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FAR > F1 > Flashcards

F1 Flashcards

1
Q

2 fundamental characteristics of useful financial information

A
  1. Relevance
  2. Faithful Representation
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2
Q

3 elements of Relevance

A
  1. Predictive value
  2. Confirmatory value
  3. Materiality
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3
Q

3 elements of Faithful Representation

A
  1. Completeness
  2. Neutrality (Free from Bias)
  3. Free from error
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4
Q

4 enhancing characteristics of useful financial info

A
  1. Comparability
  2. Verifiability
  3. Timeliness
  4. Understandability
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5
Q

Constraint on Fin Reporting

A

Cost Constraint - benefits of reporting must outweigh the cost

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6
Q

What are the 5 Financial Statements

A

Statement of…
1. Financial Position
2. Earnings
3. Comprehensive Income
4. Cash Flows
5. Changes in Owner’s Equity

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7
Q

What does a ‘classified’ balance sheet do

A

Separates Current and Non-Current assets/liabilities

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8
Q

What are the steps to set an Accounting Standard?

A

FASB:
1. adds to agenda
2. research and issue discussion memo
3. public hearings
4. evaluate research and issue an Exposure Draft (1st version of new standard)
5. solicit new comments and modify draft
6. finalize new standard by vote (4 out of 7 FASB members)
7. issue Accounting Standard Update

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9
Q

Current Ratio

A

Current Assets over Current Liabilities

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10
Q

Quick Ratio

A

(Current Assets - Inventories - Prepayments) over Current Liabilities

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11
Q

Debt to Equity

A

Total Liabilities over Shareholder’s Equity

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12
Q

Income Statement Organized

A

Sales
COGS
=Gross Income
Selling, general & admin (Selling can be separate)
Depreciation
=Operating Income
Non-operating items (unusual & infrequent)
=Income before tax/Income from Operations
Income tax
=Income from continuing operations
Income from Discontinued Operations (report net of tax)
=Net Income

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13
Q

2 distinctions on an Income Statement

A

Continuing Operations
- Operating + unusual & infrequent

Discontinued Operations (net of tax)

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14
Q

Gross margin

A

Gross profit over Sales

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15
Q

Net margin

A

Net profit over Sales

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16
Q

EPS/Earnings Per Share

A

Net income over weighted average of common shares outstanding

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17
Q

Revenue is reported net of what

A

Discounts and Returns (anything else in another line item, e.g. recovery of bad debt, purchase discounts)

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18
Q

5-step approach to Revenue Recognition

A

ISTAR (I am a STAR)
1. Identify contract with customer
2. Separate performance obligations
3. Transaction price (determine)
4. Allocate the transaction prices to separate performance obligations
5. Recognize revenue when the entity satisfies each performance obligation

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19
Q

Rule of Conservatism and Combination of Contracts

A

The overarching rule of conservatism suggests that we recognise revenue only when the job is done.

Lawyers might separate contracts (e.g. 1 for building the machine, 1 for installing, 1 for ongoing support) but we apply substance over form and look at all contracts as one.

‘when two or more contracts are entered into with the same customer or related parties at or near the same time, the contracts should be combined…. consideration for one contract is tied to the performance of another contract’

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20
Q

When is a Performance Obligation satisfied

A

A good/service is transferred when the customer obtains control of it

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21
Q

Examples of when Performance Obligations are not separately identifiable

A
  • when the goods/services are highly interrelated
  • when the entity provides significant service of integrating goods/services into a bundle that represents a combined output
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22
Q

When Transaction Price is variable

A

Take the range of possible amounts and use either one of these, which ever is a better predictor:
1. Weighted average
2. Most likely amount (mode)
When there are few options use option 2 because 1 won’t correspond to a real outcome

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23
Q

When Transaction Price has noncash consideration

A

Measure the fair value at the contract inception (when it was signed)

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24
Q

When a Transaction Price has financing

A

If < 1 year then discounting is unnecessary
Otherwise adjust transaction price by time value of money.
Recognise revenue for discounted amount then recognise interest income each year.

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25
Q

Allocating the Transaction Price

A

Allocate Proportionally according to Stand Alone prices.
Discounts - apply proportionally to all obligations

26
Q

Two methods of Recognizing Revenue

A
  1. Output method - e.g. newspapers - based on output to customer
  2. Input method - e.g. CPA firm - based on inputs to satisfaction of performance obligation
27
Q

When to Recognize Revenue over time vs at a point in time

A

Recognize over time if meeting the following critieria:
1. Good/service enhances an asset that the customer controls
2. Customer consumes entity performance benefit as it performs it
3. Entity is not creating an asset for itself and has enforceable right to receive payment for performance as it performs it

Example - building a house for a customer.
- If the upfront payments (security deposit, instalment payments etc) are non-refundable and the entity can’t direct the unit to another customer - Over Time
- If the upfront payments etc are refundable - Point in Time

Recognize at a point in time if it doesn’t meet above criteria

28
Q

Two methods of Recognizing Revenue over time

A
  1. Output method - e.g. newspapers - based on output to customer
  2. Input method - e.g. CPA firm - based on inputs to satisfaction of performance obligation
29
Q

What is a contract modification?

A

A change in the price or scope (or both).

Modification is treated as a new contract if the scope increases because of new goods/services and change in contract price represents stand-alone prices

30
Q

Deferred vs Unearned Revenue

A

They are both liabilities on the Balance Sheet but Unearned Revenue is for services (e.g. service element of a contract) and Deferred Revenue is for Goods.

Similarly, Sales Revenue is for Goods and Earned Revenue is for services.

31
Q

What are Incremental Costs of obtaining a contract?

A

Costs that would not otherwise have been incurred if the contract hadn’t been obtained

32
Q

How to account for incremental costs of a contract

A

If entity expects to recover costs: capitalise as asset and amortize (e.g. Commissions to sales employees only on successful pitch, legal fees on drawing up the contract)

If costs incurred regardless of whether contract was obtained then expense them (e.g. Travel Costs to make the pitch)

33
Q

Eligible costs to Fulfill a Contract

A

Meet all of these criteria. Will be recognised as an asset and released as COGS when performance obligation is met:

  1. Relate directly to a contract (e.g. direct labor, materials, allocated costs)
  2. Generate or enhance the resources of an entity (e.g. existing employee providing tech support does not fulfill this)
  3. Expected to be recovered (expect revenue)
34
Q

Contract costs that should be expensed when incurred

A

Selling, general and Admin costs, wasted labor and material costs

35
Q

Revenue Recognition when an entity is an Agent (as opposed to Principal)

A

Agents recognise the net revenue (i.e. just the commission) in the revenue line and a liability for monies due to the Principals.

A company is the principal if it controls the good or service being sold. If so it recognises gross sales and rest as COGS

36
Q

What is a Repurchase Agreement and what are the types

A

The sale of a good with the right of return. The Customer has the right to return the product for a refund. There are three types

  1. A Forward - the seller is obliged to repurchase the asset (buyer has no choice)
  2. A Call Option - the seller has the right to repurchase the asset (buyer has no choice)
  3. A Put Option - the seller is obliged to repurchase the asset at the customer’s request (buyer has the choice)
37
Q

Accounting for a Forward or Call Option Repurchase Agreements (situations where the buyer has no choice)

A

If the Forward or Call Option repurchase commitment is equal to or more than the original price paid then it constitutes a Financing Arrangement. The difference between original price and repurchase price is treated as interest expense.

If it’s less than original selling price then treat as a lease

Finance journal entries
On original sale, Dr Cash, Cr Financial Liability

Over period recognise interest: Dr Interest exp, Cr Financial Liability

If Option lapses, recognise sale: Dr Financial Liability, Cr Sale (including interest)

38
Q

Accounting for a Put Option Repurchase Agreements (situations where the buyer has the choice)

A

Where the buyer has the choice to exercise the Repurchase Agreement then also need to consider whether the buyer has significant economic incentive to exercise the right:

If repurchase prices is less than original selling price and:

  1. If there is significant incentive - a lease
  2. If no significant incentive - a sale with right of return

If repurchase prices is more than original selling price and:

  1. repurchase is more than the expected MV of the asset - Financing Arrangement
  2. repurchase price is less than (or =) the repurchase price of asset and no significant economic incentive to exercise - a sale with right of return
39
Q

Accounting for Bill and Hold arrangements

A

Revenue can’t be recognised until the customer obtains control of the product. For control in a Bill and Hold, all of the following criteria must be met:

  1. Must be a substantive reason for the arrangement (e.g. customer requested)
  2. Product has been separately identified as belonging to the customer
  3. Product is ready for delivery
  4. Entity cannot direct the product to another customer
40
Q

Accounting for Consignments

A

When the dealer/distributor does not have control of the product.

Recognise revenue when the dealer/distributor sells the product (or when it obtains control).

41
Q

Accounting for Warranties

A

A warranty that comes as standard (e.g. 1 year at time of purchase) is not a separate performance obligation and so not accounted for separately. If the law requires a warranty etc then not separate.

If you the option to buy an extended warranty then that is a separate performance obligation. Beyond normal assurance that the product will comply with agreed specs.

42
Q

Refund Liabilities and Right of Return

A

Refund Liability reflects the amount the entity expects not to be entitled to receive.

Journal on original sale
Dr Cash
Cr Revenue
Cr Refund Liability (amount entity expects not to be entitled to receive)

When receive returned products
Dr Refund Liability
Cr Cash

43
Q

Recognising Revenue for Long-Term Construction contracts

A

2 methods allowed:

  1. Percentage-of-Completion Method = revenue over time
    This is the standard method and required most of the time
  2. Completed Contract Method = at a point in time
    Only allowed in some circumstances and only allowed in US GAAP (not IFRS)
44
Q

Under what circumstances must you use the Percentage-of-Completion method for long term contracts?

A

When you can:

  1. Reasonably estimate profits
  2. Provide a reliable measure of progress towards completion
45
Q

Accounts used in Percentage-Completion Method accounting

A

Balance Sheet:

Current Assets:
- Accounts Receivable (for due on account payments)
- Construction in Progress account. An inventory account where construction costs and Gross Profit are accumulated. So period GP journal would be:
Dr COGS (cost of LT construction contracts) for portion of inventory used in period
Dr Construction in Progress for Gross Profit
Cr Revenue from LT construction contracts for sales to recognised

Current Liabilities:
- Progress Billings - Billings on construction are accumulated here.

For Balance Sheet reporting, the Construction in Progress account and the Progress Billings account are netted against each other.

46
Q

How to calculate percentage of Gross Profit to date in Percentage-of-Completion method

A

N.B. an estimated loss on total contract must be recognised in full immediately. Previous profit recognised reversed out

47
Q

When to apply the Completed Contract Method for Long-term contracts

A

U.S. GAPP only. Can only use when:
1. Difficult to estimate
2. Many contracts
3. Contracts are of a short duration

48
Q

Accounting for Completed Contract Method for Long-term contracts

A

Same accounts as in Percentage Completion Method. But you don’t have the periodic journal recognising Gross Profit. No Gross Profit is recognised until the contract is completed.

Exception to this is if you see there will be an overall loss on the contract. In which case recognise this in full immediately.

49
Q

When to report a loss from a Discontinued Operation

A

Report all amounts in the period in which they happen. Ignore future estimates including losses

50
Q

Accounting for discontinued operations held for sale

A

You treat an operations component ‘held for sale’ the same as a disposed of operation:

Recognised profit/loss from full year regardless of when ‘held for sale’ or sold

51
Q

When to treat a component disposal as discontinued operation?

A

When disposal:

  1. represents a strategic shift
  2. it has a major effect on a company’s operations
52
Q

Things to calculate for a Discontinued Operation

A
  1. Results of operations for that period only (no estimates for future periods)
  2. Gain or loss on disposal (in year of sale)
  3. Impairment loss (and subsequent impairment reversal) - impair when made held for sale, then reverse later if necessary. Selling Price - Costs to Sell = NRV. If NRV < Book Value then impaired. If NRV increases to more than book value later then reverse previous impairment but don’t recognise a gain.
53
Q

Accounting for Changes in Accounting Estimates

A
  1. Prospective application (not an error, no restatement)
  2. When a change in acc’g priniciple is considered inseparable from estimate use propsective approach. E.g. Changes in Depreciation Method or changing to LIFO inventory valuation.
  3. If a change in estimate affects lots of future periods then disclose in the notes.
54
Q

Accounting for Changes in Accounting Principle

A
  1. Retrospective Application (restatement)
  2. Has to be justified: either required by GAAP or it’s preferable (more fairly represent my situation - no income smoothing)
  3. Calculate cumulative effect of prior adjustment. Multiply this by (1-Tax) and adjust b/f Retained Earnings for this (b/f of comparatives, if applicable)
  4. Exceptions - changes in Depreciation Method (straight line etc) or change to LIFO - handled like an change in estimate (prospective)
55
Q

Situations that require Restatement (other than change in Acc’g Principle)

A
  1. Changes in the companies included in Consolidation
  2. Error correction (material, e.g. non-GAAP to GAAP)
56
Q

Comprehensive Income =

A

Net Income + Other Comprehensive Income

57
Q

Other Comprehensive Income rolls up into which equity account?

A

Accumulated OCI (not Retained Earnings)

58
Q

Other Comprehensive Income examples

A

PUFI:
- Pension Adjustments
- Unrealised Gains/Losses on available-for-sale debt securities, cash-flow hedges (n.b. unrealised gains/losses on investments securities go through IS)
- FX translation method (not remeasurement method, which goes to IS)
- Instrument specific credit risk (e.g. Fair Value option)

59
Q

Reclassifications between OCI and IS

A

OCI is like a holding tank until the transaction is ready to be reported in Income Statement. Reclassification Adjustments necessary to move from Accumulated OCI to Retained Earnings.

E.g. recongnize unrealised gains on held-for-sale securities in OCI. When gain realized you move from OCI to IS.

60
Q

Disclosures on OCI

A

Tax
OCI items are either reported net of tax, or before tax with one line for tax.

But you do have to report the tax associated with each line and this can be done either on the statement or in a note.

Components
Changes in accumulated balances of each component (PUFI) have to be disclosed either in the face of the statement (as a Matrix) or in a note

Reclassifications
Have to be disclosed separately from current-period OCI

FAR (2 decks)

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