CPA EXAM: FAR (F5)

What are trading securities? How is the value of trading securities recorded? (M1)

• Debt securities that are bought and held for the purpose of selling them in the near future

  • May be an operating or investing cash flow based on the nature and purpose of the acquisition

    • Current = Operating

    • Non-current = Investing

• Recorded at fair value through P&L

  • Unrealized and realized gains and losses are recorded directly on the company’s income statement

What are available-for-sale securities? How is the value of available-for-sale securities recorded? (M1)

• Debt securities not classified as either trading or held-to-maturity

  • Not intended to be sold in near future but also not intended to be held until maturity

  • Investing cash flow

• Recorded at fair value through OCI

  • Unrealized gains and losses are recorded in OCI

    • The portion of the change in fair value that relates to credit risk is recognized in the income statement

  • Realized gains and losses are recorded on the income statement

What are held-to-maturity securities? How is the value of held-to-maturity securities recorded? (M1)

• Debt securities where the company has the intent and ability to hold them until maturity

  • Investing cash flow

• Recorded at amortized cost

  • Not marked up or down to fair market value

What adjustment is needed when reclassifying from a trading security to an available-for-sale or held-to-maturity security? (M1)

No adjustment is needed since all unrealized holding gains and/or losses have already been recognized

What adjustment is needed when reclassifying an available-for-sale or held-to-maturity security to a trading security? (M1)

Any unrealized gains and losses need to be immediately recognized in current earnings on the income statement

What adjustment is needed when reclassifying from an available-for-sale to a held-to-maturity security? (M1)

Any previously recorded unrealized gains and losses in OCI need to be amortized

What adjustment is needed when reclassifying from a held-to-maturity security to an available-for-sale security? (M1)

Any unrealized gains and losses need to be immediately recorded in OCI

How is impairment measured and recorded for available-for-sale securities? (M1)

• Impairment/credit loss is recorded on the income statement as the difference between the present value and the amortized cost

  • PV - AC = Credit Loss (Income Statement)

    • Limited by the amount that FV is below AC

  • AC - FV = Unrealized Loss (OCI)

• Recorded as a current period expense with an offsetting allowance

  • DR. Credit Loss

    • CR. Allowance for Credit Loss

How does the record of an available-for-sale debt security sale differ from that of a trading security? (M1)

• When recording the sale of an available-for-debt security, any unrealized gains and losses and OCI need to be reversed

  • DR. Unrealized Gain or CR. Unrealized Loss

How are equity securities recorded? (M1)

• Normally carried at fair value through P&L for investments of 1%-19% or those without significant influence

  • All unrealized gains and losses are recorded on the income statement

When are dividends from investments in equity securities NOT recognized in net income? (M1)

Not Recognized:

• Liquidating Dividends

  • The excess of a shareholder’s dividend over their share of an entity’s earnings

  • Treated as a return of capital

• Stock Dividends

• Dividends from Equity Method Investments

When is the equity method used? (M2)

• Used for investments where the investor has significant influence or does NOT have control

  • General rule is 20%-50% ownership

How is the investment account impacted under the equity method? (M2)

Initial Acquisition:

• Recorded at purchase price

Dividends:

• Treated as a return of capital and decreases investment account

Net Income:

• Increases investment account by investor’s share of the entity’s net income/loss

Differences Between BV and FV of Net Assets:

• Decreases investment account by amortization amount

How are differences between an investor’s purchase price and the book value of an entity’s net assets accounted for? (M2)

Attributable to Differences Between BV and FV of Net Assets:

• Amortized over the life of the asset and decreases the investment account

  • DR. Equity Investee Income

    • CR. Investment in Investee

Goodwill:

• Not a separate asset

• Not amortized

• Has no separate impairment test

How are impairment losses recognized under the equity method? (M2)

• Recognized when the FV of the investment is less than the CV

  • Change must be believe to NOT be temporary

• Impairment loss is recorded and the investment account is reduced to the lower FV

  • Impairment loss may NOT be reversed

When and how is the acquisition method used? (M3)

• Used when an investor gains control over the investee

  • General rule is >50%

• When purchased, 100% of the net assets acquired are recorded at fair value

  • This is done even if the investor does not acquire 100% of the investee

What are the 8 required consolidation adjustments? (M3)

1. Common Stock of Subsidiary

   1. Eliminated

2. APIC of Subsidiary

   1. Eliminated

3. RE of Subsidiary

   1. Eliminated

4. Investment in Subsidiary

   1. Eliminated

5. Non-Controlling Interest

   1. Created and Reported at FV

6. Balance Sheet Adjustment to FV

   1. All Accounts are Adjusted

7. Identifiable Intangible Assets Recorded

   1. All Intangible Assets are Recorded at FV

8. Goodwill/Gain

What is pushdown accounting? (M3)

• An election by the subsidiary that allows them to use the stepped-up basis associated with the parent’s purchase price

  • All identifiable assets and liabilities are remeasured at fair value on the acquisition date

    • Consideration > FV of Assets = Goodwill

    • Consideration < FV of Assets = Bargain Gain

  • Recorded in a “pushdown capital” account

What is the journal entry for pushdown accounting? (M3)

• DR. Assets (FV)

• DR. Goodwill [Pushdown Capital - (Asset FV - Liability FV)]

  • CR. Liabilities (FV)

  • CR. Pushdown Capital (Purchase Price)

  • CR. Bargain Gain [(Asset FV - Liability FV) - Pushdown Capital]

What adjustments are required for reversing intercompany merchandise transactions? (M3)

• Eliminate sales revenue

• Reduce retained earnings by profit previously recognized

• Reduce COGS by amount recognized by seller

• Reduce COGS recognized in third party sale

  • Should be recorded at cost to original seller and not at the buyer’s cost

• Reduce ending inventory

  • Should be recorded at cost to original seller and not at the buyer’s cost

How do you calculate and record the adjustments to COGS and ending inventory for intercompany transactions if only some of the merchandise is sold to a third party? (M3)

1. Calculate Profit Recognized by Seller

   1. Selling Price - Original Cost = Profit

2. Allocate Profit to COGS and Ending Inventory

   1. % Sold x Profit = Adjustment to COGS

   2. % Not Sold x Profit = Adjustment to Ending Inventory

3. Record Journal Entry

   1. DR. Sales (Total Sales Price)

      1. CR. COGS (Total Original Cost)

      2. CR. COGS (Adjustment Amount)

      3. CR. Ending Inventory (Adjustment Amount)

What happens if a member of a consolidated group purchases an affiliate’s debt from an outsider? What is the journal entry? (M3)

• Debt is considered to be retired and a gain/loss is recognized

  • Gain/loss is only recognized through an elimination entry on the consolidated income statement

  • Reacquired Price - BV of Debt = Gain/Loss

• Journal Entry:

  • DR. Bonds Payable (BV)

  • DR. Premium on Bond

  • DR. Loss (Reacquisition Price - BV of Debt)

    • CR. Investment in Bonds (Reacquisition Price)

    • CR. Gain (Reacquisition Price - BV of Debt)

    • CR. Discount on Bond

What are the 3 methods to account for the admission of a partner? (M4)

1. Exact Method

2. Bonus Method

3. Goodwill Method

How do you calculate an partnership investment using the exact method? (M4)

1. Calculate Total New Equity of Partnership

   1. Total New Equity = Current Equity / (1 - % Interest Being Acquired)

2. Calculate Partner’s Contribution

   1. Contribution = Total New Equity x % Interest Being Acquired

How do you use the bonus method for the investment of a new partner? (M4)

• Determine total capital and interest of new partner

  • If NBV of interest < amount contributed, old partner(s) receive a bonus

  • If NBV of interest > amount contributed, new partner receives a bonus

    • Old partner(s) accounts are reduced to contribute to new partner’s account

How do you use the goodwill method for the investment of a new partner? (M4)

• Calculate implied value of partnership based on the new partner’s contribution and goodwill

  • Implied Value = Contribution / % Interest

  • Goodwill = Implied Value - Total New Equity

• Allocate goodwill to old partner(s) accounts

How do you use the bonus method for the withdrawal of a partner? (M4)

• Calculate the bonus and allocate it to the remaining partner(s) capital accounts

  • Bonus = Cash Amount Paid to Withdrawing Partner - Withdrawing Partner’s Capital Account Balance

How do you use the goodwill method for the withdrawal of a partner? (M4)

• Calculate the implied value of the partnership and goodwill

  • Implied Value = Cash Amount Paid to Withdrawing Partner / % Interest

  • Goodwill = Implied Value - Total Equity

• Allocate to all partners

  • Withdrawing partner’s account should be equal to the cash amount they are being paid

What is the order of operations when liquidating a partnership? (M4)

1. Dispose of Assets and Collect Cash

   1. Allocate gain or loss to partners

2. Pay off Creditors

3. Pay off Partner Advances

4. Allocate Partner Deficiencies (If Necessary)

5. Distribute Remaining Cash to Partners

What adjustments are made to net income to arrive at operating cash flows using the indirect method? (M5)

Net Income

+ Non-Cash Expenses (Depreciation, Amortization, Bad Debt, Expense, etc.)

- Non-Cash Income/Gains (Amortization of Bond Premium)

+ Decreases in Operating Assets

+ Increases in Operating Liabilities

- Increases in Operating Assets

- Decreases in Operating Liabilities

What is included in operating cash flows? (M5)

• Cash receipts and disbursements from income statement transactions and current assets and liabilities

  • Excludes current portion of long-term debt and notes payable

• Includes all current assets except cash and cash equivalents and all current non-interest bearing liabilities

  • EX. Receiving dividends, interest received on debt, payment to suppliers, customer collections, etc.

What is included in investing cash flows? (M5)

• Cash flows from the purchase or sale of non-current assets

  • EX. Loaning money to others, purchasing or disposing of securities, purchasing or disposing of PP&E, etc.

What is included in financing cash flows? (M5)

• Cash flows from debt and equity activities

  • EX. Issuance of own stock, taking out a loan, repaying principal of long-term debt, treasury stock, paying dividends, etc.

What is the difference between total income tax expense, current income tax expense and deferred tax? (M6)

• Total Income Tax Expense

  • The total expense recorded based on the financial statement income

    • Total Income Tax Expense = Current Income Tax Expense ± Deferred Tax

• Current Income Tax Expense

  • The current tax actually due to the IRS based on taxable income

    • Current Income Tax Expense = Taxable Income x Current Year Tax Rate

• Deferred Tax

  • The income tax asset or liability resulting from temporary differences between taxable and financial statement income

    • Deferred Tax Asset/Liability = Total Temporary Differences x Future Tax Rate

What are examples of permanent differences between taxable and financial statement income? (M6)

• Tax Exempt Income (Nontaxable)

• Life Insurance Proceeds on Key Person (Nontaxable)

• Dividends Received Deduction (Nontaxable)

• Life Insurance Premium Payments (Not Tax Deductible)

• Fines, Penalties, Bribes, etc. (Not Tax Deductible)

• Portion of Meal and Entertainment Expense (Not Tax Deductible)

What situations create a deferred tax asset? (M6)

• If it results in a higher taxable income, it is considered an asset because it provides a future tax benefit

  • Income is booked for tax purposes but not book purposes

    • EX. Unearned Rent, Unearned Interest, Unearned Royalties, etc.

  • Expense is booked for book purposes but not tax purposes

    • EX. Bad Debt Expense, Start-Up Expenses, Warranty Expense, etc.

What situations create a deferred tax liability? (M6)

• If it results in a lower taxable income, it is considered a liability because more taxes will be paid in future periods

  • Income is booked for book purposes but not tax purposes

    • EX. Installment Sales, Difference in Contractor’s Accounting, etc.

  • Expense is booked for tax purposes but not book purposes

    • EX. Depreciation Expense, Amortization, Prepaid Expenses, etc.

What is the journal entry for recording a DTL? What is the journal entry for reversing a DTL in future years? (M6)

Initial Record:

• DR. Current Income Tax Expense

• DR. Deferred Income Tax Expense

  • CR. Deferred Tax Liability

  • CR. Income Tax Payable

Reversal:

• DR. Deferred Tax Liability

  • CR. Deferred Income Tax Expense

What is the journal entry for recording a DTA? What is the journal entry for reversing a DTA in future years? (M6)

Initial Record:

• DR. Current Income Tax Expense

• DR. Deferred Tax Asset

  • CR. Deferred Income Tax Benefit

  • CR. Income Tax Payable

Reversal:

• DR. Deferred Income Tax Benefit

  • CR. Deferred Tax Asset

What is an uncertain tax position? (M7)

• When there is some level of uncertainty of the sustainability of a particular tax position taken by a company

  • Company must have a more-likely-than not level of confidence before reflecting a tax benefit related to the position

What is the two-step approach to accounting for uncertain tax positions? (M7)

1. Determine the Expected Outcome and Thresholds

   1. Entity must consider the expected outcome with the taxing authority if dispute is taken to the highest court

      1. Must be “more-likely-than-not” (defined as >50% chance) that position will be upheld or test is failed

   2. Thresholds are determined based on the technical merits of the position

2. Measurement of Tax Benefit

   1. Entity can recognize the largest amount of tax benefit that has a >50% of being realized upon ultimate settlement of the dispute

      1. Cumulative probability is considered

   2. Income tax liability is recognized for the difference between the largest possible tax benefit and the more-likely-than-not benefit

How are DTLs and DTAs reported on the balance sheet? (M7)

• Reported as non-current, regardless of when reversal is expected to occur

• Netted together and presented as a single amount

How is an NOL reported on the balance sheet? (M7)

• Operating losses create a DTA to reduce taxes payable in a future period

How have the offsetting rules for NOLs changed? (M7)

Before 2018:

• Carried forward for 20 years

• Offsets 100% of taxable income

2018-2020:

• Carried forward indefinitely

• Offsets 100% of taxable income

After 2020:

• Carried forward indefinitely

• Offsets 80% of taxable income

What is the DRD and what are its exclusion limits? (M7)

• The DRD is a deduction allowed based on ownership percentage to avoid triple taxation

  • Only allowed for tax purposes and results in a permanent difference

• Available Exclusions:

  • Ownership 0%-19%: 50% Exclusion

  • Ownership 20%-80%: 65 Exclusion

  • Ownership 80%+: 100% Exclusion