Professional Documents
Culture Documents
PREPARED BY
sameh Y. El lithy, CMA, CIA.
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Investors 4
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This financial statement provides information about the nature and amounts
of investments
in enterprise resources, obligations to creditors, and the owners’ equity in net
resources.
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higher debt are relatively more risky because they will need more of their assets to
meet
their fixed obligations (interest and principal payments).
Liquidity and solvency affect a company’s financial flexibility, which measures the
“ability of an enterprise to take effective actions to alter the amounts and timing of
cash
flows so it can respond to unexpected needs and opportunities.”3 For example, a
company
may become so loaded with debt—so financially inflexible—that it has little or no
sources of cash to finance expansion or to pay off maturing debt. A company with a
high
degree of financial flexibility is better able to survive bad times, to recover from
unexpected
setbacks, and to take advantage of profitable and unexpected investment
opportunities.
Generally, the greater an enterprise’s financial flexibility, the lower its risk of
failure.
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value but
that a company cannot record objectively. For example, the knowledge and skill
of Intel employees in developing new computer chips are arguably the company’s
most significant assets. However, because Intel cannot reliably measure the
value of its employees and other intangible assets (such as customer base,
research superiority, and reputation), it does not recognize these items in the
balance sheet. Similarly, many liabilities are reported in an “off-balance-sheet”
manner, if at all.
The bankruptcy of Enron, the seventh-largest U.S. company at the time, highlights
the omission of important items in the balance sheet. In Enron’s case, it failed
to disclose certain off-balance-sheet financing obligations in its main financial
statements.
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The income statement is the report that measures the success of company
operations for
a given period of time. (It is also often called the statement of income or
statement of
earnings.1) The business and investment community uses the income
statement to
determine profitability, investment value, and creditworthiness. It provides
investors
and creditors with information that helps them predict the amounts, timing,
and uncertainty
of future cash flows.
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translate
into future success. However, analysts can better predict future revenues, and hence
earnings and cash fl ows, if a reasonable correlation exists between past and future
performance.
3. Help assess the risk or uncertainty of achieving future cash fl ows.
Information on
the various components of income—revenues, expenses, gains, and losses—
highlights the relationships among them. It also helps to assess the risk of not
achieving a particular level of cash flows in the future. For example, investors and
creditors often segregate IBM’s operating performance from other non-recurring
sources of income because IBM primarily generates revenues and cash through its
operations. Thus, results from continuing operations usually have greater
significance for predicting future performance than do results from non-recurring
activities and events.
In summary, information in the income statement—revenues, expenses, gains, and
losses—helps users evaluate past performance. It also provides insights into the
likelihood
of achieving a particular level of cash flows in the future.
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and reporting these types of values is still lacking.
2. Income numbers are affected by the accounting methods employed. One
company
may depreciate its plant assets on an accelerated basis; another chooses straight-
line
depreciation. Assuming all other factors are equal, the fi rst company will report
lower income. In effect, we are comparing apples to oranges.
3. Income measurement involves judgment. For example, one company in good
faith
may estimate the useful life of an asset to be 20 years, while another company uses
a 15-year estimate for the same type of asset. Similarly, some companies may make
optimistic estimates of future warranty costs and bad debt write-offs, which result
in lower expense and higher income.
In summary, several limitations of the income statement reduce the usefulness of
its information for predicting the amounts, timing, and uncertainty of future cash
flows.
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questions:
1. Where did the cash come from during the period?
2. What was the cash used for during the period?
3. What was the change in the cash balance during the period?
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indicates where the company’s cash comes from and how the company uses
its cash. Employees, creditors, stockholders, and customers should be particularly
interested in this statement, because it alone shows the flows of cash in a
business.
3. The reasons for the difference between net income and net cash fl ow from
operating
activities. The net income number is important: It provides information on the
performance
of a company from one period to another. But some people are critical of
accrual-basis net income because companies must make estimates to arrive at it.
Such is not the case with cash. Thus, as the opening story showed, fi nancial
statement
readers can benefi t from knowing why a company’s net income and net cash
fl ow from operating activities differ, and can assess for themselves the reliability of
the income number.
4. The cash and noncash investing and fi nancing transactions during the
period.
Besides operating activities, companies undertake investing and fi nancing
transactions.
Investing activities include the purchase and sale of assets other than a company’s
products or services. Financing activities include borrowings and repayments
of borrowings, investments by owners, and distributions to owners. By
examining a company’s investing and fi nancing activities, a fi nancial statement
reader can better understand why assets and liabilities increased or decreased during
the period. For example, by reading the statement of cash fl ows, the reader
might fi nd answers to the following questions:
• Why did cash decrease for Home Depot when it reported net income for the
period?
• How much did Southwest Airlines spend on property, plant, and equipment last
year?
• Did dividends paid by Campbell’s Soup increase?
• How much money did Coca-Cola borrow last year?
• How much cash did Hewlett-Packard use to repurchase its common stock?
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For that reason, the direct method is preferable even though both methods are
acceptable. The indirect
method is more commonly used, however, because a separate reconciliation
between the income statement
and cash flows from operating activities is not required, as it is with the direct method.
Under the indirect
method, the reconciliation is created when the cash flows from operating activities
figure on the statement of
cash flows is calculated because it begins with net income
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identify the basic disclosures related to each of the
statements (footnotes, supplementary schedules, etc.)
The footnotes or disclosures to financial statements are used
when parenthetical explanations would not suffice to
describe situations particular to the entity.
Typical disclosures include
contingencies,
contractual situations,
accounting policies, and subsequent events.
The notes to the financial statements are also considered an
integral part of the financial statements but are not an actual
financial statement.
The purpose of the notes is to provide informative
disclosures that are required by GAAP.
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identify issues related to the valuation of accounts
receivable, including timing of recognition and
estimation of uncollectible accounts
GAAP requires that accounts receivable be carried on
the balance sheet at net realizable value (NRV).
NRV is gross accounts receivable less the allowances for
uncollectible accounts, returns and allowances, and discounts.
Allowances for returns and allowances and discounts are not
covered on the CMA examination.
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determine the financial statement effect of using the
percentage-of-sales (income statement) approach as opposed
to the percentage-of-receivables (balance sheet) approach in
calculating the allowance for uncollectible accounts
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distinguish between receivables sold (factoring) on a with-
recourse basis and those sold on a without-recourse basis, and
determine the effect on the balance sheet
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identify issues in inventory valuation, including which
goods to include, what costs to include, and which
cost assumption to use
All goods available for sale and still owned by the
company are included in inventory.
This would include goods out on consignment, goods in transit
shipped FOB destination (title transfers at the destination) as
well as owned goods on hand.
Which of the three inventory cost assumptions noted below to
use is up to management
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identify issues in inventory valuation, including which
goods to include, what costs to include, and which
cost assumption to use
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identify and compare cost flow assumptions used in
accounting for inventories
The cost flow assumptions used for inventory
valuation are
Specific Identification,
FIFO (first in, first out),
LIFO (last in, first out), and
Average cost (weighted average for a periodic
inventory moving average for a perpetual inventory).
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identify and compare cost flow assumptions used in
accounting for inventories
Specific Identification includes in cost of goods sold the costs of
the specific items sold.
FIFO values the ending inventory at the newest (current) costs
and the cost of goods sold at the oldest costs.
LIFO values the ending inventory at the oldest costs and cost of
goods sold at the newest (current) costs.
Weighted average cost values both the ending inventory and cost
of goods sold at the weighted average cost of the goods for the
period.
The moving average method recomputes the average cost of the
inventory whenever a shipment is received and uses the
recomputed average to determine the cost of the next sale.
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demonstrate an understanding of the lower of cost or
market rule for inventories
GAAP requires that inventories be valued and carried at
lower of cost or market (LCM).
Cost may be one of the following: FIFO, LIFO, average
cost, or specific identification.
Market is defined as replacement cost.
There is, however, a ceiling and a floor on replacement cost.
The ceiling is NRV (replacement cost less costs to complete
and dispose of).
The floor is NRV reduced by the normal profit margin.
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calculate the effect on income and on assets of using
different inventory methods
When inventory costs are consistently rising,
FIFO results in the highest net income due to the lowest cost of
sales and the highest inventory value on the balance sheet.
LIFO results in the lowest net income due to the highest cost of
sales and lowest inventory value on the balance sheet.
Average cost results would be between FIFO and LIFO.
When Inventory costs are consistently falling,
FIFO and LIFO would be reversed; an average cost would still
be in between.
The relationships of the three methods would be
indeterminable if inventory costs are fluctuating up and
down.
PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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analyze the effects of inventory errors
An error in the end-of-period inventory will affect the cost of sales
for the period, net income for the period, ending retained earnings
for the period, beginning inventory for the next period, cost of
sales for the next period, and net income for the next period.
The cost of sales and net income errors in the next period would be in the
opposite direction from those in the first period.
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analyze the effects of inventory errors
The retained earnings at the end of the next period
would be correct.
For example, a dollar overstatement in this period’s inventory
will understate this period’s cost of sales by a dollar, overstate
its net income by a dollar, and overstate its retained earnings
by a dollar.
The error will overstate the next period’s beginning inventory
by a dollar, overstate its cost of sales by a dollar, understate its
net income by a dollar, and restore retained earnings to where
it would have been had the error not occurred.
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identify advantages and disadvantages of the different
inventory methods
Specific Identification
Used when handling a relatively small number of costly,
easily distinguishable items.
Matches actual costs against actual revenue.
Cost flow matches the physical flow of the goods.
May allow a company to manipulate net income.
Specific identification calls for identifying each item sold and each item in
inventory. A
company includes in cost of goods sold the costs of the specific items sold. It
includes in
inventory the costs of the specific items on hand. This method may be used
only in
instances where it is practical to separate physically the different purchases
made. As a
result, most companies only use this method when handling a relatively
small number
of costly, easily distinguishable items. In the retail trade, this includes some
types of
jewelry, fur coats, automobiles, and some furniture. In manufacturing, it
includes special
orders and many products manufactured under a job cost system.
This method appears ideal. Specific identification matches actual costs
against
actual revenue. Thus, a company reports ending inventory at actual cost. In
other words,
under specific identification the cost flow matches the physical flow of
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the goods. On
closer observation, however, this method has certain deficiencies.
Some argue that specific identification allows a company to manipulate net
income. For example, assume that a wholesaler purchases identical plywood early
in the year at three different prices. When it sells the plywood, the wholesaler can
select either the lowest or the highest price to charge to expense. It simply selects
the plywood from a specific lot for delivery to the customer. A business manager,
therefore, can manipulate net income by delivering to the customer the higher- or
lower-priced item, depending on whether the company seeks lower or higher
reported earnings for the period.
Another problem relates to the arbitrary allocation of costs that sometimes occurs
with specific inventory items. For example, a company often faces difficulty in relating
shipping charges, storage costs, and discounts directly to a given inventory item. This
results in allocating these costs somewhat arbitrarily, leading to a “breakdown” in the
precision of the specific identification method
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identify advantages and disadvantages of the different
inventory methods
FIFO generates an ending inventory valuation close to
current (replacement) cost.
It minimizes income taxes when prices are consistently
falling.
One disadvantage of FIFO is that it matches older costs
in cost of sales to revenue in income determination.
Second, it results in higher income taxes than either
LIFO or average cost when inventory costs are
consistently rising.
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possibly distorting gross profit and net income.
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identify advantages and disadvantages of the different
inventory methods
LIFO matches the most current costs (through cost of
sales) to revenue in income determination.
It minimizes income taxes when inventory costs are
consistently rising.
Its main disadvantage is that the inventory valuation on
the balance sheet could be many years out of date.
Since LIFO become available prior to World War II, the
inventory valuation could be over 70 years old.
Last, it is an extremely complex system when used for
perpetual inventory valuation,
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non-
LIFO earnings, noting that failing to match current costs against current revenues
creates transitory or “paper” profits (“inventory profits”). Inventory profits occur
when the inventory costs matched against sales are less than the inventory
replacement
cost. This results in understating the cost of goods sold and overstating profit. Using
LIFO (rather than a method such as FIFO) matches current costs against revenues,
thereby reducing inventory profits.
Tax Benefi ts/Improved Cash Flow
LIFO’s popularity mainly stems from its tax benefits. As long as the price level
increases
and inventory quantities do not decrease, a deferral of income tax occurs. Why?
Because
a company matches the items it most recently purchased (at the higher price level)
against revenues. For example, when Fuqua Industries switched to LIFO, it realized
a
tax savings of about $4 million. Even if the price level decreases later, the company
still
temporarily deferred its income taxes. Thus, use of LIFO in such situations improves
a
company’s cash flow.12
The tax law requires that if a company uses LIFO for tax purposes, it must also use
LIFO for financial accounting purposes13 (although neither tax law nor GAAP
requires
a company to pool its inventories in the same manner for book and tax purposes).
This
requirement is often referred to as the LIFO conformity rule. Other inventory
valuation
methods do not have this requirement.
Future Earnings Hedge
With LIFO, future price declines will not substantially affect a company’s future
reported
earnings. The reason: Since the company records the most recent inventory as sold
first,
there is not much ending inventory at high prices vulnerable to a price decline. Thus
LIFO eliminates or substantially minimizes write-downs to market as a result of price
decreases. In contrast, inventory costed under FIFO is more vulnerable to price
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declines,
which can reduce net income substantially.
Major Disadvantages of LIFO
Despite its advantages, LIFO has the following drawbacks.
Reduced Earnings
Many corporate managers view the lower profits reported under the LIFO method in
inflationary times as a distinct disadvantage. They would rather have higher reported
profits than lower taxes. Some fear that investors may misunderstand an accounting
change to LIFO, and that the lower profits may cause the price of the company’s
stock
to fall.
Inventory Understated
LIFO may have a distorting effect on a company’s balance sheet. The inventory
valuation
is normally outdated because the oldest costs remain in inventory. This
understatement
makes the working capital position of the company appear worse than it
really is. A good example is Walgreens, which uses LIFO costing for most of its
inventory,
valued at $6.1 billion at fiscal year-end 2014. Under FIFO costing, Walgreens’
inventories have a value of $8.4 billion—approximately 38 percent higher than the
LIFO amount.
The magnitude and direction of this variation between the carrying amount of
inventory and its current price depend on the degree and direction of the price
changes
and the amount of inventory turnover. The combined effect of rising product prices
and
avoidance of inventory liquidations increases the difference between the inventory
carrying
value at LIFO and current prices of that inventory. This magnifies the balance
sheet distortion attributed to the use of LIFO.
Physical Flow
LIFO does not approximate the physical flow of the items except in specific situations
(such as the coal pile discussed earlier). Originally, companies could use LIFO only in
certain circumstances. This situation has changed over the years. Now, physical flow
characteristics no longer determine whether a company may employ LIFO.
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Involuntary Liquidation/Poor Buying Habits
If a company eliminates the base or layers of old costs, it may match old, irrelevant
costs
against current revenues. A distortion in reported income for a given period may
result,
as well as detrimental income tax consequences. For example, Caterpillar at one
time
experienced a LIFO liquidation, resulting in an increased tax bill of $60 million.14
Because of the liquidation problem, LIFO may cause poor buying habits. A company
may simply purchase more goods and match these goods against revenue to avoid
charging the old costs to expense. Furthermore, recall that with LIFO, a company
may
attempt to manipulate its net income at the end of the year simply by altering its
pattern
of purchases.1
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identify advantages and disadvantages of the different
inventory methods
Average costing is an easy-to-use and understand
method.
It is relatively easily programmed when used for
perpetual inventory valuation.
It provides little tax advantage when costs are
consistently rising or falling.
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recommend the inventory method and cost flow
assumption that should be used for a firm given a set
of facts
Specific Identification recommended when handling a
relatively small number of costly, easily distinguishable
items.
LIFO is the recommended system when prices are
consistently rising and the inventory level is constant or
rising.
FIFO would be best when prices are consistently falling
or the inventory is being depleted.
Average cost is recommended when the inventory level
fluctuates materially and /or the prices fluctuate.
Average cost is best for commodities and fungible goods.
PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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demonstrate an understanding of the following
security types: trading, available-for-sale, and held-to-
maturity
Trading securities are bought and sold to generate profit
on short-term price changes.
They consist of debt securities with maturities less than one
year as well as
equity securities.
Typical trading securities are Treasury bills, commercial paper,
money market and euro deposits, and short-term certificates of
deposit (CDs) purchased with excess short-term cash.
Trading securities are carried on the balance sheet at
fair market value (marked to market).
Holding gains and losses when marking to market are
reported directly in the income statement.
PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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demonstrate an understanding of the following
security types: trading, available-for-sale, and held-to-
maturity
Available-for-sale securities are those debt and equity
securities that are neither trading securities nor held-to-
maturity securities.
They may be short term or long term and are marked to
market, as are trading securities.
Holding gains and losses are carried in other
comprehensive income rather than in net income.
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demonstrate an understanding of the following
security types: trading, available-for-sale, and held-to-
maturity
Held-to-maturity securities are either debt securities
intended to be held to maturity
Held-to-maturity debt securities are carried at amortized
historical cost.
A typical held-to-maturity security would be a corporate
bond.
IMA BOOK:
Held-to-maturity securities are either debt securities intended to be held to
maturity or equity securities purchased with the intent to acquire the issuing
corporation. Held-to-maturity debt securities are carried at amortized
historical cost. A typical held-to-maturity security would be a corporate bond.
Held-to-maturity equity investments are accounted for by the fair value
method (same as available-for-sale securities noted above) if they rep resent
less than 20% of the outstanding stock of the issuer or by the equity meth o
d if they represent 20% or more.
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demonstrate an understanding of the fair value
method, equity method, and consolidated method for
equity securities
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demonstrate an understanding of the fair value
method, equity method, and consolidated method for
equity securities
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determine the effect on the financial statements of
using different depreciation methods
Depreciation is the systematic, rational allocation of a
tangible asset’s cost less estimated residual (net
salvage) value over the estimated life of the asset.
The periodic depreciation is debited to depreciation expense
shown on the income statement and credited to the
accumulated depreciation account (an offset or contra account
to the asset account).
Straight-line depreciation produces a constant amount
of depreciation per period calculated as cost less
estimated residual divided by the estimated asset life.
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determine the effect on the financial statements of
using different depreciation methods
Accelerated depreciation produces a declining amount of
depreciation per period calculated as the declining balance
percentage divided by the estimated life times the net book value
of the asset at the beginning of the period.
Estimated residual value is ignored in the calculation. The net book value is
cost less accumulated depreciation. Care must be taken to depreciate the
asset down to its estimated residual value but not below it.
Units of production or activity depreciation produces a varying
amount of depreciation per period calculated as the cost less
estimated residual value divided by the estimated production or
activity level expected over the life of the asset times the amount
of actual production or activity for the period.
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recommend a depreciation method for a given a set of
data
The recommendation of a specific method depends on the
depreciation pattern preferred by the organization.
(1) Activity method:
Assumes that depreciation is a function of use or productivity instead of the
passage of time.
The life of the asset is considered in terms of either the output it provides,
or an input measure such as the number of hours it works.
(2) Straight-line method:
Considers depreciation a function of time instead of a function of usage.
The straight-line procedure is often the most conceptually appropriate when
the decline in usefulness is constant from period to period.
(3) Decreasing-charge methods:
Provide for a higher depreciation cost in the earlier years and lower
charges in later periods.
The main justification for this approach is that the asset is the most
productive in its early years. PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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demonstrate an understanding of the accounting for
impairment of long-term assets
The determination of impairment of a long-term asset involves two
steps.
The first is a recoverability test, where the carrying (net book) value of the
asset is compared with the expected undiscounted cash flows from the
asset's use and disposal.
If the carrying value exceeds the expected cash flows, an impairment loss
calculation is required.
The impairment loss is the amount by which the carrying value
exceeds the fair value of the asset.
The fair value of the asset would be the net proceeds from selling the asset
in an orderly market.
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demonstrate an understanding of the accounting for
impairment of intangible assets, including goodwill
The impairment of an intangible other than goodwill involves
determining if the carrying value of the in tangible exceeds its fair
value.
If it does, an impairment loss equal to the difference has occurred and must
be recognized.
The impairment of goodwill involves three steps.
First, the company performs a qualitative assessment to
determine whether it is likely that the fair value of the reporting
unit to which the goodwill is attached is less than its carrying
value.
Then, if it is, a recoverability test need be performed.
The test involves a comparison of the carrying amount of the
reporting unit with the fair value of the reporting unit.
If the carrying amount exceeds the fair value, an impairment loss equal to that
difference has occurred and must be recognized.
PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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identify the classification issues of short-term debt
expected to be refinanced
GAAP requires that refinanced short-term debt be classified as a
current liability unless the refinancing would extend the maturity
date beyond one yean
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identify the classification issues of short-term debt
expected to be refinanced
GAAP requires that refinanced short-term debt be classified as a
current liability unless the refinancing would extend the maturity
date beyond one yean
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pays off short-term debt of $40,000 on January 17, 2018, and issues long-term
debt of $100,000 on February 3, 2018. Marquardt’s financial statements, dated
December
31, 2017, are to be issued March 1, 2018. Should Marquardt exclude the $40,000
short-term debt from current liabilities? No—here’s why: Repayment of the shortterm
obligation required the use of existing current assets before the company
obtained funds through long-term financing. Therefore, Marquardt must include the
short-term obligations in current liabilities at the balance sheet date (as shown in
Illustration 13-10).
11As part of its simplification initiative, the FASB is considering a change in these
classification criteria. In
preliminary deliberations, the Board has tentatively decided that debt is classified as
noncurrent if at the
balance sheet date either (1) the liability is contractually due to be settled more than
12 months (or
operating cycle, if longer) after the balance sheet date, or (2) the company has a
contractual right to defer
settlement of the liability for at least 12 months (or operating cycle, if longer) after the
balance sheet date.
Thus, facts and circumstances as of the balance sheet date will determine
classification of debt, not
judgments about intent and ability to refinance. See http://www.fasb.org (click on
Projects, then
Technical Agenda).
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compare the effect on financial statements when
using either the expense warranty approach or the
sales warranty approach for accounting for warranties
The expense warranty method is the generally accepted method
of accounting for warranty expense and liability and should be
used whenever the warranty is an integral and inseparable part of
the sale that creates a warranty loss contingency.
The estimated warranty expense and associated liability are recorded in the
year of the sale of the product for which the warranty applies.
Actual warranty expenditures when they occur are charged to the estimated
liability.
The expense method provides for the proper matching of warranty expense
to the product revenue through accrual accounting.
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compare the effect on financial statements when
using either the expense warranty approach or the
sales warranty approach for accounting for warranties
The sales warranty approach defers a portion of the original sales
price (the estimated warranty expense) until the actual warranty
costs are incurred.
At that time the revenue and expense equal to the amount
deferred are recognized.
The result is a type of cash basis accounting that does not
provide a proper match of revenue and expense.
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define off-balance sheet financing and identify
different forms of this type of borrowing
Off-balance sheet financing is a form of financing whereby
liabilities are kept off the organization’s balance sheet.
It is often used to keep the organization’s debt/equity and equity
multiplier (leverage) ratios low to avoid debt covenant violations.
Examples of off-balance sheet financing are
joint borrowing ventures where each partner has 50% and operating lease
obligations.
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demonstrate an understanding of interperiod tax
allocation/deferred income taxes
Deferred income tax liabilities or assets are created by
the temporary differences between the handling of
revenues and expenses for financial purposes (books)
as opposed to for income tax purposes.
Income tax expense is based on the financial statement
handling of revenues and expenses.
Income tax payable is calculated based on the Internal
Revenue Service (IRS) rules and regulations.
The deferred income tax liability or asset is basically the
difference between the income tax expense and the income
tax payable.
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define and analyze temporary differences, operating
loss carrybacks, and operating loss carryforwards
Temporary differences between book and tax are those
that will reverse in the future. There are four types of
temporary differences. They are:
1. Revenues or gains taxable after book recognition.
2. Expenses or losses tax deductible before book recognition.
3. Revenues or gains taxable before book recognition.
4. Expenses or losses deductible after book recognition.
Items 1 and 2 create deferred tax liabilities while items 3
and 4 create deferred tax assets.
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define and analyze temporary differences, operating
loss carrybacks, and operating loss carryforwards
Operating losses that offer no tax benefit in the year of
occurrence may be carried back or carried forward to
offset either prior or future tax liabilities.
Operating losses may be carried back two years and carried
forward 20 years.
An operating loss carryback is recognized in the year of
the loss since it is realizable and measurable.
Operating loss carryforwards create need future tax liabilities
to offset against and create a deferred tax asset.
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74
distinguish between deferred tax liabilities and
deferred tax assets
Deferred tax liabilities represent future tax liabilities that
ensue from deferring taxes to be paid into the future.
Deferred tax assets represent future tax benefits
(reductions) that ensue from deferring tax benefits in to
the future.
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75
differentiate between temporary differences and
permanent differences and identify examples of each
Examples of temporary differences creating deferred tax
liabilities are:
Using the cash basis for tax recognition of profit from
installment sales.
Using the cash basis for recognition of earnings of
subsidiaries.
Using Modified Accelerated Cost Recovery System (MACRS)
depreciation for taxes and straight line for book.
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76
differentiate between temporary differences and
permanent differences and identify examples of each
Examples of temporary differences creating deferred tax
assets are:
Using the cash basis for tax recognition of rental incomes.
Using the cash basis for recognition of warranty expenses.
Using the direct write-off method for bad debt recognition or
tax purposes and the allowance method for books.
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77
differentiate between temporary differences and
permanent differences and identify examples of each
Permanent differences result from items that
(1) enter into pretax financial income but never into taxable income, or
(2) enter into taxable income but never into pretax financial income.
Items are recognized for financial reporting purposes but not for tax
purposes.
Examples:
1. Interest received on state and municipal obligations.
2. Expenses incurred in obtaining tax-exempt income.
3. Proceeds from life insurance carried by the company on key officers or employees.
4. Premiums paid for life insurance carried by the company on key officers or employees
(company is beneficiary).
5. Fines and expenses resulting from a violation of law.
Items are recognized for tax purposes but not for financial reporting
purposes.
Examples:
1. “Percentage depletion” of natural resources in excess of their cost.
2. The deduction for dividends received from U.S. corporations, generally 70% or 80%.
PART 1 – Financial Reporting, Planning,
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indicate the proper income statement and balance
sheet presentation of income tax expense and
deferred taxes
Income tax expense is presented on the income
statement in two ways.
Income tax expense related to continuing operations may be
shown as one of the continuing operations expenses deducted
from continuing operations revenues to obtain net income, or,
preferably, it could be shown as a deduction from continuing
operations earnings before taxes.
Income taxes related to discontinued operations or
extraordinary items are netted with the gain or loss from
the discontinued operation or extraordinary item.
Deferred tax assets and deferred tax liabilities are
shown on the balance sheet as noted in next LOS.
PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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79
explain the issues involved in determining the amount
and classification of tax assets and liabilities
The amounts of the deferred tax assets and liabilities
are calculated using the tax rates enacted at the time of
the calculation.
Deferred tax assets may be current assets or other long-term
assets, depending on when the tax benefit is expected to be
realized.
Current is one year or less while long term is greater than one year.
Similarly, deferred tax liabilities may be current or long-term
liabilities, depending on when they are expected to be paid.
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IFRS Difference
Income tax allocation was long an American phenomenon. With respect to
the International Accounting Standards Board (IASB) and its predecessor,
the International Accounting Standards Committee, tax allocation has not
been an important subject. IAS 12, Income Taxes, as originally issued in
1979, addressed the tax issue but allowed for options. The most recent
international standard-setting activity involving tax allocation occurred
in 2009. The goal of that project was to resolve problems in practice
under IAS 12 without changing its fundamental approach and without
increasing the divergence from U.S. GAAP. The project originally started as
a convergence project with U.S. GAAP.
The IASB may soon consider a major review of the accounting for income
taxes as part of its agenda consultation process. Part of the reason for the
lesser activity by the IASC and IASB can be attributed to the fact that many
countries require conformity between tax accounting and financial statement
reporting. Of course, neither the U.S. GAAP nor international standards
require such conformity to any degree. The result is that many members of
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the IASB are from countries where tax allocation is not an issue.
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82
distinguish between an operating lease and a capital
lease
A lessee is an operating lease if the long-term lease
does not meet any of the following criteria:
Title transfers to the lessee at the end of the lease term.
A bargain purchase option is available to the lessee.
The lease term is greater than or equal to 75% of the leased
assets useful life.
The present value of the lease payments at the lessee’s
borrowing rate is greater than or equal to 90% of the assets
fair market value (FMV).
Meeting any one of the criteria makes the lease a
capital lease for financial accounting purposes.
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83
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84
explain why an operating lease is a form of off-balance
sheet financing
An operating lease is a form of off-balance sheet
financing because the lease creates a liability for the
present value of the expected lease payments that is not
shown on the balance sheet. The lease payment
commitment, however, should be disclosed in the
appropriate footnote.
The lessee has the right to use the leased asset, but neither
the asset nor a liability for future lease payments is recorded in
its financial statements.
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85
demonstrate an understanding of why lessees may
prefer the accounting for a lease as an operating lease
as opposed to a capital lease
The lessee would prefer that leases be operating as
opposed to capital in order to keep the lease liability of
the balance sheet and to show the interest porting of the
lease payment.
Treating a lease as an operating lease would improve
the organization’s solvency ratios, such as debt or
debt/equity, as well as its interest coverage (number of
times interest is earned).
The improved solvency ratios make it less likely that the
organization will violate debt covenants or restrictions.
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recognize the correct financial statement presentation
of operating and capital lease
Operating lease payments are shown as expenses in the income
statement, as dictated by accrual accounting.
There is no balance sheet presentation of the lease.
A capital lease creates a liability on the balance sheet equal at the
lease’s inception to the present value of the future lease
payments at the lessees borrowing rate.
The lease payments, therefore, consist of an interest portion and
a reduction in the lease liability.
The interest portion is equal to the lessee borrowing rate times the amount
of lease liability at the beginning of the period covered by the payment. The
splitting of the lease payments into interest and liability reduction requires
the lessee to setup a lease amortization table similar to a mortgage
amortization table.
The lessee treats the leased asset as part of long-term assets
and depreciates the asset as appropriate.
The depreciation is Included with other depreciation on the income
PART 1 – Financial Reporting, Planning,
statement. Performance, and Control
© Sameh . Y.El lithy, CMA, CIA.
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87
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88
identify transactions that affect paid-in capital and
those that affect retained earnings
Paid-in capital or capital received consists of
capital stock at par or stated value
plus capital received in excess of par or stated value.
Transactions affecting paid-in capital include
proceeds from the issuance of shares,
retirement of repurchased shares,
stock splits, stock dividends, and
the conversion of debt to equity.
Retained earnings are the “running” record of net Incomes minus
dividends since the inception of the corporation.
In addition to net incomes and dividends, retained earnings are
affected by the appropriation of retained earnings or the removal
of an appropriation. PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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89
determine the effect on shareholders’ equity of large
and small stock dividends, and stock splits
Stock dividends occur when the corporation issues
shares to existing shareholders on a pro rata basis.
A large stock dividend occurs when the number of shares
issued exceeds 25% of the outstanding shares.
The accounting for a large stock dividend requires the
capitalization of retained earnings at the par or stated value of
the stock.
An amount equal to said value is transferred from retained
earnings to com m on stock par or stated value.
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90
determine the effect on shareholders’ equity of large
and small stock dividends, and stock splits
A small stock dividend occurs when the number of
shares issued is less than 20% of the outstanding
shares.
In this case, retained earnings are capitalized at the market
value of the stock at the time of the stock dividend issue.
An amount equal to that value is transferred from retained
earnings to capital received (par or stated value and excess
over par or stated value) as appropriate.
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91
determine the effect on shareholders’ equity of large
and small stock dividends, and stock splits
A stock split involves the recall and reissue of all
shares to reflect a change in the par or stated
value caused by the split.
For example, a two-for-one stock split would involve halving
the par or stated value of the shares and doubling the number
of shares authorized, issued, and outstanding and in the
treasury.
Stock splits are issuances of shares that do not affect
any aggregate par value of shares issued and
outstanding or total equity. Stock split reduces the par
value of each stock and increases the number of shares
outstanding.
No entry is made, and no transfer from retained earnings
occurs. PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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92
identify reasons for the appropriation of retained
earnings
The appropriation (restriction or reservation) of
retained earnings puts shareholders on notice
that the portion of retained earnings appropriated
is no longer available for dividend distribution.
Reasons for the appropriation of retained
earnings include
plant expansion,
sinking funds for debt retirement, and
treasury stock acquisition..
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Part 1 – Section A.2. Recognition,
measurement, valuation, and disclosure
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apply revenue recognition principles to various types
of transactions
According to the revenue recognition principle, revenues
and gains should be recognized when
(1) realized or realizable and
(2) earned.
Revenues and gains are realized when goods or
services have been exchanged for cash or claims to
cash.
Revenues and gains are realizable when goods or
services have been exchanged for assets that are
readily convertible into cash or claims to cash.
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Revenues are earned when the earning process has
been substantially completed, and the entity is entitled
to the resulting benefits or revenues.
Thus, revenue on sales can be recognized in the statement of
income even if the cash from sales is not received yet.
In other words, The basic revenue recognition principle
states that revenue is recognized when the following criteria
are met:
The earnings process is compete or virtually complete.
A measurable exchange has taken place.
The collectability of cash is reasonably assured. In other
words, it is earned, measurable, and collectible, and an
exchange has taken place. This describes the default point-
of-sale method.
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96
identify issues involved with revenue recognition at
point of sale, including sales with buyback
agreements, sales when right of return exists, and
trade loading (or channel stuffing)
A sale with a buyback agreement may not be
recognized as a sale (revenue) until the buyback
period expires.
The earnings process is not complete.
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transferred the risks and rewards of ownership to the buyer.
Two Examples
Example #1: Seller Corporation sells a piece of equipment to Buyer Corporation at
price of $120,000. The
cost of the equipment in Seller’s inventory is $100,000. As part of the sales
agreement, Seller agrees to
repurchase the equipment at the end of three years at its fair value at that time. When
Buyer Corporation
takes possession of the equipment, Buyer pays the full selling price of $120,000 to
Seller.
In the above scenario, Seller Corporation has fulfilled its performance obligation to
Buyer, the risks and
rewards of ownership have been transferred to Buyer Corporation, and Buyer
Corporation has no
restrictions on its use of the equipment. Therefore, a sale has taken place and it
should be recorded as
sales revenue and the cost to Seller for the equipment should be debited to cost of
goods sold and credited
to inventory.
Example #2: Seller Corporation sells a piece of equipment to Buyer Corporation at
price of $120,000. The
cost of the equipment in Seller’s inventory is $100,000. As part of the sales
agreement, Seller agrees to
repurchase the equipment at the end of three years at a price of $75,000. Buyer
Corporation does not pay
Seller Corporation the purchase price but instead signs a note agreeing to pay Seller
for the equipment in
36 monthly payments. Seller requires Buyer to maintain the equipment in good
condition and maintain
insurance on it.
In the second scenario, many of the risks and rewards of ownership have remained
with Seller Corporation.
Because Buyer is required to maintain the equipment in good condition and insure it
and Seller
Corporation has agreed to repurchase it at a set price, this is not a sale but rather a
financing transaction.
The equipment should remain on the balance sheet of Seller Corporation and no
revenue should be
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recognized.
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97
identify issues involved with revenue recognition at
point of sale, including sales with buyback
agreements, sales when right of return exists, and
trade loading (or channel stuffing)
A sale with a right of return may be recorded as
a sale (revenue) as long as sales returns and an
allowance for returns are presented on the
income statement and balance sheet,
respectively.
Again, the earnings process is not complete.
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account in the chart of accounts but it carries a debit (negative) balance.
If returns take place frequently and are material, the company should set up an
allowance account for
returns. An allowance account for returns is handled in the same manner as the
allowance for doubtful debts
is handled. The allowance for doubtful debts is explained in the next few pages, so it
is not described here.
We said above that usually the seller can recognize revenue when a right of return
exists. However, in order
to recognize revenue, the seller must meet a series of conditions. These conditions
are:
• the price of the transaction is substantially fixed or determinable at the time of the
sale,
• the buyer has paid for the item or is obligated to pay for the item, and this obligation
is not contingent
upon the resale of the item,
• the buyer’s obligation is not changed in the case of theft, destruction or damage,
• the buyer is a separate entity from the seller,
• the seller does not have future obligations to assist in the resale of the item, and
• the amount of future returns can be estimated.
If these conditions are not all met, the seller should not recognize revenue until the
right of return has expired
Or
Note: The last of the criteria listed above is probably the most important. If the
amount of returns can be
estimated, the company can recognize revenue when the sale is made and it will set
up the corresponding
allowance account. these conditions have been met.
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identify issues involved with revenue recognition at
point of sale, including sales with buyback
agreements, sales when right of return exists, and
trade loading (or channel stuffing)
Trade loading or channel stuffing involves
shipping to your customers without a customer
order.
It is norm ally done at year-end to inflate
revenues. Since there is no customer order, there
is no agreement with the customer, and,
consequently, a sale should not be recognized.
As before, the earnings process is not complete.
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If a manufacturer does offer incentives to get its wholesalers or distributors to
purchase more product, it
should record an appropriate allowance for sales returns.
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99
identify instances where revenue is recognized before
delivery and when it is recognized after delivery
The recognition of revenue before delivery
occurs with either
the percentage-of-completion method for recording
long-term contracts or
the production method for handling the mining of
precious metals such as platinum and gold that have
a ready market with a determinable price.
The production method also applies to diamond mines.
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100
identify instances where revenue is recognized before
delivery and when it is recognized after delivery
The recognition of revenue after delivery occurs
in two cases.
The first occurs when there are “strings” attached to
the sale, such as a buyback provision or right of
return.
The second occurs when the collectability of cash is
not reasonably assured.
In this second case, revenue is recognized by a cash
method called the installment sales method.
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101
distinguish between percentage-of-completion and
completed-contract methods for recognizing revenue
Both the percentage-of-completion method and
the completed contract method apply to the
recognition of revenue and expenses related to
long-term construction contracts.
The percentage-of-completion method
recognizes construction revenue and expenses
as the construction project progresses over time.
The completed contract recognizes all of the
revenue and expenses related to the project at
the project’s completion.
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102
demonstrate an understanding of the proper
accounting for losses on long-term contracts
Expected losses on long-term contracts are to be recorded in
the period in which the loss becomes apparent.
Two types of losses can become evident under long-
term contracts:
(1) Loss in current period on a profitable contract:
Under the percentage-of-completion method only, the estimated cost
increase requires a current-period adjustment of excess gross profit
recognized on the project in prior periods. The company records this
adjustment as a loss in the current period because it is a change in
accounting estimate.
(2) Loss on an unprofitable contract:
Under both the percentage-of-completion and the completed-contract
methods, the company must recognize the entire expected contract loss
in the current period.
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compare and contrast the recognition of costs of
construction, progress billings, collections, and gross
profit under the two long-term contract accounting
methods
When using the completed contract method,
the progress billings and collections are recorded in
construction receivables on the balance sheet.
Costs of construction are carried on the balance
sheet in an inventory account called “construction in
progress” and are expensed to the income statement
when the project is completed and the revenue is
recognized.
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Under the percentage-of-completion method,
the progress billings, collections, and construction in
progress are handled in the same fashion as with the
completed contract method.
Revenue is recognized by the percentage-of-
completion of the project in a given period.
The credit to revenue is offset by debits to costs of revenue
equal to the construction costs incurred and to construction
in progress.
The debit to construction in progress is equal to the
difference between the revenue and costs of revenue.
It is the gross profit from the project for the period.
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105
the situations in which each of the following revenue
recognition methods would be used: installment sales
method, cost recovery method, and deposit method
There are three methods of recognizing revenue
after delivery:
the installment sales method,
the cost recovery method, and
the deposit method.
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The installment sales method is used when the
collectability of cash is spread over a long period of
time.
This is common for real estate and franchise contracts. The
revenue is recognized on a pro rata basis through the gross
profit on the contract.
The cost recovery method does not recognize revenue
until all of the costs related to the sale have been
collected.
It is used when the collectability is highly uncertain.
The deposit method is used when the seller receives
cash before the transfer of ownership occurs.
Since the risks and rewards of ownership have not
transferred, the deposits are recorded as unearned revue (a
performance obligation). Revenue is recognized upon the
transfer of ownership.
PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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offset against the related receivable on the balance sheet. Subsequent income
statements
report the gross profit as a separate item of revenue when revenue is recognized
as earned.
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107
discuss the issues and concerns that have been
identified with respect to revenue recognition
practices
The issues related to revenue recognition were presented in the
coverage of the revenue recognition principle in the previous
LOS.
The issues are:
Has the revenue been earned?
Is the revenue measurable?
Has an exchange taken place?
Is the collectability of cash reasonably assured?
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108
demonstrate an understanding of the matching
principle with respect to revenues and expenses and
be able to apply it to a specific situation
The matching principle states that expenses are
either
to be matched to the revenues they create, as in
matching cost of sales to sales, construction costs of
revenue to construction revenue, or gross profits in
the installment sales method,
or matched to the period to which they pertain.
Matching to the period would include such expenses as
advertising, promotion, research and development, interest,
and utilities.
Interest expense is recognized based on the passage of time. In the
case of bonds, notes, and capital leases, the effective interest method is
used. PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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109
The expense recognition principles are
associating
cause and effect,
Such a direct relationship is found when the cost of goods sold is
recognized in the same period as the revenue from the sale of the
goods.
systematic and rational allocation,
For example, depreciation charges for a non-current asset are allocated
between accounting periods on a systematic and rational basis, by
means of an appropriate depreciation policy and depreciation method.&
immediate recognition.
When the future economic benefits associated with an asset are no
longer expected to arise, the value of the asset is written off, and the
write-off is treated as an expense.
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An expense may also be recognised when a liability
arises without the recognition of any matching asset.
For example, a liability might arise when an entity
recognises that it will have to make a payment to
settle a legal dispute.
The cost of the future liability is treated as an expense in
the period when the liability is recognised.
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Part 1 – Section A.2. Recognition,
measurement, valuation, and disclosure
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112
define gains and losses and indicate the proper
financial statement presentation
A gain is the excess of revenue over cost from a
transaction that is outside the normal course of
business.
Examples would be the gain from the sale of fixed assets or
investments or the gain from early retirement of debt.
A loss is the expiration of an asset without creating
revenue. It occurs when there is an excess of cost over
revenue from a transaction outside the normal course
of business.
Examples would be a fire loss, loss on sale of fixed assets or
investments, or loss on early debt retirement.
Gains and losses are preferably shown in other revenues,
expenses, gains, and losses shown below operating income on
the income statement. PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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113
demonstrate an understanding of the treatment of
gain or loss on the disposal of fixed assets
When a fixed asset is disposed of, the balances for that
asset in both of the associated accounts (the fixed asset
and accumulated depreciation accounts) must be written
off the books, and a gain or loss is recognized for the
difference between the fair value of what is received and
the book value of the asset at the time of the disposal
(cost − accumulated depreciation).
The gain or loss on the disposal of a fixed asset should
be shown in the income statement as part of other
revenue, expenses, gains, and losses below operating
income.
Note: The amount of the gain or loss is equal to the difference between the
fair value of anything that
was received for the asset and the asset’s carrying value (i.e., book value).
This calculation of gain or loss
applies also to assets lost because of condemnation or to incidents that are
covered under insurance such
as theft or fire. The condemnation or insurance settlement is what was
received for the asset, just as if the
asset had been sold, and the gain or loss is the difference between that and
the asset’s book value.
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define and calculate comprehensive income
Comprehensive income includes
net income from the income statement and
other comprehensive net income.
Other comprehensive net income includes, for the most part,
unrealized gains and losses on investments, foreign
currency translation gains and losses, and
unrealized gains and losses on hedging transactions.
Other comprehensive income may be appended
to the income statement or shown as a separate
statement of comprehensive net income.
It cannot be buried in the statement of stockholders’
equity or retained earnings.
PART 1 – Financial Reporting, Planning,
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Performance, and Control
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115
identify correct treatment of extraordinary items and
discontinued operations
Discontinued operations are shown net of tax in
the income statement after the after-tax net
income from continuing operations.
The net gain or loss from discontinued operations
is split between
the gain or loss from the operations as it was running
and
the gain or loss from the disposal of the discontinued
operation.
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116
identify correct treatment of extraordinary items and
discontinued operations
Extraordinary items are shown net of tax after
discontinued operations (if they exist) in the
income statement.
For an item to be extraordinary, it must meet
three requirements.
It has to be unusual,
infrequent, and
outside management control.
Discussion of extraordinary items should be
deleted to reflect the most recent accounting
standards. PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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117
Part 1 – Section A.2. Recognition,
measurement, valuation, and disclosure
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(i) revenue recognition, with respect to the sale of
goods, services, deferred receipts and construction
contracts;
IFRS requires revenue recognition based on a
contract with the customer. Revenue is
recognized as contract milestones are met.
IFRS allows the percentage-of-completion
method for the recognition of revenue for long-
term or multiyear contracts.
IFRS also apply the cost‐recovery method for
long‐term contracts
U.S. GAAP allows both percentage-of-completion
and completed contract methods.
PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
GAAP IN MOTION
The recent standard on revenue recognition was the result of joint work by
the FASB and IASB. As a result, the
Boards issued a converged standard with few differences between GAAP
and IFRS.
Alternatively, if the criteria for recognition over time are not met, the
company
recognizes revenues and gross profit at a point in time, that is, when the
contract is
completed. In these cases, contract revenue is recognized only to the extent
of
costs incurred that are expected to be recoverable. Once all costs are
recognized,
profit is recognized. This approach is referred to as the cost‐recovery (zero‐
profit) method. The company accumulates construction costs in an inventory
account (Construction in Process), and it accumulates progress billings in a
contra
inventory account (Billings on Construction in Process).
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119
(ii) expense recognition, with respect to share-based
payments and employee benefits;
The differences between U.S. GAAP and IFRS
treatment of share-based payments and
employee benefits are beyond the scope of the
CMA examination.
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(iii) intangible assets, with respect to development
costs and revaluation;
Under U.S. GAAP Research and development
(R&D) costs must be expensed as incurred and
are thus never capitalized.
GAAP requires expensing of all costs associated with
internally generated intangibles.
In fact, both IFRS and U.S. GAAP require the
expensing of basic research expenditures.
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Under IFRS, costs in the development phase of a
research and development project are capitalized
once technological feasibility (referred to as
economic viability) is achieved.
Development costs may result in recognition of an
intangible asset if the entity can demonstrate the (1)
technical feasibility of completion of the asset, (2) intent to
complete, (3) ability to use or sell the asset, (4) way in
which it will generate probable future economic benefits, (5)
availability of resources to complete and use or sell the
asset, and (6) ability to measure reliably expenditures
attributable to the asset.
GAAP requires expensing of all costs associated with
internally generated intangibles.
IFRS allows the revaluing of intangibles to fair value less
accumulated amortization. U.S. GAAP does not.
PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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(iv) inventories, with respect to costing methods,
valuation and write-downs (e.g., LIFO);
IFRS does not allow the use of LIFO for inventory
valuation while U.S.GAAP does.
IFRS does not have the ceiling (net realizable value -
NRV) and floor (NRV reduced by the normal profit
margin) rules for LCM. It only uses NRV.
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(v) leases, with respect to leases of land and
buildings;
IFRS requires the disclosure of the net present
value (NPV) of operating leases.
Operating leases are recorded as liabilities if there
are long-term provisions.
Under IFRS, when leasing real estate (land and
buildings), the land and buildings must be considered
separately.
U.S. GAAP considers them separately only when the
land value at the inception of the lease exceeds 25%
of the fair value of the leased real estate. Capital
lease treatment in IFRS and in U.S. GAAP is basically
the same.
PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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(vi) long-lived assets, with respect to revaluation,
depreciation, and capitalization of borrowing costs;
IFRS allows the revaluation of long-lived assets
(property, plant, and equipment [PP&E]) to fair
value less accumulated depreciation. U.S.GAAP
does not.
Both IFRS and U.S. GAAP require the
capitalization of interest during construction (IDC)
when borrowed funds are used in connection with
expenditures for self-constructed assets.
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(vii) impairment of assets, with respect to
determination, calculation and reversal of loss;
Under U.S. GAAP, the amount of impairment loss on
long-lived assets is the amount by which its carrying
value exceeds its fair value.
IFRS calculates the impairment loss as the amount by
which the carrying value exceeds the recoverable
amount.
The recoverable amount is the higher of:
(1) fair value less cost to sell and (2) value in use (the
present value of the future cash flows in use, including the
disposal value),
IFRS allows the reversal of impairment losses not to exceed
the Initial carry in g amount of the asset. U.S. G A AP prohibits
reversal of any impairment losses. IFRS prohibits reversals for
goodwill.
PART 1 – Financial Reporting, Planning,
© Sameh . Y.El lithy, CMA, CIA.
Performance, and Control
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(viii) financial statement presentation, with respect to
extraordinary items and changes in equity;
IFRS prohibits the separate presentation of
extraordinary items in the income statement. U.S.
GAAP allows presentation of extraordinary items.
Extraordinary items are those that are unusual,
infrequent, and outside management control. All
three criteria must be met.(revised recently)
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