CPA FAR - F2 FLASHCARDS

List the steps associated with the five-step approach to revenue recognition

1. Identify the contract.

2. Identify the performance obligations.

3. Determine the transaction price.

4. Allocate the price to each obligation.

5. Recognize revenue when each obligation is satisfied.

What criteria must be met in order to recognize revenue on a contract?

All five must exist:

1. Approved by both parties.

2. Rights identified.

3. Payment terms identified.

4. Commercial substance.

5. Collection is probable.

When is a performance obligation considered distinct?

Two tests:

1. Customer can benefit from it on its own.

2. It is separately identifiable in the contract.

What is the transaction price?

The amount the seller expects to receive for transferring goods or services.

What factors affect the transaction price?

1. Variable consideration.

2. Significant financing component.

3. Noncash consideration.

4. Consideration payable to the customer

VSNC

How is the transaction price allocated?

Based on the relative stand-alone selling prices of each performance obligation.

When is revenue recognized over time?

If one of these applies:

1. Customer receives benefits as work is performed.

2. Customer controls the asset as it’s created.

3. Asset has no alternative use and seller has an enforceable right to payment.

When is revenue recognized at a point in time?

When control transfers to the customer.

Identify two methods of revenue recognition for long-term construction-type contracts under U.S. GAAP.

Over time or at a point in time.

When are losses on long-term construction contracts recognized?

Immediately when discovered, regardless of the method used for revenue recognition.

Formula for current-year gross profit (percentage-of-completion)?

= (Cost to date / Total estimated cost) x Total estimated gross profit - Gross profit recognized to date

How are costs to obtain a contract treated?

Capitalize (record as an asset) if you expect to recover the cost through the contract.

Expense immediately if the cost would have been incurred even without obtaining the contract.

Principal vs. Agent - How is revenue recognized?

Principal

1. Controls the good/service before transfer.

2. Records gross revenue (full selling price).

Agent

1. Never controls the product.

2. Records only the commission or fee.

Forward or Call Option repurchase agreement - How is it accounted for?

1. Repurchase price < Original price → Lease

2. Repurchase price ≥ Original selling price → Financing arrangement

Put Option repurchase agreement - How is it accounted for?

If repurchase price < original selling price:

1. Customer has significant incentive to return → Lease

2. No significant incentive → Sale with right of return

If repurchase price ≥ original selling price:

1. Repurchase price > expected market value → Financing

2. Otherwise (and no incentive) → Sale with right of return

What conditions are required for a bill-and-hold arrangement?

1. Substantive reason.

2. Ready for delivery.

3. Recognized as customer’s specific product.

4. Seller cannot use or redirct it elsewhere.

SRRC

What is a consignment arrangement?

A dealer sells products for the owner - The dealer does not own the inventory

What are the indicators of a consignment arrangement?

Exists if:

1. Seller keeps control until the product is sold.

2. Dealer doesn't have to pay until the product is sold.

3. Seller can take back or transfer the product.

When is a warranty a separate performance obligation?

Is separate if:

1. Customer can buy it separately, OR

2. It provides an extra service beyond guaranteeing the product works.

Then:

1. Allocate part of the transaction price to the warranty.

What is a refund liability?

The amount the company expects to refund to customers.

When is it recognized?

Customer have a right of return and returns are expected.

How is a change in accounting estimate reported?

Prospectively. From now on.

How is a change in accounting principle reported?

Retrospectively

1. Adjust beginning Retained Earnings of the earliest year presented.

2. Restate prior financial statements.

What are the exceptions to reporting a change in accounting principle?

If it’s impracticable to determine prior effect, like change to LIFO or change in depreciation method, report prospective like a change in estimate.

What are the three types of accounting changes?

1. Change in Accounting Principle

2. Change in Accounting Estimate

3. Change in Accounting Entity

PEE

How is a change in accounting entity reported?

Retrospectively. Restate all prior financial statements presented

How are error corrections reported?

Prior period adjustment

1. Adjust beginning retained earnings

2. Restate prior financial statements

What 4 situations require adjusting journal entries?

1. Deferred revenue → Cash received before earning revenue.

2. Prepaid expense → Cash paid before incurring expense.

3. Accrued revenue (Receivable) → Revenue earned before cash received.

4. Accrued expense (Payable) → Expense incurred before cash paid.

What is the journal entry to recognize earned deferred revenue?

Dr. Deferred revenue

Cr. Revenue

What are the 3 rules for adjusting journal entries?

1. Recorded before financial statements are prepared.

2. Never involve Cash.

3. Always effect one BS account and one IS account.

What belongs in the Summary of Significant Accounting Policies?

Identify and describe:

1. Measurement basis used.

2. Significant accounting principles and methods.

What must be disclosed about risks and uncertainties?

1. Nature of operations.

2. Use of estimates.

3. Significant estimates.

4. Concentrations (current vulnerability).

NUSC

What is a subsequent event?

A subsequent event happens after the balance sheet date but before the financial statements are issued.

What are two types of subsequent events?

1. Recognized → Adjust the financial statements.

2. Nonrecognized → Disclose only.

What is fair value?

Selling price (Exit price) in a fair and open market.

What are the three valuation approaches for fair value?

1. Market approach → Uses prices of similar assets.

2. Income approach → Uses discounted future cash flows.

3. Cost approach → Uses replacement cost.

MIC

What are the three levels of the fair value hierarchy?

1. Level 1 - Quoted market prices and highest reliability (highest priority).

2. Level 2 - Observable inputs and similar assets or market data.

3. Level 3 - Unobservable inputs and company’s own estimates.

How is gross margin calculated?

= Net sales - COGS / Net sales

What are the general guidelines for OCBOA financial statements?

1. Different titles than GAAP statements.

2. Balance sheet and Income statement equivalents required.

3. Explain changes in equity.

4. No Cash flow statement required.

5. Similar disclosures to GAAP.

How is profit margin calculated?

= Net income / Net sales

How is return on equity (ROE) calculated?

= Net income / Average total equity

How is return on assets (ROA) calculated?

= Net income / Average total assets

What is the operating cash flow ratio formula?

= Cash flow from operations / Ending current liabilities

What is the current ratio formula?

= Current assets / Current liabilities

What is the quick ratio formula?

= (Cash and equivalents + Short-term investments + Net receivables) / Current liabilities

How is days in inventory calculated?

= Ending inventory / (COGS / 365)

How days sales in accounts receivable calculated?

= Ending net A/R / (Net sales / 365)

How is days of payables outstanding calculated?

= Ending A/P / (COGS / 365)

What is the cash conversion cycle formula?

= Days in inventory + Days sales in A/R - Days of payable outstanding

What is the Debt-to-equity ratio formula?

= Total liabilities / Total equity

What is the total debt ratio formula?

= Total liabilities / Total assets

What is the Times Interest Earned (TIE) formula?

= Earning before interest and taxes (EBIT) / Interest expense

or

= Income before interes expense and taxes / Interest expense

What does Gross Margin calculate?

Measures how much profit is left after paying for inventory (COGS).

What does Profit Margin calculate?

Measures how much net profit the company earns from each sales dollar.

What does ROE calculate?

Measures how well the company generates profit for its shareholders.

What does ROA calculate?

Measures how efficiently the company uses all of its assets to generate profit.

What does Current Ratio calculate?

Measures short-term liquidity (ability to pay current debts).

What does Quick Ratio calculate?

Measures immediate liquidity without relying on inventory.

What does the Operating Cash Flow ratio calculate?

Measures the company's ability to pay current liabilities using cash generated from operations.

What does Days Sales in Accounts Receivable calculates?

Measure the average number of days it takes to collect from customers.

What does Days in Inventory calculates?

Measure the average number of days inventory sits before being sold.

What does Days of Payables Outstanding calculate?

Measures the average number of days the company takes to pay its suppliers.

What does the Cash Conversion Cycle calculate?

Measures how many days cash is tied up in operations before it is recovered from customers.

What does the Debt-to-Equity ratio calculate?

Measures how much debt is used compared to shareholders’ equity (financial leverage).

What is the Total Debt Ratio formula?

Measures what percentage of assets is finance by debt.

What does the Times Interest Earned (TIE) formula calculate?

Measures the company’s ability to pay its interest expense.