-------------Overview

OCI: includes unrealized holding gains/losses, foreign currency fluctuations, defined benefit pension
adjustments

Valuation accounts: adjust value of the asset/liab but are not assets/liabs in themselves. Reflected on
the B/S, not the statement of S/E

Principle Market = market in which the greatest volume and level of activity for an orderly
transaction to occur for an asset or liability.

Highest/Best use of asset to determine FMV considers:

• Legally permissible, Financially feasible, physically possible
• Does not consider “readily accessible”

Realization Concept – Conversion of a noncash resource to cash (e.g. sell machine)

Statement of Comprehensive income format:

Net Income
OCI
Comprehensive income

• Comprehensive income includes all changes to equity except investments by or distributions

to owners

Valuation Approaches: Income, cost, & market approaches should be used

SFAC’s: set forth objectives and fundamentals that will be the basis for future development of
financial accounting and reporting standards.
Cash – Free and clear, can be spent on operations
Bond Sinking Fund -> not cash (must back out): B/S – Bond sinking fund
Compensating balance -> not cash (back out): B/S – investment
Overdrafted checking -> Current liability unless another acct at same bank can cover the
shortage

Overdrafts in accounts with no available cash in another account at the same bank to offset are
classified as current liabilities. They are not deducted from the total amount of cash at another bank.

• 3 month rule -> Cash equivalent

• CD’s, T-bills, commercial paper
• Original Maturity must be <= 3 months
• Ex: 6 month CD maturing in a week is not cash

• Checks written before 12/31 but mailed after…

- Must add back to arrive at cash!!!

• Bank Reconciliations to arrive @ cash

Reconciling Items
Ending Bank Balance
(+) Deposits in Transit
(-) Outstanding checks

Disregard
• Returned bad checks (already backed out by bank)
• Bank Service charge (already reflected in bank statement)
• Interest (also already included)

Bad Debt Expense

1) Direct Write-off Method – Write off when customer defaults

Bad Debt Expense xx

A/R xx

• Can only use direct write-off if BDE is immaterial to the F/S

2) Allowance Method (required if BDE is material)

• Two approaches (I/S and B/S approach)
• Allowance Account -> normal credit balance
Recording the allowance
BDE xx
Allowance xx

Recovery of bad debt previously written-off

A/R xx
Allowance xx
Cash xx
A/R xx

Pledged Receivables – Using A/R to securitize a loan

• Requires a footnote
Factoring Receivables (w/o recourse = sale is final)
• Selling receivables to factor who must collect

JE: Cash xx
Loss xx
A/R xx

Factoring w/recourse:
• Company collects the receivables and is liable to the factor
• As receivables are collected, the payback the note w/ interest

JE: A/R Factored xx

A/R xx
Cash xx
Note payable xx
Non-interest Bearing Notes
• Must impute interest of the note (KEY = record note at discounted PV)
• Seller side Example: Must amortize discount to interest income over life of note
When Sale is made (Note receivable has face value of 400K, 10% rate for similars)
Cash 125K
Note receivable 300K (use discounted PV: (face * discount factor))
Building 350K
Gain on Sale 75K

End of Year 1
Note Receivable 30K (300K Carrying value * 10% Eff. Interest rate)
Interest Income 30K

End of Year 2
Note Receivable 33K (330K Carrying value * 10%)
Interest Income 33K

Buyer Side Example: (Must amortize 100K difference to interest expense over life)
Point of Sale:
Building 425K
Note Payable 300K (400K discounted to PV @ 10%)
Cash 125K

End of Year 1
Interest Expense 30K (300K Carrying value * 10% Eff. Interest rate)
Note Payable 30K

End of Year 2
Interest Expense 33K
Note Payable 33K (330K Carrying value * 10% Eff. Interest
rate)
Unreasonable Interest: Due in < 1 year under customary trade terms
• Not required to impute interest on the note!!!
• No need to discount Note Receivable at all, book at face value

Unreasonable Interest: Due in > 1 year…

1. Calculate Maturity value using actual interest stated on the note
2. Discount back to PV at a fair rate of interest

Total Interest Revenue Earned Over life of a Note

= (Sum of yearly payments) – (PV of note when recorded)

Income from a Note Receivable (cash exchange ONLY)

JE: Accrued int receivable xx [face amt * stated rate]
Amort of loan fee xx [plug]
Interest Income xx [PV of note * effective interest rate]
Interest earned over the life of discounted note = [Sum of payments] - [PV of note, discounted at
market rate]
Discounting

*W/recourse: at the date of discounting, Dr. Cash, Cr. N/R discounted [FACE AMT]

Determining the proceeds received from discounting a note receivable consists of three steps:
1. Determine the maturity value of the note. This amount is based on the face amount, the stated rate of
interest, and the time to maturity of the note.
2. Apply the banks discount rate to the maturity value of the note to obtain the amount of the discount charged
by the bank.
3. Subtract the discount charged by the bank from the maturity value of the note to obtain the proceeds
received from the bank.

Investments
FASB 115- Does not apply to investments under the equity method
 • Deals with handling unrealized gains/losses
• When transferring from one portfolio type to another (e.g. Trading to AFS), adjust to FMV
on date of the transfer!!!
• Goes to income statement “unrealized gain/loss” if Trading is involved
• Goes to OCI if trading is not involved in the transfer

• Divide investments into 3 categories

1) Held-to-Maturity Securities (HTM)
• Carried on the B/S at amortized cost
• Debt securities ONLY, that MGT has intent and ability to HTM
• Current -> Mature in 12 months or fewer from B/S date
• Noncurrent -> Matures more than 12 months from B/S date

2) Trading Securities
• Carried on B/S as current asset
• Carried at FMV
• Write up to FV -> “unrealized holding gain”
• Write down to FV -> “unrealized holding loss”
• Any unrealized gain/loss included in I/S
• JE example: Investment in XYZ xx
Unrealized gain xx
• Can be debt or equity
• Gains/losses go to the I/S under “continuing operations”

3) Available for sale securities (AFS)

• Anything not classified as HTM or Trading
• Can be current or noncurrent
• Can be debt or equity (classify equity securities according to MGT intent)
• Carry on B/S as aggregate FMV
• NOT ADJUSTED on a security-by-security basis
• JE (if marking up to FMV):
Market Adjustment xx
OCI xx

• B/S presentation:
AFS securities 18K
Market Adjustment 12K
Total AFS @ FMV 30K

• “Unrealized gain/loss” goes directly to S/E under “OCI”

• When sold, use original cost to determine the realized gain/loss
Permanent Decline in Market
• Applies only to HTM or AFS securities and never Trading
• Must be extreme such as company going bankrupt
• Goes to I/S (earnings)- see below…
JE for Permanent Decline:
Loss on investment xx
Investment in ABC xx

Derivatives and Hedging

• An entity is required to disclose all significant concentrations of credit risk arising from all
financial instruments
• Credit risk disclosure included in Notes to the Financial Statements
• Disclosure of FV: required if practicable and material to the F/S
• If unable to estimate FV, must disclose…
• 1) Information pertinent to estimating the fair value of the financial instrument
• 2) Reason why it’s not able to be estimated

Derivatives must contain 3 characteristics

1. an underlying and notional amount or payment provision
2. zero or small investment
3. net settlement

“Perfect Hedge” = no possibility of future gain or loss

Changes to values of non-hedging derivatives à EARNINGS