CPA EXAM: FAR (F4)

What are the two methods for recording discounts on trade accounts payable? (M1)

Gross Method:

• Assumes discount is not going to be taken

Net Method:

• Assumes discount is going to be taken

What are some of the payables an entity may have? (M1)

• Trade Accounts Payable

• Trade Notes Payable

• Interest Payable

• Salaries and Wages Payable

• Sales Tax Payable

What is the difference between payroll tax and payroll deduction? (M1)

Payroll Taxes:

• An expense for the employer for their share of unemployment taxes, FICA taxes, etc.

Payroll Deductions:

• Withholdings of employee shares of income taxes, FICA taxes, etc.

What is included in the costs associated with exit and disposal activities? (M1)

• Involuntary employee termination benefits

• Costs to terminate a contract that is not a lease

• Consolidating facilities

• Relocating employees

• Moving PP&E

What is an asset retirement obligation (ARO)? (M1)

• A legal obligation associated with the retirement of a tangible long-lived asset

• Recorded as a liability for future payment required to clean up, close down, or restore the condition of the asset

  • Liability = Amount to be Paid in the Future x Present Value Factor

How are asset retirement obligations (ARO) accounted for? (M1)

Initial Measurement:

• Liability and asset account are created at the fair value of the obligation

  • Liability account is associated with the future payment

  • Asset account is capitalized to increase the carrying amount of the asset

Subsequent Measurement:

• Depreciation is used to reduce the asset account

• Accretion is used to increase the liability account using the appropriate discount rate

How do you account for gain contingencies? (M2)

• Gain contingencies are never accrued per the rules of conservatism

  • If the chances of collection are greater than remote, it can be disclosed in the footnotes

How do you account for loss contingencies? (M2)

Probable:

• Accrue for the loss

• Record journal entry

• Disclose in footnotes

Reasonably Possible:

• Do NOT accrue for the loss

• Do NOT record journal entry

• Disclose in footnotes

Remote:

• Do NOT accrue for the loss

• Do NOT record journal entry

• Do NOT disclose in footnotes unless it is for…

  • The guarantee of others debt

  • Obligation of commercial banks

  • Guarantees of repurchased receivables

How do you calculate the estimated liability for premium claims? (M2)

1. Calculate Total Estimated Coupon Redemption

   1. Total Estimated Coupon Redemption = Total Number of Coupons x Redemption Rate

2. Calculate Coupons Left to be Redeemed

   1. Coupons Left to Be Redeemed = Total Estimated Coupon Redemption - Coupons Already Redeemed

3. Calculate Outstanding Premium Claims

   1. Outstanding Premium Claims = Coupons Left to Be Redeemed / Number of Coupons Needed Per Claim

4. Calculate Estimated Liability

   1. Estimated Liability = Outstanding Premium Claims x Per-Premium Cost

How are warranty liabilities and expenses accounted for? (M2)

• Warranty liability is recorded every period based on an estimated warranty expense

  • Liability is increased and expense is recorded

    • Liability and inventory accounts are later reduced when the actual warranty expense is incurred

What are the six present value concepts?

Single Lump Sum:

• Present Value of $1

• Future Value of $1

Multiple Equal Cash Flows at the End of Each Period:

• Present Value of an Ordinary Annuity

• Future Value of an Ordinary Annuity

Multiple Equal Cash Flows at the Beginning of Each Period:

• Present Value of an Annuity Due

• Future Value of an Annuity Due

What are the formulas for present and future values? (M3)

Present:

• Future Value / (1+r)^n

Future:

• Present Value x (1+r)^n

How do you distinguish liabilities from equity? (M3)

Liabilities:

• Have a maturity date

• Carry an obligation to repay capital

Equity:

• No maturity date

• No obligation to repay capital

How do you impute and amortize interest? (M3)

• If a note contains no interest or an unreasonable rate of interest, the present value of the obligation at the appropriate market rate must be determined

  • The payable is recorded at its face amount

  • The item received in exchange is recorded at the present value

  • The difference between the payable and the item account is amortized as interest expense

What are the two types of debt covenants? (M3)

1. Affirmative

   1. Activities the debtor has to do

      1. EX. Pay taxes, safeguard assets, etc.

2. Negative

   1. Activities the debtor should not do

      1. EX. Borrow excessive amounts, pay excess dividends, etc.

What are some concessions if a debt covenant is violated? (M3)

1. Waive the debt-to-equity ratio restriction temporarily or permanently

2. Change the interest rate

3. Change the terms of the debt

When is a bond sold at a premium versus a discount? (M4)

Premium:

• Bond is sold for more than par value

  • Indicates that the market value is lower than the coupon rate

  • Considered a gain for the borrower because they are getting more money than they are required to pay back

Discount:

• Bond is sold for less than par value

  • Indicates that the market value is higher than the coupon rate

    • Means the interest expense incurred will exceed the actual coupon payment

How do you calculate the bond selling price? (M4)

Price = PV of the Future Principal Payment + PV of the Future Periodic Coupon Payments

• Both cash flows are discounted at the market rate of interest

What are the journal entries for bonds sold at a premium versus a discount? (M4)

Premium:

• DR. Cash (Selling Price)

  • CR. Premium (Selling Price - Face Value)

  • CR. Bonds Payable (Face Value)

Discount:

• DR. Cash (Selling Price)

• DR. Discount (Face Value - Selling Price)

  • CR. Bonds Payable (Face Value)

How do you use the effective interest method for amortizing bond premiums and discounts? (M4)

Premiums:

1. Coupon Payment = Face Value x Stated Rate

2. Interest Payment = Carrying Value x Market Rate

3. Amortization = Coupon Payment - Interest Payment

   1. Amortization amount directly reduces the carrying value of the bond to bring it down to face value

Discounts:

1. Coupon Payment = Face Value x Stated Rate

2. Interest Payment = Carrying Value x Market Rate

3. Amortization = Interest Payment - Coupon Payment

   1. Amortization amount directly increases the carrying value of the bond to bring it up to face value

How are bond issuance costs accounted for? (M4)

• Presented as a direct reduction to the carrying amount of the bond, similar to bond discounts

  • Debited at the inception of the bond issuance and amortized

• Must use the increased effective rate to calculate interest

What are the two methods to amortize bond premiums and discounts? (M5)

1. Straight-Line Method

   1. Not GAAP but is allowed under GAAP if results are not materially different than the effective interest method

2. Effective Interest Method

How do you use the straight-line method for amortizing bond premiums and discounts? (M5)

• Amortization = (Premium/Bond ± Bond Issuance Costs) / Number of Periods Bond is Outstanding

  • Results in consistent amortization amount, coupon payment, and interest expense for every period

How do you calculate the amount of interest that has accrued on a bond since the last interest payment? (M5)

• Face Value x (Coupon Rate / Times Paid Per Year) x (Number of Months Since Last Payment / Total Months Interest is Paid On)

  • Accrued interest for bonds issued between interest dates is added to the selling price to increase cash received by the borrower

    • Payable is also created for the remaining interest due on the payment date

What is troubled debt restructuring? (M6)

When a creditor allows a debtor certain concessions to improve the likelihood of collection

What gain/loss does a debtor report on troubled debt restructuring when transferring assets or equity interests? (M6)

Gain on Extinguishment of Debt:

• Gain = Carrying Value of Debt - FMV of Asset(s)

Gain/Loss on Asset:

• Gain/Loss = FMV of Asset(s) - Book Value of Asset(s)

  • Reported in aggregate with gain on extinguishment of debt

How should a debtor account for a modification of terms on a debt agreement? (M6)

• If the undiscounted future cash payments are less than the carrying amount, the debtor should…

  • Reduce the carrying amount

  • Recognize the different as a gain on the restructuring of debt

• No interest expense will be recognized after the date of restructuring

How should a creditor account for extinguishment or modification of a debt agreement? (M6)

• When assets or equity is received as full settlement, they are accounted for at their FMV at time of restructuring

  • Loss = FMV of Asset/Equity - Carrying Value of Receivable

How does a creditor report impairment loss on the restructuring of debt? (M6)

• Impairment should be measured based on the loan’s present value of expected future cash flows

• Impairment is recorded by creating a valuation allowance with a corresponding debit to bad debt expense

  • 1. PV of Future Cash Flows - PV of Principal + PV Coupon Payments

  • 2. CV of Receivable - Discounted PV of Future Cash Flows - Impairment

What is recorded by a debtor if a bond is extinguished at maturity versus before maturity? (M6)

At Maturity:

• The carrying value is equal to the face amount of the bond and no gain or loss is recorded

Before Maturity:

• Gain or loss will be recognized

  • Gain/Loss = (CV of Bond ± Discount/Premium) - Cash Paid for Extinguishment

What is in-substance defeasance? (M6)

• An arrangement in which a company places purchased securities into an irrevocable trust

  • Securities are pledged for the future principal and interest payments on long-term debt

What are the two criteria for a contract to be considered a lease? (M7)

1. Contract must depend on an identifiable asset in which the lessor does not have a substantive substitution right

2. Contract must convey the right to control the use of the asset over the lease term to the lessee

What are the four criteria for contracts to be combined for accounting purposes? (M7)

1. One or more contracts contains or is a lease

2. Contracts are entered into at approximately the same time

3. Parties to the contracts are the same, or are related parties

4. One or more of the following;

   1. Performance of one contract affects the consideration paid for the other

   2. Contracts have the same commercial objectives and were negotiated as part of a package

   3. The right to use underlying assets do not meet the accounting criteria for separate lease components

What are the five criteria for a lease to be classified as a finance lease? (M7)

1. Ownership of the underlying asset transfers to the lessee at the end of the lease term

2. The lessee has the written option to purchase the underlying asset and the possibility is “reasonably certain”

3. The NPV of all lease payments is >90% of the asset’s fair value

4. The term of the lease represents >75% of the remaining economic life for the underlying asset

5. The asset is specialized

How are operating leases accounted for by the lessee? (M7)

• ROU Asset and Lease Liability are recorded at the start of the lease

  • Carrying amounts are calculated using the present value of the lease payments using the market rate

  • Both are amortized over the life of the lease using the effective interest method

• Lease expense is reported as one line item as a combination of the depreciation expense of the asset and the interest expense

  • Lease expense reduces cash while accumulated amortization reduces the lease liability

What are the lessee’s journal entries for accounting for an operating lease? (M7)

Recording at Inception:

• DR. ROU Asset (PV of Annual Payments Discounted at Implicit Rate)

  • CR. Lease Liability (PV of Annual Payments Discounted at Implicit Rate)

Recording Lease Expense:

• DR. Lease Expense (Total Annual Payment)

  • CR. Cash (Total Annual Payment)

Recording Amortization:

• DR. Lease Liability (Total Annual Payment - Interest Expense)

  • CR. Accumulated Amortization (Total Annual Payment - Interest Expense)

How are finance leases accounted for by the lessee? (M7)

• ROU Asset and Lease Liability are recorded at inception of the lease term

  • Lease Liability = PV of Lease Payments Owed

  • ROU Asset = PV of Lease Payments Owed + Initial Direct Costs

• Lease expense and interest expense are recorded separately

  • Total annual payment will reduce cash and the lease liability, while recording interest expense

  • Amortization expense is recorded separately to reduce ROU asset

    • Calculated using entity’s method of amortization/depreciation for similar assets

What are the lessee’s journal entries for accounting for a finance lease?

Recording at Inception:

• DR. ROU Asset (PV of Annual Payments + Initial Direct Costs)

  • CR. Lease Liability (PV of Annual Payments)

Interest/Lease Expense:

• DR. Interest Expense (CV of Lease Liability x Interest Rate)

• DR. Lease Liability (Total Annual Payment - Interest Expense)

  • CR. Cash (Total Annual Payment)

Amortization Expense:

• DR. Amortization Expense

  • CR. Accumulated Amortization

How are payments from operating and finance leases classified? (M7)

Operating:

• Lease Payments: Operating

• Preparing Asset for Use: Investing

Financing:

• Interest Payments: Operating

• Principal Payments: Financing