CPA Exam - FAR

Cash

Money that is FREE and CLEAR and available to be spend in current operations.

Not Cash:

Security deposits & bond sinking funds

Three-Month Rule

Highly liquid securities with ORIGINAL maturity dates of three months or less are treated as cash.

Bad Debts - Direct Write-Off Method

- No entry for bad debts until customer actually defaults.

- At default, the cutomer's account is written off.

- Theoretically weak, matching issue

- Only allowed if bad debt expense is immaterial

Bad Debts - Allowance Method

Income Statement Approach

Balance Sheet Approach

Income Statement Approach

- Matching Concept

- Estimate of bad debt expense is based on the income statement

- Allowance account balance has no bearing on the amount of adjustment

Balance sheet reporting:

Accounts Receivable

Less: Allowance for bad debts

= Net realizable value of A/R

Balance Sheet Approach

- Estimate of bad debt expense is based on the balance sheet

- Period sales have no bearing on the amount of adjustment

Written-off account later collected

Reverse write-off entry. Collect as usual.

Assigning Accounts Receivable

- Assignment of A/R normally is done with recourse

- Assignment usually is done without notification to customers

Factoring Accounts Receivable

- With or without recourse.

Pledging A/R

- Use receivables as security for a loan

- Requires footnote disclosure

Noninterest-Bearing Notes

APB 21 requires interest to be inputed

- When a note is made under customary trade terms and is due in less than one year, there is no requirement to impute interest to that note.

Investments

- Held-to-Maturity

- Trading Securities

- Available-for-Sale Securities

Held-to-Maturity Securities

- Debt securities only

- Mgt has both intent and ability to hold the securities to maturity

- Classified on BS based on maturity date

- Carry on balance sheet at amortized cost

Trading Securities

- Equity or Debt securities held primarily for sale in the near term

- Classified on BS as current

- Carried on BS at FMV

- Unreal holding gains/losses belong on the income statement

Available-for-sale Securities

- Debt or Equity securities not classified as either HTM or Trading

- Debt is classified on BS by maturity date

- Equity securities are classified by mgt's intent

- Carried on BS at aggregate FMV

- Unreal G/L go directly to SH equity (other comprehensive income)

Derivatives

Investment that derives its value from something else (asset or liability)

Hedging

Strategy of investing in a derivative to counteralance the potential loss from another security or transaction

Non-Hedge Derivatives

- Record on BS as asset or liability at FMV

- Report unrealized G/L on IS

Fair Value Hedge

Protects against potential loss from the change in an asset's or liabilities's FMV

- Record on BS as asset or liability at fair market value

- Report unrealized holding G/L on IS

Cash-Flow Hedge

Protects against potential loss from an asset's or liability's future cash flow

- Record on BS as asset or liability

- Unreal G/L depend on whether hedge is effective

- Effective cash flow hedges counterbalance losses elsewhere

- Ineffective cash flow hedges are reported on the IS

Foreign currency hedges accounted for as FV hedges

- Foreign currency denominated firm commitment hedge

- Foreign currency available-for-sale securities hedge

Foreign currency hedges accounted for as CF hedges

- Foreign currency denominated forecasted transaction hedge

- Net investment in foreign operations hedge

Inventory

Property held for resale, property in the process of production, and property consumed in the process of production

Types of Inventory Accounts

Manufacturing

- Finished goods inventory

- Work-in-process inventory

- Raw materials inventory

Merchandising

- Property held for resale

Ownership Criteria

If merchandise is owned by a business enterprise on the last day of the fiscal year, regardless of location, the merchandise is included in ending inventory.

Goods on Consignment

Merchandise is always included in the consignor's ending inventory. The merchandise is not included in the ending inventory of the consignees.

Periodic Inventory System

If business entities elect to employ a periodic inventory system, the beginning inventory balance is reflected in the merchandise inventory account throughout the year.

Periodic Systems

- Specific Identification

- Weighted Average

- FIFO

- LIFO

Specific Identification

Somewhat large, distinguishable products

Weighted Average

The weighted average cost per unit must be calculated. The ending inventory valuation is equal to the number of units in ending inventory multiplied by the WA cost per unit. Likewise, the cost of goods sold for the period is equal to the number of units sold multiplied by the WA cost per unit.

Weighted Average Cost Per Unit =

Cost of Goods /

Number of Units

FIFO

Assumes ending inventory contains the most recently acquired units

LIFO

Assumes ending inventory contains the oldest inventory layers

Cost of Goods Sold

Beginning Inventory

+ Net Cost of Purchases

= Goods available for Sale

- Ending Inventory

=Cost of Goods Sold

Purchases

Balance in purchases account

+ Freight in

- Purchases discounts

- Purchase returns & allowances

Perpetual Inventory System

The merchandise inventory account is used to maintain a perpetual record of the net cost of merchandise on hand. Under the perpetual inventory system, the merchandise inventory account has a balance that is changing as the level of inventory changes throughout the accounting period.

Perpetual Systems

- Specific Identification

- Moving Average

- FIFO

- LIFO

Acquisition Cost

Includes all costs incurred in getting the merchandise to an entity's location and ready for use

Lower of Cost or Market (LCM)

Due to conservatism, inventory is shown on the BS at the LCM

Market

Generally replacement cost, subject to a range of values defined by an established ceiling value and an established floor value.

Ceiling Value

Net realizable value - reduce the sales price by the estimated cost to complete and sell the inventory

Floor Value

Net realizable value reduced by the normal profit margin

The LCM comparison must be completed on a consistant basis from year to year.

The LCM comparison must be completed on a consistant basis from year to year.

Holding loss of inventory

Direct method - any holding loss related to inventory is simply included in COGS

Allowance Method - Identified separately

Dollar-Value LIFO

- Converts ending inventory in FIFO dollars into LIFO dollars.

- Reduces the impact of liquidation problem

- Facilitates Internal FIFO use

Conversion Index

Ending Inv in CY $ /

Ending Inv in Base Year $

Estimating Inventory

- Gross Margin Method

- Retail Inventory Method

Gross Margin Method

To use the gross margin method, a company must have a consistant gross margin percentage.

Retail Inventory Method

Ending Inventory @ Retail

X Cost Ratio

= Ending Inventory

Property, Plant, & Equipment

Tangible, long-term, operational assets specifically related to the primary business activity or purpose typically referred to as fixed assets.

Categories of PPE

- Plant & Equipment

- Land

- Natural Resources

Plant & Equipment

Buildings, machinery, and equipment: depreciable assets with a finite useful life.

Land

Land that a company uses for primary business operations. NOT include real estate held for investment purposes. Not depreciated.

Natural resources

Items such as a gravel it, coal mine, a tract of timber land, and an oil well. Produce income until all the natural resources are extracted and sold. Depletable asset.

Acquisition cost

The acquisition cost of PP&E includes both the cash equibalent price and all costs incurred to get the asset on location and ready for use.

Issuance of Securities for asset

The acquisition cost of an asset acquired through the issuance of stocks or bonds is the FMV of the security or the FMV of the asset acquired, whichever can most clearly be determined.

Donated Assets

Donated assets are recorded at their FMV.

Group purchases

If a group of fixed assets are acquired in a single transaction, the total negotiated price is allocated to the individual assets acquired based on the respective FMV of the individual assets acquired.

Nonmonetary transaction

The acquisition is recorded at the FMV of the asset surrendered for the FMV of the asset received, whichever is more clearly determinable. Any gains or losses are recognized regardless of boot.

Construction period interest

Interest cost is considered a "get ready" cost and is capitalized only during the construction period.

Interest capitalization period begins when:

- Qualifying expenditures have been made.

- Activities necessary to prepare the asset for its intended use are in progress

- Interest cost is being incurred.

Capitalized Interest =

Average Accumulated Expenditures

x Interest Rate

Interest Rate

Weighted average specific rate for specific loans

x Weighted average non-specific rate for excess over specific loans

Depreciation Causes

- Physical Factors (wear & tear)

- Functional Factors (obsolescense)

Depreciation Calculation Factors

- Cost

- Estimated useful life

- Estimated salvage value

Straight line depreciation

(Cost - Salvage Value)

/ Useful life

Sum-of-the-years' digits

SYD = N(N+1)/2

N=Useful life

Depreciation = (N/SYD)(Cost-Salvage Value)

Double-Declining Balance

Depreciation Expense = Double-Declining Rate x Asset Book Value

Depletion

(Cost+Restoration Costs-Residual Value)

/ # of Units

Determining Impairment

- Estimate the expected future net cash flows of the asset and its eventual disposition.

- If the sum of expected future net cash flows is less than the CV of the asset, the asset is impaired.

- If the sum of the expected future net cash flows is greater than the CV of the asset, no impairment has occurred.

Measurement of Impairment

If an impairment is indicated, the loss is measured by the amount by which the CV exceeds its FV

Reporting an Impairment

Impairment loss is not extraordinary and generally is reported as income from continuring operations.

Intangible Assets

Long-term operational assets that lack physical substance or presence.

Acquisition Cost - Developed Internally

Internally developed intangible assets are likely the result of research and development activities which are expensed in the period incurred. Therefore, the capitalized cost of an internally developed intangible asset usually is composed of the legal and other related registration costs.

Organization Costs

Costs incurred in the initial planning state of a business enterprise and oftentimes, include implementation of an initial business plan. Organization costs typically are amortized over a period of five years.

Organization Costs:

- Initial Accounting Services

- Initial Legal Services

- State Incorporation Fees

- Expenses of Temporary Directors

- Organizational Meetings

Deferred Charges

Actually long-term prepaid expenses. Deferred charges typically are presented on the BS in conjunction with intangible assets.

Deferred Charges:

- Prepaid Insurance

- Prepaid rent

- Machingery rearrangements costs

- Deferred income taxes

Research & Development Costs

Expensed in the period incurred (Labor, material, & overhead)

Research

An attempt to disover new knowledge

Development

A translation of knowledge into new plans, new designes, or new products.

Computer Software development

R&D activities continue until the technological feasibility of the software has been established. The establishment of the technological feasiblity occurs when the program model or working model fo the software is complete. R&D expensed. After feasibility capitalized.