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Flashcards in F10 Deck (49):

Define fair value.

fair value is the price to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date.


Describe the valuation techniques that can be used to measure the fair value of an asset or liability.

1. Market Approach - Uses prices and other relevant information from market transactions involving identical or comparable assets or liabilities to measure fair value
2. Income Approach - converts future amounts, including cash flows or earnings, to a single discounted amount to measure the fair value of assets or liabilities.
3. Cost Approach - Uses current replacement cost to measure the fair value of assets.


Describe the hierarchy of fair value inputs. Which inputs have the highest priority?

1. Level 1 inputs - quoted prices in active markets for identical assets or liabilities.
2. Level 2 inputs - inputs other than quoted market prices that are directly or indirectly observable for an asset or liability
3. Level 3 inputs - Unobservable inputs for the asset or liability that reflect the entities assumptions and are based on the best available information.
Note: Level 1 inputs have the highest priority


In creating a new partnership interest with an investment of additional capital, what three methods can be used?

* Exact method
* Bonus method
* Goodwill method


Describe the exact method of creating a new partnership interest with an investment of additional capital

The purchase price equals the book value of the capital account purchased.

* No adjustment to the existing partners' capital accounts
* No goodwill or bonus


Describe the bonus method of creating a new partnership interest with an investment of additional capital.

Bonus Method:
New partner's capital account = (A + B + C) x C's percentage ownership
Excess of new partner's contribution over capital interest received is a bonus to the old partners.
Excess of capital interest received over new partner's contribution is a bonus to the new partner


Describe the goodwill method of creating a new partnership interest with an investment of additional capital.

* Goodwill is recognized based on the total value of the partnership implied by the new partner's contribution
* Goodwill is shared by existing partners using the agreed profit/loss ratio


Describe the bonus method of withdraw of a partner.

* The difference between the balance of the withdrawing partner's capital account and the amount that person is paid is the amount of the bonus.
* The bonus is allocated among the remaining partners' capital accounts in accordance with their remaining profit and loss ratios.


Describe the goodwill method of withdrawal of a partner.

The partners may elect to record the implied goodwill in the partnership based on the payment to the withdrawing partner. The amount of the implied goodwill is allocated to all of the partners in accordance with their profit and loss ratios.

After allocating goodwill, the balance in the withdrawing partner's capital account should equal the final distribution to the withdrawing partner.


In liquidating a partnership, what is the order of preference?

1. Creditors
2. Loans and advances to partners
3. Capital accounts of partners

Remember that all losses must be provided for before disposal; that is, maximum potential losses before distribution of cash.


What is a variable interest entity (VIE)?

A corporation, partnership, trust, LLC, or other legal structure used for business purposes that either does not have equity investors with voting rights or lacks sufficient financial resources to support its activities.


Who is the primary beneficiary of a VIE and how does the primary beneficiary account for its VIE investment?

The entity with the power to direct the activities of the VIE that most significantly impacts the entity's economic performance and:
1. Absorbs the expected VIE losses; or
2. Receives the expected VIE residual returns

The primary beneficiary must consolidate the VIE


Who consolidates when one entity receives the expected returns from a VIE and another entity absorbs the expected losses?

The entity that absorbs the expected losses consolidates.


Define an asset retirement obligation (ARO).

The legal obligation associated with the retirement of a tangible long-lived asset that results from the acquisition, construction, development, and/or normal operation of a long lived asset.


How is an ARO initially measured?

At fair value (present value of the future obligation) as an asset (asset retirement cost) and a liability (asset retirement obligation).


How is an ARO accounted for in periods after initial measurement?

The ARO liability is adjusted for accretion expense and the ARO asset is depreciated


Name four types of restructurings involving debt.

1. Transfer of assets
2. Transfer of equity interest
3. Modification of terms
4. A combination of above three


How is the gain (loss) measured in a trouble debt restructuring involving the modification of terms?

It is the difference between the carrying amount of the obligation prior to restructuring and undiscounted total future cash flows required after restructuring, if undiscounted future cash flows are less than the carrying amount.


How is the gain (loss) measured in a troubled debt restructuring involving a transfer of assets?

Restate the assets transferred to fair value and recegnize a gain or loss in ordinary income

Recognize a gain for the difference between the fair value of the assets transferred and the carrying amount of the debt forgiven. The gain is possibly reported as extraordinary under US GAAP if it meets the US GAAP requirements ( material, infrequent, and unusual)


When is a gain (loss) NOT recognized on troubled debt restructuring?

For debtor, when there is a modification of terms and payment of the entire debt is not affected.

For creditor, when the total cash to be received is greater than the amount receivable. The difference is amortized as interest.


When is a loan considered impaired?

Probable that all amounts due (principal and interest) will not be received.


How is an impaired loan reported by the creditor?

Present value of the loan's expected future cash flows discounted at the loan's effective interest rate.
DR. bad debt expense
CR. Allowance for credit losses


What are the general disclosures for the debtor in a troubled debt restructuring?

1. A description of the main changes in terms and/or features of settlements.
2. Gain or restructuring of payables (in the aggregate)
3. Net ain or loss on transfers of assets recognized in the period ( in the aggregate)
4. Per share amount of the aggregate gain on the restructuring of payables.
5. The amount of contingently payable amounts included in the carrying amount of restructured payables (and any conditions that would cause those amounts to become payable or to be forgiven)


What are the general disclosures for creditors in a troubled debt restructuring?

1. The creditor's policy for recognizing interest income
2. Any commitment the creditor has to lend additional funds to the debtor
3. The activity in the allowance account for the reporting period
4. The average recorded investment in impaired loans for the period (including the amount of related interest income and the interest income recognized on a cash basis)


Explain the difference between the net method and gross method of recording accounts payable.

Gross Method - the gross method records a purchase without regard to the discount. When invoices are paid the discount period, a purchase discount is credited.

Net Method - Under the net method, purchases and accounts payable are recorded net of the discount. If payment is made within the discount period, no adjustment is necessary. If payment is made after the discount period, a purchase discount loss account is debited.


How are notes receivable and payable recorded in the financial statements?

Notes receivable and payables (contractual rights to receive or pay money at a fixed or determinable rate) must be recorded at present value at the date of issuance.

If a note is non interest bearing or the interest rate is unreasonable (usually below market), the value of the note must be determined by inputting the market rate of the note and by using the effective interest method.


What is the effective interest rate method?

The effective interest rate method is a method under which each payment on a note (or other loan) would be divided between an interest component and a principal component as though the note had a constant effective stated rate (or adequate rate) of interest.


How are premium or discounts resulting from recording notes payable and receivable at present value presented in the financial statements?

The premium or discount that arises from the use of present values on cash and noncash transactions is inseperable from the related asset or liability. Therefore, such premium or discount valuation accounts are added to (or deducted from) their related asset or liability on the balance sheet.

Discounts or premiums resulting from imputing interest must not be classified as deferred charges or credits.


Premiums, warranties, and service contracts are examples of estimated liabilities. When are the liabilities for these types of expenses recorded and why?

Estimated liabilities for premiums, warranties, and service contracts are recorded in the same period as the revenue associated with the various transactions in order to accomplish matching of costs and revenues. Example - when a product is sold with a warranty, the future expense of satisfying the warranty is estimated and recorded as a liability in the same period as the sale.


What is the difference between estimated liabilities?

Generally estimated liabilities are for amounts that will be paid in the future where the amount is not known precisely when the liability must be recorded. Estimated liabilities are recorded in the current period in order to match the expenses to be paid in the future to the revenue recorded in the current period. Example - estimated liability for warranties.

Accrued liabilities are generally recorded for amounts that are known and for expenses that have been incurred, but for which payment has not yet been made. Example - Accrued payroll expense, when payment is made on the first day of the nest period.


Identify the three ranges of likelihood that a future event will confirm a contingent liability.

1. Probably
2. Reasonably possible
3. Remote.


When are contingent liabilities accrued?

* When the loss is both probable and can be reasonably estimated, then record and disclose.
* Financial statement disclosure only for reasonably possible contingent losses
* Remote contingent losses are not disclosed, unless they are "guarantee type" contingent losses, which must be disclosed.


What is the accounting treatment of gain contingencies?

Gain contingencies are not reflected on the balance sheet but are disclosed as to their nature and amount if likelihood is probable and to do so would not be misleading


What is a subsequent event and what are the two categories of subsequent events?

An event or transaction that occurs after the balance sheet date but before the financial statements are issued or are available to be issued.

1. Recognized subsequent events - provide additional information about conditions that existed at the balance sheet date.
2. Non recognized subsequent events - provide information about conditions that occurred after the balance sheet date and did not exist on the balance sheet date.


What disclosures are required for subsequent events?

1. If an entity is not an SEC filer, the entity must disclose the date through which subsequent events have been evaluated.
2. Non recognized subsequent events should be disclosed if disclosure is necessary to keep the financial statements from being misleading.


List the disclosure requirements for financial instruments under US GAAP

* Fair value and related carrying amounts
* Concentrations of credit risk
* Market risk (optional)


Describe the financial instrument fair value option under US GAAP

On specified election dates, an entity may choose to measure eligible financial instruments at fair value with unrealized gains and losses reported in earnings. The fair value option is irrevocable.


Define derivative instrument

A "derivative instrument" is a financial instrument (or other contract) that "derives" its value from the value of some other instrument and has all three of the following characteristics:
1. One or more underlyings and one or more notional amounts or payment provisions (or both)
2. Requires no initial net investment, and
3. Its items require or permit a net settlement


Define underlying and notional amount as they relate to a derivative financial unstrument

Underlying - a specified price, rate, or variable (eg, interest rate, security price, foreign exchange rate, index of prices or rates)
Notional amount - a specified unit of measure (eg, currency units, shares, bushels, pounds)


Name four common derivative instruments

* Option contracts
* Futures contracts
* Forward contracts
* Swap contracts


Identify the three types of hedge designations

* Fair value hedge
* Cash flow hedge
* Foreign currency hedge


Describe the accounting for changes in fair value associated with each type of hedge designation.

Fair value hedge - included in current earnings with gain or loss from change in value of offsetting asset/liability

Cash flow hedge - Effective portion: included in other comprehensive income until cash flows from hedged item are realized. Ineffective portion: included in current earnings

Foreign currency hedge - Fair value hedge: included in current earnings with gain or loss from change in value of offsetting asset/ liability. Cash flow hedge: included in OCI (effective portion). Net investment hedge: included in OCI, as cumulative translation adjustment


When should an entity prepare its financial statement using the liquidation basis of accounting?

* When liquidation is imminent, and entity must prepare its financial statements using the liquidation basis of accounting
* Generally, a company is in liquidation when it is converting its assets to cash or other assets and is settling its obligations with creditors with the intent of ceasing its activities.
* Financial statements must be prepared using a basis of accounting that helps financial statement users understand how much the organization will have available to distribute to investors after disposing of its assets and settling its obligations.


What are the criteria for " imminent liquidation"

In order for liquidation to qualify as "imminent" the following criteria must be met:
* The likelihood of the entity returing from liquidation is remote; and either:
1. a liquidation plan is approved by the individuals wiht authority to make the plan effective, and the likelihood is remote that the plan's execution will be blocked by other partied; or
2. a liquidation plan is imposed by other forces such as an involuntary bankruptcy


Describe the proper accounting when liquidation basis is initially applied.

On the effective date that the liquidation basis must be applied, a cumulative effect adjustment is required to account for any differences between existing measurements and the measurements required under the liquidation basis. At each subsequent reporting date, assets, liabilities, and accruals must be remeasured.


Describe the measurement basis for assets and liabilities under the liquidation basis of accounting.

* Assets must be measured and presented at the amount of cash proceeds expected from liquidation. Items that were not previously recognized under US GAAP (eg, trademarks and patents) but are expected to be sold in liquidation or used in settling liabilities should be recognized.
* Liabilities should be measured and recognized according to the US GAAP that otherwise applies to them. Adjustments can be made to reflect changes in assumptions (such as when payments are expected to be made) stemming from the decision to liquidate.


Describe the accounting for costs expected to be incurred during and at the end of the liquidation process.

Costs that are expected to be incurred during and at the end of the liquidation process must be accrued, as well as income expected to be earned during the period of time the entity is in liquidation. All amounts must be presented separately and at non discounted values.


Describe the financial statements required under the liquidation basis of accounting

An entity preparing financial statements under the liquidation basis of accounting must present both a Statement of Net Assets in Liquidation and a Statement of Changes in Net Assets in Liquidation.

For the latter, the initial statement will present only changes in net assets that occurred during the time frame since imminent liquidation was established.


What are the disclosures required for a company that is applying the liquidation basis of accounting?

* A statement that the financial statements are prepared using the liquidation basis of accounting
* The plan for liquidation
* Significant assumptions and methods used to measure assets and liabilities
* The expected time frame for completing the liquidation process.
* The type and amount of costs and income accrued, as well as the period over which these costs and revenues are expected to occur.