Financial Accounting Master
Financial Accounting Master
CHAPTER 1
Decision Usefulness
Primary Decision-Specific Qualities – Relevance and Reliability
Relevance (PFT) – Predictive Value, Feedback Value, & Timeliness
Reliability (NRFV) – Neutrality, Representational Faithfulness, &
Verifiability.
Passing Feels Terrific & Nobody Relies on Financials unless Verified
(IDEA)
I Income from continuing operations (gross then net of tax) (operating and non
operating)
D Income from discontinued operations (net of tax)
E Extraordinary item (net of tax)
A Accounting Principle change (to R/E net of tax)
Discontinued Operations
1. Accounting for discontinued operations item can consist of gain or loss on current
year’s operations, gain/loss on sale and impairment loss. Any of these must be reported
as part of discontinued operations in the same year as they occurred. If the operations are
being “held for sale,” they are treated as discontinued.
4. Anticipated future gains or losses are not recorded until they occur.
5. Subsequent directly related expenses are classified in the period they occur as
discontinued operations. Must demonstrate cause-and-effect relationship and occur no
later than one year after the date of disposal (unless circumstances beyond the control of
the entity exist).
Extraordinary Items
Unusual or infrequent items are reported within the ‘upper’ (I) part of the income
statement and before tax (other gains/losses). Ex. Gain or loss on sale of available-for-
sale securities, losses form major strike by employees, write downs.
Accounting Changes
1. Changes in estimate, such as the useful life of a plant asset, are incorporated into
the accounting records for the current and future periods. No change in
estimate has any implications for prior financial statement periods.
2. Changes in principle (or method) involve switching from one acceptable method
to another. The cumulative effect is the change in retained earnings that results
from restating prior years from the ‘old’ method to the ‘new’ method at the
beginning of the year. The cumulative effect is reported in the statement of
retained earnings. (GAAP to GAAP)
In the single step income statement presentation of income from continuing operations,
total expenses (including income tax expense) are subtracted from total revenues: thus,
the income statement has a single step. The benefits of a single step income statement are
its simple design and the fact that the presentation of types of revenues or expenses do
not appear to the user to be classified as more important than others.
The multiple step income statement reports operating revenues and expenses separately
from non-operating revenues and expenses and other gains and losses. The benefit of the
multiple step income statement is enhanced user information (because the line items
presented often provide the user with readily available data with which to calculate
various analysis ratios.
Cost Categories
Summary of Significant Accounting Policies reflects the methods and policies employed
by the firm.
Interim financial reporting uses the same GAAP as do annual financial reports.
Timeliness is emphasized over reliability and income taxes are estimated each quarter
based on the estimated average tax rate for the whole year.
SEGMENT REPORTING
3. The ‘90% single industry dominance test’ means if one segment individually
contains 90% or more of the firm’s revenues, profits and assets, then the segment
reporting requirement is waived for that firm.
1. These firms have not yet started their primary operations or have generated
insignificant revenues to date.
2. Development stage enterprises use ‘regular GAAP’ with a couple of differences
regarding labeling and summation of cumulative reporting.
1. Assets are probable future economic benefits obtained as a result of a past event
and liabilities are probable future sacrifices or economic benefits. Revenue is
recognized when earned and expenses when incurred and these two need to be
matched in their appropriate period.
3. Franchise fees, initial and continuing, are revenues to the franchisor and expense
to the franchisee depending on the circumstances.
- the present value of any contract amounts relating to future services (to be
performed by the franchisor) should be recorded as unearned revenue.
- the franchisor should report revenue from initial franchise fees when all material
conditions of the sale have been “substantially performed.” (usually the
franchisee’s first day of operations)
- the initial franchisee fee is capitalized by the franchisee and amortized over the
expected period of benefit of the franchise. (expected life of franchise)
- continuing franchise fees should be recorded as an expense to the franchisee and
revenue to the franchisor in the proper period.
INTANGIBLE ASSETS
1. Some intangibles are identifiable [copyrights and patents, e.g.] while one is
unidentifiable [goodwill]. Purchased identifiable intangible assets should be
recorded at cost plus additional expenditures necessary to purchase.
2. Amortizing identifiable intangibles with finite lives is done over the shorter of the
estimated economic and legal life. Goodwill and identifiable intangibles with
infinite lives are no longer amortized and are subject to impairment testing.
3. The cost of intangible assets developed internally and not specifically identifiable
(or having indeterminate lives) should be expensed when incurred.
- exception: Cost that can be capitalized: Legal fees and other costs related to a
successful defense of the asset, registration or consulting fees, design costs (ex.
Of a trademark) and other direct costs to secure the asset.
4. Expenses that increase the useful life of the intangible asset will require an
adjustment to the calculation of the annual amortization.
5. patent is amortized over the shorter of its estimated life or remaining legal life.
START-UP COSTS
In financial accounting, start-up costs are expensed as incurred. [Note: tax rules permit
these costs to be capitalized.] These costs are expensed due to conservatism It is not
definite the new entity will be a success.
R & D include cost incurred prior to tech feasibility for developed software that is to
be sold, leased, or marketed.
TECHNOLOGICAL
FEASIBILITY RELEASE PRODUCT
IDEA ESTABLISHED FOR SALE
IMPAIRMENTS
Think of this as two impairment tests: recoverability and calculating the impairment loss.
1. Meet the recoverability test if the asset’s carrying value > the sum of future
undiscounted net cash flows
2. Then, if the asset’s carrying value > the asset’s fair market value, the excess is the
impairment loss.
Step3: compute gross profit earned (profit to date): Step 1 * Step 2 = PTD
Step 4: compute gross profit earned for the current year: PTD at current FYE
(PTD at beginning of period)
Current year-to-date GP
3. Both methods recognize estimated losses immediately. General rule for losses
with a few exceptions.
2. Cost recovery method is more conservative than the installment method and is
used when collectibility is more doubtful. Revenue is not recognized until the cost
of the asset sold is recovered. Profit is recorded as Deferred gross profit (contra-
receivable)
Cr Sales
Cr Deferred Gross Profit
DR COGS
DR AR
PARTNERSHIPS
2. Admission of new partners may be by the exact, bonus or goodwill method. The
bonus method adjusts the partners’ capital accounts for any difference and the
goodwill method adjusts the assets for the difference.
- Exact Method:
Total new equity= existing equity + new partners % (new equity)
- Bonus Method: (current equity Balance controls the calculation)
Bonus will be credited in the following manner
Existing partners – when new partner pays more than NBV
New partners – when new partner pays less than NBV
- Goodwill:
Going in investment (dollars) controls capital account allocation &
goodwill calculation.
4. When a partnership is liquidated, assets are sold, gains or losses are allocated to
partners, liabilities are paid and the partners are entitled to receive the balance in
their capital account. Partners who wind up with debit (overdrawn) balances owe
that deficiency to the partnership and the other partners.
Financial Accounting & Reporting
CHAPTER 3
MARKETABLE SECURITIES
Marketable securities have readily determinable fair values. These include equity and/or
debt securities.
2. The trading securities portfolio can contain debt and/or equity securities intended
for active trading. The portfolio itself is carried at cost and is reported at fair value
in the financial statements through the use of a valuation account. Unrealized
gains or losses are reported on the income statement.
3. The available-for-sale securities portfolio can contain debt and /or equity
securities that do not fit into either of the other two portfolios. The portfolio itself
is carried at cost and is reported at fair value in the financial statements through
the use of a valuation account. Unrealized gains or losses are reported in Other
Comprehensive Income (the ‘U’ in PUFE). Should be reported as either current
assets or noncurrent assets, depending on the intent.
1. Use cost method when investor cannot exercise significant influence over investee
– generally ownership of less than 20% of outstanding shares.
2. Use equity method when investor can exercise significant influence (generally
from 20% to 50% of ownership of outstanding shares).
5. Stock dividends are not accounted for under the Cost and Equity Methods. Only a
memo is made.
1. Record the investment at cost. Generally, dividends received by the investor are
treated as dividends revenue. Dividends in excess of earnings, or liquidating
dividends, reduce the investment account. “Return of Capital” The basis is
adjusted to FMV as required for marketable equity securities using a valuation
account. The “Investment in Investee” is not adjusted for investee earnings.
2. Sale of a cost method investment merely involves comparing the proceeds with
the cost basis of the securities sold to determine the realized gain/loss. [Note
liquidating dividends lower the cost basis.]
THE EQUITY METHOD
1. Record the investment at cost. Generally, dividends received from the investee
reduce the Investment account and the investor “picks up” its share of investee’s
earnings by increasing the Investment account and recognizing the earnings on its
income statement. Under the equity method, the Investment account is similar to a
“bank account.”
- B: Beginning Balance
- A: Add: Investee’s earnings (like bank interest; it is income when earned, not
when taken out).
- S: Subtract: Investee’s dividends (like bank withdrawals; and it is not
income)
- E: Ending Balance
2. Differences between the price paid for and investment and the book value of the
investee’s net assets are allocated first to the FMV of assets and then to Goodwill.
Excess asset FMV is depreciated, while the excess value of Land and Goodwill
are not amortized.
Goodwill Excess =$
FMV X% =$
NBV X% =$
Purchase
Price
DO NOT CONSOLIDATE
COST METHOD EQUITY METHOD
Goodwill
not amortized
not impaired
1. The purchase is recorded for the fair value of any consideration paid. Direct
expenses are added to cost and securities issuance costs reduce Additional Paid-In
Capital.
2. The purchase begins as the date of acquisition, unlike pooling, which is accounted
for as if the combinor and the combinee(s) had always been together.
3. If the purchase price exceeds the fair value of the net identifiable assets acquired,
the excess is goodwill. Any goodwill is implicitly part of the Investment account.
4. If the purchase price is smaller than the fair value of the net identifiable assets
acquired, the shortfall is used to reduce proportionately the fair values of non-
current assets acquired (other than non-current investments).
5. If these non-current assets acquired have been reduced to zero without having
used up the shortfall entirely, the remaining shortfall is treated as an extraordinary
gain.
The consolidating journal entry eliminates the owners’ equity accounts of the
subsidiary (common stock, A.P.I.C. and retained earnings), eliminates the Investment
account, recognizes the minority interest (MI percent ownership of subsidiary’s
equity), adjust acquired assets to their fair values and recognizes goodwill in the
consolidated balance sheet. The mnemonic CARIMAG is used for the elements of the
eliminating journal entry. When later years’ balance sheets are shown, it is necessary
to adjust RE back to purchase date. See example on page 25 & 30
INTERCOMPANY TRANSACTIONS
Companies are under common control or companies are under common management
The subsidiary’s books are adjusted to reflect the fair values of assets and liabilities as
seen by the parent firm by “pushing down” the consolidation adjustments to the financial
statements of the subsidiary. If goodwill was implicit in the purchase price, the goodwill
is recorded explicitly in the subsidiary’s books. The owners’ equity accounts of the
subsidiary are adjusted to make the sub’s book balance after these adjustments. The SEC
requires push down accounting for all “substantially owned” subsidiaries.
1. Working Capital is a measure of the solvency of an entity. The Current Ratio and
Quick Ratio are used for analysis purposes.
2. Current assets and liabilities generally must meet the one year test or normal
operating cycle if longer.
CASH AND CASH EQUIVALENTS
1. Cash must be readily available. Cash equivalents are debt securities with maturity
dates within 90 days of date purchased. The only occasion when time to maturity
matters is at the purchase date.
a. Restricted cash must be segregated from other cash.
2. Bank reconciliations reconcile ending balances per bank and book adding and
subtracting items causing differences between the two balances. Outstanding
items are adjustments on the ‘bank side’ and ‘adjusting journal entry information’
are adjustments on the ‘book side’.
ACCOUNTS RECEIVABLE
2. Estimating Uncollectibles
a. Direct write-off method, used for tax, is not GAAP
b. Allowance method is GAAP. The allowance for uncollectible accounts is
a contra-asset. Percentage of sales method (income statement approach)
determines bad debt expense as a percentage of sales or credit sales for the
period. In the balance sheet approach (aging method) the ending balance
in the allowance account must equal an amount determined by an analysis
of the aged A/R schedule.
c. In the allowance method, writing off an account receivable involves
debiting the allowance and crediting accounts receivable.
d. When collecting an account previously written off, restore the account
receivable and the allowance into the accounts and then record the
collection in the normal way. (reverse write-off JE and record collection)
3. Factoring receivables can be done with or without recourse. With recourse means
the transferor retains the risk of uncollectibility. Factoring without recourse is a
sale of the receivable and the assignee assumes the risk of loss.
4. Pledging (Assignment) – the process whereby the company uses existing accounts
receivable as collateral for a loan. The company retains title to the receivables but
“pledges” that it will use the proceeds to pay the loan.
NOTES RECEIVABLE
1. Discounting notes receivable involves transferring the note to a third party usually
for cash. This transfer can be with or without recourse If done with recourse a
contingent liability is created for the transferor.
a. Compute the maturity value of the note by adding the interest to the face
amount of the note
Face value of the note
Interest on note to maturity
Payoff value of note at maturity
d. Derive the interest income (or expense) by subtracting the face value of
the note from the amount paid by the bank for the note
INVENTORIES
4. Perpetual and periodic inventory systems control how we account for purchases
and sales of inventory.
- Perpetual system records purchases with a debit to inventory. Periodic
system records purchases with a debit to purchases.
- Perpetual system records inventory sales in two journal entries. The
periodic system only records the receivable and revenue at time of sale.
The inventory account is updated at the end of the period after taking a
physical count.
5. Inventory methods include first-in, first-out (FIFO), last-in, first-out (LIFO) and
weighted average. These methods may apply to both periodic and perpetual
systems. Since FIFO values inventory at most recent costs, it will generally result
in a higher net income than other methods in a period of rising prices. Weighted
average is called “moving average” in perpetual.
6. The gross profit and retail inventory methods attempt to estimate ending
inventory based on the historical gross profit or cost complement percentage.
With perpetual inventory systems there is generally no need to estimate ending
inventory.
9. Period Costs:
Marketing costs, Freight out, Re-handling costs, Abnormal Spoilage, Idle plant
capacity costs.
FIXED ASSETS
1. Fixed assets are valued at historic cost to acquire and put into use with few
exceptions. Donated fixed assets are recorded at fair value and a gain or revenue
is recognized equal to that value.
3. Accounting for replacements depends on how the accounting records have been
kept for the asset being replaced.
- If the carrying value of the old asset is known, remove it and recognize any gain
or loss. Capitalize the cost of the improvement/replacement to the asset account
- If the carrying value of the old asset is unknown, and:
o The asset’s life is extended, debit accumulated depreciation for the cost of
the improvement/replacement.
o The usefulness (utility) of the asset is increased, capitalize the cost of the
improvement/replacement to the asset account.
Increase life X
Improvement/Replacement:
Increase Usefulness X
Ordinary Repair: X
Increase life X
Extraordinary repair:
Increase Usefulness X
5. Land should be recorded to reflect all the costs necessary to make the land ready
for its intended use. Land improvements have finite lives and should be
depreciated.
When preparing the land for the construction of a building:
Land cost – filling in a hole or leveling
Building cost – digging a hole for the foundation
“Basket Purchase” of land and Building
Allocate the purchase price based on the ration of appraised values of
individual items.
7. The composite (dissimilar assets) and group (similar assets) depreciation methods
depreciate an entire class of assets over a single life
- The straight-line, sum-of-the-years’ digits and declining balance methods
are the three major methods of depreciation.
Rate per unit * #of units produced (or hrs worked) = depreciation expense
9. Depletion is similar to the units-of-production method except the former is
applied to ‘wasting’ assets. Restoration costs should be included.
2. Having met the recoverability test, the impairment test is met if the carrying value
of the asset exceeds its fair value.
3. If the impaired asset is held for use, the asset is written down to fair value and
subsequent depreciation is based on that fair value. If the fair value were to
subsequently ‘rebound’, no restoration is permitted.
4. If the asset is held for disposal, depreciation is discontinued. If the fair value were
to partially recover prior to sale, a restoration is permitted. This restoration result
is similar to discontinued operations items in F1.
Total Impairment
DR Accumulated depreciation
DR Loss due to impairment
CR Asset
Partial Impairment
DR Loss on impairment
CR Accumulated depreciation
Remember:
Determining impairment- use undiscounted future net cash flows
Amount of impairment – use present value future net cash flows (PV net cash
flows = FMV)
Undiscounted future net cash flows
(Net carrying value)
Positive Negative
No Impairment Impairment
Loss
Assets held Assets held
for use for disposal
1. Present value of $1 (Capital lease buyout at end of lease (Bargain Purchase) &
Bond principal payout at end)
2. Future value of $1 (Like a bank account)
3. Present value of an ordinary annuity. (Annuity in Arrears) (used for periodic lease
pmts & periodic bond interest pmts).
4. Future value of an ordinary annuity. (investing in an IRA)
5. Present value of an annuity due, and
6. Future value of an annuity due.
Ordinary Annuity
vs. 10 00 10 00 10 00 0
Annuity Due
10 00 10 00 10 00 0
Conversion
Present value of an ordinary annuity for 3 periods at 8% 2.577
Plus: 1:00 1.000
Present value of an annuity, due for 4 periods at 8% 3.577
1. Operating leases are essentially ‘rentals’ and all cash flows have to be straight-
lined over the lease period as the periodic expense to the lessee and as lease
revenue to the lessor (matching principle). Cash payments intended to be
returned to the lessee are excluded from the expense/revenue calculation and are
treated as deposits.
4. Rent Kicker (ex. Percentage rent) – A premium rent payment required for
specific events – Record as period expense.
LESSEE LESSOR
Remaining Months
D
DR Rent expense R Cash
C
DR Accrued rent payable R Rental Income
C
CR Cash/rent payable R Accrued rent receivable
1. Lessees account for capital leases as though purchased if one or more of 4 (owns)
tests is met:
a. Ownership transfers to lessee at end of lease
b. Written bargain purchase option exists [PO<estimated fair value]
c. Ninety percent of the leased property’s fair value is less than or equal to
the present value of the minimum lease payments.
d. Seventy-five percent of the asset’s economic life will be consumed in the
lease term.
2. Lessees record the capital leased asset and the lease liability at the present value
of the minimum lease payments, not to exceed fair value of asset. Lesser of cost
or FMV.
DR Fixed asset- leased property
CR Liability – obligation under capital lease.
3. Minimum lease payments include the required periodic payments and the
bargain purchase and/or guaranteed residual value (if any). Executory costs
(maintenance, insurance, taxes, etc.) are excluded.
4. The interest rate used is the lesser of the rate implicit in the lease (if known) or
the lessee’s incremental borrowing rate. The lease liability is amortized using the
effective interest method.
5. Depreciation is based on the lease term unless the lease has a bargain purchase
option or ownership transfers to lessee at end of the term.
1. Lessors with capital leases may have sales type or direct financing leases.
Lessors have capital leases when meeting one of the 4 OWNS tests as described
for lessees above. In addition, there can be no material uncertainties about
collectibility or unreimbursable costs.
Gross Investment
DR Cost of Goods Sold
2 Net Investment CR Inventory (asset sold)
Cost of Asset
((PV Unguaranteed Residual)
Cost of Goods Sold
Journal Entry
DR Lease payments receivable #1
DR Cost of Goods Sold #4
CR Sales #5
CR Equipment given
CR Unearned interest revenue #3
3. In a direct-financing type lease, the lessor acts essentially as a finance company
and does not recognize gross profit on sale; Interest revenue is recognized by the
effective interest method.
4.
Lessor Accounting
Direct Financing Lease Calculations
(with unguaranteed residual value)
Lease payment
+ Unguaranteed residual value
Gross Investment
2 Net Investment
Journal Entry
DR Lease Receivable (gross investment) #1
CR Equipment (at cost or FMV) given
CR Unearned interest revenue #3
1. If the seller/lessee retains substantially all (90+ %) of the rights, any gain is to be
deferred over the leased asset.
2. “Minor” (<10%) retention allows full recognition of any gain, while mid-range
(10%-90%) requires a separate calculation.
Excess Profit on Sale - Leaseback
SALE-LEASEBACK : SUMMARY
Major Middle Minor
90% or more 90% - 10% 10% or less
Defer All Defer
GAIN (up to PV of leaseback) No Deferral
(Amortize over leaseback) (Amortize over leaseback)
LOSS (NBV > FMV)
(real economic Recognize Recognize Recognize
losses) Immediately Immediately Immediately
OTHER LOSSES
(artificial loss) Defer All Defer All Recognize
(Amortize over leaseback) (Amortize over leaseback) Immediately
SUBLEASES
1. Sublease classification by sub-lessee
- same category as original lease
2. Sublease classification by sub-lessor
-if original lease was an operating lease, then as an operating lease
-if original lease was a capital lease, by:
-O or W, sublease is a capital lease
-N or S, sublease is an operating lease unless is meet the req. for cap lease.
Stated (Nominal) Interest Rate – (coupon rate)- rate specified on the bond contract
Market (Effective yield) Interest Rate – rate actually earned by the bond holder, caused
by discount or premium.
FMV Bond = PV of future interest pmts (at market rate) + PV of principle (at market
rate)
Carrying value of bond = FACE +/- (unamortized premium/discount)
2. Bond selling price is the sum of the present value of the total face value of the
bond plus the present value of future interest payments, both discounted at the
effective (market) interest rate. In general, when the bond coupon rate exceeds
the market rate the bond will sell at a premium. If the bond coupon rate is below
the market, the market will adjust and the bond will sell at a discount.
3. Bonds can be issued for more or less than their face amounts. If sold above the
100 face value, the excess is premium. If sold below 100, the difference is
discount. Premium and discount result from market interest rate fluctuations and
they are amortized to interest expense using the straight-line or effective interest
(preferred) method. Unamortized discount or premium is a component of the
carrying value of a bond. Carrying value is eventually face value at the maturity
of the bond and it is used to calculate the interest expense when using the
effective interest method of premium/discount amortization.
DIFF AMORTIZATION
4. Bond issue costs are amortized using the straight-line method. The bond issue
costs are recorded as an asset and amortized over the bond life.
DR Cash
DR Discount
DR Bond Issue Cost (Asset)
CR Bonds Payable
5. When bonds are issued between interest payment dates, the selling price includes
the accrued interest to date. (use coupon rate to determine accrued interest)
7. Bond Sinking Funds are created to avoid a cash shortage at the time of debt
repayment. It is generally a non-current (restricted) asset. Determining how much
to invest in a sinking fund is like an IRA. Use the FV of an ordinary annuity to
figure out how much to deposit each period (pg50).
Example
BONDS OUTSTANDING METHOD SUMMARY
(1) (2) (3) (4) (5) (6)
FRACTION OF PRE / DIS INTEREST INTEREST
OUTSTANDIN AMORTIZATIO
G TOTAL BONDS N PAYMENT EXPENSE
(coupon% * col. (col. 5 -
PERIOD VALUE OUTSTANDING (pre/dis * Col.3) 2) col.4)
10. Detachable stock purchase warrants have a value separate from the bond and the
value of the warrants is part of stockholders’ equity. The warrant gives the
bondholder the right to buy stock at a fixed price within a specific time. At issue
date allocate bond proceeds between the bond and the warrants. The warrants
only or market value method may be used.
a. Warrants only method – used if only the fair market value of the
warrants is known.
Detachable Warrants/ Warrants Only Method
Bond Premium/Dis. Warrants Cash Common Stock
face pre/dis Total Warrant Amt cash per share Stock Par
*0 *0 * % exercised * amt exercised * amt exercised
total par
APIC SQUEEZE
0 + 0 + Amt Converted + Total Cash paid = Total CS
BOND STILL HELD DETACHABLE
b. Market Value Method – market value of both the warrants and bonds is
known.
Detachable Warrants Market Value Method
To record purchase of convertible bonds with detachable warrants
DR Cash
CR Bonds Payable
CR APIC-Warrants
DR/CR Discount/Premium PLUG
To record exercise of warrants
DR Cash (additional received)
DR APIC-Warrants
CR Common stock (at par)
CR APIC in excess of par
11. Extinguishment of debt can occur at maturity or earlier (if the issuer calls the
bond). Early extinguishment can cause and extraordinary item if it is both
unusual and infrequent.
(gain) or loss = Reacquisition price- Net carrying amount
Net Carrying amount = face value +/- unamortized premium/discount –
unamortized issue costs.
Face of payable
+ accrued interest
Total obligation
GAIN
2. If an equity interest is transferred, there may be a gain to the extent that the FMV
of the equity transferred exceeds the face of the payable. This gain may also be
classified as extraordinary if it meets the requirements.
3. If there is a modification of terms, the debtor does not change the carrying
amount of the debt unless it exceeds the face of the payable. This gain may also
be classified as extraordinary if it meets the requirements.
4. If there is a modification of terms, the debtor does not change the carrying amount
of the debt unless it exceeds the total future cash payments under the new terms.
1. Pension plans can be broken out into defined benefit and defined contribution.
The CPA exam has emphasized defined benefit plans in which an employer
provides an employee with defined retirement benefits in exchange for current or
past services. As employees work, the pension benefits accumulate and actuarial
computations are necessary to determine the present value of the future payments
due. A pension plan and the sponsoring company are two separate legal entities.
The CPA exam and GAAP for pensions addressed in this chapter are concerned
with how the sponsor company accounts for the plan.
Accounting for pension plans is concerned primarily with determining the amount of
- Pension expense that appears on the sponsoring company’s income
statement,
- Any related pension accounts (asset, liability, and/or contra-equity
accounts) that appear on the sponsor company’s balance sheet.
INCOME STATEMENT
PENSION EXPENSE FORMULA
Six components:
I. Current Service Cost = PV of all benefits earned this period or the increase in
the PBO.
II. Interest Cost = increase in PBO during the current period due to passage of
time.
BEGINNING OF PERIOD PBO
SETTLEMENT RATE
INTEREST COST
- Benefit payment
Ending fair value of plan assets
-When deciding which balance (assets or liabilities) for the gains/losses components, use
the “GREATER” of the two.
-When deciding which period to amortize the existing obligation over (15 years or
average service life), use the “GREATER” of the two.
5. The Minimum Pension Liability is the excess of the ABO over the fair value of
the plan assets. An additional liability will be recorded to the extent that the MPL
exceeds the accrued pension cost already recorded, limited to the extent of
unrecognized prior service costs. Any excess at that point will be reported as a
component of Other Comprehensive Income (the P in PUFE).
a. Fair Value (Asset) > ABO (Liability) – the plan is considered to be
sufficiently funded – no entry is necessary.
b. ABO (Liability) > Fair Value (Asset) – the plan is considered to be under
funded and the sponsor company must ensure that the BS reflects a
liability at least equal to the excess of the ABO at the end of the year. This
is the Minimum Pension Liability.
i. Accrued Pension Cost >= Minimum Liability –No entry is
necessary because the liability on the BS already equals or exceeds
the minimum.
ii. Accrued Pension Cost< Minimum Liability - The liability
already on the BS is insufficient (below the minimum). An
additional liability must be recorded
6.
CURRENT LIABILITY (accrued pension cost liability)
"SIR-AGE"
(payments)
(prior year prepaid)
CURRENT LIABILITY
DR NET PENSION EXPENSE
CR ACCRUED PENSION COST/LIABILITY
1. The cost of retire health care and other benefits is accrued if the obligation is
attributable to services already rendered, these rights accumulate or “vest”,
payment is probable and the amount can be reasonably estimated.
2. Benefits are accrued over the attribution period, the period from the date of hire
to the date fully eligible for the benefit. The components of the cost and other
disclosures follow rules similar to defined benefit pension plans.
6. Three significant differences between accounting for post retirement benefits and
accounting for pensions. For postretirement benefits other than pensions:
a. Option to Expense total transition obligation
b. 20 year minimum for amortization of transition obligation
c. A minimum liability/obligation need NOT be recorded, no journal entry is
required, however, report in notes.
1. These benefits (severance pay, salary continuation, etc.) are enjoyed after
employment and are not the same as after retirement benefits.
2. GAAP requires the accrual of a liability if the same four criteria as for
postretirement benefits are met.
CONTINGENCIES
2. Loss contingencies that are probable and can be reasonably estimated must be
accrued. The best estimate of the loss should be accrued. However, if there is no
best estimate, a range of losses is given, the minimum amount is accrued and the
remaining amount is disclosed in a footnote. Gain contingencies that are probable
are not accrued but are disclosed.
3. The nature and amount of a loss or gain contingency that is reasonably possible
is disclosed in a footnote and is not accrued.
5. Unasserted claims follow similar rules for disclosure and/or accrual for any other
loss contingency.
6. General or unspecified business risk (such as fire, floods, strikes, and war) do
not meet the conditions for accrual, and no loss accrual shall be made, nor a
disclosure.
CONTINGENCY TREATMENTS
Accrue Disclose
Amounts Amt Nature Ignore
1 LOSS contingency that is probable and:
a. Amount or range can be reasonably estimated X (or minimum) X
b. Amount cannot be reasonably estimated Range X
Intraperiod tax allocation involves apportioning the total tax provision for financial
accounting purposes in a period between the income or loss among the multistep income
statement. (IDEA, PUFE, & Components of stockholders’ equity).
The objective of interperiod tax allocation is to recognize through the matching principle
the amount of current and future tax related events that have been recognized in financial
accounting income.
The asset and liability (sometimes referred to as the Balance Sheet Approach) method is
required by GAAP for comprehensive allocation.
1. GAAP and tax (IRS) accounting rules differ considerably. Some of the
differences are permanent because they never reverse. Other differences are
temporary because they involve mere timing differences between the financial
and tax accounting implications.
4. Tax expense is subdivided into two components: current tax expense [CTE] and
deferred tax expense [DTE].
OWE NOW + OWE LATER = EXPENSE ON FINANCIAL STMT
5. Current tax expense [CTE] is merely the result of multiplying taxable income
from the tax return by the tax rate. The exam routinely ignores estimated tax
payments by firms.
TEMPORARY
TAX RETURN DIFFERENCE FINANCIAL STATEMENT
+DEFERRED LIABILITY
CURRENT LIABILITY = TOTAL TAX EXPENSE
- DEFERRED ASSET
NEVER MULTIPLY THE F/S INCOME BY THE TAX RATE TO GET THE TAX EXPENSE
Total tax expense for financial statements is the combination of current tax plus/minus
deferred taxes.
The CPA examiners frequently provide an incorrect calculation of financial statement
income times the current tax rate. This is an incorrect method to determine the total
expense for the following reasons:
6. The deferred tax account(s) is the balance sheet must be adjusted at the end of
each year to reflect the appropriate amount of deferred tax liability [DTL] or the
appropriate amount of a deferred tax asset [DTA].
FINANCIAL STATEMENT
A INCOME FIRST B TAX RETURN INCOME FIRST
FINANCIAL STATEMENT
TAX RETURN INCOME LATER INCOME LATER
GIFT CERTIFICATE
FUTURE PREPAID
TAX INC. LATER = TAX TAX INC. FIRST = TAX
LIABILITY BENEFIT
(ASSET)
1 Installment Sales 1 Prepaid rent
2 Contractors accounting (% vs completed) 2 Prepaid interest
3 Equity method (undistrubuted dividends) 3 Prepaid royalties
FINANCIAL STATEMENT
C EXPENSE FIRST D TAX RETURN EXPENSE FIRST
FINANCIAL STATEMENT
TAX RETURN EXPENSE LATER EXPENSE LATER
GIFT CERTIFICATE
FUTURE FUTURE
TAX DEDUCT LATER = TAX TAX DEDUCT FIRST = TAX
BENEFIT LIABILITY
(ASSET)
1 Bad debt expense (allowance vs. direct w/o) 1 Depreciation expense
2 Est. liability/warranty expense 2 Amortization of franchise
3 Start-up expenses 3 Prepaid expense (cash basis for tax)
9. DTA’s and DTL’s must be re-calculated each year based on enacted tax rates in
the year(s) in which the taxable item is expected to be realized or paid.
a. Use the tax rate in effect when the temporary difference reverses itself. Do
not allow the CPA examiners to trick you into using the following:
i. Anticipated
ii. Proposes
iii. Unsigned
10. For Balance Sheet presentation, deferred tax items are classified as they relate to
current or noncurrent assets and liabilities. DTA’s and DTL’s classified as current
are netted together and only one account appears on the Balance Sheet.
Noncurrent DTA’s and DTL’s receive similar treatment.
a. RULE #1 – Deferred tax items should be classified based on the
classification of the related asset or liability for financial reporting
b. RULE #2 – Deferred tax items not related to an asset or liability should be
classified (current or noncurrent) based on the expected reversal date of
the temporary difference.
c. RULE #3 – Deferred tax liabilities and assets should be net across the
balance sheet NOT up & down. Current with current & noncurrent only
with noncurrent.
11. If it is more likely than not (a likelihood of more than 50 percent) that all or
part of a deferred tax asset will not be realized, a valuation allowance must be set
up to reduce the asset.
Intraperiod tax allocation relates to apportioning the total tax provision among the
various Income Statement sections (IDEA) from F1.
The Required Reading reviews Other Liabilities that have some history on the CPA
exam. There are also three appendices adding more detail on defined benefit pension
plans.
Financial Accounting & Reporting
CHAPTER 7
FINANCIAL INSTRUMENTS
STOCKHOLDERS’ EQUITY
Capital Corp
Common stock, $10 par value, authorized 50,000 shares, issued 30,000
shares of which 5,000 are held in the treasury 300,000.00
350,000.00
ADDITIONAL PAID-IN CAPITAL (capital in excess of par or stated value)
Excess of issue price over par value of common/preferred stock sold $29,000.00
Excess of sales price over cost of treasury shares sold 15,000.00
Excess of FMV over par of stock issued as stock dividend 20,000.00
Defaulted stock subscriptions 10,000.00
FMV of common shares contributed by shareholders to corporation 75,000.00
FMV of fixed assets contributed by local government 60,000.00 209,000.00
RETAINED EARNINGS
Appropriated (reserved) for general contingencies 50,000.00
Appropriated (reserved) for possible future inventory decline 20,000.00
Appropriated (reserved) for plant expansion 40,000.00
Appropriated (reserved) for higher replacement cost of fixed assets 60,000.00
Unappropriated (unreserved) 200,000.00 370,000.00
929,000.00
ACCUMULATED OTHER COMPREHENSIVE INCOME 10,000.00
a. Cumulative – all or part of the preferred dividend not paid in any year
accumulates and must be paid in the future before dividends can be
paid to common shareholders. (dividends in arrears)
b. Participating – “first share equally then pro-rata”
. Fully participating – means that preferred stockholders participate in excess dividends
without limitation.
. Convertible – may be exchanged for common stock (at the option of the stockholder) at a
specified conversion rate.
- The primary difference between the cost method and the legal method is
the timing of the recognition of “gain or loss” on treasury stock
transactions. Note that under both methods the “gains or losses” are
recorded as a direct adjustment to stockholders’ equity and are not
included inn the determination of net income.
- COST METHOD- the treasury shares are recorded and carried at their
reacquisition cost. A gain or loss will be determined when treasury stock
is reissued or retired, and the original issue price and book value of the
stock do not enter into the accounting.
TO RECORD THE RESALE OF TREAS. STOCK AT A GAIN TO RECORD PURCHASE OF TREASURY SHARES AT A GAIN
DR Cash (amount of the sale) DR Treasury stock (1,000 @ $1 par)
D
CR Treasury stock (at cost) R APIC (pro rata: 1,000 * $9)
CR Additional paid-in capital (sales proceeds > cost) CR Cash (1,000*8)
CR APIC - Treas. Stock (2000) PLUG
TO RECORD THE RESALE OF TREAS. STOCK AT A LOSS TO RECORD THE RESALE OF TREAS. STOCK
DR Cash DR Cash (amount of the sale) (18,000)
DR APIC - Treasury Stock CR Treasury stock (1,000 shares @ $1 par) 1,000
DR R/E (excess of loss beyond the APIC balance) CR APIC $17,000
CR Treasury Stock (at cost)
STOCK SUBSCRIPTIONS
Compensatory Plan- SFAS 123R, issued in December, 2004 now requires that
compensatory stock options be valued at the fair value of the option issued, not on
the market value of underlying stock.
This compensation expense, calculated on the grant date of the options, is
allocated over the service period, in accordance with the matching principle. The
service period is the vesting period, which is the time between the grant dated and
the vesting date.
Any subsequent changes in the market price should be reflected in the fiscal
periods in which the changes take place as adjustments to the compensation
expense for that period. (CHANGE IN ESTIMATE – PROSPECTIVE)
DR COMPENSATION EXP
CR APIC- STOCK OPTIONS
A. Basic earnings per share assume no potentially dilutive securities. Basic EPS
divides ‘income available for common shareholders’ by the weighted average
number of common shares outstanding.
Simple Capital Structure – No options, warrants, convertible PS, convertible bonds.
Present EPS for income from continuing operations and for net income on the face of
the income statement. Only report Basic EPS.
Stock dividends and Stock Splits must be treated as though they occurred at the
beginning of the period. The shares outstanding before the stock dividend or
split must be restated for the portion of the period before the stock
dividend/split.
Complex Capital Structure – when it has securities that can potentially be converted
to common stock and would therefore dilute (reduce) EPS (of common stock). Both
basic and diluted EPS must be presented.
B. Diluted EPS employs the “if converted” and/or “treasury stock” method to re-
compute EPS as it would be if any dilutive securities such as convertible bonds or
preferred stock, rights, warrants and options. Antidilutive securities are not
considered.
Dilutive EPS = Income available to common shareholder + net interest on dilutive securities
Weighted Average Number of Common Shares, assuming all dilutive securities
are converted to common stock
D. The “if-converted” method should be used to determine the dilutive effects of the
convertible securities. The “if-converted” method assumes that the securities were
converted to common stock at the beginning of the period (or at time of issue, if
later).
E. Contingent shares, if dilutive, are part of the Basic EPS calculation if all
conditions for issuance are met. The numerator is simply NI, since it is assumed
all convertible PS are converted to CS at the beginning of the period or when
issued (which ever is later). Thus, PS dividends are not paid out.
F. Basic and Diluted EPS are disclosed by income statement component (IDEA) for
a proper presentation. Cash flow per share should not be reported. Basic and
diluted EPS for discontinued items and extraordinary items are reported on the
face of the income statement or in the notes.
EPS Summary
Weighted
Average Options & Warrants Convertible Bonds convertible P/S Contingent issues
Conditions have
BASIC yes N/A N/A N/A been fully satisified
FMV > Exercise
Price Any Dilutive Any Dilutive
If Converted
Treasury Stock If Converted Method
Method "pretend" Method "pretend" "pretend" Based upon
DILUTED yes Do NOT reduce conditions having
NIAT by the been met to date
Adjust net income preferred stock
Repruchase common for interest expense dividend
stock at the average (not incurred) (pretend they
price reduced by taxes were converted)
STATEMENT OF CASH FLOWS
i. Dividends paid
ii. Paying principal on note/bond/mortgage
iii. Common Stock/Equity transactions
iv. Owner-Oriented and Creditor-Oriented Activities
B. Cash equivalents (treated as cash) are debt securities with an original maturity
date of three months or less
C. The Operating Activities section adjusts Net Income to Cash Provided, or Used,
by Operating Activities. The mnemonic CLAD is useful to remember the various
adjustments.
D. The Indirect Method nets the cash flows from the three sections and reconciles it
to beginning and ending cash. Supplemental Disclosures of Cash Flow and
Noncash Investing and Financing Activities and Accounting Policy are also
included.
F. Information about material non-cash financing and investing activities (those that
do not result in cash receipts or payments) should be provided separately in a
supplemental disclosure.
As you can see, there is a lot to cover in F7 and, once again, the simulations will bring
out most of the important concepts to know
B. Monetary assets and liabilities are “fixed” in terms of dollars while non-monetary
assets and liabilities are not. Holding net monetary assets during inflation results in a
loss of purchasing power.
-Monetary – held during periods of inflation will result in a loss of purchasing power,
holding monetary liabilities will result in a gain of purchasing power.
-Non-Monetary – assets and liabilities will fluctuate with inflation and deflation.
Holders of non-monetary items may lose or gain with the rise or fall on the CPI if the
non-monetary item does not rise or fall in proportion to the change in the CPI. In
other words, a non-monetary asset or liability is affected by (1) the rise or fall of the
CPI and (2) the increase or decrease in the fair value of the non-monetary asset.
HOLDING
MONETARY During a period of During a period of
ASSETS deflation inflation
HOLDING
MONETARY During a period of During a period of
LIABILITIES inflation deflation
Governmental Units
Colleges and Universities
Health Care Organizations
Voluntary Health and Welfare Organizations
Foundations
Other not-for-profit Organizations
B. Government – wide financial statements are prepared using the accrual method of
accounting to permit an economic resources and measurement focus. This method is
essentially the same as used in ‘for profit’ accounting and is covered in more detail in F9.
Major funds are presented using the basis of accounting and measurement focus unique
to each category of fund. Only major funds (as defined by the GASB) are presented. Non-
major funds are displayed in the aggregate.
Fiduciary funds are excluded form the government-wide presentation. Enterprise funds
are carried into the Business-type Activities section of the government-wide financial
statements. Internal Service funds are often merged with Governmental Activities
displayed in the government-wide financials.
The use of a measurement focus and basis of accounting in the governmental y funds
different from the measurement focus and basis of accounting used in the government-
wide financial statements provides the elements of the reconciliation between the
governmental fund financial statements and the government-wide financial statements.
Adding fixed assets excluded from governmental fund financial statements and
subtracting non-current liabilities also excluded from governmental fund financial
statements are two of the most significant reconciling items between governmental fund
financials and government-wide financials.
C. Governmental funds use modified accrual basis of accounting and provide a current
financial resources measurement focus. Revenues are recognized when measurable
and available. Expenditures (not “expenses”) are generally recognized when resources
are spent. There are no non-current assets in governmental funds. The five
governmental (GRASPP) funds are the General, Special Revenue, Debt Service, Capital
Projects and Permanent funds.
D. Proprietary (SE) funds use full accrual accounting and the economic resources
measurement focus. The Internal Service and Enterprise Fund are the two proprietary
funds
E. Fiduciary (Trust) funds use full accrual accounting and the economic resources
measurement focus. The “PAPI” funds are Pension, Agency, Private Purpose and
Investment Trust funds.
GOVERNMENTAL FUNDS
NO Profit Motive
NO Income Statement
NO Matching Principle
NO Accrual Method
B. Recording the budget at the start of the year requires creating a journal entry
involving Estimated Revenues, Appropriations and Estimated Other Sources/Uses. Any
excess, or projected surplus, is credited to Budgetary Fund Balance. A projected shortfall,
or deficit, would be debited to that account. This entry is closed at the end of the year.
C. Revenue is recorded in the real accounts when it is measurable and available. Real
property taxes are considered revenue when billed to property owners. Sales taxes, if
measurable, due within sixty days after fiscal year-end are considered revenue.
G. Fixed Assets purchased, constructed or leased are not capitalized; however, they are
reported on the Government-Wide F/S (F9). Likewise, long-term debt is not recorded as
debt in a governmental fund, it is an Other Financing Source. LTD also goes to the
Government-Wide F/S. Nor is there depreciation expense recorded on governmental fund
F/S.
A. There is only one general fund in a particularly governmental entity. The general
fund is created at beginning of the governmental unit, and it exists throughout the life of
that unit. The general fund accounts for the general activities of a government that are not
accounted for by any other fund.
General government
Taxes activities
Public safety and Regulation Public Safety
Intergovernmental Culture and Recreation
Charges for Services
Other Revenues
B. Special revenue funds contain funds ‘earmarked’ (legally restricted) for particular
purposes. Users of these funds services are expected to provide less than 50% of the
costs. Intent controls the accounting, regardless of future realization.
Expendable trust funds are special revenue funds. Expendable trust activities (scholarship
and endowment funds) represent funding whose principal and income may be expended
in the course of their designated operations so that they are depleted by the end of their
designated lives.
Grants – when a grant is received, the recipient government monitors and/or determines
eligibility. Recognize revenues and expenditures equally based on payments of the
grantor.
RECEIPT OF GRANT
RULE OF THUMB FOR USE OF THE CORRECT FUND IS:
MONITORING = SPECIAL REVENUE FUND
NONMONITORING = AGENCY TRUST FUND
C. Debt service funds (DSF) pay for the principal and interest related to general
obligation debt. This is debt incurred by governmental funds (GRASPP). Other (SE-
PAPI) funds service their own debt. There is no accrual of interest expenditures or
interest payable.
The balance and interest payable in the debt service fund represent currently due
installments only.
The general fund may pay interest and principal directly form the general fund to the
bondholders, instead of directly to the debt service fund if the use of a debt service fund
is not mandated.
ENCUMBRANCES ACCOUNTS ARE NOT USED FOR DEBT SERVICE FUNDS AND
PERMANENT FUNDS.
D. Capital projects funds are created for each project underway for better accountability
of resources budgeted for each project. Only projects for governmental funds are
accounted for within a capital projects fund. These funds will use BAE-BAE accounting.
Financing sources may be long-term debt issues, capital grants, government grants or
special assessments charged to property owners benefited by the project.
Capital Grants – received in advance are often recorded as a liability and displayed as
earned as they are expended. Government grants may be restricted and are reported as
“revenues” when earned or may be unrestricted, and recognized immediately.
Restricted = Deferred Revenue, Reverse deferral when amount was earned.
E. Permanent funds are legally restricted. Only income can be spent with the principal
amounts ‘permanently’ restricted from spending. The funds are used for the benefit of the
public.
ENCUMBRANCES ACCOUNTS ARE NOT USED FOR DEBT SERVICE FUNDS AND
PERMANENT FUNDS.
THE EASY WAY TO DETERMINE WHERE RESTRICTED FUNDS ARE RECORDED
IS:
FUND USE SPENDING
Special Revenue Fund Public Principal and interest (expendable)
Permanent Fund Public Interest Only (nonexpendable)
Private purpose Fund Private Interest and/or principal (expendable)
LONG-TERM ADVANCES
DR CASH
CR DUE TO OTHER FUND
* FULL ACCRUAL CARRY EVERYTHING * FULL ACCRUAL CARRY EVERYTHING
A. Internal service funds serve other governmental units. The financial statements of an
IS fund are the Statement of Net Assets a Statement of Revenues, Expenses and Changes
in Net Assets, and a Statement of Cash Flows. Net Assets are classified as Unrestricted,
Restricted and invested in capital assets, net of related debt.
Internal Service Funds – established to finance and account for services and supplies
provided exclusively to other departments within a government unit or to other
governmental units, typically on a cost reimbursement basis. (eg. Central janitorial
services, central printing)
Self Insurance Funds – when a government elects to establish self-insurance funds, the
internal service is the appropriate fund. Other funds transfer “self-insurance premiums”
B. Enterprise funds serve users that are expected to provide over 50% of the resources
to fund the operation. The financial statements of an Enterprise Fund are the same as
those for an Internal Service Fund.
Enterprise Fund – used to account for operations that are financed and operated in a
manner similar to private business enterprises.
Activities are required to be reported as enterprise funds if:
- The activity is financed w/debt that is secured solely by a pledge of net
revenue from fees and charges.
- Laws and regulations require that the cost of providing services be
recovered through fees
- The pricing policies of the activity establish fees and charges designed to
recover its costs.
Municipal Landfills (The Dump)- Reporting and Disclosure – the estimated total current
cost of MSWLF closure and postclosure care should be disclosed as “estimated total
current cost of MSWLF closure and postclosure care to be recognized”
Estimated total costs should include:
- cost of equipment expected to be installed and facilities expected to be
constructed near or after the date that the MSWLF stops accepting solid
waste and during the post closure period. Only equipment to be
exclusively used for the MSWLF.
- Cost of gas monitoring & collection system
- Cost of final cover (capping) expected to be applied near or after the date
that the MSWLF stops accepting solid waste.
This estimate should be adjusted annually. Under proprietary fund reporting, a portion of
this estimated cost is recognized as an expense and as a liability, based on usage, each
period the MSWLF is operating. All costs are recognized as of the date of closure.
A. Pension trust funds account for government-sponsored pension (defined benefit and
defined contribution) and post-retirement plans such as health care benefits. (eg.
Employee retirement plan, deferred compensation plan) Additions and Deductions
replace Revenues and Expenses in the Statement of Changes in Fiduciary Net Assets.
Statement of Fiduciary net Assets does not include the required actuarial liability. It is
reported in the statement of funding progress.
Actuarial valuations in RSI are required biennially for plans with over 200 participants
and triennially for plans w/less than 20 participants.
B. Agency trust funds “MAILMAN” (no monitoring of recipient) are custodial funds.
Their assets equal their liabilities and there is no fund balance.
- Tax Collection Funds
Sales tax agency fund
- Clearance Funds
Food stamps, alimony
* If a governmental unit has monitoring and/or determines eligibility,
then the special revenue fund is used.
- Special Assessments
* If a governmental unit has liability, accounting is made through the
capital projects and debt service funds.
NO INCOME STATEMENT
NO CASH FLOWS
CA = CL
C. Private purpose trust funds (not general public use), such as an Escheat Property
Fund, contain resources for the benefit of other parties or entities
The private purpose trust fund is the designated fund for reporting all other trust
arrangements under which principal and income are for the benefit of one of the
following:
-specific individual
-private organizations
-other governments
Income form the principal of a private purpose trust may be placed w/another fund.
Capital gains & losses are recorded as adjustments to fund principal and not to income,
unless the grantor specified otherwise.
D. Investment Trust funds – accounting and reporting for certain investments and for
external investment pools established that a government entity that sponsors one or more
external investment pools (sponsoring government) should report the external portion of
each pool as separate investment trust fund. Investment trust funds are generally reported
using fair value.
Accounting & Reporting
CHAPTER 9
- The primary Govt. consists of all organizations that make up the legal
govt. entity. Neucleus of the financial reporting entity.
Change in Estimate for either the required method to the modified or the modified to the
required.
G. Donated artwork and historical treasures should be capitalized at their fair values
unless they will be exhibited, preserved and the proceeds of any sale will be used
to acquire other assets for the collection. (same for not –for-profits)
J. Reconciliation bet. Modified accrual govt. funds and govt.-wide accrual basis F/S
is preformed for the Balance Sheet (GALSBARE) and the statement of Revenues,
Expenditures and changes in Fund Balance (GOES BARE). Review pg 22
BALANCE SHEET
G GRASPP - Fund Balance
+ A Assets (non-current)
- L Liabilities (non-current)
+ S Service (internal) Fund Net Assets
B Basis of Accounting
A Accrued
R Revenue &
E Expenses
STATEMENT OF REVENUED, EXPENDITURES AND CHANGES IN FUND
BALANCE
G GRASPP - Net Change in Fund Balance
- O Other Financing Sources
+ E Expenditure - Capital Outlay (net of depreciation)
+ S Service (internal) Fund Net Income
B Basis of Accounting
A Additional Accrued
R Revenues &
E Expenses
K. Proprietary Funds
a. Statement of Cash Flows
i. Direct method is required
ii. Reconciliation of operating income (not net income) to net cash
provided by operations is required
iii. There are 4 categories (instead of three categories in commercial
accounting)
1. operating activity
2. investing activity
3. capital and related financing activities
4. non-capital financing activities
L. Required supplementary info other than MD&A will include interfund loans (due
to/form), interfund services provided or used, and interfund transfers or
reimbursements. Include budgetary comparison schedules that show the original
budget, the final amended budget, and actual amounts (budgetary basis).
M. Within columns we will eliminate interfund activity and between columns we will
not eliminate interfund activity.
NOT-FOR-PROFIT ORGANIZATIONS
The operating purpose does not include profit although there is nothing precluding the
generation of a profit.
(non-governmental)
C. Required F/S
Statement of Financial Position (A-L =NA)
Statement of Activities
Statement of Cash Flows
Statement of Functional Expenses (required HW reading)
Assets and Liabilities are displayed according to relative liquidity. Classified as current
or noncurrent. Nearness to cash and nearness to maturity.
Contributions, pledges, and gifts are classified into one of the following three categories
according to the existence or absence of donor imposed stipulations
Operating Activities
- include applicable agency transactions
- when using the direct method, operating activities should be reported by
major class of gross receipts (contributions, program income, etc)
- include receipts of unrestricted resources designated by the governing
body to be used for long lived assets
Financing Activities
- include cash transactions related to borrowing that are typically found in
commercial statements of cash flows but also include cash transactions
related to certain restricted contributions
- SUBCLASSES OF FINANCING ACTIVITIES
i. Proceeds form Restricted contributions – cash received with donor
imposed restrictions limiting its use to long-term purposes such as
increases to an endowment, purchases of assets or annuity
agreements is displayed as a financing activity. Disbursements of
these restricted contributions for either temp. investments or the
purpose for which they were intended are classified as investing
activity.
ii. Other financing activity – receipts & disbursements associated
with borrowing, disbursements associated with split interest
agreements, and receipts of interest & dividends restricted to
reinvestment.
Investing Activities
- Proceeds form the sale of works of art or purchases
- Investment in equipment
- Proceeds from the sale of assets that were received in prior periods and
whose sale proceeds were restricted to investment in equipment.
H. REVENUE
DR Expense or asset
CR contributions - non operating revenue
If the following (above) are not met, the donation must be recognized as an asset &
revenue.
Donated Materials –
- to be used will increase assets and support at the time of the
donation.
DR Asset
CR Contribution – support
When donated items are sold at greater than FMV, the amount received in excess is
contribution income.
Restricted Contributions
DR Pledge Receivable
CR Allowance for uncollectible
CR Restricted Rev- (temp. res. Net assets)
RESTRICTED
DR Reclassification: satisfaction of restriction
CR Cash/restricted net assets
UNRESTRICTED
DR Cash/unrestricted net assets
CR Reclass: satisfaction of restriction
DR Operating Expense
CR Cash/unrestricted
AMOUNT TRANSFERRED
(FAIR VALUE DUES/ PURCHASE)
CONTRIBUTION REVENUE
Transfers of assets to a NFP org. or charitable trust that holds contributions for others are
treated as “an extension of the equity method of accounting “If variance power is present,
treat inflows as revenue. If no variance power is present, treat inflows as liabilities.
Beneficiaries recognize their rights to assets held by others unless the recipient is
explicitly granted variance power.
DR Asset
AS LIABILITY
CR Refundable Advance
DR Asset
AS INCOME
CR Contribution Revenue
Investments in securities are reported at fair value. Gains and losses are reported in the
Statement of Activities as increases or decreases in unrestricted net assets unless use is
restricted (by donor).