200 disposal gain would be reported in year 2 in the discontinued operations section of the income statement.
Exit or Disposal Activities and Discontinued Operations
FAR_Participant_Part1 171 23 December 2017 4:01 AM
171
Next Year (continued)If a disposal gain had been estimated in the year of the decision to dispose, the gain is not recognized.
Rather, the actual disposal gain is recognized in the year of disposal and reported in the discontinued operations section of the income statement
Proficiency QuestionThe book value of the net assets of a discontinued segment is $300,000. The fair value is $200,000 and the cost of disposal is $20,000
Ignoring income tax, the estimated disposal loss is $120,000
True or False
True
The estimate loss is (200,000 – 300,000) – 20,000
Abbott Labs, Dec 31, 2014 Annual report
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 172 23 December 2017 4:01 AM
172
Abbott Labs, Dec 31, 2014 Annual report
Abbott Labs, Dec 31, 2014 Annual report
Abbott Labs, Dec 31, 2014 Annual report
FAR_Participant_Part1 173 23 December 2017 4:01 AM
173
Public Company Reporting Topics (SEC, EPS, Interim, and Segment)U.S. Securities and Exchange Commission (SEC)SEC—Role and Standard-Setting Process
SEC—Role andStandard-Setting Process
Creation of the SECThe SEC was created by Congress after the 1929 stock market crash.
The SEC has the legal authority to set accounting standards, but has delegated that responsibility to the private sector—currently the FASB.
Purpose of the SECThe SEC enforces compliance with US GAAP for all publicly traded companies.
Compliance with IFRS for foreign registrantsTo promote efficient allocation of capital through open, orderly and fair securities marketsAccess to information that is decision-useful (relevant) to the market participant is critical
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 174 23 December 2017 4:01 AM
174
Foreign Issuers Reporting to the SECIn 2008, as part of the “roadmap” to international convergence, the SEC eliminated the reconciliation to US GAAP for foreign private issuers.This is a significant step to acknowledging the IASB approved IFRSs.Elimination of the reconciliation should encourage more foreign businesses to list on US exchanges.
Foreign Private IssuerA foreign private issuer is any non-governmental foreign issuer that:
Has the majority of its securities owned outside of the US Officers and directors are not US citizens or residentsThe majority of assets are outside the USThe business is administered principally outside of the US
Securities Issued and TradedThe SEC regulates the initial issuance and subsequent trading of securities.
The SEC’s database is IDEA (Interactive Data Electronic Applications) where financial statement information is stored in XBRL (eXtensible Business Reporting Language)
XBRL tags accounting data into a taxonomy to ease the access to the data
SEC—Role and Standard-Setting Process
FAR_Participant_Part1 175 23 December 2017 4:01 AM
175
Organizational Structure Five commissioners appointed by the President of the US
Four divisions
Office of the Chief Accountant
Divisions• Oversees compliance • Filings submitted to this division
Corporate Finance
Corporate Finance
• Investigates violations• Makes recommendations for punishment
EnforcementEnforcement
• Oversees the secondary markets and exchanges, brokers, and dealers
Trading and Markets
Trading and Markets
• Oversees investment advisors and investment companies
Investment ManagementInvestment
Management
Laws Administered by the SECThe Securities Acts of 1933 and 1934The Public Utility Holding Company Act of 1935Trust Indenture Act of 1939Investment Company Act of 1940Investment Advisors Act of 1940Securities Investor Protection Act of 1970Sarbanes-Oxley Act of 2002
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 176 23 December 2017 4:01 AM
176
Participation in Standard SettingEven though the SEC delegates standard setting to the FASB, the SEC participates in the setting of accounting standards.
SEC pronouncements along with the FASB Accounting Standards Codification comprise authoritative US GAAP for public companies.
Private companies do not have to comply with SEC pronouncements.
Pronouncements IssuedFinancial Reporting Releases• Formal pronouncements—highest ranking
authoritative source for public companiesFRR
Staff Accounting Bulletins• SEC’s current position on technical issuesSAB
Accounting and Auditing Enforcement Releases• Reports enforcement actions
AAER
FAR_Participant_Part1 177 23 December 2017 4:01 AM
177
SEC Reporting Requirements
SEC Reporting Requirements
What is a Security?Section 2.1 of the 1933 Act defines a security as: Any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral trust certificate, reorganization certificate or subscription, transferable share, investment contract, voting trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or in general, any interest or instrument commonly known as a “security,” or any certificate of interest or participation in, temporary or interim certificate for, receipt of, guarantee of, or warrant or right to subscribe to or to purchase any of the foregoing.
The Securities Act of 1933This act applies to the registration of the initial public offering (IPO) of securities.
Form S-1 is the basic registration form for new securities.
Part 1 is the prospectus and provides information about the company, business operations, risks, financial statements and use of proceeds.
Part 2 provides information about the cost of the issuance, information about the directors and officers, and additional financial schedules.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 178 23 December 2017 4:01 AM
178
Financial Statements for IPOThe following audited financial statements must be presented:
2 years of balance sheets3 years of income statements, statements of cash flow and statements of shareholders’ equity
IPO Process
IssuerIssuer Under-writerUnder-writer DealerDealer PublicPublic
The Securities Act of 1934This act applies to reporting information about securities that are already issued.
Regulation S-X provides detailed guidance on the reporting requirements
Form 10-K is the annual filing
Form 10-Q is the quarterly filing
Form 8-K reports significant events
SEC Reporting Requirements
FAR_Participant_Part1 179 23 December 2017 4:01 AM
179
Annual Filing—Form 10-KThe financial statements in Form 10-K must be audited by an independent registered auditor.
2 years of balance sheets3 years of income statements, statements of cash flows, and statements of shareholders equity
Annual Filing—Form 10-KIn addition to the audited financial statements, there are significant disclosures:
Management Discussion and Analysis (MD&A)Reports on controlsManagement certificationsMuch, much more (see study guide)
Quarterly Filing—Form 10-QThe financial statements in Form 10-Q are not audited, but are reviewed by the auditor.
Disclosures in the 10-Q are not as extensive as the 10-K.
Update on significant matters since the last quarter such as legal proceedings, changes in securities outstanding.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 180 23 December 2017 4:01 AM
180
Coca Cola, Inc.—10-Q Income Statement
Coca Cola, Inc.—10-Q Balance Sheet
Coca Cola, Inc.—10-Q Cash Flows
FAR_Participant_Part1 181 23 December 2017 4:01 AM
181
Earnings per ShareIntroduction to Earnings per Share
Introduction toEarnings Per Share
Earnings per Share Overview
Introduction
Basic Earnings per Share (BEPS)
Diluted Earnings per Share (DEPS)
Earnings per Share and IFRS
Need to Know for the CPA Exam
Terminology
How to calculate EPS
Disclosure requirements
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 182 23 December 2017 4:01 AM
182
Why Is EPS Important?
For public companies, reporting EPS on the income statement is required.
EPS measures profitability relative to ownership of that company.
Company A Company B
Earnings (Net Income) $1 million $2 million
Common Shares 200,000 500,000
EPS $5.00 $4.00
Two Measures of EPS
1. Basic EPS (BEPS)
Computed on common shares outstanding and net income.
2. Diluted EPS (DEPS)
Includes the assumed conversion of potential common stock (PCS). PCS includes stock options and other securities that could become common stock in the future. DEPS is an “as if” calculation.
There is a dilutive effect of PCS when DEPS is less than BEPS.
Basic EPS Formula
Only for common stock outstanding
PCS not considered when computing BEPS.
Common stock dividends have no effect on EPS.
Note: The denominator is not the ending number of CS outstanding but the weighted average.
Net income – Preferred stock dividendsWeighted average shares of common outstanding
Introduction to Earnings per Share
FAR_Participant_Part1 183 26 December 2017 11:01 PM
183
Diluted EPS Formula
Numerator and denominator impact of PCS are considered when computing DEPS.
Basic EPS PCS Impact
Net Income – PS dividends +/- Adjust to NI for assumed conversion of PCS
Wtd avg shares of CS O/S + Shares from assumed conversion of PCS
Reporting Requirements
BEPS is required.
DEPS is required if the firm has dilutive PCS (complex capital structure).
BEPS and DEPS are shown on the face of the income statement for:
Income from continuing operations (IFCO)
Net income (NI)
An entity that reports discontinued operations may present BEPS and DEPS for discontinued operations on the face of the income statement or in the footnotes to the financial statements.
BEPS Reporting Example
Other Information:Common shares outstanding all year are 13,1001,000 shares of 4%, $100 par, nonconvertible cumulative preferred stock outstanding all yearAnnual preferred dividend: 1,000($100)(.04) = $4,000
Income amounts (after tax):
Income from continuing operations $ 40,000
Discontinued operations (net) (10,000)
Net Income $ 30,000
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 184 23 December 2017 4:01 AM
184
BEPS Reporting Example
Income from continuing operations $2.75 ($40,000 – $4,000) / 13,100
Discontinued operations (.76) $10,000 / 13,100
Net Income $1.99 ($30,000 – $4,000) / 13,100
A carefully laid plan will get you there!
lzf/iStockphoto
FAR_Participant_Part1 185 23 December 2017 4:01 AM
185
Basic Earnings per Share
Basic Earnings Per Share
Earnings per Share Overview
Introduction
Basic Earnings per Share (BEPS)
Diluted Earnings per Share (DEPS)
Earnings per Share and IFRS
Common Computational Issues
BEPS Numerator
What amount of preferred stock dividends to subtract from net income
BEPS Denominator
Computing the weighted average shares when stock is issued or purchased during the year and impact of stock dividends and splits
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 186 23 December 2017 4:01 AM
186
BEPS NumeratorCumulative Preferred Stock
Deduct one full year of dividends regardless of amount declared or paid.
Noncumulative Preferred Stock
Deduct dividends declared in the current year.
BEPS Numerator TipsCumulative preferred stock dividends are subtracted in calculating BEPS for each year, whether declared or not.
Dividends in arrears on cumulative preferred stock declared in a subsequent year are NOT subtracted in the numerator of BEPS in the year declared.
No tax effect on the preferred stock dividend.
ALMAGAMI/Shutterstock
Quiz
There are 1,000 shares of 7%, $100 preferred stock outstanding. For the current year, what amount of preferred dividends is subtracted in calculating BEPS when the preferred stock is cumulative, there are two years’ dividends in arrears, and $4,000 of dividends were paid?
Answer:
The amount of dividends accrued for the current year:
1,000 shares × $100 par × 7% = $7,000
Basic Earnings per Share
FAR_Participant_Part1 187 23 December 2017 4:01 AM
187
Quiz—Twist
There are 1,000 shares of 7%, $100 preferred stock outstanding. For the current year, what amount of preferred dividends is subtracted in calculating BEPS when the preferred stock is noncumulative, $2,000 of dividends were declared in the current year, and $3,200 of dividends were paid?
Answer:
The amount of dividends declared:
$2,000
BEPS Denominator
The denominator of BEPS is the weighted average (WA) common shares outstanding, not ending shares outstanding or ending shares issued.
If 1 million shares are purchased to hold as treasury stock on July 1, the effect is to reduce the WA by 500,000 shares (1 million for half a year).
BEPS Denominator Tips
Stock dividends and splits are retroactively applied to the beginning of the year. Any stock issuance or treasury stock purchase before the stock dividend or split is adjusted for the dividend or split.
The dividend or split is also applied to statements of earlier periods that are shown comparatively with the current statements.
ALMAGAMI/Shutterstock
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 188 23 December 2017 4:01 AM
188
{(1,000 × 12/12
+ 600 × 3/12)
- 120 × 1/12}
Example Weighted Average Calculation
Calculate the weighted average shares outstanding:
Jan 1: 1,000 common shares outstanding
Oct 1: Issue 600 shares
Nov 4: Split stock 2-for-1
Dec 1: Acquire 120 shares for treasury
Dec 9: Issue 40% stock dividend
2
1.4
Weighted averages shares outstanding = 3,206
Answer―Weighted Average Calculation
Below is the calculation of weighted average shares outstanding:
{ [1,000(12/12) + 600(3/12)](2) – 120(1/12)}(1.4) = 3,206
A company had 400,000 shares of common stock issued and outstanding on January 1, Year 1, and had the following equity transactions for Year 1:
What should the company use as the denominator for the calculation of basic earnings per share for year ended December 31, Year 1?
A. 1,650,000B. 1,575,000C. 1,325,000D. 1,075,000
Example Question
Transactions DateIssued 200,000 new shares for cash April 1Issued new shares as result of 3-for-1 stock split July 1Purchased 300,000 shares treasury stock for cash October 1
Copyright © 2016 by the American Institute of Certified Public Accountants, Inc., is reprinted and/or adapted with permission.
Basic Earnings per Share
FAR_Participant_Part1 189 23 December 2017 4:01 AM
189
Calculate the weighted average shares outstanding:
{(400,000 × 12/12
+ 200,000 × 9/12)
- 300,000 × 3/12}
Answer―Example Question
Jan 1: 400,000 common shares outstanding
Apr 1: Issue 200,000 shares
Jul 1 : Split stock 3-for-1
Oct 1: Acquire 300,000 shares for treasury
Weighted averages shares outstanding = 1,575,000
Answer: B
Below is the calculation of weighted average shares outstanding:
({[400,000 + (200,000 9/12)] 3} – 300,000 3/12)
= 1,575,000
Comparative StatementsRetroactively apply stock dividends and splits to comparative years.
The retroactive application ensures that the base on which EPS is computed uses the same measuring unit.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 190 23 December 2017 4:01 AM
190
Example Comparative Statements
During Year 2, a firm split its stock 2-for-1. The beginning common shares outstanding was 20,000 and the ending was 40,000.
There was no other change in CS outstanding for Year 2 or Year 1.
Net income in both years was $80,000. The firm has only CS, and there are no PCSs.
In the Year 2 income statement, what is reported BEPS for both years?
Example Comparative Statements
Year 2 Year 1Year 1 beforerestatement
Net Income $80,000 $80,000 $80,000
Wtd Avg Shares 40,000 40,000 20,000
BEPS $2.00 $2.00 $4.00
Adjust Year 1 shares outstanding to allow comparison between years.
Conclusion
BEPS Numerator
Subtract preferred dividends from NI. If cumulative, always subtract; if not cumulative, subtract only what was declared.
BEPS Denominator
Use weighted average shares outstanding; weight by the number of months since issue. All CS splits and dividends are applied retroactively.
Basic Earnings per Share
FAR_Participant_Part1 191 23 December 2017 4:01 AM
191
Hang in there with me. Mistakes and frustration are part of the learning process!
Pascal Genest/Getty Images
FAR_Participant_Part1 192 23 December 2017 4:01 AM
192
Diluted Earnings per Share
Diluted EarningsPer Share
Earnings per Share Overview
Introduction
Basic Earnings per Share (BEPS)
Diluted Earnings per Share (DEPS)
Earnings per Share and IFRS
Diluted EPS
Diluted EPS incorporates potential common stock (PCS) securities that can become common stock in the future.
This is an “as if” calculation to see the impact on EPS if all potential conversions of stock were to occur.
Basic EPS is the benchmark and is adjusted for the effect of PCS.
Diluted Earnings per Share
FAR_Participant_Part1 193 23 December 2017 4:01 AM
193
Target Corporation
Target Corporation, 2016 10k
BEPS
DEPS
Wtd Avg
Computation Process
Compute BEPS first because it is the starting point.
Use the information in BEPS:
1. To make changes in numerator and denominator for assumed conversion and exercise of PCS.
2. As the benchmark for antidilution.
Diluted EPS Formula
Include numerator and denominator impact of PCS when computing DEPS.
Basic EPS PCS ImpactNet Income – PS dividends +/- Adjust to NI for assumed conversion of PCS
Wtd avg shares of CS O/S + Shares from assumed conversion PCS
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 194 23 December 2017 4:01 AM
194
Potentially Convertible Securities
When computing the numerator and denominator effects of PCS, different techniques are used depending on the type of PCS.1. For convertible preferred stock and convertible bonds, use the “if-
converted method.” The convertible securities are assumed to have been converted.
2. For stock options and warrants, use the “treasury stock method.” The options and warrants are assumed to have been exercised, and treasury stock is purchased.
3. When there is more than one PCS, use the dilution/antidilutionmethod—use the PCS that is the most dilutive first.
If―Converted ExampleAssume there are 100, 5%, $1,000 convertible bonds outstanding all year.
Each bond is convertible into 20 shares of common stock.
The bonds were issued at face value, and the tax rate is 30%.
Net income is $18,500, and weighted average common stock outstanding is 5,000 before considering PCS.
BEPS = $18,500 / 5,000 = $3.70
What is DEPS?
If―Converted Effect
The convertible bonds are dilutive because $1.75 < $3.70.
[100($1,000)(.05)(1 ‒ .30)] [100(20)]
Net effect of bond conversion = $1.75
Diluted Earnings per Share
FAR_Participant_Part1 195 23 December 2017 4:01 AM
195
If―Converted BEPS and DEPSBasic EPS Diluted EPS
Numerator Denominator Numerator Denominator
Net Income $18,500 $18,500
Interest 100($1,000)(.05)(1 ‒ .30) 3,500
CS outstanding 5,000 5,000
Conversion of bonds 100(20) 2,000
Totals $18,500 5,000 $22,000 7,000
EPS $3.70 $3.14
If―Converted Twist
If the bonds were issued during the year, then both the numerator and denominator effects would be multiplied by the fraction of the year the bonds were outstanding.
Assume April 1 issuance (9/12 months or 75%)
(.75) 3,500 = 2,625= $1.75
(.75) 2,000 = 1,500
If―Converted TwistBasic EPS Diluted EPS
Numerator Denominator Numerator Denominator
Net Income $18,500 $18,500
Interest [100($1,000)(.05)(1 ‒ .30)].75
2,625
CS outstanding 5,000 5,000
Conversion of bonds [100(20)].75
1,500
Totals $18,500 5,000 $21,125 6,500
EPS $3.70 $3.25
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 196 23 December 2017 4:01 AM
196
Treasury Stock Method Example
Assume the same net income of $18,500 and weighted average common stock outstanding of 5,000 before consideration of PCS.
In addition, assume 5,000 options to purchase the firm’s $2 par CS for $10 were outstanding all year, and the average market price of CS was $25.
Treasury Stock Method Example
Three steps for the treasury stock method for incorporating assumed exercise of stock options to DEPS:
1. Assume exercise: 5,000($10) = $50,000 proceeds from exercise and 5,000 increase in CS outstanding.
2. Use the proceeds to purchase treasury stock at $25: $50,000/$25 = 2,000 shares purchased for the treasury.
3. Incremental shares (denominator effect): 5,000 – 2,000 = 3,000 shares added to denominator of DEPS.
Treasury Stock Method ExampleBasic EPS Diluted EPS
Numerator Denominator Numerator Denominator
Net Income $18,500 $18,500
CS outstanding 5,000 5,000
Shares issued 5,000
Shares repurchased (2,000)
Totals $18,500 5,000 $18,500 8,000
EPS $3.70 $2.31
Diluted Earnings per Share
FAR_Participant_Part1 197 23 December 2017 4:01 AM
197
Multiple Potential Common Stock
Apply the same logic when there is more than one PCS.
Compute the numerator and denominator effect for each PCS.
Enter the PCS with the lowest ratio, and compute an initial value for DEPS.
Keep going until you have either:
Entered all PCS, or
There is an antidilutive PCS. Stop if PCS is antidilutive; DEPS is the previous value computed.
Multiple Potential Common Stock Example
Assume net income is $50,000 and the WA common shares is 10,000. The company also has the following:
8% convertible bond, 200 bonds each convert to 40 common shares. The bond yield was 10%, and the tax rate is 40%. Bonds were issued at par, and no bonds have been converted.
4% convertible, cumulative preferred stock, $100 par, 1,000 shares issued and outstanding. Each preferred share is convertible into 2 shares of common. The preferred was issued at par.
Basic EPS is ($50,000 – 4,000) / 10,000 = $4.60
Effect of Conversion
Effect of Bond Conversion
[.08($200,000)(1 ‒ .40)]
[200 bonds × 40 CS]
= $1.20
Effect of PS Conversion
Numerator effect: $ 0
Denominator effect:(2 CS for 1 PS)
2,000
= $ 0
1st2nd
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 198 23 December 2017 4:01 AM
198
Effect of Preferred Stock Conversion
Numerator Denominator
Net Income $50,000
Preferred Dividends 0
CS O/S 10,000
Shares issued (2 CS for 1 PS) 2,000
Totals $50,000 12,000
DEPS $4.16
Effect of Bond ConversionNumerator Denominator
Net Income $50,000
Interest [(.08 × $200,000) (1 - .4)] 9,600
CS O/S 10,000
Shares issued (200 bonds × 40 CS) 8,000
Totals $59,600 18,000
DEPS $3.31
Multiple Potential Common Stock Example
Basic EPS Diluted EPS
Numerator Denominator Numerator Denominator
Net Income $50,000 $50,000
Preferred dividend (4,000) 0
CS O/S 10,000 10,000
Conversion of PS 2,000
Conversion of bonds 9,600 8,000
Totals $46,000 10,000 $59,600 20,000
EPS $4.60 $2.98
Diluted Earnings per Share
FAR_Participant_Part1 199 23 December 2017 4:01 AM
199
Target Corporation
Target Corporation, 2016 10k
BEPS
DEPS
Wtd Avg
Diluted EPS Summary
Remember that DEPS builds directly on BEPS.
Always compute BEPS first, even if a problem on DEPS doesn’t ask you to do so—you always have to be careful to check for antidilution.
If the PCS was outstanding only part of the year, then the incremental shares are weighted by that fraction of the year.
You can study anywhere with Wiley CPAexcel!
DonKurto/iStockphoto
FAR_Participant_Part1 200 23 December 2017 4:01 AM
200
Earnings per Share and IFRS
Earnings Per Shareand IFRS
Earnings per Share Overview
Introduction
Basic Earnings per Share (BEPS)
Diluted Earnings per Share (DEPS)
Earnings per Share and IFRS
U.S. GAAP–IFRS Differences
U.S. IFRS
Dilution under treasury stock method uses year-to-date calculations.
Dilution calculated independently each period.
Per share measures not allowed on alternative measures of performance.
Per share measures allowed on alternative measures of performance.
Contingently convertible securities included in DEPS calculation unless contingency unlikely to occur.
Contingently convertible securities included only if contingency condition met at reporting date.
FAR_Participant_Part1 201 23 December 2017 4:01 AM
201
One day soon, you will be chillin’ on the beach!
Aleksandar Todorovic/Shutterstock
FAR_Participant_Part1 202 23 December 2017 4:01 AM
202
Segment Reporting
Segment Reporting
Segment ReportingMany corporations operate a diverse set of businesses.
GAAP requires disclosures by major segments to allow assessment of those businesses or segments.
GAAP is disclosure only.
Segment ReportingThree focuses:
1. What is a segment (operating segments)?
2. Which segments must report this information (reportable segments)?
3. What information is reported?
Segment Reporting
FAR_Participant_Part1 203 23 December 2017 4:01 AM
203
Operating SegmentIdentified by management as a significant component meeting these criteria:
1. Generates revenues and expenses
2. Chief operating decision maker reviews results
3. Provides financial information about its operations
Reportable SegmentsAn operating segment meeting at least one of three quantitative tests
Not all firm components are operating segments; not all operating segments are reportable segments
Three Quantitative Tests for Reportable Segment
The three tests separately involve revenues, net income and assets.
Each uses 10% or more
If a test is met, the operating segment is a reportable segment.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 204 23 December 2017 4:01 AM
204
Test 1—Operating RevenueAn operating segment’s revenue (internal plus external) that is ≥ 10% of the combined revenues (internal and external) of all operating segments.
Test 2—Operating ProfitFirst: Compute two amounts and use the larger absolute value
Combined operating profit of all operating segments reporting
positive profit
Combined operating loss of all operating segments reporting an
operating loss
Second: If the absolute value of an operating segment’s operating profit or
loss is ≥ 10% of the larger amount above, then it is a reportable segment.
Test 2—Operating Profit: ExampleAssume segments have the following profits (losses) $100, 50, (25), 75, (30), 10.
The sum of operating profit for operating segments with positive profit is 235.
The sum of losses for operating segments with operating losses is (55).
The higher absolute value is 235
An operating segment with either an operating profit or loss ≥ than $23.5 is a
reportable segment (25) and 10.
Segment Reporting
FAR_Participant_Part1 205 23 December 2017 4:01 AM
205
Test 3—Identifiable AssetsAn operating segment’s identifiable assets that are ≥ 10% of the combined assets of all operating segments.
75% Revenue RuleSales to unaffiliated customers ≥ 75% of consolidated revenues
Consolidated revenues
Other operating segments (not meeting a quantitative test) are added to the reportable group until the 75% measure is met.
More than 10 reportable segments may exceed the cost-benefit constraint.
Reportable Segment DisclosuresDescription of the segmentFactors used to identify reportable segmentsTypes of products and servicesEarnings, total assets External revenue and internal revenueInterest revenue and expenseDepreciation, amortization and depletionUnusual and infrequent expensesIncome tax expense
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 206 23 December 2017 4:01 AM
206
Reportable Segment Disclosures (continued)Operating segment disclosures are required in interim financial reports.
Reconciliation between reportable segments = items (e.g., revenue, profit, assets) and the related consolidated items.
Restate previously reported information for changes in internal organization.
Enterprise-Wide Disclosures
Information about products or services
Information about geographic areas
Also, if one customer accounts for 10% ormore of the firm’s revenues, that fact mustbe disclosed.
Coca-Cola, Inc.Footnote Excerpt: Operating Segments
Segment Reporting
FAR_Participant_Part1 207 23 December 2017 4:01 AM
207
Coca-Cola, Inc.Footnote Excerpt: Operating Segments
FAR_Participant_Part1 208 23 December 2017 4:01 AM
208
Interim Financial ReportingInterim Reporting Principles
Interim Reporting Principles
Interim Reporting PrinciplesInterim financial statements are issued between annual reports.
Interim reports help provide timely information.
Securities regulators may require interim statements.
SEC in the US requires interim reporting.
Interim Reporting PrinciplesDifferences between annual and interim reports:
Interim period statements are not audited.Certain methods used for interim are not allowed for annual.
Example: Gross profit method to estimate ending inventory and cost of goods sold
Interim Reporting Principles
FAR_Participant_Part1 209 23 December 2017 4:01 AM
209
General Accounting GuidelineInterim reports are an integral part of the annual report, not stand-alone reports.
A discrete view of interim reporting would view each interim period as a discrete independent period.
Example: Revenue received in one interim period is not allocated to other interim periods.
RevenueRevenue recognition proceeds the same way as for annual reports.
Example: A customer advance received in Q1 that applies equally to the last three quarters is allocated evenly over those three quarters.
ExpensesAn expenditure relating to more than one interim period, is recognized in those periods rather than immediately.
Example: Rent prepaid at the end of Q1 for the last three quarters of the year is recognized equally as rent expense in those last three quarters.
Expenses related to revenue are recognized in the same interim period as the revenue.
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 210 23 December 2017 4:01 AM
210
Income Tax ExpenseFirms face a graduated annual income tax rate. The average annual tax rate is not known until the end of the year.
For each interim period, the annual rate is estimated.
Cumulative Year-to-Date Income × Estimated Annual Tax Rate
= Required Tax Provision to Date
– Prior Periods' Recognized Exp.
= Current Interim Period's Tax
Income Tax ExampleLindy Company, a calendar year corporation, has the following income before income
tax provision and estimated effective annual income tax rates for the first three
quarters of 20X7:
Income before Estimated effectiveincome tax annual tax rate
Quarter provision at end of quarter First $60,000 40%Second 70,000 40%Third 40,000 45%
What is Lindy's income tax provision in its interim income statement for the third
quarter?
Income Tax SolutionCumulative income × est. tax rate = cumulative provision requiredQ 1 and 2 130,000 × .40= 52,000 Q3 170,000 × .45= 76,500
24,500Income Tax Expense 24,500
Income Tax Payable 24,500
Interim Reporting Principles
FAR_Participant_Part1 211 23 December 2017 4:01 AM
211
Exceptions to Integral ViewThe following items are not allocated to more than one interim period (discrete view):
Gains and losses on disposal of equipment Discontinued operations
FAR_Participant_Part1 212 23 December 2017 4:01 AM
212
Interim Reporting—Details and IFRS
Interim Reporting—Details and IFRS
Interim ReportingRecall that interim financial statements are issued between annual reports
Provide timely information
Securities regulators may require interim statements
In the U. S. we take an integral view approach
Decline in Inventory ValueInventory is written down to net realizable value or market value when below costDeclines in inventory value are recorded in the interim period in which it occursExample: Inventory value declines below cost in Q2; the loss and write-down of inventory is recorded in Q2
Interim Reporting—Details and IFRS
FAR_Participant_Part1 213 23 December 2017 4:01 AM
213
Decline in Inventory ValueLater recoveries are recorded in the interim period they occurLC-NRV or LC-M is suspended for interim reporting if the decline is expected to be recovered by year-endIf the expected recovery fails to occur by year-end, the loss is recognized in Q4
Inventory—LIFO LiquidationsIf a liquidation is expected to be replenished before year-end, the estimated replacement cost is used for cost of goods soldIf replenishment is not expected, the liquidation is recorded and cost of goods sold reflects the lower cost
Accounting Principle Changes and Error Corrections
Accounting principle changes and error corrections: the retrospective approach is applied in the interim period in which the change is made
The RE balance at the beginning of the interim period of change is adjusted
Previous interim period statements within the same annual period are adjusted as well
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 214 23 December 2017 4:01 AM
214
Accounting Principle Changes and Error Corrections
Example: A principle change in Q3 adjusts beginning Q3 RE for the effect on all previous years and on Q1 and Q2 of the current year
Q1 and Q2 statements are retrospectively restated
U.S. IFRS
Major Differences
Based on integral view
Allocation of costs over each Q
Based on discrete view
Must meet definition of asset in order to
allocate
U.S. IFRS
Major Differences
Can defer cost variances if recovery expected
Can defer decline in inventory value if recovery
expected
Cannot defer cost variances
Cannot defer decline in inventory value
FAR_Participant_Part1 215 23 December 2017 4:01 AM
215
Special Purpose FrameworksCash, Modified Cash, Income Tax
Cash, Modified Cash, Income Tax
Cash Basis Modified Cash Basis Income Tax BasisRegulatory BasisOther Basis
Sometimes called—Other Comprehensive Basis of Accounting(OCBOA)
Special Purpose Reporting Frameworks
FrameworksFinancial Accounting Standards Board
(FASB)International Accounting Standards Board
(IASB)American Institute of
Certified Public Accountants (AICPA)
ApplicableFinancialReporting Framework
U.S. Generally Accepted Accounting Principles (GAAP): U.S. GAAP–based financial statements for nongovernmental entities
Private Company Council accounting alternative: U.S. GAAP-based financial statements with modifications/simplifications
International Financial Reporting Standards: GAAP–based financialstatements for foreign private issuer
IFRS for Small- and medium-sized entities (SMEs):GAAP–based financial statements with modification/simplification of full IFRS
Special purpose frameworks (SPF): Non-GAAP financial statements prepared using a type of SPF such as FRF for SMEs, cash basis, modified cash basis, tax basis, regulatory basis, contractual basis
Applicability Mandatory for public business entities
May be elected by private, for-profit entities
Required unless entity meets eligibility for accounting alternative
Small- and medium-entities without public accountability
FRF for SMEs may be used by smaller- to medium-sized for-profit private entities when U.S. GAAP-based financial statements are not required
Authoritative Guidance
FASB Accounting Standards Codification (ASC) and Accounting Standards Updates (ASU)
ASC/ASU with modifications for simplicity
IFRS IFRS with modifications for simplicity
FRF for SMEs
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 216 23 December 2017 4:01 AM
216
AICPA’s FRF for SMEsAICPA has a financial reporting framework (FRF) for small- and medium-sized entities (SMEs) It provides guidance on the concepts, and presentation of financial statements prepared under cash, modified cash, income tax basis.
This is NOT GAAP
Key Points to KnowBasics of each presentation formatThe reporting of certain information within an special purpose frameworkFinancial statement titles must be descriptive (and not misleading)
Why Is This Important? GAAP Accrual Accounting is not used by:
Sole Proprietors
Over 20 Million in the USPartnerships
Over 2.8 Million in the US
Cash, Modified Cash, Income Tax
FAR_Participant_Part1 217 23 December 2017 4:01 AM
217
Cash Basis Financial StatementsBased solely on cash receipts and disbursements
Cash received = revenue recognitionCash paid = expense recognition
Pure cash basis balance sheetCash = equityNo other assets or liabilities
Appropriate for:Small, closely-held businesses Sole proprietors
Combination of cash basis and accrual basis
Modifications have support by GAAP
Modified Cash Basis Financial Statements
Common and acceptable modifications to cash basis is recognizing:
InventoryProperty, Plant and Equipment (PP&E)
Along with depreciation or amortizationIncome taxes and other payablesAccounts receivableInterest-bearing payables
Along with interest expense and interest payable
Modified Cash Basis Financial Statements
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 218 23 December 2017 4:01 AM
218
Income Tax Basis Financial StatementsBased on income tax rules and regulations
Taxable amount = RevenueDeductible amount = Expense
Certain nontaxable and nondeductible items included as revenues or expenses
Muni bond interest receivedLife Insurance premiums on officersFines
Possible changes due to IRS findings should be disclosed in notes.
Other Regulatory BasisStructured to comply with regulatory requirements
State Insurance Regulatory AgencyPublic Utility Regulatory Agency
Use should be restricted to the filing entity and the regulatory agency
FAR_Participant_Part1 219 23 December 2017 4:01 AM
219
Private Company Council
Private Company Council
Private Company CouncilWhat do you need to know?
The purpose of PPCDefinition / characteristics of a public business entityWhat accounting standards are modified
Purpose of the Private Company CouncilThe Private Company Council (PCC) works with the FASB to identify where alternative accounting for private companies is needed.The PCC develops proposed modifications for FASB approval.
The trade off is relevance of the information vs cost-benefit.
Users of the financial statements of public vs private companies
Wiley CPAexcel® Exam Review Lecture Slides: Financial Accounting and Reporting
FAR_Participant_Part1 220 23 December 2017 4:01 AM
220
Public Business EntityAn entity required to file or furnish financial statements with the SEC or other regulatory agencies
An entity required to make US GAAP statements publicly available on a periodic basis
The consolidated subsidiary of a public entity is not considered a public entity other than the information presented with the parent company.
GoodwillGoodwill should be amortized on a straight-line basis over 10 years, or less than 10 years if it is appropriate.Assign goodwill to a reporting unitTested for impairment when a triggering event occurs.
If there is a triggering event, the entity applies the normal impairment testing, including the pre-test option.
Intangibles Acquired in Business Combination
Not required to recognize separately from goodwill certain intangibles that cannot be sold or licensed independent from the business
Customer contracts, customer relationships, and non-compete agreements
Must recognize other intangibles that are 1) separable or 2) contractual or legal such as copyrights, trademarks, and customer lists
Private Company Council
FAR_Participant_Part1 221 23 December 2017 4:01 AM
221
Intangibles Acquired in Business Combination (continued)
If the private company elects this guidance it must also adopt the good will accounting alternative to amortize goodwill over a period not to exceed 10 years.