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ECON 2710
Elizabeth Farrell

Final Exam Review ACTG 3110 December 11, 2013 CHAPTER 11 – Financial Instruments Introduction Objectives: - Invest idle cash: low risk, easily convertible; return through interest or dividends and gain; usually sell when cash is needed - Active portfolio: normal course of business; returns based on price fluctuations; offset (hedge) gains or losses - Long-term investments: money market instruments (bonds); interest and principal cash flows; increase investment revenue - Strategic alliances: beneficial intercompany relationships; - Legal frameworks: tax reasons, limit liability Financial instrument – contract that gives rise to a financial asset (right to receive cash or another financial asset) of one party and a financial liability or equity instrument of another party; usually debt securities and share investments ALL INVESTMENTS ARE INITIALLY MEASURED AT FAIR VALUE (ACQUISITION COST) PLUS (SOMETIMES) TRANSACTION COSTS Investments Debt: - Amortized Cost: o Held and managed within a business model whose objective is to hold assets in order to collect contractual cash flows o Must have contractual terms that give rise to specific dates to cash flows that are solely payments of principal and interest on principal amount o Common shares cannot be included because no contractual cash flows o Objective: hold investment to collect CF but do not have to hold until maturity o Record at investment cost and add transaction costs (brokerage fees) o Interest = investment revenue using EFFECTIVE INTEREST METHOD - FVTPL: o Investments that do not qualify as AC; CATCH ALL o Held for the purpose of resale o Revalue to FV each reporting date with changes to earnings o Record at investment cost and expense transaction costs o Interest = investment revenue using EFFECTIVE INTEREST METHOD o Dividends = investment revenue when declared Shares: - FVTPL: SEE ABOVE - FVTOCI: o Equity instruments only o Choice only upon initial recognition; CANNOT BE REVOKED o Cannot have been acquired primarily for resale o Revalue to FV each reporting date with changes to OCI o When sold, remain in equity reserve or transfer directly to retained earnings o Record at investment cost and add transaction costs o Dividends recorded are investment revenue - Cost o Equity instruments only [Type text] [Type text] [Type text] o When not traded in active markets o Cannot establish fair value o Record at investment cost and add transaction costs o Dividends = investment revenue Subsidiaries: - Parent has control over the investee - Control: power to govern financial and operating policies of an entity o Share ownership o Control over Board of Directors o Right granted under Shareholder Agreement - Consolidation Method Associates: - Investor has ability to exercise significant influence over investee - 20% or more of shares and other stuff - Equity Method: o Record at acquisition cost o Proportionate share of investee’s earnings is Dr. Investment and Cr. Revenue o Dividends is a Cr. to Investment  Reduces Book Value Joint Venture: - Economic activity is divided by two or more investors - Decision making is shared - Equity Method: SEE ABOVE Levels of Fair Value Estimation Level 1: Price Quotes from stock exchange, dealer, broker, pricing service Level 2: Inferred fair value – reference similar but not identical transaction and adjust for differences in term and risk (DCF) Level 3: Unobservable data If not determinable – COST Impairment Indicators: - Financial Difficulty - Breach of contract - Concessions because of financial difficulty - Probable bankruptcy or financial reorganization - Disappearance of active market - Decrease in cash flows Not always record impairment of AC Regular impairment tests for Cost No impairment for FVTPL and FVTOCI Disclosure Passive 1. Important components of each F/S category 2. Information related to value (cost, carrying value and fair value by category); explain methods to assess fair value; details about changes in fair value 3. Legal terms (maturity dates, interest rates, collateral) 4. Revenue and expense amounts, OCI reserve amounts Final Exam Review ACTG 3110 December 11, 2013 5. Risk information both qualitative and quantitative 6. Accounting policy info Strategic 1. Subsidiary – disclose the event itself 2. Associates: a. Summarize financial info b. Income from investments c. FV of investment in associates d. Revenue from investment in associates ASPE: Debt: - Amortized Cost: o Either Effective interest or straight line - Fair value through profit and loss Equities: - Fair Value through profit and loss - Cost (if prices are not quoted in an active market) Associate: - Equity - Cost (if no active markets) Subsidiary - Consolidation - Cost (if no active markets) - Equity Joint Venture: - Proportionate consolidation - Equity - Cost (if no active markets) CHAPTER 10 – Depreciation, Amortization, Impairment Depreciation Component Depreciation Accounting: each significant component of an asset is depreciated Accounting Policy Choice: - Straight Line Method: default method; utilization is fairly constant over useful life - Inputs and Outputs: physical capacity constraint present - Accelerated methods: declining balance and SYD method; rapid obsolescence or heavy use in earlier years Fractional-year Depreciation: - Exact calculation approach: precise amount of depreciation for each fractional period - Convention approach: o Half-year convention: half-year’s depreciation is charged on all assets acquired or disposed of during the year; depreciation rate multiplies by average of beginning and ending balances of the asset accounts [Type text] [Type text] [Type text] o Full-first-year convention: full year’s depreciation is charged to all assets that exist at the end of the year even those that were acquired in the middle but no depreciation on assets disposed of during the year o Final-year convention: depreciation is determined based on balance in capital asset account at beginning of the period; no depreciation on assets purchased during the year and full depreciation on assets disposed during the year Group Depreciation: when small assets with no significant components and short useful lives - When sell, Dr. Cash, Cr. PPE Group and Dr. or Cr. the difference to Acc. Depreciation for the PPE Group Impairment Definitions Impairment loss: amount by which the carrying amount of an asset or CGU exceeds recoverable amount CGU: smallest group of assets that will generate cash inflows independent of cash flows of other groups of assets Recoverable amount: higher of FVLCTS and value in use Value in use: discounted cash flows from use of asset and disposal Impairment Test: process of comparing carrying value of an asset to RA Steps: 1. Identification of an asset of CGU 2. Review of external and internal impairment indicator 3. If mandatory annual testing, measure RA 4. Write down to RA and allocate impairment loss Indicators: - Change in business environment (new product from competitor) - Physical damage - History of operating losses  company can’t recover cost of the asset - Probability that company will retire or dispose of asset early is >50% - Loss of patent infringement lawsuit When CGU is impaired, loss is allocated on the pro-rata basis: - Cannot reduce the carrying amount of the asset below higher of 1) fair value 2) zero Reversal Cannot reverse goodwill Reverse if fair value of the asset is recovered; recognize in income immediately Up to carrying amount of the asset that would have been if not impaired Goodwill Impairment - Must be done on annual basis - Must be tested as part of CGU o If loss, first impairment on goodwill, then proceed with assets Disclosure - Description of impaired asset/CGU; facts and circumstances leading to impairment - Amount of impairment loss, F/S presentation - Reversals and amounts, financial statement presentation - Method used to determined recoverable amount Final Exam Review ACTG 3110 December 11, 2013 Revaluation Model Use fair value as basis of measurement Between revaluations, record depreciation and impairment Fair value: - PV of future cash flows - Estimated based on depreciated replacement cost Frequency: depends on volatility of fair value of the asset Depreciation: taken every year How to eliminate accumulated depreciation after revaluation: - Elimination method: cost of asset is restated to revalued amount and depreciation is eliminated - Proportionate method: original cost and accumulated depreciation is restated proportionately so net carrying amount equals revalued amount Disclosure: - Date of evaluation - If appraiser was used - Method used to determine fair value - Amount of revaluation surplus - Carrying amount of the asset ASPE Impairment: - Review impairment indicators every reporting date - 2 step test: o Carrying amount is compared to undiscounted cash flows from use and disposal o If impairment is indicated, compare carrying amount to fair value - No reversals CHAPTER 9 – PP&E, Intangibles and Goodwill Definition PP&E: tangible item acquired for use in revenue-producing activities of the enterprise and expected to be used for more than one period Investment Property: unique classification of land and/or building that are held for rent or capital appreciation Biological Assets: living plants and animals Intangible assets: long-lived assets that do not have physical substance; separately identifiable; legal or contractual rights; held to generate revenue and not intended for sale in ordinary course of business Goodwill: not a separately identifiable asset; arises as a residual in the purchase of other assets acquired in a business combination Valuation: Cost Model: - Cost less accumulated depreciation and accumulated impairment losses since acquisition; - Cost = acquisition price and all costs directly attributable to the acquisition, construction, development or betterment of the asset such as installation [Type text] [Type text] [Type text] - Cost = fair value at the date of purchase Revaluation Model - PP&E, intangible assets with an active market, exploration and evaluation costs for mineral resources - Fair value as measurement base - Revaluation does not occur every year; revalued amount less accumulated depreciation and accumulated impairment losses Fair Value Model: - Investment property - Fair Value is determined every year - No depreciation Recognition Criteria: - Probable future economic benefit that will flow to the company - Cost has been measured reliably Component Accounting - If an asset has significant components that depreciate at different rates, asset is separated - Group similar items - Maintenance is expensed Spare Parts: - Minor parts that are not specific to asset are in inventory - Parts to be used for more than one period and are specific to the asset  PP&E - Expense minor spare parts Safety and Environmental Costs: - These involuntary costs are capitalized - Although no defined future benefit, it is derived from use of the whole asset - Voluntary costs capitalized only if benefit; if not, expense Basket Purchase of Several Assets: - Several assets acquired for single lump-sum price may be lower than the sum of individual asset price to make sale (or attached) - Allocation is based on relative fair values of assets involved Subsequent Costs: - Costs after acquisition related capital assets - Replace major part or major inspection  capitalize - Anything like accident, neglect etc. is expensed Maintenance and Ordinary Repairs - Usually expense because required to keep asset in usable condition Additions: - Capital expenditures and recorded as capital asset at cost Replacement of a Major Part or Betterment - Cost is capitalized and any carrying amount of the part that is being replaced is recorded as a loss Major Inspection: - Capitalized; any remaining carrying amount from previous inspection is recorded as a loss Measurement of PP&E Cost: - Includes purchase price, directly attributable costs and dismantling or site restoration - Does not include start-up costs, relocation costs and initial operating losses - Land includes costs to obtain title Final Exam Review ACTG 3110 December 11, 2013 - Some land improvement stuff is separately recorded and depreciated even though land is not Capitalization Norms: - Self-constructed Assets: o Sum of the expenditures relating to its construction o Costs such as direct materials, labour and overhead are capitalized to the constructed asset - Overhead Cost: o If directly attributable to construction or development is included in cost of self- constructed asset o Cannot capitalize general overhead costs - Interest Cost: o Interest (and other time-related costs like property taxes and insurance) should be capitalized to the asset under construction but only if they occur during ACTIVE construction activities o Must meet 3 conditions:  Expenditures are incurred for construction  Entity incurs interest costs  Construction activities have started o If construction stops temporarily (strike) must stop capitalization until construction resumes o End when construction is complete - Fair market value cap: o If fair value of the asset is lower than construction costs capitalized, must record a loss o If fair value is higher, nothing happens When capital assets are exchanged for equity securities, barter transaction Donated assets: - Non-reciprocal transaction - Record at fair value and increase shareholders’ equity by contributed surplus Asset Retirement Obligations: - Legal requirement or constructive obligation to incur costs when an asset or group is retired - Initial recognition: o Discount liability’s cash flows at a pre-tax rate o Credit liability for PV of ARO o Capitalize the amount to asset - Subsequent depreciation and accrual o Must depreciate together with the asset o Must record interest expense Specific Intangible Assets: Internally Developed Intangibles: 1) Identifiable intangible: separable, from contractual or legal rights 2) Recognition criteria: a. Controlled by entity as a result of past transactions or events b. Future economic benefits must from flow intangible asset c. Cost must be reliably measured Costs in R&D Phase [Type text] [Type text] [Type text] - Research: original and planned investigation undertaken with hope of gaining new knowledge o Must expense - Development: application of research findings into a plan or design for production of new and substantially improved products o Criteria:  Technologically feasible so available for sale or use  Management must have intent to complete and then produce and market or use the asset  Entity must be able to use or sell asset  Probable future economic benefits (external market or internal usefulness) is established  Adequate resources exist or are expected to be available to complete the project  Costs can be measured Stuff that CANNOT be capitalized • Start-up costs • Training • Advertising and promotion • Costs of relocation or reorganizing all or part of an entity Computer Software Costs: - For internal use: o Use capitalization criteria for internally developed intangibles - For product: o Costs of determining technological feasibility are expensed o Use capitalization criteria for internally developed intangibles Website Development Costs: - Planning stage ▯ Expense - Website application and infrastructure  capitalize and amortize - Graphics  capitalize and amortize - Content  expense or capitalize depending on nature of costs - Operating costs  expense Exploration and Evaluation Assets: - Pre-Exploration and Evaluation Phase: prior to obtaining legal right to explore; expense before entity obtains legal right - Exploration and evaluation: capitalize costs until technical feasibility and commercial viability of the resource is reached - Post-exploration and evaluation: same principles as PP&E apply o Successful efforts method: accumulate costs by site, unsuccessful efforts are written off until determined to be successful Derecognition of Long-Lived Assets Cost Model: - Depreciated up to date of disposal to update recorded book value - Record gain or loss - Involuntary conversions: when its not a choice like a natural disaster Replacement of Major Parts: any remaining carrying amount of the part is recorded as a loss Final Exam Review ACTG 3110 December 11, 2013 Goodwill Can only be recorded when purchased along with identifiable assets to constitute an operating unit Difference between actual purchase price and FV of net assets acquired Measuring goodwill: - Establish cost of acquisition - Establish FV of all assets assumed - Costs less FV of net assets = goodwill Negative goodwill - When FV of net assets > purchase price ▯ bargain purchase ▯ negative goodwill - Before recording, reassess FV, writedown assets with subjective or uncertain fair values Cash flow: if costs are capitalized they will never affect cash flows from operations (investment activities and depreciation is removed) Presentation and disclosure By class: - Measurement base - Depreciation methods - Useful lives or depreciation rates - Gross carrying amount - Accumulated depreciation - Restrictions Government Assistance Forgivable Loan: - Recognized when there is reasonable assurance that the conditions are met - Forgiven when conditions are met - Must assess conditions; if likely to be met, record as a grant and disclose conditions and unforgiving balance in notes Grant Related To Asset - Deduct from deferred income that is recognized over the life of the asset - Record as deferred income over the life of the asset; amortize to income on same basis as asset is depreciated Other Government Assistance - To offset current expenses: net government assistance against the related expenses or recognizing as other income in current period; if for future then defer and recognize when expenses are ASPE Valuation Rule – Historical cost Interest Capitalization – Capitalize, no guidance on calculation ARO – same shit CHAPTER 8 – Inventories and Cost of Sales Inventory valuation: - Historical cost: lower of cost or NRV - Market value, either NRV or fair market value, depending on inventory [Type text] [Type text] [Type text] Work in progress: common type of inventory; even for service companies, basically capitalize all costs of providing service under inventory but then after process is complete, move from asset to expense and recognize in the income statement when revenue is recognize Items to Include in Inventory: - Goods purchased and in transit should be included provided that purchaser has ownership - FOB shipping point: seller has title until carrier delivers goods to final customer (FOB designation) - Include goods that are owned by out on consignment - What not to include: o Held for sale on commission or consignment but owned by someone else o Have been received from supplier but rejected and are awaiting return to supplier - Repurchase Agreements: sell and buy back inventory items at prearranged prices if not resold by certain date; o Goods must remain on seller’s books because it is sort of like a loan Elements of Cost - All costs incurred to bring to present location and condition - Net of discounts, rebate and concessions that effectively reduce cost - Purchased for resale o Materials, incidental costs, customs and excise duties  laid-down cost o Freight costs are often recorded in a separate account which is allocated and added to inventory and to Cost of Goods sold for reporting purposes o What’s not included: insurance costs on goods in transit, material handling expenses, import brokerage fees  reported in separate expenses; period costs such as selling, warehouse, distribution o Cash discounts on purchases to encourage timely payment  Record inventory net of those discounts - Service contracts: o Direct Costs: personnel providing service, material needed to complete contract o Overhead costs: consists of costs necessary to complete service contracts but can’t attribute directly o Do not include G&A Expenses’ - Manufactured Goods: o What’s included:  Raw materials  Work in progress – incurred on goods that are in production but not finished  Finished goods o Conversion cost – cost of producing a finished item o Allocate overhead based on normal capacity (normal operating level) - Supplies inventory: items used in productive activities but 1) used during production, 2) too small to keep track Periodic or Perpetual Recording Method - Difference is frequency with which cost flows are calculated - Periodic: at least once a year, then total inventory cost is calculated from cost records using chosen cost flow policy - Perpetual system: continuously updated for each purchase and sale Cost Flow Assumptions: - Specific identification: when inventory is not interchangeable - FIFO Final Exam Review ACTG 3110 December 11, 2013 - Average cost Applying LCM Rule NRV – estimated selling price in normal course of business less estimated costs of completion and estimated amount of costs needed to make the sale When write-downs are not necessary: - Amount of NRV is an anomaly and will recover right after year end - If inventory is part of the finished good and final price is stable Reversing Writedowns: - Upper limit for recognizing increase in NRV is originally recorded historical cost - Reversal is not a gain but a reduction in Cost of Sales Methods of Recording Writedowns: - Direct inventory reduction method: CV is adjusted by amount of writedown; new value will show NRV; only possible when NRV is applied to individual items - Inventory allowance method: writedown is a contra-inventory account (allowance to reduce inventory to NRV); inventory remains at cost on books but reported as net - Both methods report amount on income statement or disclose in notes, not just hide in cost of sales Other Issues for Inventories at Cost: Damaged and Obsolete Inventory: - You need special inventory categories for damaged shit - Valued at NRV Losses on Purchase Commitments - Must accrue loss when: o Purchase contract is not subject to revision or cancellation o Loss is likely and material o Loss can be reasonably estimated - Onerous contract: when purchase contract binds company to price that’s higher than market (dr. estimated loss on onerous purchase commitment cr. est. liability on opc) Inventory Errors: - Cut-off errors: o When we reach end of period, must draw line between this year and next; o Make sure that everything stays in respective periods - Counting errors: o Correct current year by changing RE and Inventory accounts o Restate past year’s comparative to show correct inventory and income - Self-correcting Errors: Inventory Estimation Methods - Gross Margin Method: o Constant gross margin to estimate inventory values from current sales o Gross margin rate estimated on basis of recent past performance and assumed to be constant in the short run o 2 characteristics:  Need to make gross margin rate for every line of product [Type text] [Type text] [Type text]  Apply rate to relevant groups of items o It’s totally fine if the gross margins really are constant in the short run (make sure no price slashes or increase in theft) o Steps:  Estimate gross margin rate  Compute total cost of goods AFS (beginning inventory + purchases)  Estimated gross margin amount (sales X GMR)  Compute COS (Sales – GM)  Compute ending inventory (Cost of goods AFS – COS) - Retail Inventory Method o Easy to use o Reduce record-keeping requirements because you use periodic system o Steps:  Find Cost of goods AFS at cost and retail (beg inv + purchases)  Ratio of cost to sales (COGAFS at cost / COGAFS at retail)  Find
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