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Financial Accounting & Reporting Review Course: F1 Angel Chau , AICPA (inactive) firstname.lastname@example.org. Financial Accounting and Reporting (FAR). Intro - 3.
Review Course: F1
Angel Chau, AICPA (inactive)
Intro - 3
Relevant portions of the following pronouncements issued by SEC are included for reference:
F1 - 7
1. Present and potential investors and creditors (external users)
2. users with a reasonable understanding of economic and business situations.
1. To provide information that is useful in making rational investment and credit decisions
2. To help users assess the timing and uncertainty of cash flows. (to value the company how do they generate cash flow)
3. To provide information on economic resources, claims and changes in them. (to assess risk / required rate of return from FS)
Make a difference to decision making process
R & R
Passing Feels Terrific
Under IASB framework, the subcategories of relevance are predictive value, feedback value and materiality.
R & R
Nobody Relies on Financials unless Verified
Under IASB framework, the subcategories of reliability are neutrality, representational faithfulness, substance over form, prudence, and completeness.
Five elements of Present Value Measurement (Asset or Liability)
According to the FASB SFAC No.2, neutrality is an ingredient of:
A Yes Yes
B Yes No
C No Yes
D No No
What is the underlying concept governing the recording of gain contingencies?
performance for “a period of time”
Reported on Income Statement
IIncome (or Loss) from Continuing Operations
DIncome (or Loss) from Discontinued Operations (reported net of tax)
E Extraordinary Items (reported Net of Tax)
A Cumulative Effect of Change in Accounting Principle
(Must Remember IDEA)
Reported on Statementof Retained Earnings
Review example on F1-19
Get familiar with it
Scott Corporation sold a fixed asset used for operations for greater than its carrying amount. Scott should report the transaction in the income statement using the:
a. Gross concept, showing the proceeds as part of revenues and the carrying amount as part of expenses in the continuing operations section.
b. Net concept, showing the total amount as an extraordinary item, net of income taxes.
c. Net concept, showing the total gain as part of discontinued operations, net of income taxes.
d. Net concept, showing the total gain as part of continuing operations, not net of income taxes.
Which of the following should be included in general and administrative expenses?
a. Yes Yes
b. Yes No
c. No Yes
d. No No
Discontinued Operations Calculation
Future operating losses expected to be incurred as part of an exit or disposal activity are recognized in the periods incurred.
The board of directors of Super Conglomerate, Inc. voted to dispose of its Tiny Co. subsidiary on Oct 31, Yr 8. On that date, the net book value of the subsidiary was $15M, but Super believes it could not sell for more than $12.5M. No buyer had been found as of Dec 31 Yr 8, but the company was committed to the plan to sell and was actively looking for a buyer. On May 1 Yr 9, the sale was completed for $13M.
The subsidiary’s operating results for Yr 8 & Yr 9 were:
1/1/Yr8 – 10/31/Yr8 $5M
11/1/Yr8 – 12/31/Yr8 $1.5M
1/1/Yr9 – 4/30/Yr9 $2.25M
Super’s tax rate is 30%
How Should the disposal of Tiny Co. be reported on Super’s Yr 8 FS?
Loss from Discontinued operations – Yr 8
Under U.S. GAAP:
Examples of extraordinary item:
IFRS prohibits the reporting of extraordinary item on the Income Statement or in notes to the FS.
Choice "a" is correct.
Raim - component of income from continuing operations. Because Raim sustains flood losses every two to three years, the flood losses are not "infrequent." Thus, the flood loss is not an "extraordinary item." (U or I)
Cane - as an extraordinary item. Here, the flood losses are infrequent because Cane never before (in the last 20 years) had flood losses. Furthermore, the flood losses are unusual in nature in that they are unrelated to the ordinary and typical activities of the company. (U & I, Net of Tax)
Choices "b", "c", and "d" are incorrect, per rules above.
Midway Co. had the following transactions during 1992:
What amount should Midway report in its 1992 income statement as extraordinary loss before income taxes?
Equipment loss $ 800,000
Building loss 300,000
Insurance proceeds (1,000,000)
Hurricane loss $ 100,000
Accounting Changes :
Error corrections are not accounting changes. Therefore it’s separately presented as Prior Period Adjustments
Not an error – do not restate prior periods; prospective approach
A change in accounting estimate occurs when it is determined that the estimate previously used by the company is incorrect.
All 6 above affects current & future I (income from continuing operations)
If a change in accounting estimate affects several future periods, (e.g. as in above example), the effect on “income before extraordinary items”, net income, and the related per share information for the current year should be disclosed in the notes to the FS.
For 1991, Pac Co. estimated its two-year equipment warranty costs based on $100 per unit sold in 1991. Experience during 1992 indicated that the estimate should have been based on $110 per unit. The effect of this $10 difference from the estimate is reported:
a. In 1992 income from continuing operations.
b. As an accounting change, net of tax, below 1992 income from continuing operations.
c. As an accounting change requiring 1991 financial statements to be restated.
d. As a correction of an error requiring 1991 financial statements to be restated.
Choice "a" is correct. The effect of the new estimate of warranty costs (from $100 to $110) is a change in estimate and will be reported in 1992 "income from continuing operations."
Rule: Changes in estimates affect only the current and subsequent periods (not "prior periods," not "retained earnings").
Choice "b" is incorrect. An accounting change of "principle" is shown net of tax on the retained earnings statement.
Choice "c" is incorrect. Restating prior years financial statements is only required when comparative financial statements are shown for prior period adjustments of subsequently discovered "corrections of errors", changes in entity or changes in accounting principle.
Choice "d" is incorrect. The facts stating a new estimate of warranty costs indicate a "change of estimate," not a "correction of an error."
Changes in accounting principle should be recognized by adjusting beg. R/E in the earliest period presented for the cumulative effect of the change, and, if prior period FS are presented, they should be restated.
Exception in the General Rule: Handle prospectively
Under IFRS, when it is impracticable to determine the cumulative effect of an error the entity is required to restate the information prospectively from the earliest dale that is practicable. US GAPP does not have an impracticality exemption for error corrections.
Which of the following statements is correct regarding accounting changes that result in financial statements that are, in effect, the statements of a different reporting entity?
a. Cumulative-effect adjustments should be reported as separate items on the income statement in the year of change.
b. No restatements or adjustments are required if the changes involve consolidated methods of accounting for subsidiaries.
c. No restatements or adjustments are required if the changes involve the cost or equity methods of accounting for investments.
d. The financial statements of all prior periods presented should be restated.
Choice "d" is correct. Financial statements of all prior periods presented should be restated when there is a "change in entity" such as resulting from:
1. Changing companies in consolidated financial statements.
2. Consolidated financial statements vs. Previous individual financial statements.
Choice "a" is incorrect. Cumulative-effect adjustments are reported in the retained earnings statement in the year of change.
Choice "b" is incorrect. Restatements are required for changes in entity (of subsidiaries).
Choice "c" is incorrect. Restatements are required for changes of GAAP involving the cost or equity methods of accounting for investments.
PURER bypass I/S and R/E, directly goes to Equity
PUFE Rescue you from the Comprehensive Income questions.
Which of the following information should be disclosed in the summary of significant accounting policies?
a. Refinancing of debt subsequent to the balance sheet date.
b. Guarantees of indebtedness of others.
c. Criteria for determining which investments are treated as cash equivalents.
d. Adequacy of pension plan assets relative to vested benefits.
For interim financial reporting, a company's income tax provision for the second quarter of 1992 should be determined using the:
Effective tax rate expected to be applicable for the full year of 1992 as estimated at the end of the first quarter of 1992.
Effective tax rate expected to be applicable for the full year of 1992 as estimated at the end of the second quarter of 1992.
Effective tax rate expected to be applicable for the second quarter of 1992.
Statutory tax rate for 1992.
Choice "b" is correct.
The best, most current estimate of the annual effective tax rate should be used to determine the income tax provision for the second quarter.
This rate is the effective tax rate expected to be applicable for the full year of 1992 as estimated at the end of the second quarter of 1992.
APB 28 para. 19
Benefit > Cost; provides best relevant information to users
Users can better understand the individual segment’s performance, and analyze for future scenarios, e.g. how does the allocated costs impact the rest of the entity if this segment discontinues.
Revenue for that segment – internal & external
Less: Directly traceable costsdirect salary, direct rent, etc
Less: Allocated Costs by CFO
Operating Profit or Loss (EBIT) for that segment;
DSE issues the FS in conformity w/ US GAAP, review F1 – 57 for disclosure requirements
Start ups devotes most of its resources into R&D. There is no guarantee that it will be successful. Take the conservative approach and recognize all cost into expenses.
This framework outlines
Level 1 Inputs are quoted prices in active markets for identical assets or liabilities that the entity has access to on the measurement date.
Active market characteristics: high trading volume, small bid/ask spread, highly liquid.
Level 2 inputs are based on market observables.
FASB acknowledged that active markets for identical assets and liabilities are relatively uncommon and, even when they do exist, they may be too thin to provide reliable information. To deal with this shortage of direct data, the board provided a second level of inputs that includes :
Securities offering Registration statement for IPO or new offerings
Form 10K – annual report
Form 10Q – quarterly report
Form 11K – annual report of employee’s defined benefit plan(s)
Form 20F – annual report by foreign private issuers
Form 40F – annual report by specific Canadian companies registered with SEC
Form 6K – semi-annual report by foreign private issuers, similar to 10Q
Form 8K – report major corporate events such as asset acquisitions or disposals, changes in securities and trading markets, changes to accountants or financial statements, and change in corporate governance or management
Form 3, 4, &5 – filed by directors, officers, or beneficial owners of more than 10% of a class of equity securities of a issuer
In Regulation S-X, the SEC sets forth the form and content of and requirements for interim and annual FS to be filed w/ the SEC. The key provisions are below: