FAR SEC 5 Flashcards
What is the most liquid asset?
Cash.
Are securities held as investments the same as cash equivalents?
No, securities held as investments are reported in different classifications on the balance sheet.
What is the standard of value for transactions reported in the financial statements?
As the customary medium of exchange, CASH provides the standard of value (the unit of measurement) of the transactions that are reported in the financial statements.
How important is internal control of cash?
Cash is the most liquid of assets. Because of that liquidity and the ability to transfer it electronically, internal control of cash must be strong.
Is cash always a current asset?
No. Cash is classified as a current asset unless its use is restricted to such purposes as payments to sinking funds.
In this case, cash is reported as a noncurrent asset with an account title such as bond sinking fund.
What condition applies for cash to be reported as a noncurrent asset?
Cash is only reported as a noncurrent asset if its use is restricted to such purposes as payments to sinking funds.
How is cash reported when it is a noncurrent asset?
If cash is a noncurrent asset, the cash is reported as a noncurrent asset with an account title such as bond sinking fund.
Which four forms of cash or cash equivalents should be reported in the cash current asset account?
To be classified as current, cash must be readily available for use. The cash account on the balance sheet should consist of
1) Coin and currency on hand, including petty cash and change funds
2) Demand deposits (checking accounts)
3) Time deposits (savings accounts)
4) Near-cash assets
What are four attributes of near-cash assets?
Near-cash assets
1) They include many negotiable instruments, such as money orders, bank drafts, certified checks, cashiers’ checks, and personal checks.
2) They are usually in the process of being deposited (deposits in transit).
3) They must be depositable. They exclude unsigned and postdated checks.
4) Checks written to creditors but not mailed or delivered at the balance sheet date should be included in the payor’s cash account (not considered cash payments at year end).
Must restricted cash be set aside in special accounts? How should restricted cash be presented?
Restricted cash is not actually set aside in special accounts. However, it is designated for special uses and should be separately presented and disclosed in the notes.
Must restricted cash be set aside in special accounts?
Restricted cash is not actually set aside in special accounts.
How should restricted cash be presented?
Restricted cash is designated for special uses and should be separately presented and disclosed in the notes.
What are examples of restricted cash?
Examples are bond sinking funds, new building funds, and restricted compensating balances.
Is restricted cash always a noncurrent asset?
No. If cash is restricted to pay a current obligation, it is still a current asset. For an example, a bond sinking fund used to redeem noncurrent bond debt is noncurrent, but a fund to be used to redeem bonds currently redeemable is a current asset.
What factor determines if cash is current or noncurrent?
The nature of the use determines whether cash is current or noncurrent.
A bond sinking fund used to redeem noncurrent bond debt is noncurrent, but a fund to be used to redeem bonds currently redeemable is a current asset.
What are compensating balances?
As part of an agreement regarding either an existing loan or the provision of future credit, a borrower may keep an average or minimum amount on deposit with the lender. This compensating balance increases the effective rate of interest paid by the borrower.
-It also creates a disclosure issue because the full amount reported as cash might not be available to meet general obligations.
Why do compensating balances result in a disclosure?
Compensating balances create a disclosure issue because the full amount reported as cash might not be available to meet general obligations.
Do compensating balances require a disclosure?
Yes.
What are the three elements of the definition of cash equivalents?
Cash equivalents are
1) Readily convertible to known amounts of cash and
2) So near maturity that interest rate risk is insignificant.
3) Only investments with an original maturity to the holder of 3 months or less qualify.
What are three examples of cash equivalents?
Cash equivalents are short-term, highly liquid investments. Common examples are Treasury bills, money market funds, and commercial paper.
When would money market mutual funds, commercial paper, treasury bills, or certificates of deposit qualify as cash equivalents (current assets)?
If these are readily convertible to a known amount of cash and have an original maturity to the holder of 3 months or less, they would qualify as cash equivalents.
Can an asset be considered cash equivalent if its current time to maturity is less than 3 months but its original time to maturity was greater than 3 months?
No. However, the asset would become a current non-cash asset once its time to maturity is less than the greater of one year or the length of the operating cycle.
What is a nonsufficient funds (NSF) check?
Nonsufficient funds (NSF) checks and postdated checks should be treated as receivables. These are noncash assets.
How are advances for expenses to employees treated?
Advances for expenses to employees may be classified as receivables (if expected to be paid by employees) or as prepaid expenses. These are noncash assets.
What is an overdraft?
An overdraft is a current liability unless the entity has sufficient funds in another account at the same bank to cover it.
When is an overdraft not a current liability?
Only if entity has sufficient funds in another account at the same bank to cover it.
What are four examples of noncash short-term investments?
Noncash short-term investments are usually substantially restricted and thus not readily available for use by the entity. They should be classified as current or temporary investments, not cash. However, they may qualify as cash equivalents.
1) Money market funds are essentially mutual funds that have portfolios of commercial paper and Treasury bills. However, a money market fund with a usable checking feature might be better classified as cash.
2) Commercial paper (also known as negotiable instruments) consists of short-term (no more than 270 days) corporate obligations.
3) Treasury bills are short-term, guaranteed U.S. government obligations.
4) Certificates of deposit are formal debt instruments issued by a bank or other financial institution and are subject to penalties for withdrawal before maturity.
Are some current or temporary investments considered cash equivalents?
Yes, they may qualify as cash equivalents.
What are four rules for recording cash?
1) Cash may be recorded in a general ledger control account, with a subsidiary ledger for each bank account. An alternative is a series of general ledger accounts.
2) On the balance sheet, one account is presented. It reflects all unrestricted cash.
3) Each transfer of cash from one account to another requires an entry.
4) At the end of each period, a schedule of transfers should be prepared and reviewed to make certain all cash transfers are counted only once.
What is a bank reconciliation?
A bank reconciliation is a schedule comparing the cash balance per books with the balance per bank statement (usually received monthly). The common approach is to reconcile the bank balance to the book balance to reach the true balance.
Why is bank reconciliation necessary?
The bank and book balances usually vary. Thus, the reconciliation permits the entity to determine whether the difference is attributable to normal conditions, error, or fraud. It is also a basis for entries to adjust the books to reflect unrecorded items. The bank and the entity inevitably record many transactions at different times. Both also may make errors.
For bank reconciliation, what are the three items known to entity but not known to bank?
1) Outstanding checks. The books may reflect checks written by the entity that have not yet cleared the bank. These amounts are subtracted from the bank balance to arrive at the true balance.
2) Deposits in transit. A time lag may occur between deposit of receipts and the bank’s recording of the transaction. Thus, receipts placed in a night depository on the last day of the month are reflected only in the next month’s bank statement. These receipts are added to the bank balance to arrive at the true balance.
3) Errors. If the bank has wrongly charged or credited the entity’s account (or failed to record a transaction at all), the error will be detected in the process of preparing the reconciliation.
For bank reconciliation, what are the three items known to bank but not known to entity?
1) Amounts added by the bank. Interest income added to an account may not be included in the book balance. Banks may act as collection agents, for example, for notes on which the depositor is the payee. If the depositor has not learned of a collection, it will not be reflected in its records.
-These amounts are added to the book balance to arrive at the true balance.
-They should be recorded on the entity’s books, after which they are no longer reconciling items.
2) Amounts subtracted (or not added) by the bank. These amounts generally include service charges and customer checks returned for insufficient funds (NSF checks). Service charges cannot be recorded in the books until the bank statement is received. Customer checks returned for insufficient funds are not added to the bank balance but are still included in the book balance.
-These amounts are subtracted from the book balance to get the true balance.
-They should be recorded on the entity’s books, after which they are no longer reconciling items.
3) Errors. Bookkeeping errors made by the entity will likewise be discovered.
What are the four common reconciliation items?
1) Additions to book balance of interest earned, deposits collected, or errors.
2) Additions to bank balance of deposits in transit or errors.
3) Subtractions to book balance of service charges, NSF checks, or errors.
4) Subtractions to bank balance of outstanding checks, errors.
What is the Fair Value Option (FVO)?
The FVO allows entities to measure most recognized financial assets and liabilities at fair value.
An entity may elect the FVO for most recognized financial assets and liabilities.
May an entity elect the fair value option for all recognized financial assets and liabilities.
No. An entity may elect the FVO for most (but not all) recognized financial assets and liabilities. There are FVO exceptions where FVO is unavailable.
What are the 5 cases where the fair value option is not allowed?
The FVO may not be elected for the following:
1) An investment that must be consolidated
-The FVO is not an alternative to consolidation.
-Consolidation is required for subsidiaries and variable interest entities. Study Unit 14 addresses these topics.
2) Postretirement employee benefit obligations, employee stock option and purchase plans, and deferred compensation obligations
3)Most financial assets and liabilities under leases
4) Demand deposit liabilities
5) Financial instruments at least partly classified in equity
Is the decision to elect the fair value option revocable?
No. The decision whether to elect the FVO is made irrevocably at an election date (unless a new election date occurs).
For complex situations, how can the fair value option election be made on a case-by-case basis for each different instrument involved?
1) With certain exceptions, the decision is made instrument by instrument and only for an entire instrument.
2) Thus, the FVO generally need not be applied to all instruments in a single transaction.
-For example, it might be applied only to some of the shares or bonds issued or acquired in a transaction.
What are the four criteria for determining the existence of a fair value option election date?
The election may be made only on the date of one of the following:
1) Initial recognition of an eligible item
2) Making an eligible firm commitment
3) A change in accounting for an investment in another entity because it becomes subject to the equity method
4) Deconsolidation of a subsidiary
How are fair value option financial assets and liabilities presented on the balance sheet? (2 elements)
Balance Sheet
1) Under the FVO, financial assets and liabilities are measured at fair value each balance sheet date.
2) Assets and liabilities measured using the FVO are reported by separating their reported fair values from the carrying amounts of similar items measured using another attribute, such as amortized cost or present value.
How are fair value option financial assets and liabilities presented on the income statement? (2 elements)
Income Statement
1) Transaction costs related to the acquisition of an item for which the FVO was elected must be expensed as incurred. They must not be capitalized at the initial cost of the item.
2) Dividends received from an investment that is accounted for using the FVO are recognized as dividend income.
How are changes in fair value of financial assets reported under the fair value option?
Under the FVO, unrealized holding gains and losses on the remeasurement to fair value of financial assets are recognized in the income statement (net income) at each subsequent reporting date.
How are changes in the fair value of financial liabilities reported under the fair value option? (4 elements)
1) Under the FVO, unrealized gains and losses on the remeasurement to fair value of financial liabilities are recognized in the statement of comprehensive income.
2) The portion of the total change in the fair value attributable to the change in instrument-specific credit risk is recognized as an item of other comprehensive income (OCI).
This amount is the difference between
-The total change in the fair value of the financial liability and
-The amount that results from a change in a base market risk, such as a risk-free interest rate.
3) The remaining change in fair value (total change in fair value – change attributable to instrument-specific credit risk) is recognized directly in the income statement.
4) When the financial liability is derecognized, the accumulated gains or losses due to changes in instrument-specific credit risk are reclassified from OCI to the income statement.
How are Equity Method journal entries made after the acquisition date? (3 elements)
1) Under the equity method, the investor recognizes in income its share of the investee’s earnings or losses in the periods for which they are reported by the investee. The journal entry is as follows: (see the image)
2) The investor’s share of the investee’s earnings or losses is recognized only for the portion of the year that the investment was held under the equity method.
3) The investor’s share of the investee’s earnings or losses is adjusted to eliminate intraentity profits and losses not realized in third-party transactions.
What are the three categories of debt securities?
How are held-to-maturity debt securities presented on the balance sheet? (4 elements)
1) On the face of the balance sheet, held-to-maturity securities are presented net of any unamortized premium or discount. (This topic is addressed in Subunit 5.6.)
2) Amortization of any discount (premium) is reported by a debit (credit) to held-to-maturity securities and a credit (debit) to interest income.
3) Individual securities are presented as current or noncurrent.
4) The allowance for credit losses must be separately presented as a deduction from the held-to-maturity securities’ balance. [SEE IMAGE]
For debt securities, what 5 rules apply for transfers between categories?
