Module 7a Basic Concepts pg.

41, handout pgs 1-2

Know the Conceptual Framework and definitions on page 2 of handout

When assets increase, S.H.E. increases and when liabilities decrease, S.H.E. increases.

Distributions to owners i.e. paying owners dividends

Dr. Retained Earnings (R/E) or dividends (contra asset account)
Cr. Cash

Recognize = do J/E & appears in FS

1. Always recognize losses, but don’t always recognize gains due to accounting conservatism.
Realization = means only that something happened. Occurs at time of sale rather than when cash is collected.
Matching principal = match expenses to revenue, NOT revenue to expenses

The stem is the last part of the question.

COGS = Beg. Inv. + net purchases – End. Inv.
Purchases = pmts + ending A/P – Beg. A/P

When you see word “expected” it means probability.

Income is recognized when earning process is complete. Expenses are recorded when incurred not necessarily
when paid.

Cash Basis is NOT GAAP.

Gift certificates sold – Dept store debits cash & credits unearned revenue. They will recognize revenue when
1. Gift cards are redeemed.
2. Gift cards expire.

SFAC 7 Using cash flow info & PV in accounting measurements

1. provides a framework for using future cash flows (FCF) as basis of acctg measurement.
2. Provides general principles governing use of PV
3. addresses measurement issues, NOT recognition questions
4. Does NOT specify when fresh-start measurements are appropriate
5. Applies only to measurements at initial recognition, fresh-start measurements, & amort
techniques based on FCF.

The only objective of PV, when used in accounting measurements at initial recognition and fresh-start
measurements, is to estimate Fair Value.

A PV measurement that is able to capture the economic differences btwn various assets & liabilities includes
following elements according to SFAC 7:
1. an estimate of FCF or series of FCF @ diff times
2. Expectations about possible variations in amt or timing of those cash flows
3. Time value of money (TVM) represent by the risk-free rate of interest.
4. Price for bearing uncertainty inherent in asset or liability.
5. Other, sometimes unidentifiable factors, including illiquidity & market imperfections.
SFAC 7 two approaches to computing PV that may be used to estimate FV of an asset/liability.
a) Expected cash flow approach
i. Uses all expectations about possible cash flows instead of single most-likely cash flow.
1. Uses estimated cash flows & PROBABILITIES
a. i.e. Yr 1 200,000 * .95238 * .20 = 38,094
Yr 2 200,000 * .90703 * .50 = 90.703
Yr 3 200,000 * .86384 * .30 = 51,830
1.00 180,627
b) Traditional approach
i. Uses a single set of estimated cash flow & a single interest rate.
1. Adjustments for factors 1-5 listed above are embedded in discount rate.

Installment Sales Method

Cash collections * Gross Profit Percentage = Realized Gross Profit
Ending A/R * Gross Profit Percentage = Deferred Gross Profit
Or DGP = Gross profit - RGP
Gross Profit Percentage = (Installment sales – cost of installment sales)/Installment sales
Or GPP = GP/Sales
Gross Profit= install sales – cost of install sales
Ending A/R = Installment sales – Collections on installment sales
Install Sales = DGP/GPP
Beg. A/R is always install sales.

Only include Principal in cash collections on install loans.

For sales made in prior years, companies apply gross profit rate of each years sales against cash collections of
A/R resulting from that year’s sales to arrive at realized gross profit. Ex: In 2006, the GPP was 25% & in 2007,
the GPP was 30%. Any cash collections of 2006 sales in 2007 will use 2006 GPP.

Cost Recovery Method

Company recognizes profit only when cash collections (principal & interest) exceed total cost of goods sold.

Franchises
Franchisor only recognizes revenue or initial franchise fee when initial service obligation has been completed,
so initially Cr. Unearned Revenue at PV of total pmts. Direct Franchise costs are deferred until related revenue
is recognized. If franchise fee is represented in a note, then
Dr. Notes Receivables (at gross amt of pmts)
Cr. Unearned Revenue (PV of pmts)
Cr. Discount on N/R (Plug)

Per SFAC 6, comprehensive income includes all changes in equity during a period except those resulting from
investments by owners and distributions to owners.

Conservatism is the underlying concept governing GAAP pertaining to recording gain contingencies. In an
effort to not overstate assets/income, gain contingencies are NOT recorded until they are no longer
contingencies and are disclosed only when probabilities are high that a gain contingency will become reality.

Per SFAC 6 Revenues are INFLOWS of assets or settlements of liabilities or both during a period as a result of
an entity’s major or primary operations.
3 attributes in measuring inventory:
1. Historical Cost
2. Replacement Cost
3. Net realizable value
Which are all used in measuring inventory at lower of cost or market.
Module 7b Error Correction pg. 90
If EI is understated for 2007, then 2007 income is also understated, and 2008 income is OVERstated. The error
will self-correct by 1/01/09.

Understatement of BI causes understatement in CAFS AND COGS. Overstatement of EI causes understatement

of COGS.

For corrections of an error, the FS of all periods should be restated & corrections made to reflect any period-
specific effects of the error.

Module 7c Accounting changes

See pages 3-4 of handout.

When it’s impossible to determine whether a change in acctg principle or a change in acctg. estimate has
occurred, the change should be considered as a change in estimate.

ASC Topic 250 states that a change in the periods benefited by a deferred cost should be treated as a change in
accounting estimate. Changes in accounting estimates are accounted for in the period of change and future
periods if the change affects both.

A change in the salvage value of an asset is a change in accounting estimate. ASC 250-10-45-17 states that a
change in accounting estimate should be accounted for in the period of change and future periods if the change
affects both.

if the estimated useful life of an intangible asset is revised, the unamortized cost should be allocated over the
remaining periods of the new useful life.

The effect of a change in acctg. principle that is inseparable from the effect of a change in acctg estimate should
be reported as a component of income from continuing operations, in the period of change and future periods if
the change affects both.

Per ASC 250-10-45-18, the effect of a change in accounting principle which is inseparable from the effect of a
change in accounting estimate should be accounted for as a change in accounting estimate.

the period-specific effects must be reported net of tax effects

Indirect effects from a change in accounting principle should be reported in the period in which the accounting
change occurs.
Module 7d Financial Statements pg. 129 & pg 5 of handout
Must be able to prepare multi-step income stmt as show on pg 129.
1st Prepare IS to find NI
2nd Prepare stmt of changes in R/E or S.H.E. to find ending R/E to include on BS
3rd Balance Sheet
4th Stmt of CF

All FS must include heading/title:

1. Name of Company
2. Statement of Earnings or name of stmt
3. For the year ended (BS date)

Basic income stmt

Sales
-COGS
=Gross margin
-operating expenses
=operating income
+other revenue & gains
-other expenses & losses
=Income from continuing operations BEFORE taxes
-provision for income taxes
= Income from continuing operations
+/-Discontinued operations: net of taxes
+/- extraordinary gains/losses (net)
=NI
+OCI
=Comprehensive income (NI + OCI)

COGS is used w/periodicity inventory system.

COG purchased calculation

Gross purchases
Less: Purch. Discounts
Less: Returns & Allowances
= net purchases
+ Freight-in or transportation in
= COG purchased

Freight in/transportation in – shipping costs to get goods from vendors to you (product cost)

COGS calculation
Beginning inventory
+COG purchased
= COG available for sale
Less: ending inventory
=COGS
Cost of Goods Manufactured (CGM) formula
Begin. WIP
+Direct materials used
+Direct labor
+Factory overhead
-Ending WIP
=CGM

Or find CGM using COS (cost of sales) formula:

Beg. finished goods
+CGM
-End finished goods
= COS

Net sales = gross sales – sales discount – sales returns & allowances

Items included under ‘Operating expenses’ on IS

• Selling expenses
o Freight out – cost of getting goods to your customers
o Warranty expense
o Depreciation expense on a sales showroom
o Bad Debt expense (some consider it a G & A expense)
• G&A expenses – overall expenses for operations
o Depreciation expense on corporate office
o Auditing fees, attorney fees etc.
• R&D expense
o Depreciation expense on equipment used only in R&D
o Salaries for scientists doing R&D
• Organizational/opening expenses
o Expenses associated with opening a new store etc.
• Impairment losses for public companies

Items included under ‘Other revenues and gains’ on IS

• Interest revenue
• Equity in investment earnings
• Gain on sale of AFS securities, equipment etc.

Items included under ‘Other expenses and losses’ on IS

• Restructuring charge (However, if it’s material then it’s included under ‘operating expense’)
1. should be measured & recognized at FV when they are incurred.

To be classified as discontinued operations, a component must meet “held for sale” criteria (a-f below) PLUS
the 2 criteria below.
“Held for sale”
A. Mgmt commits to plan of disposal
B. Assets are available for sale
C. Active program to locate a buyer has been initiated.
D. Sale is probable
E. Asset is being actively marketed for sale at a fair price.
F. It is unlikely the disposal plan will significantly change
Additional criteria that MUST be met for component to be considered discontinued ops:
1. Operations & cash flows of component have been or will be eliminated from ongoing ops of entity as a
result of disposal.
2. entity will not have any significant involvement in ops of the component after disposal.

IS & R/E stmt categories

1. Unusual OR infrequent items
a. Unusual or infrequent event considered to be material that doesn’t qualify as extraordinary.
b. Included on IS in income from continuing ops right after revenues and expenses.
2. Discontinued Operations (net of tax)
a. Results from disposal of a biz component.
b. Included on IS as a separate category after income from continuing ops.
3. Extraordinary items (net of tax)
a. An unusual AND infrequent non recurring event which has material effects
b. Incl.on IS as a separate category after discontinued ops. & before cumulative effect of acctg changes.
c. Items that are NEVER extraordinary
i. No gain or loss from a foreign currency devaluation
ii. Effects of a labor strike
iii. Write downs of assets ex: inventory, impairments of receivables, A/R, PP&E.
4. Change in Acctg principle
a. Change from one GAAP to another GAAP.
b. No longer on IS. See treatment of changes in acctg principles.
5. Correction of an Error
a. A correction of a material error from a prior period
b. Not on IS, report net of tax in R/E as an adjustment of the beginning balance.

Information to include in summary of significant accounting policies:

Disclosure of accounting policies should identify & describe the acctg principles followed by the reporting
entity and methods of applying those principles.

GAAP definition of comprehensive income: Total of net income and Other Comprehensive Income.

Companies are required to show Comprehensive Income. The 3 approaches in reporting Comprehensive
income:
1. Present a second IS (ex: Comprehensive Income Stmt) (FASB preferred method)
2. Present a combined IS (ex: Stmt of Income & Comprehensive Income) (FASB preferred method)
3. Present comprehensive income in Stmt of Changes in S.H.E (prevalent in industry)
*Regardless of which approach you choose, you must show ending balance of Accumulated Other
Comprehensive Income on the BS AFTER R/E. OCI gets closed to ACCUMULATED OCI. The accumulated
OCI is reported on BS as a component of equity, SEPARATE from R/E & addt’l paid-in capital.
**Net income is a temp acct that gets closed to R/E.

Examples of Other Comprehensive Items (MUST MEMORIZE)

1. reclassification adjustments (“backing it out” from previous year & is opposite of what was done last yr)
2. Unrealized holding gain or loss on AFS securities (assuming FVO is not used)
3. Pension or Other Postretirement Benefit (OPBR) Adjustments under SFAS No. 158 for:
a. Gains or losses associated w/pension or OPRB
b. Prior service costs or credits associated with pension or OPRB
c. Transition assets or obligations associated with pension or OPRB
4. Unrealized holding gain or loss on derivatives held as cash flow hedges.
5. Cumulative foreign currency translation adjustment (current rate method)
Balance Sheet categories
Assets
Current assets
Long-term investments:
PP& E
Intangible assets net of amortization
Other assets
=Total Assets
Liabilities
Current Liabilities
Noncurrent Liabilities
=Total Liabilities
Stockholders’ Equity
Capital Stock
Additional Paid-in Capital
Retained earnings
Accumulated OCI
=Total Stockholder’s Equity
= Total Liabilities & Stockholders’ equity

SFAS 57 Related-Party Disclosures

A. Definitions
a. Affiliate – a business entity/party effectively controlling or controlled by another or associated with
others under common ownership or control
b. Control – a greater than 50% ownership
c. Immediate family- those that principal owners/mgmt might control or be influenced by or vice versa.
d. MGMT – board of directors, CEO, vice presidents etc. & persons w/o formal titles.
e. Principal owners – owners of > 10% of a firm’s voting interests. Includes known beneficial owners.
f. Related parties- affiliates, equity method investees, employee benefit trusts, principal owners, mgmt
or any party that can significantly influence a transaction.
B. FS to include disclosures of material transactions btwn related parties EXCEPT:
a. Compensation agreements, expense allowances, & other similar items in ordinary course of biz.
b. Transactions which are eliminated in the prep of consolidated/combined FS
C. Disclosures of material transactions shall include:
a. Nature of relationship(s)
b. Description of transaction(s), including those assigned zero or nominal amts.
c. Dollar amts of transactions for ea. IS period & effect of any change in method of establishing terms.
d. Amts due to/from related parties, including terms & manner of settlement.
*When a control relationship exists, disclose such relationship even though no transactions have occurred.
**Representations concerning related-party transactions shall not imply terms were equivalent to those resulting
in arm’s-length bargaining unless such stmt can be substantiated.

A. Subsequent events- those occurring AFTER the BS date but BEFORE FS are issued or avail to be issued.
a. Recognized Subsequent event – condition EXISTED at BS date & therefore is recognized in FS.
i. Ex: if warranty liability is included on Dec 2009 FS and in February 2010 you find out
there’s a recall on 2009 sold units, which increases warranty liability, then adjust warranty
liability in 2009 FS.
ii. Only recognize a loss for a recognized subsequent event in the current year FS.
1. Gains are NOT recognized until realized
b. Nonrecognized subsequent event – condition did NOT exist at BS but arose AFTER BS date.
Event is NOT recognized in FS.
 i. If event is such that FS would be misleading, then a footnote disclosure is required indicating
nature of event & estimate of FS effects.

SFAS 157 Fair Value Measurement

Definition: the price that would be rec’d to sell an asset or paid to transfer a liability in an orderly transaction
btwn market participants @ measurement date (at exit price).

3 techniques to measure FV: FV hierarchy

Level 1: Market approach (most observable) i.e. bank prime rate and default rate
- uses prices and relevant info from market transactions for identical or comparable assets/liabilities.
Level 2: Cost approach (less observable) i.e. Kelly blue book
- Relies on current replacement cost to replace asset w/a comparable asset, adjusted for
obsolescence.
Level 3: Income approach (Unobservable) i.e. financial forecast
- uses PV techniques to discount cash flows or earnings to PV amounts.

A change in valuation techniques used to measure FV should be reported as a change in accounting estimate
reported on a prospective basis.

FVM assumptions:
1. the asset/liability is sold/transferred in principal market, or if no principal market exists, the most
advantageous market.
a. Principal market
i. A market in which the greatest volume & level of activity occurs
b. Most advantageous market
i. Maximizes price rec’d for asset or minimizes amt paid to transfer liability.
c. BOTH market participants in the principal OR advantageous market should have following
characteristics:
1. Be independent of reporting entity (not related parties)
2. Be knowledgeable
3. Able to transact
4. Willing to transact (motivated, but not forced to transact)
2. the highest and best use of the asset which will maximize value of asset or group of assets
a. “In-use” asset
i. Asset provides maximum value by using it w/other assets as a group.
ii. Valuation based on price to sell asset assuming asset is used w/other assets as group.
b. “In-exchange” asset
i. Asset provides maximum value on a stand-alone basis.
ii. Valuation based on price that would be rec’d in a current transaction to sell asset stand-alone.

Note: Fair value option method does NOT apply to consolidations, pensions, share-based pmts, stock
options, OPEB, exit or disposal activities, leases, or financial instruments that are a component of equity.

Add’tl important FS disclosures required if FVO is elected: 2 methods for BS disclosure:

1. present the aggregate FV and non-fair-value amts in the same line w/amts measured at FV
parenthetically disclosed. OR
2. present two separate line items for FV and non-fair value carrying amts.
3. see add’tl disclosures on pg 138 (1-6)

If FVO is NOT elected, HTM securities are reported at amortized cost.

FV exit price – price that would be received to sell an asset in an orderly transaction btwn market participants
at the measurement date.

FV entry price – price paid to acquire the asset

Development stage enterprise acctg see pg 138, letter f

Changing Prices
See pg 12 of HO for constant $ acctg and Current cost acctg.
Constant dollar accounting is encouraged but NOT required by FASB.

Constant dollar (aka historical cost)

1. Monetary Assets & liabilities
a. Net them & calculate a purchasing power gain or loss
b. Purch power gain/loss = Mon. A Mon L. * (EOY CPI-BOY CPI/BOY CPI)
2. Nonmonetary items
a. Convert them
i. Conversion factor = current period CPI/Base year CPI
ii. Conversion factor * nonmonetary item

Current Cost
1. Monetary Assets & Liabilities
a. Do NOTHING!
2. Nonmonetary items
a. Restate to current costs & calculate holding gain/loss
b. PP&E and inventory
i. Use current cost & measure at lower of current cost or recoverable amt.
c. Depreciation expense & COGS
i. Use avg. current cost = (BOY + EOY)/2

Monetary vs. Nonmonetary

1. Monetary
a. Amts are fixed by statute or contract in terms of numbers of dollars
i. Ex: cash, A/R, N/R, A/P, N/P & B/P, loans to employees, allowance for doubtful accts, &
unamortized premium on B/P.
2. Nonmonetary
a. Ex: Inventory, PP&E, unearned service revenue, accum. depreciation, depreciation exp, COGS.
b. When the repayment of loan principal is adjusted by an index, the receivable/payable is
classified as a nonmonetary item.

Risks & uncertainties

Examples of concentrations that create vulnerabilities that are required to be disclosed:
1. market in which entity conducts its operations
2. available sources of supply of materials used in operations of an entity
3. volume of business transacted w/certain contributor
Bonds Module 11b pg 361
3 categories of Bonds:
1. Trading – holding bond for speculative reason. Short-term. Buy low & Sell high.
• Reported at FMV on BS
• Gains and losses are reported on income stmt under I of IDE
• Does NOT use amort schedule
2. HTM-Held to Maturity- you hold bonds until maturity.
• Reported at CV on BS
• Uses amort schedule
3. AFS – available for sale – neither trading or held to maturity.
• Reported at FMV on BS
• Gains and losses are reported in OCI on income stmt.
• Uses amortization schedule

If you select FVO, then you do NOT need to do amort schedule for AFS or HTM and instead just put FMV
under ‘income from continuing operations’.

Original cost of bonds is the purchase price minus accrued interest.

Bonds: Secured vs. unsecured

Secured: collateralized
Unsecured: debenture

Term bond: means principle matures @ end

Serial bond: principle matures in installments. i.e. annually

Callable bonds: bonds that are redeemable prior to maturity date.

Accounting for Bonds

1. Use FV option
a. Election to use FV s/b made on date entity initially recognizes item.
b. FV must be applied to entire instrument and you are stuck with FV option forever for
particular instrument.
c. Interest expense can be calc various ways, but company MUST disclose how it was
measured in NOTES to FS.
d. Any gain/loss in revaluing bond to FV s/b included on Income stmt for current period.
e. Must disclose FV of bond and principal obligation value.
2. Use effective interest method to amortize premium/discount if FV option is NOT elected. See pg 362
for example of effective interest method.

2 methods allowed for disclosing financial liabilities (bonds) on BS.

1. Disclose total FV & non-FV amts in the aggregate w/a parenthetical disclosure of amts measured at
FV.*
2. Present 2 separate line items to display FV & non-FV carrying amounts separately.*
*regardless of which method used, must disclose difference btwn aggregate FV & aggregate unpaid
principal balance.
Bonds issued at:
• Face amount
o Yield rate=Face rate
• Premium
o Yield rate < Face rate
• Discount
o Yield rate > Face rate

Issuer: Records bonds using gross method

Investor: Records bonds at either gross or net, but CPA exam usually does net method for Investor.

Bond Issuance Costs – costs incurred to issue bonds.

• i.e. printing, engraving, acctg, legal fees, promotion cost & commissions.
• Treated as deferred charge w/a debit balance & you put it w/”other assets” on BS. Only acceptable
option under GAAP.
o Amortize on a straight-line basis over life of bond. Report amort. Expense on income stmt under
“other expenses & losses”
 Dr. Amortization expense
 Cr. Bond issue costs

If bonds are dated prior to date they are issued, then the ‘term’ is reduced by time btwn the 2 dates.
Example: 5 yr bonds dated 4/01/09 are not issued until 8/31/09, then they are no longer considered
5yr/60 month bonds but rather 55 month bonds which is what you would amortize it over. Begin
amortization by issue date which would be 8/31/09.
If bonds are purchased/sold between interest payment dates, the purchaser/seller will also include accrued
interest through the purchased/sold date in the total cash paid/rec’d for bonds.

Bond sinking fund – a long-term asset acct used to pay off debt principal. Considered NON-current
• Do NOT net B/P & bond sinking fund together.
• Fund balance is increased when periodic additions are made to fund and when revenue is earned on
investments being held in fund.
o When cash in the fund is used to purchase investments, fund balance does not change because
you are trading cash for investments. They basically cancel each other out.
• Must disclose aggregate amts of maturities & sinking fund requirements for all long-term borrowings for
each of the 5 years following BS date.
o i.e. Maturities total by yr + sinking fund requirements total by yr = what needs to be disclosed
for each of the 5 yrs following BS date.

Market value of bond = PV of maturity value + PV of interest pmts.

PV of maturity value use: PV of $1 based on market rate
PV of Interest pmt use: PV of ordinary annuity of $1 based on market rate
Effective Interest Rate Method
• Interest to be recorded is calculated: effective interest rate*Net book value
o Effective interest rate is aka Market interest rate
o Net book value is aka carrying value
• 5 column headings in Amortization table
o Period
o Interest expense (effective interest rate*Net book value)
o Interest payable/pmt (Face amt*face rate)
o Amortization/discount PLUG (interest expense – interest pmt)
 Add to CV if bond was sold at discount
 Subtract from CV if bond was sold at premium.
 Increases each yr regardless if bond sold at discount or premium.
 At maturity date, it should equal amount of discount or premium.
o Carrying Value
 Increased in discount situations by adding amort. Expense
 Decreased in premium situations by subtracting amort expense
 It always approaches what we owe aka face value.

If interest expense/revenue is material, you MUST use effective interest method. If it’s immaterial, then you can
use straight line method. Further clarification: Straight-line method is an acceptable method for amortization of
discount or premium as long as the results obtained are NOT materially different from those produced by the
effective-interest method. If they are materially different, then you MUST use effective interest method.

CONVERTIBLE BONDS
2 approaches to account for bond conversions: choose whichever is more reliable.
1. Book value method (valuing the transaction at cost)
a. No gain or loss is recognized.
2. Market value method (of the stocks or bonds)

APIC= book value of bonds – par value of stock

When you issue regular bonds or convertible bonds:

• Both assets & liabilities increase.
When you convert the bonds into common stock:
• Liabilities decrease and S.H.E increases.
When you issue bonds w/detachable purchase warrants (most preferred bonds by people):
• Increases Assets, liabilities & S.H.E
Under book value method, there is no gain or loss.
Effective Interest method steps: see pg 362 in book for full example
Situation: $10,000 in bonds, semiannual interest @ 6% contract rate, maturing in 6 years, & market rate of 5%.
1. Find the market value (today’s value)by adding PV of maturity value and PV of interest pmts.
a. MV = $10,514
2. Is bond sold at discount or premium? Setup amortization schedule
a. Bond is being sold at premium
3. Do the journal entries for issuer at gross (includes premium/discount amt)
a. At time of issuance
i. Dr. Cash $10,514
Cr. B/P 10,000
Cr. Bonds premium 514
b. First int. pmt
i. Dr. Interest exp. 300
Cr. Cash 300
c. Premium amortization
i. Dr. Bond premium 37.15
Cr. Interest expense 37.15
4. Do the J/E for INVESTOR at net (no discount or premium account)
a. At time of acquisition
i. Dr. Bond investment 10,514
Cr. Cash 10,514
b. First int. pmt
i. Dr. Cash 300
Cr. Interest Rev. 300
c. Premium amortization
i. Dr. Interest revenue 37.15
Cr. Bond Investment 37.15

The annual interest income for a bond purchased at a premium would equal the cash interest received LESS the
premium amortization for the year.

The annual interest income for a bond purchased at a discount would equal the cash interest received PLUS the
discount amortization for the year.

Discount on B/P is contra account to B/P. Subtracted from B/P

Premium on B/P is an adjunct account to B/P. Added to B/P

WATCH THE DATES FOR COMPUTING INTEREST EXPENSE, INTEREST PAYABLE, BONDS
PAYABLE ETC.
Module 11c Present Value: Debt Restructure

Accounting for Troubled Debt

Impairments Restructurings
Affect only Creditor’s books Affect both Debtor’s & Creditor’s books

Settlements to the Debt Modifications of Terms

(paying off the debt)

Debtor Transfers an asset to Creditor Debtor gives Creditor stock

1) Settlement of Debt – Debt is settled by exchange of assets

a. Debtors
i. gain recognized = CV of debt – consideration given to extinguish debt
ii. If noncash asset is given,
1. Revalue noncash asset to FV and
2. Determine restructuring gain
b. Creditors
i. Assets received in full settlement are recorded at FV
1. ordinary loss = receivable – asset FV
2. Account for assets as if purchased for cash.
2) Modification of Terms – Debt continued w/a modification of terms
a. Debtors
i. Total future cash flows of restruct. debt (both principal & stated interest) vs. prerestruct. CV
1. If total future CF > CV, no adjustment is made to CV of debt
a. New effective interest rate must be computed, making:
i. PV of total future CF = CV of debt (principal & accrued interest)
2. If total future CF < CV,
a. Current debt is reduced to amt of future CF & gain is recognized.
i. No int exp is recognized in subsequent periods as loan was written
down below CV. All pmts (including interest) applied to principal amt.
b. Creditors
i. Measure impairment
1. based on PV of ex. Future CF (after restructuring) discounted @ loan’s effective
interest rate.
a. Effective int. rate based on orig. contractual rate, not rate in restructuring
agreement.
b. Interest revenue for subsequent year = orig. int. rate * new BV (PV of future
cash flows)
2. May also be measured at loan’s observable market price or FV of collateral if loan is
collateral dependent.
 a. collateral dependent- a loan with a repayment expected to be provided solely
by the underlying collateral.
3. If impairment < recorded investment in loan (incl. accrued int, net deferred loan
fees/costs, & unamortized premium or discount), recognize impairment by creating a
valuation allowance.
a. Dr. bad debt ex & Cr. Valuation allowance
Module 12 Deferred Taxes
1. Concepts
a. Temporary differences – create a deferred tax asset (pay tax now, prepaid tax) OR create a
deferred tax liability (wait to pay tax later, owe government money in future)
i. Book
1. Percent completion
2. Accrual basis
3. Warranty expense (matching)
4. Allowance
5. S/L
ii. Tax
1. Completed contract
2. Cash rent received in advance
3. Warranties paid (don’t want estimating)
4. Direct write off
5. MACRS
b. Permanent Differences – Items on IS that are never on tax return. Do not result in FTA or FDA.
i. Interest revenue on state and muni bonds (tax free)
ii. Life insurance premiums paid & proceeds from on key officers
iii. Payment of fines/penalties
iv. Income tax expense
v. 80% of DRD (dividends rec’d deduction)
vi. Equity income
vii. Percentage depletion from equity method
c. Income tax expense
i. Tax Payable = Tax Due – Estimated Pmts or TI
ii. Tax Liability = TI x Tax Rate
iii. Tax Expense = current + deferred…Plug typically [see JE below]
iv. Current portion expense (TI x Current Tax Rate)
v. Deferred tax expense (Tax Expense - Current) or (income tax expense – income tax payable)
1. Net DTA/DTL current
2. Net DTA/DTL non-current
3. LINKED to original account classification KEY
Dr. Tax Expense (Plug)
Dr. DTA (calculate for each item)
Cr. Tax Payable (TI * Tax Rate)
Cr. DTL (calculate for each item)
vi. DTL when tax value (lower taxable value) < book value, example: claimed more
depreciation on tax return than on books, tax relief is provided in ADVANCE of GAAP
1. DTL = FTA x future tax rate
vii. DTA when tax value (higher taxable value) > book value… tax relief is provided AFTER an
expense is deducted in GAAP
1. DTA = Future deductible amt x future tax rate
2. Example: long-term loss accrual in excess of deductible amt, accrual of warranty
expense, subscriptions received in advance.
2. Dividends Received Deduction (DRD)
a. Permanent and temporary difference for equity investments
i. 80% never taxed, permanent difference
ii. 20% dividend will be timing (temporary difference)
3. Equity method used for temp differences from income on long-term investments
a. Value of investment or amount of investment in affiliate
 i. = Begin. balance of investment + equity income in affiliate - Dividends rec’d
1. Equity income in affiliate = investment % * affiliate’s NI
a. Included in net income on IS
2. Dividends rec’d = investment % * dividends PAID by affiliate
b. Future Taxable amount computation (total TI – current TI)
i. = Dividends owed – 80%DRD – current taxable income
1. Dividends owed aka Equity income = investment % * affiliate’s NI
2. 80% DRD = 80% * Dividends owed
3. Total taxable income = Dividends owed – 80%DRD
a. = Dividends owed – (80%*Dividends owed)
4. Current taxable income = dividends rec’d * 20%
ii. = (investment %*subsidiary net income)–dividend rec’d
iii. Dividend rec’d = investment % * dividends paid by subsidiary
c. Expenses
i. Income tax expense = tax rate * total TI
ii. Current tax expense = tax rate * current TI
iii. Deferred Income tax expense = tax rate * FTA
d. What is put on tax return = Dividend received
e. Key items…
i. Compare Book Equity Income vs Dividend
ii. DTL is the temporary 20% difference * tax rate
4. Net Operating Loss (you elect)
a. Carry back 2 years, Carry forward 20 years
i. Carry back – file a return and receive a refund for a previous year
ii. Carry forward, reduce tax this year and in future years
Carryback
Dr. Tax refund receivable
Cr. Tax loss benefit (income tax expense)
Carryforward
Dr. Deferred Tax Asset
Cr. Tax loss benefit
5. Income Statement Disclosures
a. Allocate income tax expense to continuing operations, discontinued operations, prior period
adjustments (R/E)
b. Disclose current/deferred
6. DTA Valuation Account – if more likely than not ( >50%) not all deferred tax asset will be realized
(Basically DTA is reduced back into an income expense)
DTA Valuation Account:
Dr. Income Tax Expense
Cr. Allowance to reduce DTA to expected realizable value
a. B/S disclosure
i. DTA – Allowance = NET DTA
ii. Evaluated at end of each accounting period, REVERSE out if change
b. Positive Evidence
i. Income from temporary differences
ii. Taxable income in CBG years
iii. Tax planning strategies that would create taxable income
c. Negative Evidence
i. Cumulative losses
ii. Losses in early future years
iii. Unsettled circumstances where unfavorable resolution would adversely affect future
operating results
Per ASC Topic 740, income tax expense includes the following components:

1. Current tax expense or benefit

2. Deferred tax expense or benefit, exclusive of (5) below
3. Investment tax credits and grants
4. The benefits of operating loss carryforwards
5. Adjustments of a deferred tax liability or asset for enacted changes in tax laws or a change in the tax
status of an enterprise.

Since current tax expense/benefit depends on the tax rate, a change in the income tax rate for 2009 will affect
the amount of income tax assessed in 2009.

NOTES:
If future benefit is more likely than not (50% or greater) to be realized, then benefit can be recognized currently
as a deferred tax benefit.

To calculate expense from year 1 to year 2, find the difference btwn the beginning and ending account balances
and that will be tax expense for current year.

Income tax deferred is always the amt to adjust DTL from beg. bal to end. bal.

Temp. differences resulting from depreciation, are always classified as NONcurrent.

A high taxable income means more income taxes will have to be paid so the future impact is a DTL.

Future taxable amount = cumulative temp diff. * tax rate

Cumulative temp diff = prior year temp. diff + current yr temp. diff.

Dividends rec’d Deduction is allowed for dividends rec’d from domestic corporations in which ownership
percentage is less than 80% and equal to or greater than 20%.
Module 17 Derivative Instruments & Hedging Activities
An interest rate swap agreement involves the exchange of cash flows determined by different interest rates.
Fluctuations in interest rates after the agreement is entered into may result in the risk of exchanging a lower
interest rate for a higher interest rate. Financial instruments, including swaps, also bear credit risk or the risk
that a counterparty to the agreement will not perform as expected.

Only call (put) options are included in the definition of derivative financial instruments. Leases are excluded
because they require a payment equal to the value of the right to use the property. Equity securities and
adjustable rate loans are excluded because they require an initial net investment equivalent to the fair value

Fair value hedges will recognize gains and losses for the effective portion of the hedging instrument in current
earnings for each reporting period. Cash flow hedges will recognize gains and losses for the effective portion of
the hedging instrument in other comprehensive income.

ASC Topic 830 remains in effect for hedges of net investments in foreign operations. The hedged net
investment is viewed as a single asset. The provisions for recognizing the gain or loss on the hedged
asset/liability and the hedging instrument in ASC Topic 815 do not apply to the hedges of net investments in
foreign operations.

Derivative financial instruments include

1. Interest rate and foreign currency swaps
2. Currency swaps
3. Interest rate caps/floors/collars

For entities with concentrations of credit risk, the following disclosures are required per ASC 825-10-50 as
amended.
• Information about shared activity, region, or economic characteristics of the group.
• Amount of accounting loss that the entity would incur as a result of the concentrated party's failure to perform
according to the terms of the contract.
• Information regarding entity's policy of requiring collateral

Gains and losses of a fair value hedge will be recognized in current earnings. Therefore, answer (a) is correct.
The effective portion of a cash flow hedge is reported in other comprehensive income and the ineffective
portion is reported on a cumulative basis to reflect the lesser of the cumulative gain/loss on the derivative or the
cumulative gain/loss from the change in expected cash flows from the hedged instrument.

The four foreign currency hedges are an unrecognized firm commitment, an available-for-sale security, a
foreign currency denominated forecasted transaction, and a net investment in foreign operations. A hedge of a
recognized asset or liability is a fair value hedge or cash flow hedge, not a foreign currency hedge.

Under ASC Topic 815, derivative instruments contain

1. One or more underlyings and one or more notional amounts

2. No initial net investment or smaller net investment than required for contracts with an expected similar
response to market changes, and
3. Terms that require or permit net settlement, net settlement by means outside the contract, and delivery of an
asset that is substantially the same as net settlement.

The general criteria for a hedging instrument are that sufficient documentation must be provided at the
beginning of the process and the hedge must be “highly effective” throughout its life.
Two primary criteria must be met in order for a derivative instrument to qualify as a hedging instrument. First,
sufficient documentation must be provided at the beginning of the process to identify (1) the objective and
strategy of the hedge, (2) the hedging instrument and the hedged item, and (3) how the effectiveness of the
hedge will be assessed on an ongoing basis. Second, the hedge must be “highly effective” throughout its life.

An American call option provides the holder the right to acquire an underlying at an exercise or strike price,
anytime during the option term. The forward contract is an agreement between two parties to buy and sell a
specific quantity of a commodity, foreign currency, or financial instrument at an agreed-upon price, with
delivery and/or settlement at a designated future date. A swaption is an option on a swap that provides the
holder with the right to enter into a swap at a specified future date at specified terms or to extend or terminate
the life of an existing swap.
Module 19 Governmental Accounting pg. 809
Governmental accounting focuses on 2 types of accountability: test
Operational accountability
Demonstrated by government-wide financial statements
illustrate how effective and efficient the organization has been at using its resources, and the resources available
to meet its future obligations.
Fiscal accountability
Demonstrated by fund financial statements
illustrate organization’s compliance with laws and regulations affecting its spending activities.
Note: the integrated approach refers to the fact that gov’t fiinancial statements show operational and fiscal
accountability and the relationship between the two.
Requires a reconciliation btwn the government-wide financial statements and the fund financial statements.