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Financial Accounting & Reporting Review Course: F1 Angel Chau, AICPA (inactive)

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1 Financial Accounting & Reporting Review Course: F1 Angel Chau, AICPA (inactive)

2 Financial Accounting and Reporting (FAR)  This section contains 3 testlets ( 30 MC each, total of 60 points ) + 1 testlet (7 Task based simulations, 40 points) and lasts for 4 hours.  The weights attached to five basic tasks are as follows: 1. Concepts and principles for financial statements (17%– 23%) 2. Typical items of financial statements (27%–33%) 3. Specific types of transactions and events in financial statements (27%–33%) 4. Accounting and reporting for governmental units (8%– 12%) 5. Accounting and reporting for nongovernmental and not- for-profit organizations(8%–12%) Intro - 3

3 F1 Outline  GAAP history and SFA concepts  Financial Statements Presentation: 1. Income Statement 2. Statement of Retained Earnings 3. Statement of Comprehensive Income 4. Balance Sheet 5. Notes to Financial Statements 6. Interim Financial Reporting 7. Segment Reporting 8. Development Stage Enterprises (DES)  Fair Value Measurement & Disclosure  First Time Adoption of IFRS  SEC Filing Requirements

4 GAAP Setting Bodies & History  1934: Securities and Exchange Commission (SEC) (the ultimate legal authority to establish US GAAP)  1939 – 1959: Accounting Research Bulletins (ARB)  1959 – 1973: Accounting Principles Board (APB)  1973  : Financial Accounting Standards of Board (FASB)  Effective 2009/7/1: the FASB Accounting Standards Codification became the single source of authoritative nongovernmental US GAAP. Accounting and financial reporting practices not included in the Codification are not GAAP.

5 Authoritative Literature Included in the Codification (FEDPRIA) 1. F 1. Financial Accounting Standards Board (FASB) a. Statements of Financial Accounting Standards b. Interpretations c. Technical Bulletins d. Staff Positions e. Staff Implementation Guides f. Statement No. 138 Examples 2. Emerging Issues Task Force (EITF) Abstracts and Topics D 3. Derivative Implementation Group Issues 4. Accounting Principles Board Opinions 5. Accounting Research Bulletins 6. Accounting Interpretations 7. American Institute of Certified Public Accountants (AICPA) a. Statements of Position b. Auditing and Accounting Guides (Incremental accounting guidance only) c. Practice Bulletins d. Technical Inquiry Service (for software revenue recognition)

6 SEC Standards Included in the Codification Relevant portions of the following pronouncements issued by SEC are included for reference: 1. Regulations S-X 2. Financial Reporting Release (FRR) 3. Accounting Series Releases (ASR) 4. Interpretative Releases (IR) 5. Staff Accounting Bulletins (SAB) 6. EITF Topic D and SEC Staff Observer Comments  The SEC section of the Codification do not contain the entire population of SEC rules and regulations

7 Ongoing Standard – setting Process  The FASB updates the codification for new GAAP issued by FASB & for amendments to SEC content with Accounting Standards Updates.  An Exposure draft is issued for public comments. Staff analyzes and studies all comment letter and position papers for the board to redeliberate on the issue. When Board is satisfied that all reasonable alternative have been considered, an Accounting Standards Update is issued.  A majority vote of 3 of 5 FASB members is required to approve an Exposure Draft for issuance and to amend the ASC.  All new GAAP and SEC amendments are fully integrated into the existing structure of the Codification

8 International Accounting Standards Board (IASB)  Established in 2001 as part of International Accounting Standards Committee (IASC) Foundation  Purpose of IASB is to develop a single set of high quality, global accounting standards  Adopts International Accounts Standards (IAS) issued by IASC  Issues International Financial Reporting Standards (IFRSs)  IASC Foundation also sponsors International Financial Reporting Interpretations Committee (IFRIC) which o provides guidance on newly identified financial reporting issues not addressed in the IFRSs and assists the IASB in achieving international convergence of accounting standards

9 International Convergence of Accounting Standards  The IASB and the FASB have been working together towards the international convergence of accounting standards since 2002 by eliminating differences between US GAAP and IFRS, target to complete by  The goal of convergence project is a single set of high quality, international accounting standards that companies can use for both domestic and cross border financial reporting.  SEC supports the IASB/FASB convergence project and will make a decision regarding the incorporation of IFRSs (in 2011?). First time US issuer report in that system will follow within 4-5 years after decision made.

10 Conceptual Frameworks underlying Financial Accounting  The FASB creates a conceptual framework (set forth in 6 Statements of Financial Accounting Concepts or SFAC) that are not GAAP, but provides basic reasoning behind US standards.  The IASB developed a conceptual framework for IFRS(set forth in the Framework for the Preparation and Presentation of Financial Statements)

11 SFAC No. 1 "Objectives of Financial Reporting by Business Enterprises“  Defines the users of accounting information as 1. Present and potential investors and creditors (external users) 2. users with a reasonable understanding of economic and business situations.  Defines the objectives of financial reporting. (focus on informational needs of external users) 1. To provide information that is useful in making rational investment and credit decisions 2. To help users assess the timing and uncertainty of cash flows. (to value the company how do they generate cash flow) 3. To provide information on economic resources, claims and changes in them. (to assess risk / required rate of return from FS) F1 - 7

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13 external F1 -8

14 SFAC No.2 - Constraints  US GAAP 1. Benefits > Costs 2. Materiality  IFRS 1. Timeliness 2. Balance between benefit and cost 3. Balance between qualitative characteristics Under IASB framework, materiality is a component of relevance F1 -8

15 SFAC No.2: B.U.D  B enefit > Cost  U nderstandability  Primary Qualities of D ecision Usefulness a. Relevance Make a difference to decision making process 1. P 1. Predictive Value (information has ability to assist users in evaluating past, present, or future events) 2. F 2. Feedback Value (enables decision makers to confirm prior expectations or to adjust or correct he assessment made) 3. T 3. Timeliness (having the information available while it is able to influence decisions) Passing Feels Terrific Under IASB framework, the subcategories of relevance are predictive value, feedback value and materiality. R & R F1 - 9

16 SFAC No.2: B.U.D  Primary Qualities of D ecision Usefulness b. Reliability 1. N 1. Neutrality (information is free from bias and free from outside influences) 2. RF 2. Representational Faithfulness (agreement between financial reporting and the recourses or events represented. Information must be valid. ) Substance over legal form. 3. V 3. Verifiability (same results could be duplicated with the same measurement techniques) R & R Nobody Relies on Financials unless Verified Under IASB framework, the subcategories of reliability are neutrality, representational faithfulness, substance over form, prudence, and completeness. F1 - 9

17 SFAC No.2: Secondary Characteristics 1. Comparability. (Apple vs. Microsoft)  Accounting information that has been measured and reported in a similar manner for different enterprises is considered comparable. 2. Consistency. (Current Yr vs. Prior Yr)  Accounting information is consistent when an entity applies the same accounting treatment to similar events from period to period. When applies new accounting policies, cumulative effect must be disclosed.

18 SFAC 7: Using Cash Flow Information & Present Value in Accounting Measurements F  Provides a framework for accountants when using future cash flow as a measurement basis for assets or liabilities.  e.g. for bonds, the forecasted future cash flow includes factors such as future coupon payments, timing of payments, principle payment at maturity date etc. Accountants need to consider the risk of achieving the cash flow, take the discount rate as the required rate of return and discount the future value into present value as basis of measuring the bond

19 SFAC 7: Using Cash Flow Information & Present Value in Accounting Measurements Five elements of Present Value Measurement (Asset or Liability) 1. Estimate of future cash flow (e.g. Estimate future dividend, future selling price etc.) 2. Expectations about timing variations of future cash flows (e.g. term of lease or bond interest payments) 3. Time value of money (inflation, losing of purchasing power) 4. The price for bearing uncertainty 5. Other factors (e.g. liquidity risk and exchange rate risk)

20 SFAC 7: Using Cash Flow Information & PV in Accounting Measurements 1. Traditional Approach  Used when assets and liabilities have contractual (i.e. fixed) cash flows that are not expected to vary.  Present value bonds – scheduled known payments 2. Expected Cash Flow Approach  Used in more complex cases, uses only the risk free rate of return as the discount rate and then turns its attention to the expected future cash flows, considering uncertainties (e.g. default risk) as adjustment to the future cash flows.  PV of warranties – uncertain future payments (Toyota sells a 5 yrs long car warranty

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23 CPA-0010 According to the FASB SFAC No.2, neutrality is an ingredient of: Reliability Relevance A Yes Yes B Yes No C No Yes D No No

24 CPA-0010 Answer is B  Relevance : Passing Feels Terrific  Predictive Value  Feedback Value  Timeliness  Reliability: Nobody Relies on Financials unless Verified  Neutrality  Representational Faithfulness  Verifiability

25 CPA What is the underlying concept governing the recording of gain contingencies? A. Conservatism B. Relevance C. Consistency D. Reliability

26 CPA – Explanation  A is correct (detailed explanation after page F1-78 on the book)  Gain contingency – defer it until it actually happens so we don’t overstate asset or revenue  Loss contingency – accrue it now so we don’t understate liability or loss

27 Uses of the Income Statement  The income statement is useful in determining profitability, value for investment purposes, and credit worthiness.  Also useful in predicting information about future cash flows based on past performance performance for “a period of time”

28 Presentation order (IDEA) I I Income (or Loss) from Continuing Operations o Includes operating activities, non-operating activities, and income taxes o individual line items show gross of tax, then total reported net of tax D D Income (or Loss) from Discontinued Operations (reported net of tax) E E Extraordinary Items (reported Net of Tax) A A Cumulative Effect of Change in Accounting Principle o reported net of tax o is the cumulative effect of a change from one GAAP to another GAAP because the new method presents the financial information more fairly than the old method (Must Remember IDEA) Reported on Income Statement Reported on Statement of Retained Earnings

29 Get Familiar w/ Multiple Step Income Stmt Presentation Review example on F1-19 Get familiar with it

30 CPA Scott Corporation sold a fixed asset used for operations for greater than its carrying amount. Scott should report the transaction in the income statement using the: a. Gross concept, showing the proceeds as part of revenues and the carrying amount as part of expenses in the continuing operations section. b. Net concept, showing the total amount as an extraordinary item, net of income taxes. c. Net concept, showing the total gain as part of discontinued operations, net of income taxes. d. Net concept, showing the total gain as part of continuing operations, not net of income taxes.

31 CPA-0031 Explanation  Choice "d" is correct. The transaction resulted in a gain, which should be reported using the net concept (i.e., proceeds less carrying amount). This gain resulted in the recognition of an asset not in the ordinary course of business, but it did not qualify as an extraordinary item or as part of discontinued operations.  Choices "a", "b", and "c" are incorrect, per the above explanation.

32 CPA Which of the following should be included in general and administrative expenses? Interest Advertising a. Yes Yes b. Yes No c. No Yes d. No No

33 CPA Explanation  Choice "d" is correct. Interest expense is classified as a separate line item on the income statement. Advertising is classified as a selling expense.  G&A expenses: Officers, Accountants, Legal, Insurance, Property Tax.

34 Introduction to Discontinued Operations  Discontinued operations are reported separately from continuing operations in the income statement according to the IDEA mnemonic, net of tax.  The (normal) loss from discontinued operations can consist of an impairment loss (net realizable value –carrying value), a gain/loss from actual operations, and a gain/loss on disposal.

35 Definitions of A Component of an Entity A. Component of an Entity – a part of entity for which operations and cash flows can be clearly distinguished, both operationally and for financial reporting purposes, from the rest of entity 1. U.S. GAAP a. An operating segment b. A reportable segment c. A reporting unit d. A subsidiary e. An asset group 2. IFRS a. A separate major line of business or geographical area of operations b. A subsidiary acquired exclusively with a view to resale

36 Definitions of Discontinued Operations B. Held for Sale - in the period in which ALL of the following criteria are met: 1. Management commits to a plan to sell the component 2. The component is available for immediate sale in its present condition 3. An active program to locate a buyer has been initiated 4. The sale of the component is probable and the sale is expected to be complete within one year 5. The sale is being actively marketed 6. Actions required to complete the sale make it unlikely that significant changes to the plan will be made or that the plan will be withdrawn

37 U.S. GAAP vs. IFRS  IFRS: before a component can be classified as held for sale, the individual assets and liabilities of the component must be measured in accordance with applicable standards and any resulting gains and losses must be recognized. After classification as held for sale, the component is reported at the lower of carrying value and fair value less cost to sell.  U.S. GAAP: does not require the measurement of individual assets & liabilities before classification as held for sale, but the classification of a component as held for sale does trigger an impairment analysis of the component.

38 Discontinued Operations: Accounting Rules A. Types of Entities to be considered discontinued operations: A. Has been disposed of, or B. Is classified as held for sale B. Conditions that both must be present A. Eliminated from ongoing operations – the operations and cash flows of the component have been or will be eliminated from the on going operation of the entity as a result of the disposal B. No Significant continuing involvement – the entity will not have any significant continuing involvement in the operations of the component after the disposal

39 Discontinued Operations: Accounting Rules Discontinued Operations Calculation 1. Types of items included in results of discontinued operations a. Results of operations of the component b. Gain or loss on disposal of the component c. Impairment loss (and subsequent increases in fair value) of the component 1) Initial and subsequent impairment losses are recognized 2) Subsequent increases in fair value results in a gain on I/S (subsequent increase in FV minus cost to sell) and is recognized no more than previously recognized cumulative loss; excess goes to OCI 2. Report in the Period disposed or held for sale 3. Stop Depreciation and Amortization

40 Calculation Example  F1 – 23  Understand this example, you are good with discontinued operations

41 Accrue liability related to Exit or Disposal Activities  New – U.S. GAAP. requires recognition of a liability for the costs in association with exit or disposal activities A. Exit and disposal costs include: 1. Involuntary employee termination benefits 2. Costs to terminate a contract 3. Other costs associated with exit or disposal activities, including costs to consolidate facilities or relocate employees B. Criteria for liability recognition - commitment to exit by itself is not enough, all followed must be met: 1. An obligating event has occurred 2. The event results in a present obligation to transfer assets (payment) or to provide services in the future, and 3. The entity has little or no discretion to avoid the future transfer of assets or proving of services Future operating losses expected to be incurred as part of an exit or disposal activity are recognized in the periods incurred.

42 Exit or Disposal Activities C. Liability Measurement - should be at fair value which should be determined using the US GAAP fair value measurement techniques discussed later. The liability may be adjusted in future periods as a result of revisions to the timing of or estimated cash flows from the exit or disposal activity. Revisions are accounted for prospectively (change in estimate) D. Income Statement Presentation – costs associated with exit or disposal activity related to Discontinued Operation in D; costs not related to Discontinued Operation in I. E. Disclosure – in the notes to the FS in the period the exit or disposal activity is initiated and all subsequent periods until the activity is completed

43 TBS (7 Task based simulation) The board of directors of Super Conglomerate, Inc. voted to dispose of its Tiny Co. subsidiary on Oct 31, Yr 8. On that date, the net book value of the subsidiary was $15M, but Super believes it could not sell for more than $12.5M. No buyer had been found as of Dec 31 Yr 8, but the company was committed to the plan to sell and was actively looking for a buyer. On May 1 Yr 9, the sale was completed for $13M. The subsidiary’s operating results for Yr 8 & Yr 9 were: 1/1/Yr8 – 10/31/Yr8$5M 11/1/Yr8 – 12/31/Yr8$1.5M 1/1/Yr9 – 4/30/Yr9$2.25M Super’s tax rate is 30% How Should the disposal of Tiny Co. be reported on Super’s Yr 8 FS?

44 TBS – Answer Loss from Discontinued operations – Yr 8

45 Extraordinary Item Under U.S. GAAP : 1. Material 2. Unusual (significantly different from the typical business) 3. And Infrequent (not expected to recur in the foreseeable future) 4. Not normally considered in evaluating the ordinary operating results of an entity Examples of extraordinary item: 1. The abandonment of or damage to a plant due to an unusual and infrequent natural disaster 2. An expropriation of a plant by the government 3. A prohibition of a product line by a newly enacted law or regulation 4. Certain gains or losses from early retirement of long term debt only if which meet the criteria of unusual and infrequent and if so will be stated in CPA exam question

46 Non-extraordinary items  Examples: 1. Gain or loss from disposal of PPE used in the business 2. Large write down or write off of : receivable, inventory, intangible, long term security 3. Gain or loss from foreign currency transactions or translation 4. Loss from major labor strike 5. Long term debt early retirement that is NOT both unusual & infrequent  Material unusual OR infrequent items are presented as a separate line item (non-operating) in Income from Continued Operations. The nature and financial effects should be disclosed on the face of Income Statement or in the footnotes. IFRS prohibits the reporting of extraordinary item on the Income Statement or in notes to the FS.

47 CPA-00050

48 CPA Explanation Choice "a" is correct. Raim - component of income from continuing operations. Because Raim sustains flood losses every two to three years, the flood losses are not "infrequent." Thus, the flood loss is not an "extraordinary item." (U or I) Cane - as an extraordinary item. Here, the flood losses are infrequent because Cane never before (in the last 20 years) had flood losses. Furthermore, the flood losses are unusual in nature in that they are unrelated to the ordinary and typical activities of the company. (U & I, Net of Tax) Choices "b", "c", and "d" are incorrect, per rules above.

49 CPA Midway Co. had the following transactions during 1992: 1. $1,200,000 pretax loss on foreign currency exchange due to a major unexpected devaluation by the foreign government. 2. $500,000 pretax loss from discontinued operations of a division. 3. $800,000 pretax loss on equipment damaged by a hurricane. This was the first hurricane ever to strike in Midway's area. Midway also received $1,000,000 from its insurance company to replace a building, with a carrying value of $300,000 that had been destroyed by the hurricane. What amount should Midway report in its 1992 income statement as extraordinary loss before income taxes? a. $100,000 b. $1,300,000 c. $1,800,000 d. $2,500,000

50 CPA Explanation  Choice "a" is correct. Foreign currency devaluations and losses from discontinued operations are not extraordinary items. The hurricane is an extraordinary item and the loss, net of insurance, is $100,000.  Choice "b" is incorrect. The loss from devaluation is not considered to be extraordinary.  Choice "c" is incorrect. The hurricane loss is as follows: Equipment loss $ 800,000 Building loss 300,000 Insurance proceeds (1,000,000) Hurricane loss $ 100,000  Choice "d" is incorrect. Foreign currency devaluations and losses from discontinued operations are not extraordinary items.

51 A Cumulative Effect of Accounting Changes and Error Corrections: IDEA Accounting Changes : 1. Changes in accounting estimates -- Prospective 2. Changes in accounting principles - retrospective 3. Changes in accounting entity – retrospective Error corrections are not accounting changes. Therefore it’s separately presented as Prior Period Adjustments

52 Changes in Accounting Estimate A change in accounting estimate occurs when it is determined that the estimate previously used by the company is incorrect. A. Events Resulting in Estimate Changes 1. Changes in the lives of fixed assets 2. Adjustments of year-end accrual of officer’s salaries and/or bonus 3. Write downs of obsolete inventory 4. Material non-recurring IRS adjustments 5. Settlement of litigation 6. Changes in accounting principle that are inseparable from a change in estimate (e.g. change to LIFO, change in depreciation method) All 6 above affects current & future I (income from continuing operations) Not an error – do not restate prior periods; prospective approach

53 B.If a change in accounting estimate affects several future periods, (e.g. as in above example), the effect on “income before extraordinary items”, net income, and the related per share information for the current year should be disclosed in the notes to the FS. C.Changes in ordinary accounting estimates (e.g. uncollectible, inventory adjustments, % of sales, aging) does not have to be disclosed unless Material

54 CPA For 1991, Pac Co. estimated its two-year equipment warranty costs based on $100 per unit sold in Experience during 1992 indicated that the estimate should have been based on $110 per unit. The effect of this $10 difference from the estimate is reported: a. In 1992 income from continuing operations. b. As an accounting change, net of tax, below 1992 income from continuing operations. c. As an accounting change requiring 1991 financial statements to be restated. d. As a correction of an error requiring 1991 financial statements to be restated.

55 CPA Explanation Choice "a" is correct. The effect of the new estimate of warranty costs (from $100 to $110) is a change in estimate and will be reported in 1992 "income from continuing operations." Rule: Changes in estimates affect only the current and subsequent periods (not "prior periods," not "retained earnings"). Choice "b" is incorrect. An accounting change of "principle" is shown net of tax on the retained earnings statement. Choice "c" is incorrect. Restating prior years financial statements is only required when comparative financial statements are shown for prior period adjustments of subsequently discovered "corrections of errors", changes in entity or changes in accounting principle. Choice "d" is incorrect. The facts stating a new estimate of warranty costs indicate a "change of estimate," not a "correction of an error."

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57 Changes in Accounting Principle (GR: Retrospective)

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59 Reporting Changes in an Accounting Principle Changes in accounting principle should be recognized by adjusting beg. R/E in the earliest period presented for the cumulative effect of the change, and, if prior period FS are presented, they should be restated. Exception in the General Rule: Handle prospectively A) Impracticable to estimate – To LIFO, impractical to reestablish and recalculate old inventory layers B) Change in depreciation method is both a change in Accounting principle and change in Accounting estimate

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61 Under IFRS, when it is impracticable to determine the cumulative effect of an error the entity is required to restate the information prospectively from the earliest dale that is practicable. US GAPP does not have an impracticality exemption for error corrections.

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63 CPA Which of the following statements is correct regarding accounting changes that result in financial statements that are, in effect, the statements of a different reporting entity? a. Cumulative-effect adjustments should be reported as separate items on the income statement in the year of change. b. No restatements or adjustments are required if the changes involve consolidated methods of accounting for subsidiaries. c. No restatements or adjustments are required if the changes involve the cost or equity methods of accounting for investments. d. The financial statements of all prior periods presented should be restated.

64 CPA Explanation Choice "d" is correct. Financial statements of all prior periods presented should be restated when there is a "change in entity" such as resulting from: 1. Changing companies in consolidated financial statements. 2. Consolidated financial statements vs. Previous individual financial statements. Choice "a" is incorrect. Cumulative-effect adjustments are reported in the retained earnings statement in the year of change. Choice "b" is incorrect. Restatements are required for changes in entity (of subsidiaries). Choice "c" is incorrect. Restatements are required for changes of GAAP involving the cost or equity methods of accounting for investments.

65 Comprehensive Income (Non – Owner Transactions) PURER bypass I/S and R/E, directly goes to Equity

66 PUFE R PUFE R escue you from the Comprehensive Income questions. PUFE Rescue

67 Comprehensive income should not be reported on a per share basis

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73 Balance Sheet Presentation Review F  Classified BS distinguishes current vs. non- current items.  Note for Stockholder’s Equity section  Contributed Capital: Capital Stock, PIC in excess of PAR  Internally generated : Retained Earning, Accumulated Other comprehensive Income  Contra Equity: Treasury Stock

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76 CPA Which of the following information should be disclosed in the summary of significant accounting policies? a. Refinancing of debt subsequent to the balance sheet date. b. Guarantees of indebtedness of others. c. Criteria for determining which investments are treated as cash equivalents. d. Adequacy of pension plan assets relative to vested benefits.

77 CPA – C is correct

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79 Interim Financial Reporting 1. Not required under US GAAP or IFRS 2. In US, SEC requires quarterly FR 3. GAAP in Interim Reports = GAAP in most recent annual report : consistency of applying accounting principles 4. Matching Rev & Exp by quarter 5. In US, IFR emphasizes on Timeliness over Reliability (unaudited) 6. IFR is an integral part of annual report and clearly marked as “unaudited” 7. US GAAP does not establish presentation minimums for IFR, IFRS does. (see F1 – 47)

80 Income Taxes on IFR 1. Take YTD cumulative income X best estimate of effective tax rate at the end of that period 2. Then subtract the result from the provision included in previous quarter to avoid double counting

81 CPA For interim financial reporting, a company's income tax provision for the second quarter of 1992 should be determined using the: a.Effective tax rate expected to be applicable for the full year of 1992 as estimated at the end of the first quarter of b. Effective tax rate expected to be applicable for the full year of 1992 as estimated at the end of the second quarter of c. Effective tax rate expected to be applicable for the second quarter of d.Statutory tax rate for 1992.

82 CPA Explanation Choice "b" is correct. The best, most current estimate of the annual effective tax rate should be used to determine the income tax provision for the second quarter. This rate is the effective tax rate expected to be applicable for the full year of 1992 as estimated at the end of the second quarter of APB 28 para. 19

83 Required disclosure for all public companies under both GAAP & IFRS

84 Segment Reporting  Required disclosure for all public companies:  Operating Segments (annual & interim)  Products and services  Geographic areas  Major product lines  Use same accounting principles as in Main FS  E.g. cannot use LIFO in segment reporting, but uses FIFO in main reports  Intercompany transactions are NOT eliminated  Scope :  segment reporting applies to Public Companies ONLY Benefit > Cost; provides best relevant information to users

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86 What’s not an operating segment? 1. Corporate Headquarters or certain functional departments that do not earn revenue (Accounting, Facilities, Legal, etc.) 2. Pension Plans & Other post-retirement benefit plans

87 Reportable Segment

88 Material tests for reportable segments  10% materiality test (must only meet one): 1. Combined Revenue (internal + external) 2. Profit or loss 3. Asset  75% reporting sufficiency test  Must break down 75% of the entire consolidated revenue by operating segments. Irrelevant of the 10% thresholds.  The max no of reportable segments is 10.  Any other segments that do not meet the 2 tests above, lump together and disclose in an “all other segments” category.

89 Segment Profit or Loss Defined 1. Formula: Users can better understand the individual segment’s performance, and analyze for future scenarios, e.g. how does the allocated costs impact the rest of the entity if this segment discontinues. Revenuefor that segment – internal & external Less: Directly traceable costsdirect salary, direct rent, etc Less: Allocated Costs by CFO Operating Profit or Loss (EBIT)for that segment;

90 Unallocated General Revenues / Expenses

91 CPA-00127

92 CPA Answer

93 Start ups devotes most of its resources into R&D. There is no guarantee that it will be successful. Take the conservative approach and recognize all cost into expenses. DSE issues the FS in conformity w/ US GAAP, review F1 – 57 for disclosure requirements

94 Fair Value Measurements and Disclosures

95 About FV  FAS 157 defines fair value as the price received to sell an asset or the price paid to transfer a liability in a transaction taking place in an active market. This is sometimes referred to as "exit value".  FV does not include transaction cost but may include transportation cost.  FV assumes the highest and best use of an asset.  Orderly transaction- Not a fire sale  Market participants (buyer & sellers) are independent ( non- related parties)  Principle market is the one with greatest volume  Most Advantageous Market  use if no principal market exist  MAM is the one w/ best price for assets/liabilities after considering transaction costs (which is not included in FV measurement but only help locate MAM)

96 Fair Value Determination

97 FV measurement framework This framework outlines A. 3 Valuation Techniques to measure FV of asset / liability 1. Market Approach – identical & comparable asset /liability transactions in the market 2. Income Approach – discount future earnings into present value, e.g. rental real estate 3. Cost Approach – uses current replacement cost B. Hierarchy of inputs to be used in the valuation techniques

98 Level 1 input Level 1 Inputs are quoted prices in active markets for identical assets or liabilities that the entity has access to on the measurement date. Active market characteristics: high trading volume, small bid/ask spread, highly liquid.  An example would be a stock trade on the New York Stock Exchange; price for a barrel of oil in the market, etc.  Information at this level is based on direct observations of transactions involving the identical assets or liabilities being valued, not assumptions, and thus offers superior reliability.  To use this level, the entity must have access to an active market for the item being valued. Most Reliable

99 Level 2 Input Level 2 inputs are based on market observables. FASB acknowledged that active markets for identical assets and liabilities are relatively uncommon and, even when they do exist, they may be too thin to provide reliable information. To deal with this shortage of direct data, the board provided a second level of inputs that includes :  Quoted prices for similar assets or liabilities in active markets (e.g. no 3-bedroom houses are identical, but similar within the neighborhood)  Quoted prices for identical or similar assets in markets that are not active  Observable data other than quoted prices such as earnings, cash flow, interest rate, etc. Less Reliable

100 Level 3 Input  Level 3 inputs are unobservable inputs for the asset or liability. It reflects management’s estimates.  Level 3 inputs should be used only when observable (Level 1 & 2) inputs are unavailable or when undue cost and effort is required to obtain observable inputs. Least reliable

101 FV MC 1

102 FV MC 1 Answer

103 FV MC 2

104 FV MC 2 Answer

105 FV MC 3

106 FV MC 3 Answer

107 FV MC 4

108 FV MC 4 Answer

109 FM MC 5

110 FV MC 5 Answer

111 First Time Adoption of IFRS  An entity’s first IFRS FS are the first annual FS in which the entity adopts IFRS and makes an explicitly and unreserved statement in those FS of compliance w/ IFRS.  An entity’s first IFRS FS must include  B/S – 3 (beg. of prior period, end of prior period, end of current period; e.g.: 1/1/10, 12/31/10, 12/31/11)  All others – 2 (2 Statements of comprehensive income, 2 Income statements(if using 2 stmt approach for comprehensive income, 2 Statements of cash flows, 2 Statements of changes in equity)  IFRS must be consistently applied from beginning and throughout the reporting period for these statements

112 First Time Adoption of IFRS  Date of transition to IFRS = date of opening BS presented.  E.g. First IFRS annual report is for 12/31/2011, then date of transition is 1/1/2010 (or equivalently 12/31/2009)

113 Explanation of transitions to IFRS  An entity should disclose how the transition from previous GAAP to IFRS affected its reported financial positions, financial performances, and cash flows.  The disclosure includes: a. A reconciliation of equity change from GAAP to IFRS b. A reconciliation of total comprehensive income from GAAP to IFRS c. Disclosures related to the recognition or reversal of impairment losses  Similar reconciliation are required for any interim financial report for part of a period covered by the first IFRS FS.

114 First Adoption of IFRS MC 1

115 FAIFRS MC 1 Answer

116 First Adoption of IFRS MC 2

117 FAIFRS MC 2 Answer

118 First Adoption of IFRS MC 3

119 FAIFRS MC 3 Answer

120 First Adoption of IFRS MC 4

121 FAIFRS MC 4 Answer

122 SEC filing requirements (public issuer and large private held) Securities offering Registration statement for IPO or new offerings 1. Disclosures about the securities being offered for sale 2. The relationship of the new securities to the company’s other securities 3. Information similar to that filed in the annual filing 4. Audited financial statements 5. A description of business risk factors Form 10K – annual report  due 90 /75/60 days after end of fiscal year  Required for US registered companies Form 10Q – quarterly report  Due 45/40 days after end of fiscal quarter  Unaudited FS (timeliness over reliability) Form 11K – annual report of employee’s defined benefit plan(s)  401K; Employee Stock Purchase plan

123 SEC filing requirements Form 20F – annual report by foreign private issuers Form 40F – annual report by specific Canadian companies registered with SEC Form 6K – semi-annual report by foreign private issuers, similar to 10Q Form 8K – report major corporate events such as asset acquisitions or disposals, changes in securities and trading markets, changes to accountants or financial statements, and change in corporate governance or management Form 3, 4, &5 – filed by directors, officers, or beneficial owners of more than 10% of a class of equity securities of a issuer

124 Regulation S-X In Regulation S-X, the SEC sets forth the form and content of and requirements for interim and annual FS to be filed w/ the SEC. The key provisions are below: A. Requirements for Interim Financial Statements 1. Interim FS filed w/ SEC must be reviewed by an independent CPA and the review report must be filed w/ the FS 2. The interim FS should include 1. BS end of most recent quarter of preceding fiscal year) 2. Income Statement(most recent fiscal quarter, YTD, and corresponding periods for the preceding fiscal year) 3. Statements of cash flows(From end of previous year to end of most recent quarter, and corresponding periods for the preceding fiscal year)

125 Regulation S-X B. Requirements for Annual FS 1. Annual FS must be audited by CPA and audit report must be filed along. 2. The audited FS must include BS for 2 most recent fiscal years and Statements of Income, Change in owner’s Equity, and Cash Flow for each of the 3 fiscal years preceding the date of the most recent audited BS. (the exact opposite to IFRS requirements BS- 3, others – 2)

126 Supplemental Questions

127 Task Based Simulation

128 Solution

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