F5 M4 FAR CPA

Exact Method

When the purchase price of a partnership interest is equal to book value of the capital account purchased, NO goodwill or bonus are recorded

• Determine the exact amount a new partner will have to pay to get their capital account in the exact proportional interest to the new assets of the partnership ←— Must calculate what contribution should be in order for it to match the BV of what they’re buying

• Purchase Price = BV

• No adjustment needed to existing partner’s capital accounts

Bonus Method

When the purchase price is more or less than book value of the capital account purchased, bonuses are adjusted between the old and new partner’s capital accounts and do NOT affect partnership assets; Based off the balance in total capital accounts

• Bonus can either be paid/ received for the new partner or old partner

• Must adjust existing partners’ capital accounts

  • Interest to NEW Partner < Contribution = Bonus (Old Partner)

  • Interest to NEW Partner > Contribution = Bonus (New Partner)

Goodwill Method

Goodwill is recognized based upon the total value of the partnership implied by the new partner’s contribution

• The purchase price can be more than book value

• Based on the Investment going in (dollars) which controls the computation

Profit and Loss Distribution

Income or loss is distributed among the partners in accordance with their agreement

• If agreement is absent:

  • All partners share equally regardless of what their capital account balances are or the amount of time each partner spends on partnership

• All payments for interest on capital, salaries, and bonuses are deducted before any distribution

Liquidation of a Partnership

The process of winding up the affairs of a partnership after dissolution

• Involves the realization of cash from the disposal of the partnership assets and paying off all liabilities to creditors

  • Remainder (if any) is distributed to the partners

Capital Deficiency

A debit balance in a partner’s capital account (Equity account) that indicates the partnership has a claim against the partner

• Partnership has legal right to offset loan account (Partner loaned money to partnership) to satisfy deficiency

• If deficiency still exists, the remaining partners must absorb the deficiency according to their respective profit and loss ratios

• Any partner may pay deficiency in cash directly to the partnership

Partner Liquidation Schedule

Schedule with the objective to distribute case, as it becomes available, to the partners

• It is important than no partner is overpaid or underpaid

• A partnership is NOT completely liquidated until all claims are settled and their affairs wound up

Statement of Cash Flow

A statement that is a required part of a full set of financial statements, that has a purpose of providing information about the sources of cash and cash equivalents and the uses of cash and cash equivalents

Goal = To reconcile and explain why the beginning cash is different from ending cash

• Material non-cash events are presented in the supplemental disclosure

• Cash Flow amounts per share are not disclosed

• Includes Restricted Cash and Restricted cash equivalents

Operating Cash Flows

Cash receipts and disbursements from transactions reported on the income statement and current assets and current liabilities; focuses on changes of operating assets and operating liabilities; focuses on the cash generated from the core business operations

• Excludes current N/P and current portion of Long-term debt

• 2 ways to calculate:

  1. Direct Method

  2. Indirect Method: Net income is adjusted to arrive at net cash flows from operating activities

Crypto assets converted immediately into cash = Operating activity

• Collecting interest and dividends are considered Operating activities included in Net Income

Operating Assets

All current assets except cash and cash equivalents that are part of Operating Cash Flows

• Shows growth potential

Operating Liabilities

All non-interest bearing obligations that are part of Operating Cash Flows; shows changes to capital structure

• Excludes Notes payable, current portion of long-term debt

Investing Cash Flow

Cash receipts and disbursements from non-current assets that includes cash flows from the purchase/ sale of non-current assets

• Buying or selling non-current assets:

  • Making loans to other entities (N/R)

  • Buying or disposing of investment securities of other entities (debt or equity: AFS, HTM, Trading (if non-current)

  • Acquiring or disposing of PP&E and acquiring another entity under the acquisition method, where the payment for the acquisition is shown net of cash acquired

Financing Cash Flow

Cash receipts and disbursements from debt (interest-bearing) and equity; includes cash flow from non-current liability (creditor-oriented) and equity (owner-oriented) activities

• Includes:

• Change in interest bearing debt and equity

• Note Payable, debt, Bond Payable, debenture, mortgage, line of credit

Cash Inflow: Taking on more debt/ Equity

Cash outflow: Repaying Principal, repurchase stock, pay dividend

Financing Liability

Any liability that is interest bearing apart of Financing Cash Flows (Include even if it’s current)

• Note, debt, bond, debenture, mortgage, line of credit

Includes dividends

Indirect Method

Way to calculate the Operating Cash Flow where companies report net cash flows from operating activities indirectly, by adjusting net income to reconcile to its net cash flow from operating activities

• Reconcile Net Income to the cash generated from the core business by removing non-operating transactions gains/ losses and converting from accrual basis to cash basis

• Supplemental disclosure of cash paid for interest and income taxes must be separately disclosed

Intraperiod Tax Allocation

Involves apportioning the total tax provision for financial accoutning purposes between income or loss; describes how taxes are spread out or assigned to different parts of the financial statements

• Helps companies show how all of their taxes are allocated

• “within” one period

• “IDA PUFI”

Interperiod Tax Allocations

Recognize through the matching principle the amount of current and future tax related to events that have been recognized in financial accounting income (book income)

• “Between” two different periods (Current period and Future tax year)

• 2 types of Differences between Book Income and Taxable Income:

  1. Permanent Differences

  2. Temporary Differences

Permanent Differences

A transaction that affects only financial income or taxable income, NOT both; creates a discrepancy between taxable income and book income that are permanent and will never reverse, as items that are Book Income will never be Tax income

• NO Deferred Taxes

• Differences that affect only the current period tax computation; only affect the period in which they occur

Differences will cause some item to be either:

1. Nontaxable (Income)

   1. Tax-exempt interest income on municipal/ state bonds

   2. Life insurance proceeds on officer’s key person policy

   3. Dividends-received deduction for corporations

2. Nondeductible (Expenses)

   1. Life insurance premiums when corporation is beneficiary

   2. Certain penalties, fines, bribes, kickbacks

   3. Nondeductible portion of meals and entertainment expense

   4. Excess percentage depletion over cost depletion

3. Special tax allowances

Temporary Differences

Differences between book income and taxable income that exist for a period of time, but will eventually reverse tin future tax periods and will affect/ create the deferred tax computation (DTL/ DTA)

• Timing issue

Affects the deferred tax computation; items that are first recognized for tax purposes will eventually be recognized for GAAP purposes (or vice versa)

Asset and Liability Method

Method that requires that either income taxes payable of a deferred tax liability/ asset be recorded for all tax consequences of the current period

• Used to squeeze out the amount of income tax expense after the amount of deferred tax assets and liabilities have been determined.

• Required by GAAP

Deferred Tax Liability (DTL)

Anticipated future tax liabilities derived from situations where taxable income will be greater than future book income due to temporary differences

• Results in paying less taxes in the current period, but paying more taxes in future period

• Benefit now, pay taxes later

  • Current Taxable income < Current Book Income

  • Reverses: Future taxable income > Future book income

    • Income:

• Occurs when an item is recognized first for Book income, and then recognized for Taxable income later

  • Pay taxes later = Future tax liability

    1. Installment Sales

    2. Contractors accounting: % vs. completed contract

    3. Equity Method: Undistributed dividends

Expense:

• Occurs when an expense is taxed first and then we book expense later

  • Tax deduction early = Future tax liability

  • Pay less taxes upfront, because we get a deduction first

    • Depreciation Expense

    • Amortization of franchise

    • Prepaid expenses (cash basis for tax)

Deferred Tax Asset (DTA)

Anticipated future benefits derived from situations in which future taxable income will be less than future book income due to temporary differences

• Arises when the amount of taxes paid in the current period exceed the amount of income tax expense in the current period

• Paying taxes up front but don’t get the tax benefit until later in the future

  • Pay tax before you can expense it

Income:

• Occurs when an item is recognized first for Taxable income, and then recognized for Book income later

  • Pay taxes early = Future tax benefit (asset)

    1. Prepaid Rent

    2. Prepaid Interest

    3. Prepaid Royalties

• IRC = “Prepaid” ←—→ GAAP = “Unearned”

• Under book Income, we would recognized revenue when it’s earned; under taxable income we recognize all revenue upfront (cash)

Expense:

• Occurs when item is booked as an expense first under Book Income, and get the Tax expense later under IRC

  • Tax Deduction later = Future tax benefit (asset)

  • Paying more tax upfront

    • Bad Debt Expense (Allowance - GAAP vs. Direct Write-Off - IRC)

    • Estimated Liability/ warranty expense

    • Start up Expenses

Valuation Allowance (Contra-Account)

Amount of DTA that is NOT expected to be used

• Recognize when it is more likely than not (more than 50%) that part or all of the DTA will not be realized

If a change in judgement about the ability to realize a DTA in future years is made = Reverse Valuation Allowance

• Recognize the valuation adjustment in income from continuing operations in the period of change

  • Adjustment is the difference between the required ending balance to the current balance

Uncertain Tax Position

Some level of uncertainty of the sustainability of a particular tax position taken by a company

• When you take an aggressive position related to your company’s tax return

• Must give IRS notice of aggressive positions

• Position should be reported on the financial statements

2-Step Approach:

Step 1: Recognition of the Tax Benefit

• What’s the expected outcome in court (must be greater than 50%)

Step 2: Measurement of the Tax Benefit

• Figure out what tax benefit you would receive and find settlement amount to avoid court

More-likely-Than-Not Test

Standard used to justify uncertain tax position that assesses if there’s more than 50% likelihood chance of winning

Threshold Considerations:

Enacted Tax Rate

Rate used to calculate deferred taxes for temporary differences; tax rate when the taxable item is expected to be paid (liability) or realized (asset)

• Future tax rate changes = Enacted/ Applicable Tax Rate

• ONLY AFFECTS DTA/ DTL; use standard rate for taxable income to find CY interest expense

Liability Method

Method that requires the deferred tax account balance (DTA/ DTL) be adjusted when the tax rates change

• Must use enacted future effective tax rate to calculate DTA / DTL

• Treat as a change in estimate and recognize in. the period of change

Annual effective tax rate

Average tax rate a taxpayer pays for the year; when tax rate (enacted tax rate) changes, this rate changes

Net Operating Loss (NOL)

Creates a DTA (Deferred tax benefit)

Prior to 2018: Can be carried forward for up to 20 years to offset 100% of taxable income in future years

After 2018: Can be carried forward indefinitely

After 2021: Can be carried forward to taxable years, but are LIMITED to 80% of taxable income before the NOL deduction

• Reduces our tax payable in a future period without paying any cash

Debit DTA: Reduces tax payable in a future period (BS)

Credit Income Tax Benefit: Reduces NOL in current period, which reduces the book loss (Not a contra-expense) (IS)

Dividends-Received Deduction (DRD)

Method of exclusion based on the percentage of ownership in the stock of the other corporation that avoids triple taxation

• Creates a permanent difference

Ownership 0-19% —→ 50% Exclusion

Ownership 20-80% —→ 65% Exclusion

Ownership 80%+ —→ 100% Exclusion