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Flashcards in Part III: Specific Transactions Deck (144):
1

accounting principle changes and correction of errors

a. Management may change significant estimates or accounting principles, or a material error may be found that would have affected prior year's F/S.

2

estimate changes

This is when you change the estimate useful life of PPE or change depreciation methods.

3

accounting principle changes

Changing from one GAAP principle to another such as LIFO to FIFO.

4

error correction

This is when an error is discovered that affects prior year income.

5

prospective application (going forward only)

1. Used w/changes in estimates.
2. The new estimate is applied to current and future years.

6

retrospective application (going back in time)

1. Used w/changes in accounting principle and w/changes in errors.
2. The change in prior years is recorded and an R/E adjustment is made. This requires RESTATEMENT of prior-yr. F/S.

7

adjustment to R/E

Either a:
1. cumulative effect of the change in accounting principle.
2. Or, a prior period adjustment for error correction.

8

asset retirement obligation (ARO)

a. With certain assets that have environmental impact or are affected by other regulations, there will be significant costs to dispose of the asset.
b. These future costs need to be accounted for as an ARO.

9

examples of ARO

Closing a mine, decommissioning nuclear processes, or site reclamation.

10

How are future ARO costs recorded?

Such costs are capitalized as an asset, and as a liability.
1. The amount capitalized is the weighted PV of the future costs to retire the asset.
2. The asset's base is depreciated over its useful life.

11

accretion expense

1. When the ARO is increased each year as time goes on.
2. Accretion expense = ARO bal. * Interest rate at initial measurement
3. Annual accretion expense is an operating expense and is NOT considered interest expense.

12

business combination

1. When an acquiring business gains control of another business.
2. Control is considered as > 50% of voting ownership.

13

merger

Entity A absorbs entity B.

14

consolidation

Entity A and Entity B consolidate their net assets and become Entity C.

15

acquisition

Entity A acquires a controlling interest in entity B, but both continue as separate legal entities.

16

If the price paid for the business is greater than the FMV of the net assets, the difference is booked as...

goodwill.

17

transaction costs

All costs associated w/a business combination are expensed as incurred.
This includes legal fees, audit fees, finder fees, etc.

18

At the date of acquisition, consolidated NI =

parent's NI.

19

For the full year of the combination, consolidated NI =

parent's NI for the year + sub's NI after the combination.

20

For years after the combination, consolidated NI =

parent's NI for the year + sub's NI for the year.

21

non-quantitative disclosures required for business combinations

1. Name and desc. of acquiree.
2. Acquisition date.
3. % voting equity acquired.
4. Primary reason for combination.
5. Description of how acquirer gained control.
6. Qualitative factors that make up the goodwill account.

22

acquisition date value disclosures required for business combinations

1. FV of each class of consideration transferred and total amount transferred.
2. FV of non-controlling interest ad techniques/inputs used to determine FV.

23

goodwill disclosures required for business combinations

1. Amount allocated to each reportable segment.
2. Amount expected to be tax deductible.
3. For bargain purchase:
a. Amount of gain.
b. Where gain shows in F/S.
c. Description of basis for gain.

24

publicly traded entity disclosures

1. Amounts of post-combo revenue and earnings of sub included in consolidated NI.
2. Revenue and earnings for the period as though combination occurred at beginning of period.

25

GAAP vs. IFRS: Contingent Assets/Liabilities

GAAP: Contingent assets and liabilities can be recognized if criteria is met.
IFRS: Contingent assets are not recognized.

26

GAAP vs. IFRS: Goodwill

GAAP: Goodwill allocation to the reporting units.
IFRS: Goodwill is allocated to the cash-generating units.

27

GAAP vs. IFRS: Goodwill Impairment Testing

GAAP: Goodwill impairment is a 2-step process.
IFRS: Goodwill impairment is a 1-step process.

28

consolidated F/S

1. Present all economic resources and obligations of the economic activity.
2. Emphasize economic substance over form.

29

At the date of consolidation, the assets and liabilities of the parent and sub are...

combined on the B/S.

30

At the date of consolidation, will the I/S and SCF show from the parent? Or the sub? Or both?

Just the parent b/c their operations weren't combined until that date.

31

consolidating elimination entries

1. These entries eliminate:
a. The investment in the sub on the parent's books.
b. The shareholders' equity of the sub.
2. And recognize the noncontrolling interest in sub's net assets.

32

Remember that with the equity method of accounting...

the parent adjusts their investment in the sub based on the sub's income and dividends.

33

How does the sub's income increase or decrease parental investment?

Increase.

34

How does the sub's dividends increase or decrease parental investment?

Decrease.

35

Under the cost method of accounting, does the parent adjust the investment in the sub?

The parent does NOT adjust the investment in the sub.

36

The parent's investment in the sub will be...

the same on the investment date as at the date of combination.

37

noncontrolling interest

portion of the subsidiary NOT owned by the parent.

38

intercompany transactions

must be removed on consolidated F/S, or else the level of activity would be overstated for both entities.

39

downstream transaction

when parent sells to the sub.

40

upstream transaction

when the sub sells to the parent.

41

The following transaction types need to be eliminated in consolidated F/S:

1. Intercompany receivables/payables
2. Intercompany revenues/expenses
3. Intercompany inventory
4. Intercompany fixed assets
5. Intercompany bonds

42

derivatives

financial instrument with an underlying, a notional amount, and a net settlement (such as a stock option)

43

underlying

specified price or rate (stock price)

44

notional amount

specified unit of measure (# of shares)

45

net settlement

determined by underlying * notional amount
(100 shares at $20 per share).

46

common types of derivatives

1. option contracts.
2. future contracts.
3. forward contracts.
4. swap contracts.

47

option contracts

agreement between a buyer and seller that gives the purchaser of the option the right to buy or sell a particular asset at a later date at an agreed upon price.

48

future contracts

contract between two parties to buy or sell an asset for a price agreed upon today (the futures price) with delivery and payment occurring at a future point, the delivery date.

49

forward contracts

an informal agreement traded through a broker-dealer network to buy and sell specified assets, typically currency, at a specified price at a certain future date.

50

swap contracts

these are usu. swapping fixed interest rate for a variable rate

51

measurement

1. Derivatives are recognized as either an asset or a liability.
2. Measured at FV.
3. Changes in FV result in G/L recognized in earnings.

52

hedging item

You hedge against an asset or liability that is subject to a possible loss.

53

hedging instrument

contract or some other arrangement that mitigates the possible loss of the hedging item.

54

hedging

You use a hedging instrument (contract) to hedge against a hedging item (asset/liability subject to potential loss).

55

Items you would use hedging for:

1. Commodity price fluctuation risk.
2. Foreign exchange fluctuation risk.
3. Interest rate fluctuation risk.
4. Credit risk.

56

FV risk

risk of loss due to a change in the FV of a hedging item.
1. Converts fixed risk into a floating risk.

57

firm commitment

agreement that specifies all significant terms such as dates, prices, and quantities.

58

FV hedge

used to hedge against FV risk, because, at the date that the firm commitment is made, prices are locked down by the contract, but by the actual transaction date, prices are locked down by the contract, but by the actual date of the transaction, market prices could have gone up and down.

59

basic accounting formula for FV hedge

a. Adjust hedging instrument to FV at B/S date.
b. Adjust hedged item to FV at B/S date.
c. Recognize in current income the G/L from revaluing each.
d. If the hedge does not exactly offset the G/L on the hedged item, the difference is a G/L in current income.

60

cash flow risk

risk of loss due to a change in cash flows from a hedged item.
1. Converts a floating risk into a fixed risk.
2. A forecasted transaction is an example of this type of risk. This is a transaction that is expected to occur. A cash flow hedge would be used with this type of transaction.

61

basic accounting formula for cash flow hedges:

a. Determine change in PV of expected cash flow of hedged item.

62

effective portion (cash flow hedging)

Recognize the difference in the FV of the derivative up to the amount of change in PV of expected cash flow in OCI. This is the effective portion.

63

ineffective portion (cash flow hedging)

The amount difference than the change in PV of expected cash flow in current income.

64

disclosures for derivatives

1. Specific disclosures are required for entities that issue derivatives and/or hold derivatives.
2. Entities that hold derivatives must disclose a lot of info about their reasons for usiing derivatives and the purposes of using derivatives.
3. They must also disclose info distinguishing btwn. FV derivatives and cash flow derivatives.
4. BOTH the net G and net L recognized in earnings during the period and the amount of G/L deferred in OCI must be disclosed.

65

contingent liabilities

potential liabilities that a company is aware of, and depending on how probable they are, there are different requirements

66

If the contingent liability is probable and can be estimated...

then it should be recognized on F/S.

67

If it is probable but cannot be estimated...

then it should be disclosed in a note.

68

If it is possible...

then it should be disclosed in a note.

69

If the possibility is remote...

then it doesn't need to be disclosed.

70

gain contingencies

never recognized; only mentioned only in a footnote.

71

GAAP vs. IFRS: Contingent Liabilities

GAAP: If a contingent liability is going to be recognized, you use the lowest amount in the range of possibilities.
IFRS: Use the midpoint in the range of possible liability.

72

EPS

(NI - pref. dividends) / weighted avg. comm. shares

73

basic EPS

computed only on comm. shares outstanding and NI.

74

diluted EPS

calculating EPS if all possible preferred shares and/or stock options were converted to common shares.

75

EPS denominator

1. Denominator is not just the ending # of shares. If any shares were issued in the year you're calculating EPS for, you need to multiply the # of shares by the % of the year.
--1,000 shares issued on July 1 = 1,000 * (6/12) = 500 shares.

76

EPS- What amount of preferred stock dividends to subtract if stock is cumulative? If stock is non-cumulative?

a. If the pref. stock is cumulative, you subtract one full year of dividends- no matter what amount is declared or paid.
b. If the pref. stock is non-cumulative, you subtract the only the amount of pref. dividends declared that year.

77

diluted EPS

(NI - pref. stock dividends + adjustments to income for assume conversion of potential comm. stock) / (weighted avg. comm shares outstanding + shares from assumed conversion of potential common shares)

78

Do basic EPS and diluted EPS have to be recorded under GAAP?

1. Basic EPS is reported.
2. Diluted EPS is required only if the firm has dilutive preferred shares.

79

GAAP vs. IFRS: EPS for Extraordinary Items

GAAP: If a company experienced extraordinary items during the year, then EPS for extraordinary items will be reported.
IFRS: Extraordinary items are not allowed.

80

extraordinary item

item that is both unusual and infrequent in occurrence.
1. These items are presented net of tax.
2. They are presented after discontinued operations on the I/S.
3. EPS for extraordinary items is also presented on I/S.

81

foreign currency transactions

transactions done in another currency, but reported in the U.S. dollar. So the issue is how to convert these transaction to U.S.D. and the related G/L.

82

exchange rate

price of one unit of one currency in terms of another currency

83

direct rate

domestic price of one unit of a foreign currency.
1 Euro = $1.57.

84

indirect rate

This is the foreign price of 1 unit of domestic currency.
$1 = 0.87 Euro.

85

spot rate

The exchange rate at the current date.

86

forward rate

The exchange rate now, for a date in the future.

87

functional currency

the currency of the primary economic environment that the business operates in.

88

When the domestic currency weakens compared to a foreign currency...

A/R creates an exchange gain b/c you get paid more than you were initially owed and A/P creates an exchange loss b/c you're paying back more money than you originally owed.

89

When the domestic currency strengthens compared to a foreign currency...

A/R creates an exchange loss and A/P creates an exchange gain.

90

recording foreign currency transactions

1. On the day of the transaction, multiply foreign currency by spot rate to the get the $ value.
2. At B/S date, of the same thing to get a new $ value.
a. The difference is an exchange G/L, and adjust the value of the A/R or A/P.
3. At settlement date of transaction, determine the new $ amount to settle transaction (F/C units * spot rate = new $ value).
4. Difference between new $ value and what's on the books is an exchange G/L.

91

FX exchange contract

obligation to buy or sell a foreign currency

92

FX option contract

that gives the right to buy or sell a foreign currency, but not an obligation to do so

93

FX option contract- speculation or FV/CF hedge

1. If the instrument is used for speculation, then any G/L are recognized in current income.
2. If instrument is an FV or CF hedge, then G/Ls apply to the related rules.

94

recording currency

currency that the foreign books and F/S are in

95

reporting currency

currency that the final F/S will be in

96

functional currency

currency of the primary economic environment that the entity operates in:
1. If the local economy is in hyperinflation.
OR
2. If foreign operations could not operate w/out U.S. entity's operations.

97

hyperinflation

inflation of 100% or more for 3 straight years.

98

translated

When the sub's local recording currency is the functional currency.

99

remeasured

When the sub uses the local recording currency, but the functional currency is the U.S.D.

100

translation (B/S)

Assets and liabilities are translated using the spot/current rate at the B/S date.

101

translation (I/S)

I/S accounts are translated using:
1. The exchange rate at the date the item was earned or incurred.
2. The weighted avg. exchange for the period (it is usu. just be this).

102

translation (R/E)

R/E is computed- the converted trial balance will not balance.
1. A translation adjustment is made to balance. It is an OCI item.

103

remeasurement

1. Use current spot rate for all monetary assets and liabilities (like A/P and A/R).
2. Use historic rate for non-monetary items like FAs, prepaids, CoGS, depr.
3. Use weighted avg. for revenues and expenses that occurred evenly throughout the year.

104

Differences between remeasurement and translation

Remeasurement is the only one that uses any type of historic rates.

105

If remeasured trial balance will not balance either...

1. A remeasurement adjustment is needed to make it balance.
2. This remeasurement adjustment is recognized as a G/L is income from continuing operations and flows through R/E.

106

remeasurement, then translation

1. It's simply remeasured, then translated.
2. Two conversion adjustments:
1. First, a remeasurement adjustment which goes through the I/S.
2. Second, a transaction adjustment which goes through the OCI statement.

107

interim reporting

a. These are F/S issued between annual reports.
b. Interim statements are reviewed.
c. Tax rate is estimated in each interim period.

108

formula for interim reporting

(cumulative year-to-date income * est. annual tax rate) - any tax expense recognized in prior interim periods

109

operating lease

this is basically a rental agreement

110

capital lease

treated as if it were a sale

111

4 criteria for determining if a lease is a capital lease instead of an operating lease:

1. If ownership transfers at the end of the lease.
2. If there is a bargain purchase option.
3. If the lease term is greater than or equal to 75% of the useful life of the leased asset.
4. If the PV of the lease payments is greater than or equal to 90% of the cash price of the leased asset.
5. If ANY one of the above are true, it is capital lease.

112

operating lease accounting

Avg. rental per period is used for expense and revenue recognition.

113

leasehold improvements

Any costs for leasehold improvements are capitalized to a leasehold improvement asset account and amortized over the shorter of either the remaining lease term or the useful life of the improvement.

114

capital lease accounting

When capitalizing lease payments, exclude executory costs.

115

executory costs

insurance, maintenance, and property taxes.

116

interest rate on capital lease

The lessee's interest rate on the lease will be the lower of the lessor's implicit rate and the lessee's incremental borrowing rate is the rate on similar debt.
1. The problem will give you these two rate and it's the lower of the two.

117

GJ entries for interest rate

Leased asset
Lease liability
1. Then, cash payments are lowering the lease liability, w/a portion being int. exp. on each payment.

118

Are bargain purchase options included in or excluded from the minimum lease payments?

Included in the minimum lease payments.

119

Is an unguaranteed residual included in or excluded from the minimum lease payments?

Excluded from the minimum lease payments.

120

Is a guaranteed residual included in or excluded from the minimum lease payments?

Included in the minimum lease payments.

121

GAAP vs. IFRS: Remaining Life Rule

Under IFRS, instead of the 75% life remaining rule, any major portion of the remaining useful life would be a capital lease.

122

GAAP vs. IFRS: Cash Value Rule

IFRS: Instead of GAAP's 90% of cash value rule, if the PV of minimum lease payments is substantially all of the asset's FV, it's a capital lease.

123

GAAP vs. IFRS: Specific Use

GAAP: No specific use.
IFRS: If the asset under lease is specialized or unique to the point that only the lessee can use it w/out requiring major modifications, it's a capital lease.

124

nonmonetary exchange

1. When one asset is exchanged for another asset.
2. Usu. fixed assets (FAs) are involved in this type of exchange.

125

exchange has commercial substance

Means the transaction will significantly change the cash flows to the company.

126

accounting treatment for exchanges WITH commercial substance:

1. The valuation of the new asset should be its FV.

127

accounting treatment for exchanges WITH commercial substance- if neither asset's FV can be determined

If neither asset's FV can be determined, then no G/L is recognized and the new asset is recognized and the new asset is recorded at the BV of the asset +/- cash paid/cash received.

128

accounting treatment for exchanges WITH commercial substance- determining FV of new asset

1. If cash paid to acquire the new asset, then it will have a BV of more than the old asset. So, record the FV of the new asset + the cash you paid.
2. If you receive cash along w/a new asset, logically your old asset was worth more than the asset you're receiving, so you would record the new asset at the FV of the old asset - cash received.

129

accounting treatment for exchanges WITHOUT commercial substance- loss

If there is a loss, record the loss and then record the new asset its FV.

130

accounting treatment for exchanges WITHOUT commercial substance- gain but no cash is received

If there is a gain but no cash is received, then no gain is recognized, but you record the new asset at the BV of the asset exchanged + any cash you paid.

131

accounting treatment for exchanges WITHOUT commercial substance- gain and cash is received

If there is a gain and you received cash, recognize the gain in proportion to the cash received and the new asset is recorded at FV - unrecognized portion of the gain.
1. IF the proportion of cash received to total consideration received is > 25%, record the gain in full and the asset acquired at FV.

132

related party

someone who can significantly influence a transaction or event

133

Are RPTs arms-length? Must RPTs be disclosed?

No and Yes.

134

R&D costs

All R&D costs are expensed.

135

R&D activities are...

1. Research aimed to discover new knowledge.
2. Searching for new ways to apply new research findings.
3. Formulation and design of possible products or process alternatives.
4. Product testing.
5. Modification of design.
6. Design, construction, and testing of preproduction product prototypes.
7. Design of tools and molds involving new technology.
8. Design and construction of a pilot plant not useful for commercial production.
9. Engineering activity required to take a designed product to the mfg. stage.

136

GAAP vs. IFRS: R&D costs

Under IFRS, R costs expensed, D costs capitalized.

137

risk and uncertainties disclosures

Certain risks and uncertainties that have have to be disclosed in the financials.
1. Going concern concerns.
2. Info about firm's products and services, and principal markets needs to be disclosed.
3. Significant estimates.
4. Vulnerabilities due to significant concentrations.

138

significant estimates

1 & 2. FV and inv. estimates.
3. Equipment obsolescence.
4. Valuation allowances for DTAs.
5. Impairment testing.
6. Contingencies.

139

vulnerabilities due to significant concentrations

1. Volume of business w/particular customers or suppliers.
2. Revenue from specific products.
3. Specific sources of services or materials.
4. Market or geographic area of operations.

140

segment reporting

GAAP requires disclosure by major segments.

141

3 tests to define what has to be a reportable segment w/in a business:

1. If an op. seg.'s revenue > or = 10% internal + external (combined) revenue.
2. If absolute value of seg.'s op. P/L > or = 10% entire firm's op. P/L.
3. If op. seg.'s identifiable assets are > or = 10% of entire firm's combined assets.

142

reportable segment disclosures

1. Description of segment.
2. Factors used to identify reportable segments.
3. Earnings and total assets of segments.
4. External and internal revenue.
5. Depr, amort, and depletion.
6. Extraordinary items.
7. Inc. tax exp.

143

When can a firm capitalize the costs related to the development of computer software?

1. Once the software has reached technological feasibility.
2. Before then, all costs are expensed.
3. Once the product is on the market and being sold, costs during this stage are capitalized.

144

subsequent events

1. Events occurring after B/S date but before date of F/S issuance.
2. Conditions existing at B/S date (Type 1) require recoginition in B/S.
3. Conditions that did not exist as of the B/S date (Type 2) require disclosure in footnotes.