F5 M1 FAR CPA

Financial Asset

Entity receives payments

Financial Liability

A contract that imposes on one entity an obligation to deliver cash or another financial instrument to a second entity or exchange other financial instruments on potentially unfavorable terms with the second entity

Fair Value Option

Entities may choose to measure eligible financial instruments at Fair Value

• All Gains and losses (including realized and unrealized), income, interest, and dividends will flow through the Income Statement

  • Investment income/loss is presented as a net figure reflecting true total earnings (or loss) from the investment

• Follows trading security rules

• Eligible Financial instruments:

  1. Available-for-Sale Debt

  2. Equity using Equity Method: Own 20-50% Interest

**FV Changes in Derivatives (G/L) go directly to Income Statement

Debt Security

Any security representing a creditor relationship with an entity

• Include:

  1. Corporate bonds

  2. Redeemable Preferred Stock

  3. Government Securities

  4. Convertible Debt

  5. Commercial Paper

Classified into:

1. Trading Securities

2. Available-For-Sale Securities

3. Held-To-Maturity Securities

Trading (Held-For-Trading) Security

Debt securities that are bought and held principally for the purpose of selling them in the near term; classified as a current asset

• Unrealized or Realized Gains/ Losses and interest on the bond is recognized on the Income Statement

• Operating Cash Inflow/ Outflow (Current Asset)

FV through P/L

Available-For-Sale Debt Security

Debt securities NOT meeting the definition of a trading/ held-to-maturity classifications

• Unrealized Gains/ Losses go directly to Equity

• Realized Gains/ Losses and Interest on the bond are recognized on the Income Statement

• Investing Cashflow (Non-current Asset)

If impaired —→ Gain/ Loss goes on Income Statement as Realized Gain/ Loss

FV through OCI

Held-To-Maturity Debt Security

Corporation has the positive intent and ability to hold securities to maturity

• Must be reported at Amortized cost which is relevant if purchase price is other than par

  • No realized or unrealized Gains/ Losses are recorded because you are not marking it to FV and you’re not selling it

  • Interest in bond is recognized ion the Income Statement

• Corporation must have the Intent and Ability to hold it to maturity

Fair Value

The market price of the security; what a willing buyer and seller would pay and accept to exchange the security

• Changes in Fair Value of Trading and AFS securities result in Unrealized Holding Gains/ Losses

Realized Gain or Loss

Gain/ Loss that is recognized on the Income Statement when:

1. Debt security is sold

2. Available-For-Sale debt security is deemed to be impaired

Security is Sold

Trading Security: Carrying Value of Security (Cost ± Unrealized Gain/ Loss) - Selling Price = Realized G/L

Available For Sale Security: Original Cost - Selling Price = Realized G/L

• Must remove whole amount of Unrecognized Gain/ Loss previously recorded that went to OCI

Impairment of Debt Securities

Write down the investment to the Present Value of future cash flows and record the Loss by calculating the Expected Credit Loss of the security

• Expected Credit Loss = PV of future Cash Flows (Payments and Principal) - Amortized Cost

  • Credit Loss is recognized on the Income Statement as a current period expense; use Allowance for Credit Losses when recording

  • Only Applies to AFS and HTM Securities

    • Should be reported at the net amount expected to be collected

  • HTM Securities:

    • Write down security to it’s PV of future cash flows then subtract Amortized cost to find Expected Credit Loss —→ Income Statement

  • AFS Securities:

  • Maximum Loss on Income Statement = Expected Credit Loss

  • Additional Loss will go to OCI as Unrealized Loss

Unrealized Holding Gain/ Loss

Gain/ Loss that is either recognized on the Income Statement (Trading Security) or OCI (AFS Security) due to changes in Fair Value

• NOT a sale

• When recording, use a Valuation account (Fair Value Adjustment) to either increase/ decrease Asset

Equity Security

A security that represents an ownership interest in an enterprise or the right to acquire or dispose of an ownership interest in an enterprise at fixed or determinable prices

• Includes:

  • Ownership shares (common/ Preferred stock)

  • Rights to acquire ownership (stock warrants, rights, call options)

  • Rights to dispose of ownership (Put option)

Preferred Equity & No Significant Influence (Less than 20% Ownership)

• Uses Trading Security rules —→ FV through P/L

• Carried at Fair Value through Net Income (FVTNI)

• All Gains/ Losses (Realized/ Unrealized) go to Income Statement

Practicability Exception

Allows an entity to measure an equity investment that is NOT publicly traded (Privately-held) at cost less impairment, plus/minus observable price changes or identical or similar investments from the same issuer

• Applicable for equity investments that do NOT have a readily determinable Fair Value

• Non-public Equity Investments are reported on the Balance Sheet at Carrying Value = Cost - Impairment

  • Impairment occurs if…

    1. Heightened concerns regarding the ability of an investee to continue as a going concern

    2. Significant and adverse changes in industry

    3. Significant decline in earnings, asset quality, credit rating of the investee

    4. Company offers to buy stock from investee for less than the carrying value and investee is willing to sell

Liquidating Dividend

A distribution that exceeds the investor’s share of the investee’s retained earnings; a return of capital that decreases the investor’s basis in the investment

• Must reduce Investment account

• Dividend > Retained Earnings

Credit Risk

Possibility of loss from the failure of another party to perform according to the terms of a contract

Concentration of Credit Risk

Occurs when an entity has contracts of material value with one or more parties in the same industry or region or having similar economic characteristics

• Required Disclosure in the notes to the financial statements

Market Risk

The possibility of the loss from changes in market value

• Due to changes in economic circumstances

• Optional disclosure

Equity Method

Used to account for investments if Significant Influence can be exercise d by the investor over the investee

• Dividends on Common stock are NOT income (Instead will be a return of capital)

• Do NOT mark to FV

Recorded at the price paid to acquire the investment (Initial Carrying Value = Cash paid + Debt Issued + FV Stock Issued)

Investment account is adjusted for investee’s earning of income and payment of dividends:

• Increases by the investor’s share of the investee’s net income (Debt Investment Credit Equity in Subisidary/ Investment Income)

• Decreases by the investor’s share of the investee’s distribution of dividends (Debit Cash Credit Investment)

Significant Influence

A company that owns 20% to 50% of voting stock of another “Investee” company

• Must use Equity Method when presenting the investment in the Investee in:

  • Consolidated financial statements that include other consolidated entities, but NOT the “Investee”; or

  • Unconsolidated parent company financial statements (Parent’s standalone financial statements before consolidating)

Standstill Agreement

Investor surrenders significant rights as a shareholder

Asset Fair Value Differences

Differences between the book value and fair value of the acquired

• Identifiable Asset

Goodwill

The excess of the purchase price over the fair value

• Unidentifiable

• Unlike consolidation, under Equity Method —→ Goodwill is NOT a separate asset on the Balance Sheet

  • NOT amortized/ NO separate impairment test

    • Embedded within the carrying value of investment

Goodwill = Purchase Price - Share of FV Net Assets

Excess Deprecation (Amortization)

The excess of an asset’s fair value over its book value is amortized over the life of the asset and multiplied by ownership % in company

• This additional amortization causes the investor’s share of the investee’s net income to decrease

  • Debit Equity in Earnings Credit Investment in Investee

Consolidated Financial Statements (Voting Interest Model)

Prepared when a parent-subsidiary relationship has been formed if entity can control at least 50% of the shares of the subsidiary company

• Majority of shares

• All majority-owned subsidiaries MUST be consolidated EXCEPT subsidiaries in bankruptcy or in legal reorganization

  • Consolidation = Parent and Subsidiary are now ONE

Controlling Interest

An investor owning more than 50 % of a subsidiary

• Will consolidate subsidiary

Noncontrolling Interest (NCI)

The portion of the equity (net assets) of a subsidiary that is not attributable to the parent

• Reported at Fair Value in the equity section of the consolidated balance sheet, separately from the parent’s equity

• Has NO control

Wholly-Owned Controlling Interest

Parent owns 100% interest in subsidiary

• Must consolidate subsidiary at 100% Fair Value on acquisition date

Pushdown Accounting

An elective, entity-level choice that allows the acquired company to reestablish its stand-alone financial statements using the stepped-up basis associated with the acquirer’s purchase price allocation; subsidiary remeasures all identifiable assets and liabilities to the same acquisition-date fair values recognized by the new Parent

• Based on the Parent’s purchase price allocation, the acquiree “pushes down” adjustments into the subsidiary’s books

• Only applies whenever a change in control occurs

• Goodwill = Consideration > FV Assets

  • Goodwill is recorded directly on the subsidiary’s books

• Bargain Purchase Gain = Consideration < FV of assets

  • Gain is recognized in APIC (NOT on the Income Statement)

• “Pushdown capital” account within Equity is recorded reflecting the Parent’s ownership (Consideration)

Acquisition Method

Method used to account for business combinations in which the investor/parent establishes control over the investee/subsidiary

• 100% of net assets acquired (regardless of ownership %) are recorded at Fair Value with any unallocated balance creating Goodwill

• When the companies are consolidated, Consolidating Workpaper Eliminating Journal Entry is made:

  • Subsidiary’s entire equity (CS, APIC, RE) is Eliminated

  • Investment in Subsidiary is Eliminated

  • Noncontrolling Interest is created

  • Subsidiary’s Balance Sheet is Adjusted to Fair Value

  • Subsidiary’s identifiable assets are recorded at Fair Value

  • Goodwill/ Bargain Gain is created (PLUG)

Intercompany Transactions

Transactions that lack the criteria of being “arm’s length”

• When consolidating, 100% of the transactions must be Eliminated because the Parent and Subsidiary are considered to be one

  • Eliminate by undoing original intercompany transaction (As if transaction never happened in the first place)

Intercompany Inventory/ Merchandise Transactions

Occurs when affiliated companies sell inventory/ merchandise to one another

• Total amount of the intercompany sale and cost of goods sold of the Seller should be Eliminated

• Intercompany Profit must be Eliminated from:

  • Ending Inventory of the Buyer

  • COGS of the Buyer

• Intercompany Profit in the beginning inventory that was recognized by the selling affiliate in the previous year must be Eliminated by an adjustment to RE (Debit)

Inventory sold to outsiders —→ Adjust COGS

Inventory still on hand —→ Adjust Ending Inventory

Intercompany Bond Transactions

One party of the consolidated group acquires an affiliate’s debt from an outsider, the debt is considered to be retired and a gain/loss is recognized on the consolidated Income Statement

• Gain / Loss on Extinguishment of Debt = Reacquired Price - CV of debt

  • Not reported on either company’s books; ONLY recorded through an elimination entry on the Consolidated Income Statements

  • All intercompany account balances are also eliminated (Ex: Accrued Interest/ interest receivable)

Intercompany Sale of Land

Gain or Loss on the sale of land remains unrealized until the land is sold to an outsider

• Elimination Entry:

1. The intercompany gain/ loss

2. Adjusts land to its original cost (As if transaction NEVER occurred)

In subsequent years, Debit RE and Credit Land to eliminate Intercompany Profit until the land is sold

Intercompany Sale of Depreciable Fixed Assets

The Gain/ loss on the intercompany sale of a depreciable asset is unrealized from a consolidated financial statement perspective until the asset is sold to an outsider

• Elimination Entry:

  • Eliminates the intercompany gain/loss

  • Adjusts asset and accumulated depreciation to their original balance on the date of sale

Consolidated Balance Sheet

Statement that includes 100% of the Parent’s and Subsidiary’s assets and liabilities (after eliminating intercompany transactions)

• Does NOT include Subsidiary’s Equity ←— ELIMINATED

• NCI is established/ presented as part of Equity, which is separated from Parent Equity

• Goodwill appears when consolidating ONLY

Consolidated Income Statement

Statement that includes 100% of the Parent’s revenues and expenses and all of the subsidiary’s revenues and expenses after the date of acquisition

• Subsidiary’s pre-acquisition revenues and expenses are NOT included

• Show Separately:

  • Consolidated Net income

  • Net Income attributable to the Parent

  • Net Income attributable to NCI

Statement of Comprehensive Income

Statement that is an extension of the Income Statement that shows separately:

• Consolidated Comprehensive Income

• Comprehensive Income attributable to the NCI

• Comprehensive Income attributable to the Parent

Consolidated Statement of Changes in Equity

Statement must include a reconciliation of the beginning-of-period and end-of-period carrying amount of total equity and must show how much equity is attributable to the Parent and how much equity is attributable to NCI

• NCI is presented as part of equity

Consolidated Statement of Cash Flows