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CPA FAR Exam > CPA FAR I-75 CH 14 > Flashcards

CPA FAR I-75 CH 14 Flashcards

1
Q

Debt Securities classification (3 categories)

A

Trading security
Available for Sale
Held to Maturity

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2
Q

Investments in Debt Securities

A

Corp bonds
Government securities
convertible debt
redeemable preferred stock

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3
Q

trading security

A

current asset, operating cash flows

intent is to take advantage of ST changes in prices

short term profits, fair value, mark to market at year end

unrealized gains and losses go to income statement

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4
Q

AFS- available for sale

A

to be held indefinitely but not necessarily to maturity

most likely noncurrent asset, investing cash flows

mark to market at year end, unrealized go to OCI

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5
Q

HTM- held to maturity

A

must have intent and ability to hold to maturity

value at amortized cost

Investing cash flows

usually non-current asset unless happens to mature under one year

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6
Q

recent changes in treatment of unrealized losses

A

recent changes in treatment of unrealized losses when the decline is the result of credit deterioration

assuming no credit deterioration, just a market decline, AFS unrealized losses go to OCI, and HTM unrealized losses would NOT be recognized in either OCI or earnings

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7
Q

operating cash flow examples

A

cash paid for trading debt security (outflow)
interest income (inflow)

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8
Q

investments in debt securities- trading

A

fair value method is applied

current asset on B/S

operating outflow for purchase

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9
Q

AFS and HTM: CF statement

A

purchases are investing outflows on statement on cash flows for AFS and HTM

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10
Q

True or false: Unrealized gains are recognized in earnings as unrealized losses for debt securities-trading.

A

TRUE!

all unrealized gains and losses for debt securities-trading reported in earnings.

debt securities-trading= reported at fair value= mark to market

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11
Q

Recent changes: treatment of unrealized losses when the decline is the result of credit deterioration.

A

Assuming no credit deterioration and just a market decline, AFS unrealized losses, OCI.

If there is a credit deterioration of the issuing investee, that portion of unrealized loss is shown in earnings.

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12
Q

Investments in debt securities are typically reported at fair value at year end if debt securities are classified as
1. trading
2. AFS

A

Both!

Investments in debt securities are marked to market at year end if the debt securities are classified as trading or AFS

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13
Q

Impairment AFS securities

A

when the fair value of the AFS debt is less than the carrying value, the entity (the investor) must determine if the decline in fair value below cost is the result of credit loss (entity-specific credit decline) or other factors (general mkt conditions)

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14
Q

unrealized losses on AFS debt securities

A

are shown in OCI if the decline in fair value is NOT associated with credit loss.

If associated with credit loss, the unrealized losses are reclassified to earnings.

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15
Q

If decline in fair value is later determined to be from credit deterioration =

A

reclass loss from OCI to earnings which will impact the Income statement

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16
Q

Determining credit loss

A

The entity determines whether a credit loss exists by comparing the present value of the cash flows expected to be collected from the security to the security’s amortized cost.

The estimated cash flows should include factors based on past events, current conditions, and reasonable and supportable forecasts.

The credit loss is the excess or amortized cost over present value of expected cash flows

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17
Q

AFS securities (loss due to market conditions): JE

A

DR Unrealized loss- OCI
CR Fair value adjustment-AFS

loss adjustment- decline in fair value due to market conditions

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18
Q

AFS securities (loss due to credit loss of issuer): JE

A

DR Credit loss expense (income statement)
CR Allowance for credit loss (contra account)

recognize the loss in earnings on income statement

decline in fair value to credit deterioration of issuer

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19
Q

credit loss reassessment

A

at each reporting date, the entity must reassess if there is any additional decline in fair value attributed to credit loss, and if so, adjust the allowance for credit loss.

The adjustment will result in additional credit loss expense or reversal of the credit loss expense, The reversal is limited to the balance in the allowance for credit loss account (contra asset = normal credit balance) which is intended to reflect deteriorating credit value associated with debt investments. Balance cannot go below zero (not an adjunct account and should not increase the value of the asset).

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20
Q

Actual write offs

A

similar to AR, if the entity determines that it will not recover the loss associated with the previously estimated credit loss, the entity writes off any credit losses in the allowance against investment security the net effect of which reduces the basis of the security

Write off results in new amortized cost basis for the security that cannot be written back up for subsequent recoveries

DR Allowance for credit loss
CR Investment for Debt security AFS

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21
Q

A company with an investment in AFS debt securities has previously recognized a credit loss as part of the investment’s decline in fair value. If the entity determines that it will not recover the loss associated with the previously estimated credit loss:

A

allowance for credit loss should be debited (B/S only)

DR Allowance for credit loss
CR Investment for debt security AFS

This is because the previous adjustment was credit loss expense (I/S) and allowance for credit loss was a contra asset.

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22
Q

Disclosure for AFS debt securities

A

companies will present AFS debt security at fair value as a current or noncurrent asset depending on management’s intent

in the cash flow statement, AFS debt securities are considered investing cash flow

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23
Q

HTM Held to maturity security

A

noncurrent asset unless it happens to mature within one year

valuation = amortized cost

No fair value adjustment at year end

investing cash flows

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24
Q

amortized cost

A

cost plus unamortized premium (or minus unamortized discount)

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25
Q

HTM and issuer credit loss

A

usually HTM on balance sheet reported at amortized cost

If the company believes the HTM bond issuer may have trouble repaying the bonds = credit loss

Credit losses are an exception to accounting treatment for HTM securities (similar to AFS)

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26
Q

Current expected credit loss model

A

at each B/S date, management is required to estimate the expected credit loss assoc with issuer’s ability or inability to repay debt to the investor.

The CECL model replaces the old impairment model that was based only on actual losses by the issuer

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27
Q

CECL model - current expected credit loss

A

is going to measure all expected credit losses for a financial asset as of each B/S date and it is based on:
1. historical experience
2. current conditions
3. reasonable/supportable forecasts from data analytics

*know this for CPA exam

replaces impairment model

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28
Q

Estimate the credit loss

A

where did management come up with $1,000 estimated credit loss?

Using historical experience and reasonable forecasts, management determined that the potential credit loss for this investment $1,000
Net value of the investment (Excel sheet) $101,200 = net amount the investor expects to receive from the debt investment

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29
Q

Company holds HTM debt securities on the B/S that have dropped in value below amortized cost. To measure expected credit loss, management:

A

could aggregate HTM investments that share similar risks or estimate the expected credit loss of each security on an individual basis

Management can use discounted cash flow over contractual term of the investment

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30
Q

Company holds HTM debt securities on the B/S that have dropped in value below amortized cost. A credit loss was booked I/S and allowance for credit loss on B/S. What is correct regarding future reporting dates?

A

Further estimates are required regarding credit losses already booked regardless of whether there is future deterioration or recovery.

reassess at future reporting dates

At each reporting date, the entity must re-estimate the amount expected to be collected and adjust the allowance for credit loss. The adjustment will result in either additional credit loss or reversal of credit loss expense

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31
Q

Company holds HTM debt securities on the B/S that have dropped in value below amortized cost. A credit loss expense was booked I/S and allowance for credit loss on B/S. At each reporting date, the company re-estimates the amount to be collected…

A

and may reverse previous credit losses but only up to the amount previously recognized

Allowance for credit loss= contra asset account = cannot go below zero = normal credit balance = not an adjunct acct

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32
Q

allowance for credit loss is a …

A

contra asset account (normal credit balance) and is intended to reflect deteriorated credit value associated with the debt investment

It is NOT an adjunct account (normal debit= reflects increase in value) and allowance for credit loss cannot dip below zero

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33
Q

Write off HTM debt security

A

when deemed uncollectible

It does NOT impact income statement; B/S impact only

DR Allowance for credit loss
CR Investment HTM debt

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34
Q

Which of the following is correct regarding HTM debt securities?
1. Unrealized gains reported OCI
2. Unrealized losses due to credit deterioration is reported in earnings

A

Incorrect: 1. Unrealized gains reported OCI (unrealized losses are not reported/HTM not reported fair value/HTM reported at amortized cost unless credit deterioration)

CORRECT: 2. Unrealized losses due to credit deterioration is reported in earnings

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35
Q

Equity securities

A

can be preferred stock or common stock

preferred stock = NO significant influence in investee
common stock= may or may not have significant influence

all unrealized gains or losses go on I/S not OCI

Publicly traded = mark to market at Y/E

if significant influence= trading security rules aka cost method or FVNI (fair value net income) method

36
Q

Equity securities: ownership interest

A

common or preferred stock

represent an ownership interest in an enterprise

includes the right to acquire or dispose of an ownership interest in an enterprise at a fixed or determinable price

37
Q

Equity securities: represented by shares

A

may be represented by ownership shares, common, preferred, and other forms of capital stock

rights to acquire ownership shares, stock warrants, stock rights, call options, and rights to dispose of ownership shares, put options

38
Q

Equity securities: do not include

A

redeemable preferred stock= use debt security rules

treasury stock = not equity security and is company’s own stock repurchased and held

convertible bonds are NOT equity securities

39
Q

Which of the following is considered equity security?
1. shares of common stock
2. shares of preferred stock
3. options and warrants to purchase shares of common stock

A

All of the above!

40
Q

Common Equity- No significant influence/Preferred Equity

A

DR Investment in investee $100,000
CR Cash $100,000

Fair value at year end drops to $90,000:
DR Unrealized loss on equity sec $10,000
CR Valuation account $10,000

loss flows thru income statement=
net income decreases, RE decreases, and total equity decreases

41
Q

Dividends received - no significant influence

A

Dividends rec’d are income (unless dividend is liquidating)

DR Cash (B/S)
CR Dividend income (I/S)

Liquidating dividend:

DR Cash
CR Investment in investee (return of capital)

42
Q

Equity securities: non-public companies

A

If the investee company is non-public, we carry the investment on our books at COST LESS IMPAIRMENT LOSS

Impairment loss is a realized loss on the I/S, and the asset is written down

43
Q

Sale of equity security

A

does not give rise to a gain or loss is all changes in the equity’s fair value have been reported in earnings as unrealized gains or losses as they occurred up to the moment of sale

44
Q

FVNI- dividends received by investor

A

Fair value net income method
dividends are distributions of earnings paid to shareholders

a big benefit of equity investing is the participation of dividend or corporate earnings

2 types of dividends = cash dividends or stock dividends

45
Q

FVNI- dividends received by investor

A

cash dividends rec’d are income under the FVNI method

46
Q

Do not recognize stock dividends

A

Stock dividends are not cash dividends. Cash dividends are considered income to the investor. Stock dividends are not income to the investor.

Stock dividends are additional shares of stock being distributed to the investor which serve to lower the cost basis per share when it is time to sell.

For now, no entry to the investor in connection to a stock dividend.

47
Q

Return of capital distribution

A

reduce investment in investee for return of capital distribution

If investee gives investor more money than they have in RE= return of capital

Liquidating dividend:
DR Cash $10
CR Dividend Income $7
CR Investment in investee $3

48
Q

FVNI method-when to reduce investment account

A

other than fair value adj at Y/E, under FVNI method, the investment account is reduced only if:
-Shares of stock are sold
-cumulative distributions exceed cumulative earnings (return of capital)
-Investee incurs losses that substantially reduce net worth (impairment)

49
Q

Which of the following is correct regarding the FVNI method (fair value net income)?
1. investment in investee account is adjusted for investee earnings
2. the investment in investee is adjusted to fair value at the end of the reporting period

A

CORRECT: 2. the investment in investee is adjusted to fair value at the end of the reporting period

  1. not adjusted
50
Q

Which of the following is correct regarding the FVNI method (fair value net income)?
1. Cash dividends paid by the investee are reported as income by the investor if paid out of investee earnings
2. unrealized losses at year end are reported in OCI

A

CORRECT: 1. Cash dividends paid by the investee are reported as income by the investor if paid out of investee earnings

  1. reported earnings not OCI
51
Q

Which of the following is correct regarding the FVNI method (fair value net income) for equity investments?
1. the investor should hold less than 50% but more than 20% of the investee shares
2. Dividends rec’d by the investor in excess of investee earnings should be a reduction in the investment account

A

CORRECT: 2. Dividends rec’d by the investor in excess of investee earnings should be a reduction in the investment account

  1. incorrect, FVNI is for < 20% and no significant influence
52
Q

Under FVNI method, cash dividends rec’d by the investor are reported as:
1. income to the investor if the dividends are NOT in excess of the investee earnings
2. an increase in the investment in Investee account

A

CORRECT: 1. income to the investor if the dividends are NOT in excess of the investee earnings

53
Q

Under FVNI method, the investment in investee account is reduced for:
1. stock dividends rec’d
2. ordinary losses incurred by the investee

A

Neither!

Under cost method or FVNI, investment acct is only reduced if:
shares of stock are sold
cumulative dividends exceed cumulative earnings (return of capital)
subsidiary incurs losses that substantially reduced net worth (substantial = yes and ordinary =NO)

54
Q

Equity method

A

20-50% stock ownership (could be below 20% if the investor if the largest shareholder, has a majority of board of director seats)

investor exercises significant influence (sometimes greater than stock ownership %)

55
Q

Equity method- original journal entry

A

DR Investment in Investee
CR Cash
*amount includes cash paid plus legal fees

The account will change when the investee earns income and pays dividends

56
Q

Investee income- Equity method

A

assume investee earns $100,000/year and investor owns 24%

Journal:
DR Investment in investee $24,000 (B/S)
CR Income from Investee $24,000 (I/S)

*increase in investment account to reflect earnings

57
Q

Equity method: Investee cash dividends received

A

assume investee paid $5,000 cash dividends to investor

Journal:
DR Cash $5,000 (B/S)
CR Investment in investee $5,000 (B/S)

*decrease in investment account for cash rec’d from investee

58
Q

Investee stock dividends received

A

stock dividends from investee result in memo entry only

No journal entry for the receipt of additional shares of stock under the equity method (and FVNI method as well)

**Stock dividends do not impact earnings for either method

The new shares will serve to reduce the basis/share

59
Q

Common stock and preferred stock: significant influence test

A

if an investor owns both CS and PS of investee company, the significant influence test is generally met by the amount of CS stock owned (typically the only voting stock owed).

60
Q

preferred stock cash dividends

A

preferred stock cash dividends are considered income, regardless of stock ownership %

61
Q

Own both CS and PS: Investee income

A

if both common stock and preferred stock are owned, the calculation of income to be reported I/S includes:
-preferred stock cash dividends
-share of earnings available to CS stockholders, net income reduced by preferred dividends

**Under equity method= common dividends are not income to the investor

62
Q

Dividend impact: Common stock and FVNI

A

FVNI = no impact on investment account = it is dividend income (no significant influence)

FVNI JE:
DR Cash
CR Dividend income

Equity method = decrease investment account/not div income (significant influence)

63
Q

FVNI Method= when to reduce investment account

A

other than for fair value adjustment at the end of the year (mark to market Y/E), under FVNI method, the investment account is only reduced:
-shares of stock are sold
-cumulative distributions exceed cumulative earnings (return of capital)
-investee incurs losses that substantially reduce net worth

64
Q

Liquidating dividends received reduce the carrying amount of the investment account under which method:
1. FVNI method
2. Equity method

A

Both!

Liquidating dividends reduce the carrying amount for the investment account under both FVNI and Equity methods

Under the equity method, all dividends reduce the investment account

65
Q

Rose Corp received a cash dividend from CS investment. Rose Corp would report an increase in the investment account if it uses:
1. Fair value through net income method
2. Equity method

A

Neither

FVNI = dividend income, no impact investment account

Equity method = reduces investment account

66
Q

Baynar Inc acquired 40% of the outstanding non-voting preferred stock of Durbin Co.
What method for recording the investment should Baynar use?

A

FVNI method

significant influence cannot be exercised by non-voting stock

67
Q

A company has a 22% investment in another company that it accounts for using the equity method,
Which disclosure should be included in company’s annual statement?

A

-The company’s accounting policy for the investment

22% equity method and significant influence

68
Q

Which of the following, if received from investee, will affect the income reported by the investor using the equity method?
1. cash dividend
2. stock dividend

A

Neither

cash div and equity = reduces investment account carrying value

stock div = memo only = never income

69
Q

which of the following will affect the income of an equity method investor but will not affect the income of FVNI method investor?
1. Stock dividend
2. cash dividend

A

Neither

cash dividends and stock dividends do not affect income reported under the equity method

70
Q

which of the following will affect the income of an FVNI method investor but will not affect the income of equity method investor?
1. Stock dividend
2. cash dividend

A

cash dividend = dividend income for FVNI

stock method does not impact either equity or FVNI users

71
Q

Company owns 30% of the voting CS of Sanibel company
Company will probably use the equity method of accounting for this investment:

A

Company is assumed to be able to exercise significant influence over the affairs of Sanibel Co (own 20% or more of investee voting stock)

72
Q

Difference between purchase price and Book Value of Investee Assets

A

Under the equity method, additional adjustments to the investment account are possible if more is paid for the stock than book value of the assets

If a company has a book value $1,000,000 and we are buying 30% of the company, we should be paying $300,000.

If paid over book = goodwill (intangibles/not amortized) or attributed to certain assets to be amortized over the life of the asset

73
Q

Paid over book value

A

Book Value $100,000
buying 30% of the company
should be $30,000 sell price
If pay $40,000, we paid over BV by $10,000

Premium is paid when fair value of the assets of the company happen to be worth more than the book value of those same assets

Why pay $10,000 premium? What assets were worth $10,000 more than BV? The asset may have appreciated since original cost. Assets were undervalued.

74
Q

Book value =

A

stockholders’ equity

BV = total assets less total liabilities = SE

75
Q

Amortize based on specific assets

A

-if you paid a premium b/c of inventory, then amortize the premium over the life of the inventory (prob one year)
-If you paid a premium b/c of equipment, then amortize the premium over the life of the equipment.
-If you paid a premium b/c they had a valuable building, amortize the premium over the life of the building.

*Treat amortization as a decrease in the investment account

76
Q

Adjust the investment account

A

adjustments to the investment account under the equity method result from differences between price paid for the investment and the book value of the investee’s net assets

77
Q

Asset fair value differences

A

the difference between book value and fair value of the net assets acquired is allocated to the specific assets

**amortize each year to reduce the investment account = any remaining difference is goodwill and not amortized due to indefinite life

78
Q

Amortize the asset fair value over book value

A

the excess of an asset’s fair value over its book value is amortized over the life of the asset (excess caused by land is not amortized)

The additional amortization causes the investor’s share of the investee’s net income to decrease

DR Equity in investment income (reduce income)
CR Investment in Investee (reduce investment)

79
Q

Goodwill: amortize or not?

A

Do not amortize goodwill

Goodwill = Not subject to impairment (total equity method investment is subject to impairment testing yearly)

80
Q

Consolidations and goodwill

A

there will be a goodwill impairment test in consolidations

81
Q

Stocks= indefinite life (does not mature)

bonds= defined life

A

stock premium = represents partial ownership of underlying assets

paid premium for stock = find out why (undervalued assets) and/or goodwill

bonds = amortize premium over the life of the bond

82
Q

Cash surrender value of life insurance

A

life insurance can be purchased for key employees a “term” or “whole life”

Whole life has an investment portion/cash surrender value which is an asset on the company’s B/S. The portion of each premium that represents an investment portion which serves to reduce insurance expense for that period.

83
Q

The investment portion increases for whole life insurance policies every year.

Investment portion: whole life insurance first year

A

In the first year of the whole life policy, there may be no investment portion yet. The entire premium would be charged to expense much like a term policy for the first year. No cash surrender value yet.

DR Insurance expense $900
CR Cash $900

84
Q

Investment portion: whole life insurance subsequent years

A

BY the second year, there usually is some investment portion of the $900 premium.

Ex. Year 2
DR Insurance expense $800
DR Investment in cash surrender value (B/S asset) $100
CR Cash $900

Year 3
DR Insurance expense $700
DR Investment in cash surrender value (B/S asset) $200
CR Cash $900

85
Q

True or False: Whole life insurance:
Each year, an increasing portion of the premium on life insurance is allocated to investment feature of whole life insurance

A

True

no investment feature for term life

86
Q

Disclosure of investment feature

A

The asset, investment in cash surrender value, is shown on the B/S as either an investment or sometimes as other assets

CPA FAR Exam (25 decks)

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