CMALS1 - Session1 - Ver 2010

Wiley
CMAexcel Learning System

Exam Review 2015
Part 1: Financial Reporting, Planning,
Performance, and Control
Session 1
Wiley CMAexcel Learning System, Part 1: Financial Reporting, Planning, Performance, and Control.
Copyright © 2014, Institute of Management Accountants. Published by John Wiley & Sons, Inc.
Part 1: Financial Reporting,
Planning, Performance, and
Control
• Section A: External Financial Reporting Decisions
• Section B: Planning, Budgeting, and Forecasting
• Section C: Performance Management
• Section D: Cost Management
• Section E: Internal Controls
Part 1: Financial Reporting, Planning, Performance, and Control 2

Course Sessions
Session 1 Session 6
• Introduction to CMA Credential and • Section C, Topic 1
Wiley CMAexcel Learning System
• Section A, Topics 1 and 2 Session 7
• Section C, Topics 2 and 3
Session 2
• Exam Study Tips Session 8
• Section A, Topic 2, continued • Section D, Topics 1 and 2
• Section B, Topic 1
Session 9
Session 3 • Section D, Topic 2 (continued)
• Section B, Topics 2 and 5
Session 10
Session 4 • Section D, Topics 3, 4, and 5
• Section B, Topics 5 (continued), 4, and
6 Session 11
• Section E, Topics 1, 2, and 3
Session 5
• Section B, Topic 3 Session 12
• Test-Taking Tips
• Writing an Essay Question
Session 1
• Introduction to CMA Credential and Wiley CMAexcel
Learning System
• Section A, Topic 1: Financial Statements
• Section A, Topic 2: Recognition, Measurement, Valuation,
and Disclosure: Fair Value Standards and Measurement,
Cash and Cash Equivalents, Accounts and Notes Receivable,
Inventory
• Section A, Topic 2 (cont.): Recognition, Measurement,
Valuation, and Disclosure: Investments; Property, Plant, and
Equipment; Intangibles, Current Liabilities
• Exercise 1: Inventory Valuation, LIFO to FIFO
• Exercise 2: Investments

IMA and CMA Program Overview
• Benefits of IMA membership
• Content specifications for CMA exam
• Becoming a CMA candidate
• Taking an exam: registration, testing locations, testing windows
• Wiley CMAexcel Learning System features and overview
• How to access the online practice tests

Benefits of IMA Membership
• Face-to-face networking and professional development
opportunities—over 200 chapters around the world
• Subscription to IMA’s award-winning publication:
Strategic Finance
• Online learning courses—learn at your own pace
• Online library—let IMA's cybrarian brainstorm your research
requirements
• Opportunity to pursue CMA designation
• Access to IMA’s Ethics Center: tools, resources, and advice on
ethically sound practices in global business

Part 1 Exam Content Specifications
• Exam: 4 hours total
100 multiple-choice questions (3 hours to complete)
2 essay questions (1 hour to complete)
• Five sections:
Section A: External Financial Reporting Decisions (15%)
Section B: Planning, Budgeting, and Forecasting (30%)
Section C: Performance Management (20%)
Section D: Cost Management (20%)
Section E: Internal Controls (15%)

Steps to Become a CMA Candidate
• Become a member of the Institute of Management
Accountants (IMA)
• Pay the CMA Program Entrance Fee

Become a CMA Candidate Early!
By enrolling early you can:
• Receive the monthly CMA Connect online newsletter filled with
articles and tips.
• Gain access to the ICMA online candidate community.
• Have time to review and prepare all certification requirements and
ensure you receive key updates and communications from ICMA.
• Ensure you are eligible to sit for an exam part (only registered
candidates can sit for an exam).

How to Register for an Exam Part
After becoming an IMA member and entering the CMA program:
• Complete the online Exam Registration Form; select the exam(s) you
plan to take and pay the associated fee(s).
• Receive a registration acknowledgment with exam authorization
number, authorization window, and instructions on how to schedule
an exam.
• Schedule your exam appointment with Prometric.
See www.prometric.com/ICMA for a list of test sites.
• Exam(s) must be taken within the assigned authorization window.

WCMALS Exam Testing Windows
• Both exams (Parts 1 and 2):
January and February
May and June
September and October
• Scores are not available immediately, because the essay
response section of the exam must be corrected manually.

How to Use the Wiley CMAexcel Learning
System
• Read the self-study book.
• Use the participant guide to take notes.
• Use the Online Test Bank.
Multiple-choice questions.
Essay questions in Resources section.

WCMALS Book Content Features:
Helpful Symbols
• Key terms appear in boldface where they are defined in text.
• Key formulas highlighted with a “key” symbol.
• Study tips highlighted with “book” symbol.
• Knowledge checks highlighted with “lightbulb” symbol.
• Practice questions highlighted with “question mark” symbol.

Online Test Bank
• Integrate the online tests throughout your study program.
• Use the grade book function to track your progress over time.
• Check the Resources section for any additional study
documents.
• Practice tests are drawn from a large bank of questions. Be sure
to repeat the tests many times to ensure you have seen all
questions.
• Be sure to understand all concepts—don’t just memorize
questions and answers.

How to Access the Online Test Bank
• Use the Wiley CMAexcel Web site to access your online

practice test. Visit www.wileycma.com

Topic 1: Financial Statements
• Income Statement
• Statement of Changes in Shareholders’ Equity
• Balance Sheet
• Statement of Cash Flows
• Limitations of Financial Statements
• Financial Statement Footnotes and Disclosures
• Users of Financial Statements
Part 1, Section A, Topic 1: Financial Statements 16

Income Statement
• Commonly referred to as profit and loss (P&L)
statement
• Measures earnings of an entity’s operations over a
given time period (e.g., one year, quarter, one month)
• Content of statement used to measure profitability,
creditworthiness, and entity valuation
• Major components include: revenues, gains,
expenses, and losses
• Two formats for presenting income statement
Single-step format
Multiple-step format (more commonly used)

Other Comprehensive Income
• FASB Accounting Standards Codification (ASC) Topic 220, Comprehensive
Income, requires reporting of certain unrealized gains and losses outside of
income as components of other comprehensive income (OCI).
• Comprehensive income (CI) = Net income +/– Items of other
comprehensive income
• Current accounting standards require reporting of CI in one of two ways:
In a single continuous statement of CI that lists the components of net
income and total net income, the components of OCI and total OCI,
and the total of CI.
In a two-statement approach: an income statement, which must present
the components of net income and total net income, and a statement of
OCI—immediately following the income statement— which must
present the components of OCI, a total for OCI, and a total for CI.

Single-Step versus Multiple-Step
Single-Step format Multiple-Step format
• Begins with revenues and gains, • Disaggregates into operating and
and subtracts expenses and non-operating categories
losses • Revenues/expense = operating;
• No attempt to categorize Gains/losses = nonoperating
revenues, expenses, gains, • Presents various subcategories (e.g.,
losses or arrive at interim cost of goods sold, operating
subtotals expenses, nonoperating revenues,
• Simple and easy to prepare; gains, expense, losses)
however, not commonly used in • Presents various profitability
practice subtotals (e.g., gross profit, income
from operations, income before
taxes, etc.)
• More commonly used; more useful
for analysis
Single-Step Income Statement
Revenues
Net sales $2,734,620
Dividend revenue 90,620
• Subtracts total Rental revenue 67,077
expenses and losses Total revenues 2,892,317
from total revenues Expenses
and gains Cost of goods sold 1,823,938
Selling expenses 416,786
Administrative 322,709
Interest expense 115,975
Income tax expense 61,579
Total expenses 2,740,987
To Statement of Changes $151,330
Net income
in Shareholders’ Equity $1.89
Earnings/common share

Example: Multiple-Step Income Statement
Sales Revenue
Sales $2,808,835
Less: Sales discounts $22,302
Less: Sales returns and allowances 51,913 74,215
Net Sales revenue 2,734,620
Cost of Goods sold
Merchandise inventory, Jan 1, Y1 424,321
Net purchases (less freight-in) 1,850,153
Total merchandise available for sale 2,274,474
Less: Merchandise inventory, Dec. 31, Y1 450,536
Cost of goods sold $1,823,938
Gross profit on sales 910,682

Example: Multiple-Step Income
Statement (continued)
Operating Expenses
Selling expenses $416,786
Administrative expenses 322,709 739,495
Income from operations 171,187
Other Revenues and Gains
Dividend and rental revenue 157,697
328,884
Other Expenses and losses
Interest on bonds and notes 115,975
Income before income tax 212,909
Income tax 61,579
Net income for the year To Statement of Changes $151,330
Earnings per common share in Shareholders’ Equity $1.89

Additional Income Statement Items
• Presented at bottom of income statement as separate line after “Income from
Continuing Operations”; presented “net” of tax
• Discontinued operations (always presented first)
Component of an entity that has clearly distinguishable operations and
cash flows is disposed of or meets the FASB’s criteria as “held for sale”
• Extraordinary items (always presented after discontinued operations)
Material items that are both unusual in nature and infrequent in
occurrence
Items that are unusual but not infrequent in occurrence, or infrequent in
occurrence but not unusual, are not reported as extraordinary. Must meet
both the “unusual in nature” and the “infrequent in occurrence” criteria
to qualify

Presentation of Additional Income Statement Items
Net Sales
– Cost of goods sold
Gross profit on sales
• Located below income – Operating expenses
from continuing Operating income
operations +/– Other gains and losses
• Shown net of tax Earnings before tax
– Discontinued – Tax expenses
operations Income from continuing
operations
– Extraordinary items
+/– Discontinued operations
+/– Extraordinary items
+/– Changes in accounting principle
Net income

Question: Income Statement
In the preparation of a multiple-step income statement, all of the
following would be part of income from operations with the except
of:
a. gross profit
b. selling expenses
c. interest expense
d. cost of goods sold
Answer: c. Interest expense. In a multiple-step income

statement, interest expense is shown below income from
operations as part of “other expenses and losses”

Question: Income Statement Additional Items
Which of the following would best exemplify an item that would warrant
extraordinary classification in the income statement?
a. Loss incurred because of a strike by employees.

b. Material flood damage that occurred in an area known to be
susceptible to such disasters.
c. A loss incurred by a U.S. company whose property (located in South
America) was expropriated (taken over) by a dictator
unsympathetic to U.S. businesses.
d. Early extinguishment of material bond debt.
Answer: c. A loss incurred by a U.S. company whose property (located

in South America) was expropriated (taken over) by a dictator
unsympathetic to U.S. businesses.
Statement of Changes in Shareholders’ Equity
• When balance sheet is issued, FASB requires disclosure of changes

in each separate shareholders’ equity account (commonly presented
in the form of a statement).
• Includes several components: capital stock (common and preferred at
par value), additional paid-in capital, retained earnings, accumulated
other comprehensive income.
• Format of financial information includes in statement:
• Beginning balance for the period
• Additions
• Deletions
• Ending balance for the period

Example: Statement of Changes in
Shareholders’ Equity
Common Additional
Retained
Stock, Paid-In Total
Earnings
$1Par Capital
Balance, Jan. 1, Y1 $24,680 $345,520 $90,251 $460,451
Net income To Statement of From Income 151,330 151.330
Cash dividends paid Changes in Statement (33,330) (33,330)
Common stock Shareholders’
issued Equity1,000 14,800 15,800
Balance, Dec. 31,

$25,680 $360,320 $208,251 $594,251
Y1
To Balance Sheet
Balance Sheet
• “Balance” expressed by accounting equation: Assets = Liabilities +
Shareholders’ Equity
• “Snapshot” of a company’s assets and the claims on those assets at a
specific point in time.
• Helps financial statement users evaluate an entity’s capital structure
and assess liquidity, solvency, financial flexibility, and operating
capability.
• Divided into three sections: assets, liabilities, and shareholders’
equity
• Assets and liabilities are further categorized as “current” or
“long-term” (long-term assets and liabilities appearing below the
respective “current” subtotals)
• Assets presented in order of liquidity; liabilities listed in the
order in which they come due
• Sometimes referred to as “Statement of Financial Position”
Major Components and Classifications of the
Balance Sheet
Assets • Current assets (cash, A/R, inventory)
• Long-term investments
• Property, plant, and equipment (PP&E)
• Intangible assets
• Other assets
Liabilities • Current liabilities (A/P, interest payable, current portion
of long-term debt)
• Long-term liabilities (bonds, mortgages)
• Other liabilities
Shareholders, • Capital stock
equity • Treasury stock (contra equity)
• Additional paid-in capital
• Accumulated other comprehensive income
• Retained earnings
Format of Balance Sheet
Asset Liabilities & Equity
Current assets: Current liabilities:
Cash, cash equivalents $24,628 A/P $175,321
Receivables 552,249 Current portion of L/T debt 36,000
Other Receivables 18,941 Other current liabilities 147,500
Note Receivable 80,532 Total current liabilities 358,821
Inventory 252,567 L/T debt 117,343
Prepaid insurance 7,500 Total liabilities 476,164
Total current assets 936,417 Shareholders’ equity:
Fixed assets: Common stock, par 25,680
PP&E APIC 360,320
209,330
Less: Account, depreciation Retained earnings 208,251
(75,332)
Net fixed assets Total shareholders’ equity 594,251
133,998
Total assets Total liabilities and equity $1,070,415
$1,070,415
From Statement of Changes in Shareholders’ Equity
Question: Balance Sheet (#1)
Celio Products, Ltd. was incorporated on January 1 of Year 1 with $500,000 from the
issuance of common stock and borrowed funds of $75,000. During the first year of
operations, Celio had net income of $25,000 and paid a $2,000 cash dividend. As of
December 31 Year 1, liabilities had increased to $94,000. In Celio’s December 31
Year 1 balance sheet, how much are total assets?
Answer: This question tests knowledge of the accounting equation and how that
equation is an expression of the “balancing” of assets, liabilities, and shareholders’
equity in the balance sheet:
Assets = Liabilities + Shareholders’ Equity
Liabilities at December 31 = $94,000

Shareholders’ Equity at December 31 = Common Stock ($500,000) + *Retained
earnings ($23,000) = $523,000
Assets = Liabilities + Shareholders’ equity, or $94,000 + $523,000 = $617,000
*Note: Retained earnings = Beginning retained earnings + Net income – Dividends =

Ending retained earning, or $0 + $25,000 – $2,000 = $23,000
Question: Balance Sheet (#2)
Jared Corporation has the following asset accounts: inventory,

accounts receivable, short-term investments, prepaid expenses, and
cash. List these accounts in the order that they should be presented on
a properly presented balance sheet.
Answer: Cash, short-term investments, accounts receivable, inventory,

prepaid expenses.

Statement of Cash Flows Overview
• Reports the effects of cash inflow and outflows and net change in cash from
operating, investing, and financing activities (always presented in that order)
Operating activities: related to normal business operations; the effect
Investing activities:
of changes derived
in operating primarily
assets from changes in long-term
and liabilities
assets
Financing activities: derived primarily from changes in long-term
• Measuresliability
cashand equity
flows overaccounts
a period of time (e.g., a year, a quarter, one month,
etc.)
• Helps financial statement users assess whether an entity requires external
financing or is generating cash flows, meeting obligations, and paying
dividends
• Uses the income statement and comparative balance sheet information in its
preparation
• Requires certain footnote disclosures usually at the bottom of the statement
(e.g., significant non-cash investing and financing activities)

Condensed Format of Statement of Cash Flows
Cash affects liquidity, operating capability, and financial flexibility.
FASB Accounting Standards Codification (ASC) Topic 230 prescribes
the following basic format for the Statement of
Cash Flows:
+/– Cash provided (used) by operating activities
+/– Cash provided (used) by investing activities
+/– Cash provided (used) by financing activities
= Net cash inflow (outflow) during the year
Net cash inflow/outflow can be used to calculate end of year cash

balance
+ Cash balance at beginning of year
+/ – Net cash inflow (outflow) during the year
= Cash balance (end of year)
Indirect versus Direct Method
Indirect Direct
• Reconciles net income to cash flow from • Cash flow from operating activities calculated
operating activities on the face of the by converting revenues and expenses from
statement by: accrual basis to cash basis and reporting the
• Adding back non-cash expenses, (e.g., cash effects directly on the face of the statement
depreciation) (e.g., reported as “cash collected from
• Adding back losses, subtracting gains customers” or “cash paid to suppliers”)
on non-operating activities (e.g., gain • If used, FASB requires reconciliation of net
on sale of PP&E) income to cash flows from operating activities
• Adjusting for changes in operating be disclosed in a separate schedule
assets and liabilities to “flush out” • Preferred FASB method, but not commonly
accrual effects (e.g., change in A/R, used
change in A/P) • Focus on CMA Examination is indirect, not
• No reconciliation approach for investing and direct method
financing activities
*Note: The difference in the two methods arises in the presentation of cash flow from operating
activities; however, both methods derive the same total cash flow from operating activities.
Statement of Cash Flows: Non-Cash Items
• Net income includes non-cash items that impact current income, but are the result of prior-
period costs incurred and do not affect current period cash flows. Net income, therefore,
requires adjustments for those items in deriving operating cash flows. Examples include:
Depreciation expense (on PP&E); amortization expense (on intangible assets)
Amortization of deferred costs (e.g., bond issue costs)
Amortization of premium or discount on bonds payable
• Gains/losses on investing and financing activities also require income adjustments in order
to derive operating cash flows; gains/losses part of net income, but sales proceeds from
these transactions presented in investing and/or financing activities as applicable.
• Net income includes certain accrual-related items that have no cash impact in the current
period; these also require adjustments to net income in deriving operating cash flows.
Examples include:
Accrued sales (uncollected)
Accrued expenses (unpaid)

Cash Flow Statement: Indirect Method
Start with Net Income
+ Noncash expenses (e.g., depreciation, amortization)
– Gains from investing and financing activities
+ Losses from investing and financing activities
+ Decreases in current assets
– Increases in current assets
+ Increases in current liabilities
– Decreases in current liabilities
+ Amortization of discounts on bonds
– Amortization of premiums on bonds
Operating cash flow

Example: Full Cash Flow Statement Presentation
Operating Net income $151,330
Activities Adjustments to convert net income to a cash basis: 48,784
Net cash provided by operating activities 200,114
Additions to PP&E (123,730)
Investing Proceeds from sale of store 3,980
Activities Net cash used in investing activities (119,750)
Increase in notes payable 1,100
Increase in APIC 14,800
Financing From Statement of
Decease in L/T debt (50,500)
Changes in
Activities Increase in common stock Shareholders’ Equity 1,000
Cash dividends paid ($33,330)
Net cash used in financing activities ($66,930)
Net increase in cash and cash equivalents 13,434
Cash and cash equivalents at beginning of year To 11,194
Balance
Cash and cash equivalents at end of year $24,628
Sheet

Question: Classification of Cash Flow
Transactions (#1)
According to ASC Topic 230, Statement of Cash Flows, all of the

following should be classified under the operating activities
section of the Statement of Cash Flows except:
a. Purchase of land and building.

b. Decrease in prepaid insurance.
c. Decrease in inventory.
d. Depreciation expense.
Answer: a. Purchase of land and building.

Question: Classification of Cash Flow
Transactions (#2)
ASC Topic 230, Statement of Cash Flows, classifies cash receipts
and cash payments by operating, investing, and financing
activities. Which one of the following transactions should be
classified as a financing activity?
a. Purchase of treasury stock.

b. Payment of interest on a mortgage note.
c. Purchase of equipment.
d. Sale of trademarks.
Answer: a. Purchase of treasury stock.

Question: SOCF—Operating Activities
At the end of the current fiscal year, XM Company reported net income of $40,000. In
addition, the XM experienced the following changes in account balances from the
beginning to the end of the fiscal year:
• Increase in accounts receivable: $3,000
• Decrease in inventory: $4,500
• Increase in Prepaid expenses: $1,500
• Increase in accounts payable: $7,500
• Decrease in long-term debt: $12,000
What amount should be reported as cash flow from operating activities on XM’s
statement of cash flows for the current fiscal year?
a. $47,500
b. $49,500
c. $32,500
d. $34,500
Answer: a. $47,500
Question: SOCF—Investing Activities
Bernstein & Power Corporation (B&P) had the following activities in Year 1:
• Acquired 2,000 shares of stock in Weis & Salute, Inc. for $26,000. B&P
intends to hold the stock as a long-term investment.
• Sold an investment in Manganelli Motors for $35,000, when the carrying value
was $33,000, thereby recognizing a gain on the sale of $2,000.
• Acquired a $50,000, four-year certificate of deposit from a bank.
• Collected dividends on $1,200 on stock investments.
In B&P’s Year 1 statement of cash flows, net cash flows from investing activities
should be:
a. $37,200
b. $38,050
c. $39,800
d. $41,000
Answer: d. $41,000
Question: SOCF—Financing Activities
During the current year, Grandoff Corporation had the following activities related
to its financial operations:
• Principal repayment on debt: $425,000
• Dividend payment on common stock: $50,000
• Purchase of fixed assets: $30,000
• Proceeds from sale of treasury stock $20,000
How much should Grandoff report as net cash used in financing activities in its
current year statement of cash flows?
a. $495,000
b. $475,000
c. $455,000
d. $425,000
Answer: c. $455,000

Limitations of Financial Statements
• Historical cost
• Different accounting methods
• Omit non-objective items of value
• Use of estimates and judgments
• Off-balance-sheet information
• Non-cash transactions

Financial Statement Footnotes and Disclosures
• Used when parenthetical explanations would not suffice to fully
describe certain events or situations that are important and/or material
enough to users in making decisions about a particular entity.
• Common disclosures revolve around:
Contingencies
Contractual situations
Accounting policies
Subsequent events

Users of Financial Statements and Their Needs
• Internal users
• Need financial statements for internal decision-making; information used to
plan and control operations on short- and long-term basis
• Users include: executives, managers, management accountants, employees
who have vested interests in company (i.e., through stock option plans, etc.)
• External users
• Rely on an entity’s published financial statements in making investment
decisions
• Creditors and investors comprise two main sources of capital for publicly-
traded entities, so primary focus is on the needs of these two groups
 Creditors—interested in entity’s ability to repay debt and comply with
debt covenants
 Investors—need to assess investment return and make decisions about
buying, holding, or selling an entity’s securities
• Other external users include: stock exchanges, unions, analysts, regulatory
agencies
Part 1: Financial Statements 47

Section A, Topic 2: Recognition, Measurement,
Valuation, and Disclosure
• Fair Value Standards and Measurement; Cash and Cash

Equivalents; Accounts and Notes Receivable; Inventory
• Investments, Property, Plant, and Equipment;
Intangibles; Current Liabilities
Part 2, Section A, Topic 2: Recognition, Measurement, Valuation, and Disclosure 48

Topic 2: Recognition, Measurement, Valuation,
and Disclosure
• Fair Value Standards and Measurement

• Cash and Cash Equivalents
• Accounts and Notes Receivable
• Inventory

Fair Value Standards
• A fair value measurement is the value of exchange in

an arm's-length transaction.
• Defined in FASB ASC Topic No. 820, Fair Value
Measurement (as formerly addressed in FASB
Statement No. 157).
• If multiple values exist, then the most advantageous
value is used.
• Assume the best use of the asset, regardless of the
current use.

Determining Fair Value
• Market approach
• Income approach
• Cost approach

Fair Value Hierarchy
• Level 1: Highest priority to quoted prices in active

markets.
• Level 2: If no active market exists, prices can be inferred
from values of related assets.
• Level 3: Fair value determined from unobservable inputs.

Cash and Cash Equivalents
Cash
• Readily available for payment of current liabilities
• No contractual restrictions or limits
Cash equivalents
• Marketable securities
• Maturity < 3 months
Restricted cash
• Cash that cannot be used
• Held in separate bank account

Top Inc. has a revolving line of credit with their local bank
requiring a compensating balance and full repayment each
quarter. Which of the following is the proper method of reporting
the compensating balance?
a. Report as a separate item under noncurrent assets

b. Report as a separate item under cash and cash equivalents
c. Include as part of restricted cash if immaterial and as a current
asset if material
d. Include as part of cash and cash equivalents if immaterial and as a
current asset if material
Answer: b.
A compensating balance is a minimum balance requirement
designed to offset part of the risk of lending. Depending on the
agreement, compensating balances may or may not be
restricted.
Accounts Receivable (A/R)
• Claims against customer, debtors
• Classifications
Balance sheet
• Current—due within one year or the operating cycle,
whichever is longer
• Noncurrent—due after one year or the operating cycle
Source
• Trade—accounts receivable, some notes receivable
• Nontrade—interest receivable, dividends receivable, etc.

Trade and Cash Discounts
• Trade discounts
Discounts provided off list prices to arrive at net selling price; also known as
“volume or quantity discounts”; no special accounting treatment.
• Cash discounts
Incentives for early or prompt payment.
Expressed in shorthand, such as 2/10, net 30—means a 2% discount will be
granted if payment is made within 10 days; if not, full payment is due within 30
days.
Discounts not taken represent an opportunity cost.
Two methods for accounting for cash discounts:
 Gross method: records each receivable and sale at gross amount; sales/cash
discounts are recognized in accounting entries if the payment is received
within the deadline date for the discount (reported as contra revenue
account).
 Net method: records each receivable and sale at net amount; unused
discounts, or discounts forgone, are recognized and reported in a “sales
discounts forfeited” account, which is separate revenue account.
A vendor offers cash discount terms of 1/15, n/30. What would be the
opportunity cost of not taking this discount?
a. 1.01%
b. 16.67%
c. 24.58%
d. 37.25%
Answer: c.
Discount % 365
Effective Cost of Discount = 
(100 – Discount %) (Net Period – Discount Period)
0.01 365
=  = 0.101 24.3333 = 24.58%
0.99 (30 - 15)

According to FASB ASC Topic 835, Interest (formerly
APB Opinion No. 21), how should long-term
receivables and trade receivables be recorded?
Answer:
• Long-term receivables recorded at
present value
• Trade receivables recorded at maturity
value
Net realizable value (NRV) for trade
receivables

Valuation and Uncollectible Accounts
• Direct write-off method
Recognize bad debts when they occur
• Debit bad debt expense, credit A/R
Not GAAP (cash basis accounting)
• Allowance method = GAAP

Estimate bad debts in advance
• Dr. bad debt expense, Cr. allowance for
uncollectible accounts
• Balance sheet or income statement approaches

Allowance method, balance sheet approach:
• Percentage of outstanding A/R method
Determine uncollectible A/R, adjust allowance and record bad debt
expense
Measuring uncollectible accounts
• Single percentage applied to outstanding A/R
• $150,000  3% = $4,500 ending balance in allowance
• If beginning allowance = $2,000, then expense = $2,500
• Aging of A/R method
Percentage uncollectible varies with age of account

Balance Sheet Approach: Aging of A/R Method
Dec. 31 Over 120
Under 60 Days 61–90 Days 91–120 Days
Customer Balance Days
East Inc. $ 54,880 $44,800 $10,080
West Inc. 210,000 179,200 $30,800
North Inc. 41,440 33,600 $7,840
Total $306,320 $257,600 $10,080 $7,840 $30,800
Uncollectible Required Balance in

Age Amount Estimate (%) Allowance
Under 60 days old $257,600 5% $12,880
60–90 days old 10,080 15% 1,512
91–120 days old 7,840 20% 1,568
Over 120 days 30,800 25% 7,700
Year-end balance of allowance for doubtful accounts $23,660

Allowance method, income statement approach:
• Percentage of sales method (matching principle)
% of Bad Debt  Total Sales = Bad Debt Expense
2.5%  $200,000 = $5,000
• Percentage of net credit sales method

% of Bad Debt  Net Credit Sales = Bad Debt Expense
3%  $175,000 = $5,250

Write-Offs and Collection of Write-Off Methods
Direct Write-Off Method
• Write-off • Collection
Dr. bad debt expense Dr. cash
Cr. A/R Cr. uncollectible accounts
recovered
Allowance Method
• Write-off • Collection
Dr. allowance for doubtful Dr. A/R, Cr. allowance to
accounts reinstate, and then
Cr. A/R Dr. cash, Cr. A/R

Which of the following are true of the income statement
approach to calculating the allowance for uncollectibles?
I. Based on value of sales

II. Based on value of accounts receivable
III. Calculates allowance for uncollectible accounts, bad debt
expense is the adjustment to the allowance
IV. Calculates bad-debt expense and increases the allowance by
that amount
a. I and III
b. I and IV
c. II and III
d. II and IV
Answer: b
Answer:
Unlike the balance sheet approaches, which emphasize

the amount of net receivable shown on the balance
sheet, the income statement approaches emphasize the
bad debt expense shown on the income statement.
Therefore, they disregard any balance that may be

shown in the allowance for bad debt account.

Notes Receivable
Promissory note:
• Written, unconditional promise to pay a specified
amount on a specified date
• Negotiable, fairly liquid
• Interest stated or implied
• Short-term notes recorded at face value
• Long-term notes recorded at present value

Notes Receivable
Notes issued at face value

• Stated interest rate = market interest rate
• No discount or premium
• Three-year note, $100,000, 8% stated, 8% market interest
Face value of the note $100,000
Present value of the principal
($100,000 PV of 13,8%) = ($100,000 0.79383) $79,383
 
Present value of the interest
($8,000 PV-OA of 1 3,8%) = ($8,000 2.57710) $20,617
 
Present value of the note $100,000
Difference $0

Notes Receivable
Zero-interest-bearing notes
• Implicit interest rate/discount
• Discount amortized over life of note
Face Value – Present Value = Discount
$100,000 – $79,383 = $20,617
• Entry to record note receivable:
Dr. notes receivable $100,000

Cr. discount on notes receivable $20,617
Cr. cash $79,383

Zero-Interest-Bearing Notes: Amortizing a
Discount on Notes Receivable
Cash Interest Discount Note Carrying
Received Revenue Amortized Amount
Issue date $79,383
Year 1 end $0 $6,351 $6,351 85,734
Year 2 end 0 6,859 6,859 92,593
Year 3 end 0 7,407 7,407 100,000
$0 $20,617 $20,617
Dr. discount on notes receivable $6,351
Cr. interest revenue $6,351

Computing Discount on Interest-Bearing Notes
• Three-year note, $100,000, 8% stated interest, 9% market
rate
Face value of the note $100,000

Present value of the principal
($100,000 PV of 13,9%) = ($100,000 0.77218)
 $77,218
Present value of the interest
($8,000  PV-OA of 13,9%) = ($8,000 2.53130) $20,250
Present value of the note $97,468
Difference $2,532

Notes Receivable
Interest-bearing notes
• Entry to record:
Dr. notes receivable $100,000

Cr. discount on notes receivable $2,532
Cr. cash $97,468

Amortizing Interest-Bearing Notes
Cash Interest Discount Note Carrying
Received Revenue Amortized Amount
Issue date $97,468
Year 1 end $8,000 $8,772 $772 98,240
Year 2 end 8,000 8,842 842 99,082
Year 3 end 8,000 8,912 918 100,000
$24,000 $26,532 $2,532
Dr. cash $8,000
Dr. discount on notes receivable $772
Cr. interest revenue $8,772

Why dispose of accounts/notes receivable, and
how can it be done?
Answer:
Why
• Immediate cash
• Short-term liquidity without borrowing or selling stock
How
• Secured borrowing uses receivables as collateral for a loan
• Factoring, securitization, or sale with or without recourse

Disposition of Accounts and Notes Receivable
Factoring:
• Factors buy receivables and assume collection risks
• Credit approval
Securitization:
• Bundle similar receivables into investment fund
• Sellers service receivables
Sale:
• Without recourse—purchaser assumes risk of bad debts
(factoring)
• With recourse—seller retains risk of bad debts

Disposition of Accounts and Notes Receivable
Sale with recourse: Financial components approach
• $100,000 sale of receivables
• 2% finance charge
• 3% collateral for bad debt Loss on Sale Calculation
Carrying
Net Proceeds Calculation (book)
value $100,000
Cash received
Net
$100,000 – (2% + 3%) $95,000
proceeds 94,000
Due from factor 3,000 $98,000
Loss on
Less: Allowance for sale of
doubtful accounts (4,000) receivables (6,000)
Net proceeds $94,000

A/R Disclosure Requirements: Partial Balance Sheet
Current Assets
Cash and equivalents $1,383,985
Accounts receivable* $6,643,478
Less: Allowance for doubtful accounts 370,167
6,273,311
Notes receivable—trade* 2,973,930 9,247,241
Total current assets 10,631,226
Noncurrent Receivables
Notes receivable from officers and key employees 278,307
Claims receivable (settlement collected over five years) 432,900
*Note on accounts and notes receivable; In July Y1, the firm refinanced part of its
indebtedness evidenced by an 8% note payable. The note is secured by substantially
all the A/R and is payable on demand.

What are the different types of inventory
accounts?
Answer:
• Goods held for sale

Finished goods or merchandise inventory
• Goods created during the production process
Work-in-process inventory
• Materials used in production
Raw materials inventory

Perpetual Inventory Systems
Continuous updating of inventory balances on a
computer-based system
• Cost of goods sold measured at sale

• Periodic physical counts for comparison still
necessary
Beginning Inventory + Purchases – Cost of

Goods Sold = Ending Inventory

Under a perpetual system, what accounts are
debited and credited for:
• Cost of goods (recognized at time of sale)?

• Inventory purchases?
• Purchase discounts?
• Freight-in?
• Purchase returns?

Activity Debit Credit
Cost of goods Cost of
Inventory
(recognized at time of sale) goods sold
Inventory purchases Inventory A/P or cash
Purchase discounts A/P Inventory
Freight-in Inventory A/P or cash
Purchase returns A/P Inventory

Periodic Inventory Systems
Use a “Purchases” account to record inventory

purchases
• Cost of goods sold measured at end of period

• A physical count is required to determine
ending inventory
Beginning Inventory + Purchases Account –

Ending Inventory (from physical count) =
Cost of Goods Sold

What is the total cost of goods available for sale and the cost
of goods sold for a firm with $350,000 in beginning
inventory and $400,000 in ending inventory for a period that
also had a cost of goods acquired or produced of $670,000?
Beginning inventory, Jan. 1 $350,000

Cost of goods acquired or produced during the year 670,000
Total cost of goods available for sale 1,020,000
Ending inventory, Dec. 31 (400,000)
Cost of goods sold during the year $620,000

Inventory Valuation—Goods
What goods to include?
• Goods held on consignment—exclude (no

title)
• Goods in transit—include if purchased FOB
shipping point; exclude if FOB destination
• Sale agreements (high returns, installment
sales)—include if estimable
Sales with buyback agreements

Inventory Valuation—Costs
What goods to include?

• Manufacturing overhead, acquisition (freight-in), and
production costs—include; non-production admin.,
selling expenses—exclude
i.e., include product costs, exclude period costs
• Minus purchase (cash) discounts
• Minus purchase returns and allowances

Which one of the following would not be considered a
carrying cost associated with inventory?
a. Insurance costs
b. Shipping costs
c. Cost of obsolescence
d. Storage costs
Answer: b
Although freight-in costs are included in inventory costs, freight-

out or shipping costs are not included in inventory costs because
they are period costs. Inventory carrying costs are costs associated
with needing to hold or store inventory. Shipping costs would be
incurred even if inventory was not held for any length of time.

Describe the four inventory cost flow
assumptions:
Answer:
• Specific identification
Tracks the actual cost of each specific item sold to determine cost
of goods sold
• Average cost
Uses an average cost to price both COGS and ending inventory
• First-in, first-out (FIFO)
The oldest costs are assigned to COGS, and the most recent to
ending inventory
• Last-in, first-out (LIFO)
The most recent costs are assigned to COGS, and the oldest to
ending inventory

Perpetual FIFO
First-In, First-Out Inventory Cost Flow Assumption (Perpetual)
Cost of goods sold (1,300 units):
July 15 1,000 units @ $40 $40,000
July 28 300 units @ $60 18,000
Total $58,000
Ending inventory (1,200 units):
Beginning Inventory + Purchases – COGS = Ending Inventory
$40,000 + $88,000 – $58,000 = $70,000*
*700 units @ $60 = $42,000

500 units @ $56 = 28,000
$70,000

Perpetual LIFO
Last-In, First-Out Inventory Cost Flow Assumption (Perpetual)
Cost of goods sold (1,300 units):
July 15 1,000 units @ $60 $60,000
July 28 300 units @ $56 16,800
Total $76,800
Ending inventory (1,200 units):
Beginning Inventory + Purchases – COGS = Ending Inventory
$40,000 + $88,000 – $76,800 = $51,200*
*1,000 units @ $40 = $40,000

200 units @ $56 = 11,200
$51,200

Adapted from ICMA question, used with permission.
Date Activity Units (u)

Jensen Company uses a May 1 Balance 100 u @ $ 10/u
perpetual inventory system. May 9 Purchase 200 u @ $ 10/u
The purchases and sales made
May 16 Sale 190 u
during the month of May are
shown on the right. May 21 Purchase 150 u @ $ 12/u
May 29 Sale 120 u
If Jensen Company uses the first-in, first-out (FIFO) method of

inventory valuation, the May 31 inventory would be:
a. $1,460 Answer: d. The FIFO method makes the accounting assumption
b. $1,493 that goods purchased earlier are used or sold before goods
c. $1,562 purchased later. May 1 inventory value: 100 $10 = $1,000.  May
d. $1,680 9: $1,000 + (200 $10) = $3,000. May  16: $3,000 – (190
$10) = $1,100.May 21: $1,100 + (150 $12) = $2,900. May 
29: $2,900 – 110 $10) – (10 $12)  = $1,680.

Date Activity Units (u)

Jensen Company uses a May 1 Balance 100 u @ $ 10/u
perpetual inventory system. May 9 Purchase 200 u @ $ 10/u
The purchases and sales made
May 16 Sale 190 u
during the month of May are
shown on the right. May 21 Purchase 150 u @ $ 12/u
May 29 Sale 120 u
If Jensen Company uses the last-in, first-out (LIFO) method of

inventory valuation, the May 31 inventory would be:
a. $1,460 Answer: a. Under the FIFO method, the cost of the last goods bought
b. $1,493 are assigned to cost of goods sold and the ending inventory. May
c. $1,562 include the cost of the earliest purchases. May 1 inventory value: 100
d. $1,680  May 9: $1,000 + (200 $10) = $3,000.
$10 = $1,000.  May 16:
$3,000 – (190 $10) = $1,100. May 21: $1,100 + (150 $12) = 
$2,900. May 29: $2,900 – (120 $12) = $1,460.

When inventory prices are rising (inflation), how will using
perpetual FIFO or LIFO affect cost of goods available for sale,
cost of goods sold, inventory valuation, and income levels?
Answer:
• LIFO results in lower income
• FIFO results in higher inventory valuation
Effects of Inventory Cost Assumptions
Cost Flow Cost of Goods Cost of Ending

Assumption Available for Sale Goods Sold Inventory
FIFO, Perpetual $128,000 $58,000 $70,000
LIFO, Perpetual 128,000 76,800 51,200

LIFO Liquidation

Ending Inventory at Price Index

Wright Hardware adopted Dec. 31
End of Year Prices at Dec. 31
the dollar-value LIFO
Y1 $240,000 100
method of inventory
valuation at Dec. 31, Y1. Y2 275,000 110
Inventory balances and Y3 300,000 120
price indices are shown in
the table.
Wright Hardware’s ending inventory as of Dec. 31, Y2,

computed by the dollar-value LIFO method was:
a. $240,000
b. $250,000
c. $251,000
d. $275,000 Answer: b $275,000/1.1 = $250,000
e. $300,000

Ending Inventory at Price Index

Wright Hardware adopted Dec. 31
End of Year Prices at Dec. 31
the dollar-value LIFO
Y1 $240,000 100
method of inventory
valuation at Dec. 31, Y1. Y2 275,000 110
Inventory balances and Y3 300,000 120
price indices are shown in
the table.
Wright Hardware’s ending inventory as of Dec. 31, Y3,

computed by the dollar-value LIFO method would be:
a. $240,000
b. $250,000
c. $251,000
d. $300,000 Answer: b $300,000/1.2 = $250,000
e. $275,000

LIFO Reserve
LIFO
LIFO

Inventory Errors
• Two main types of inventory errors
Misstated ending inventory
• When amounts excluded from ending inventory (understatement):
• Cost of goods sold is overstated
• Net income is understated
• Balance sheet assets understated
• Impacts key financial statement ratio metrics
• When additional amounts included in ending inventory (overstatement)
• Cost of goods sold is understated
• Net income is overstated
• Balance sheet assets overstated
• Impact key financial ratio metrics
Misstated purchases and inventory
• When amounts for purchases excluded from both purchases and inventory (purchases
and inventory understated):
• Balance sheet assets and liabilities (e.g., A/P) understated
• No impact on net income (purchases and inventory omitted result in no impact on
cost of goods sold)
• Impacts key financial statement ratio metrics
Lower of Cost or Market (LCM)
• When market values decline, inventory is written down and

cost of goods sold increased
• Market = replacement cost, subject to a
Ceiling (net realizable value)
Floor (net realizable value less normal profit)
• LCM applied to either individual items, product categories,
or the whole inventory

Data for Sportway Co.’s inventory:
Per Unit Skis Ski Boots Parkas

Historical Cost $190.00 $106.00 $53.00
Selling Price 217.00 145.00 73.75
Cost to Distribute 19.00 8.00 2.50
Current Replacement Cost 203.00 105.00 51.00
Normal Profit Margin 32.00 29.00 21.25
(1) The ceiling and floor of 2) “Cost” in LCM (3) “Market” in

the market value that should for ski boots is: LCM for parkas is:
be used in the LCM
comparison of skis are: a. $105 a. $51.00
b. $106 b. $53.00
a. $217 and $198 c. $108 c. $71.25
b. $217 and $186 d. $137 d. $73.75
c. $198 and $166
d. $185 and $166


Historical Cost $190.00 $106.00 $53.00
Selling Price 217.00 145.00 73.75
(1) The ceiling and floor of the market value that should be
used in the LCM comparison of skis are:
a. $217 and $198

b. $217 and $185
c. $198 and $166 Answer: c. The ceiling is the net realizable value, or
d. $185 and $166 price less costs required to complete the sale: $ 217–
$19 = $198. The floor is NRV less the normal profit
margin: $198 – $32 = $166.


Historical Cost $190.00 $106.00 $53.00
Selling Price 217.00 145.00 73.75
(2) “Cost” in LCM for ski boots is:
a. $105
b. $106
c. $108
d. $137 Answer: b. Historical cost is used as the “cost”
in LCM: $106


Historical Cost $190.00 $106.00 $53.00
Selling Price 217.00 145.00 73.75
(3) “Market” in LCM for parkas is:
a. $51.00
b. $53.00
c. $71.25
d. $73.75 Answer: a. Market is the normal replacement
cost in LCM: $51

Estimating Inventory
• Estimates of inventory may be required when:
• Impractical to get precise inventory count (e.g., preparing quarterly
financial statements and not practical to perform physical count)
• Auditors need an estimate in connection with a periodic review of the
financial statements
• Inventory destroyed in some catastrophe like a fire
• Methods for estimating inventory

• Gross profit method
Involves estimating cost of goods sold through the use of
historical gross profit percentage, which can then be used to
derive an estimate of ending inventory.
• Retail inventory method
Involves estimating cost of inventory using retail prices by
applying a computed “cost-to-retail” ratio to the retail/sales
prices
Session 1 Exercise 1
Inventory Valuation, LIFO to FIFO
Valuation, and Disclosure: Fair Value Standards and
Measurement, Cash and Cash Equivalents, Accounts
and Notes Receivable, Inventory

Topic 2: Recognition, Measurement, Valuation,
and Disclosure (cont.)
• Investments
• Property, Plant, and Equipment
• Intangibles
• Current Liabilities

Debt Securities
• Debt securities have many forms: loans to other
entities, federal and municipal securities,
commercial paper, corporate notes and bonds,
convertible debt.
• Debt securities are categorized into three different
“buckets” for financial reporting purposes:
Held-to-maturity securities—report at amortized cost
Trading securities—report at fair value
Available-for-sale securities—report at fair value
• Recognition of unrealized gains and/or losses is
dependent upon security’s categorization

Accounting for Unrealized Holding Gains and Losses
Unrealized
Security Holding Gains and Balance Sheet Valuation
Losses
Held-to-maturity Not recognized Amortized cost (acquisition cost
+/– premium or discount)
Trading Recognized in net Fair value
income
Recognized in other Fair value
Available-for-sale
comprehensive
income and
accumulated other
comprehensive
income

MV Co. had no investments until it purchased the
following debt securities in June, Year 1:
As of May 31, Year 2 As of May 31, Year 3

Amortized cost Fair Value
(AC) (FV) AC FV
Cleary bonds $164,526 $168,300 $152,565 $147,600
Beau bonds 204,964 205,200 193,800 204,500
More bonds 305,785 285,200 289,130 291,400
Total $675,275 $658,700 $635,495 $643,500

If the securities are properly classified as “available-for-sale securities”
under FASB ASC Topic 320, the unrealized gain or loss as of May 31, Year
3 would be:
a. Recognized as a separate component of shareholder. Equity within a year- end

credit balance of $8,005 in the Unrealized Holding Gain/Loss account.
b. Recognized as a $24,580 unrealized holding loss on the income statement.
c. Recognized as a separate component of shareholders equity with a Year- end
debit balance of $8,005 in the Unrealized Holding Gain/Loss account.
d. Not recognized
Answer: a.
FASB ASC Topic 320, Investments—Debt and Equity Securities (as formerly addressed in FASB
Statement No. 115), prescribes (fair) market value accounting for all securities except held-to
maturity debt instruments. Available-for-sale securities are valued at fair value and unrealized
holding gains and losses are recognized as other comprehensive income (and as a separate
component of stockholders’ equity). Fair value of $643,500 less amortized cost of $635,495 =
$8,005. This amount is an unrealized holding gain and is therefore recognized as noted in the
correct answer.
P Part 1, Section A, Topic 2: Recognition, Measurement, Valuation, and Disclosure 108

If the securities are properly classified as “held-to-maturity securities”
under FASB ASC Topic 320, the unrealized gain or loss as of May 31, Year
3 would be:
a. Recognized as a separate component of shareholder. Equity within a year- and

credit balance of $8,005 in the Unrealized Holding Gain/Loss account.
b. Recognized as a $24,580 unrealized holding loss on the income statement.
c. Recognized as a separate component of shareholders equity with a Year- end
debit balance of $8,005 in the Unrealized Holding Gain/Loss account
d. Not recognized
Answer: d.
FASB ASC Topic 320 prescribes (fair) market value accounting for all securities
except held-to-maturity debt instruments. Held-to-maturity securities are valued at
amortized cost (acquisition cost plus/minus unamortized premium or discount); so
no unrealized holding gains or losses are recognized.

Equity Securities
Valuation
Ownership Interest
method?
Less than
Passive Fair Value
20%
20%–50% Significant Equity method
Greater than Consolidated

Controlling
50% financial statements

Less than 20% Ownership
Fair value method

• Available-for-sale
Unrealized gains (losses) on portfolio—reported in
other comprehensive income (OCI)
Realized gains (losses)—reported in net income and
reclassification adjustment made to OCI
• Trading
Unrealized gains (losses) on portfolio—reported in net
income

Between 20% and 50% Ownership
• “Significant influence”
• Equity method
• Carrying value is adjusted based on the proportionate share of
ownership
Increase carrying value—net income
Decrease carrying value—net loss, dividends, and
amortization/depreciation of excess investment over book
value of net assets acquired that relates to
amortizable/depreciable assets
• Intercompany transactions are eliminated to the extent of
investor ownership

Between 20% and 50% Ownership
Calculation of Investment Carrying Amount
Acquisition cost, 1/1/Year 1 (Y1) $20,000,000
Plus: Share of Y1 income before

$21,380,000
dividends and amortization 1,380,000
Less: (630,000)
Dividends received 6/30
and 12/31
Amortization of undervalued
(100,000) (730,000)
depreciable assets
Carrying amount, 12/31/Y1 $20,650,000

Greater than 50% Ownership
• Controlling interest; parent and subsidiary relationship
• Consolidated financial statements—“single entity”
• Purchase accounting is required:
Record acquired firm at fair market value (FMV) of
consideration given (or at EMV of net assets acquired if
more reliable)
Good—will initially computed as the total fair value of
consideration given up to acquire the Subsidiary + Fair
value of any non-controlling interest + Fair value of any
previously held equity interests in the subsidiary – Fair
value of net assets acquired
No amortization of goodwill allowed

K Co. has debt and equity investments in B Inc. with carrying values of $100,000
and $200,000, respectively. B recently included K’s debt in a filing for bankrupty.
The net realizable value of the equity securities is $60,000. B is expected to regain
much of its value after the bankruptcy. Which of the following would be the best
way to record these investments?
I. Debt: Record unrealized loss of $100,000, do not write down

II. Debt: Write down realized loss of $100,000, include in net income
III. Equity: Record unrealized loss of $140,000, do not write down
IV. Equity: Write down realized loss of $140,000 in net income
a. I and III
b. II and IV
c. II and III
d. I and IV

Answer: c
The most common impairments are bankruptcies or other

loss of liquidity on the part of the investee.
Because it is likely that the debt funds will not be collected,

they are permanently written down. However, even though
the NRV for the equity is lower than the equity
investment’s carrying amount, the likelihood of the value
of this investment regaining value is high, so these losses
should remain unrealized, at least in the short term.

Data on impairment of an "available-for-sale" bond:
• Debt security purchased for $500,000 in Year 1

• Unrealized loss of $60,000 recorded in Year 3
• Impairment loss of $75,000 recorded in Year 4
What is the impairment entry in year 4?
Answer:
Dr. loss on impairment $75,000
Dr. fair value adjustment $60,000

Cr. available for sale securities $75,000
Cr. Unrealized holding loss $60,000

Property, Plant, and Equipment (PP&E)
• Held for use in operations; not for resale
• Life span greater than one year; depreciable (except land)
• Tangible in nature
• Recorded at cash (or equivalent) price plus costs incurred to
prepare for intended use (transportation, installation)

According to FASB ASC Topic 835, Interest (formerly addressed in FASB
Statement No. 34), interest should be capitalized for assets that are:
a. In use or ready for their intended use in the earnings activities of

the firm
b. Being constructed as discreet projects for the firm’s own use
c. Acquired with externally restricted gifts or grants
d. Routinely produced and are used in the earning activities of the
enterprise
Answer: b.
According to GAAP, capitalizing interest costs arising during construction
is appropriate for self-constructed assets

Nonmonetary Exchanges of PP&E
• Does exchange have commercial substance?
Yes, if cash flows will change as a result
• If exchange has commercial substance

Record asset acquired at FMV of assets given up (use FMV of
asset received if more reliable)
Gains or losses are recognized
• If exchange does not have commercial substance

Record asset acquired at book value of asset given up
Losses recognized; gains not reported unless “boot” (e.g., cash) was
received in the exchange—then a portion of the gain would be
recognized

When can costs subsequent to acquisition of
PP&E be capitalized?
Answer:
Capitalized if they increase the economic benefit of the
asset:
• Extends asset life
• Increases productivity by either:
Increasing quantity of output
Increasing product quality

Improvements and Replacements
Approaches for capitalizing cost of improving or

replacing assets:
• Substitution method
• Capitalizing new cost
• Charge accumulated depreciation

Using the substitution method, find the accounting entries for a
replacement heating system:
• Old heating system cost $90,000; accumulated depreciation of $81,000; scrap
value of $600
• New heating system costs $70,000 plus $5,000 in installation costs
New heating system $75,000
Accumulated depreciation $81,000

Loss on disposal ($9,000 – $600) $8,400
Old heating system $90,000
Cash ($75,000 – $600) $74,400

Depreciation
Allocates cost over the life of an asset

Examples use the following asset: $1,000,000 machine with a
$150,000 salvage value
To calculate depreciation, determine:
• Depreciable base (e.g., $850,000)
• Useful life (e.g., estimated at 70,000 units or 7 years)
• Method of depreciation:
Activity method
Straight-line method
Accelerated methods: sum–of–the–years’ digits,
declining balance
Activity Method of Depreciation
• Allocates cost in accordance with asset use
• Estimate total expected usage (units produced, hours run, miles
driven)
• Depreciation expense will vary based on the usage of the asset each
accounting period
Depreciation Charge per Unit = Depreciable Base / Estimated
Lifetime Usage
= $850,000 / 70,000 units
= $12.14 (rounded) per unit
Depreciation Expense = Actual Usage Depreciation charge
per unit
= 9,500 units $12.14(rounded per unit)
= $115,330
Straight-Line Method of Depreciation
• Time-based: provides a consistent amount of depreciation expense
• Depreciation expense will remain the same for each full year of asset
use
Depreciation charge = Depreciable Base
= $850,000 Estimated Service Life

7 = $121,428.57

Determine the depreciation expense for an asset with
an acquisition cost of $150,000 and $10,000 of inbound
freight incurred
The asset will have an estimated life of eight years

and has no salvage value
Answer: The asset will have depreciation expense of

($150,000 + $10,000)/8 years = $20,000 for each of the eight years

Sum-of-the-Years’ Digits Method of Depreciation
Formulaic Approach
Depreciation charge = Years of Useful Life Remaining
Sum of All Years of Useful Life
Sum of All Years of Useful Lifen=(n + 1) , n = All Years of Useful Life
2
Intuitive Approach Year Reverse Order Depreciation

For a 5-year asset, the sum of the
Year 1 5 5/15 = 33%
years’ digits is:
1 + 2 + 3 + 4 + 5 = 15 Year 2 4 4/15 = 27%
List the years, reverse the orders of Year 3 3 3/15 = 20%

the digits, divide by sum of the Year 4 2 2/15 = 13%
years’ digits:
Year 5 1 1/15 = 17%

Sum-of-the-Years’ Digits Method Example
Depreciable Years of Life Depreciation Depreciation End of year

Year
base remaining Fraction expense book value
0 $850,000 $1,000,000
1 $850,000 7 7/28 $212,500 $787,500
2 $850,000 6 6/28 $182,143 $605,357
3 $850,000 5 5/28 $151,786 $453,571
4 $850,000 4 4/28 $121,429 $332,142
5 $850,000 3 3/28 $91,071 $241,071
6 $850,000 2 2/28 $60,714 $180,357
7 $850,000 1 1/28 $30,357 $150,000

150% Declining Balance Method of Depreciation
 = 21.43% / year
150% declining balance and 7-yr. depreciation = 14.29% 150%
Book Value at Depreciation Book Value at End of

Year Rate
Beginning of Year Charge Year
1 $1,000,000 21.43% $214,300 $785,700

2 785,700 21.43% 168,376 617,324
3 617,324 21.43% 132,293 485,031
4 485,031 21.43% 103,942 381,089
5 381,089 21.43% 81,667 299,422
6 299,422 21.43% 64,166 235,256
7 235,256 21.43% 50,415 184,841
8 $184,841 21.43% $34,841 $150,000

Sum-of-the-Years’ Digits Method of Depreciation
Double declining balance & 7year depreciation = 14.29%  200% = 28.57% /year
Book Value at Depreciation Book Value at

Year Rate
Beginning of Year Charge End of Year
1 $1,000,000 28.57% $285,700 $714,300
2 714,000 28.57% 204,076 510,224

3 510,224 28.57% 145,771 364,453
4 364,453 28.57% 104,124 260,329
5 260,329 28.57% 74,376 185,953
6 185,953 28.57% *35,953 *150,000
* = Depreciation of $53,127 reduced to arrive at salvage value

Kruse Company acquired a company airplane on June 3, Year 1. The
following information relates to this purchase:
Airplane cost $123,750

Estimated useful life in years 6
Estimated useful life
in operating hours 15,000
Estimated residual value $11,250
Actual hours flown in the year ended May 31.
Year 1 1,984
Year 2 2,800
Year 3 1,690
Year 4 1,824

The depreciation expense for the scale year ended May 31, Year
4, using the activity method for all years would be:
a. $13,680
b. $14,110
c. $15,048
d. $18,750
Answer: a. Computations are provided as follows:

1) First find Depreciable Base = Airplane Cost – Estimated Residual (or Salvage)
Value
= $123,750 – $11,250
= $112,500
2) Find Depreciation Charge per Unit = Depreciable Base/Lifetime Usage
= $112,500/15,000 hours
= $7.50 per hour

3) Last compute Depreciation Expense = Actual Usage Depreciation Charge per
Unit

= 1,824 hours $7.50 per hour
= $13,680

The depreciation expense for the scale year ended May 31, Year 2,
using the double-declining-balance method for all years would be:
a. $17,188
b. $25,000
c. $27,500
d. $37,500
Answer. c. When using the double-declining balance, net book value is used as
depreciable base, which disregards salvage value. Depreciation on a straight-line base
equates to 1/6 (since the asset has a 6-year estimated useful life), or 16.666 percent per
year. Double this is 33.333 percent. In the first fiscal year, depreciation expense would
be computed as: $123,750 33.333 percent = $41,250. The  depreciable base coming
into the second fiscal year is, therefore, $82,500; depreciation expense for fiscal year 2
is then computed as follows: $82,500 33.333 percent = $27,500.


Impact of Straight-line versus Double-Declining Balance
Depreciation
• Straight-line:
Depreciation expense: $121,429 (rounded)
Income tax expense: since income is reduced by $121,429, the tax benefit

(or reduction of income tax expense) is: $121,429 40% = $48,572
(rounded)
Net income: in light of the above tax effect, net income would decrease
by $121,429 – $48,572, or $72,857.
Assets: depreciation expense of $121,429 increases accumulated
depreciation by the same amount, and, therefore, decreases assets by
$121,429
• Double-declining balance:
Depreciation expense: $285,700 (rounded)
Income tax expense: since income is reduced by $285,700, the tax
benefit (or reduction of income tax expense) is: $285,700 40% =
$114,280 (rounded)
Net income: in light of the above tax effect, net income would
decrease by $285,700 – $114,280, or $171,420
Assets: depreciation expense of $285,700 increses accumulated
depreciation by the same amount, and, therefore, decreases assets by
$285,700
How is PP&E valued?
When is its carrying value impaired?
How is impairment measured?
Answers:
• Fixed assets are valued at historical cost less
accumulated depreciation
• When the value of PP&E cannot be recovered
through expected future cash flows to be derived from
the asset, the asset is deemed to be impaired
• Impaired assets should be written down to their fair
value

Disposition of PP&E
Assets can be sold, exchanged, involuntarily

converted, or abandoned
• General rule—depreciate until the date of disposal;

then remove all accounts and recognize a gain or
loss
• Involuntary conversions—floods, fires, etc.; gain
could occur if insurance proceeds are greater than
the book value

PP&E Financial Statement Presentation
and Disclosure Requirements
• Basis of valuation (i.e., historical cost)

• Depreciation expense for the period
• Balances of major classes of assets
• Accumulated depreciation
• General description of methods used to
calculate depreciation for major asset
classes

Intangibles
Lack physical substance and are not financial instruments
Categories: Valuation:
• Marketing • Purchased
• Customer On balance sheet at cost
• Artistic (indefinite life) or amortized
cost (finite life)
• Contract
• Internally created
• Technological
• Goodwill R&D costs expensed
Some costs (e.g., legal and
registration fees) incurred to obtain
intangibles, capitalized

Question
In a business combination that is accounted for as a purchase, the

acquiring company records the net assets of the acquired
company at their:
a. Replacement cost
b. Fair market value
c. Book value
d. Original cost
Answer: b.
Under the purchase method, the acquiring company allocates the
acquisition purchase price to all tangible and identifiable
intangible assets acquired, and liabilities assumed, based on their
fair values.
Goodwill
• Not amortized
• Tested for impairment
Potential impairment exists when fair value (FV) of
reporting unit < its carrying value (including existing
goodwill); implied FV of goodwill as of impairment
assessment date needs to be determined
• Measurement of impairment loos

Loss = Excess of implied fair value of goodwill over
its carrying value.
Implied fair value of goodwill = Fair value of reporting
unit – Fair value of reporting unit’s identifiable net
assets (excluding existing goodwill)

To comply with FASB ASC Topic 730, Research and
Development (formerly addressed in FASB Statement No. 2),
expenditures for R&D:
a. Must be capitalized in the period incurred and amortized over
the estimated life of the asset
b. May be expensed or capitalized in the period incurred
c. May be either capitalized or expensed depending on the
amount and useful life of the expected cash receipts
d. Must be expensed in the period incurred, unless the costs
have alternate future uses, in which case, that portion of the
costs may be capitalized.
Answer: d.
All R&D costs are expensed as incurred, unless they have future alternate
uses outside of R&D. In these cases, that portion of the costs can be
capitalized and depreciated/amortized.

Current Liabilities
• Liabilities
“Probable future sacrifices of economic benefits
arising from present obligations”
• Current liabilities
“Obligations whose liquidation is reasonably
expected to require use of existing ... Current
assets or the creation of other current liabilities”

Types of Current Liabilities
• General: Accounts payable, current maturities of long-term

debt, dividends payable, returnable deposits and advances,
unearned or deferred revenues, taxes payable
• Employee-related: Payroll taxes, compensated absences,
bonus obligations
• Estimated: Warranties, premiums, and coupons

Notes Payable
Written agreements to pay a certain sum on a certain date:

• Current: valued at maturity value
• Noncurrent: valued at present value
Interest-bearing notes payable:
• Borrower repays maturity value plus stated interest
Zero-interest-bearing notes payable:

• Borrower repays maturity value, but initially receives
discounted amount
• Discount is the implicit interest recognized

Zero-Interest-Bearing Notes Payable
• $1,050,000 note, present value $1,000,000
Accounting entry:
Dr. Cash $1,000,000
Dr. discount on notes payable $50,000

Cr. notes payable $1,050,000
Balance Sheet presentation of discount:

Current liabilities
Notes payable $1,050,000

Less: Discount on notes payable 50,000
$1,000,000

Current Maturities of Long-Term Debt
• Represent the portion of long-term liabilities, such as

mortgages, capital leases, that will become payable within
the next year or company’s operating cycle, whichever is
longer.
• Portions of long-term debt that will use current assets in their
settlement.
• Exclude short-term debt obligations expected to be
refinanced if intent and ability to refinance is demonstrated.

Other Common General Current
Liabilities
• Dividends payable—distributions of earnings committed to
be paid, but not year paid, to shareholders
• Returnable deposits and advances—cash received as a
deposit or advance, which are expected to be repaid
• Unearned or deferred revenues—prepayments received for
future goods or services to be delivered
• Taxes payable – amounts due to various government
agencies assessed on sales and income for example

Employee-Related Liabilities
• Payroll deductions
Most common – payroll taxes
• Amounts withheld from employee paychecks
• Employer additional taxes
• Compensated absences
Accrue as long as services rendered, rights accumulate or
vest, payment is probable, amount can be estimated
Vacation days accrued; sick days may or may not need
be accrued depending on whether or not they vest
• Bonus obligations
Recognized when earned

Estimated Liabilities
• Warranties, premiums, coupons
Record estimated cost in period that product is
sold
Employs “matching principle”
• Warranties accounted for in two basic ways:
Cash basis
Accrual basis (which includes expense warranty
approach, and sales warranty approach)

Perfect Co. manufactures the Perfect Juice Extractor, which is to be
sold with a full, two-year consumer warranty. Perfect has no previous
experience manufacturing juice extractor machines or selling
products to customers. Perfect is unable to reasonably estimate the
amount of future warranty costs related to the machines, and should:
a. Set up an estimated warranty liability

b. Use the cash basis method to account for warranty costs
c. Use the accrual method to account for warranty costs
d. Use an estimated warranty expense account

Answer: b.
The cash basis is required when it is improbable a

liability has been incurred or if the liability is not
reasonably estimable
No warranty liability is recognized in the period of sale

and warranty costs are charged during the period in
which the warranty is exercised

Contingencies
Contingencies arise when an organization has the possibility of
losses (loss contingency) or the right to receive assets or reduce a
liability (gain contingency) based on the future outcome of an
existing situation or event.
Accounting for loss contingencies:
• Probably and amount estimable = accrue/record and disclose
the loss
• Reasonably possible = disclosure only
• Remote = do not accrue/record or disclose
Accounting for gain contingencies:
• In employing conservatism, gain contingencies are not
recorded; however, disclose in footnotes if gain is highly
likely and material
• Examples: disputed tax refunds, pending litigation that is
expected to be favorable (where organization is plaintiff)
• Remote = do not accrue/record or disclose
According to FASB ASC Topic 450, Contingencies (formerly
addressed in FASB Statement No. 5), a loss contingency should be
accrued on a company’s records only if it is:
a. Reasonably possible that a liability has been incurred and the amount
of the loss is known
b. Probable that a liability has been incurred and the amount of the loss
is unknown
c. Probable that a liability has been incurred and the amount of the loss
can be reasonably estimated
d. Reasonably possible that a liability has been incurred and the amount
of the loss can be reasonably estimated
Answer: ASC Topic 450 requires that loss contingencies be accrued and recorded
when the loss is probable and can be estimated. Loss contingencies that are
reasonably possible, but not probable, require disclosure only. And, loss contingencies
that are remote can be disregarded (not accrual/recording or disclosure is necessary).

What are the accounting entries for a loss
contingency? What note disclosure is required?
Answer:
• Debit a loss or expense and credit a contingent liability
• Debit a loss or expense and credit a contra asset

Bad debt expense, threatened asset expropriation
• Disclose
Nature of contingency
Estimate of loss, or range of loss, or statement that loss
cannot be estimated

Valuing Current Liabilities
• Usually recorded at maturity or face value

• Present value and the imputing of interest as addressed
in FASB ASC Topic 835, Interest (formerly APB
Opinion No. 21), is ignored
Difference between present value and future value
usually not material

Presentation and Disclosure Requirements for Current Liabilities
(in thousands) Y2 Y1
Current liabilities
Short-term Borrowings $4 $18
• Valued at maturity A/P 1,930 1,269
amount Accrued payroll 1,331 809
• Ordered by Accrued liabilities 2,884 2,075
Liquidation Deferred service Revenues 1,081 678
preference Income taxes Payable 1,031 483
Maturity data Note payable 60 102
Total current liabilities $8,321 $5,434

Session 1 Exercise 2
Investments
Valuation, and Disclosure: Investments, Property,
Plant, and Equipment, Intangibles, Current
Liabilities

Session 1 Wrap-Up
Content covered in Session 1
• Introduction to CMA Credential and Wiley CMAexcel Learning System
• Section A, Topic 1: Financial Statements
• Section A, Topic 2: Recognition, Measurement, Valuation, and Disclosure: Fair Value
Standards and Measurement, Cash and Cash Equivalents, Accounts and Notes Receivable,
Inventory
• Exercise 1: Inventory Valuation, LIFO to FIFO
• Section A, Topic 2 (cont.): Recognition, Measurement, Valuation, and Disclosure:
Investments; Property, Plant, and Equipment; Intangibles; Current Liabilities
• Exercise 2: Investments
Content to be covered in Session 2
• CMA Exam Study Tips
• Section A, Topic 2 (cont.): Recognition, Measurement, Valuation, and Disclosure: Long-term
Liabilities and Bonds Payable, Early Extinguishment of Debt, Equity and Earnings Per Share
(EPS), Revenue Recognition
• Section A, Topic 2 (cont.): Recognition, Measurement, Valuation, and Disclosure:
Comprehensive Income, Leases, Pensions, Deferred Income Taxes, Stock Options,
Discontinued Operations, Extraordinary Items, Derivatives, Segment Reporting, IFRS versus
GAAP
• Section B, Topic 1: Strategic Planning
• Exercise: Amortizing a Premium or Discount


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Wiley

CMAexcel Learning System

Part 1: Financial Reporting, Planning, Performance, and Control 2

Part 1: Financial Reporting, Planning, Performance, and Control 4

Part 1: Financial Reporting, Planning, Performance, and Control 5

Part 1: Financial Reporting, Planning, Performance, and Control 6

Part 1: Financial Reporting, Planning, Performance, and Control 7

• Pay the CMA Program Entrance Fee

Part 1: Financial Reporting, Planning, Performance, and Control 8

Part 1: Financial Reporting, Planning, Performance, and Control 9

Part 1: Financial Reporting, Planning, Performance, and Control 10

Part 1: Financial Reporting, Planning, Performance, and Control 11

Part 1: Financial Reporting, Planning, Performance, and Control 12

• Key formulas highlighted with a “key” symbol.

• Study tips highlighted with “book” symbol.

• Knowledge checks highlighted with “lightbulb” symbol.

• Practice questions highlighted with “question mark” symbol.

Part 1: Financial Reporting, Planning, Performance, and Control 13

Part 1: Financial Reporting, Planning, Performance, and Control 14

• Use the Wiley CMAexcel Web site to access your online

Part 1: Financial Reporting, Planning, Performance, and Control 15

Part 1, Section A, Topic 1: Financial Statements 16

Part 1, Section A, Topic 1: Financial Statements 17

Part 1, Section A, Topic 1: Financial Statements 18

Part 1, Section A, Topic 1: Financial Statements 20

Part 1, Section A, Topic 1: Financial Statements 21

Part 1, Section A, Topic 1: Financial Statements 22

Part 1, Section A, Topic 1: Financial Statements 23

Part 1, Section A, Topic 1: Financial Statements 24

Answer: c. Interest expense. In a multiple-step income

Part 1, Section A, Topic 1: Financial Statements 25

a. Loss incurred because of a strike by employees.

d. Early extinguishment of material bond debt.

Answer: c. A loss incurred by a U.S. company whose property (located

• When balance sheet is issued, FASB requires disclosure of changes

Part 1, Section A, Topic 1: Financial Statements 27

Balance, Dec. 31,

Assets = Liabilities + Shareholders’ Equity

Liabilities at December 31 = $94,000

Assets = Liabilities + Shareholders’ equity, or $94,000 + $523,000 = $617,000

*Note: Retained earnings = Beginning retained earnings + Net income – Dividends =

Jared Corporation has the following asset accounts: inventory,

Answer: Cash, short-term investments, accounts receivable, inventory,

Part 1, Section A, Topic 1: Financial Statements 33

Part 1, Section A, Topic 1: Financial Statements 34

Net cash inflow/outflow can be used to calculate end of year cash

Part 1, Section A, Topic 1: Financial Statements 37

Part 1, Section A, Topic 1: Financial Statements 38

Part 1, Section A, Topic 1: Financial Statements 39

According to ASC Topic 230, Statement of Cash Flows, all of the

a. Purchase of land and building.

Answer: a. Purchase of land and building.

Part 1, Section A, Topic 1: Financial Statements 40

a. Purchase of treasury stock.

Answer: a. Purchase of treasury stock.

Part 1, Section A, Topic 1: Financial Statements 44

Part 1, Section A, Topic 1: Financial Statements 45

Part 1, Section A, Topic 1: Financial Statements 46

Part 1: Financial Statements 47

• Fair Value Standards and Measurement; Cash and Cash

Part 2, Section A, Topic 2: Recognition, Measurement, Valuation, and Disclosure 48

• Fair Value Standards and Measurement

Part 1, Section A, Topic 2: Recognition, Measurement, Valuation, and Disclosure 49