Flashcards in Part II: F/S Accounts Deck (241):
examples of cash
3. Cash in bank
4. Negotiable instruments like checks
5. Money orders
examples of cash equivalents
1. U.S. T-bills
2. Commercial paper
3. Money market funds
takes the ending bank balance and shows what makes up the difference to the book balance
bank reconciliation formula
Bank statement bal.
+ Deposits in transit
+ Cash on hand
- Outstanding checks
+/- Bank errors
= True ending cash balance.
How is A/R recorded?
recorded at NRV on the B/S.
NRV- amount of cash the company expects to actually collect
net realizable value
1. Amount of cash the company expects to actually collect.
2. NRV = selling price - costs to complete inventory
items that reduce A/R
sales discounts, sales returns, non-collectible amounts
When A/R is recorded, the gross amount is shown, along w/a journal entry for the discount.
A/R is recorded w/the discount already factored in.
direct write-off method
1. When the account becomes uncollectible:
Bad debt expense
2. This is rarely used and doesn't conform to GAAP.
allowance is contra account to A/R
I/S approach (allowance method)
Estimates bad debt as a % of sales and directly calculates the amount of bad debt expense.
B/S approach (allowance method)
Estimates bad debt as a % of A/R and directly calculates the ending balance of the allowance account.
notes receivable (N/R)
1. More long-term and formal than A/R.
2. Stated or implicit rate.
3. If there is no stated rate of interest, the note will be discounted at PV to get the PV of FCFs.
1. Impaired if PV of FCFs
sale of receivables
Companies can sell or factor their receivables if they need to accelerate the collection of cash.
If the "sale" of A/R does not meet the criteria to be considered a sale.
criteria for an A/R transfer to be considered a sale
1. Assets are isolated from transferor.
2. Transferee is free to exchange the assets or is free to pledge or sell the assets.
3. There is no agreement where the transferor will be required to repurchase the assets.
The company receives a loan for the amount of A/R.
1. They turn over their A/R to a 3rd party in exchange for cash and they pay the 3rd party a fee.
2. The 3rd party collects payments from the customers on the A/R.
factoring with recourse
Transferor bears the cost of bad debt- if customers don't pay, the transferor loses money.
factoring without recourse
1. The factor/3rd party has no recourse against the transferor.
2. This is usu. accounted for as a sale of receivables.
assignment of A/R
A company assigns A/R as collateral for a loan.
1. The borrower must reclassify any assigned A/R as "assigned A/R."
same as assigning A/R, but less formal, so no footnote disclosure is needed.
Is inventory always a current asset?
free on board (FOB) destination
seller owns the inventory until it reaches the buyer's warehouse
FOB shipping point
seller owns the inventory until it is shipped; then, it is recorded in the buyer's inventory.
items that are included in the cost of inventory
items included in inventory costs
1. Purchase returns.
2. Freight-in (shipping cost to get inventory to the warehouse).
3. Sales tax on acquisition.
4. Insurance on transit.
items excluded from inventory costs
1. Freight-out (a selling expense).
2. Interest on purchase (financing).
periodic inventory system
company periodically physically counts all the inventory, then a value is assigned.
for large items, such as cars
CoGS / # units for sale
When prices are rising using FIFO, CoGS is the lowest and provides the highest NI, also the highest ending inventory.
When prices are rising using LIFO, CoGS is the highest and provides the lowest NI, also the lowest ending inventory.
perpetual inventory system
1. Records the purchases and sales of inventory items as they occur.
2. Physical counts still take place to verify the inventory.
same as periodic system.
Lowest CoGS, highest NI, highest end. inv.
Different from periodic system b/c a cost is assigned after each sale.
1. Last item purchased is the first one sold.
a. Highest CoGS, lowest NI, lowest end. inv.
2. Provides tax advantages b/c lower NI.
LIFO liquidation (perpetual)
oldest layer of cost is reduced b/c more units were sold than purchased in the current year, which taps into the older "layers" of inventory.
1. Using LIFO pools to track inventory.
2. Main point is that this uses a conversion index.
1. CI = end. inv. in current-yr. dollars / end. inv. in base-yr. dollars.
2. Used in dollar-value LIFO to determine inventory value for LIFO layer added in current year.
When is lower of cost or market (LCM) used?
applied to inventory no matter what cost assumption is being used
Under LCM, if market price for inventory
impaired and must be written down.
cost to go out and replace the same inventory today
NRV, or selling price - costs to complete inventory
NRV - normal profit margin.
determining market value
1. If replacement cost (RC) is between ceiling and floor, RC = market.
2. If RC > ceiling, market = ceiling.
3. If RC
gross margin method
1. Used to estimate CoGS using gross margin.
2. Sales - cost = margin.
retail inventory method
1. Used by retailers to estimate the cost of ending inventory.
2. Basic steps
1. Calculate ending inventory at retail prices.
2. Calculate cost-retail ratio.
3. Apply cost-retail ratio to ending inventory at retail prices (excluding net markdowns) to get ending inventory at cost/ establish LCM for ending inventory.
inventory errors- How to solve these problems.
1. If you encounter a question like, "purchases were overstated, what was the effect?", write out the inventory equation and walk through the info on the question.
- End. Inv.
Companies will enter into agreements to purchase certain amounts of certain items, sometimes w/in a certain time period.
loss on purchase commitments
If the market price of an item subject to this kind of agreement goes down, the buyer might have to recognize a loss.
Does the loss on purchase commitments have to be disclosed in the F/S?
1. If the terms can be modified, the potential loss can be disclosed in the notes, but not needed in F/S.
2. If the terms cannot be modified, the loss is probable and must be accrued and recognized on the B/S.
IFRS inventory differences
1. Under IFRS inventory is valued at LCM or NRV. Under GAAP, it is NRV.
2. LIFO not allowed at all under IFRS.
3. Reversal of inventory write-downs is allowed under IFRS, but not under GAAP.
Property, Plant, and Equipment (PPE)
assets that produce revenue for the business, and so their cost is allocated over time by depreciation
categories of PPE
2. Machinery and equipment.
3. Land- only asset that is not depreciated.
4. Land improvements- these have a finite life so they are depreciable.
5. Natural resources- depleted, not depreciated.
costs included in the asset account instead of being expensed
2 categories of capitalized costs
1. Costs to get the asset ready to use.
To bring the asset to its intended use and location- sales tax, testing costs, shipping costs, etc.
2. Costs to extent the asset's useful life or increase productivity.
If a cost just maintains the asset, like an oil change...
this is a regular expense and is NOT capitalized.
valuation of capital assets
general rule is that the plant assets should be valued at the market value of the consideration given for the asset, or the market value of the asset, whichever is more readily determinable
How do you value a truck you bought with cash...
you put the truck on your books at the price you paid.
If you purchase a truck on credit...
you value the asset at the PV of FCFs.
If you issue securities to pay for a truck...
you value the truck at the value of the truck or the value of the securities you issued- whichever is more readily determinable.
If someone donates a truck to your business...
the FV immediately expensed through contribution expense, the asset is taken off the books, and FV - BV is recorded as G/L.
When a company is constructing a significant asset, interest on the project can be capitalized.
rationale for interest capitalization
Rationale is that interest on the construction costs is deferred by adding it to the cost of the asset, and will eventually be expensed through depreciation.
3 things have to be happening at the same time in order for interest to be capitalized:
a. Interest cost is being incurred.
b. Construction activities are taking place.
c. Construction expenses are occurring.
amount to capitalize
The amount capitalized is the lesser of actual interest cost during the period or avoidable interest.
A. Interest that could have been avoided by paying off debt if the construction expenses weren't going on.
B. Calculated by multiplying the interest rate by "average accumulated expenditures" during the period.
average accumulated expenditures
1. AAE is the average amount invested in the project during the year.
2. If AAE > interest-bearing debt, then all interest costs will be capitalized b/c all of the debt could have been avoided.
use the specific interest rates on the construction loans first, then the average interest rate on the remaining debt.
treat all debt the same and apply the average interest rate to all debt.
(cost - salvage value) / # of years
service hours method
(cost - (salvage / total service hours)) * hours used
units of output
(cost - (salvage / total units)) * units produced
(# years remaining * (cost - salvage)) / sum-of-the-years
(2 * straight-line rate) * (cost - acc. depr.)
costs to acquire natural resources such as land or cost to lease a property
costs to locate the natural resources.
only costs of successful exploration are capitalized, unsuccessful are expensed
all exploration costs are capitalized
allocation of the natural resource to inventory
depletion journal entry
Contra account for the natural resource asset
An asset's value should be written down if its FV
3 categories of impaired assets
1. Assets held in use.
2. Assets held for disposal or sale.
3. Assets to be disposed of other than a sale.
assets held in use
impairment loss = CV - FV.
assets held for disposal or sale
a. CV > NRV = loss.
assets to be disposed of other than a sale
a. Continue to treat it as a regular asset.
b. It's depreciated like normal.
c. Apply impairment if applicable.
GAAP vs. IFRS: Fixed Asset Impairment
GAAP: cannot reverse FA impairment.
IFRS: FA impairment reversal permitted if circumstances change, but not on goodwill.
GAAP vs. IFRS: Fixed Asset Impairment Review
GAAP: impairment review necessary if circumstances change or if there is a reason to re-evaluate
IFRS: annual review of estimated useful life and depr. required
GAAP vs. IFRS: Component Depr.
IFRS: difference components of an asset that have difference useful lives should be depr. by their respective useful lives.
This gives the investor an ownership interest in a company- such as common or preferred stock.
0 - 20%
a. No real influence.
b. Valued at cost or FV.
c. Categorized as TS of AFS
d. Either current or noncurrent investment on B/S
21 - 50%
a. Significant influence
b. Valued using equity method or FV
c. Categorized as an equity investment
d. Noncurrent investment on B/S
a. Controlling influence
b. Valued at equity or cost method.
c. This investment becomes a subsidiary.
d. Consolidated financials
investments in debt
1. bonds and notes
2. No ownership- investor is going to receive interest payments and principal repayment.
3. If the investor intends to HTM investment, then it is an HTM investment and valued at amortized cost.
4. If HTM is not intent, investment is a TS or AFS investment, and valued at FV.
HTM (no significant influence)
1. Only debt
2. Carried at amortized cost.
3. Interest is earned.
4. Can be current or noncurrent depending on maturity date.
TS (no significant influence)
1. Debt or equity.
2. Investor is looking for short-term profits.
3. Carried at FV.
4. These will almost always be current assets on B/S.
AFS (no significant influence)
1. Debt or equity.
2. Carried at FV.
3. Adjust CV to FV at B/S date.
4. G/L recognized in OCI.
Changes in AFS securities is one OCI item.
transfers between categories (HTM, TS, AFS)
1. When an HTM or AFS security is moved into the TS category, carry investment at FV and recognize unrealized G/L in income.
2. When AFS changed to HTM, unrealized G/L in AOCI is amortized over life of debt.
3. When HTM is moved to AFS, carry at FV and G/L is recorded in AOCI.
cost method investments
1. Applies only to equity w/no significant influence.
2. Recorded on B/S at cost.
3. Dividends recognized in earnings.
GAAP vs. IFRS: Investment Classifications
GAAP: HTM, TS, AFS
IFRS: HTM and FV
GAAP vs. IFRS: Reversal of Impairment of Debt
GAAP: no impairment of debt can be reversed
IFRS: impairment can be reversed if there is evidence
GAAP vs. IFRS: HTM Classification
GAAP: Must have positive ability and intent to HTM.
IFRS: holding debt must be part of business model
Used for 21%-50% ownership of voting shares in an entity.
equity method & significant influence: Does owning more shares really give you more influence?
1. You can own 21-49% of shares and still not have significant influence if your interests are blocked- you have no representation on the board.
2. You can own
recording the investment
1. Record the investment at cost on your books.
2. If the purchase price is greater than FMV, you allocate the difference to goodwill.
3. Dividends reduce the investment on your books, and then it is pro rata: If you paid $1,000 for 30% of the common stock, then they pay out $100 in dividends, you will reduce your investment by $30.
4. On the other hand, if your company reported $100 of NI, you would increase your investment by $30.
GAAP vs. IFRS: FV Option
GAAP: FV option can be applied to equity investees.
IFRS: Only certain investors- not regular businesses can.
GAAP vs. IFRS: Accounting Policies of Investor and Investee
GAAP: Investor and investee can have different accounting policies.
IFRS: Not allowed.
GAAP vs. IFRS: Equity Method and Asset Sale
GAAP: Equity method applied until the investment is sold.
IFRS: Investment must be reclassified to AFS before sold.
1. 2+ entities engage in an activity for profit that is usually for a limited purpose or a limited time period.
How does the investor recognize the joint venture....
The investor recognizes contribution to the JV as an investment on its books, at is recorded at the CV of contributed assets.
1. Inventors are paid additional shares as dividends.
2. There is no income to the investor, they just recognize the additional shares.
3. It reduces per-share cost.
If an investor is paid cash as dividend, then there is dividend income.
1. Company declares a 2-1 or 3-1 split of their stock.
2. No income to the investor, it just reduces the per-share cost and the additional shares are recognized.
IFRS Investment Property
1. This is a specific class of investments that IFRS uses.
2. Can be land, building, or both that is for the purpose of earning rent or capital appreciation, or both.
treatment of IFRS Investment Property
A. Recognize the investment using either the FV method or the cost method.
treatment of IFRS Investment Property- FV method
1. Adjust to FV at each B/S date and recognize the G/L in income for the period.
treatment of IFRS Investment Property- cost method
1. Keep the investment on the B/S at cost.
2. If it's depreciable, it will be depreciated.
3. If impaired, recognize loss.
4. When it's sold, CV - selling price = G/L
markup/markdown of equity securities at FV
1. Equity securities at FV are already marked up or down at the end of each period- no additional adjustment is needed.
For AFS equity securities, if the loss is other than temporary...
the losses go through earnings. Otherwise, if the losses are temporary, they stay in OCI.
losses on debt securities
recognized in earnings.
2 types of intangibles
(legally) identifiable: copyrights, customer lists, patents
2 types of life for intangibles
definite life- has a finite life
indefinite life- no foreseeable limit on asset life
For definite life intangibles:
a. Capitalize external costs.
b. Amortized over useful life by straight-line method.
c. Impairment is BV - FV (or CV - FV).
For indefinite life intangibles:
a. Capitalize external costs.
b. Not amortized, except goodwill for nonissuers.
c. Impairment is BV - FV (or CV - FV).
1. Excess over FMV of acquired company's assets.
2. Represents brand value, customer loyalty, etc.
3. Not amortized, but can be impaired.
4. Impairment loss is part of continuing operations.
revaluation of goodwill
GAAP: not allowed
IFRS: allowed if in active market
reversal of impairment loss
GAAP: not allowed
recognition of goodwill
GAAP: at reporting unit level
IFRS: at cash-generating unit level
1. Wages accrued as employees work, and then paid out as wage or salary expense on payday.
2. Also includes employer portion of taxes and fringe benefits such as FICA and Medicare.
specific type of deferred/unearned revenue.
1. Usus. the extended warranty revenue is amortized on a SL basis over the warranty's life.
W/notes payable problems, you are given two rates. What are they? How do you use them?
1. stated and effective rate.
2. When the effective rate > stated rate, note is issued at discount. Stated > effective = premium.
3. If the note is to be reported at PV, use the effective rate.
rate stated in note and determines actual cash interest paid each period
yield rate; market rate of interest- determines interest expense and bond price
discount account (N/P)
1. Contra account to note.
2. Discount is amortized over life of note and increases liability of note.
premium account (N/P)
1. Adjunct account to note.
2. Premium is amortized over life of note and decreases liability of note.
has a claim to specific assets
has no claim to specific assets and bondholders are unsecured creditors
bonds that mature at staged intervals
single maturity bond
a bond with a single maturity date.
1. Most CPA problems are this type of bond.
callable and redeemable bonds
bonds that can be matured before the maturity date for a specified price
can be. converted into stock.
1. Most bond problems are w/ single-maturity, non-convertible, regular bonds.
For bond problems, you need to know:
1. Issue date.
2. Face value- usu. stated at 10, $1,000 bonds for a total of $10,000.
3. Coupon/stated rate- determines cash interest paid.
4. Effective/yield rate- determines int. exp and bond price.
5. Interest payment dates- usu. semiannual
6. Maturity date of bond.
a. Discount (stated market)
c. Par (stated = market)
PV of FCF payments discounted at the yield rate.
Usu. the PV is given, or it is given as "$100,000 of bonds at 97."
figuring out interest payments and amounts for bonds
When you're figuring out int. payments and amounts, keep track of your dates and the number of payments each year, as well as the # of months applicable to the question they are asking.
a. If stated rate = 10% and semiannual payment, then use 5% to get the payment.
b. If bonds are issued on Oct 1 and they ask what the interest expense was, remember it is only for 3 months.
bond issue costs
1. Include accounting, legal, printing, and underwriting fees.
2. Bond issue costs are capitalized to a deferred charge account which is an asset, and it is amortized as expense over the bond term.
3. Some problems will include bond issue costs.
FV option for bonds
A company can elect to record a bond at FV:
1. The election can never change.
2. Can apply to 1 or several bonds.
4. Amortization of premium or discount still applies.
5. Any change in FV is recognized in earnings as unrealized G/L.
change in FV for bonds (G/L)
1. Increase in FV means a loss: the company owes more.
2. Decrease in FV is a gain: the company owes less.
IFRS Bond Difference
GAAP: Bond issue costs are capitalized and then amortized.
IFRS: Debt issue costs reduce any premium or increase any discount.
At conversion, you just transfer the bond balances to stock accounts and no G/L is recorded.
market value (MV) method
At conversion, you compare the MV of the bonds to the MV of the stock, the bond accounts are closed, and the difference is a G or L.
bonds with warrants
1. A company can issue bonds that also give the bond purchaser stock warrants/stock rights.
2. Both the bonds and the warrants need to be allocated a value.
bonds w/warrants: Both the bonds and the warrants need to be allocated a value.
a. If the FV of both the bonds and warrants is known (this will be given to you in the problem), then you allocate the total bond price in proportion to the FVs.
b. If only one FV is known, you assign the FV to that security and allocate the remaining bond price to the other security.
When allocating a value to the warrants, this is recorded in...
equity, not debt.
troubled debt restructuring
1. A debtor can't pay their debt, and the creditor decides there is more to gain by making a concession instead of forcing the debtor into bankruptcy.
a. Creditor records a loss in making a concession.
b. Debtor records a gain.
1. Creditor gives a debtor specific covenants that they have to meet; usu. financial ratios that the debtor has to maintain.
If debtor falls out of covenant...
There are penalties, such as the debt being due immediately.
common vs. preferred stock
Common stock has voting rights and preferred doesn't.
Preferred stock usually has dividends and dividend priority over common shareholders, as well as priority in liquidation. Pref. stock is a debt/equity hybrid.
accounts affected by stock issuance
Cash for amount of stock issued
CS (# shares * par)
PIC in excess of par
preferred stock can be...
callable, redeemable, and convertible.
If redeemable pref. stock has a specified date at a specified price...
it is usually classified as debt.
1. Dividends are reported as int. exp.
When callable or redeemable stock is called or redeemed...
any dividends in arrears are paid first.
When a company purchases its own stock.
What kind of account is treasury stock? How does it affect assets, liabilities, and equity?
1. T stock is a contra-equity account.
2. It does not represent ownership and it lowers cash and owners' equity.
How does t stock affect income, EPS, and R/E?
1. No effect on NI.
2. Increases EPS.
3. R/E can be decreased.
2 methods of accounting for t stock
cost method (t stock)
DR: T stock (at cost when purchased)
CR: Cash (at cost)
par method (t stock)
DR: T stock (at par)
When T stock is purchased, CS is reduced pro-rata for the # of the T shares purchased.
1. Distribution of cash or other property from a firm to its owners.
2. A distribution of earnings, not an expense.
When is the liability for dividends recognized?
At the declaration date.
date of record
cutoff date for the owners who will receive dividends.
1. If you bought stock in the company after the date of record, no dividends for you.
date the dividends are actually paid out
dividends in arrears
dividends that accumulate b/c they weren't actually paid out during a period
Is a liability recorded on dividends in arrears?
Not until such dividends are declared.
How do dividends affect F/S accounts?
Dividends reduce the owners' equity account when paid.
1. This is when a firm declares dividends but doesn't have the money to pay them.
2. It's essentially a N/P from the firm to the owners, and interest is paid on the note until the dividends are paid.
when dividends are a return OF capital instead of a return ON capital
1. These usually happen in industries involving natural resources.
1. This occurs when a firm pays "dividends" of additional stock in the company.
Do stock dividends increase the # of shares outstanding? Do they change ownership %s?
Yes and No.
If the stock dividend
capitalized at market value.
If the stock dividend > or = 25% of outstanding shares, the dividend is...
capitalized at par value.
What accounts are affected by a stock split?
None. R/E and CS are not affected.
Order of dividend payments...
1. Pref. shareholders receive dividends in arrears.
2. Pref. shareholders receive current dividend.
3. Comm. shareholders receive matching amount that = preferred % * total par of comm. shares outstanding.
4. Preferred receive an additional % if any dividends remain.
5. Common receive any remaining dividends after that.
amount of dividends given to pref. shareholders
preferred % * total par of common shares outstanding.
amount of dividends given to comm. shareholders
same as given to preferred
retained earnings (R/E)
R/E = Income to date - Dividends declared to date +/- Other adjustments.
1. It keeps track of a firm's earnings to date.
How should R/E be reported in financials?
An R/E statement can be a separate statement, or it can be part of the Statement of Changes in Owners' Equity.
2 things that can change prior-year R/E balances
1. The cumulative effect of an accounting principle change.
2. The correction of an error that results in a prior period adjustment.
BV/share = comm. shareholders' equity / # of comm. shares outstanding
BV/share = (total owners' equity - pref. stock claims) / # of comm. shares outstanding
2 criteria for recognizing revenue
1. Revenue is earned- goods/services have been provided.
2. Reasonable assurance that the receivables will be collected.
When is the installment sale method used?
When the collectability of a receivable is questionable, or collection will take a long time.
installment sale method
1. Divides money into return of cost and gross profit.
2. To do these problems, calculate GP margin and then you'll have an extra sales account called DGP.
3. DGP = GP margin % * sales. Then, as money is received, the margin % of that money reduces DGP b/c GP is being recognized.
4. Along w/DGP reduction a money is received, you have the initial JE:
cost recovery method
1. Uses the same DGP account, but, instead of realizing GP as % of money received, no GP is realized until all cost has been recovered.
sales with a significant right of return
1. These are sales where the buyer knowing they can return the goods is a big reason they purchased, so revenue cannot be recognized until the return privilege has expired....
2. ...unless the returns can be estimated.
accounting for contract revenue
1. Recognizing revenue on projects that take several years to complete.
2. 2 methods:
%-of-completion (basics) (similar to installment sale)
recognize profit as work proceeds; this method is required if the total project cost an be estimated
special accounts used in %-of-completion
1. Construction in progress (CIP), which is an inventory account.
2. Billings- contra CIP account and prevents double counting
%-of-completion (how it works)
1. Costs incurred in the year (given)
+ Estimated remaining cost to complete
= Estimated project costs.
2. Knowing the est. project cost lets you figure out the amount of revenue after any given year.
3. Est. profit in current yr.
- Profit recognized in past years.
= Profit recognized in yr. 2
completed contract (similar to cost recovery)
1. You don't recognize any profit until project completion.
2. Accounting is same under % of completion except there are no yr-end entries to record revenue. Record revenue at project end.
2 types of pension plans
defined contribution plan
defined benefit plan
defined contribution plan
1. Annual employer contribution is defined- performance dependent on employee.
--Employer contributes set annual amount into an investment account for the employee held by 3rd party trustee
Is a defined contribution or defined benefit plan simpler?
defined benefit plan (DB)
annual retirement benefit is defined.
annual pension expense- 5 components (DB)
1. service cost
2. interest cost
3. expected return on plan assets
4. amortization of prior service cost
5. amortization of net G/L
increase in PBO based on what employees earn in the current year
growth in PBO based in interest accruing.
1. Beg. yr. PBO * discount rate.
expected return on plan assets
expected amount of growth in the pension fund for the year
1. Beg. plan assets * expected rate of return
projected benefit operation (PBO) formula
1. B/S item.
2. Contributions to date
+ Actual earnings on fund to date
- Benefits paid to date
increase in PBO
decrease in PBO
goal of pension equation
to figure out what needs to be contributed by the employer on an annual basis in order to have the money to pay an employee a certain amount each year once the employee reaches retirement age.
give employees the right to purchase their employers' stock at a fixed price after working for the company for a period of time.
main elements of stock options
1. Grant date.
2. Vesting date.
3. Service period.
4. Compensation expense.
Date the options are awarded to the employee.
Date in the future when the employee can actually exercise the option.
Amount of time between grant and vesting dates.
1. expense recognized during service period.
2. equals FV of the options expected to be exercised.
How is FV of options expected to be exercised (compensation expense) measured?
At the grant date using an option pricing model (usu. Black-Scholes).
How is total compensation expense amortized?
On a straight-line basis over the service period.
estimated forfeiture rate change
If this changes, so does compensation expense.
When is the change in compensation expense recognized?
In the current year.
1. These options require some performance target to be met before the options will vest.
2. The change in expected # of options to be exercised is treated the same way as changes in forfeiture rate.
expiration of fixed options
If the options expire un-exercised, there is no reversal of the compensation expense.
expiration of performance-based options
If performance criteria is not met and no options are exercised, then the compensation expense that was recognized is reversed.
1. When an employee is given a stock award, the stock is restricted until the stock vests.
2. Employee does not own the stock until the award vests.
total compensation expense for stock awards
1. FV of the stock on the date that the employee receives the "award."
For stock awards, when is compensation expense is recognized...
over the service period.
If the award does not vest...
the compensation expense is reversed.
stock appreciation rights (SAR)
1. This is a form of stock compensation that pays an employee an amount equal to the increase in the stock price between a grant date and exercise date.
If cash will be paid on stock appreciation rights, how is this recorded...
a liability is recorded- SAR liability.
income tax differences
1. Differences will arise between accounting income and tax income.
1. Arise from interest on something like municipal bonds- there would be interest income in accounting income, but it wouldn't be counted in taxable income.
2. Any tax exempt interest.
3. Fines and penalties.
4. Life insurance premiums on key employees.
5. Dividends received deduction.
Items recognized in different years between accounting and tax income.
deferred tax liability (DTL)
Items that will be taxable in the future create a DTL, b/c there is an amount that will increase taxable income in the future, and therefore increased taxes.
deferred tax asset (DTA)
Items that will be deductible in the future create a DTA, b/c it will reduce taxable income in the future.
a. W/DTA, there needs to be future taxable income in order to realize the tax asset.
valuation allowance- type of account
1. Contra account to the deferred tax asset.
How do you determine if a valuation allowance should be used or not?
Use a "more likely than not" standard.
net operating losses (NOL)
a. When you have deductions that exceed your taxable income, or negative taxable income, a NOL is created.