pez final review.docx

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SEC1) Briefly explain the differences between state securities laws and federal securities

litigation? What was it necessary to pass federal securities laws?

The Federal Securities Laws are comprised of a series of statutes, which in turn authorize a series

of regulations promulgated by the government agency with general oversight responsibility forthe securities industry, the Securities and Exchange Commission.The two main statutes involved in the Federal Securities laws are the The Securities Act of 1933and the The Securities Exchange Act of 1934. Generally speaking, the '33 Act governs theissuance of securities by companies, and the '34 Act governs the trading, purchase and sale ofthose securities. Each has a wealth of regulations promulgated by the Securities and ExchangeCommission, as well as regulations adopted by the National Association of Securities Dealers,Inc. and the various stock exchanges

State Securities LawsWhile the SEC directly, and through its oversight of the NASD and the various Exchanges, is the

main enforcer of the nation's securities laws, each individual state has its own securitiesregulatory body, typically known as the state Securities Commissioner. Each state has its ownsecurities act, which governs, at least, the registration and reporting requirements for broker-dealers and stock brokers doing business, sometimes even indirectly, in the state. The variousstate securities regulators have most of their impact in the area of registration of securitiesbrokers and dealers, and in the registration of securities transactions. State laws governingissuance and trading of securities are commonly referred to as blue sky laws.Compliance with federal securities laws (or exemption from compliance) does not implycompliance with or exemption of compliance from state securities laws;State law allows an official to judge the merits of an offering and could prohibit an offering if itis not fair, just, and equitable.

2) What are four elements of fraud?Generally speaking, a claim for [common law] fraud must include the following elements: (1) afalse statement of material fact; (2) defendants knowledge that the statement was false; (3)defendants intent that the statement induce the plaintiff to act; (4)plaintiffs relianceupon thetruth of the statement; and (5)plaintiffs damages resulting from reliance on the statement.

3) What is fraud by omission? When does a duty to speak (disclose) arise? A fraud claim based on intentional non-disclosure (i.e., omission), has the same elements asfraud, except that an omission is actionable as fraud only where there is an independent duty todisclose the omitted information. The duty to speak arises when one party has information thatthe other [party] is entitled to know because of a fiduciary or other similar relation of trust andconfidence between them.

4) What is the basic difference between 1933 Securities Act and 1934 Securities and

Exchange Act? When does each apply? Under which Act is litigation risk higher?


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The Securities Act of 1933 (the 1933 Act):Applies any times new securities are sold to general public (like IPOs or seasoned equityofferings). Requires full and fair disclosure of the character of securities sold

Securities must be registered with the SEC before they are offered to the public (prospectus).Securities Exchange Act of 1934 (the 1934 Act):Applies to the subsequent trading in outstanding securities that are listed on an exchange Provides for periodic filing of annual reports.

The Securities Act of 1933 legislation had two main goals: (1) to ensure more transparency infinancial statements so investors can make informed decisions about investments, and (2) toestablish laws against misrepresentation and fraudulent activities in the securities markets.

The Securities Exchange Act of 1934 was created to provide governance of securitiestransactions on the secondary market (after issue) and regulate the exchanges and broker-dealersin order to protect the investing public.1933 Act applies to original issue of securities (initial public offering) where the 1934 Actapplies to secondary trading.

Most securities litigation concerns actions under the 1934 Act.

5) What is the purpose of Section 10b(5) of the 1934 Act?The rule prohibits any act or omission resulting in fraud or deceit in connection with thepurchase or sale of anysecurity.It shall be unlawful for any person, directly or indirectly, by the use of any means orinstrumentality of interstate commerce, or of the mails or of any facility of any national securitiesexchangeTo make any untrue statement of a material fact or to omit to state a material fact necessary inorder to make the statements made, in the light of the circumstances under which they weremade, not misleading

6) What is fraud on the market? How does it to tie to the theory of market efficiency?Idea that stock prices are a function of all available information about the company, thereforemisstatements defraud the entire market and impact the price of the stock.The Fraud-on-the-Market theory establishes a rebuttable presumption of reliance and satisfiestransaction causation.Absence of loss causation is relevant to showing that either (1) the alleged misrepresentationwas not material or (2) the market was not efficient, either of which can rebut the presumption.

*7) Which Divisions of the SEC deal with the accounting matters? What are the basic

differences between those Divisions?
http://en.wikipedia.org/wiki/Security_(finance)http://en.wikipedia.org/wiki/Security_(finance)


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The Chief Accountant is the commissions chief accounting officer for all accounting and

auditing matters. Chief Accountant advises the commission on accounting matters. But theultimate power to establish the accounting rules lies with the SEC Commissioners.?

*8) How does filing review process of the Division of Corporation Finance influence thelikelihood of restatements?

-look in to red flags, and send a comment letter out and wait for a response.

9) How does the work of the Division of the Corporation Finance affect the work of the

Division of Enforcement?Only the most egregious and obvious of these accounting errors lead to action by the Division ofEnforcement. In the overwhelming majority of cases, the registrant restates its financialstatements quietly after a challenge by the Division of Corporation Finance. Although furtheraction by the Division of Enforcement may be considered, most often the staff decides that theinvestment of additional time and resources into the investigation and litigation of the accounting

error is unlikely to accomplish significantly more than the comment process achieved alreadywith the registrants restatement of its financial statements.

10) Who has the ultimate power to establish the accounting standards for public companies

in the United States? How does it affect FASB?The ultimate authority for standard setting for public companies lies with the SEC.SEC prescribed business segment reporting before FASBOverruled FASB on issue of oil and gas accounting.SEC was the driving force behind adoption of fair value accounting

11) What is the nature of the relationship between SEC and PCAOB?Today, auditing standards for public companies are entirely within purview of Public CompaniesAccounting Oversight Board (PCAOB).The members of PCAOB are appointed by the SEC.Under the 2010 Supreme Court case, PCAOB members could be removed by the SEC at will.

12) What is the purpose of Regulation S-K?Standardizes non-financial disclosure requirements for documents to be filed with the SEC.

13) What is the purpose of Regulation S-X?It stipulates financial disclosure requirements under the Security Acts. It is the principalaccounting regulation of the SEC, containing substantially all the requirements for financialstatement, related footnotes, and supplemental financial schedules required under the SEC Acts.It presents a minimum standard of disclosure.Audited balance sheets for 2 most recent fiscal years, income statements and cash flowstatements for 3 most recent yearsAll notes to the financial statements and related financial statement supporting schedules.

14) What is the purpose of Regulation FD?Prohibits selective disclosure:


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On August 15, 2000, the SEC adopted Regulation FD to address the selective disclosure ofinformation by publicly traded companies and other issuers. Regulation FD provides that whenan issuer discloses material nonpublic information to certain individuals or entitiesgenerally,securities market professionals, such as stock analysts, or holders of the issuer's securities whomay well trade on the basis of the informationthe issuer must make public disclosure of that

information. In this way, the new rule aims to promote the full and fair disclosure.

15) What is the purpose of Regulation G?Requires reconciliation of pro-forma disclosures to GAAP:For purposes of Regulation G, a non-GAAP financial measure is a numerical measure of aregistrants historical or future financial performance, financial position or cash flow that:1. Excludes amounts, or is subject to adjustments that have the effect of excluding amounts, thatare included in the most directly comparable measure calculated and presented in accordancewith GAAP in the statement of income, balance sheet or statement of cash flow (or equivalentstatements) of the issuer2. Regulation G will not apply to a non-GAAP financial measure included in disclosure relating

to a proposed business combination, the entity resulting therefrom or an entity that is a partythereof the disclosure is contained in a communication that is subject to the communicationsrules applicable to business combination transactions.

*16) What is Staff Accounting Bulletin? What level of authority does it have? Staff Accounting Bulletins reflect the Commission staff's views regarding accounting-relateddisclosure practices. They represent interpretations and policies followed by the Division ofCorporation Finance and the Office of the Chief Accountant in administering the disclosurerequirements of the federal securities laws.Examples: SAB 101 (revenue recognition), SAB 99 (materiality).SEC has recently stopped issuing SABs and now all of its views are summarized in Corp FinFinancial Reporting Manual:Level E

*17) What is the primary source of accounting guidance used by the Division of

Corporation Finance? What is its relationship with Staff Accounting Bulletins?l Division of Corporation Finance:

o Reviews both 33 and 34 Act Filingso Approximately 80% of Division employees involved in file reviewso As required by SOX, each SEC filer must be reviewed at least every 3 yearso Initially performed by a first level examiner and then by a second level reviewer for

consistencySAB represents interpretations and policies followed by the Division of Corporation Finance andthe Office of the Chief Accountant in administering the disclosure requirements of the federalsecurities laws.

18) What is form S-1? What is its purpose?A document filed with the SEC explaining an initial public offering of securities. Form S-1 mustcontain a complete description of the security and the terms of the sale. It must also include


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applicable information about the issuer's financial situation and applicable risk factors. This isdone to protect investors from fraud.The Securities Exchange Act of 1933, often referred to as the "truth in securities" law, requiresthat these registration forms are filed to disclose important information upon registration of acompany's securities. This helps the SEC achieve the objectives of this act, which is requiring

investors to receive significant information regarding securities offered, and to prohibit fraud inthe sale of the offered securities.

19) What types of companies are exempt from the registration requirements? Intrastate offerings: shares only sold to residents of the state in which an issuer is

incorporated. No fixed limit exists on the size of offerings and number of purchasers. Private offering exemption to sophisticated investors (e.g. bank loans, private placements

of securities with VC funds and institutional investors (e.g. Facebook) Small offering exemption (aka Regulation A short form offerings over one year amount

is


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22) Give examples of some financial statement disclosure requirements in form S-1 (for

example, three years of income statement data, etc.) l Audited income statementthree yearsl Audited balance sheettwo years

l Statement of cash flowsthree yearsl Statement of stockholders equity three years

23) What could be the maximum age of financial statements for them to be eligible to be

filed in form S-1?Most recent statements must be no older than 135 days before the S-1 effective date, e.g.,September 30, 2011 interim information would be acceptable if effective on or before February15, 2012. If effective after February 15, FY2012 would have to be audited.

24) What is incorporation by reference?Incorporation by reference is the act of including a second document within another document by

only mentioning the second document.[1] this act, if properly done, makes the entire seconddocument a part of the main document. Incorporation by reference is often done in creating lawsas well as in contract law and trust and estate law. If financial statements are incorporated byreference into a registration statement, then stricter liability rules under 1933 Act apply.

25) What are top considerations in taking a company public?. Pros:. Diversification by the owner, Tax planning (liquidity of an estate), Liquidity, Broader access

to sources of capital, Expansions through business combinations, Employee benefitplans/incentives, Higher market visibility

. Cons:

. Lack of operating confidentiality, Lack of business flexibility (loss of single authority)

. Initial costs of offering. IPOs are expensive, Cost of public reporting, Insider tradingrestrictions on management, Possible loss of management control (threat of hostiletakeovers), Pressure to meet short-term results (myopia)

Fair Value Accounting (FVA) 1--10.. 1) What is the purpose of ASC 820-10 (SFAS 157)? Give examples of its scope (when it is

applied).ASC 820-10 (formerly FAS 157) is a principles based standard which provides a framework for

how to defi ne/determi ne fair valuewhen required or allowed by GAAP. ASC 820 defines how to determine fair value when its use is required or allowed. ASC 820 does not address when to apply or measure financial or non-financial assets or

liabilities at fair value. When to use fair value is determined by specific standards (e.g. business combinations

standard tells us to use fair value to estimate acquisitions goodwill)

2) Define price in the context of ASC 820-10. How is this definition different between

assets and liabilities? What role does credit risk play in pricing liabilities?

. ASC 820-10-35-3 states that the objective of a fair value measurement is to

. determine the pri ce that would be received to sell the asset or paid to transfer


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. b. A firm commitment that would otherwise not be recognized at inception and thatinvolves only financial instruments(for example, a forward purchase contract for a loanthat is not readily convertible to cashthat commitment involves only financialinstrumentsa loan and cashand would not otherwise be recognized because it is not aderivative instrument).

. c. A written loan commitment.. d. The rights and obligations under an insurance contract that has both of the followingcharacteristics:

. 1. The insurance contract is not a financial instrument (because itrequires or permits theinsurer to provide goods or services rather than a cash settlement).

. 2. The insurance contracts terms permit the insurer to settle by paying a third party to providethose goods or services.

. e. The rights and obligations under a warranty that has both of the following characteristics:

. 1. The warranty is not a financial instrument (because it requires or permits the warrantor toprovide goods or services rather than a cash settlement).

. 2. The warrantys terms permit the warrantor to settle by paying a third party to provide those

goods or services.. f. A host financial instrument resulting from the separation of an embedded nonfinancialderivative instrument from a nonfinancial hybrid instrument under paragraph 815-15-25-1, subject to the scope exceptions listed below (for example, an instrument in which thevalue of the bifurcated embedded derivative is payable in cash, services, or merchandisebut the debt host is payable only in cash).

7) How can FVO be applied?. The financial instruments guidance in ASC 825-10 permits reporting entities to apply the FVO

on an instrument-by-instrument basis.. Therefore, a reporting enti ty can elect the FVO for certain i nstruments but not others with in

a group of simi lar items (e.g., for some avail able-for-sale securi ties but not for others).. However, if the FVO is not elected for all eligible instruments within a group of similar

instruments, the report ing enti ty is requir ed to disclose the reasons for its partialelection.

. In addition, the reporting entity must disclose the amounts to which it applied the FVO and theamounts to which it did not apply the FVO within that group.

. A financial instrument that represents a single contract may not be further separated into partsfor purposes of electing the FVO. However, a loan syndication arrangement may result inmultiple loans issued to the same borrower. Under ASC 825-10, each of those loans is aseparate instrument, and the FVO may be elected for some loans but not others.

8) What are the market approach, the income approach, and the cost approach to FV?The market approach uses prices and other relevant information generated by market transactions

involving identical or comparable assets, liabilities or a group of assets and liabilities.The income approach converts future amounts for example cash flows or income andexpenses to a single current (i.e. discounted) amount. When the income approach is used,the fair value measurement reflects current market expectations about those futureamounts; The cost approach reflects the amount that would be required currently toreplace the service capacity of an asset (often referred to as current replacement cost).


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9) Describe FV Hierarchy. Fair Value Hierarchydefines which fair value to pick. We always want to try to use the best

(lowest) possible level (i.e. Level 1 is better to use than Level 2, etc.). Level 1: Active Markets Valuations

. Level 2: Observable Inputs other than prices. Level 3: Includes unobservable inputs (such as entitys own assumptions about cash flows,risk, etc.)

10) What are observable and non-observable inputs?. Observable inputs are based on data observable from the outside. Examples are:

Prices or quotes from exchanges or listed markets Proxy observable market data that is proven to be highly correlated and has a logical,

economic relationship with the instrument that is being valued (e.g., electricity prices in twodifferent locations, or zones that are highly correlated); and

Other direct and indirect market inputs that are observable in the marketplace.

. Unobservable inputs come from inside the entity, i.e. represent entitys own data orassumptions on valuation inputs.

*11) If you needed to name one main characteristic distinguishing between Level 1 and

Level III characteristics, what would it be?Observable & unobservableObservable inputs are based on data observable from the outside.Unobservable inputs come from inside the entity, i.e. represent entitys own data orassumptions on valuation inputs.

*12) What disclosures are needed for level 1, 2, and 3 securities? What specific additional

disclosures are needed for level 3 securities?Disclosures under ASC 820

The extent (scope) to which a reporting entity measures assets and liabilities at fair value; The valuation techniques and inputs used to measure fair value; and the effect of fair

value measurements on earnings. The required quantitative disclosures for recurring measurements in tabular format.

In addition, qualitative disclosures about the valuation techniques and inputs used to measure fairvalue are required in all interim and annual periods.ASC 820s disclosure requirements vary depending on whether the asset or liability is measured

on a recurring or nonrecurring basis and the classification of the fair value measurement withinthe fair value hierarchy.

Disclosures recurring measurementThe fair value measurement at the reporting date.

The level that a measurement falls within the fair value hierarchy, segregated betweenLevel 1, Level 2 and Level 3 measurements by class of assets or liabilities.

The amounts of significant transfers between Level 1 and Level 2 and the reasons for thetransfers. Significant transfers into each level shall be disclosed separately from transfersout of each level.For Level 3 fair value measurements


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A reconciliation of the beginning and ending balances, separately presenting changes during theperiod attributable to any of the following:

Total gains or losses for the period (realized and unrealized), separately presenting gainsor losses included in earnings (or changes in net assets) and gains or losses recognized inother comprehensive income.

A description of where those gains or losses included in earnings (or changes in netassets) are reported in the statement of income or in other comprehensive income.

Purchases, sales, issuances, and settlements (each type disclosed separately)For the disclosure of gains or losses for Level 3 measurements, the amount of the total gains orlosses for the period in included in earnings relating to those assets and liabilities still held at thereporting date and a description of where those unrealized gains or losses are reported in thestatement of income.For Level 2 and Level 3 fair value measurements, a description of the valuation technique andthe inputs used in determining the fair values of each class of assets or liabilities. If there hasbeen a change in the valuation technique that change shall be disclosed as well as the reason formaking it.

Disclosures non-recurring measurementFair value measurements recorded during the period and the reasons for the measurements. The level within the fair value hierarchy in which the fair value measurements in their

entirety fall. Transfers in and/or out of Level 3 and the reasons for those transfers Significant transfers into Level 3 shall be disclosed separately from significant transfers

out of Level 3 For fair value measurements using significant other observable inputs (Level 2) and

significant unobservable inputs (Level 3), a description of the valuation techniques andthe inputs.

In addition, a reporting entity should discuss changes, if any, in the valuation techniques used tomeasure similar assets and/or liabilities in prior periods, including the reasons for changes, inboth interim and annual financial statements.

13) Give examples of level 1, 2, and 3 securities which we covered in our cases.Level 1 assets and liabilities have observable fair market values that are published on a

major exchange. Examples include active, exchanged-traded equity securities, exchange listedderivatives, certain government securities, some sovereign government obligations, etc.

Level 2 assets and liabilities are those whose fair market value cannot be retrieved from amajor exchange, but can be calculated from other observable data points. Level 2 asset valuescan be based on quotes from inactive markets or on values generated from a specific pricingmodel. Examples include:1) restricted stocks that have quoted prices on inactive markets, 2)corporate and municipal bonds (which are rarely traded) that have quoted prices, 3) assets whosepricing models have observable inputs like interest rate and currency swaps, and 4) certainresidential and commercial mortgage related assets, loans, securities, and derivatives that haveobservable market values

Level 3 assets are those whose fair value cannot be determined via observable measures.They are commonly illiquid, and have values that can only be assessed using estimates or risk-adjusted value ranges. Level 3 assets have valuation models whose primary inputs areunobservable; for example, certain private equity investments, some residential and commercial


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mortgage related assets, long-dated or complex derivatives, etc. Valuation of these (generallyilliquid) assets is typically based on market expectations and assumptions.

The underlying premise of these categories is the extent to which the inputs into thevaluation models are observable -- the more observable the data, the more reliable the valuation.Thus, the value of a Level 1 asset is considered to be more reliable than the valuation of a level 3

asset, for example. In theory, stock valuation should now be easier and more reliable becausepublically traded companies are required to classify each of their assets as Level 1, 2, or 3.

14) How does non-performance risk affect valuation of liabilities? In accordance with ASC 820, the fair value of a liability is based on the price to transfer

the obligation to a market participant at the measurement date. ASC 820-10-35-16 states: A fair value measurement assumes both of the following:

o The liability is transferred to a market participant at the measurement date (theliability to the counterparty continues; it is not settled).

o The nonperformance risk relating to that liability is the same before and after itstransfer.

The effect of nonperformance risk may differ depending on the liability, e.g. whether theliability is an obligation to deliver cash (a financial liability) or an obligation to deliver goods orservices (a non-financial liability), and the terms of credit enhancements related to the liability, ifany, e.g. a pledge of assets against default. The fair value of a liability would reflect the effect ofnon-performance risk on the basis of its unit of account. Therefore, the issuer of a liability doesnot include the effect of an inseparable third-party credit enhancement in the liabilitys fair valuemeasurement if it accounts separately for the liability and the credit enhancement. Consequently,the fair value of the liability reflects the effect of non-performance risk based on the issuers owncredit standing.

15) If markets become inactive (or not orderly), how does it affect FV reporting? What

consequences does it have for fair value hierarchy classification?If a reporting entity concludes there has been a significant decrease in the volume and level

of activity for an asset or liability, the reporting entity should perform further analysis of thetransactions or quoted prices observed in that market. Further analysis is required because thetransactions or quoted prices may not be determinative of fair value and significant adjustmentsmay be necessary when using the information in estimating fair value.

When the market for a financial instrument is inactive, observed market prices might notalways be appropriate as the basis for determining fair value. Transaction prices in inactivemarkets may be inputs when measuring fair value, but would likely not be determinative. In suchcircumstances, fair value is estimated based on the results of a valuation technique that makesmaximum use of inputs observed from markets, and relies as little as possible on inputsgenerated by the entity.

The overriding objective of any valuation technique is to estimate what the market price ofthe instrument would have been at the balance sheet date in an arms length transactionmotivated by normal business considerations. Regardless of the valuation technique used, thattechnique should not ignore relevant information and should reflect appropriate risk adjustmentsthat market participants would make for credit and liquidity risks.

The inactive markets and distressed transactions guidance applies to all assets and liabilitieswithin the scope of pronouncements that require or permit fair value measurements under ASC


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820. The guidance does not apply to Level 1 inputs, regardless of changes in the volume andlevel of activity for an asset or liability. Level 1inputs are defined in ASC 820 as quoted pricesfor an identical asset or liability in an active market.

16) What is a CDS? What is a CDO? What role did they play in the recent financial crisis?

Two major credit derivatives that played a role in the financial crisis were Credit DefaultSwaps (CDS) and Collateralized Debt Obligations (CDO).CDS is akin to mortgage insurance you may have to buy when you get a house. When a

lender buys a CDS he pays an insurance premium to the seller of CDS to buy protection in case aborrower defaults. If a borrower defaults, a seller of the CDS has to cover the lenders losses.The price of the CDS depends on the notional amount of the debt. Hence, CDS is a creditderivative (on a liability side of the balance sheet) and has to be carried at fair value by theCDSs seller.

Just like with any insurance, as long as the number of defaults is low, the sellers of CDSmake profit between the premiums they collect and the costs of defaults they have to cover. Aslong as the defaults are not massive, selling CDSs is a potentially very profitable proposition.

What was the CDSs role in major defaults during the recent crisis?AIG was one of the largest CDSs sellers. When massive defaults on the subprime debtstarted, AIG was obliged to cover those losses. Because losses were so massive, AIG did nothave the ability to cover them, and hence had to be bailed out by the government. AIG did notproperly price their CDSs because they did not have good information on the likelihood ofmassive defaults. Hence, any cash they collected from CDSs premiums was not sufficient tocover massive losses. This is in part due to failure to correctly apply fair value to potentiallyhighly risky subprime debt. AIG also did not correctly fair valued expected liabilities associatedwith future CDS payouts on their balance sheets. Otherwise, the market would have priceprotected AIG stock, and stockholders would not have lost as much.

There could be two types of CDOs: Cash CDO and Synthetic CDO.Cash CDO

Lender sells her loans to a special purpose vehicle (SPV). SPV then issues debt notes invarious tranches: senior (highest rated, mezzanine and equity (lowest rating)). SPV invests theproceeds from this sale into the low risk investments. Original borrowers repay their loans to theSPV. Simultaneously SPV repays her obligations to the holders of various tranches. SPV makesmoney on the spread between subprime loans and interest it pays on her own notes.The ability of SPV to repay the notes is driven by her ability to collect on the subprime debt. If abank maintains material recourse or repurchase obligations on the assets it transfers to SPV, it isnot a sale, but rather a borrowing transaction requiring a liability with fair value on the banks

balance sheet. If original subprime debt is not correctly valued by the holders of CDOs notes (i.e.risk premium was too low), then CDOs notes are majorly overvalued. Plenty of evidencesuggests that bad information played a role in massive original over-valuation of CDOs.

Contributors to this original over-valuation:o No docs loanso Manipulation of FICO scores to gain more favorable credit rating on CDOs debt.o Assumption of indefinite price increases in housing marketo Low required collateral on houses.o Credit rating agencies gave highly optimistic ratings to CDOs debt.


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Synthetic CDOThe biggest difference between cash CDO and a synthetic CDO is that the original bank

lender does not sell assets to the SPV, but rather SPV sells a CDS to the originating bank.

Simultaneously SPV issues notes and makes money on the difference between CDS premia itcollects and interest it has to pay on the notes.Same issues that pertain to cash CDO still pertain to synthetic CDO. Bad information on the

underlying loans increases a chance that an originating bank that bought a CDS will requirecompensation. Massive CDS defaults will lead to eventual default of the CDO and losses toholders of the CDOs notes.

17) What concerns does PCAOB have when it comes to fair value reporting?

The PCAOB is gathering its Standing Advisory Group to discuss the work undertaken so farby its Pricing Sources Task Force,formed to study how auditors audit the fair value of financialinstruments when those instruments are not actively traded and how third-party pricing sources

are used in the valuation and audit.The task force has so far studied a variety of issues related to financial instrument valuation,including the nature and extent of information pricing sources provide to issuers and auditors, theprocesses and controls over information gathered from pricing sources, and the auditor'sprocedures related to that information. Third-party pricing sources could include any number ofsources from outside the company where companies might gather and rely on data to build a casefor the fair value of an instrument that is not actively traded, and therefore not readily priced bythe market. The task force has determined that a service organization audit at the pricing sourcecould help assure controls over the pricing information, but auditors would still need their ownaudit evidence to support the fair value of financial instruments.

18) Describe goodwill impairment testing rules under IFRS and US GAAP. How are they

different?The differences in U.S. GAAP and IFRSs goodwill impairment treatment flow largely from

a fundamental difference in accounting approaches. As a principles-based accounting approach,IFRSs provide a conceptual basis for accountants to follow in a one-step test that has both a fairvalue and an asset-recoverability aspect. U.S. GAAP, on the other hand, dictates that goodwill istested for impairment through a two-step, fair value test with the level of impairment, if present,determined in Step 2 after an extensive analysis of related asset values. However, the FASBs

recent issuance of a step zero qualitative assessment for goodwill impairment testing didintroduce an element of a principles-based approach under U.S. GAAP. Principles-basedstandards allow accountants to apply significant professional judgment in assessing a transaction.This is substantially different from the underlying box-ticking approach historically commonin rules-based accounting standards.

The lack of precise guidelines in a principles-based approach may create inconsistencies inthe application of standards across organizations and countries, particularly in a very subjectivearea such as fair value. On the other hand, rules-based standards can be viewed as insufficientlyflexible to accommodate a topic such as fair value, which often requires significant professionaljudgments gained through experience, with extremely limited market data.
http://pcaobus.org/News/Events/Pages/11092011_SAGMeeting.aspxhttp://pcaobus.org/Standards/SAG/Pages/PricingSourcesTaskForce.aspxhttp://deloitte.wsj.com/cfo/2013/02/13/goodwill-impairment-testing-building-a-solid-approach-to-step-zero/http://deloitte.wsj.com/cfo/2013/02/13/goodwill-impairment-testing-building-a-solid-approach-to-step-zero/http://deloitte.wsj.com/cfo/2013/02/13/goodwill-impairment-testing-building-a-solid-approach-to-step-zero/http://pcaobus.org/Standards/SAG/Pages/PricingSourcesTaskForce.aspxhttp://pcaobus.org/News/Events/Pages/11092011_SAGMeeting.aspx


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19) Describe goodwill quantitative assessment option under recently passed US GAAP

changes. What consequences does it have?

Prior to 2012, companies were required to perform a quantitative assessment. In 2011 theFASB revised the requirements for annual Goodwill impairment testing to allow companies theannual option to assess qualitative factors to determine whether it is necessary to perform the

quantitative two-step Goodwill impairment test.According to FASB ASC 350-20-35-3C, in performing the qualitative assessment,companies should consider the totality of relevant events and circumstances that suggest it is

more likely than not that the fair value of a reporting unit is less than its carrying amount. If,after evaluating the totality of the events and circumstances, a company determines that ismore likely than not that the fair value of a reporting unit is greater than its carrying amount,then no further evaluation is needed. The goodwill is not considered impaired. If, however, acompany determines that it is it is more likely than not that the fair value of a reporting unit isless than its carrying amount, then the company is required to proceed through the two-stepimpairment test.

The first part of the two-step Goodwill impairment test is to examine whether a given

reporting unit is impaired. If it is not, then the company can cease testing after the first step. If itis, then the second part of the test is designed to identify whether the impairment pertains to theGoodwill asset that has been allocated to that reporting unit or to its other components (i.e., theidentifiable net tangible and intangible assets).

(dont need)20) What is acquisition method? How do we measure goodwill under

acquisition method? Be able to do a numerical example, like we did on the quiz.

The acquisition method of accounting takes into account two forms of accounting --acquisition accounting and merger accounting. In this form, any acquisition by a company,whether it be in terms of brick-and-mortar or monetary assets, must be accounted for at fairvalue. A fair value is defined as a rational estimate of an asset's current worth. In this method, thedifference between the purchase price and the fair value price needs to be accounted for in the"goodwill" section of the balance sheet.

Identify the acquirer Determine acquisition date Identify/measure assets acquired/liabilities assumed Recognize any goodwill. Any negative goodwill (bargain purchase) needs to be

recognized as an acquisition gain.

International Convergence1) What is the goal of international convergence? Why is it done?

The FASB believes that, over time, the ultimate goal of convergence is the development of aunified set of high-quality, international accounting standards that companies worldwide woulduse for both domestic and cross-border financial reporting.

2) How would you describe the current status of international convergence process? What

are some key projects currently under consideration?During the past ten years, the FASB and IASB collaborated through joint projects to developcommon standards. The FASB has issued those standards as U.S. GAAP and the IASB hasissued them as IFRS. Over time, the two sets of standards are expected to both improve in


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quality and become increasingly similar, if not identical. The four remaining joint projects are:revenue recognition; financial instruments; leases; and insurance.

3) What is -F reconciliation, and what kind of firms have been exempt from filing it? How

did this exemption affect US firms cross-listed in the EU?

A form issued by the Securities and Exchange Commission (SEC) that must be submitted by all"foreign private issuers" that have listed equity shares on exchanges in the United States. Form20-F calls for the submission of an annual report within six months of the end of the company'sfiscal year, or if the fiscal year-end date changesThere are four types of form 20-F filings. A foreign company need to file Form 20-F to getregistered with the SEC. A foreign company can issue its annual report using Form 20-F. If acompany changes its fiscal year, it will also need to file a Form 20-F. Finally, if a companyoperated as a shell company, it needs to file a Form 20-F with the SEC.2007 SEC removed 20-F reconciliation requirement for the Foreign Private Issuers that reportunder IFRS. EU passed a similar waiver of reconciliation to EU reporting rules in 2008.

4.What are some key convergence sticking points?Error Correction (US GAAP requires retroactive restatements; IFRS does not when notpractical) ;LIFO: no LIFO under IFRS is allowed.Reversal of impairments. Not allowed under US GAAP. Allowed under IFRS.PP&E re-valuation. Not allowed under US GAAP.Component depreciation. Required under IFRS; allowed under US GAAP.Development Costs. Must be expensed under US GAAP. Can be capitalized under IFRS undercertain conditions.-US doesnt have to reconcile if the follow with gap

*5. What is the SEC doing with respect to adopting IFRS?SECs plan: Work Plan addresses the following areas:Sufficient development and application of IFRS for the US domestic reporting system;The independence of standard setting for the benefit of investors;Investor understanding and education regarding IFRSExamination of the US regulatory environment that would be affected by a change in theaccounting standards;The impact on issuers, both large and small;Human capital readinessWork plan considers:The comprehensiveness of IFRSThe auditability and enforceability of IFRSThe comparability of IFRS financial statements within and across jurisdictionsWhat is SEC doing?: Constituent outreachResearch into experience of regulators in other jurisdictionsReview of financial statements prepared under IFRS

6. What is condorsementCondorsement: Convergence and Endorsement of IFRS standards


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The frameworks objective is to converge IFRS into U.S. GAAP through aFASB led transition

process so that U.S. issuers eventually could assert that they are also in compliance with IFRS asissued by the IASB.The framework is essentially an endorsement approach, differing versions of which have beenused by most countries with established capital markets. The FASB would change U.S. GAAP

over a defined period by endorsing, and thereby incorporating, individual IFRSs into U.S.GAAP.

7. What are some key factors that the SEC is concerned with in its Progress Report on the

Adoption of IFRS (e.g. auditability, comprehensiveness and comparability of IFRS)The comprehensiveness of IFRSSEC is inventorying areas in which IFRS does not provide guidance or where it provides lessguidance than US GAAPAnalyzing how issuers, auditors and investors currently manage these situations in practice;Identifying areas in which issuers, auditors, and investors would most benefit from additional

IFRS guidance.

The auditability and enforceability of IFRSSEC is in process of analyzing:Audit and regulatory challenges in the audit of financial statements prepared under IFRS andenforcement of IFRSTrends in error corrections and accounting-related enforcement actionsHow auditors, private security litigators and regulators manage these challenges in practice.The comparability of IFRS financial statements within and across jurisdictionsSEC is in process of analyzing:Factors that influence the degree of comparability of financial statements prepared under IFRSAssessing the extent to which financial statements prepared under IFRS may not be comparablein practice and how investors manage these situationsIdentifying ways to improve the comparability of financial statements prepared under IFRS ona cross-border basis to provide the most benefit to investors

8. What kind of IFRS did EU adopt? Does it mean that all EU firms financial statements

are automatically accepted in the US without 20-F reconciliation?

EU endorses the IFRS: Variation in this approach: (1) full adoption of IFRS; (2) translation tolocal language; (3) make modifications to address country-specific issues.A newly issued IFRS must go through multiple steps before it becomes authoritative in EU. Onlythose IFRSs that are adopted by the EUneed to be applied. For example, EU decided to carveout IAS 39 for certain entitiesThis means that certain standards may be adopted in the US but not in the EU, and may require20-F reconciliation to be accepted.

9. Based on reading Hail et al. (2010) paper and our discussion in class, are there clear

benefits of adopting IFRS in the US? What kind of jurisdictions are more likely to benefit

from the IFRS adoption?

The benefit of a better Financial reporting standard is unclear.There are positive effects:Improved liquidity and cost of capital


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Right of Return: Revenue will no longer be recognized for units expected to be returned.Liability for expected refunds needs to be recognizedWarranties: If a customer has an option to buy a warranty separately, it is a separateperformance obligation; revenue should be allocated separately related to such a warrantycontract

If no separate purchase warranty option exists, a cost accrual for warranty is appropriate(warranty reserve) unless the warranty provides a service to the customer beyond assurance thatthe entitys performance was as specified in the original contract.Customers with higher than normal credit risks: Transaction price needs to be adjusted forconsideration of credit risk. Collectability is no longer a criteria for revenue recognition, andhence revenue can be recognized earlier.

*14. What is multiple deliverable arrangement? Why is it important?

Definition: Product and service sales are negotiated at the same time with a single customer,resulting in a single contractually binding arrangement with multiple deliverables.Why is this important: This arrangement presents a challenging revenue recognition question:

under accrual accounting, how should revenue be measured and assigned to components of thesale? Old standards lead to inconsistency and incomparability for such arrangements.

15) What is vendor specific objective evidence (VSOE)? Where is it used? Vendor specific objective evidence is used in revenue recognition concerning software sales,which requires the seller to establish vendor-specific objective evidence (VSOE) of fair valuefor each separate product or service promised under a single contract. Software vendors typicallybundle products and servicessuch as the software license, installation, training services, andpostcontract customer support (PCS)under a single contract. A vendor is required todetermine VSOE of fair value for each product or service in order to recognize partial revenuebefore the entire contract is fulfilled. If a vendor cannot establish VSOE of fair value, it mayhave to defer recognizing all revenue until the last element in the contract is delivered.

IFRS vs. US GAAP1) What are the requirements of first time adoption of IFRS? (e.g. retroactive balance

sheet,etc)if an entity adopts IFRSs for the year ended 31 December 2009, it must apply all IFRSs effectiveat that date retrospectively to the 2009 and 2008 reporting periods, and to the opening statementof financial position on 1 January 2008 (assuming only one year of comparative information isprovided). Effectively, this general principle would result in full retrospective application ofIFRSs as if they had been the framework for an entitys accounting since its inception. However,

IFRS 1 adapts this general principle of retrospective application by adding a limited number ofvery important exceptions and exemptions. An entitys first IFRS financial statements should

include at least three statements of financial position (including one at the date of transition, i.e.at the beginning of the comparative period), two statements of comprehensive income, twoincome statements (if presented), two statements of cash flows and two statements of changes inequity. All of these statements must be in compliance with IFRSs.

1.recognition of all assets and liabilities whose recognition is required by IFRSs;2. derecognition of items as assets or liabilities if IFRSs do not permit such recognition;


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relationship is fully designated and documented subject to all other hedge accountingrequirements of IAS 39 being met. However, if an entity designated a net position as a hedgeditem under previous GAAP, it may designate an individual item within that net position as ahedged item, provided that the designation is made by the date of transition.Hedging relationships that were designated as hedges under previous GAAP, but which do not

qualify for hedge accounting under IAS 39, are treated in accordance with the requirements ofIAS 39 relating to the discontinuation of hedge accounting. Under previous GAAP, gains andlosses on a cash flow hedge of a forecast transaction may have been deferred in equity. If, at thedate of transition, the transaction is still highly probable and the hedging relationship wasdesignated appropriately and documented as effective, hedge accounting may be continued inaccordance with IAS 39. If the forecast transaction is not highly probable, but is still expected tooccur, the entire deferred gain or loss remains in equity until the forecast transaction occurs.

Non-controlling interestsThis exception applies for entities that have adopted the 2008 amendments to IFRS 3 BusinessCombinations and IAS 27 Consolidated and Separate Financial Statements. These amendmentsintroduced new measurement requirements for non-controlling interests (previously described as

minority interests) and a new mandatory exception to IFRS 1.The exception stipulates that a first-time adopter should apply the following requirements of IAS27(2008) prospectively from the date of transitionto IFRSs: the requirement that total comprehensive income be attributed to the owners of the parent andto the non-controlling interests even if this results in the non-controlling interests having a deficitbalance; the requirements regarding the accounting for changes in the parents ownership interest in asubsidiary that do not result in a loss of control;and the requirements regarding the accounting for a loss of control over a subsidiary, and therelated requirements in paragraph 8A of IFRS 5 Non-current Assets Held for Sale andDiscontinued Operations.

3) What is the difference between US GAAP revenue recognition principle and IFRS

revenue recognition principle?GAAP: Generally, the guidance focuses on revenue being (1) either realized or realizable and (2)earned. Revenue recognition is considered to involve an exchange transaction; that is, revenueshould not be recognized until an exchange transaction has occurred. beyond this standard, thereare often detailed rules depending on the industry (ie. software revenue recognition).IFRS: Two primary revenue standards (IAS 18 Revenue and IAS 11 Construction Contract)capture all revenue transactions within one of four broad categories: Sale of goods Rendering of services Others use of an entitys assets (yielding interest, royalties, etc.) Construction contractsRevenue recognition criteria for each of these categories include the probability that theeconomic benefits associated with the transaction will flow to the entity and that the revenue and

costs can be measured reliably. Additional recognition criteria apply within each broad category.The principles laid out within each of the categories are generally to be applied withoutsignificant further rules and/or exceptions. The concept of VSOE of fair value does not exist


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under IFRS, thereby resulting in more elements likely meeting the separation criteria underIFRS. Although the price that is regularly charged by an entity when an item is sold separately isthe best evidence of the items fair value, IFRS acknowledges that reasonable estimates of fairvalue (such as cost plus a reasonable margin) may, in certain circumstances, be acceptablealternatives.

4) What are the differences between US GAAP and IFRS with respect to long-term service

contracts? Long-term construction contracts?Long-term service contractsGAAP: (cost-to-cost method is prohibited) Generally, companies would apply theproportional-performance model or the completed-performance model. Revenue is recognizedbased on a discernible pattern and, if none exists, then the straight-line approach may beappropriate. Revenue is deferred if a service transaction cannot be measured reliably.IFRS: (cost-to-cost method is allowed) IFRS requires that service transactions be accounted forby reference to the stage of completion of the transaction (the percentage-of-completionmethod). The stage of completion may be determined by a variety of methods, including the

cost-to-cost method. Revenue may be recognized on a straight-line basis if the services areperformed by an indeterminate number of acts over a specified period and no other method betterrepresents the stage of completion.When the outcome of a service transaction cannot be measured reliably, revenue may berecognized to the extent of recoverable expenses incurred. That is, a zero-profit model would beutilized, as opposed to a completed-performance model. If the outcome of the transaction is souncertain that recovery of costs is not probable, revenue would need to be deferred until a moreaccurate estimate could be made.

Long-term construction contractsCompleted Contract Method:prohibited under IFRS but allowed under GAAP is a readilyestimate of percentage completion cannot be madePercentage-of-completion method: Within the percentage-of-completion model there are twoacceptable approaches: the revenue approach and the gross-profit approach. IFRS utilizes arevenue approach to percentage of completion. When the final outcome cannot be estimatedreliably, a zero-profit method is used (wherein revenue is recognized to the extent of costsincurred if those costs are expected to be recovered). The gross-profit approach is not allowedunder IFRS.

Combining and segmenting contracts:GAAP: Combining and segmenting contracts is permitted, provided certain criteria are met, butit is not required so long as the underlying economics of the transaction are reflected fairly.

IFRS: required when certain criteria are met.

5) Give examples of differences in accounting for assets (e.g. assets revaluations,LIFO, etc.) Issues:

Assets revaluations allowed under IFRS, and not allowed under US GAAP Differences in criteria for impairment testing for long-lived assets Capitalization of development costs Differences in criteria for impairment of intangibles with indefinite lives Differences in inventory accounting (LIFO is prohibited in IFRS) Differences in lease capitalization rules (IFRS is more principles-based).


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6) How does one account for impairment of long-lived assets under US GAAP? IFRS?GAAP: INTANGIBLES, An impairment loss is recognized for the amount by which thecarrying amount of the asset exceeds its FV. Option to first assess qualitative factors todetermine whether it is necessary to estimate the FV of an asset. By electing this option youonly have to estimate if MLTN the asset is impaired. ASSETS HELD AND USED, Impairment

recognized when CV is greater than both undiscounted cash flows (Recoverability test) and FV.IFRS: An impairment loss is recognized for the amount by which the carrying value of the assetexceeds its recoverable amount. The recoverable amount is the greater of: (a) the fair valueless costs to sell and (b) the value in use (i.e. the PV of future cash flows expected to be derivedfrom the asset). Impairment recognized for this difference.

7) How does one account for impairment of acquisition goodwill under US GAAP? IFRS?GAAP: MLTN test can be performed to see if reporting unit (including goodwill) carrying valueexceeds FV, then (1) if CV of reporting unit is >FV and if (2) CV of goodwill is > implied FV.Then, impairment loss recognized for difference to the extent that goodwill exists.IFRS:when the CV of a cash generating unit (including goodwill) is > recoverable amount,

impairment loss recognized for the difference to the extent that goodwill exists. definition ofrecoverable amount is same as above.

8) What are basic differences in accounting for leases between IFRS and US GAAP?GAAP: Applies only to PPE. The guidance contains four specific criteria for determiningwhether a lease should be classified as an operating lease or a capital lease by a lessee. Thecriteria for capital lease classification broadly address the following matters: Ownership transfer of the property to the lessee Bargain purchase option Lease term in relation to economic life of the asset Present value of minimum lease payments in relation to fair value of the leased assetThe criteria contain certain specific quantified thresholds such as whether the present value ofthe minimum lease payments equals or exceeds 90 percent of the fair value of the leasedproperty.IFRS:Goes beyond PPE. The guidance focuses on the overall substance of the transaction.Lease classification as an operating lease or a finance lease (i.e., the equivalent of a capital leaseunder US GAAP) depends on whether the lease transfers substantially all of the risks andrewards of ownership to the lessee.Although similar lease classification criteria identified in US GAAP are considered in theclassification of a lease under IFRS, there are no quantitative breakpoints or bright lines to apply(e.g., 90 percent).A lease of special-purpose assets that only the lessee can use without major modificationgenerally would be classified as a finance lease. This also would be the case for any lease thatdoes not subject the lessor to significant risk with respect to the residual value of the leasedproperty.Importantly, there are no incremental criteria for a lessor to consider in classifying a lease underIFRS. Accordingly, lease classification by the lessor and the lessee typically should besymmetrical.

9) What is other than temporary impairment of Available for Sale Securities under US

GAAP? How does such an impairment work under IFRS?


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GAAP: a significant or prolonged decline in the fair value of an investment below its cost

management must assess whether (a) it has the intent to see the security or (b) it is MLTN that itwill be required to see the security prior to its anticipated recovery. Then see if the ability torecover cost basis in investment exists. Under ASC 320-10-35, an OTTI has occurred:

the entity intends to sell the security

it is MLTN the entity will be required to sell before recovery of securities amortized costbasis the entity does not expect to recover the entire amortized cost basis of the security.

compare PV of cash flows expected to be collected to amortized cost basis. impair excess.Under IFRS, the concept of OTTI does not exist and either a significant or prolonged decline infair value is considered objective evidence of impairment.

10) How does US GAAP generally treat reversal of impairment charges? How is it different

under IFRS?GAAP:Long-lived assets: The reversal of impairments is prohibited.

Debt and Securities: Impairments of loans held for investment measured under ASC 310-10-35and ASC 450 are permitted to be reversed; however, the carrying amount of the loan can at notime exceed the recorded investment in the loan.One-time reversals of impairment losses for debt securities classified as available-for-sale orheld-to-maturity securities, however, are prohibited. Rather, any expected recoveries in futurecash flows are reflected as a prospective yield adjustment.IFRS:Long-Lived Assets: If certain criteria are met, the reversal of impairments, other than those ofgoodwill, is permitted.Debt and Securities: For financial assets carried at amortized cost, if in a subsequent period theamount of impairment loss decreases and the decrease can be objectively associated with anevent occurring after the impairment was recognized, the previously recognized impairment lossis reversed. The reversal, however, does not exceed what the amortized cost would have beenhad the impairment not been recognized.For available-for-sale debt instruments, if in a subsequent period the fair value of the debtinstrument increases and the increase can be objectively related to an event occurring after theloss was recognized, the loss may be reversed through the income statement.Reversals of impairments on equity investments through profit or loss are prohibited.

11) What are the differences in accounting for contingent liabilities/provisions between

IFRS and US GAAP?GAAP:A loss must be probable (in which probable is interpreted as likely) to be recognized.While ASC 450 does not ascribe a percentage to probable, it is intended to denote a highlikelihood (e.g.,70% or more).Provisions may be discounted only when the amount of the liability and the timing of thepayments are fixed or reliably determinable, or when the obligation is a fair value obligation(e.g., an asset retirement obligation under ASC410-20). The discount rate to be used is dependentupon the nature of the provision, and may vary from that used under IFRS. However, when aprovision is measured at fair value, the time value of money and the risks specific to the liabilityshould be considered.


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In the event a range of measurements exist, Most likely outcome within range should be accrued.When no one outcome is more likely than the others, the minimum amount in the range ofoutcomes should be accrued.In regards to restructuring costs, Under ASC420, once management has committed to a detailedexit plan, each type of cost is examined to determine when recognized. Involuntary employee

termination costs under a one-time benefit arrangement are recognized over future serviceperiod, or immediately if there is no future service required. Other exit costs are expensed whenincurred.IFRS: A loss must be probable (in which probable is interpreted as MLTN) to be

recognized. More likely than not refers to a probability of greater than 50%.Provisions should be recorded at the estimated amount to settle or transfer the obligation takinginto consideration the time value of money. The discount rate to be used should be a pre-taxrate (or rates) that reflect(s) current market assessments of the time value of money and the risksspecific to the liability.In the event a range of measurements exist, Best estimate of obligation should be accrued. For alarge population of items being measured, such as warranty costs, best estimate is typically

expected value, although midpoint in the range may also be used when any point in a continuousrange is as likely as another. Best estimate for a single obligation may be the most likelyoutcome, although other possible outcomes should still be considered.In regards to restructuring costs, Once management has demonstrably committed (i.e., a legalor constructive obligation has been incurred) to a detailed exit plan, the general provisions ofIAS 37 apply. Costs typically are recognized earlier than under US GAAP because IAS 37focuses on the exit plan as a whole, rather than individual cost components of the plan.

12) What are the differences in accounting for restructuring provisions between IFRS and

US GAAP?IFRS IFRS: A provision for restructuring costs is recognized if an entity has a present obligation. Present obligation exists when a company is demonstrably committed to restructuring, i.e.an entity has a legal or a constructive obligation.A constructive obligation exists if an entity has a formal plan to restructure, this plan has beenannounced to those affected, or an entity cannot withdraw from the plan if it already startedimplementing it. An entity must be demonstrably committed to the plan. Unusual delays to theimplementation fail this condition. Liabilities related to voluntary termination benefits are recorded when the offer is made andis measured on the basis of the number of employees expected to accept the offer.US GAAP Guidance prohibits recognition of restructuring provisions based solely on a commitmentto a restructuring plan. Recognition of a provision for one-time termination benefits requires communication ofdetails of the plan to the employees that could be affected. This communication should havesufficient details with respect to employee termination benefits (i.e. type, amount, etc.). In case of a pre-existing understanding between employers and employees as to paymentsas a result of involuntary termination, liability is accrued is both payment is probable and amountcan be reasonably determined.


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Inducements to voluntary terminations are to be recognized when (1) employees acceptoffers and (2) amounts can be estimated.

Hence, IFRS is likely to record restructuring liabilities more often, since the threshold of

recognition is lower.

13) What are the differences in accounting for debt refinancing arrangements between

IFRS and US GAAP?IFRSSuch re-classification is only allowed if refinancing occurs before balance sheet date (morestrict).US GAAPEntities can reclassify current debt as non-current if a binding agreement to refinance orrefinancing occurs before the financial statements are issued.

14) What are the differences in Income Statement /Statement of Comprehensive Income

Presentation between IFRS and US GAAP?IFRS All items can be shown either in (1) single statement of comprehensive income or in (2)two different statements (income statement and comprehensive income statement) Expenses can be presented by either function or nature. No prescribed format of comprehensive income statement exists.US GAAP Either single step income statement (all expenses are grouped by function) or multiplesteps income statement (separate operating and non-operating components). SEC requires that all expenses be separated by their function. Depreciation expense couldbe shown separately, but in this case COGS should have a caption exclusive of depreciation. Three levels of format can be utilized: (1) combined income and comprehensive incomestatement (2) separate income and comprehensive income statements (3) separate category in thestatement of changes in shareholders equity.

15) What are the differences in Balance Sheet Presentation between IFRS and US GAAP? US GAAP: Offsetting (netting of assets and liabilities) is not allowed unless right of setoffexists.Right of setoff: a debtors legal right to discharge the debt to the other party by applying the

debt the other party owes debtor (e.g. offsetting of APs with ARs) FRS: similar right of setoff requirement is present. It is also required that the entity must intendto settle either on the net basis or to realize an asset and settle the liability simultaneously. Thus,this is stricter than US GAAP.

16) What are the differences in Statement of Cash Flow Presentation between IFRS and US

GAAP?Statement of Cash Flows: Classification differences

Transaction US GAAP IFRS Classification


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Classification

Interest Received Operating Operating or Investing

Dividends

Received

Operating Operating or Investing

Interest Paid Operating Financing or Operating

Dividends Paid Financing Financing or Operating

Income Taxes Operating Operating unless specifically associated with financing orinvesting activity

(*CAN WE GET RID of above chart?)Statement of Cash Flows: Other differences

IFRS includes cash over-drafts into cash balances, while US GAAP does not. US GAAP classified changes in bank overdrafts into financing cash flows. IFRS: short-term borrowings changes are classified into financing cash flows. IFRS requires disclosure of dividends/interest received/paid and taxes paid. IFRS allows both direct and indirect methods.

17) What are the differences in Shareholders Equity Statement Presentation between

IFRS and US GAAP?IFRS Presented as a Primary statementUS GAAP

Can be presented either as a primary statement or in the footnotes to the financialstatements.

FIN 481) What is the purpose of FIN 48? What kind of guidance relevant to Uncertain TaxPositions existed prior to adoption of FIN 48?The goal of FIN 48 is to reduce inconsistencies in approaches to recognizing, measuring andpresenting income taxes in financial statements. To accomplish this, FIN 48 establishesconsistent criteria that an individual tax position must satisfy in order for any of the benefit ofthat position to be recognized in the entitys financial statements.Before FIN 48, accounting for uncertain tax positions was governed by SFAS No. 5,Accounting

for Contingencies. FIN 48 replaces SFAS No. 5 with respect to the accounting for all taxpositions, not just uncertain tax positions. FIN 48 applies to all entities that prepare GAAPfinancial statements.

2) What is more likely than not (MLTN) threshold under ASC 740?FIN 48 addresses the recognition and measurement of income tax positions using a more-likely-than-not (MLTN) threshold. The MLTN threshold means that:


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. A benefit related to an uncertain tax position may not be recognized in the financialstatements unless it is MLTN that the position will be is sustained based on its technical merits;and. There must be more than a 50 percent likelihood that the position would be sustained ifchallenged and considered by the highest court in the relevant jurisdiction.

3) What is the difference between highly certain and uncertain tax position? Highly certain tax positionA tax position is considered sufficiently certain so that no reserve was required, and does not

need to be reported on Schedule UTP, if the position is highly certain within the meaning ofFIN 48.

Uncertain tax positionIn accounting, a situation in which a taxpayer believes its interpretation of earnings recognitionis less strong than what the interpretation of the IRS is likely to be. It needs to be reported underFIN 48.

4) What is unit of account and how does it relate to MLTN threshold?

A unit of account can be thought of as the base unit for an entitys UTPmethodologyor as theitem that the entity determines to be the tax position to be evaluated. In practice, a unit of account could be an entire tax computation, individual uncertain

positions, or a group of related uncertain positions (i.e., all positions in a particular taxjurisdiction, or all positions of a similar nature or relating to the same interpretation of taxlegislation).

It is important that an accounting policy for a unit of account is established in order todetermine which positions the entitys UTP methodology will be applied to. This will also aid inthe consistency and comparability of an entitys UTP and any changes from one accounting

period to another.For uncertain tax positions, an entity must make a key decision in developing any

methodology as to whether to adopt a one step approach or a two step approach to therecognition and measurement of uncertain tax positions. The MLTN threshold is the first step inthe recognition of uncertain tax positions.

5) Explain cumulative probability approach to recognition of UTPs. How does it relate the

amount of UTP that can be recognized?. The following example, based upon Appendix A of FIN 48, illustrates the concept ofmeasuring the cumulative probability of occurring.. Assume a tax position has the following distribution pattern of possible benefit outcomes:

Possible Benefit Outcome Percentage Probability ofSuccessful Outcome

Cumulative PercentageProbability of Success

$100 (complete success inlitigation, or settlement with IRS)

10% 10%

80 (veryfavorable compromise)

20% 30%


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60(Fair compromise)

25% 55%

40(Unfavorable compromise)

30% 85%

0 (total loss) 15% 100%

In this example, $60 is the amount of tax benefit that would be recognized in the financialstatements, because it represents the largest cumulative amount of benefit that is more than 50percent likely to reflect the ultimate outcome.QUALIFIED VS. UNQUALIFIED STOCK OPTIONS

1) Describe tax implications of accounting for qualified vs. unqualified

stock options.Non-qualified Qualified

Non Qualified Stock Option: Tax consequences for recipient include No tax at the time ofgrant. The recipient receives ordinary income (or loss) upon exercise, equal to the differencebetween the grant price and the FMV of the stock at date of exercise.. Tax Consequences for theAs long as the company fulfills withholding obligations, it can deduct the costs incurred asoperating expense. This cost is equal to the ordinary income declared by the recipient. Companyinclude

Qualified Stock options:Tax consequences for recipient include No tax at the time of grant orat exercise. Capital gain (or loss) tax upon sale of stock if employee holds stock for at least 1year after exercising the option.. Tax consequences for the company include non deductionsavaible to the company.

Taxconsequences

(recipient):

No tax at the time of grant. Therecipient receives ordinary income (orloss) upon exercise, equal to thedifference between the grant price andthe FMV of the stock at date ofexercise.

No tax at the time of grant or atexercise. Capital gain (or loss) taxupon sale of stock if employeeholds stock for at least 1 year afterexercising the option.

Tax

consequences

(company):

As long as the company fulfillswithholding obligations, it can deductthe costs incurred as operating expense.This cost is equal to the ordinary

income declared by the recipient.

No deductions available to thecompany.

-add something about level 2 swaps


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