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Financial Reporting Framework for SMEs

FRFS

Financial Reporting

Framework for SMEs By Richard H. Gesseck, CPA

Course Code: 745141 FRFS GS-5000111-0414-0A

Revised: February 2014

Copyright 2014–2015

By American Institute of Certified Public Accountants Durham, North Carolina

All Rights Reserved

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Table of Contents

Overview ....................................................................................................... Overview-1

Chapter 1 ..................................................................................................................... 1-1

Foundation for Reporting under the FRF for SMEs Accounting FrameworkTM .... 1-1

Chapter 2 ..................................................................................................................... 2-1

Specific Financial Statement Elements .................................................................... 2-1

Chapter 3 ..................................................................................................................... 3-1

Business Combinations and Intangible Assets ...................................................... 3-1

Chapter 4 ..................................................................................................................... 4-1

Investments ................................................................................................................ 4-1

Chapter 5 ..................................................................................................................... 5-1

Leases ......................................................................................................................... 5-1

Chapter 6 ..................................................................................................................... 6-1

Transitioning to the FRF for SMEs Accounting Framework and Other Matters ... 6-1

Solutions ................................................................................................... Solutions 1-1

Chapter 1 ............................................................................................................................... Solutions 1-1






Copyright 2014–2015 AICPA ∗ Unauthorized Copying Prohibited i

Overview

Learning Objectives

Provide an introduction to the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities and an overview of the chapters in this course. Introduction

The AICPA has issued Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs accounting framework, or “the framework”). The framework is a special purpose framework (SPF) of accounting as are cash and income tax bases of accounting. Historically, a SPF basis of accounting was also commonly referred to as an “other comprehensive basis of accounting or OCBOA.” Presenting financial statements using the framework may fulfill the needs of financial statement users who require more financial information than provided by cash basis or income tax basis presentations. Financial statements prepared in accordance with the framework are not intended to be a presentation in accordance with generally accepted accounting principles (GAAP).

Why is the Framework Needed?

Privately-owned smaller and medium-sized entities, who do not need GAAP-compliant financial statements, have been voicing their demands for a more relevant, simplified, cost-effective framework, to meet their financial reporting needs. Bankers and other third party financial statement users have continually expressed a desire for uncomplicated, useful financial statements that are based on a reliable, principles-based framework when GAAP is not needed.

So who is the Framework Intended For?

The framework is intended for small and medium sized for profit entities with significant owner or manager involvement. Any form of organization, such as a partnership, corporation, and so on, in a broad range of industries, such as construction, service, distribution, and so on, may use the framework. The framework financial statement presentation provides the owner or manager with reliable information which confirms his or her assessment of performance, including what is owned, what is owed, and cash flows. Financial statements prepared using the FRF for SMEs accounting framework are intended generally for those external users who have direct access to the reporting entity’s management. Such financial statements would not be appropriate for entities that intend to “go public.”

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What are the Features of the framework?

The framework is non-authoritative, as are all the other SPFs, such as the income tax basis of accounting. The framework uses traditional accounting methods with accrual income tax methods. As such, differences between reporting under the framework and reporting for income tax purposes are reduced. An objective of presenting financial statements using the framework is to provide relevant information based on simplified or straight-forward principles. In addition the framework requires only targeted disclosures.

The framework is fully self-contained within approximately 200 pages. Bright lines, prescriptive rules, and excessive narration are reduced, resulting in the need for the preparer to use “professional judgment.” For example, the preparer may encounter transactions and circumstances for which specific rules may not be included in the framework.

Another feature of the framework is the use of the historical cost measurement basis and the limited use of fair value, such as for marketable equity and debt securities held-for-sale.

What are Some Other Examples of Principles under the Framework?

Presented below are some of the notable principles under the framework. This course focuses on the principles that the preparer will encounter.

Consolidation: The reporting entity elects an accounting policy to account for its investments in subsidiaries using either the consolidation method or equity method. A subsidiary is an entity in which the reporting entity’s ownership is greater than 50 percent. The election is required to be applied to all subsidiaries.

Investments: Investments in an entity in which the reporting entity’s ownership is 20 percent or more, but not more than 50 percent should be accounted for by the equity method if the reporting entity exercises significant influence. A difference between the reporting entity’s investment cost and the amount of its underlying equity in the net assets of the investee that is similar to goodwill is amortized. Investments in entities by the reporting entity of 20 percent or less are accounted for at cost unless they are held for sale.

Income Taxes: The reporting entity elects an accounting policy to account for income taxes which may be either the taxes payable method or the deferred income taxes method. Under the former policy only currently payable or refundable income taxes are reflected in the financial statements.

Goodwill: Goodwill is amortized. Goodwill should be amortized generally over the same period as that used for Federal income tax purposes, or if not amortized for such purposes then over 15 years.


Joint Ventures: The reporting entity should make an accounting policy choice to account for its interests in joint ventures using 1) the proportionate consolidation method, or 2) the equity method. Proportionate consolidation is only applicable to unincorporated entities when it is an established industry practice.

Intangible Assets: All intangible assets are considered to have finite useful lives, and are amortized over their estimated useful lives. The amortization should reflect the pattern of economic benefits if reliably determinable, if not the straight-line method is used.

How Will Practitioners Report on the Framework?

Practitioners may be engaged to audit, compile, or review financial statements prepared using the framework.

Practitioners engaged to audit the financial statements will report on whether the financial statements are presented in accordance with the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities. Guidance for the form and content of the report is included in AU-C Section 800 Special Considerations – Audits of Financial Statements Prepared in Accordance with Special Purpose Frameworks.

Practitioners engaged to review or compile FRF for SMEs accounting framework financial statements will report under AR Section 80 Compilation of Financial Statements or AR Section 90 Review of Financial Statements, as applicable. The review report states whether the independent accountant is aware of any material modifications that should be made to the FRF for SMEs accounting framework financial statements in order for them to be in conformity with the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities.

The AICPA Alert Understanding the Financial Reporting Framework for Small- and Medium-Sized Entities includes examples of audit, review, and compilation reports.

Summary of the Case for the Framework

The AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities provides an alternative form of financial reporting that is more comprehensive than the other forms of reporting under SPF. Many third-party financial statement users and preparers who do not need GAAP-based financial statements may find this form of financial reporting more responsive to the unique needs of small and medium sized entities. This form of reporting has similarities to the International Financial Reporting Standards (IFRS) for SMEs which has gained world-wide acceptance. However, IFRS for SMEs is not United States centric.


Overview of the Chapters

Chapter 1 Foundation for Reporting under the Framework

Chapter 1 addresses the objectives of financial statements prepared under the framework. The elements of financial statements are described, as well as the form and content of the basic financial statements, including guidance for consolidated financial statements and noncontrolling interests. In general, some of the more common disclosures required by the framework are reviewed. They include the basis of presentation, risks and uncertainties, related party transactions, and subsequent events. Other required disclosures are also addressed in this chapter and the remaining portions of the course.

Chapter 2 Specific Financial Statement Elements

Chapter 2 looks at the details of some of the components of the financial statement elements of financial statements prepared under the framework. Accounting methods, recognition and measurement principles, and disclosure requirements are discussed for a) inventories, b) property, plant and equipment, and asset retirement obligations, c) debt, d) equity, e) revenue, f) income taxes, and g) retirement and other postemployment benefits. The participant will likely readily understand the principles and disclosures for these financial statement components and identify how they differ from those under generally accepted accounting principles.

Chapter 3 Business Combinations and Intangible Assets

The first part of Chapter 3 describes the steps in the acquisition method of accounting for a business combination. It also describes how the assets acquired (including intangible assets other than goodwill) and liabilities assumed are measured, and how goodwill is determined followed by a discussion about amortizing goodwill and other intangible assets acquired in a business combination. The second part of Chapter 3 focuses on the measurement and amortization of internally developed other intangible assets or purchased other intangible assets related to technology, intellectual property, new processes or systems, software, and so on. Required disclosures specific to goodwill and other intangible assets are also discussed. Under the framework, neither goodwill nor other intangible assets are required to be reviewed for impairment.

Chapter 4 Investments

This chapter begins with accounting for investments in subsidiaries and the accounting policy choices available to the parent to either consolidate the subsidiary or account for it using the equity method. Investments accounted for by the equity method are then addressed. The participant will learn that the portion of the difference between the investor’s cost and the amount of its underlying equity in the net assets of the investee that is similar to goodwill (equity


method goodwill) is amortized. Accounting for investments in corporate and non-corporate joint ventures and the related methods used to account for them are distinguished and discussed. Chapter 4 concludes with a discussion of the accounting for other investments and required disclosures.

Chapter 5 Leases

Chapter 5 addresses the accounting for capital and operating leases from the perspective of lessees and lessors.

Chapter 6 Transitioning to the Framework and Other Matters

Chapter 6 begins with an explanation of how the reporting entity transitions to the framework followed by other matters that the participant will likely encounter less frequently than the subject matter addressed in the prior chapters. The later topics include, among others, accounting changes, push-down accounting, and discontinued operations.


Chapter 1

Foundation for Reporting Under the FRF for SMEs Accounting FrameworkTM

Learning Objectives

Obtain an understanding of the fundamentals underlying the Financial Reporting Framework for Small- and Medium-Sized Entities, including the components of a complete set of financial statements, the elements of such financial statements, the form and content of presentation, and general financial statement disclosures common to most entities.

Introduction

Professional judgment is required to present financial statements in accordance with the framework. A fair presentation requires

• Appropriately applying the framework;

• Providing sufficient information about transactions or events having an effect on the reporting entity’s financial statements presented that are of such size, nature, and incidence that their disclosure is necessary to understand that effect; and

• Providing information in a manner that is clear and understandable.

The objective of financial statements prepared in accordance with the framework is to provide information about the reporting entity’s

• Economic resources, obligations, and equity;

• Changes in economic resources, obligations, and equity; and

• Economic performance.

To meet the stated objective the financial statements must be understandable, relevant, reliable, and comparative.

Financial statements are relevant when they provide timely, predictive value or feedback value. Reliability is achieved through representational faithfulness, verifiability, and neutrality.

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Neutrality is influenced by the use of acceptable conservatism in making judgments regarding uncertainties. Acceptable conservatism does not encompass the deliberate understatement of assets, revenues, and gains, or the deliberate overstatement of liabilities, expenses, and losses.

Comparative financial statements provide more useful information, but are not required under the framework. Comparability is enhanced when the same accounting policies are used consistently. If the reporting entity reclassifies items from the prior year’s financial statements to conform to the current year’s presentation it should disclose them.

Items are recognized in the financial statements using the accrual basis of accounting when the following recognition criteria are met.

• The item has an appropriate basis of measurement, and a reasonable estimate can be made of the amount involved.

• For items involving obtaining or giving up future economic benefits, it is probable that such benefits will be obtained or given up.

Recognition is the process of including an item in the financial statements. Recognition does not mean disclosure in the notes to the financial statements. Disclosures provide additional information about items recognized in the financial statements or information about items that do not meet the recognition criteria. Disclosure is not an acceptable substitute for failing to appropriately account for a matter under the framework.

Feedback Questions 1. Because comparative financial statements provide useful information, they are

a. Required under both GAAP and the FRF for SMEs accounting framework. b. Required under the FRF for SMEs accounting framework, but not GAAP. c. Not required under GAAP nor the FRF for SMEs accounting framework.

2. Acceptable conservatism relates to

a. The predictive or feedback value of financial statements prepared under the framework. b. Judgments regarding uncertainties in financial statements prepared under the framework. c. The representational faithfulness of financial statements prepared under the framework.


Financial Statement Elements

Elements of the financial statements include assets, liabilities, equity, revenues, expenses, gains, and losses.

Revenues are generally recognized when performance is achieved, or partially achieved in the context of contracts in process, and reasonable assurance regarding measurement and collectability of the consideration exists. Gains are recognized when realized. Revenues result from the entity’s ordinary activities whereas gains result from peripheral or incidental transactions and events.

Expenses and losses are generally recognized when an expenditure or previously recognized asset does not have future economic benefit. Expenses are related to a period on the basis of transactions or events occurring in that period or by allocation. Expenses relate to the entity’s ordinary activities whereas losses usually relate to peripheral or incidental transactions and events.

Historical cost is the primary measurement used in financial statements prepared in accordance with the framework. Other bases less frequently used include replacement cost, realizable value, present value, and market value.

Financial statements prepared under the framework assume that the entity is a going concern, i.e. it will continue to realize its assets and discharge its liabilities in the ordinary course of business for the twelve months following the statement of financial position date. An entity that is not a going concern should prepare its financial statements on the liquidation basis of accounting. The framework should be used only by an entity that is a going concern.

Feedback Questions

3. The primary measurement used in financial statements prepared in accordance with the FRF for SMEs accounting framework is

a. Replacement cost. b. Historical cost. c. Realizable value.

4. Revenues are recognized when which of the following criteria is met:

a. Performance is achieved. b. The amount can be measured with reasonable assurance. c. The amount recognized is collectible with reasonable assurance. d. All of the above criteria must be met for revenues to be recognized.


Basic Financial Statements

A complete set of financial statements prepared using the framework includes a statement of financial position, a statement of operations, and a statement of cash flows. (Other appropriate financial statement titles may be used. Examples include a statement of assets, liabilities and equity, and a statement of revenue and expenses.) Changes in equity may be shown in a separate statement of changes in equity or disclosed in the notes to the financial statements. A statement of comprehensive income is not required by the framework. An individual financial statement, such as a statement of financial position may be presented separately. A statement of cash flows should accompany the presentation of a statement of financial position with a statement of operations.

Statement of Financial Position

Chapter 4 of the framework shows the ordinary financial statement line items (FSLI) for the statement of financial position. The FSLI under the framework are similar to those customarily presented under GAAP. The framework does require a FSLI for total liabilities. In addition, FSLI are required for investments in nonconsolidated subsidiaries and non-proportionately consolidated joint ventures and all other investments accounted for under the cost method, the equity method and market value. Investments are addressed in Chapter 4 of this course.

Assets and liabilities are normally segregated between current and noncurrent. However, the framework recognizes that the segregation of assets and liabilities between current and noncurrent may not be appropriate in financial statements of enterprises in certain industries.

A financial asset and a financial liability should be offset, and the net amount reported in the statement of financial position, only when an entity

• Currently has a legally enforceable right to set off the recognized amounts and

• Intends either to settle on a net basis or to realize the asset and settle the liability simultaneously.

As a statement of financial position classification, current assets should include those assets ordinarily realizable within one year from the date of the statement of financial position or within the normal operating cycle if it is longer than a year. Under paragraph 2.21 of the framework, the reporting entity is required to disclose the length of its operating cycle.

As a statement of financial position classification, current liabilities should include amounts payable within one year from the date of the statement of financial position or within the normal operating cycle if it is longer than a year. The normal operating cycle should correspond with that used for current assets.


The current liability classification should also include amounts received or due from customers or clients with respect to goods to be delivered, or services to be performed within one year from the date of the statement of financial position.

Obligations that would otherwise be classified as current liabilities should be excluded from the current liability classification to the extent that contractual arrangements have been made for settlement from other than current assets.

The current liability classification should include only that portion of long-term debt obligations, including sinking-fund requirements, payable within one year from the date of the statement of financial position.

Noncurrent classification of debt is based on facts existing at the statement of financial position date rather than on expectations regarding future refinancing or renegotiation. If the creditor has, at that date, or will have within one year (or operating cycle, if longer) from that date, the unilateral right to demand immediate repayment of any portion or all the debt under any provision of the debt agreement, the obligation is classified as a current liability unless

• The creditor has waived, in writing, or subsequently lost, the right to demand payment for more than one year (or operating cycle, if longer) from the statement of financial position date; or

• The obligation has been refinanced on a long-term basis before the financial statements are available to be issued; or

• The debtor has entered into a non-cancellable agreement to refinance the short-term obligation on a long-term basis before the financial statements are available to be issued, and there is no impediment to the completion of the refinancing.

Long-term debt with a covenant violation is classified as a current liability unless

1. As of the date the financial statements are available to be issued, the creditor has waived, in writing, or subsequently lost, the right, arising from violation of the covenant at the statement of financial position date, to demand repayment for a period of more than one year from the statement of financial position date; or

2. The debt agreement contains a grace period during which the debtor may cure the violation, and contractual arrangements have been made that ensure the violation will be cured within the grace period; and a violation of the debt covenant giving the creditor the right to demand repayment at a future compliance date within one year of the statement of financial position date is remote.


Statement of Operations

There is no prescribed format for the statement of operations or its title under Chapter 7 of the framework. The statement of operations should present fairly, in accordance with the framework, the reporting entity’s results of operations for the period and distinguish the following:

• Income or loss before discontinued operations;

• Results of discontinued operations; and

• Net income or loss.

In arriving at the income or loss before discontinued operations, the statement of operations should present major elements, such as revenue, cost of goods sold, operating expenses, other revenues and gains, and other expenses and losses. A format that resembles a current presentation under GAAP would be acceptable under the framework. Numerous additional informative disclosures about FSLI in the statement of operations are required including amounts for depreciation, amortization, income taxes, currency exchange gains or losses, and gains or losses identified with unusual transactions and events. These matters are addressed throughout this course. Lastly, note that under the framework, there are no extraordinary items.

Statement of Cash Flows

The form and content of the statement of cash flows under Chapter 8 of the framework is generally consistent with that currently required under GAAP. As such, it should report cash flows during the period classified by operating, investing, and financing activities in a manner that is most appropriate to its business. Either the direct or the indirect method may be used. The statement of cash flows should include a roll-forward of cash and cash equivalents from the beginning of the period to the end of the period covered by the statement reconciled to cash and cash equivalents shown in the statement of financial position at the end of the period.

Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value. Therefore, an investment normally qualifies as a cash equivalent only when it has a maturity of three months or less, when purchased. Cash subject to restrictions that prevent its use for current purposes should not be included with cash and cash equivalents but should be classified separately. The reporting entity should disclose its accounting policy for determining cash and cash equivalents.

Operating activity cash flows reflect the principal revenue-producing activities of the reporting entity. Dividend and interest income received and interest expense paid should be reported under operating activities. Amortization of debt discount or premium and deferred financing costs are


not cash flows. Also, cash flows related to income taxes are reported under operating activities, unless specifically identifiable with financing or investing activities.

Investing activity cash flows reflect the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Increases and decreases in restricted cash should be reflected under investing activities. Further, cash flows from the acquisition or disposal of a business should also be reported separately under investing activities. The reporting entity may choose to present certain cash equivalents, for example a one-month certificate of deposit as an investment rather than as a cash equivalent.

Financing activity cash flows reflect changes in the capital and borrowings of the reporting entity. The net change in overdrafts should be reported under financing activities along with dividends paid. Short-term borrowings and repayments, such as those under three months, may be netted in the statement of cash flows.

Cash flows arising from transactions in a foreign currency should be recorded in an entity's reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the cash flow.

Noncash investing and financing transactions should also be excluded from cash flows. Examples include

• The acquisition of assets by assuming directly related liabilities;

• The acquisition of assets by means of a capital lease;

• The acquisition of an entity in exchange for shares of the acquirer; and

• The conversion of debt to equity.

Noncash items should be presented on the face of the statement of cash flows or disclosed in the notes to the financial statements.

Feedback Questions

5. A complete set of financial statements under the framework includes a. A statement of financial position and a statement of operations. b. A statement of financial position, statement of operations, statement of cash flows, and

statement of comprehensive income. c. A statement of financial position, statement of operations, and statement of cash flows.


6. Under the framework, a reporting entity that has an operating cycle other than one year is required to disclose its operating cycle only

a. If it is greater than one year. b. If it is less than one year. c. Regardless of its length.

7. The reporting entity’s statement of operations under the framework should distinguish which of the following, except a. Income or loss before discontinued operations. b. Discontinued operations. c. Net income or loss. d. Extraordinary items.

8. On August 31 20X1 the reporting entity purchases a six-month CD. In its December 31, 20X1 statement of financial position that CD is reported as a. A cash equivalent. b. An investment. c. Either a cash equivalent or investment at the discretion of the reporting entity.

9. In the statement of cash flows, the net change in overdrafts should be reported under a. Operating activities. b. Investing activities. c. Financing activities.

Consolidated Financial Statements

Consolidated financial statements recognize that the separate legal entities are components of one economic unit and are distinguishable from the separate parent and subsidiary financial statements. They present two or more distinct legal entities as one single economic unit. Consolidated financial statements are based on the amounts assigned to assets, liabilities, and noncontrolling interests as of the date of acquisition of the subsidiary and the effects of transactions subsequent to that date. The retained earnings of a subsidiary as of the date of acquisition by the parent should be eliminated from consolidated retained earnings. Sometimes the carrying amount of the assets of the parent or the subsidiary includes gains or losses arising from transactions between the two companies prior to the date of acquisition. Because transactions that took place prior to the date of acquisition are ordinarily assumed to have taken place at arm's length, the amounts involved in such transactions constitute objective


evidence of value. Accordingly, such gains or losses should not be eliminated in the preparation of consolidated financial statements unless the transactions were made in contemplation of acquisition. However, gains or losses arising as a result of a business combination between related parties are eliminated. Intercompany transactions between the entities included in the consolidated financial statements may include sales and purchases of goods and services, and lending and borrowing. Revenues and expenses, and gains and losses related thereto in the separate statements of income of the individual entities along with intercompany receivables or payables in the separate statement of financial positions of the individual entities should be eliminated in the preparation of consolidated financial statements. Unrealized intercompany gains or losses arising subsequent to the date of an acquisition on assets remaining within the consolidated group, such as intercompany profit in inventory should be eliminated. The amount eliminated from assets should not be affected by the existence of a noncontrolling interest. The assets and liabilities of the subsidiary that were consolidated at the date of acquisition are deemed to have been purchased by the consolidated entity on that date. As such, the amounts determined at that date remain the same for the subsequent accounting for these assets and liabilities. Therefore, the sum of the depreciation charges in the parent and subsidiary records may not equal the appropriate depreciation charge to be presented in the consolidated financial statements, and adjustments may be necessary. Similarly, interest recognized on financial instruments measured at amortized cost may differ from the sum of interest amounts recorded by the parent and subsidiary. The depreciation, depletion, and amortization of the assets of a subsidiary should be computed for the purposes of consolidated financial statements on the basis of the amounts determined at the date of acquisition by the parent company. A material difference in the basis of accounting between a parent and a subsidiary precludes the preparation of consolidated financial statements. A difference in fiscal periods of a parent and a subsidiary does not, of itself, justify the exclusion of the subsidiary from consolidation. Normally, the subsidiary can prepare, for consolidation purposes, statements for a period that coincides with the fiscal period of the parent. The reporting parent entity should disclose its consolidation policy. Combined financial statements (as distinguished from consolidated financial statements) may be useful in certain circumstances, although they are not a substitute for consolidated financial statements. Combined financial statements could be useful when one individual owns a controlling interest in several corporations. They could also be used to present the financial position and the results of operations of a group of subsidiaries or to combine the financial statements of companies under common management.


When combined financial statements are prepared, similar principles to those used in preparing consolidated financial statements apply. Noncontrolling Interests

Noncontrolling interests in the net income of consolidated subsidiaries and noncontrolling interests in the net assets of consolidated subsidiaries are shown separately from the parent's share. Noncontrolling interests in the net assets consist of the amount of those noncontrolling interests at the date of acquisition and the noncontrolling interests' share of changes in equity since then.

The proportions of net income and changes in equity allocated to the parent and noncontrolling interests are determined on the basis of existing ownership and do not reflect the possible exercise or conversion of potential voting rights.

Only post-acquisition and predisposal income of the consolidated subsidiary is included in consolidated net income. Consolidated net income is attributed to the owners of the parent and to the noncontrolling interests. Total net income or loss is attributed to the owners of the parent and to the noncontrolling interests, even if this results in the noncontrolling interests having an accumulated deficit in net assets.

Noncontrolling interests in consolidated subsidiaries should be presented in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent.

Nonmonetary Transactions

This section establishes principles for measuring, and disclosing nonmonetary transactions. It defines when an exchange of assets is measured at market value and when an exchange of assets is measured at the carrying amount.

Measurement: The reporting entity should measure an asset exchanged in a nonmonetary transaction at the more reliably measurable of the market value of the asset given up or the market value of the asset received, unless

• The transaction lacks commercial substance;

• The transaction is an exchange of a product or property held for sale in the ordinary course of business for a product or property to be sold in the same line of business to facilitate sales to customers other than the parties to the exchange;


• Neither the market value of the asset received nor the market value of the asset given up is reliably measurable;

• The transaction is a nonmonetary nonreciprocal transfer to owners in which case other principles under the framework apply; or

• The transaction is between related parties and is not in the normal course of operations.

If market value is not reliably measureable, then the transaction is recorded based on carrying amounts. The reporting entity should measure an asset exchanged in a nonmonetary transaction that is not measured at market value at the carrying amount of the asset given up adjusted by the market value of any monetary consideration received or given. The entity paying the monetary consideration measures the nonmonetary asset received at the carrying amount of the asset given up plus the market value of the monetary consideration paid. The entity receiving the monetary consideration measures the nonmonetary asset received at the carrying amount of the nonmonetary asset given up less the market value of the monetary consideration received, unless the monetary consideration exceeds the carrying amount, in which case, a gain is recognized for the amount of such excess. Gains and losses on nonmonetary transactions are recognized in the determination of net income or loss in the statement of operations.

Commercial Substance: Under paragraph 30.07 of the framework, a nonmonetary transaction has commercial substance when the reporting entity's future cash flows are expected to change significantly as a result of the transaction. The reporting entity's future cash flows are expected to change significantly when

• The configuration of the future cash flows of the asset received differs significantly from the configuration of the cash flows of the asset given up or

• The entity-specific value of the asset received differs from the entity-specific value of the asset given up, and the difference is significant relative to the market value of the assets exchanged.

In some cases, a qualitative assessment will be conclusive in determining whether the estimated cash flows of the reporting entity are expected to change significantly as a result of the transaction.

Entity-specific value, resulting from entity-specific measurement, differs from market value by attempting to capture the value of an item in the context of the reporting entity. The reporting entity uses its expectations about its use of the asset rather than the use assumed by marketplace participants. When a transaction has commercial substance, it is measured at market value rather than entity-specific value.


Restructuring or Liquidation: The reporting entity should measure a nonmonetary, nonreciprocal transfer to its owners that represents a spin-off or other form of restructuring, or liquidation at the carrying amount of the nonmonetary assets or liabilities transferred.

Disclosures: The reporting entity should disclose the following information in the period in which a nonmonetary transaction occurs:

• The nature of the transaction;

• Its basis of measurement (market value or carrying amount);

• The amount; and

• Related gains and losses.

Foreign Currency Translation

A U.S. based reporting entity uses the “temporal” method to translate transactions denominated in a currency other than the U.S. dollar. Under the temporal method assets, liabilities, revenues, and expenses are translated into U.S. dollars in a manner that retains their bases of measurement in terms of the U.S. dollar. In particular

• Monetary items are translated at the exchange rate in effect at the statement of financial position date;

• Nonmonetary items are translated at historical exchange rates, unless such items are carried at market (for example inventory stated at net realizable value), in which case they are translated at the exchange rate in effect at the statement of financial position date;

• Revenue and expense items are translated at the exchange rate in effect on the dates they occurred (appropriate weighted averages may be used); and

• Depreciation or amortization of assets translated at historical exchange rates is translated

at the same exchange rates as the assets to which it relates. The amount of an exchange gain or loss is included in the statement of operations in determining net income or loss.


Feedback Questions

10. Under the framework, intercompany transactions

a. Do not have to be eliminated. b. Should be eliminated. c. Should be adequately disclosed.

11. Under the framework, an accumulated deficit in net assets applicable to the noncontrolling

interests is shown as

a. An asset. b. A separate component of equity. c. A part of the controlling interest’s equity.

12. A nonmonetary transaction lacks “commercial substance” when

a. The configuration of the future cash flows of the asset received differs significantly from the configuration of the cash flows of the asset given up.

b. The entity-specific value of the asset received differs from the entity-specific value of the asset given up, and the difference is significant relative to the market value of the assets exchange.

c. Neither a. or b.

Financial Statement Disclosures

Disclosures are an important element of financial statements prepared in accordance with the framework. And although disclosures are frequently required to clarify or further explain items in the financial statements they are not a substitute for proper accounting.

Basis of Presentation

Entities preparing financial statements in accordance with the framework are required to disclose their significant accounting policies and make other disclosures. Among the required disclosures is the use of the framework as the basis of accounting presentation. Because some reporting standards (for example AU-C section 800, Special Considerations—Audits of Financial Statements Prepared in Accordance With Special Purpose Frameworks [AICPA, Professional Standards]) also require an auditor or practitioner to evaluate whether the financial statements adequately describe how the special purpose framework differs from U.S. GAAP, an entity may want to include a brief description of those primary differences. The effects of the differences need not be quantified. An illustrative example of a basis of presentation footnote follows:


Basis of Presentation

The accompanying financial statements have been prepared in accordance with the Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs) issued by the American Institute of Certified Public Accountants. FRF for SMEs is a special purpose framework that differs from generally accepted accounting principles in the United States of America (GAAP). As such, these financial statements are not intended to be a presentation in accordance with GAAP. Significant differences between the accompanying financial statements and GAAP relate to [described such as accounting for variable interest entities, income taxes, and impairment losses.]

Disclosures about accounting policies other than the basis of presentation election should be provided when

• A selection has been made from alternative acceptable accounting principles and methods under the framework; or

• The accounting principles and methods used are specific to an industry in which the entity operates, such as revenue recognition under long-term contracts in the construction industry.

The reporting entity is also required to make disclosures about risks and uncertainties.

Risks and Uncertainties

Volatility and uncertainty in the business and economic environment result in the need to disclose information about the risks and uncertainties confronted by reporting entities resulting from

• The nature of the reporting entity’s operations;

• The use of estimates (including significant estimates) to prepare financial statements; and

• Current vulnerability due to certain concentrations.

Nature of Operations

A reporting entity should include in its financial statements a description of the major products or services it sells or provides and its principal markets, including the locations of those markets. Disclosures concerning the nature of operations do not have to be quantified. Relative importance may be described by terms such as predominantly, about equally, and major.


Use of Estimates (Including Significant Estimates)

The reporting entity should include in its financial statements a disclosure that the preparation of financial statements in conformity with the framework requires the use of management’s estimates. Further, the reporting entity should also include a discussion of significant estimates when based on known information available before the financial statements are available to be issued, it is reasonably possible that (a) the estimate will change in the near term (a period of time not to exceed one year from the date of the statement of financial position), and (b) the effect of the change will be material. The estimate of the effect of a change in a condition, situation, or set of circumstances that existed at the date of the statement of financial position should be disclosed, and the evaluation should be based on known information available before the financial statements are available to be issued.

Examples of assets and liabilities, and gain and loss contingencies that may be based on estimates that are particularly sensitive to change in the near term and, therefore, require disclosure if they meet the criteria in paragraph 10.04 of the framework follow:

• Inventory subject to rapid technological obsolescence.

• Specialized equipment subject to technological obsolescence.

• Valuation allowances for deferred income tax assets based on future taxable income.

• Capitalized computer software costs.

• Valuation allowances for commercial and real estate loans.

• Environmental remediation-related obligations.

• Litigation-related obligations.

• Contingent liabilities for obligations of other entities.

• Amounts reported for long-term obligations, such as amounts reported for pensions and postemployment benefits.

• Estimated net proceeds recoverable, the provisions for expected loss to be incurred, or both, on disposition of a business or assets.

• Amounts reported for long-term contracts.

Concentrations

Vulnerability from concentrations arises because an entity is exposed to risk of loss greater than it would have, had it mitigated its risk through diversification. An entity should disclose in the


financial statements certain concentrations if, based on information known to management before the financial statements are available to be issued, all the following criteria are met:

• The concentration exists at the date of the financial statements.

• The concentration makes the entity vulnerable to the risk of a near-term severe impact.

• It is at least reasonably possible that the events that could cause the severe impact will occur in the near term.

The following are examples of concentrations that require disclosure if they meet the preceding criteria:

• Concentrations in the volume of business transacted with a particular customer, supplier, or lender.

• Concentrations in revenue from particular products or services.

• Concentrations in the available sources of supply of materials, labor, or services or of licenses or other rights used in the entity’s operations.

• Concentrations in the market or geographic area in which an entity conducts its operations.

• Concentrations in credit risk (such as deposits in excess of FDIC insurance limits).

• Concentrations in the workforce covered by collective bargaining agreements.

An illustrative example of a reporting entity’s combined disclosure of the nature of its operations and its concentrations follows:

Nature of Business and Concentrations

Global, Inc. functions as a sales representative for a limited number of international defense contractors for which it receives commissions on products sold by them primarily to branches of the Italian government. In addition, Global, Inc. provides consulting services and distributes aerospace products.

As of December 31, 20X1 and 20X0, three customers and one customer represented 35% and 19% of accounts receivable. Revenues from sales, commissions, and consulting fees include amounts from a single customer of 20% in 20X1. No single customer accounted for more than 10% of revenues from sales, commissions, and consulting fees in 20X0.


Contingencies

This section addresses the accrual and disclosures of contingencies. A contingency is defined in the framework as follows: “An existing condition or situation involving uncertainty about possible gain or loss to an entity that will ultimately be resolved when one or more future events occur or fail to occur.” Contingencies include pending or threatened litigation, threat of expropriation of assets, guarantees of the indebtedness or performance of others, and possible liabilities arising from discounting promissory notes. And although contingencies usually involve making accounting estimates, not all estimates are contingencies.

The uncertainty relating to the occurrence or nonoccurrence of the future event(s), which determines the outcome of a contingency, can be expressed by a range of probabilities that provide a basis for establishing the appropriate accounting treatment. The range of probabilities follows:

• Probable. The chance of the occurrence (or nonoccurrence) of the future event(s) is likely to occur.

• Remote. The chance of the occurrence (or nonoccurrence) of the future event(s) is slight.

• Reasonably possible. The chance of the occurrence (or nonoccurrence) of the future event(s) is more than remote, but less than likely.

Predicting the outcome of contingencies, including estimating the financial effects, is a matter for judgment. In exercising judgment and determining the amount, consideration should be given to all information available prior to the date the financial statements are available to be issued.

Accounting for Contingent Losses

The amount of a contingent loss should be accrued in the financial statements by a charge to income when both of the following conditions are met:

• It is probable that a future event will confirm that the value of an asset has diminished or a liability incurred at the date of the statement of financial position; and

• The amount of the loss can be reasonably estimated.

This accounting treatment recognizes that the probable diminishment of an asset or incurrence of a liability is related to a condition or situation existing at the end of the reporting period, and not to the confirming future event. The appropriateness of accruing the effects of a contingent loss would be influenced by the extent to which the amount of the loss is known or can be reasonably estimated. The inclusion of amounts that are not reasonably estimated because they are so uncertain impairs the integrity of the financial statements.


A probable loss to an entity may be reduced or avoided by a counterclaim or a claim against a third party. In such a case, the amount of the probable recovery is an element of the contingent loss and, therefore, should be considered in determining the amount to be recognized. However, if the probability of success in the related counter claim action is not virtually certain, a potential recovery should not be taken into consideration. The amount of the probable recovery should be presented as a gross amount.

The estimation of the amount of a contingent loss to be accrued may be based on information that provides a range of the amount of loss. When a particular amount within such a range appears to be a better estimate than any other, that amount should be accrued. However, when no amount within the range represents a better estimate than any other amount, the minimum amount in the range should be accrued.

Accounting for Contingent Gains

Contingent gains usually should not be accrued because this accounting treatment could result in the recognition of gains that might never be realized.

Contingent Losses

The existence of a contingent loss at the date of the financial statements should be disclosed in notes to the financial statements when

• The occurrence of the confirming future event is probable, but the amount of the loss cannot be reasonably estimated;

• The occurrence of the confirming future event is probable, and an accrual has been made, but there exists an exposure to loss in excess of the amount accrued; or

• The occurrence of the confirming future event is reasonably possible.

Minimum disclosures should include

• The description of the nature of the contingency;

• An estimate of the amount of loss or a statement that such an estimate cannot be made; and

• Any additional exposure to loss in excess of the amount accrued.

Contingent Gains

At a minimum, contingent gain disclosures should include


• A description of the nature of the gain and

• An estimate of the amount of the gain or a statement that such an estimate cannot be made.

Disclosure of the existence of a contingent gain that is considered probable of being realized provides useful information. Therefore, disclosure should be made in the notes to the financial statements. However, the reporting entity should exercise care to avoid a misleading implication about the likelihood of realization. It is not appropriate to disclose the existence of a contingent gain that is not probable of being realized.

Guarantees A guarantor should disclose the following information about each guarantee, or each group of similar guarantees, even when the likelihood of the guarantor having to make any payments under the guarantee is slight.

• The nature of the guarantee, including the approximate term of the guarantee, how the guarantee arose, and the events or circumstances that require the guarantor to perform under the guarantee.

• The maximum potential amount of future payments (undiscounted) the guarantor could be required to make under the guarantee before any amounts that may possibly be recovered under recourse or collateralization provisions in the guarantee (see the last two bullets that follow). When the terms of the guarantee provide for no limitation to the maximum potential future payments under the guarantee, that fact should be disclosed. When the guarantor is unable to develop an estimate of the maximum potential amount of future payments under its guarantee, the guarantor should disclose that it cannot make such an estimate.

• The current carrying amount of the liability, if any, for the guarantor’s obligations under the guarantee, regardless of whether the guarantee is freestanding or embedded in another contract.

• The nature of any recourse provisions that enable the guarantor to recover from third parties any of the amounts paid under the guarantee.

• The nature of any assets held as collateral or by third parties that, upon the occurrence of any triggering event or condition under the guarantee, the guarantor can obtain and liquidate to recover all, or a portion of, the amounts paid under the guarantee.

Disclosures of guarantees issued to benefit entities that meet the definition of a related party should also consider related party disclosure requirements.


Commitments Commitments that are material in relation to the current financial position or future operations should be disclosed. Examples include

• Commitments to purchase or construct new facilities;

• A commitment to reduce debt;

• An obligation to maintain working capital;

• Commitments to acquire assets; and

• Unconditional purchase obligations and firm purchase commitments.

Feedback Questions

13. The FRF for SMEs accounting framework is

a. A variation of GAAP. b. A special purpose framework. c. Rules based.

14. Under the framework, the ranges of probabilities used in accounting for contingencies include all of the following, except

a. Possible. b. Remote. c. Reasonably possible. d. All of the above.

Disclosure of Related Party Transactions

This section addresses the disclosure of related party transactions in the reporting entity’s financial statements.

Related parties exist when one party has the ability to exercise, directly or indirectly, control, joint control, or significant influence over the other. Two or more parties are related when they are subject to common control, joint control, or common significant influence. Related parties also include management and immediate family members. Management should make reasonable efforts to identify all related parties.

The most commonly encountered related parties of a reporting entity include the following:


• An entity that directly or indirectly, through one or more intermediaries, controls, is controlled by, or is under common control with, the reporting entity.

• An individual who directly, or indirectly through one or more intermediaries, controls the reporting entity.

• The other party, when an investment is accounted for by the equity or the proportionate consolidation method and the reporting entity, is either the investor or the investee.

• Management.

• An individual having an ownership interest in the reporting entity that results in significant influence or joint control.

• Members of the immediate family of individuals described in the second, fourth, and fifth bullets above.

• The other party, when a management contract or other management authority exists, and the reporting entity is either the managing or managed party.

• Any party that is subject to significant influence, whether by reason of an ownership interest, management contract, or other management authority, by another party that also has significant influence over the reporting entity.

• Any party that is subject to joint control by the reporting entity.

A transaction between a venturer and a joint venture involving the exchange of an asset for an interest in the joint venture is considered a transaction between the venturers. When the venturers are unrelated, such a transaction is not a related party transaction.

Related Party Disclosure

The reporting entity should disclose information about its transactions with related parties including

• A description of the relationship between the transacting parties.

• A description of the transaction(s), including those for which no amount has been recognized.

• The recognized amount of the transactions classified by financial statement category.

• The measurement basis used.

• Amounts due to, or from, related parties and the terms and conditions relating thereto.

• Commitments with related parties, separate from other commitments.


• Contingencies involving related parties, separate from other contingencies.

Description of Relationship

Terms such as affiliate, associate, and related company are insufficiently precise to describe relationships. With additional explanation, the effect of the related party relationship on the entity is more understandable. Terms such as controlled investee, significantly influenced investee, jointly controlled entity, common control entity, management, shareholder, member of the immediate family of the shareholder or management, and director describe the relationships better.

Description of Transactions

A clear description of a related party transaction that sets out the significance of the transaction to the operations of the entity clarifies the effects of the transaction on the entity. Such a description includes information about the nature of the items exchanged and whether the exchange is in the normal course of operations.

An exchange of goods or services between related parties that has not been given accounting recognition is also a related party transaction. For example, an entity may provide a related party with management services or use of a patent or license in the normal course of operations without receiving consideration in exchange. An explanation of the nature of such a transaction and the fact that no consideration has been received or paid is useful to explain the effect of the transaction on the entity.

Amount of Transactions

Information about related party transactions is often significant to the financial statement user regardless of the size of such transactions. To convey the extent of related party transactions, the recognized amounts of such transactions are disclosed. Disclosure of information aggregated by financial statement category (for example, revenue, purchases, major operating costs, interest expense or income, and management fee income or expense) and nature of relationship is more useful than disclosure of individual transactions with related parties, except for individually significant transactions.

Representations that the exchange amount is equivalent to market value (or an arm's length equivalent value) are not made unless they can be substantiated. When an entity has undertaken a related party transaction on the same terms as current transactions with unrelated parties, with similar volumes, terms, and conditions, that fact is disclosed. In many cases, a market value cannot be determined unless there are identical transactions, and the values of the items


exchanged are determined by the market (for example, the market value of an exchange of gold and cash is determined by the market.

Subsequent Events

A complete set of financial statements prepared in accordance with the framework reflects all transactions through the date of the latest statement of financial position presented. The framework also requires that the reporting entity recognize and disclose certain events occurring after the latest statement of financial position date and before the financial statements are available to be issued.

Financial statements are available to be issued when

• A complete set of financial statements or a single financial statement, including all required note disclosures, has been prepared;

• All final adjusting journal entries have been reflected in the financial statements;

• No changes to the financial statements are planned or expected; and

• The financial statements meeting the preceding requirements have been approved in accordance with the entity's process to finalize its financial statements.

There are two types of subsequent events:

1. Those that provide further evidence of conditions that existed at the financial statement date; and

2. Those that are indicative of conditions that arose subsequent to the financial statement date.

The extent to which, and the manner in which, the effect of a subsequent event is reflected in the financial statements will depend on its type.

Subsequent events may provide additional information relating to items included in the financial statements and may reveal conditions existing at the date of the financial statements that affect the estimates involved in their preparation. All such information that becomes available prior to completion of the financial statements should be used in evaluating the estimates made, and the financial statements should be adjusted where necessary.

Financial statements should not be adjusted for those events occurring between the date of the financial statements, and the date the financial statements are available to be issued that do not relate to conditions that existed at the date of the financial statements.


Subsequent Events Disclosure

Disclosure should be made of the date through which subsequent events have been evaluated and the fact that this is the date that the financial statements were available to be issued.

Disclosure should also be made of those events occurring between the date of the financial statements and the date the financial statements are available to be issued that do not relate to conditions that existed at the date of the financial statements, but are of such a nature that they should be disclosed to keep the financial statements from being misleading. Under such circumstances, at a minimum, the disclosure should include

• A description of the nature of the event and

• An estimate of the financial effect, when practicable, or a statement that such an estimate cannot be made.

Examples of such events that may require disclosure in notes to the financial statements include

• An event, such as a fire or flood, that results in a loss;

• Decline in the market value of investments;

• Purchase of a business;

• Commencement of litigation when the cause of action arose subsequent to the date of the financial statements;

• Changes in foreign currency exchange rates; and

• The issue of capital stock or long-term debt.

Other Disclosures

There are other required disclosures required under the framework. Many of them are addressed in the remainder of this course.

Feedback Questions

15. Under the framework, disclosure is required for exchanges of goods or services between related parties that have not been given accounting recognition:

a. Unless such transactions are in the normal course of business. b. Unless the owner/manager objects to such a disclosure. c. Neither a. nor b. are acceptable reasons for non-disclosure.


16. Disclosures about subsequent events should include all of the following, except

a. The date through which subsequent events have been evaluated. b. The date the financial statements were available to be issued. c. Events occurring after the date the financial statements are available to be issued that

relate to conditions that existed at the date of the financial statements.


Chapter 2

Specific Financial Statement Elements

Learning Objective

• Learn about the nuances of accounting for some of the core components of financial statement elements of the FRF for SMEs accounting framework.

Introduction

This chapter addresses accounting for 1) inventories, 2) property, plant, and equipment and asset retirement obligations, 3) debt 4) equity, 5) revenue, 6) income taxes and 7) retirement and other postemployment benefits under the framework. Additional financial statement elements such as leases and investments are addressed elsewhere in this course. Inventories

This section focuses on determining the cost amount for inventories, including any write-downs to net realizable value. Inventories include products purchased and/or produced for sale. Inventories produced for sale include finished products or work in progress being produced by the entity, and the materials and supplies to be used in the production process. Inventories shown in the statement of financial position should be measured at the lower of cost or net realizable value (NRV). NRV is the estimated selling price in the ordinary course of business less the estimated costs of completion for in-process products and estimated costs necessary to make the sale, such as selling expenses. The cost of inventories includes all costs to purchase, convert, and bring the inventories to their present state. Purchase costs include the purchase price, freight, handling, taxes, and other costs directly attributable to purchasing, less discounts, rebates, and similar items. Conversion costs include direct labor and manufacturing overhead, both fixed and variable. Overhead reflects normal capacity. As such, costs associated with volume inefficiencies are expensed as incurred. Other costs to bring the inventories to their present state which may be appropriate to include in the cost of inventories include nonproduction overhead or the costs of designing products for specific customers. Cost should be assigned to inventories using one of the following methods: first-in, first-out (FIFO), last-in, first-out (LIFO), or weighted average. In addition, the specific identification method is appropriate for inventory segregated for a specific project (purchased or produced).


Inventories are usually written down to NRV item-by-item or in the aggregate. Such a write-down may be recorded using a valuation allowance account. NRV write-downs should be disclosed separately from the consumed inventory costs described as cost of products or goods sold.

Case 2-1 NRV

Facts: Assume the reporting entity has 100 units of product A (unit cost of $1) on hand as of December 31, 20X1. It expects to sell 60 units in 20X2 and none thereafter. As such, the reporting entity records a valuation allowance for slow moving and obsolete (S+O) inventory for 40 units or $40 at December 31, 20X1. In 20X2 it sells 70 units and fully expects to sell the balance in 20X3 with the changed economic circumstances. Question: What is the amount of the S+O allowance at December 31, 20X2 under the framework? Answer: $12 (30 units × 40%) which is the same as under U.S. GAAP.

Disclosures: Among other disclosures, the reporting entity should disclose its accounting policies to measure inventories, including the cost formula used, such as FIFO. The reporting entity should also disclose the classifications of inventories, for example materials, finished goods, and so on, as appropriate to the nature of its business. Feedback Question

1. Disclosures of inventory classifications such as finished goods, materials, and so on are

a. Required under GAAP only. b. Required under the FRF for SMEs accounting framework only. c. Required under the FRF for SMEs accounting framework and GAAP.

Property, Plant, and Equipment and Asset Retirement Obligations

This section addresses accounting for property, plant, and equipment (PP&E), including accounting for asset retirement obligations (AROs) under the framework. Participants will find the concepts addressed under the framework to be familiar and traditional. Cost for PP&E

PP&E should be recorded at cost. Cost includes material, labor, and overhead directly attributable to acquiring, constructing, or developing the asset, as well as the cost associated with the initial recording of any related ARO as of the asset’s acquisition date. Cost may also include


capitalized interest if that is an adopted policy of the reporting entity. Incidental revenues derived from the asset prior to its substantial completion and availability for use are credited to cost. Costs incurred to enhance the service potential of an item of PP&E (for example, improvements) are capitalized. Enhancements increase output or service capacity, lower operating costs, extend the useful life, or improve the quality of output. Depreciation of PP&E

The FRF for SMEs accounting framework uses the terms depreciation and amortization interchangeably. In this course depreciation will be used in the context of physical assets such as buildings and equipment, and amortization will be used in the context of intangible assets and leasehold improvements. Under paragraph 14.13 of the framework, depreciation should be recognized over the useful life of the asset in a rational and systematic manner appropriate to the nature of an item of PP&E with a limited life and use by the reporting entity. The amount of depreciation is calculated based on the cost of the asset less any residual value. Any depreciation method that is rational and systematic is appropriate. If the cost of the asset consists of significant separable components with distinctively different lives, then the cost is allocated to the components when practicable as described under paragraph 14.15 of the framework. Practitioners may refer to this form of accounting as “component life depreciation.” Depreciation methods and estimates of the life and useful life of an item of PP&E should be reviewed on a regular basis. Significant events that may indicate a need to revise the depreciation method or estimate of the useful life of an item of property, plant, and equipment include

• A change in the extent the asset is used;

• A change in the manner in which the asset is used;

• Removal of the asset from service for an extended period of time;

• Physical damage;

• Significant technological developments; and

• A change in the law, environment, or consumer styles and tastes affecting the period.


Reductions in PP&E

The carrying value of PP&E is reduced due to the cessation of the asset’s use or for a write-down in the carrying value. Future depreciation should reflect the reduction in carrying value. Disclosure should be made of the facts and circumstances leading to a reduction in carrying value.

ARO

The reporting entity should recognize a liability for an ARO in the period in which it is incurred when a reasonable estimate of the amount of the obligation can be made. If a reasonable estimate of the amount of the obligation cannot be made in the period the ARO is incurred, the liability should be recognized when a reasonable estimate can be made. Only a legal obligation associated with the retirement of a tangible long-lived asset (PP&E), including an obligation created by promissory estoppels, establishes a clear duty or responsibility to another party that justifies recognition of a liability. Long-lived assets include leasehold improvements. The amount recognized as an ARO should be the best estimate of the expenditure required to settle the present obligation at the statement of financial position date. The best estimate of the expenditure required to settle the present obligation is the amount that the entity would rationally pay to settle the obligation at the statement of financial position date, or to transfer it to a third party at that time. It will often be impossible or prohibitively expensive to settle or transfer the obligation at the statement of financial position date. Therefore, the estimate of the amount that an entity would rationally pay to settle or transfer the obligation is reported. The estimate of the expenditure required to settle the present obligation is determined by the judgment of the management of the reporting entity, supplemented by experience of similar transactions and, in some cases, reports from independent experts. Future events that may affect the amount required to settle an obligation are reflected in its measurement when there is sufficient, objective evidence that they will occur. Expected future events may be particularly important in measuring an ARO. For example, an entity may believe that the cost of cleaning up a site at the end of its life will be reduced by future changes in technology. The amount recognized reflects a reasonable expectation of technically qualified, objective observers, taking account of all available evidence about the technology that will be available at the time of the clean-up. Thus, it is appropriate to include expected cost reductions associated with increased experience in applying existing technology, or the expected cost of applying existing technology, to a larger or more complex clean-up operation than has previously been carried out. However, a reporting entity does not anticipate the development of a completely new technology for cleaning up unless it is supported by sufficient, objective evidence. The effect of possible new legislation is taken into consideration in measuring an existing obligation when the new legislation is enacted. New legislation enacted after the date of the statement of financial position, but before the date the financial statements were available to be issued may require disclosure as a subsequent event.


A present value technique is often the best available technique with which to estimate the expenditure required to settle the ARO at the statement of financial position date. When a present value technique is used, the reporting entity estimates future cash flows on a basis consistent with the objective of measuring the ARO. Uncertainties surrounding the amount to be recognized as an ARO are incorporated in the best estimate of the expenditure required to settle it. AROs are reviewed at each statement of financial position date and adjusted to reflect the current best estimate. Changes in an ARO may be due to the passage of time or to revisions to the timing or amount of cash flows, or to the interest rate used in determining the best estimate of the expenditures required to settle the present ARO at the statement of financial position date. In periods subsequent to its initial measurement and recording, a reporting entity should recognize period-to-period changes in the ARO resulting from

• The passage of time and

• Revisions to either the timing, the amount of the original estimate of undiscounted cash flows, or the discount rate.

The carrying amount of the ARO is increased for changes due to the passage of time before changes resulting from a revision to either the timing or the amount of estimated cash flows. The reporting entity measures changes in the ARO due to passage of time by applying an interest method of allocation to the amount of the liability at the beginning of the period. The interest rate used to measure that change is the discount rate applied to measure the liability at the beginning of the period. That amount is recognized as an increase in the carrying amount of the liability and an expense. The expense is classified as an operating item in the statement of income, not as interest expense. It is referred to in this section as accretion expense, but an entity may use any descriptor as long as it conveys the underlying nature of the expense. Changes resulting from revisions to the timing or the amount of the original estimate of undiscounted cash flows or revisions to the discount rate are recognized as an increase or a decrease in the carrying amount of the ARO and the related asset. When asset retirement costs change as a result of a revision to estimated cash flows, the reporting entity adjusts the amount of asset retirement cost allocated to expense in the period of change if the change affects that period only, or in the period of change, and future periods, if the change affects more than one period. Changes in asset retirement costs that affect future periods will result in adjustments of capitalized asset retirement costs and will affect subsequent depreciation of the related asset. Such adjustments are depreciated on a prospective basis. Upon initial recognition of the ARO, the reporting entity should recognize an equal increase in the carrying amount of the related long-lived asset for its retirement cost.


Disclosures

Traditional disclosures related to PP&E and ARO are required. Under the framework, the reporting entity is required to disclose, among other matters, the amount of depreciation, the depreciation method, and the depreciation period or rate. The financial statements should also disclose the following information in the period in which the carrying value of a long-lived asset is reduced (other than for depreciation) due to the cessation of the asset’s use or to a write-down in the carrying value of the asset:

• A description of the long-lived asset;

• A description of the facts and circumstances leading to the reduction in carrying value; and

• If not separately presented on the face of the statement of operations, the amount of the reduction in carrying value and the caption in the statement of operations that includes that amount.

The reporting entity should disclose the following information about its asset retirement obligations:

• A general description of the ARO and the associated long-lived assets.

• The amount of the ARO at the end of the year.

• The total payments charged to the ARO during the year.

• The carrying amount of assets legally restricted for purposes of settling the ARO.

The reasons a reasonable estimate of the amount of an ARO cannot be made should be disclosed. Feedback Questions

2. Under the framework,

a. Depreciation methods are prescribed. b. Any depreciation method that is rational and systematic is appropriate. c. Component life depreciation must be used.


3. The carrying value of equipment should be reduced, except when the reporting entity

a. Changes the depreciation method due to a change in estimated useful life. b. Ceases to use the asset. c. Becomes aware of circumstances that warrant a write down in its carrying value.

Debt

The reporting entity should remove a financial liability for debt when it is extinguished (discharged, cancelled, or expired). A transaction between a borrower and lender to replace a debt instrument with another instrument having substantially different terms is accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. Similarly, a substantial modification of the terms of an existing financial liability or a part of it is also accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the market value of the consideration paid, including any noncash assets transferred, liabilities assumed, or equity instruments issued, should be recognized in net income for the period. Extinguishment transactions between related entities may be in essence capital transactions. When an issuer of a debt instrument repays or settles that instrument, the debt is extinguished. If an entity repays a part of a financial liability, the entity allocates the carrying amount of the financial liability at the date of repayment based on their relative market values between the part that continues to be recognized and the part that is derecognized. The difference between the carrying amount allocated to the part derecognized and the consideration paid to extinguish that part, including any noncash assets transferred, liabilities assumed, or equity instruments issued, is recognized in net income. Interest rate swap agreements entered into to convert variable rate debt into fixed rate debt are shown in the statement of financial position at their net settlement amounts. The fair value of interest rate swap agreements are not recognized in financial statements prepared using the framework. Disclosures

For bonds, debentures, and similar securities, mortgages, and other long-term debt, the reporting entity should disclose

• The title or description of the liability;

• The interest rate;


• The maturity date;

• Significant terms (for example, covenant details);

• The amount outstanding, separated between principal and accrued interest;

• The currency in which the debt is payable if it is not repayable in the currency in which the reporting entity measures items in its financial statements; and

• The repayment terms, including the existence of sinking fund, redemption, and conversion provisions.

The reporting entity should disclose the carrying amount of any financial liabilities that are secured and

• The carrying amount of assets it has pledged as collateral and

• The terms and conditions relating to its pledge.

The reporting entity should disclose the aggregate amount of payments estimated to be required in each of the next five years to meet repayment, sinking fund, or retirement provisions of financial liabilities. For financial liabilities recognized at the statement of financial position date, the reporting entity should disclose

• Whether any such liabilities were in default or in breach of any term or covenant during the period that would permit a lender to demand accelerated repayment; and

• Whether the default was remedied, or the terms of the liability were renegotiated, before the financial statements were completed.

The reporting entity should disclose the following items:

• Interest expense on current financial liabilities and long-term liabilities, separately identifying amortization of premiums, discounts, and capitalized financing costs;

• Interest capitalized;

• Unused letters of credit; and

• Long-term debt agreements subject to subjective acceleration clauses, unless the likelihood of the acceleration of the due date is remote.


An entity that issues any of the following financial liabilities or equity instruments should disclose information to enable users of the financial statements to understand the effects of features of the instrument, as follows:

• For a financial liability that contains both a liability and an equity element, the reporting entity should disclose the following information about the equity element including, when relevant:

– The exercise date or dates of the conversion option;

– The maturity or expiry date of the option;

– The conversion ratio or the strike price;

– Conditions precedent to exercising the option; and

– Any other terms that could affect the exercise of the option, such as the existence of covenants that, if contravened, would alter the timing or price of the option.

• For a financial instrument that is indexed to the reporting entity's equity or an identified factor, the reporting entity should disclose information that enables users of the financial statements to understand the nature, terms, and effects of the indexing feature, the conditions under which a payment will be made, and the expected timing of any payment.

Feedback Questions

4. The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the market value of the consideration paid, including any noncash assets transferred, liabilities assumed, or equity instruments issued, should be a. Deferred and amortized. b. Credited or charged to additional paid-in capital. c. Recognized in net income for the period.

5. For financial liabilities recognized at the statement of financial position date, the reporting

entity should disclose the following, except

a. Gross interest expense on current and long-term financial liabilities b. Whether any such liabilities were in default or in breach of any term or covenant during

the period that would permit a lender to demand accelerated repayment. c. Whether defaults were remedied, or the terms of the liability were renegotiated, before

the financial statements were completed.


Equity

This section addresses accounting for capital transactions and the presentation, and disclosure of equity and changes in equity in financial statements prepared using the framework. Capital transactions include

• Issuances of capital (including premiums, discounts, and expenses relating to the issuance), and redemptions, or cancellation of capital stock;

• Excess or deficiency of proceeds

– On purchase (acquisition) and resale by the reporting entity of its own issued capital shares or

– On purchase (acquisition) and cancellation by the reporting entity of its own issued capital shares;

• Contributions by owners or others;

• Dividends (including stock dividends);

• Distributions (cash and property); and

• Taxes arising at the time of changes in shareholder status or capital stock transactions.

Acquisition of Shares

Two methods of accounting are allowed for the acquisition by the reporting entity of its own shares of capital stock: 1) the cost method and 2) the constructive retirement method. Note that the treatment can vary depending on state laws and regulations. Under the cost method, the acquired shares should be carried at cost and shown as a deduction from shareholders' equity until cancelled, retired, or resold. Such shares held are commonly called treasury stock and are considered to be issued, but not outstanding. No adjustment is made to capital stock and related accounts that were credited upon original issuance. Under the constructive retirement method, the aggregate par or stated value of the reacquired shares are charged to the capital stock account rather than to a treasury stock account. An excess of repurchase price over par or stated value is allocated between additional paid-in capital and retained earnings. Resale of Acquired Shares

When the reporting entity acquires its own shares and subsequently resells them, no gain or loss is recognized in the statement of operations.


Under the cost method, when the reporting entity resells shares that it has acquired, the treasury stock account is credited, and any excess of the proceeds over cost should be credited to additional paid-in capital; any deficiency should be charged to additional paid-in capital to the extent that a previous net excess from resale or cancellation of shares of the same class is included therein, otherwise, to retained earnings. Under the constructive retirement method, when an entity resells shares that it has acquired, they are treated as if they were an original issue. Capital stock and additional paid-in capital are credited with the appropriate amounts. Retirement or Cancellation of Shares

When the reporting entity retires or cancels shares that it has acquired, the accounting depends on the method that was used to reacquire the shares. If the cost method was used, the treasury stock account is credited, and the cost is allocated to the capital stock and related accounts (for example, additional paid-in capital). If the constructive retirement method was used, no further accounting would be necessary if those reacquired shares are retired or cancelled. Dividends

Dividends should be recognized when declared. When the reporting entity has acquired its own shares and such shares have not been cancelled, any dividends otherwise payable with respect to these shares should be treated as a reduction of dividends and should not be reflected as income. Presentation and Disclosure

The reporting entity should separately present the changes in equity for the period and the components of equity. For a partnership, changes should include capital contributions, income or losses, and withdrawals. Components of equity should include the capital accounts. If changes in equity are limited, the reporting entity may present a statement of operations and retained earnings instead of a separate statement of changes in equity. Notes receivable by the reporting entity for sales of its capital stock (which may include preferred stock) or equivalent ownership instruments for unincorporated entities should be shown in equity, unless collected in cash before the financial statements are issued. Charges in the statement of operations for salaries, interest, or similar items accruing to the owners of an unincorporated business should be reported separately or otherwise disclosed. If there are no such charges, that fact should be disclosed instead. Restrictions of the distributions of retained earnings should be disclosed. Disclosures related to capital stock include among others, the shares authorized, par or stated value, shares repurchased or issued during the period, dividend rates on preferred shares, redemption price of redeemable shares, conversion provisions, and shares held in treasury.


Stock and Other Equity Compensation

The reporting entity should describe the general terms of awards under a stock, including vesting and the maximum term of options granted. The reporting entity does not recognize compensation expense for awards under the framework. Equity Transactions with Nonemployees

Transactions between the entity and a nonemployee whereby the entity receives goods or services in exchange for equity should be measured at the value of the consideration received or the equity given, whichever is more reliable. Limited Liability Entities: Presentation and Disclosures

There are presentation and disclosure requirements unique to limited liability entities under the framework. A limited liability entity should present information related to changes in owners’ (members') equity for the period. This information may be presented as a separate statement, combined with the statement of operations, or in the notes to financial statements. The equity section in the statement of financial position of a limited liability entity should be titled owners’ (or members’) equity. If more than one class of members exists, each having varying rights, preferences, and privileges, the limited liability entity is encouraged to report the equity of each class separately within the equity section. If a limited liability entity does not report the amount of equity of each class of owners (members) separately within the equity section, it should disclose those amounts in the notes to financial statements. If a limited liability entity records amounts due from owners for capital contributions, such amounts should be presented as deductions from owners’ equity. Even though an owner’s liability may be limited, if the total balance of the owners’ equity account or accounts is less than zero, a deficit should be reported in the statement of financial position. If a limited liability entity maintains separate accounts for components of owners’ equity (for example, undistributed earnings, earnings available for withdrawal or unallocated capital), disclosure of those components, either on the face of the statement of financial position or in the notes to financial statements, is permitted. Significant differences in the rights, preferences, and privileges of different classes of members should be disclosed.


Feedback Question

6. Methods of accounting for the acquisition by the reporting entity of its own capital stock include each of the following, except

a. The cost method. b. The treasury method. c. The constructive retirement method.

Revenue

This section focuses on the timing of revenue recognition for revenue arising in the ordinary course of the reporting entity selling products and/or rendering services. Revenue from sales or services should be recognized when performance is achieved. Under paragraph 19.04 of the framework, for a transaction involving the sale of goods, performance should be regarded as having been achieved when the following conditions have been fulfilled:

• The seller of the goods has transferred to the buyer the significant risks and rewards of ownership, all significant acts have been completed, and the seller retains no continuing managerial involvement in, or effective control of, the goods transferred to a degree usually associated with ownership.

• Reasonable assurance exists regarding the measurement of the consideration that will be derived from the sale of goods and the extent to which goods may be returned.

Under 19.05 of the framework, in the case of rendering of services and long-term contracts and modifications to those contracts, performance should be determined using either the percentage of completion method or the completed contract method, whichever relates the revenue to the work accomplished. Such performance should be regarded as having been achieved when reasonable assurance exists regarding the measurement of the consideration that will be derived from rendering the service or performing the long-term contract. In addition to the conditions referred to under paragraphs 19.04 and 19.05 of the framework, performance should be regarded as being achieved when all the following criteria have been met:

• Persuasive evidence of an arrangement exists.

• Delivery has occurred, or services have been rendered.

• The seller’s price to the buyer is fixed or determinable.


Some of the items management should consider in determining if persuasive evidence of an arrangement exists are

• Customary business practices and past dealings between parties.

• Side arrangements.

• Consignment arrangements.

• Rights to return the product.

• Requirements to repurchase the product.

Generally, delivery is not considered to have occurred unless the product has been delivered to the customer's place of business or another site specified by the customer. Some of the aspects of the revenue arrangement management should consider in determining if delivery has occurred or services have been rendered are as follows:

• Bill and hold arrangements.

• Customer acceptance of product.

• Layaway sales arrangements.

• Nonrefundable fee arrangements.

• Licensing and similar fee arrangements.

• Risk of loss has passed to the buyer.

In determining if the seller's price to the buyer is fixed or determinable, management should consider the impact of the following factors:

• Cancellable sales arrangements.

• Right of return arrangements.

• Price protection or inventory credit arrangements, or both.

• Refundable fee for service arrangements.

The revenue recognition criteria are applied separately to each transaction. If the sales agreement includes multiple deliverables the recognition criteria are applied to the separate deliverables.


If the seller retains significant risks of ownership, it is normally inappropriate to recognize the transaction as a sale. Such risk exists when 1) there is a liability for the unsatisfactory performance of the product that is not covered by normal warranty; 2) the purchaser has a right to rescind the transaction; and 3) the products are shipped on consignment. Revenue is recognized on long-term contracts consisting of multiple acts (for example, building an apartment complex or producing a complex machine) using the percentage of completion method. Revenue is recognized on a rational and consistent basis proportionately by reference to performance. Performance may be measured using inputs or outputs. Inputs may include labor hours, costs incurred, or other measures. Outputs may include produced units, milestones achieved, or other measures. If multiple indeterminate services are provided over a specific time period, revenue may be recognized using a straight line basis unless some other method better reflects the pattern of performance. The completed contract method is used when the entity cannot reasonably estimate the extent of progress toward completion. The completed contract method may also be used if both of the following conditions are met:

• The completed contract method is used for income tax reporting purposes.

• The financial position and results of operations of the entity would not vary materially from those resulting from the use of the percentage of completion method (for example, in circumstances in which an entity has primarily short-term contracts).

Recognition of amounts of additional contract revenue relating to contract-related claims is appropriate only if it is probable that the claims will result in additional contract revenue and if amounts can be reliably estimated. Those two requirements are satisfied by the existence of all the following conditions:

• There is a legal basis for the claims.

• Additional costs are caused by circumstances that were unforeseen at the contract date and are not the result of contractor performance deficiencies.

• Costs associated with the claims are identifiable or otherwise determinable and are reasonable in view of the work performed.

• Evidence supporting the claims is objective and verifiable.

If the foregoing requirements are met, revenue from contract-related claims should be recorded only to the extent that contract costs relating to the claims have been incurred. Costs attributable to claims should be treated as costs of contract performance as incurred.


A practice such as recording revenues from claims only when the amounts have been received or awarded may be used. If that practice is followed, the amounts should be disclosed in the notes to the financial statements. When uncertainty exists as to the ultimate collection of the revenue, it may be appropriate to recognize the revenue only as cash is collected. If the uncertainty arises subsequent to the revenue being recognized, the provision to reflect the potential loss should be charged to operations. The amount of revenue previously recorded should not be adjusted. If collection of the revenue is dependent upon the sale of the product by the purchaser then the selling reporting entity should not recognize the revenue until collected. If the product sold by the reporting entity is subject to material and unpredictable returns, revenue should not be recognized until a predictable pattern is established. This may be the case for new products. It may be sufficient to provide an allowance for returns. When the reporting entity acts as a principal it records revenues and cost of sales for products it sells. If the reporting entity acts as an agent then it records revenues in the form of commissions as its fee for arranging the sale. Features that indicate that the reporting entity is acting as a principal follow:

• The reporting entity has the primary responsibility for providing the goods or services to the customer or for fulfilling the order.

• The reporting entity has inventory risk before or after the customer order, during shipping, or on return.

• The reporting entity has latitude in establishing prices.

• The reporting entity bears the customer's credit risk for the amount receivable from the customer.

One feature indicating that the reporting entity is acting as an agent is that the amount it earns is predetermined, being either a fixed fee per transaction or a stated percentage of the amount billed to the customer. Disclosures

The reporting entity should disclose its revenue recognition policy for each significant different type of revenue transaction, including multi-deliverable arrangements and the amount of revenue recognized by its major categories. Judgment is required to determine the categories that the reporting entity uses. Usually the description of the nature of the business operations of the entity and the types of revenues it earns should be congruent.


Feedback Question

7. Performance should be regarded as achieved when which of the following conditions have been met? a. Persuasive evidence of an arrangement exists. b. Delivery has occurred, or services have been rendered. c. The seller’s price to the buyer is fixed or determinable. d. Performance should be regarded as achieved only when all of the conditions in a. through

c. have been met. Income Taxes

A reporting entity should make an accounting policy election to account for income taxes using either

• The taxes payable method; or

• The deferred income taxes method.

Taxes Payable Method

Under the taxes payable method, only currently refundable or recoverable income taxes and currently payable income taxes as reportable in the reporting entity’s income tax returns are recognized in its financial statements. When a tax loss is used to recover income taxes previously paid, the benefit is recognized in the period the tax loss occurs. Deferred Income Taxes Method

Under the deferred income taxes method, the reporting entity recognizes current income taxes, deferred income taxes on taxable temporary differences, deductible temporary differences, unused income tax loss and income tax credit carryovers. A valuation allowance is provided for that portion of the deferred income tax assets that is not more likely than not to be realized. Realization is dependent on the existence of sufficient taxable income, including the use of income tax planning strategies. Measurement and Intraperiod Allocation Under the Deferred Method

Income taxes are measured using enacted tax rates and laws (including those related to capital gains and alternative minimum tax) enacted as of the date of the statement of financial position and expected to apply when the deferred income tax asset is realized or the deferred income tax liability is settled. Also, income tax expense or benefit is allocable to income before income taxes from continuing operations, discontinued operations, equity for certain transactions and events, the correction of an error, a change in accounting principle, and a business combination.


Disclosure

The reporting entity is required to disclose which method of accounting for income taxes it has elected. In addition, if the reporting entity has adopted the taxes payable method, the reporting entity should disclose a discussion of the differences of income tax rate or expense related to income or loss for the period before discontinued operations to the statutory income tax rate or the dollar amount that would result from its application, including the nature of each significant reconciling item. The entity may include or omit a numerical reconciliation. Other customary disclosures, such as the amounts and expirations of income tax loss carryovers are generally required. Retirement and Other Post-Employment Benefits

This section addresses principles for the recognition, measurement, and disclosure of the cost of retirement and other post-employment benefits under the framework. The reporting entity is required to recognize the cost of retirement benefits and certain post-employment benefits over the periods in which employees render services to the entity in return for the benefits. Other post-employment benefits are recognized when the event that obligates the reporting entity occurs. These benefits include

• Pension and other retirement benefits expected to be provided after retirement to employees and their beneficiaries, such as pension income, health care benefits, life insurance, and other miscellaneous benefits provided to employees after retirement;

• Post-employment benefits expected to be provided after employment but before retirement to employees and their beneficiaries, such as long- and short-term disability income benefits (including workers’ compensation), severance benefits, salary continuation, supplemental unemployment benefits, job training and counseling, and continuation of benefits such as health care benefits and life insurance; and

• Termination benefits.

Basic Principles

An obligation for retirement and other post-employment benefits possesses all the characteristics of liabilities. The two basic types of retirement or pension plans are defined contribution and defined benefit. If deferred compensation contracts, as a group, are equivalent to a pension plan, they are accounted for the same as a pension plan. Other deferred compensation contracts should be accounted for on an individual basis for each employee. Measurement and Disclosure of Defined Contribution Plans

The pension cost to be recorded as expense for an accounting period should normally be the contribution that applies to that period accounted for on the accrual basis.


The reporting entity should disclose the following information about its defined contribution plans:

• A general description of each plan.

• The amount of cost recognized in the period.

Measurement and Disclosure of Multiemployer Plans

Pension cost consists solely of the contribution required for the year, unless termination of participation in the plan is probable. In that case, then any additional amounts required to be funded should be accrued. The reporting entity should disclose the following information about significant multiemployer plans:

• The name of the plan and a description of the type of plan.

• If withdrawal from the plan is probable or reasonably possible, whether withdrawal from the plan would give rise to an obligation.

• The amount of cost recognized in the period.

Measurement and Disclosure of Individual Deferred Compensation Contracts

If the contract is based on current and future employment, only amounts attributable to current employment are accrued. If expected future benefits are attributable to more than one year of service, the cost of those benefits should be accrued over the period of the employee’s service. At the end of that service period, the total amount accrued should equal the present value of the benefits expected to be provided. The reporting entity should disclose the following information in the aggregate about individual deferred compensation contracts:

• A general description of the contracts, including expected timing of benefit payments and the discount rate used to determine present value.

• The liability at the statement of financial position date and the amount charged to expense in the statement of operations.


Recognition, Measurement, and Disclosure of Defined Benefit Plans

The reporting entity should make an accounting policy election to account for defined benefit plans using either the

• Current contribution payable method or

• One of the accrued benefit obligation methods.

Current Contribution Payable Method

Under this method, only the contribution attributable to the current year is expensed. And the following disclosures are required:

• A description of the plan, including plan participants and the nature of determining benefits.

• Information about the funded status of the plan, including the benefit obligation, the market value of plan assets, and the excess of the benefit obligation over market value of plan assets.

• The current year’s contribution and expected contribution for the subsequent year.

• The expected rate of return on plan assets and the discount rate used to determine the accrued benefit obligation.

Accrued Benefit Obligation Methods

The accrued benefit obligation methods require recording the accrued benefit obligation. Under the framework, the reporting entity may account for its defined benefit plans using either 1) the immediate recognition approach or 2) the deferral and amortization approach. The reporting entity is required to use the same method for all of its defined benefit plans. Immediate Recognition Approach

Under the immediate recognition approach, the accrued benefit obligation is determined based on the actuarial valuation report prepared for funding purposes. When an appropriate valuation report is not available, the entity determines the accrued benefit obligation using the same assumptions as required under the deferral and amortization approach. The entity recognizes the net amount of the accrued benefit obligation and the market value of plan assets, if any, in its statement of financial position. Actuarial and plan asset gains and losses and prior service costs are included in the cost of the plan for the year.


Deferral and Amortization Approach

Under the deferral and amortization approach, the reporting entity determines the accrued benefit obligation based on an actuarial valuation report prepared specifically for accounting purposes. The reporting entity recognizes in its statement of financial position an accrued benefit liability or accrued benefit asset, which represents the sum of the current and prior years' benefit costs less the reporting entity's accumulated cash contributions to the plan. Prior service costs are deferred and amortized over future periods. Further, actuarial and plan asset gains and losses may also be deferred and amortized over future periods. The market value of plan assets, if any, and the accrued benefit obligation are disclosed in the notes to the financial statements.

Disclosures for Defined Benefit Plans

The reporting entity should disclose the following information about its defined benefit plans:

• A description of the plan, including plan participants and the nature of determining benefits;

• Information about the funded status of the plan, including benefit obligation, market value of plan assets, and the plan deficit or excess, at the end of the reporting period; and

• The expected rate of return on plan assets and the discount rate used to determine the accrued benefit obligation.

The framework does not specifically require the reporting entity to disclose the amount of expense for the period.


Chapter 3

Business Combinations and Intangible Assets

Learning Objectives

• Learn to account for business combinations under the FRF for SMEs accounting framework, including the determination of goodwill.

• Learn to account for intangible assets acquired in business combinations and internally developed intangible assets or purchased intangible assets.

• Learn amortization methods and periods for goodwill and other intangible assets. (Note: For the remainder of this course, intangible assets other than goodwill are referred to as intangible assets.)

Introduction

The reporting entity should account for each business combination using the acquisition method under the framework. The acquisition method requires the reporting entity to

1. Identify the acquirer.

2. Determine the acquisition date.

3. Recognize and measure the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree.

4. Recognize and measure goodwill or a gain from a bargain purchase.

The acquirer is the entity that obtains control of the acquiree. Of course, the acquiree is the “business” that the acquirer obtains control of in a business combination.

Control is usually obtained as of the acquisition date, which is generally the date of the closing of the transaction.

The acquirer recognizes separately from goodwill as of the acquisition date the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The identifiable


assets acquired and liabilities assumed must meet the definitions of assets and liabilities in Chapter 1 “Financial Statement Concepts” of the framework.

Some of the assets acquired and liabilities assumed by the acquirer may not have been previously recognized in the financial statements of the acquiree. Examples may include the acquiree’s brand name, customer relationships, backlog, patents, and so on.

The acquirer should measure the recognized identifiable assets acquired and liabilities assumed at their market values as of the acquisition date. (Market value is the amount that would be agreed upon in an arm’s length transaction between knowledgeable, willing parties who are under no compulsion to act.) Further, the acquirer should recognize and measure any noncontrolling interest in the acquiree at the noncontrolling interest’s proportionate share of the acquiree’s identifiable net assets. An example follows.

Case 3-1 Determining Amount of Noncontrolling Interest

Facts: P acquires a 90% ownership interest in S for cash of $55,000. As of the acquisition date the historical cost of S’s identifiable assets is $150,000 and their market value is $170,000. The historical cost of S’s liabilities is $125,000, which is equal to market value.

Question: What amount should P report in its consolidated statement of financial position as of the acquisition date for the noncontrolling interest in S?

Answer: P the acquirer should recognize and measure any noncontrolling interest in S, the acquiree, at the noncontrolling interest’s proportionate share of the acquiree’s identifiable net assets or $4,500. [(Market value of identifiable assets - $170,000 less market value of liabilities - $125,000) × (noncontrolling interest’s proportionate share - 10%)]

As described above, the acquirer should measure the recognized identifiable assets acquired and liabilities assumed at their market values as of the acquisition date. However, there are some exceptions and modifications. They relate to intangible assets, asset retirement obligations, income taxes, employee benefits, indemnification assets, and assets held for sale. These matters are discussed below.

Intangible Assets

Business combinations frequently include the acquisition of identifiable intangible assets, such as customer relationships, intellectual property, trademarks, and so on. An intangible asset is


identifiable when it is separable or arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations. An asset is separable if it can be separated from the entity and sold, transferred, licensed, rented, or exchanged. The cost of an intangible asset acquired in a business combination is its market value at the acquisition date.

The reporting entity should make an accounting policy choice to account for an intangible asset acquired in a business combination to either

• Separately recognize the intangible asset, or

• Not separately recognize the intangible asset, but rather subsume it into goodwill.

To separately recognize an identifiable intangible asset, its market value on the acquisition date should be measured reliably. The acquirer should then assign a useful life to the recognized identifiable intangible asset. When the precise length of such an intangible asset’s useful life is not known, the acquirer should estimate its useful life. Guidance for determining the useful life of an intangible asset is provided in paragraph 13.58 of the framework. If the acquirer cannot reliably measure the acquisition date market value of the intangible asset or estimate its useful life, then separate recognition of the intangible asset as an identifiable asset is not permitted and the value of the intangible asset should be subsumed into goodwill.

The accounting policy election to separately recognize or not separately recognize an identifiable intangible asset may be made on an individual intangible asset basis. Once made, the accounting policy chosen for a specific intangible asset cannot be subsequently reversed.

Asset Retirement Obligations (ARO)

The acquirer should recognize a liability for an ARO as of the acquisition date if there is a legal obligation. The amount recognized for the ARO should be the best estimate of the expenditure required to settle the obligation as of the acquisition date. The market value of the related asset should reflect the expenditures to settle the ARO as of the acquisition date.

Income Taxes

If the acquirer uses the deferred income tax method of accounting it would recognize deferred income taxes arising from temporary differences in the bases of assets acquired and liabilities assumed in a business combination.


Employee Benefits

The accrued benefit obligation is calculated using best estimate assumptions consistent with those that will be used on a going-forward basis in accordance with the framework. Similarly, plan assets are valued at market value. Any previously existing unamortized net actuarial or asset gains (losses), unamortized prior service costs, and unamortized transitional obligation or unamortized transitional asset is eliminated with the result that the accrued benefit asset or accrued benefit liability is the difference between the accrued benefit obligation and the market value of plan assets. The carrying amount of an accrued benefit asset in the acquired entity’s financial statements may need to be reduced when the acquirer expects limitations on its ability to access a plan excess as a result of existing regulations of the relevant jurisdiction and the plan.

Indemnification Assets

Indemnification assets recognized are measured on the same basis as the related indemnity obligation.

Assets Held for Sale

Noncurrent assets of the acquiree to be sold by the acquirer should be measured at market value less costs to sell.

Recognizing and Measuring Goodwill or a Gain from a Bargain Purchase Under paragraph 28.28 of the framework, the acquirer should recognize goodwill as of the acquisition date measured as the excess of the consideration transferred and the amount of any noncontrolling interest in the acquiree over the net amount of the identifiable assets acquired and the liabilities assumed.

Goodwill would be similarly recognized and measured for a business combination achieved in stages.

If the net amount of the identifiable assets acquired and the liabilities assumed exceeds the consideration transferred and the amount of any noncontrolling interest in the acquiree, then the acquirer should recognize a gain on a bargain purchase, which should be reported in its statement of operations.

The following is an example of recognizing and measuring goodwill.


Case 3-2 Determining the Amount of Goodwill

Facts: Use the facts from Case 3-1.

Question: What is the amount of goodwill?

Answer: $14,500 [(Consideration transferred - $55,000 plus noncontrolling interest in S - $4,500—see Case 3-1) less (the net amounts of the identifiable assets acquired - $170,000 less the liabilities assumed - $125,000)].

Consideration Transferred

The consideration transferred in a business combination is measured at market value. If it includes nonmonetary assets, those assets are adjusted to their market values before applying the acquisition method.

If the consideration includes contingent consideration, the acquirer recognizes such consideration when its payment is probable and reasonably estimable. The classification of the contingent consideration as debt or equity is based on the definitions of the underlying financial instruments. Goodwill is recognized for the contingent consideration.

Measurement Period

All of the information with which to measure the assets acquired and liabilities assumed of the acquiree may not be available as of the end of the acquirer’s reporting period. As such, the business combination is incomplete and provisional amounts are recognized. These provisional amounts are subsequently remeasured to reflect new information with a corresponding charge or credit to goodwill. Material differences would result in a retrospective adjustment of the prior year’s provisional amounts. The measurement period should not exceed one year from the acquisition date.

Acquisition-Related Costs

Acquisition-related costs (finder’s fees and consulting fees charged by financial advisors, attorneys, valuation experts, and accountants) are expensed as incurred. Entities may present significant acquisition related costs as a FSLI amount in their statement of operations or otherwise disclose in a note to financial statements the amount of such costs and the FSLI that includes them.


Amortization of Goodwill and Intangible Assets

Under the framework, all intangible assets, including goodwill, are considered to have a finite life.

A recognized intangible asset is amortized over the best estimate of its useful life. The amortization method should reflect the pattern in which the asset’s economic benefits are consumed or provided. If the pattern cannot be reliably determined the straight-line method is used. Both the amortization method and useful life should be reviewed annually. Goodwill should be amortized over the same period as that used for Federal income tax purposes, or if not amortized for Federal income tax purposes then over a period of 15 years.

Goodwill and intangible assets acquired in connection with a business combination are not required to be reviewed for impairment under the framework.

Internally Developed or Purchased Intangible Assets

So far this chapter has addressed goodwill and other intangible assets acquired in connection with business combinations. The remainder of this chapter focuses on internally developed other intangible assets or purchased other intangible assets related to technology, intellectual property, new processes or systems, software, and so on.

An “other intangible asset” has certain characteristics as follows: 1) it is identifiable; 2) it is under the control of the reporting entity; and 3) it will provide future economic benefits.

The asset is identifiable if it can be sold, licensed, rented, transferred or exchanged (such as separable) or arises from a contractual or legal right. The asset is under the control of the reporting entity if the reporting entity has the power to obtain the future economic benefit from that asset. The future economic benefit may be additional revenue or cost savings, or some other form.

An intangible asset should be recognized if, and only if

• It is probable that the expected future economic benefits that are attributable to the asset will flow to the reporting entity,

• The cost of the asset can be measured reliably, and

• The useful life of the asset can be reasonably estimated.


The probability of expected future economic benefits is determined using reasonable and supportable assumptions that represent management's best estimate of the set of economic conditions that will exist over the useful life of the intangible asset.

A purchased intangible asset should be measured initially at cost.

A reporting entity may incur costs related to the research and development of an internally-generated intangible asset. Costs incurred during the “research” phase related to the intangible asset are expensed. The accounting treatment of costs during the development phase is an accounting policy choice. As such, the reporting entity may choose to expense or capitalize such costs.

An internally developed intangible asset is recognized only if the reporting entity can demonstrate all of the following:

• The technical feasibility of completing the intangible asset so that it will be available for use or sale.

• Its intention to complete the intangible asset and use or sell it.

• Its ability to use or sell the intangible asset.

• The availability of adequate technical, financial, and other resources to complete the development and to use or sell the intangible asset.

• Its ability to measure reliably the expenditure attributable to the intangible asset during its development.

• How the intangible asset will generate probable future economic benefits. Among other things, the entity can demonstrate the existence of a market for the output of the intangible asset or the intangible asset itself or, if it is to be used internally, the usefulness of the intangible asset.

Amortization of Purchased Intangible Assets and Internally Developed Intangible Assets

The accounting for purchased intangible assets and internally developed intangible assets is the same as accounting for intangible assets acquired in a business combination. Purchased intangible assets and internally developed intangible assets should be amortized over their estimated useful lives. All such intangible assets should be considered to have finite useful lives. The useful life of an intangible asset that arises from contractual or other legal rights should not exceed the period of the contractual or other legal rights but may be shorter depending on the period over which the entity expects to use the asset. If the contractual or other legal rights are conveyed for a limited term that can be renewed, the useful life of the intangible asset should


include the renewal period(s) only if there is evidence to support renewal by the entity without significant cost.

The amortization method and estimate of the useful life of an intangible asset should be reviewed annually.

When the precise length of an intangible asset’s useful life is not known, the intangible asset is amortized over the best estimate of its useful life. Guidance for determining the useful life of an intangible asset is provided in paragraph 13.58 of the framework.

Feedback Questions

1. Under the framework,

a. Goodwill is considered to have a finite life and is amortized. b. Goodwill is considered to have an infinite life and is not amortized but reviewed for

impairment at least annually. c. The accounting for goodwill is based on the reporting entity’s accounting policy election.

2. An intangible asset should be recognized if, and only if

a. It is probable that the expected future economic benefits that are attributable to the asset will flow to the reporting entity.

b. The cost of the asset can be measured reliably. c. The useful life of the asset can be reasonably estimated. d. All of the above must be present.

3. A reporting entity may incur costs related to the research and development of an internally-

generated intangible asset. Costs incurred during the “research” phase are expensed as incurred under the framework. Costs incurred during the development phase are

a. Expensed at completion or termination of the project. b. Capitalized over 15 years. c. Either expensed as incurred or capitalized depending on the reporting entity’s accounting

policy election. Start-up Costs

The reporting entity may incur start-up costs consisting of legal and other administrative costs to establish a legal entity, open a new facility or business, start new operations, or launch new products or services. Management of the reporting entity should make an accounting policy


election to either expense start-up costs as incurred or capitalize such costs and amortize them over 15 years.

Presentation

Goodwill and other intangible assets should be reported as separate line items in the reporting entity’s statement of financial position.

Disclosures

Disclosures related to business combinations, and goodwill and intangible assets are similar to those under GAAP. Some specific disclosures follow.

An acquirer is required to show the amounts recognized as of the acquisition date for each major class of assets acquired and liabilities assumed. The acquirer is also required to disclose its accounting policy to either separately recognize or not separately recognize intangible assets, that is subsume them into goodwill.

The financial statements should disclose for goodwill and intangible assets the following information:

• The carrying amount in total and by major intangible asset class.

• The aggregate amortization expense for the period.

• The amortization method used, including the amortization period or rate by major intangible asset class.

• The accounting policy for internally generated intangible assets, including the treatment of development costs, such as expensed or capitalized.

An intangible asset class is a group of intangible assets that are similar, either by their nature or by their use in the operations of an entity.

If the reporting entity has incurred expenditure on start-up costs, the policy for accounting for those costs should be disclosed.


Feedback Question

4. Under the framework, start-up costs are

a. Expensed at completion or termination. b. Capitalized and amortized over 5 years. c. Either expensed as incurred or capitalized depending on the reporting entity’s accounting

policy election.


Chapter 4

Investments

Learning Objectives

• Understand the accounting policy elections available for investments under the FRF for SMEs accounting framework.

• Learn to appropriately apply methods of accounting to investments based on the facts and circumstances, including the nature of the investments.

Introduction

This chapter focuses on accounting for investments in subsidiaries, investments accounted for under the equity method, investments in joint ventures, and other investments. Also addressed are investments held for sale or sold. Lastly, investment disclosure and presentation requirements are addressed.

Investments in Subsidiaries

Under the framework, a subsidiary is an entity in which another entity (the parent) owns more than 50 percent of its outstanding residual equity interests. Ownership of more than 50 percent of the outstanding residual equity interests is indicative of control. As such, the parent reporting entity should make an accounting policy election under the framework to either

• Consolidate its more than 50 percent-owned subsidiaries; or

• Account for its more than 50 percent-owned subsidiaries using the equity method.

All subsidiaries should be accounted for under the same accounting policy. Note that the framework does not recognize “financial control” as defined in GAAP. In addition, the concept of variable interest entities does not exist in the framework.

A material difference in the basis of accounting between a parent and a subsidiary precludes the preparation of consolidated financial statements and the use of the equity method.

Based on the elected accounting policy, the financial statements should be labeled accordingly, for example “consolidated” or “unconsolidated.”


Feedback Question

1. Under the framework, a reporting entity owning more than 50 percent of the outstanding equity interests in another entity should not

a. Consolidate that entity. b. Account for its investment in that entity using the equity method. c. Account for its investment in that entity using the cost method.

Investments Accounted for by the Equity Method

This section addresses accounting for an ownership investment by the reporting entity (investor) in another entity (investee) that is neither a subsidiary (that is, the investor’s ownership is not in excess of 50 percent) nor a “joint venture,” as defined. Investments in subsidiaries were discussed previously and investments in joint ventures are discussed in the following section.

Investments in other entities in which the reporting entity owner holds 20 percent or more, but not more than a 50 percent ownership interest should be accounted for by the investor reporting entity using the equity method. That accounting is based on the rebuttable presumption that the investor reporting entity has the ability to exercise significant influence over the investee. If the investor reporting entity does not have that ability, then it should account for the investment using the cost method, except if the investment is held for sale. In the latter case the investment is measured at market value.

Under the equity method, the investment account of the investor reflects

• The cost of the investment in the investee;

• The investment income or loss (including the investor's proportionate share of discontinued operations) relating to the investee subsequent to the date when the use of the equity method first became appropriate;

• The investor's proportionate share of a change in an accounting policy, a correction of an error relating to prior period financial statements, and capital transactions of the investee subsequent to the date when the use of the equity method first became appropriate; and

• The investor's proportion of dividends paid by the investee subsequent to the date when the use of the equity method first became appropriate.

The difference between the investor’s cost and the amount of its underlying equity in the net assets of the investee that is similar to goodwill (equity method goodwill) is amortized.


Any unrealized intercompany gain or loss, and any gain or loss that would arise in accounting for intercompany bond holdings, are eliminated. The elimination of an unrealized intercompany gain or loss has the same effect on net income regardless of whether the consolidation or equity method is used. In the application of the equity method, the gain or loss is eliminated by adjustment of investment income from the investee or by separate provision in the investor’s financial statements, as appropriate in the circumstances.

An investor generally should discontinue applying the equity method if the investment, and net advances, is reduced to zero. An investor's share of losses in excess of the carrying amount and net advances of the investment should be recorded if

• The investor has guaranteed the obligations of the investee;

• The investor is otherwise committed to provide further financial support to the investee; or

• The investee seems assured of imminently returning to profitability.

If the investee subsequently reports net income, the investor should resume applying the equity method only after its share of net income equals the share of net losses not recognized during the period where the equity method of accounting was suspended.

When an investor ceases to be able to exercise significant influence, cost is deemed to be the carrying amount of the investment at that time.

Feedback Question

2. An equity method investor’s share of losses in excess of the carrying amount and net advances to the investee should be recorded, unless

a. The investor has guaranteed the obligations of the investee. b. The investor is committed to provide further financial support to the investee. c. The investee does not seem assured of imminently returning to profitability.

Investments in Joint Ventures

Under the framework, a joint venture is defined as an economic activity resulting from a contractual arrangement whereby two or more venturers participate, directly or indirectly, in the jointly controlled economic activity. Joint control is the proportionate contractually-agreed sharing of the continuing power to determine strategic operating, investing, and financing policies.


A venturer reporting entity should make an accounting policy election to account for its interests in joint ventures using the

• Proportionate consolidation method; or

• Equity method.

The proportionate consolidation method may only be applied to investments in unincorporated entities in the construction industry.

All interests in joint ventures should be accounted for using the same method. Equity method investees should normally follow the same basis of accounting (that is, the FRF for SMEs accounting framework) as the investor. Accordingly, financial statements of equity method investees should be adjusted, if necessary, to conform with principles in the framework, unless it is impracticable to do so.

Under the proportionate consolidation method, the venturer reporting entity reflects its pro rata share of the assets, liabilities, revenues, and expenses that it jointly controls in its financial statements. This method may be applied regardless of the extent of ownership interest in the unincorporated joint venture.

Feedback Question

3. Under the framework, the reporting entity’s 40 percent investment in a corporate joint venture should be accounted for using

a. Full consolidation. b. Equity method. c. Cost method.

Other Investments

The cost method should be used when accounting for investments other than those for which the investor is able to exercise significant influence over an investee and equity and debt investments held for sale. These types of investments include certain other investments, such as works of art and other tangible assets held for investment purposes.


Investments Held for Sale or Sold

Equity and debt investments held for sale should be stated at market value. Changes in market values are reflected in operating results. Investments held for sale include securities that management is currently attempting to sell.

The cost for investments sold is determined based on the average carrying value.

Feedback Question

4. Under the framework, the cost of investments sold is determined based on

a. Average carrying value. b. Specific cost. c. First-in, first-out cost.

Disclosures

The basis used to account for investments should be disclosed. When the fiscal periods of an investor and an investee are not the same and the equity method is used to account for the investment, events relating to, or transactions of, the investee that have occurred during the intervening period and significantly affect the financial position or results of operations of the investor should be disclosed. This disclosure is not necessary if these events or transactions are recorded in the financial statements. Other than investments held for sale, an entity should disclose the name and description of each significant investment, including the carrying amounts, and proportion of ownership interests held in each investment.

Subsidiaries

In consolidated financial statements, management should provide a listing and description of all subsidiaries, including their names, income from each subsidiary, and the proportion of ownership interests held in each subsidiary. When an entity prepares consolidated financial statements, it should describe them as being prepared on a consolidated basis and each statement should be labeled accordingly.

In unconsolidated financial statements, management should disclose the basis used to account for its subsidiaries. An entity that prepares unconsolidated financial statements should provide a listing and description of all subsidiaries, including their names, carrying amounts, income from each, and its proportion of ownership interests held in each of them. Further, when an entity accounts for its investments in subsidiaries using the equity method, it should describe its financial statements as being prepared on an unconsolidated basis and each statement should be


labeled accordingly. Investments in unconsolidated subsidiaries should be presented separately from other investments in the statement of financial position. Income or loss from those investments may be presented as a gross or net amount in the statement of operations.

Investments in Joint Ventures

The basis used to account for an entity’s interests in joint ventures should be disclosed. A venturer should provide a listing and description of interests in significant joint ventures, including the names, business purposes, carrying amounts, and proportion of ownership interests held in each joint venture. A venturer should disclose its share of any contingencies and commitments of joint ventures, and those contingencies that exist when the venturer is contingently liable for the liabilities of the other venturers of the joint ventures. Certain other disclosures are required as well.

Financial Statement Presentation

In the statement of financial position each significant category of investment (such as investments in subsidiaries accounted for using the equity method, investments held for sale and so on) should be shown as a separate line item.

In the statement of operations, significant income from each of the different categories of investments should also be shown as a separate line item. For example, the reporting entity should show income from equity method investments separately from income from cost method investments. There are several other financial statement presentation requirements.


Chapter 5

Leases

Learning Objectives

• Learn to distinguish among the different types of leases from the perspective of lessees and lessors.

• Learn to account for operating leases, capital leases, sales-type leases, and financing leases.

Introduction

There are numerous defined terms related to leasing transactions in the FRF for SMEs accounting framework. The defined terms are generally consistent with the definitions that traditionally have been used in accounting over the years. As such, this chapter presumes that the participant has a working knowledge of the common lease related terms.

Leasing activities are addressed in this chapter from the perspectives of the lessee and the lessor. The lessee classifies its leases as either operating or capital. The lessor classifies its leases as operating, sales-type, or direct financing.

Underlying the classification of leases are the benefits and risks of ownership of the leased property. The party to the lease that derives substantially all the benefits and the risks of ownership reflects the underlying property in its financial statements.

Under paragraph 25.08 of the framework, a lease that transfers substantially all the benefits and risks of ownership related to the leased property from the lessor to the lessee should be accounted for as a capital lease by the lessee and as a sales-type or direct financing lease by the lessor.

Under paragraph 25.09 of the framework, a lease in which the benefits and risks of ownership related to the leased property are substantially retained by the lessor should be accounted for as an operating lease by the lessee and lessor.


Under paragraph 25.05 of the framework, the lessee will receive substantially all the benefits and have the risks of ownership when, at the inception of the lease, at least one of the following conditions is present:

• The terms of the lease result in ownership being transferred to the lessee by the end of the lease term or the lease provides for a bargain purchase option.

• The lease term is of such duration that the lessee will receive substantially all the economic benefits expected to be derived from the use of the leased property over its remaining life span. Although the lease term may not be equal to the economic life of the leased property in terms of years, the lessee is normally expected to receive substantially all the economic benefits to be derived from the leased property when the lease term is equal to a substantial portion (usually 75 percent or more) of the remaining economic life of the leased property. This is due to the fact that new equipment, reflecting later technology in prime condition, may be assumed to be more efficient than old equipment that has been subject to obsolescence and wear.

• The lessor is assured of recovering the investment in the leased property and earning a return on the investment as a result of the lease agreement. This condition exists if the present value at the beginning of the lease term of the minimum lease payments, excluding any portion thereof relating to executory costs, is equal to substantially all (usually 90 percent or more) of the market value of the leased property at the inception of the lease. In determining the present value, the discount rate used by the lessee is the lower of the lessee's rate for incremental borrowing or the interest rate implicit in the lease, if known.

In view of the fact that land normally has an indefinite useful life, it is not possible for the lessee to receive substantially all the benefits and risks associated with its ownership, unless there is reasonable assurance that ownership will pass to the lessee by the end of the lease term.

Under paragraph 25.06 of the framework, the lessor has transferred to the lessee substantially all the benefits and risks of ownership when, at the inception of the lease, all of the following conditions are present:

• Any one of the conditions noted in paragraph 25.05 of the framework above.

• The credit risk associated with the lease is normal when compared to the risk of collection of similar receivables.

• The amounts of any non-reimbursable costs that are probable to be incurred by the lessor under the lease can be reasonably estimated. If such costs are not reasonably estimable, the lessor may retain substantial risks in connection with the leased property. For example, this may occur when the lessor has a commitment to guarantee the performance of, or to effectively protect the lessee from obsolescence of, the leased property.


When assessing whether the condition set out in paragraph 22.05(c) exists, the discount rate used by the lessor is the interest rate implicit in the lease.

Lessee Accounting

Capital Lease

The lessee should account for a capital lease as an asset and an obligation.

The asset value and the amount of the obligation recorded at the beginning of the lease term are the present value of the minimum lease payments, excluding the portion thereof relating to executory costs. The amount relating to executory costs included in the minimum lease payments are estimated if not known to the lessee. The interest rate implicit in the lease is affected by the residual value of the leased property in which the lessee usually has no interest. As a result, to use the interest rate implicit in the lease as the discount rate when it is higher than the lessee's rate for incremental borrowing would produce an amount that is less representative of the value of the asset to the lessee than would be obtained by using the lessee's rate for incremental borrowing as the discount rate. Therefore, the discount rate used by the lessee in determining the present value of minimum lease payments should be the lower of the lessee's rate for incremental borrowing or the interest rate implicit in the lease, if practicable to determine. Notwithstanding the foregoing, the maximum value recorded for the asset and obligation may not exceed the leased asset's market value.

The capitalized value of a depreciable asset under a capital lease should be amortized over the period of expected use on a basis that is consistent with the lessee's depreciation policy for other similar assets. If the lease contains terms that allow ownership to pass to the lessee or a bargain purchase option, the period of amortization should be the economic life of the asset. Otherwise, the asset should be amortized over the lease term.

An obligation under a capital lease is similar to a loan. Lease payments should be allocated to a reduction of the obligation, interest expense, and any related executory costs. The interest expense is calculated using the discount rate used in computing the present value of the minimum lease payments applied to the remaining balance of the obligation.


Case 5-1 Lessee Accounting for a Capital Lease

Facts: Lessee enters into a five year lease for equipment which commences on 1.1.X1. Annual lease payments of $10,000 are due starting 1.1.X1. The discount rate is 6%. The present value of the lease payments on 1.1.X1 is $44,651.

Required: Prepare the journal entries for the years X1 and X2.

Answer:

First Year X1:

Equipment $44,651 Capital lease obligation $44,651 To record present value of lease payments at 1/1/X1

Capital lease obligation $10,000 Cash $10,000 To record initial lease payment on 1/1/x1

Amortization expense $8,930 Accumulated amortization $8,930 To record amortization for X1 ($44,651/5) Interest expense $2,079 Accrued interest $2,079 To record interest on capital lease obligation (6% × $34,651) for X1 Second Year X2:

Accrued interest $2,079 Capital lease obligation $7,921 Cash $10,000 To record lease payment on 1/1/X2 Amortization expense $8,930 Accumulated amortization $8,930 To record amortization for X2 Interest expense $1,604 Accrued interest $1,604 To record interest on capital lease obligation ($26,730 × 6%) for X2


Operating Lease

Under an operating lease rent expense is recognized by the lessee over the term of the lease by the straight-line method unless another systematic and rational basis is more representative of the time pattern of the user’s benefit.

Residual guarantee payments by the lessee are recognized as component of rent expense when it becomes likely that the lessee will be required to honor the guarantee. Also, contingent rentals should be recognized as rent expense when incurred.

Case 5-2 Disclosure of Accounting Policy for Recognition of Rent Expense

Facts: Lessee entered into a ten year lease for office space with the first six months “free.”

Required: Present the lessee’s accounting policy for recognizing rent expense.

Answer:

Operating Leases

The Company recognizes rent expense under operating leases over the term of the lease by the straight-line method. Differences between rent expense determined by the straight-line method and contractual lease payments are shown as accrued rent payable.

Feedback Question

1. Under the framework, rent expense is recognized by the lessee over the term of the lease

a. Based on contractual payments. b. By the straight-line method. c. By the straight-line method unless another systematic and rational basis is more

representative of the pattern of the user’s benefit.

Lessor Accounting

Direct Financing Lease

Direct financing leases normally arise when a lessor acts as a financing intermediary between a manufacturer or dealer and a lessee.


Under a direct financing lease the lessor recognizes interest income on the financing provided to the lessee. The initial entry recording the direct financing lease includes debiting lease payments receivable for the minimum lease payments to be received (excluding executory costs), crediting the asset being financed for its carrying amount, and crediting deferred interest income for the difference. The amount of deferred interest income is reduced for initial direct costs. Thereafter, the remaining balance of deferred interest income is amortized to income and recognized using the effective interest method.

Sales-Type Lease

Sales-type leases normally arise when a manufacturer or dealer uses leasing to affect sales of its product.

Under a sales-type lease the lessor recognizes a profit on the sale of the product and interest income on the financing. The initial entry recording a sales-type lease includes debiting lease payments receivable for the minimum lease payments to be received, debiting cost of sales for the product sold, crediting sales for the present value of the minimum lease payments to be received, and crediting deferred interest income for the amount of financing income to be earned. Also, the lessor would recognize as an asset the present value of the unguaranteed residual with a credit to cost of sales. Present values are determined using the interest rate implicit in the lease. Initial direct costs are charged to expense as of the inception of the lease.


Case 5-3 Lessor Accounting for a Sales-type Lease

Facts: Lessor enters into a three year lease with lessee for equipment which commences on 1.1.X1. Annual lease payments of $2,400 are due starting 12.31.X1. The discount rate is 6.87%. The present value of the lease payments on 1.1.X1 is $6,313. The market value of the leased asset is $10,000; its cost is $7,500 and its residual value is $4,500. The present value of the residual value is $3,687 which reflects a discount rate of 6.87%.

Required: Prepare the journal entries for the years X1 and X2.

Entries for X1:

Lease payments receivable ($2,400 × 3) $7,200 Residual value of leased equipment 3,687 Cost of sales ($7,500 - $3,687) 3,813 Inventory $7,500 Deferred interest ($7,200 - $6,313) 887 Sales 6,313 To record sales-type lease 1/1/X1

Cash $2,400 Lease payments receivable $2,400 To record initial lease payment on 12/31/x1

Deferred interest ($7,200 - $887 × 6.87%) $433 Residual value of leased equipment ($3,687 × 6.87%) 253 Interest income $686 To record interest for X1.

Entries for X2:

Cash $2,400 Lease payments receivable $2,400 To record initial lease payment on 12/31/x2

Deferred interest ([$6,313 + 433 - $2,400] = $4,346 × 6.87%) $299 Residual value of leased equipment ($3,940 × 6.87%) 271 Interest income $570 To record interest for X2.


Operating Lease

Income from operating leases should be recognized using the straight-line method over the term of the lease unless another systematic and rational basis is more representative of the time pattern over which the benefit from the leased property is used.

Case 5-4 Disclosure of Accounting Policy for Recognition of Rental Revenue

Facts: Lessor owns an office complex which it rents to tenants over lease terms which range from 5 to 15 years. Some of these non-cancellable leases include renewal options or increasing rents.

Required: Present the lessor’s accounting policy for recognizing rental income.

Answer:

Operating Leases

The Company recognizes rental income under non-cancellable leases over the term of the lease by the straight-line method. Differences between rental income determined by the straight-line method and contractual lease payments received are shown as deferred rental income

Initial direct costs associated with an operating lease should be deferred and amortized over the term of the lease in proportion to rental income.

Feedback Questions

2. Under a sales-type lease the lessor does not recognize which of the following:

a. Guaranteed residual value of the asset. b. Profit on the sales of the product. c. Interest on the lease payments.

3. Under a financing lease the lessor recognizes

a. Profit on the sales of the product. b. Interest on the lease payments. c. Both a. and b.


Subleases

Both the sublessee and sublessor evaluate the sublease to determine its proper classification. There is no effect on the accounting treatment of the original lease.

Sale-Leaseback Transaction

A sale-leaseback transaction involves the sale of property with the purchaser concurrently leasing the same property back to the seller.

In a sale-leaseback transaction, the lease should be accounted for as a capital, direct financing, or operating lease, as appropriate, by the seller-lessee and by the purchaser-lessor.

In view of the interdependence of the terms and the inability to objectively and practically separate the sale and lease, any profit or loss arising on the sale is generally deferred and amortized to income over the lease term. However, when the leaseback is of a portion of the remaining use of the property sold, it may be possible to separate the accounting aspects of the terms of the sale and the lease. The "portion" may be a part of the property, such as one floor of an office tower, or may consist of a portion of the property's remaining economic life, such as 3 years of an estimated life of 10 years. In substance, such a leaseback is not a lease of the same property as that sold to the purchaser-lessor.

In general, when the leaseback is classified as a capital lease, any profit or loss arising on the sale should be deferred and amortized in proportion to the amortization of the leased asset, except for leases involving land only, in which case, it should be amortized over the lease term on a straight-line basis.

In general, when the leaseback is classified as an operating lease, any profit or loss arising on the sale should be deferred and amortized in proportion to rental payments over the lease term.

When the seller-lessee retains the right to only a minor portion of the property sold, the sale and leaseback is accounted for as separate transactions based on their respective terms. The entire gain or loss is included in the determination of net income at the date of the sale unless the amount of rentals called for by the lease is unreasonable under market conditions at the inception of the lease. In these circumstances, an appropriate amount is deferred or accrued by adjusting the profit or loss on the sale and amortized to adjust those rentals to a reasonable amount. If the present value of the minimum lease payments represents 10 percent or less of the market value of the asset sold, the seller-lessee could be presumed to have transferred to the purchaser-lessor the right to substantially all the remaining use of the property sold, and the seller-lessee could be presumed to have retained only a minor portion of such use.


When the seller-lessee retains the right to more than a minor portion of the property, but less than substantially all the property, the amount of the gain or loss included in the determination of net income immediately is equal to the excess, if any, of the gain on sale over

• The present value of the minimum lease payments over the lease term, if the leaseback is classified as an operating lease or

• The recorded amount of the leased asset, if the leaseback is classified as a capital lease.

When, at the time of the sale-leaseback transaction, the market value of the property is less than its carrying value, the difference should be recognized as a loss immediately.

Leases Involving Land and Buildings Under a capital lease, the terms of which allow ownership to pass or provide for a bargain purchase option, a lessee should capitalize the land separately from building(s) in proportion to their market values at the inception of the lease.

When a lease involving land and building(s) does not contain terms that allow ownership to pass or provide for a bargain purchase option, and the market value of land at the inception of the lease is minor in relation to the total market value of the leased property, the land and the building(s) are considered a single unit for the purposes of classification of the lease. The economic life of the building(s) is considered the economic life of the unit.

When a lease involving land and building(s) does not contain terms that allow the ownership to pass or provide for a bargain purchase option, and the market value of land at the inception of the lease is significant in relation to the total market value of the leased property, the land and building(s) are considered separately for purposes of classification. The lessee and lessor allocate the minimum lease payments between the land and building(s) in proportion to their market values. Both parties classify the portion of the lease applicable to land as an operating lease.

Disclosures

Capital Lease—Lessee

For each major category of leased property, plant, and equipment, the reporting entity should disclose

• Cost;

• Accumulated amortization, including the amount of any write-downs; and


• The amortization method used, including the amortization period or rate.

For an obligation under a capital lease, the reporting entity should disclose the

• Interest rate;

• Maturity date;

• Amount outstanding; and

• Security, if any.

The reporting entity should disclose the interest expense related to lease obligations separately or as part of interest expense on long-term indebtedness.

The reporting entity should disclose the aggregate amount of payments estimated to be required in each of the next five years to meet repayment, sinking fund, or retirement provisions.

Operating Lease—Lessee

Disclosure should be made of the future minimum lease payments in the aggregate and for each of the five succeeding years under operating leases. The nature of other commitments under such leases should also be described. Leases with an initial term of one year or less may be excluded from this disclosure requirement.

Direct Financing or Sales-Type Lease—Lessor

The lessor's net investment in direct financing and sales-type leases should be disclosed along with the interest rates implicit in the leases.

Operating Lease—Lessor

The lessor should disclose the cost of property, plant, and equipment held for leasing purposes, and the amount of accumulated amortization.


Feedback Question

4. For each major category of capitalized leased equipment, the reporting entity should disclose all of the following, except

a. Cost. b. Accumulated amortization. c. Amortization method (including the amortization period or rate). d. Net investment.


Chapter 6

Transitioning to the FRF for SMEs Accounting Framework and

Other Matters

Learning Objectives

• Learn to transition to the framework from other bases of accounting.

• Learn when and how to apply “push-down” accounting.

• Learn about other less frequently encountered reporting matters under the framework.

Introduction

This chapter addresses transitioning to the framework and other matters that the participant will likely encounter less frequently than the subject matter addressed in the prior chapters. The later topics include

• Accounting changes, changes in accounting estimates, and correction of errors.

• Foreign currency translation.

• Push-down accounting.

• Disposal of long-lived assets and discontinued operations.

Transitioning to the Framework

The reporting entity should prepare a statement of financial position as of the date it transitions to the framework. This opening statement of financial position should be reflective of the framework. As such, the opening statement of financial position

• Recognizes all assets and liabilities whose recognition is required by the framework.

• Does not recognize items as assets or liabilities if the framework does not permit such recognition.


• Reclassifies items that were recognized previously as one type of asset, liability, or component of equity but are now recognized as a different type of asset, liability, or component of equity under the framework.

• Applies the framework in measuring all recognized assets and liabilities.

The accounting policies selected from the framework and used to prepare the opening statement of financial position should be used thereafter. These policies may differ from the reporting entity’s previous accounting policies before the transition to the framework. The resulting net adjustment is posted directly to equity in the opening statement of financial position. In many cases the posting will be directly to retained earnings. Note also that “accumulated other comprehensive income” would be eliminated since there is no such concept in the framework. Lastly, note that the reporting entity is not permitted to use the transition to change accounting estimates with new information to by-pass the current year’s statement of operations. Accounting estimates are discussed below. A case showing transitioning from GAAP to the framework is presented next.


Case 6-1 Transitioning to the Framework

Facts: U.S. parent owns 100% of a foreign subsidiary. The parent determines that it does not need GAAP-compliant reporting and decides to adopt the FRF for SMEs accounting framework for financial reporting purposes. In connection, the parent elects to account for its investment in the foreign subsidiary using the equity method. Further, the parent elects the income taxes payable method. There are no other significant differences between the accounting policies previously used by the parent when preparing its consolidated financial statements in accordance with GAAP and the framework. The worksheet used by the parent to prepare the opening statement of financial position, which is referred to as the opening balance sheet in the table below, using the framework follows:

OpeningUS Parent Foreign Income Tax Balance

Consolidated Subsidiary (A) Adjustment (B) Sheet

Cash and equivalents 2,016$ 165$ -$ 1,851$ Accounts receivable, net 8,175 5,990 - 2,185 Recoverable income taxes 84 - - 84 Inventory 450 337 - 113 Prepaid expenses 217 164 - 53 Total current assets 10,942 6,656 - 4,286

PP&E, net 786 322 - 464 Investment in foreign subsidiary - (1,726) - 1,726 Investment property 879 879 - -

12,607$ 6,131$ -$ 6,476$

Notes payable 72$ 72$ -$ -$ Accounts payable and accrued expenses 6,243 5,582 - 661 Income taxes 44 44 - - Deferred income taxes 578 - 578 - Current portion of capital lease obligation 32 32 - - Total current liabilities 6,969 5,730 578 661

Capital lease obligation, less current 306 306 - - Deferred income taxes 13 - 13 - Total liabilities 7,288 6,036 591 661

Common stock 2 - - 2 Retained earnings 5,222 - (591) 5,813 Accumulated OCI - Currency translation 95 95 - - Total equity 5,319 95 (591) 5,815

12,607$ 6,131$ -$ 6,476$


Notes to Case 6-1 worksheet to prepare the opening statement of financial position:

Note A: Eliminates the accounts of the foreign subsidiary included in the consolidated GAAP financial statements of the U.S. parent. The net assets eliminated become the U.S. parent’s investment in subsidiary which the parent has elected to account for by the equity method under the framework.

Note B: Eliminates the deferred income tax of the U.S. parent in conjunction with its accounting policy election to adopt the taxes payable method. The foreign subsidiary had no deferred income taxes.

Certain exemptions from the principles in the framework may be elected when preparing the opening statement of financial position. The reporting entity may elect to use exemptions related to one or more of the following:

• Business combinations

• Financial assets and liabilities

• Asset retirement obligations

A brief discussion of the exemptions is presented below. Business Combinations

When transitioning to the framework, management may elect not to apply Chapter 28, “Business Combinations,” retrospectively to business combinations that occurred before the date of transition to the framework. However, if management, when transitioning to the framework, restates any business combination to comply with Chapter 28, it must restate all subsequent business combinations and also should apply Chapter 23, “Consolidated Financial Statements and Noncontrolling Interests,” from that same date. When transitioning to the framework, if the reporting entity does not apply Chapter 28 retrospectively to a past business combination then

• The reporting entity retains the same classification as in its previous financial statements.

• At the date of transition to the framework, the reporting entity recognizes all its assets and liabilities that were acquired or assumed in a past business combination, except for financial assets and liabilities derecognized in prior periods (see paragraph 3.14 of the framework). Any resulting change is accounted for by adjusting equity, unless the change results from the recognition of an intangible asset that was previously subsumed within goodwill.


• The reporting entity excludes from its opening statement of financial position any item recognized under previous financial reporting principles that does not qualify for recognition as an asset or liability under the framework. Any resulting change is accounted for by adjusting equity, unless the change results from an intangible asset that is reclassified as part of goodwill.

• If an asset acquired, or liability assumed, in a past business combination was not recognized previously, but should be under the framework, the reporting entity acquirer recognizes and measures the item in its consolidated statement of financial position on the basis that the principles would have required in the statement of financial position of the acquiree.

Financial Assets and Liabilities

Under Chapter 6 of the framework, the reporting entity is required to separately classify the component parts of a financial instrument that contains both a liability and an equity component. However, an entity transitioning to the framework need not separate the components if the liability component is not outstanding as of the date of transition. Asset Retirement Obligations

An entity that has not previously recognized asset retirement obligations on a basis consistent with the section, “Asset Retirement Obligations,” in Chapter 17 of the framework may measure the obligation at the date of transition and estimate the amount that should be included in the carrying amount of the related asset based on the original and remaining life of the asset. The difference between the change in the obligation and the change to the carrying amount of the asset is charged to opening equity at the date of transition. Transitioning Disclosures

An entity should disclose the amount of each charge or credit to equity at the date of transitioning to the framework resulting from the adoption of these principles and the reasons therefor. If the date of transition is earlier than the current period so that prior period financial statements can be presented, those prior year financial statements need to be restated to conform to the framework. When an entity elects to use one or more of the exemptions for business combinations, financial assets and liabilities, and asset retirement obligations, it should disclose the exemptions used.


Feedback Question

1. Certain exemptions from the principles in the framework may be elected in conjunction with the adoption of the framework and preparing the “opening statement of financial position.” These exemptions relate to all of the following, except

a. Business combinations. b. Asset retirement obligations. c. Non-financial assets and liabilities.

Accounting Changes, Accounting Estimates, and Correction of Errors

This section addresses changing accounting policies subsequent to the adoption of the framework, changes in accounting estimates, and correcting errors. Changes in Accounting Policies

As described in paragraph 9.04 of the framework, the reporting entity should change an accounting policy only if the change

• Is required by the framework; or

• Results in the financial statements providing reliable and more relevant information about the effects of transactions, other events, or conditions on the reporting entity's financial position, financial performance, or cash flows.

When the reporting entity changes an accounting policy upon initial application of the framework that does not include specific transitional provisions applying to that change, or changes an accounting policy voluntarily, or changes an accounting policy as required by the framework, it should apply the change retrospectively. When a change in accounting policy is applied retrospectively the reporting entity should adjust the opening balance of each affected component of its equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied. When it is impracticable to determine the period-specific effects of changing an accounting policy for comparative information for one or more prior periods presented, the reporting entity should apply the new accounting policy to the carrying amounts of assets and liabilities at the beginning of the earliest period for which retrospective application is practicable, which may be the current period, and should make a corresponding adjustment to the opening balance of each affected component of equity for that period.


When it is impracticable to determine the cumulative effect, at the beginning of the current period, of applying a new accounting policy to all prior periods, the reporting entity should apply the new accounting policy prospectively from the earliest date practicable. Changes in Accounting Estimates

The use of reasonable estimates is an essential part of the preparation of financial statements. Estimation involves judgments based on the latest available, reliable information. For example, estimates may be required for

• Bad debts;

• Inventory obsolescence;

• The useful lives of, or expected pattern of consumption of the future economic benefits embodied in, depreciable assets;

• Progress on uncompleted contracts accounted for using the percentage-of-completion method; and

• Warranty obligations.

An estimate may need revision if changes occur in the circumstances on which the estimate was based, or as a result of new information or more experience. By its nature, the revision of an estimate does not relate to prior periods and is not the correction of an error. Distinguishing between a change in an accounting principle and a change in an accounting estimate is sometimes difficult. In some cases, a change in accounting estimate is affected by a change in accounting principle. The effect of the change in accounting principle, or the method of applying it, may be inseparable from the effect of the change in accounting estimate. Changes of that type often are related to the continuing process of obtaining additional information and revising estimates and, therefore, should be considered changes in estimates for purposes of applying this guidance. The effect of a change in an accounting estimate should be recognized prospectively by including it in net income or loss in

• The period of the change, if the change affects that period only or

• The period of the change, and future periods, if the change affects both.

To the extent that a change in an accounting estimate gives rise to changes in assets and liabilities, or relates to an item of equity, it should be recognized by adjusting the carrying amount of the related asset, liability, or equity item in the period of the change.


Prospective recognition of the effect of a change in an accounting estimate means that the change is applied to transactions, other events, and conditions from the date of the change in estimate. A change in an accounting estimate may affect only the current period's net income (loss) or the net income (loss) of both the current period and future periods. For example, a change in the estimate of the amount of bad debts affects only the current period's net income and, therefore, is recognized in the current period. However, a change in the estimated useful life of, or the expected pattern of consumption of the future economic benefits embodied in, a depreciable asset affects depreciation expense for the current period and for each future period during the asset's remaining useful life. In both cases, the effect of the change relating to the current period is recognized as income or expense in the current period. The effect, if any, on future periods is recognized as income or expense in those future periods. Correction of Errors

Errors can arise in the recognition, measurement, presentation, or disclosure of elements of financial statements. Financial statements do not comply with the framework if they contain either material errors or immaterial errors made intentionally to achieve a particular presentation of the reporting entity's financial position, financial performance, or cash flows. Potential current period errors discovered in that period are corrected before the financial statements are available to be issued. However, material errors are sometimes not discovered until a subsequent period, and these prior period errors are corrected in the comparative information presented in the financial statements for that subsequent period. The reporting entity should correct material prior period errors retrospectively in the first set of financial statements available to be issued after their discovery by

• Restating the comparative amounts for the prior period(s) presented in which the error occurred or

• If the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities, and equity for the earliest prior period presented.

The correction of a prior period error is excluded from net income for the period in which the error is discovered. Any information presented about prior periods, including any historical summaries of financial data, is restated. Corrections of errors are distinguished from changes in accounting estimates. Accounting estimates, by their nature, are approximations that may need revision as additional information becomes known. For example, the gain or loss recognized on the outcome of a contingency is not the correction of an error.


Feedback Questions

2. The reporting entity should change an accounting policy, except when

a. The change is required by the framework. b. The change is required by the FASB. c. The change results in the financial statements providing reliable and more relevant

information about the effects of transactions, other events, or conditions on the reporting entity’s financial position, financial performance, or cash flows.

3. Changes in accounting estimates may result from all of the following, except

a. Correction of an error. b. Changes in circumstances. c. New information. d. More experience.

Foreign Currency Translation

A U.S. based reporting entity uses the “temporal” method to translate transactions denominated in a currency other than the U.S. dollar. Under the temporal method as defined in the framework, assets, liabilities, revenues, and expenses are translated into U.S. dollars in a manner that retains their bases of measurement in terms of the U.S. dollar. In particular

• Monetary items are translated at the exchange rate in effect at the statement of financial position date;

• Nonmonetary items are translated at historical exchange rates, unless such items are carried at net realizable value or market, in which case they are translated at the exchange rate in effect at the statement of financial position date;

• Revenue and expense items are translated at the exchange rate in effect on the dates they occurred; and

• Depreciation or amortization of assets translated at historical exchange rates is also translated at the same exchange rates as the assets to which the depreciation or amortization relates.

The amount of an exchange gain of loss is included in the income statement in determining net income or loss. In connection with the reporting entity’s translation appropriately weighted average exchange rates may be used for revenues, expenses, gains, and losses.


Push-down Accounting

An acquisition of more than 50% of the residual equity interests in an entity by an unrelated acquirer who controls that entity after the transaction or transactions may establish a new cost basis for the continuing reporting entity. The new cost basis may be affected by applying “push-down” accounting. Push-down accounting is based on the presumption that the acquirer would find the new costs more useful in evaluating investment returns and the acquired entity’s performance. In situations when the acquirer prefers to retain the historical cost basis of the acquiree (either for its own purposes or the purposes of other financial statement users, such as holders of outstanding public debt), push-down accounting is not required. The application of push-down accounting results in comparable accounting to what would have resulted had the acquirer either purchased the assets and assumed the liabilities of the reporting entity directly, or established a new legal entity to hold the assets and assume the liabilities of the acquired entity and continued the acquiree’s operations. The application of push-down accounting provides symmetry between the carrying amounts of assets and liabilities reported in the acquired entity’s financial statements and the carrying amounts of assets and liabilities reported in the parent’s consolidated financial statements. When applying push-down accounting, the values used are those resulting from accounting for the acquisition(s) in accordance with chapter 28, “Business Combinations” of the FRF for SMEs accounting framework. When an acquisition is financed by debt, in whole or in part, it is not considered appropriate for the acquired entity to record the debt, unless it is a liability of the acquired entity. When a comprehensive revaluation of an entity’s assets and liabilities is undertaken, the transaction should be accounted for as a capital transaction, and the portion of retained earnings that has not been included in the consolidated retained earnings of the acquirer, or is not related to any continuing noncontrolling interests in the entity should be reclassified to either capital stock, additional paid-in capital, or a separately identified account within shareholders’ equity. Shareholders’ equity is also restated to reflect the purchase transaction or transactions. The treatment accorded to retained earnings is also applied to other shareholders’ equity accounts that arose prior to the purchase transaction or transactions and that are not specifically related to capital invested. The purpose of the revaluation of assets and liabilities is to provide information for assessing returns that reflect the investment of the controlling shareholder in the entity. It is consistent with this purpose that the revaluation adjustment (the net effect of the revaluation of the entity’s assets and liabilities) is accounted for as capital of the acquired entity. The revaluation adjustment is included in either capital stock, additional paid-in capital, or a separately identified account within shareholders’ equity. When one or more transactions take place between nonrelated parties, it is presumed that the transaction or transactions have been bargained in an arm's length manner between knowledgeable, willing parties who are under no compulsion to act and, therefore, that values determined in that process represent market value. However, transactions between related


parties, as defined under the framework, are not an appropriate basis for a comprehensive revaluation. When an individual or entity already owns an equity interest in the reporting entity, the revaluation or market value is proportionate to that owner’s increase in ownership. For example, if a 10-percent owner acquires the equity interest of a 90-percent owner, the revaluation is stepped up for the 90 percent that represents the new ownership. When new costs are not reasonably determinable for individual assets and liabilities, comprehensive revaluation is not appropriate. An example of when new costs are not reasonably determinable is in an acquisition when an entity is acquired as part of a group purchase (that is, when a group of assets and liabilities is acquired for a single amount), and the entity does not have, and cannot obtain from the acquirer, details of the purchase price and its allocation among assets and liabilities.

Case 6-2 Application of Push-down Accounting

Facts: P acquired 90% of the outstanding capital stock of S for cash of $55,000. As of the acquisition date the historical cost of S’s identifiable assets is $150,000 and their fair value is $170,000. The excess of fair value over cost of the assets is applicable to PP&E - $5,000 and intangible assets (customer list) - $15,000. The historical cost of S’s liabilities is $125,000 which is equal to fair value. A worksheet to apply push-down accounting to the historical cost accounts of S follows.

An example of footnote disclosures for the application of push-down accounting based on the facts in Case 6-2 is presented in Case 6-3.

S's Historical Push-downCost Adjustments Push-down

Current assets 120,000$ -$ 120,000$ PP&E, net 30,000 5,000 35,000 Intangible assets - 15,000 15,000 Goodwill - 14,500 14,500

150,000$ 34,500$ 184,500$

Current liabilities 125,000$ -$ 125,000$

EquityRetained earnings 15,000 (15,000) - Captial stock and APIC 10,000 49,500 59,500

25,000 34,500 59,500 150,000$ 34,500$ 184,500$


Case 6-3 Disclosure for Push-Down Accounting

Basis of Accounting P acquired 90% of the outstanding common stock of S on March 31, 20X1. P has directed S to prepare its financial statements to effect “push-down” accounting as of the acquisition date. As such, S has adjusted the historical cost amounts of its assets to reflect their fair values and recognized goodwill as of the acquisition date based on P’s purchase price allocation. Since the historical amounts of liabilities were considered to approximate their fair value, no adjustment of them was required. In connection with effecting push-down accounting S has increased property and plant by $5,000, recognized an intangible asset for the fair value of its customer list of $15,000, and recognized goodwill of $14,500. Goodwill represents the excess of P’s cash consideration of $55,000 and the amount of the noncontrolling interest of $4,500 in excess of the fair value of the identifiable assets acquired of $170,000, less the fair value of liabilities assumed of $125,000. Further, S’s retained earnings as of the acquisition date of $15,000 have been eliminated. The remainder of $49,500 has been reflected in additional paid-in capital. Feedback Question

4. Push-down accounting

a. Is required when more than 80 percent of the acquired reporting entity is acquired by an unrelated acquirer.

b. May be effected when more than 50 percent of the acquired reporting entity is acquired by an unrelated acquirer.

c. Is not permitted under the framework. Income Tax Benefits

Deferred income tax assets are appropriately recognized as part of a comprehensive revaluation to the extent that they are more likely than not to be realized. Deferred income tax assets that are not considered more likely than not to be realized at the time of the comprehensive revaluation should be excluded from the revaluation. If such an unrecognized deferred income tax asset were recognized subsequent to the application of push-down accounting, the benefit should be recognized in net income. Disclosure

In the period that push-down accounting has been first applied, the financial statements should disclose the following:


• The date push-down accounting was applied and the date or dates of the purchase transaction or transactions that led to the application of push-down accounting;

• A description of the situation resulting in the application of push-down accounting; and

• The amount of the change in each major class of assets, liabilities, and shareholders' equity arising from the application of push-down accounting.

In the fiscal period that push-down accounting has been applied and for the following fiscal period, the financial statements should disclose

• The date push-down accounting was applied;

• The amount of the revaluation adjustment and the shareholders' equity account in which the revaluation adjustment was recorded; and

• The amount of retained earnings reclassified and the shareholders' equity account to which it was reclassified.

Disposal of Long-lived Assets and Discontinued Operations

This section addresses accounting for the disposal of long-lived, nonmonetary assets (including PP&E, intangible finite lived assets and long-term prepaid assets) and discontinued operations under Chapter 15 of the framework. Long-Lived Assets to be Disposed of by Sale

A long-lived asset to be sold should be classified as held for sale in the period in which all of the following criteria are met:

• Management, having the authority to approve the action, commits to a plan to sell.

• It is available for immediate sale in its present condition, subject only to terms that are usual and customary for sales of such assets.

• An active program to locate a buyer and other actions required to complete the sale plan have been initiated.

• The sale is probable and is expected to qualify for recognition as a completed sale within one year, except as permitted by paragraph 15.04 under the framework.

• It is being actively marketed for sale at a price that is reasonable.

• Actions required to complete the plan indicate that it is not probable that significant changes to the plan will be made or that the plan will be withdrawn.


A long-lived asset classified as held for sale should be measured at its carrying amount. Costs to sell are period expenses when the assets are sold. A long-lived asset should not be amortized while it is classified as held for sale. When a disposal group constitutes a business, goodwill is allocated to the disposal group and included in its carrying amount. A gain or loss that results from the sale of a long-lived asset is recognized at the date of sale. Changes to a Plan of Sale

If a long-lived asset no longer meets the criteria to be classified as held for sale, it should be reclassified as held and used. A long-lived asset that is reclassified should be measured at its carrying amount before it was classified as held for sale, adjusted for any depreciation (amortization) expense that would have been recognized had it been continuously classified as held and used. Any required adjustment to the carrying amount of a long-lived asset that is reclassified as held and used is included in income before discontinued operations in the period of the subsequent decision not to sell. Statement of Financial Position Presentation

A long-lived asset classified as held for sale should be presented separately in the reporting entity's statement of financial position. The assets and liabilities of a disposal group classified as held for sale should be presented separately in the asset and liability sections, respectively, of the statement of financial position. Assets and liabilities of a disposal group classified as held for sale are not offset, other than financial assets and liabilities that meet the conditions for offsetting (see Chapter 6). Current and long-term assets (and liabilities) are presented separately unless the entity's statement of financial position is unclassified. Long-lived assets classified as held for sale are not classified as current assets unless the reporting entity has sold the assets prior to the date the financial statements are available to be issued, and the proceeds of the sale will be realized within a year of the date of the statement of financial position or within the normal operating cycle if that is longer than a year. If the assets have been classified as current assets due to the subsequent sale, any liabilities to be assumed by the purchaser or required to be discharged on disposal of the assets are classified as current liabilities. Long-Lived Assets to be Disposed of Other Than by Sale

A long-lived asset to be disposed of other than by sale should continue to be classified as held and used until disposal. Disposal other than by sale includes, for example, abandonment and a distribution to owners in a spin-off.


A long-lived asset to be abandoned is disposed of when it ceases to be used. If an entity commits to a plan to abandon a long-lived asset before the end of its previously estimated useful life, depreciation estimates are revised to reflect the use of the asset over its shortened useful life. The continued use of a long-lived asset demonstrates the presence of service potential. A gain or loss that results from the disposal of a long-lived asset other than by sale is recognized at the date of disposal. A long-lived asset distributed to owners in a spin-off is disposed of when it is distributed. Discontinued Operations

The results of operations of a component of the reporting entity that either has been disposed of (by sale, abandonment, or spin-off) or is classified as held for sale should be reported in discontinued operations if both of the following conditions are met:

• The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction; and

• The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.

Only items meeting the preceding criteria should be reported in discontinued operations. A component of an entity comprises operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity. The results of discontinued operations, less applicable income taxes, should be reported as a separate element of income for both current and prior periods. Adjustments to amounts previously reported in discontinued operations that are directly related to the disposal of a component of an entity in a prior period are classified separately in the current period in discontinued operations. Examples of circumstances in which those types of adjustments may arise include the following:

• The resolution of contingencies that arise pursuant to the terms of the disposal transaction, such as the resolution of purchase-price adjustments and indemnification issues with the purchaser;

• The resolution of contingencies that arise from and are directly related to the operations of the component prior to its disposal, such as environmental and product warranty obligations retained by the seller; and

• The settlement of employee benefit plan obligations (pension, postemployment benefits other than pensions, and other postemployment benefits), provided that the settlement is directly related to the disposal transaction (that is, there is a demonstrated direct cause-


and-effect relationship, and the settlement occurs no later than one year following the disposal transaction, unless it is delayed by events or circumstances beyond an entity's control.

Disclosure

The financial statements should disclose the following information in the period in which a long-lived asset or disposal group either has been disposed of by sale, or other than by sale, or is classified as held for sale:

• A description of the facts and circumstances leading to the disposal or expected disposal.

• If not separately presented on the face of the statement of operations, the amount of the gain or loss on disposal and the caption in the statement of operations that includes that gain or loss.

• If applicable, amounts of revenue and pretax profit or loss reported in discontinued operations.

In a period in which a decision is made not to sell an asset previously classified as held for sale, the change in accounting treatment should be disclosed. Feedback Question

5. The results of a component of the reporting entity should be reported in discontinued operations if

a. The operations and cash flows of the component have been (or will be) eliminated from

the ongoing operations of the entity. b. The entity will not have any significant continuing involvement in the operations of the

component after the disposal transaction. c. The criteria in both a. and b. must be met to be reported in discontinued operations.


Copyright 2014–2015 AICPA Unauthorized Copying Prohibited Glossary-1

Accounting and Auditing Glossary

Account – Formal record that represents, in words, money or other unit of measurement, certain resources, claims to such resources, transactions or other events that result in changes to those resources and claims.

Account Payable – Amount owed to a creditor for delivered goods or completed services.

Account Receivable – Claim against a debtor for an uncollected amount, generally from a completed transaction of sales or services rendered.

Accountants’ Report – Formal document that communicates an independent accountant’s (1) expression of limited assurance on financial statements as a result of performing inquiry and analytic procedures (Review Report); (2) results of procedures performed (type of Attestation Report); (3) non-expression of opinion or any form of assurance on a presentation in the form of financial statements information that is the representation of management (Compilation Report); or (4) an opinion on an assertion made by management in accordance with the Statements on Standards for Attestation Engagements (Attestation Report). An accountant’s report does not result from the performance of an audit.

Accounting – Recording and reporting of financial transactions, including the origination of the transaction, its recognition, processing, and summarization in the financial statements.

Accounting Change – Change in (1) an accounting principle; (2) an accounting estimate; or (3) the reporting entity. The correction of an error in previously issued financial statements is not an accounting change.

Accrual Basis – Method of accounting that recognizes revenue when earned, rather than when collected. Expenses are recognized when incurred rather than when paid.

Accrued Expense – An expense incurred during an accounting period for which payment is not due until a later accounting period. This results from the purchase of services which at the time of accounting have only been partly performed, are not yet billable, or have not been paid for.

Accumulated Depreciation – Total depreciation pertaining to an asset or group of assets from the time the assets were placed in service until the date of the financial statement or tax return. This total is the contra account to the related asset account.

Additional Paid in Capital – Amounts paid for stock in excess of its par value or stated value. Also, other amounts paid by stockholders and charged to equity accounts other than capital stock.


Adjusting Entries – Accounting entries made at the end of an accounting period to allocate items between accounting periods.

Amortization – The process of reducing a recognized liability systematically by recognizing revenues or by reducing a recognized asset systematically by recognizing expenses or costs. In accounting for postretirement benefits, amortization also means the systematic recognition in net periodic postretirement benefit cost over several periods of amounts previously recognized in other comprehensive income, that is, gains or losses, prior service cost or credits, and any transition obligation or asset.

Analytical Procedures – Substantive tests of financial information which examine relationships among data as a means of obtaining evidence. Such procedures include (1) comparison of financial information with information of comparable prior periods; (2) comparison of financial information with anticipated results (e.g., forecasts); (3) study of relationships between elements of financial information that should conform to predictable patterns based on the entity’s experience; and (4) comparison of financial information with industry norms.

Annual Report – The annual report to shareholders is the principal document used by most public companies to disclose corporate information to their shareholders. It is usually a state-of-the-company report, including an opening letter from the Chief Executive Officer, financial data, results of continuing operations, market segment information, new product plans, subsidiary activities, and research and development activities on future programs. The Form 10-K, which must be filed with the SEC, typically contains more detailed information about the company’s financial condition than the annual report.

Assertion – Explicit or implicit representations by an entity’s management that are embodied in financial statement components and for which the auditor obtains and evaluates evidential matter when forming his/her opinion on the entity’s financial statements.

Audit Risk – The risk that the auditor may unknowingly fail to modify appropriately his/her opinion on financial statements that are materially misstated.

Audit Sampling – Application of an audit procedure to less than 100% of the items within an account balance or class of transactions for the purpose of evaluating some characteristic of the balance or class.

Auditors’ Report – Written communication issued by an independent certified public accountant (CPA) describing the character of his/her work and the degree of responsibility taken. An auditor’s report includes a statement that the audit was conducted in accordance with generally accepted auditing standards (GAAS), which require that the auditor plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, as well as a statement that the auditor believes the audit provides a reasonable basis for his/her opinion.

http://www.sec.gov/answers/form10k.htm


Bad Debt – All or portion of an account, loan, or note receivable considered to be uncollectible.

Balance Sheet – Basic financial statement, usually accompanied by appropriate disclosures that describe the basis of accounting used in its preparation and presentation of a specified date the entity’s assets, liabilities, and the equity of its owners. Also known as a statement of financial condition.

Bond – One type of long-term promissory note, frequently issued to the public as a security regulated under federal securities laws or state blue sky laws. Bonds can either be registered in the owner’s name or are issued as bearer instruments.

Book Value – Amount, net or contra account balances, that an asset or liability shows on the balance sheet of a company. Also known as carrying value.

Business Combinations – Combining of two entities. Under the purchase method of accounting, one entity is deemed to acquire another and there is a new basis of accounting for the assets and liabilities of the acquired company.

Business Segment – Any division of an organization authorized to operate, within prescribed or otherwise established limitations, under substantial control by its own management.

Capital Stock – Ownership shares of a corporation authorized by its articles of incorporation. The money value assigned to a corporation’s issued shares. The balance sheet account with the aggregate amount of the par value or stated value of all stock issued by a corporation.

Capitalized Cost – Expenditure identified with goods or services acquired and measured by the amount of cash paid or the market value of other property, capital stock, or services surrendered. Expenditures that are written off during two or more accounting periods.

Carrying Value – Amount, net or contra account balances, that an asset or liability shows on the balance sheet of a company. Also known as book value.

Cash Basis – A special purpose framework in which revenues and expenditures are recorded when they are received and paid.

Cash Equivalents – Short-term (generally less than three months), highly liquid investments that are convertible to known amounts of cash.

Cash Flows – Net of cash receipts and cash disbursements relating to a particular activity during a specified accounting period.

Casualty Loss – Sudden property loss caused by theft, accident, or natural causes.


Change in Engagement – A request, before the completion of the audit (review), to change the engagement to a review or compilation (compilation) of financial statements.

Class Actions – A federal securities class action is a court action filed on behalf of a group of shareholders under Rule 23 of the Federal Rules of Civil Procedure. Instead of each shareholder bringing an individual lawsuit, one or more shareholders bring a class action for the entire class of shareholders.

Common Stock – Capital stock having no preferences generally in terms of dividends, voting rights, or distributions.

Companies, Going Public – Companies become public entities for different reasons, but usually to raise additional capital. The SEC has prepared a guide for companies – Q&A: Small Business and the SEC – that provides a basic understanding about the various ways companies can become public and what securities laws apply. The SEC also has a list of some of the registration and reporting forms and related regulations that pertain to small and large companies.

Comparative Financial Statement – Financial statement presentation in which the current amounts and the corresponding amounts for previous periods or dates also are shown.

Compilation – Presentation in the form of financial statements information that is the representation of management (owners) without the accountant’s assurance as to conformity with generally accepted accounting principles (GAAP).

Comprehensive Income – Change in equity of a business entity during a period from transactions and other events and circumstances from nonowner sources. The period includes all changes in equity except those resulting from investments by owners and distributions to owners.

Confirmation – Auditor’s receipt of a written or oral response from an independent third party verifying the accuracy of information requested.

Consolidated Financial Statements – Combined financial statements of a parent company and one or more of its subsidiaries as one economic unit.

Consolidation – The presentation of a single set of amounts for an entire reporting entity. Consolidation requires elimination of intra-entity transactions and balances.

Contingent Liability – Potential liability arising from a past transaction or a subsequent event.

Continuing Accountant – An accountant who has been engaged to audit, review, or compile and report on the financial statements of the current period and one or more consecutive periods immediately prior to the current period.


Control Risk – Measure of risk that errors exceeding a tolerable amount will not be prevented or detected by an entity’s internal controls.

Controls Tests – Tests directed toward the design or operation of an internal control structure policy or procedure to assess its effectiveness in preventing or detecting material misstatements in a financial report.

Current Asset – Asset that one can reasonably expect to convert into cash, sell, or consume in operations within a single operating cycle, or within a year if more than one cycle is completed each year.

Current Liability – Obligation whose liquidation is expected to require the use of existing resources classified as current assets, or the creation of other current liabilities.

Current Value – (1) Value of an asset at the present time as compared with the asset’s historical cost. (2) In finance, the amount determined by discounting the future revenue stream of an asset using compound interest principles.

Debt – General name for money, notes, bonds, goods, or services which represent amounts owed.

Definite Criteria – A special purpose framework using a definite set of criteria having substantial support that is applied to all material items appearing in financial statements, such as the price-level basis of accounting.

Depreciation – Expense allowance made for wear and tear on an asset over its estimated useful life.

Derivatives – Derivatives are financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security or index. For example, a stock option is a derivative because its value changes in relation to the price movement of the underlying stock.

Detection Risk – Risk that the auditor will not detect a material misstatement.

Disclosure – Process of divulging accounting information so that the content of financial statements is understood.

Discount – Reduction from the full amount of a price or debt.

Dividends – Distribution of earnings to owners of a corporation in cash, other assets of the corporation, or the corporation’s capital stock.


Earnings Per Share (EPS) – The amount of earnings attributable to each share of common stock. For convenience, the term is used to refer to either earnings or loss per share.

Employee Stock Options Plans – An employee stock ownership plan is an employee benefit plan that is described by the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986 as a stock bonus plan, or combination stock bonus and money purchase pension plan, designed to invest primarily in employer stock. Also called an employee share ownership plan. Employee Stock Options Plans should not be confused with the term “ESOPs,” or Employee Stock Ownership Plans, which are retirement plans.

Employee Stock Ownership Plans (ESOPs) – An employee stock ownership plan (ESOP) is a retirement plan in which the company contributes its stock to the plan for the benefit of the company’s employees. With an ESOP, you never buy or hold the stock directly. This type of plan should not be confused with employee stock options plans, which are not retirement plans. Instead, employee stock options plans give the employee the right to buy their company’s stock at a set price within a certain period of time.

Equity – Residual interest in the assets of an entity that remains after deducting its liabilities. Also, the amount of a business’ total assets, less total liabilities. Also, the third section of a balance sheet, the other two being assets and liabilities.

Equity Security –Any security representing an ownership interest in an entity (for example, common, preferred, or other capital stock) or the right to acquire (for example, warrants, rights, and call options) or dispose of (for example, put options) an ownership interest in an entity at fixed or determinable prices. However, the term does not include convertible debt or preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor.

Error – Act that departs from what should be done; imprudent deviation, unintentional mistake or omission.

Executive Compensation: Where to Find in SEC Reports – The federal securities laws require clear, concise and understandable disclosure about compensation paid to CEOs and certain other high-ranking executive officers of public companies. You can locate information about executive pay in (1) the company’s annual proxy statement; (2) the company’s annual report on Form 10-K; and (3) registration statements filed by the company to register securities for sale to the public.

Expenditures – Expenditures to which capitalization rates are to be applied are capitalized expenditures (net of progress payment collections) for the qualifying asset that have required the payment of cash, the transfer of other assets, or the incurring of a liability on which interest is recognized (in contrast to liabilities, such as trade payables, accruals, and retainages on which interest is not recognized).


Extraordinary Items – Events and transactions distinguished by their unusual nature and by the infrequency of their occurrence. Extraordinary items are reported separately, less applicable income taxes, in the entity’s statement of income or operations.

Fair Disclosure, Regulation FD – On August 15, 2000, the SEC adopted Regulation FD to address the selective disclosure of information by companies and other issuers. Regulation FD provides that when an issuer discloses material nonpublic information to certain individuals or entities – generally, securities market professionals, such as stock analysts, or holders of the issuer’s securities who may well trade on the basis of the information – the issuer must make public disclosure of that information. In this way, the new rule aims to promote the full and fair disclosure.

Fair Market Value – Price at which property would change hands between a buyer and a seller without any compulsion to buy or sell.

Federal Securities Laws – The laws that govern the securities industry, include the Securities Act of 1933; Securities Exchange Act of 1934; Investment Company Act of 1940; Investment Advisers Act of 1940; and Public Utility Holding Company Act of 1935.

Financial Statements – Presentation of financial data including balance sheets, income statements and statements of cash flow, or any supporting statement that is intended to communicate an entity’s financial position at a point in time and its results of operations for a period then ended.

First in, First out (FIFO) – Accounting method of valuing inventory under which the costs of the first goods acquired are the first costs charged to expense. Commonly known as FIFO.

Fiscal Year – Period of 12 consecutive months chosen by an entity as its accounting period which may or may not be a calendar year.

Fixed Asset – Any tangible asset with a life of more than one year used in an entity’s operations.

Foreign Currency Translation – Restating foreign currency in equivalent dollars; unrealized gains or losses are postponed and carried in Stockholder’s Equity until the foreign operation is substantially liquidated.

Form 10-K – This is the report that most publicly traded companies file with the SEC on an annual basis. It provides a comprehensive overview of the company’s business and financial condition. Some companies choose to send their Form 10-K to their shareholders instead of sending a separate annual report. Currently, Form 10-K must be filed with the SEC within 90 days after the end of the company’s fiscal year.


Form 10-Q – The Form 10-Q is a report filed quarterly by most reporting companies. It includes unaudited financial statements and provides a continuing view of the company’s financial position during the year. The report must be filed for each of the first three fiscal quarters of the company’s fiscal year and is currently due within 45 days of the close of the quarter. In addition to Form 10-Q, companies provide annual reports to their shareholders and file Form 10-K on an annual basis with the SEC.

Form 8-K – This is the “current report” used to report material events or corporate changes that have previously not been reported by the company in a quarterly report (Form 10-Q) or annual report (Form 10-K).

Forms 3, 4, 5 – Corporate insiders-meaning a company’s officers and directors, and any beneficial owners of more than 10% of a class of the company’s equity securities registered under Section 12 of the Securities Exchange Act of 1934 – must file with the SEC a statement of ownership regarding those securities. The initial filing is on Form 3. Changes in ownership are reported on Form 4. Insiders must file a Form 5 to report any transactions that should have been reported earlier on a Form 4 or were eligible for deferred reporting.

Fraud – Willful misrepresentation by one person of a fact inflicting damage on another person.

Gain – Excess of revenues received over costs relating to a specific transaction.

General Ledger – Collection of all assets, liability, owners’ equity, revenue, and expense accounts.

Generally Accepted Accounting Principles (GAAP) – Conventions, rules, and procedures necessary to define accepted accounting practice at a particular time. The highest level of such principles is set by the Financial Accounting Standards Board (FASB).

Generally Accepted Auditing Standards (GAAS) – Standards set by the American Institute of Certified Public Accountants (AICPA) which concern the auditor’s professional qualities and judgment in the performance of his/her audit and in the actual report.

Going Concern – Assumption that a business can remain in operation long enough for all of its current plans to be carried out.

Going Private – A company “goes private” when it reduces the number of its shareholders to fewer than 300 and is no longer required to file reports with the SEC.

Goodwill – An asset representing the future economic benefits arising from other assets acquired in a business combination or an acquisition by a not for profit entity that are not individually identified and separately recognized.


Gross Income – A tax term meaning all income from whatever source derived, except as otherwise provided in the income tax code.

Guaranty – Legal arrangement involving a promise by one person to perform the obligations of a second person to a third person, in the event the second person fails to perform.

Hedges – Protect an entity against the risk of adverse price or interest-rate movements on its assets, liabilities, or anticipated transactions. A hedge is used to avoid or reduce risks by creating a relationship by which losses on positions are counterbalanced by gains on separate positions in another market.

Historical cost – The generally accepted method of accounting used in the primary financial statements that is based on measures of historical prices without restatement into units, each of which has the same general purchasing power.

Income – Inflow of revenue during a period of time.

Income Statement – Summary of the effect of revenues and expenses over a period of time.

Income Tax Basis – A special purpose framework that the reporting entity uses or expects to use to file its income tax return for the period covered by the financial statements.

Initial Public Offerings (IPO) – IPO stands for initial public offering and occurs when a company first sells its shares to the public.

Initial Public Offerings, Lockup Agreements – Lockup agreements prohibit company insiders – including employees, their friends and family, and venture capitalists – from selling their shares for a set period of time. In other words, the shares are “locked up.” Before a company goes public, the company and its underwriter typically enter into a lockup agreement to ensure that shares owned by these insiders do not enter the public market too soon after the offering.

Insider Trading – “Insider trading” actually includes both legal and illegal conduct. The legal version is when corporate insiders – officers, directors, and employees – buy and sell stock in their own companies. Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include “tipping” such information, securities trading by the person “tipped,” and securities trading by those who misappropriate such information.

Intangible Asset – Asset having no physical existence such as trademarks and patents.

Interest – Payment for the use or forbearance of money.


Interim Financial Statements – Financial statements that report the operations of an entity for less than one year.

Internal Control – Process designed to provide reasonable assurance regarding achievement of various management objectives such as the reliability of financial reports.

Inventory – Tangible property held for sale, or materials used in a production process to make a product.

Investment – Expenditure used to purchase goods or services that could produce a return to the investor.

Journal – Any book containing original entries of daily financial transactions.

Last in, First out (LIFO) – Accounting method of valuing inventory under which the costs of the last goods acquired are the first costs charged to expense. Commonly known as LIFO.

Lease – Conveyance of land, buildings, equipment, or other assets from one person (Lessor) to another (Lessee) for a specific period of time for monetary or other consideration, usually in the form of rent.

Leasehold – Property interest a lessee owns in the leased property.

Ledger – Any book of accounts containing the summaries of debit and credit entries.

Lessee – Person or entity that has the right to use property under the terms of a lease.

Lessor – Owner of property, the temporary use of which is transferred to another (lessee) under the terms of a lease.

Liability – Debts or obligations owed by one entity (Debtor) to another entity (Creditor) payable in money, goods, or services.

Listing and Delisting Requirements – Before a company can begin trading on an exchange or the Nasdaq Stock Market, it must meet certain initial requirements or “listing standards.” The exchanges and the Nasdaq Stock Market set their own standards for listing and continuing to trade. The SEC does not set listing standards. The initial listing requirements mandate that a company meet specified minimum thresholds for the number of publicly traded shares, total market value, stock price, and number of shareholders. After a company starts trading, it must continue to meet different standards set by the exchanges or the Nasdaq Stock Market. Otherwise, the company can be delisted. These continuing standards usually are less stringent than the initial listing requirements.

Long-Term Debt – Debt with a maturity of more than one year from the current date.


Loss – Excess of expenditures over revenue for a period or activity. Also, for tax purposes, an excess of basis over the amount realized in a transaction.

Lower of Cost or Market – Valuing assets for financial reporting purposes. Ordinarily, “cost” is the purchase price of the asset and “market” refers to its current replacement cost. Generally accepted accounting principles (GAAP) requires that certain assets (e.g., inventories) be carried at the lower of cost or market.

Management Discussion and Analysis (MD&A) – SEC requirement in financial reporting for an explanation by management of significant changes in operations, assets, and liquidity.

Management Use Only – Term used when compiled financial statements are not expected to be used by a third party.

Manipulation – Manipulation is intentional conduct designed to deceive investors by controlling or artificially affecting the market for a security. Manipulation can involve a number of techniques to affect the supply of, or demand for, a stock. They include spreading false or misleading information about a company; improperly limiting the number of publicly-available shares; or rigging quotes, prices, or trades to create a false or deceptive picture of the demand for a security.

Marketable Securities – Stocks and other negotiable instruments which can be easily bought and sold on either listed exchanges or over-the-counter markets.

Mark-to-Market – Method of valuing assets that results in adjustment of an asset’s carrying amount to its market value.

Matching Principle – The concept that all costs and expenses incurred in generating revenues must be recognized in the same reporting period as the related revenues.

Materiality – Magnitude of an omission or misstatements of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would change or be influenced.

Mergers – Mergers are business transactions involving the combination of two or more companies into a single entity. Most state laws require that mergers be approved by at least a majority of the company’s shareholders if the merger will have a significant impact on the company.

Modified Cash Basis – A special purpose framework that begins with the cash basis method (see Cash Basis) and applies modifications having substantial support, such as recording depreciation on fixed assets or accruing income taxes.


Nasdaq – Nasdaq stands for the National Association of Securities Dealers Automated Quotation System. Unlike the New York Stock Exchange where trades take place on an exchange, Nasdaq is an electronic stock market that uses a computerized system to provide brokers and dealers with price quotes. The National Association of Securities Dealers, Inc. owns and operates The Nasdaq Stock Market.

Net Assets – Excess of the value of securities owned, cash, receivables, and other assets over the liabilities of the company.

Net Income – Excess or deficit of total revenues and gains compared with total expenses and losses for an accounting period.

Net Sales – Sales at gross invoice amounts less any adjustments for returns, allowances, or discounts taken.

Net Worth – Similar to equity, the excess of assets over liabilities.

Nonpublic Entity – Any entity other than (a) one whose securities trade in a public market either on a stock exchange (domestic or foreign) or in the over-the-counter market, including securities quoted only locally or regionally; (b) one that makes a filing with a regulatory agency in preparation for the sale of any class of its securities in a public market; or (c) a subsidiary, corporate joint venture, or other entity controlled by an entity covered by (a) or (b).

No-Par Stock – Stock authorized to be issued but for which no par value is set in the articles of incorporation. A stated value is set by the board of directors on the issuance of this type of stock.

No-Par Value – Stock or bond that does not have a specific value indicated.

Notional – Value assigned to assets or liabilities that is not based on cost or market (e.g., the value of a service not yet rendered).

Objectivity – Emphasizing or expressing the nature of reality as it is apart from personal reflection or feelings; independence of mind.

Paid in Capital – Portion of the stockholders’ equity which was paid in by the stockholders, as opposed to capital arising from profitable operations.

Par Value – Amount per share set in the articles of incorporation of a corporation to be entered in the capital stocks account where it is left permanently and signifies a cushion of equity capital for the protection of creditors.

Parent Company – Company that has a controlling interest in the common stock of another.


Predecessor accountant – An accountant who (a) has reported on the most recent compiled or reviewed financial statements or was engaged to perform but did not complete a compilation or review of the financial statements, and (b) has resigned, declined to stand for reappointment, or been notified that his or her services have been or may be terminated.

Preferred Stock – Type of capital stock that carries certain preferences over common stock, such as a prior claim on dividends and assets.

Premium – (1) Excess amount paid for a bond over its face amount. (2) In insurance, the cost of specified coverage for a designated period of time.

Prepaid Expense – Cost incurred to acquire economically useful goods or services that are expected to be consumed in the revenue-earning process within the operating cycle.

Prescribed Form – Any standard preprinted form designed or adopted by the body to which it is to be submitted, for example, forms used by industry trade associations, credit agencies, banks, and governmental and regulatory bodies other than those concerned with the sale or trading of securities. A form designed or adopted by the entity whose financial statements are to be compiled is not considered to be a prescribed form.

Present Value – Current value of a given future cash flow stream, discounted at a given rate.

Principal – Face amount of a security, exclusive of any premium or interest. The basis for interest computations.

Proxy Statement – The SEC requires that shareholders of a company whose securities are registered under Section 12 of the Securities Exchange Act of 1934 receive a proxy statement prior to a shareholder meeting, whether an annual or special meeting. The information contained in the statement must be filed with the SEC before soliciting a shareholder vote on the election of directors and the approval of other corporate action. Solicitations, whether by management or shareholders, must disclose all important facts about the issues on which shareholders are asked to vote.

Purchase Method of Accounting – Accounting for a merger by adding the acquired company’s assets at the price paid for them to the acquiring company’s assets.

Quiet Period – The term “quiet period,” also referred to as the “waiting period,” is not defined under the federal securities laws. The quiet period extends from the time a company files a registration statement with the SEC until SEC staff declares the registration statement “effective.” During this period, the federal securities laws limit what information a company and related parties can release to the public. Rule 134 of the Securities Act of 1933 discusses these limitations.


Ratio Analysis – Comparison of actual or projected data for a particular company to other data for that company or industry in order to analyze trends or relationships.

Real Property – Land and improvements, including buildings and personal property that is permanently attached to the land or customarily transferred with the land.

Receivables – Amounts of money due from customers or other debtors.

Reconciliation – Comparison of two numbers to demonstrate the basis for the difference between them.

Registration under the Securities Act of 1933 – Often referred to as the “truth in securities” law, the Securities Act of 1933 has two basic objectives: (1) To require that investors receive financial and other significant information concerning securities being offered for public sale; and (2) To prohibit deceit, misrepresentations, and other fraud in the sale of securities. The SEC accomplishes these goals primarily by requiring that companies disclose important financial information through the registration of securities. This information enables investors, not the government, to make informed judgments about whether to purchase a company’s securities.

Regulation D Offerings – Under the Securities Act of 1933, any offer to sell securities must either be registered with the SEC or meet an exemption. Regulation D (or Reg D) provides three exemptions from the registration requirements, allowing some smaller companies to offer and sell their securities without having to register the securities with the SEC.

Regulatory Basis – A special purpose framework that the reporting entity uses to comply with the requirements or financial reporting provisions of a governmental regulatory agency to whose jurisdiction the entity is subject. An example is a basis of accounting insurance companies use pursuant to the rules of a state insurance commission.

Reissued Report – A report issued subsequent to the date of the original report that bears the same date as the original report. A reissued report may need to be revised for the effects of specific events; in these circumstances, the report should be dual-dated with the original date and a separate date that applies to the effects of such events.

Related Party Transaction – Business or other transaction between persons who do not have an arm’s-length relationship (e.g., a relationship with independent, competing interests). The most common is between family members or controlled entities. For tax purposes, these types of transactions are generally subject to a greater level of scrutiny.

Research and Development (R&D) – Research is a planned activity aimed at discovery of new knowledge with the hope of developing new or improved products and services. Development is the translation of research findings into a plan or design of new or improved products and services.


Retained Earnings – Accumulated undistributed earnings of a company retained for future needs or for future distribution to its owners.

Revenue Recognition – Method of determining whether or not income has met the conditions of being earned and realized or is realizable.

Revenues – Sales of products, merchandise, and services; and earnings from interest, dividend, rents.

Review – Accounting service that provides some assurance as to the reliability of financial information. In a review, a certified public accountant (CPA) does not conduct an examination under generally accepted auditing standards (GAAS). Instead, the accountant performs inquiry and analytical procedures that provide the accountant with a reasonable basis for expressing limited assurance that there are no material modifications that should be made to the statements for them to be in conformity with GAAP or, if applicable, with a special purpose framework.

Risk Management – Process of identifying and monitoring business risks in a manner that offers a risk/return relationship that is acceptable to an entity’s operating philosophy.

Security – Any kind of transferable certificate of ownership including equity securities and debt securities.

Short-Term – Current; ordinarily due within one year.

SSARS – Statements on Standards for Accounting And Review Services issued by the AICPA Accounting and Review Services Committee (ARSC).

Start-up Costs – (1) Costs, excluding acquisition costs, incurred to bring a new unit into production. (2) Costs incurred to begin a business.

Statement of Cash Flows – A statement of cash flows is one of the basic financial statements that is required as part of a complete set of financial statements prepared in conformity with generally accepted accounting principles. It categorizes net cash provided or used during a period as operating, investing and financing activities, and reconciles beginning and ending cash and cash equivalents.

Statement of Financial Condition – Basic financial statement, usually accompanied by appropriate disclosures that describe the basis of accounting used in its preparation and presentation as of a specified date, the entity’s assets, liabilities, and the equity of its owners. Also known as balance sheet.

Statutory Basis – See Regulatory Basis.


Straight-Line Depreciation – Accounting method that reflects an equal amount of wear and tear during each period of an asset’s useful life. For instance, the annual straight-line depreciation of a $10,000 asset expected to last ten years is $1,000.

Strike Price – Price of a financial instrument at which conversion or exercise occurs.

Submission of Financial Statements – Presenting to a client or third party’s financial statements that the accountant has prepared either manually or through the use of computer software.

Subsequent Event – Material event that occurs after the end of the accounting period and before the publication of an entity’s financial statements. Such events are disclosed in the notes to the financial statements.

Successor Accountant – An accountant who has been invited to make a proposal for an engagement to compile or review financial statements and is considering accepting the engagement or an accountant who has accepted such an engagement.

Tangible Asset – Assets having a physical existence, such as cash, land, buildings, machinery, or claims on property, investments or goods in process.

Tax – Charge levied by a governmental unit on income, consumption, wealth, or other basis.

Third Party – All parties except for members of management who are knowledgeable about the nature of the procedures applied and the basis of accounting and assumptions used in the preparation of the financial statements.

Trade Date – Date when a security transaction is entered into, to be settled on at a later date. Transactions involving financial instruments are generally accounted for on the trade date.

Treasury Bill – Short-term obligation that bears no interest and is sold at a discount.

Treasury Bond – Long-term obligation that matures more than five years from issuance and bears interest.

Treasury Note – Intermediate-term obligation that matures one to five years from issuance and bears interest.

Treasury Stock – Stock reacquired by the issuing company. It may be held indefinitely, retired, issued upon exercise of stock options, or resold.


Trial Balance – A trial balance consists of a listing of all of the general ledger accounts and their corresponding debit or credit balances. Also, in a trial balance, no attempt is made to establish a mathematical relationship among the assets, liabilities, equity, revenues, and expenses except that total debits equal total credits.

Unearned Income – Payments received for services which have not yet been performed.

Updated Report – A report issued by a continuing accountant that takes into consideration information that he/she becomes aware of during his/her current engagement and that re-expresses his/her previous conclusions or, depending on the circumstances, expresses different conclusions on the financial statements of a prior period as of the date of his/her current report.

Valuation Allowance – Method of lowering or raising an object’s current value by adjusting its acquisition cost to reflect its market value by use of a contra account.

Variance – Deviation or difference between an estimated value and the actual value.

Work in Progress – Inventory account consisting of partially completed goods awaiting completion and transfer to finished inventory.

Working Capital – Excess of current assets over current liabilities.

Working Papers – (1) Records kept by the auditor of the procedures applied, the tests performed, the information obtained, and the pertinent conclusions reached in the course of the audit. (2) Any records developed by a certified public accountant (CPA) during an audit.

Yield – Return on an investment an investor receives from dividends or interest expressed as a percentage of the cost of the security.

Index

A

Asset Retirement Obligations 2-1, 2-2, 2-6, 3-2, 3-3, 6-4, 6-5, 6-6

B

Business Combinations ... 3-1, 3-2, 3-6, 3-9, 6-4, 6-5, 6-6, 6-10

D

Debt1-5, 1-6, 1-7, 1-20, 1-24, 2-1, 2-7, 2-8, 3-5, 4-4, 4-5, 6-10

Disclosures 1-1, 1-2, 1-6, 1-12, 1-13, 1-14, 1-17, 1-18, 1-19, 1-23, 1-24, 1-25, 2-2, 2-6, 2-7, 2-11, 2-12, 2-16, 2-18, 2-20, 2-21, 3-9, 4-5, 4-6, 5-10, 6-5

Discontinued Operations .... 1-6, 1-8, 2-17, 2-18, 4-2, 6-1, 6-13, 6-14, 6-15, 6-16

E

Equity . 1-1, 1-3, 1-4, 1-7, 1-10, 1-13, 1-21, 2-1, 2-7, 2-9, 2-10, 2-11, 2-12, 2-17, 3-5, 4-1, 4-2, 4-3, 4-4, 4-5, 4-6, 6-2, 6-3, 6-4, 6-5, 6-6, 6-7, 6-8, 6-10, 6-11, 6-13

I

Income Taxes1-6, 1-7, 2-1, 2-17, 2-18, 3-2, 3-3, 6-3, 6-4, 6-15

Intangible Assets ......................... 2-3, 3-1, 3-2, 3-6, 3-7, 3-9 Inventories ................................................................ 2-1, 2-2 Investments . 1-4, 1-6, 1-7, 1-24, 2-1, 4-1, 4-2, 4-3, 4-4, 4-5,

4-6

L

Leases ....................... 2-1, 5-1, 5-5, 5-6, 5-8, 5-9, 5-10, 5-11

P

Postemployment Benefits ............................. 1-15, 2-1, 6-15 Property, Plant, and Equipment ...... 2-1, 2-2, 2-3, 5-10, 5-11 Push-down Accounting ....................... 6-1, 6-10, 6-12, 6-13

R

Retirement .. 2-1, 2-4, 2-5, 2-8, 2-10, 2-11, 2-13, 2-18, 5-11, 6-5

Revenue 1-4, 1-6, 1-12, 1-14, 1-16, 1-22, 2-1, 2-13, 2-14, 2-15, 2-16, 3-6, 5-8, 6-9, 6-16

Copyright 2014–2015 AICPA ∗ Unauthorized Copying Prohibited Index-1

Financial Reporting

Framework for SMEs By Richard H. Gesseck, CPA

SOLUTIONS

Course Code: 745141 FRFS GS-5000111-0414-0A

Copyright 2014–2015

By American Institute of Certified Public Accountants Durham, North Carolina

All Rights Reserved

The AICPA offers a free, daily, e-mailed newsletter covering the day’s top business and financial articles as well as video content, research and analysis concerning CPAs and those who work with the accounting profession. Visit the CPA Letter Daily news box on the www.aicpa.org home page to sign up. You can opt out at any time, and only the AICPA can use your e-mail address or personal information. Have a technical accounting or auditing question? So did 23,000 other professionals who contacted the AICPA's accounting and auditing Technical Hotline last year. The objectives of the hotline are to enhance members' knowledge and application of professional judgment by providing free, prompt, high-quality technical assistance by phone concerning issues related to: accounting principles and financial reporting; auditing, attestation, compilation and review standards. The team extends this technical assistance to representatives of governmental units. The hotline can be reached at 1-877-242-7212.

Chapter 1

Solutions to Feedback Questions

1. a. Incorrect. Neither GAAP nor the framework require comparative financial statements. b. Incorrect. The framework does not require comparative financial statements. c. Correct. Neither GAAP nor the framework require comparative financial statements.

2.

a. Incorrect. Acceptable conservatism relates to uncertainties, not the predictive or feedback value of financial statements prepared under the framework.

b. Correct. Acceptable conservatism relates to the judgments regarding uncertainties in financial statements prepared under the framework.

c. Incorrect. Acceptable conservatism relates to uncertainties, not the representational faithfulness of financial statements prepared under the framework.

3.

a. Incorrect. Replacement cost is used, but historical cost is the primary measurement. b. Correct. Historical cost is the primary measurement. c. Incorrect. Realizable value is used sometimes, but it is not the primary measurement.

4.

a. Incorrect. Performance is achieved is only one of the criteria. b. Incorrect. The amount can be measured with reasonable assurance is only one of the

criteria. c. Incorrect. The amount recognized is collectible with reasonable assurance is only one of

the criteria. d. Correct. All of the above criteria must be met before revenue can be recognized.

5.

a. Incorrect. A statement of cash flows is also required. b. Incorrect. A statement of comprehensive income is not required. c. Correct. A complete set of financial statements includes a statement of financial position,

a statement of operations, and a statement of cash flows. 6.

a. Incorrect. Paragraph 2.21 of the framework states: “If its operating cycle is less than or greater than one year, an entity should disclose that fact, along with the length of the operating cycle.”

b. Incorrect. Paragraph 2.21 of the framework states: “If its operating cycle is less than or greater than one year, an entity should disclose that fact, along with the length of the operating cycle.”

Copyright 2014–2015 AICPA ∗ Unauthorized Copying Prohibited Solutions 1-1

c. Correct. Paragraph 2.21 of the framework states: “If its operating cycle is less than orgreater than one year, an entity should disclose that fact, along with the length of theoperating cycle.”

7. a. Incorrect. “Income or loss before discontinued operations” are required under the

framework.b. Incorrect. “Discontinued operations” are required under the framework.c. Incorrect. “Net income or loss” are required under the framework.d. Correct. Under the framework, there are no “Extraordinary items.”

8. a. Incorrect. A cash equivalent has a maturity of three months or less when purchased.b. Correct. A CD with an original maturity in excess of three months is required to be

presented as an investment rather than a cash equivalent.c. Incorrect. The classification is based on facts and circumstances and the definition of a

cash equivalent rather than the discretion of the reporting entity.

9. a. Incorrect. A net change in overdrafts should be reported under financing activities not

operating activities.b. Incorrect. A net change in overdrafts should be reported under financing activities not

operating activities.c. Correct. A net change in overdrafts should be reported under financing activities.

10. a. Incorrect. All intercompany transactions have to be eliminated under the framework.b. Correct. All significant intercompany transactions and balances should be eliminated

from the consolidated financial statements.c. Incorrect. Since intercompany transactions are eliminated it is not necessary to disclose

them.

11. a. Incorrect. A deficit in the noncontrolling interest is not an asset.b. Correct. The noncontrolling interest including a deficit in net assets is shown as a

separate component of equity.c. Incorrect. The noncontrolling interest’s equity or deficit is not part of the controlling

interest’s equity or deficit.

12. a. Incorrect. The configuration of the future cash flows of the asset received differs

significantly from the configuration of the cash flows of the asset given up or b. must bemet.

b. Incorrect. The entity-specific value of the asset received differs from the entity-specificvalue of the asset given up, and the difference is significant relative to the market valueof the assets exchange or a. must be met

Copyright 2014–2015 AICPA ∗ Unauthorized Copying ProhibitedSolutions 1-2

c. Correct. A nonmonetary transaction has commercial substance when either a. or b. aremet.

13. a. Incorrect. Financial statements prepared under the framework are not intended to be a

presentation in accordance with GAAP.b. Correct. The framework is a special purpose framework.c. Incorrect. The framework is principles-based rather than rules-based.

14. a. Correct. Probable, remote, and reasonably possible are included in the ranges of

probabilities, possible is not.b. Incorrect. Probable, remote, and reasonably possible are included in the ranges of

probabilities.c. Incorrect. Probable, remote, and reasonably possible are included in the ranges of

probabilities.d. Incorrect. Probable, remote, and reasonably possible are included in the ranges of

probabilities, possible is not.

15. a. Incorrect. Even related party transactions that are in the “normal course of business”

should be disclosed.b. Incorrect. The owner/manager objecting to such a disclosure is not an acceptable rational

for nondisclosure.c. Correct. Neither a. nor b. are acceptable reasons for non-disclosure. Disclosure is

required for exchanges of goods or services between related parties that have not beengiven accounting recognition.

16. a. Incorrect. In addition to disclosing the date through which subsequent events have been

evaluated the date the financial statements were available for issuance should also bedisclosed.

b. Incorrect. In addition to disclosing the date the financial statements were available to beissued the reporting entity is also required to disclose the date through which subsequentevents have been evaluated.

c. Correct. Disclosure should be made of those events occurring between the date of thefinancial statements and the date the financial statements are available to be issued thatdo not relate to conditions that existed at the date of the financial statements, but are ofsuch a nature that they should be disclosed to keep the financial statements from beingmisleading, but not for events occurring after the date the financial statements areavailable to be issued.


Chapter 2


1. a. Incorrect. Disclosures of inventory classifications are required under GAAP and the

framework.b. Incorrect. Disclosures of inventory classifications are required under GAAP and the

framework.c. Correct. Disclosures of inventory classifications are required under GAAP and the

framework.

2. a. Incorrect. Depreciation methods are not prescribed.b. Correct. Any depreciation method that is rational and systematic is appropriate.c. Incorrect. Component life depreciation may be used when the allocation of cost to the

components parts is practicable and estimates can be made of the lives of the separatecomponents, it is not required to be used in all circumstances.

3. a. Correct. A change in the depreciation method is a change in accounting estimate and

would not result in a reduction of the carrying value of the equipment.b. Incorrect. A reduction of the carrying value is also required if the reporting entity ceases

to use the equipment.c. Incorrect. A reduction of the carrying value is also required if the reporting entity

experiences a write down in the carrying value of equipment.

4. a. Incorrect. The gain or loss is not deferred and amortized.b. Incorrect. The difference is credited or charged to net income not additional paid-in

capital.c. Correct. Such difference is recognized in net income for the period.

5. a. Correct. Interest expense should not be disclosed at a gross amount, it should be disclosed

as current financial liabilities and long-term liabilities, separately identifying amortizationof premiums, discounts, and capitalized financing costs.

b. Incorrect. The disclosures in b. are also required in addition to the requirement to disclosewhether any such liabilities were in default or in breach of any term or covenant duringthe period that would permit a lender to demand accelerated repayment.

c. Incorrect. The disclosures in a. are also required in addition to whether the default wasremedied, or the terms of the liability were renegotiated, before the financial statementswere completed.


6. a. Incorrect. The cost method and the constructive retirement method may be used.b. Correct. The cost method and the constructive retirement method may be used.c. Incorrect. The cost method and the constructive retirement method may be used.

7. a. Incorrect. All of the conditions in a. through c. must be met for performance to be

regarded as achieved.b. Incorrect. All of the conditions in a. through c. must be met for performance to be

regarded as achieved.c. Incorrect. All of the conditions in a. through c. must be met for performance to be

regarded as achieved.d. Correct. All of the conditions in a. through c. must be met for performance to be regarded

as achieved.


Chapter 3


1. a. Correct. Goodwill is considered to have a finite life and is amortized.b. Incorrect. Goodwill is considered to have a finite life and is not tested for impairment.c. Incorrect. The framework does not provide for an accounting policy election for

accounting for goodwill.

2. a. Incorrect. In addition, the useful life must be reasonably estimable, and the cost of the

asset must be reliably measured. Incorrect.b. Incorrect. In addition, the useful life must be reasonably estimable, and it should be

probable that the expected future economic benefits attributable to the asset will flow tothe reporting entity.

c. Incorrect. In addition, it should be probable that the expected future economic benefitsattributable to the asset will flow to the reporting entity, and the cost of the asset must bereliably measured.

d. Correct. All must be present for an intangible asset to be recognized.

3. a. Incorrect. Costs incurred during the development phase should be expensed as incurred

or capitalized based on an accounting policy election.b. Incorrect. Costs incurred during the development phase should be expensed as incurred

or capitalized based on an accounting policy election.c. Correct. Costs incurred during the development phase should be expensed as incurred or

capitalized based on an accounting policy election.

4. a. Incorrect. Such costs may be expensed as incurred or they can also be capitalized and

amortized over 15 years.b. Incorrect. Such costs may be capitalized and amortized over 15 years or they can also be

expensed as incurred.c. Correct. Expensing or capitalizing such costs is an accounting policy choice.


Chapter 4


1. a. Incorrect. The entity may either consolidate that entity or account for it using the equity

method depending on its accounting policy election.b. Incorrect. The entity may account for its investment in that entity using the equity method

or consolidate it depending on its accounting policy election.c. Correct. The entity may account for its investment in that entity using the equity method

or consolidate it depending on its accounting policy election.

2. a. Incorrect. An investor’s share of losses in excess of the carrying amount and net advances

of the investment should be recorded if the investor has guaranteed the obligations of theinvestee.

b. Incorrect. An investor’s share of losses in excess of the carrying amount and net advancesof the investment should be recorded if the investor is otherwise committed to providefurther financial support to the investee.

c. Correct. An investor’s share of losses in excess of the carrying amount and net advancesof the investment should be recorded if the investee seems assured of imminentlyreturning to profitability.

3. a. Incorrect. The equity method should be used.b. Correct. The equity method should be used.c. Incorrect. The equity method should be used.

4. a. Correct. Average cost is specified.b. Incorrect. Average cost rather than specific cost is required.c. Incorrect. Average cost, rather than cost determined on the first-in, first-out basis.


Chapter 5


1. a. Incorrect. Base on contractual payments are not representative of the pattern of user’s

benefit.b. Incorrect. The straight-line method is used if another systematic and rational basis is not

more representative of the pattern of the user’s benefit.c. Correct. By the straight-line method unless another systematic and rational basis is more

representative of the pattern of the user’s benefit.

2. a. Correct. The lessor recognizes as an asset the present value of the unguaranteed residual

value with a credit to cost of sales.b. Incorrect. The lessor recognizes both profit on the sales of the product and interest on the

lease payments.c. Incorrect. In addition to interest on the lease payments the lessor also recognizes profit on

the sales of the product.

3. a. Incorrect. No profit is recognized on the sales of the product.b. Correct. Interest on the lease payments.c. Incorrect. Interest on the lease payments is recognized; however, no profit is recognized

on the sales of the product.

4. a. Incorrect. For each major category of leased property, plant, and equipment, the reporting

entity should disclose the cost, accumulated amortization, including the amount of anywrite-downs; and the amortization method used, including the amortization period orrate.

b. Incorrect. For each major category of leased property, plant, and equipment, the reportingentity should disclose the cost, accumulated amortization, including the amount of anywrite-downs; and the amortization method used, including the amortization period orrate.

c. Incorrect. For each major category of leased property, plant, and equipment, the reportingentity should disclose the cost, accumulated amortization, including the amount of anywrite-downs; and the amortization method used, including the amortization period orrate.

d. Correct. Net investment is a disclosure made by the lessor in a direct financing and sales-type lease.


Chapter 6


1. a. Incorrect. In addition to business combinations, exemptions also relate to asset retirement

obligations and financial assets and liabilities.b. Incorrect. In addition to asset retirement obligations, exemptions also relate to business

combinations and financial assets and liabilities.c. Correct. Exemptions relate to financial assets and liabilities, not non-financial assets and

liabilities.2.

a. Incorrect. In addition to a change required by the framework, a change may be effectedbecause of c.

b. Correct. FASB issues standards for GAAP, the framework is a non-GAAP SPF.c. Incorrect. A change may be effected if the results in the financial statements providing

reliable and more relevant information about the effects of transactions, other events, orconditions on the reporting entity’s financial position, financial performance, or cashflows, or if the change is required by the framework.

3. a. Correct. The revision of an estimate does not relate to prior periods and is not the

correction of an error.b. Incorrect. Changes in accounting estimates may result from changes in the circumstances

on which the estimate was based, or as a result of new information or more experience.c. Incorrect. Changes in accounting estimates may result from changes in the circumstances

on which the estimate was based, or as a result of new information or more experience.d. Incorrect. Changes in accounting estimates may result from changes in the circumstances

on which the estimate was based, or as a result of new information or more experience.

4. a. Incorrect. Even when more than 80 percent of the acquired reporting entity is acquired by

an unrelated acquirer the use of push-down accounting is voluntary.b. Correct. May be effected when more than 50 percent of the acquired reporting entity is

acquired by an unrelated acquirer.c. Incorrect. Push-down accounting is voluntarily permitted under the framework.

5. a. Incorrect. In addition, to the elimination of operations and cash flows of the component

from the ongoing operations of the entity the entity must not have any significantcontinuing involvement in the operations of the component after the disposal transaction.

b. Incorrect. In addition to the entity not having any significant continuing involvement inthe operations of the component after the disposal its operations and cash flows will beeliminated from the ongoing operations of the entity.

c. Correct. Both criteria in a. and b. must be met.


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