week 1 far jan14

8/12/2019 Week 1 FAR Jan14

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Financial Accounting & Reporting Week 1

© 2014 Thomson Reuters/Tax & Accounting. All rights reserved. of 44

Table of Contents: Week 1 of 7

Introduction.................................................................................................................................................... 2 Course Materials ...................................................................................................................................... 2 Contacting Bisk CPA Review ................................................................................................................... 2 What do I do first? .................................................................................................................................... 2 How do I access the updating supplement? ............................................................................................ 2 What if I am missing materials? ............................................................................................................... 2 Faculty Advisor ........................................................................................................................................ 3 Faculty Advisor: Message Board (Threaded Discussion) ....................................................................... 3 Faculty Advisor: Email ............................................................................................................................ 3 Faculty Advisor: Online Chat Room (Office Hours Session) .................................................................. 4 Self-Study Version ................................................................................................................................... 4 Video Lectures ......................................................................................................................................... 4 Flash Cards .............................................................................................................................................. 4 Preliminary Work ...................................................................................................................................... 5 Using the Study Guide ............................................................................................................................. 5 Weekly Assignments ................................................................................................................................ 5 What database do I use to practice FAR research skills? ....................................................................... 6 Considering that the exam is nondisclosed, how similar can

the study questions be to those on the actual FAR test? ...................................................................... 6 Video Lecture Summary .......................................................................................................................... 7

Study Guide ................................................................................................................................................ 10 Chapter 1: U.S. GAAP Concepts & Framework ................................................................................... 10 Chapter 2: Cash, Receivables & Investments ...................................................................................... 11 Chapter 3: Inventory ............................................................................................................................. 13 Chapter 4: Property, Plant & Equipment ............................................................................................... 13

Viewer Guide ............................................................................................................................................... 15 FAR Lecture 1—Financial Accounting & Reporting (FAR) Introduction ................................................ 15 FAR Lecture 2—Ratio Analysis ............................................................................................................. 16 FAR Lecture 3—Cash & Accounts Receivable...................................................................................... 18 FAR Lecture 4—Accounts Receivable: Allowance Method .................................................................. 20 FAR Lecture 5—Notes Receivable ........................................................................................................ 22 FAR Lecture 6—Investments: Part 1 .................................................................................................... 24 FAR Lecture 7—Investments: Part 2 .................................................................................................... 27 FAR Lecture 8—Inventory: Part 1 ......................................................................................................... 30 FAR Lecture 9—Inventory: Part 2 ......................................................................................................... 32 FAR Lecture 10—Inventory: Part 3 ....................................................................................................... 34 FAR Lecture 11—Fixed Assets: Part 1 ................................................................................................. 36 FAR Lecture 12—Fixed Assets: Part 2 ................................................................................................. 40 FAR Lecture 13—Fixed Assets: Simulation .......................................................................................... 43

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Introduction

Course Materials

Bisk, Nathan M. CPA Comprehensive Exam Review: Financial Accounting & Reporting Online Version,

Forty Third Edition, Tampa, Florida; Bisk Education, Inc., © 2013.

Monette, Robert L. Financial Accounting & Reporting Video Lectures, Tampa, Florida; Bisk Education, Inc.,© 2011.

Contacting Bisk CPA Review

The technical support staff (email [email protected] or phone 1-800-742-1309) is available to helpcandidates resolve issues using the site and video CDs or finding and downloading updating supplements.

The customer service staff (email [email protected] or phone 1-800-280-9718) is available tohelp candidates resolve issues involving enrollment, shipments, guarantee terms, and billing.

The editors (email editor@cpaexam or phone 1-800-874-7877, extension 333) encourage candidates whobelieve they have found a content error or ambiguity to report details regarding the issue. In messages tothe editors, please include your last name, the exam window, the exam section, and the media (such asOnline CPA Review) in the subject line of email messages to the editors. If your issue relates to aparticular question, include the ID number of that question as well. For example: Johnson, Jan-Feb2014, FAR, Online CPA Review, ID 8576.

What do I do first?

Become familiar with the web site content. Read the Getting Started and Research Skills sections underthe Study tab. Download the week 1 Introduction, Study Guide and Viewer Guide (under the Study tab) and thoroughly read the introductory content. Complete the assignments listed on the page for week 1.

If you have trouble finding these materials, please contact the technical support staff.

How do I access the updating supplement?

The editors do not expect to have an updating supplement for the April-May 2014 exam window. Our firstupdating supplement for the 43rd edition likely will be posted in late May. Information from the version 42series updating supplements is incorporated into the 43rd edition, as appropriate.

If you use this material to review for subsequent exam windows, check this site about a month beforeyour exam and again about a week before your exam for a subsequent updating supplement.

The updating supplement will be at www.cpaexam.com, under the “Support” menu item as well as week 1of the classroom site. If you have trouble finding or downloading the updating supplement, please contactthe technical support staff.

What if I am missing materials?

If you believe you are missing any materials, please contact the customer service support staff.

mailto:[email protected]






mailto:editor@cpaexam






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Faculty Advisor

A faculty advisor is available to answer questions about exam content for the class duration, a period ofapproximately forty-eight days. A brief faculty advisor biography is available on the Class Roster/Emailpage. (Although some faculty advisors respond to questions after the advised period, they are not com-pensated for this extra effort. Please bear this in mind and take care not to abuse their generosity.)

If any response from a faculty advisor is not sufficient, please let him or her know. Faculty advisors wantto help you pass, but they are not mind readers! Ask your question again, elaborating on why the postedmaterials and the faculty advisor’s previous response was inadequate.

Faculty Advisor: Message Board (Threaded Discussion)

The message board is one of the premier features of the online review course. This forum facilitates can-didate review of previous discussion on a topic, as comments remain available for the duration of access.The benefit from this feature depends, to a large degree, on candidate participation.

Candidates are encouraged to post additional messages for discussion. Candidates should follow the fol-lowing general instructions when posting comments or questions.

Candidates should be specific when posting messages, especially when referencing a particular exampleor question. Candidates should attempt to include appropriate sources or references in their responses orcomments. Candidates should be able to locate the sources from the viewer guides, question database,or study guides for most, if not all, questions. This will help other candidates to refer to specific sourcesfor further readings. In order to maintain focus, candidates should delay posting messages regarding atopic that has yet to be covered.

For text, candidates should provide the outline reference. For questions in the database, candidates shouldstate the 4-digit question ID number. For material in the videos and viewer guides, candidates should statethe video title, a description, and the approximate time into a recording or page numbers of the viewerguide. For questions related to more than one source, provide information for all sources (unless thesources are identical).

The message board is viewed by candidates and, during the designated advised period, a faculty advisor.Technical support and customer service staff rarely view this board.

Faculty Advisor: Email

Email allows candidates the opportunity to ask questions and make comments without the entire classparticipating in the dialogue. The faculty advisor may use these questions for discussion in the openforums. Candidates should be just as specific when asking a question of the faculty advisor via email asin the message board. If the question is unclear to the faculty advisor, a response will be delayed whilefurther clarification is sought.

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Faculty Advisor: Online Chat Room (Office Hours Session)

Online, real-time communication with a faculty advisor is available through the office hour. Candidates areonline simultaneously to discuss topics pertaining to that session. An office hour session is a discussionwith a faculty advisor as the facilitator. In other words, this is not a prepared lecture (see the videolectures, instead). If a question requires substantial time or space for response, the faculty advisor may

choose to respond to the question through the message board or email.

Starting on the first day of the class session (a forty-eight day period), the day and time of the office houris posted on the Communicate page. Attendance at the office hour is optional for candidates, just asgoing to see a professor during office hours in a bricks-and-mortar school is not required.

Chat room transcripts are archived and available to all candidates enrolled in the class.

Self-Study Version

Some candidates are enrolled in a self-study version of the course. These candidates do not haveaccess to a faculty advisor. Self-study candidates seeking such access should contact customer serviceregarding a transfer to the standard, advised course. For the self-study course, no faculty advisor poststo the message board, participates in the online chat room, or answers email. Candidates may interactwith their classmates in these forums.

Video Lectures

Please be aware that some video lectures are designed assuming that candidates have viewed previouslectures. While the editors recommend that candidates view the videos in the order in which they are pre-sented, use them in the order most beneficial to you.

All of the video lectures have a corresponding viewer guide. Answer any questions in the viewer guidebefore watching the related video. The viewer guides are not designed to be comprehensive. Each can-didate is a little different; add additional notes to the viewer guides as appropriate for your learning style

and background.

Candidates are expected to read the entire text; the viewer guides note text areas specifically related toparticular video lectures. Bear in mind that the instructors expect candidates to read (or at least skim) therelated text before viewing the video lectures.

When the instructors mention that topics are heavily or lightly tested in greater detail than the content spe-cification outline provides, bear in mind that this is average information compiled over several exams.Candidates are scored on their performance on one exam, not average performance over several exams.

Flash Cards

Online flashcards are available for each FAR chapter. Use these in the manner and to the extent that theywork with your review habits. Some candidates find them helpful to use after watching video modules andbefore reading chapters; others prefer to use them after question drill.

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Preliminary Work

As a CPA candidate, you must first familiarize yourself with the exam, including how it is graded. This willaid you in obtaining the maximum points when you take the exam. An introduction to the exam and adiscussion of the grading procedures are provided in the Exam Preparation Tips (step 1 under theGetting Started section) area of the site. Please READ IT!!! The content specification outline for each

section of the CPA examination also is provided in this area. Be familiar with the amount of coverage foreach topic within the FAR section.

One of the most important items that each candidate must do is to design a plan of study. Your planshould be designed based upon your level of knowledge of topics prior to your review. You shoulddetermine a way to allot, at a minimum, 20 hours per week for seven weeks to the Financial Accountingand Reporting section.

To assist you in developing your study plan, see the Getting Started area of the site (under the Study tab). This section covers several steps for you to prepare for taking the CPA examination. By followingthese instructions, you will focus on the appropriate areas during your study.

While no plan is ideal for all candidates, the editors recommend the plan prepared for the online class formost online candidates: this plan is delineated in the weekly assignments. An alternative plan is includedin Getting Started; this plan is designed assuming candidates don’t have access to the features of theonline course. Whichever Bisk CPA Review plan you start with, customize it to suit your circumstances.

Using the Study Guide

The editors understand that the massive amount of content can seem overwhelming. The study guidecoordinates the candidate’s progress through the course by providing a week-by-week summary andnotes corresponding to the text outline. Throughout the FAR study guide, specific terms are used tosuggest the relative importance of various subjects and thus, the different amounts of study time thatcandidates should devote to them. However, this correlation is not absolute; the amount of time acandidate will need also depends on the degree of understanding that the candidate had prior to thisreview course. The following terms are arranged in descending order of the importance that they suggest:

MEMORIZE; STUDY; BE FAMILIAR WITH; KNOW / UNDERSTAND; and REVIEW.

Weekly Assignments

Every week in the online study plan does not have the same workload. Not every candidate will take thesame amount of time for the various assignments. Different candidates will perform different tasks tocomplete mastery of the various topics in a particular week.

You should review the amount of assigned work for each week of the entire session during the first week.(Approximate minutes of video coverage are at the end of this Introduction.) Consider the work in light ofyour current strengths and weaknesses. This will help you in scheduling assignments. Try to completeall of the assignments before the end of each week.

Assignments are for review purposes only. You do not receive a grade from the faculty advisors. Youronly “grade” comes from your state board in the form of your exam scores.

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What database do I use to practice FAR research skills?

The search engine functionality of the authoritative literature database used on the Financial Accounting& Reporting section of the CPA examination is likely to resemble the functionality of the fee-basedProfessional View of the FASB Accounting Standards Codification (FASB Codification) database. TheProfessional View of the FASB Codification will be available to faculty and students, via the Academic

Accounting Access Program. To participate in this program, accounting departments at post-secondaryacademic institutions must register with the AAA and pay a small administrative fee. (There is no cost toindividual faculty or students.) Academic Accounting Access will provide advanced search functions withspecial utilities to assist in the navigation of content, representing the fully functional view of the Codifica-tion that will be used by auditors, financial analysts, investors, and preparers of financial statements.

If you cannot gain access to fee-based Professional View or Academic View, you can still get access tothe FASB Codification using the free Basic View. This free access allows browsing by Topic, a utility toidentify the location of legacy standards, and limited print functionality. It does not allow searching, use ofany Go To navigation, nor joining sections and combining sections for viewing user-selected excerpts.The AICPA may, or may not, provide some type of free limited subscription to the FASB Codification or adatabase that is similar. Please check with the AICPA website regularly prior to testing to ensure youhave the latest information. Even if all you have is the Basic View free access, use it to become familiarwith the look and feel of the database. Just browsing by Topic will familiarize you with the database andcan lead you to answer references. Many candidates prefer a search using the table of contents to oneusing Boolean operators. Also, the Basic View does include tutorials and help pages that can teach youvarious navigation methods you can use in researching the FASB Codification.

Whichever resource you use, it’s important you become comfortable finding citations with the appropriateauthoritative literature requested. It isn’t necessary for you to have the most cutting-edge research soft-ware available to practice this basic skill. You may even do searches in other databases and on the webto get familiar with simply doing research and this will help increase your skills. The key is to practice andbecome as familiar as possible with the research methods and database structures. Then you may takethese skills and apply them to the authoritative literature database when accomplishing the Research taskon the CPA exam.

Considering that the exam is nondisclosed, how similar can thestudy questions be to those on the actual FAR test?

The AICPA content specification outline details the exam content; it is available from AICPA’s examwebsite. This outline is reproduced in the Exam Preparation Tips appendix of the Bisk CPA review books,online classes, and software. If you have trouble finding this material on the online class website or in thesoftware, please contact technical support (on the Help/Support page).

Many study questions are selected questions that the AICPA released. Other study questions are writtenby editors. Based on the way in which the AICPA examiners have handled new topics in the past and thecurrent content specifications, the Bisk CPA Review editors and consultants extrapolated what we expectto appear on the AICPA’s FAR exam section.

With a nondisclosed exam, no CPA review provider can know directly how similar any question bank is tothe actual AICPA question bank. The feedback that we hear from our candidates after they receive theirscores adds to our confidence in our product. Please contact us at [email protected] with your stateand exam score (please use a subject line similar to: Smith, FAR Exam Score) in as much detail as pos-sible. Please do NOT misinterpret this as a request to provide Bisk CPA Review with confidential examinformation; in other words, do NOT include questions from the actual AICPA exam or information that youbelieve is, or even might be, subject to the confidentiality statement that you sign before taking the test.We say “as much detail as possible” because some states only give a pass/fail grade, while others providedetail at the AICPA content specification Roman numeral level in addition to a single numerical score.



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Video Lecture Summary

Week No. Min. Title

1 1 8 Financial Accounting & Reporting (FAR) Introduction

1 2 16 Ratio Analysis

1 3 18 Cash & Accounts Receivable

1 4 18 Accounts Receivable: Allowance Method1 5 24 Notes Receivable

1 6 24 Investments: Part 1

1 7 23 Investments: Part 2

1 8 20 Inventory: Part 1



1 11 23 Fixed Assets: Part 1

1 12 17 Fixed Assets: Part 2

1 13 13 Fixed Assets: Simulation

249 Week 1 subtotal

2 14 18 R & D Costs and Intangibles2 15 21 Bonds: Part 1

2 16 17 Bonds: Part 2

2 17 20 Bonds: Part 3

2 18 11 Bonds: Simulation

2 19 21 Bonds: Additional Topics 1



2 22 18 Contingent Liabilities

2 23 13 Estimated Liabilities

2 24 13 Troubled Debt Restructuring

2 25 26 Leases: Part 1

2 26 17 Leases: Part 22 27 20 Leases: Part 3

2 28 17 Leases: Part 4

255 Week 2 subtotal

3 29 14 Postemployment Benefits: Part 1




3 33 17 Stockholders’ Equity: Part 1



3 36 20 Stockholders’ Equity: Part 43 37 21 Partnerships: Part 1

3 38 22 Partnerships: Part 2

3 39 27 Accrual Accounting Simulation

3 40 22 Long-Term Contracts: Percentage of Completion Method3 41 15 Long-Term Contracts: Completed Contract Method

3 42 18 Installment Sales Method

262 Week 3 subtotal

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Week No. Min. Title

4 44 12 Continuing Accounting Changes

4 45 16 More Accounting Changes

4 46 9 Accounting Changes Simulation

4 47 16 Income Statement: Part 1

4 48 17 Income Statement: Part 2

4 49 17 Income Statement: Part 36 50 10 Earnings Per Share: Introduction

6 51 24 Earnings Per Share (EPS): Part 1

6 52 13 Earnings Per Share (EPS): Part 2

4 53 12 Segment Reporting

4 54 15 Foreign Operations

4 55 22 Corporate Income Taxes: Part 1





278 Week 4 subtotal

5 60 20 Statement of Cash Flows: Part 1




5 64 18 Cost & Equity Methods: Part 1




5 68 18 Consolidated Financial Statements: Part 1



5 71 20 Consolidations Simulation: Jared/Munson - Part 15 72 17 Consolidations Simulation: Jared/Munson - Part 2

5 73 18 Consolidations: MCQ Drill & Bargain Purchase

5 74 27 Consolidations Simulation: Poe/Shaw

277 Week 5 subtotal

6 75 12 IFRS - Part 1

6 76 17 IFRS - Part 2

6 77 21 IFRS & SEC - Part 3

6 78 15 Governmental: Fund Accounting

6 79 12 Governmental: Modified Accrual Accounting

6 80 21 Governmental: Pine City - Part 1



6 83 19 Governmental: MCQ Drill #1

6 84 23 Governmental: Proprietary & Fiduciary Funds

6 85 16 Governmental: Mill City - Part 16 86 12 Governmental: Mill City - Part 2

196 Week 6 subtotal

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Week No. Min. Title

7 87 20 Governmental: Bell City

7 88 21 Governmental: CAFR - Part 1

7 89 12 Governmental: CAFR - Part 2

7 90 18 Governmental: MCQ Drill #2 & Reconciliation #1

7 91 5 Governmental: Reconciliation #2

7 92 7 Governmental: MCQs & Reconciliation7 93 19 Other NonProfit Organizations (ONPOs): Part 1

7 94 16 Other NonProfit Organizations (ONPOs): Part 2



7 97 13 FAR: Concluding Exam Tips

172 Week 7 subtotal1,687 Total (Approximately 28 hours)

__________________

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Study Guide

Chapter 1: U.S. GAAP Concepts & Framework

I. GAAP-Overview & Framework

A. Define financial accounting and GAAP

B. Identify and understand the standard-setting bodies

C. Be familiar with nonauthoritative guidance

II. Statements of Financial Accounting Concepts (SFAC)

A. Be familiar with the SFACs released to date

B. Understand the conceptual framework for financial reporting.

III. Accounting Environment

A. Understand who is responsible for financial statement content.

B. Identify and explain the most important underlying environmental assumptions in financialaccounting.

C. List and define the eight basic accounting principles.

D. Identify the accounting model.

E. Identify what is included in accounting policies.

IV. Statement of Financial Position-Balance Sheet

A. Identify and explain the important aspects of assets, liabilities, equity, and off-balance-sheetrisk.

B. Explain traditional valuation of assets, liabilities, and equity.

C. Define fair value measurement and describe the assumptions, valuation techniques, and dis-closures associated with it.

D. Explain the fair value option.

V. Reporting of Operations-Income Statement

A. Describe the income statement and its different formats (single versus multi-step).

B. List and explain the elements of the income statement.

C. Provide the format for the Statement of Retained Earnings.

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VI. Financial Analysis

A. Define the purpose of and factors in financial statement analysis.

B. Understand and be able to compute short-term and long-term solvency ratios.

C. Understand and be able to compute operational efficiency ratios.

D. Understand and be able to compute profitability ratios.

VII. Statement of Comprehensive Income

A. Describe the statement and its different formats.

B. Understand Other Comprehensive Income (OCI) and Accumulated Other ComprehensiveIncome (AOCI).

VIII. Statement of Cash Flows

• Describe the statement and its different formats (direct versus indirect).

Chapter 2: Cash, Receivables & Investments

I. Current Assets

A. Describe what constitutes a current asset and be able to list a few examples.

B. Identify the items to be included in and excluded from cash and cash equivalents.

C. Explain why bank reconciliations are an important component of a firm’s control proceduresand be able to complete one.

II. Accounts Receivable

A. Define trade receivables and exclusions.

B. Understand the valuation of trade accounts receivables.

C. Be able to compute the estimate for uncollectible receivables under all methods.

D. Understand how to record valuation adjustments.

III. Notes Receivable

A. Identify the types of notes receivable (interest bearing vs. noninterest bearing).

B. Identify the appropriate valuation for notes receivable (e.g., face value, present value, etc.).

C. Know the computations and entries for discounting a note receivable with recourse.

D. Define impairment of notes receivable.

E. Identify key disclosure requirements.

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IV. Receivables as Immediate Sources of Cash

A. Understand the difference between discounting, assigning, factoring, and pledging.

B. Understand disclosures about credit quality.

V. Investments in Marketable Securities

A. Explain the three classifications of marketable securities (held-to-maturity, trading, andavailable-for-sale).

B. Identify costs that should be included when marketable securities are purchased.

C. Describe how realized gains and losses are computed when marketable securities are soldand the impact of realized gains and losses on comprehensive income.

D. Identify the appropriate value to be reported at year-end for each of the three categories ofsecurities.

E. Identify the appropriate reporting for unrealized holding gains and losses for both trading andavailable-for-sale securities.

F. Explain transfers of securities among the three classifications.

G. Identify the appropriate reporting of realized gains and losses from the sale of a debt orequity security.

VI. Derivatives & Hedges

A. Define key terms applicable to financial instruments.

B. Explain the difference between a financial instrument and a derivative instrument.

C. Understand the types of derivatives and accounting for each.

D. Understand hedge accounting and be able to explain the differences between a fair valuehedge, a cash flow hedge and a foreign currency hedge.

E. Briefly summarize the disclosure requirements for financial instruments and derivatives,including concentration of credit risk issues.

F. Understand transfers and servicing of financial assets.

VII. Balance Sheet Offsetting

A Identify the four criteria for offsetting.

B. Summarize disclosure requirements.

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Chapter 3: Inventory

I. Overview

A. Define inventory.

B. Understand the criteria for determining ownership.

II. Measuring Inventories

A. Describe the periodic and perpetual inventory systems.

B. List and explain the various items that could affect the cost method of accounting forinventories.

C. Describe the application of the following inventory cost flow assumptions: specific identifica-tion, FIFO, LIFO (including dollar-value LIFO) and weighted average.

D. Be able to compute the lower of cost or market (LCM).

III. Inventory Estimation Methods

A. For the gross margin method, explain when its use is appropriate and how to apply themethod.

B. Describe how to apply the retail method of inventory estimation.

IV. Disclosures

• Be familiar with inventory disclosures.

Chapter 4: Property, Plant & Equipment

I. Classification

A. Define the term property, plant and equipment (PP&E), and explain why these assets arecapitalized rather than expensed.

B. Explain how productive assets are classified.

II. Initial Measurement

A. Define acquisition cost and give examples of costs to be capitalized in addition to the pur-chase price.

B. Explain how property, plant & equipment should be valued if acquired using assets otherthan cash (i.e., nonmonetary exchanges with and without commercial substance).

C. List the assets qualifying for interest capitalization and describe the steps in computing theamount of interest to be capitalized.

D. Explain gain and loss recognition in an acquisition by exchange.

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III. Subsequent Measurement

• Describe when it would be appropriate to expense versus capitalize an expenditure for anasset occurring after it is purchased.

IV. Cost Recovery

A. Define depreciation, and be able to compute depreciation for each of the major methods.

B. Define depletion and be able to compute.

V. Impairment

A. Describe the three categories of impaired assets.

B. Describe how each of the three categories should be valued.

VI. Disposal

A. Explain the process (including journal entry) for recording the voluntary disposal of property,plant & equipment, including the computation of gain or loss.

B. Explain the process (including journal entry) for recording the involuntary disposal of prop-erty, plant & equipment, including the computation of gain or loss.

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Viewer Guide

Editor’s Note: The weekly online viewer guide is not designed to be comprehensive. The instructor,Bob Monette, expects candidates to read the text in the interactive study area of the site before viewing theprogram. Bob also expects candidates to answer multiple-choice questions in the viewer guide for each

lecture on their own before watching the video for that lecture. Candidates may then compare theiranswers to the solutions discussed on the video and learn from the process.

FAR Lecture 1—Financial Accounting & Reporting (FAR) Introduction(Approximate video time: 8 minutes)

Read: Front Matter, Foreword, Chapter 1, and Appendix B: Exam Preparation Tips

A. Of the 4 parts of the CPA exam

1. FAR should be the part you are most comfortable with

2. FAR has the most content to study

3. Take is slow and master a topic at a time

B. AICPA Content Specification Outline (CSO) found in Appendix B of text

C. Bob’s alternate version of the content outline:

1. About 60% - 70% of the exam will be on:

a. Balance sheet issues

b. Income Statement issues

c. Statement of cash flows

d. Consolidated financial statements

2. Approximately 20% consists of:

a. Governmental accounting

b. Nonprofit and Other Nonprofit Organizations (ONPO)

3. The remaining 10% - 20% consists of miscellaneous financial accounting topics (e.g., part-nerships, foreign operations, earnings per share, etc.)

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FAR Lecture 2—Ratio Analysis(Approximate video time: 16 minutes)

Read: Chapter 1, Section IV (note that EPS ratios are not covered in this chapter)

A. Ratios: Memorize these six:

Current Ratio

Current AssetsCurrent Liabilities

This is a primary test of the overall solvency of the enterprise and its ability to meet currentobligations from current assets.

Acid-Test or Quick Ratio

Cash + Marketable Securities + Net ReceivablesCurrent Liabilities

This ratio provides a more severe test of immediate solvency by eliminating inventories and

prepaid expenses (current assets that are not quickly converted into cash).

Accounts Receivable Turnover

Net Credit Sales Average Net Receivables

This ratio provides an indication of the efficiency of credit policies and collection procedures,and of the quality of the receivables. Average net receivables is determined by adding thebeginning and ending net receivables balances and dividing by two.

Inventory Turnover

Cost of Goods Sold Average Inventory

Indicates the number of times inventory was acquired and sold (or used in production) duringthe period. It can be used to detect inventory obsolescence or pricing problems. Averageinventory is determined by adding the beginning and ending inventories and dividing by two.

Price Earnings Ratio

Market Price Per Common ShareEarnings Per Common Share

A measure of whether a stock is relatively cheap or relatively expensive based on its presentearnings.

Book Value Per Share

Total Stockholders’ EquityNumber of Shares Outstanding

This ratio measures the amount that shareholders would receive if all assets were sold at theircarrying amounts and if all creditors were paid.

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MULTIPLE-CHOICE QUESTION

1. Hoyt Corp.’s current balance sheet reports the following stockholders’ equity:

5% cumulative preferred stock, par value $100 per share; 2,500 sharesissued and outstanding $ 250,000

Common stock, par value $3.50 per share; 100,000 shares issued and

outstanding $ 350,000 Additional paid-in capital in excess of par value of common stock $ 125,000Retained earnings $ 300,000

$ 1,025,000

Dividends in arrears on the preferred stock amount to $25,000. If Hoyt were to be liquidated, thepreferred stockholders would receive par value plus a premium of $50,000. The book value pershare of common stock is

a. $7.75b. $7.50c. $7.25d. $7.00 (2451)

B. Book Value Per Share

1. Could have both common and preferred shares outstanding

2. Start with calculation of legal claims that preferred stockholders have on book value

3. Plus the common amount

C. Preferred Stockholders Legal Claims

1. Entitled to their par value ($250,000 for Hoyt)

2. Entitled to any dividends in arrears if preferred stock is cumulative ($25,000 for Hoyt)

3. Entitled to any liquidation or redemption premium ($50,000 for Hoyt)

D. Back into Common Equity (For Hoyt: $1,025,000 total – $325,000 preferred = $700,000 common).[Don’t forget to divide by outstanding common shares for Book Value Per Common Share.]

MULTIPLE-CHOICE QUESTIONS

2. Fry Inc. was organized on January 2 of the current year with the following capital structure:

• 10% cumulative preferred stock, par value $100 and liquidation value$105; authorized, issued and outstanding 1,000 shares $100,000

• Common stock, par value $25; authorized 100,000 shares; issued andoutstanding 10,000 shares 250,000

Fry’s net income for the year ended December 31 was $450,000, but no dividends were declared.How much was Fry’s book value per preferred share at December 31?

a. $100b. $105c. $110d. $115 (1265)

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Items 3 through 5 are based on the following for Lore Co.:

Selected data pertaining to Lore Co. for the calendar year is as follows:

Net cash sales $ 3,000Cost of goods sold 18,000Inventory at beginning of year 6,000Purchases 24,000 Accounts receivable at beginning of year 20,000 Accounts receivable at end of year 22,000

3. The accounts receivable turnover for the year was 5.0 times. What were Lore’s net credit sales?

a. $105,000b. $107,000c. $110,000d. $210,000 (5594)

4. What was the inventory turnover for the year?

a. 1.2 timesb. 1.5 timesc. 2.0 times

d. 3.0 times (5595)

5. Lore would use which of the following to determine the average days’ sales in inventory?

Numerator Denominatora. 365 Average inventoryb. 365 Inventory turnoverc. Average inventory Sales divided by 365d. Sales divided by 365 Inventory turnover (5596)

__________________

FAR Lecture 3—Cash & Accounts Receivable(Approximate video time: 18 minutes)

Read: Chapter 2, Sections I & II

A. Cash

1. Free and clear AND available to be spent in current operations

2. Back out items such as:

a. Security deposit on a long-term project

b. Bond sinking fund

c. Compensating balance on a bank loan

B. Cash Equivalents—Treat the same as cash

1. Three-Month Rule—Any commercial paper with original maturity of 3 months or less

a. Highly liquid securities

b. Certificate of deposit

c. Treasury bills

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1. In preparing its August 31 bank reconciliation, Apex Corp. has available the following information:

Balance per bank statement, 8/31 $18,050Deposit in transit, 8/31 3,250Return of customer’s check for insufficient funds 600

Outstanding checks, 8/31 2,750Bank service charges for August 100

At August 31, Apex’s correct cash balance is:

a. $18,550b. $17,950c. $17,850d. $17,550 (4531)

2. The following information pertains to Grey Co. at December 31, year 3:

Checkbook balance $12,000Bank statement balance 16,000Check drawn on Grey’s account, payable to a vendor, dated and

recorded 12/31, but not mailed until 1/10 of the following year 1,800

On Grey’s December 31, year 3, balance sheet, what amount should be reported as cash?

a. $12,000b. $13,800c. $14,200d. $16,000 (4827)

C. Bank Reconciliation—Primary area exam hits concerning cash

1. Theoretically stronger to start with checkbook balance

2. Things missing from bank statements include deposits in transit and outstanding checks

3. Things missing from checkbooks include interest, bank service fees, and returned checks

(these items are usually immaterial)

4. Proper cutoff is critical; add back everything that is free and clear, and available to be spentin current operations

5. Common reconciling items include: deposits in transit; outstanding checks; returned checks(NSF); bank service fees; and interest income

D. Accounts Receivable

1. Primary area tested on the exam is accounting for bad debts

2. Direct Write-Off Method

a. No bad debt entries until customer defaults, then the account is written off

b. Theoretically weak method; it goes against the matching concept

c. Acceptable under GAAP if bad debt expense is immaterial; allowance method requiredif bad debt expense is material (covered in next lecture).

__________________

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FAR Lecture 4—Accounts Receivable: Allowance Method(Approximate video time: 18 minutes)

A. Allowance Method

1. Required if a company’s bad debt expense is material

2. Set up a provision or allowance on the balance sheet

3. Two approaches:

a. Income Statement (balance in the allowance account does not matter for adjustingentry)

b. Balance Sheet (balance in the allowance account does matter for adjusting entry)


1. At January 1 of the current year, Jamin Co. had a credit balance of $260,000 in its allowance foruncollectible accounts. Based on past experience, 2% of Jamin’s credit sales have been uncollect-ible. During the year, Jamin wrote off $325,000 of uncollectible accounts. Credit sales for the year

were $9,000,000. In its December 31 year-end balance sheet, what amount should Jamin reportas allowance for uncollectible accounts?

a. $115,000b. $180,000c. $245,000d. $440,000 (5545)

Allowance for Bad Debt

260,000

325,000 180,000

115,000

2. Hall Co.’s allowance for uncollectible accounts had a credit balance of $24,000 at December 31 ofthe previous year. During the current year Hall wrote off uncollectible accounts of $96,000. Theaging of accounts receivable indicated that a $100,000 allowance for doubtful accounts was requiredat December 31 of the current year. What amount of uncollectible accounts expense should Hallreport for the current year?

a. $172,000b. $120,000c. $100,000d. $ 96,000 (4088)


24,000

96,000 172,000 PLUG

100,000

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B. Account Recovery

1. Reverse original entry to write-off the account

Accounts Receivable XXX Allowance for Bad Debts XXX

2. Record payment as usual

Cash XXX Accounts Receivable XXX


3. Inge Co. determined that the net value of its accounts receivable at December 31, based on an agingof the receivables, was $325,000. Additional information is as follows:

Allowance for uncollectible accounts, 1/1/03 $ 30,000Uncollectible accounts written-off during 2003 18,000Uncollectible accounts recovered during 2003 2,000 Accounts receivable at 12/31/03 350,000

For the year ending December 31, what would be Inge’s uncollectible accounts expense?

a. $ 5,000b. $ 11,000c. $ 15,000d. $ 21,000 (9048)


30,000

18,000 2,000

11,000

25,000

C. Accounts Receivable Terms

1. Pledged: Using receivables as security for a loan

• Requires footnote, must be disclosed

2. Factored: Selling receivables to a factor.

a. Without recourse: If the customers don’t pay, it’s the factor’s problem. In other words,the sale is final.

b. With recourse: If the customers don’t pay, it’s the company’s problem. The sale isnot final. The factor can request the funds from the company.

c. Receivables factored with recourse must be shown separately on the balance sheet.

__________________

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FAR Lecture 5—Notes Receivable(Approximate video time: 24 minutes)

Read: Chapter 2, Sections III & IV

A. Noninterest Bearing Notes

1. Notes that have no provision for interest

a. Notes receivable / notes payable are supposed to bear interest

b. Accounts receivable / accounts payable do not bear interest

2. You must impute or infer the interest that must be in that note


1. On January 1, year 5, Elia Company sold a building, which had a carrying amount of $350,000,receiving a $125,000 down payment and, as additional consideration, a $400,000 noninterest bear-ing note due on January 1, year 8. There was no established exchange price for the building, andthe note had no ready market. The prevailing rate of interest for a note of this type at January 1,

year 5 was 10%. The present value of 1 at 10% for three periods is 0.75%. What amount of inter-est income should be included in Elia’s income statement?

a. $0b. $30,000c. $35,000d. $40,000 (9070)

B. Record the Note and Adjusting Entries

1. Could be on the seller’s side or the buyer’s side of the note

2. If no established cash price for the item, discount present value of the payments using theprevailing interest rate

3. Amortize the difference between the face amount of the note and the discounted presentvalue to interest income over the life of the note

4. Record the Sale of the Building

Cash 125,000Note Receivable 300,000

Building 350,000Gain on Sale 75,000

5. Make the Seller’s Year-end Adjusting Entry for Year 5

Note Receivable 30,000

Interest Income 30,000

6. Make the Seller’s Year-end Adjusting Entry for Year 6

Note Receivable 33,000Interest Income 33,000

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Items 2 and 3 are based on the following:

On January 2, year 2, Emme Co. sold equipment with a carrying amount of $480,000 in exchange for a$600,000 noninterest bearing note due January 2, year 5. There was no established exchange price forthe equipment. The prevailing rate of interest for a note of this type at January 2, year 2, was 10%. The

present value of $1 at 10% for three periods is 0.75.2. In Emme’s year 2 income statement, what amount should be reported as interest income?

a. $ 9,000b. $ 45,000c. $ 50,000d. $ 60,000 (4415)

3. In Emme’s year 2 income statement, what amount should be reported as gain (loss) on sale ofmachinery?

a. $ 30,000 lossb. $ 30,000 gainc. $ 120,000 gaind. $ 270,000 gain (4416)

4. On January 1, year 8, Mill Co. exchanged equipment for a $200,000 noninterest bearing note due onJanuary 1, year 11. The prevailing rate of interest for a note of this type at January 1, year 8, was10%. The present value of $1 at 10% for three periods is 0.75. What amount of interest revenueshould be included in Mill’s year 9 income statement?

a. $0b. $15,000c. $16,500d. $20,000 (888)

5. On December 30, year 4, Chang Co. sold a machine to Door Co. in exchange for a noninterest-bearing note requiring ten annual payments of $10,000. Door made the first payment on Decem-ber 30, year 4. The market interest rate for similar notes at date of issuance was 8%. Information

on present value factors is as follows:

Period Present value of $1 at 8%Present value of ordinary

annuity of $1 at 8%9 0.50 6.25

10 0.46 6.71

In its December 31, year 4, balance sheet, what amount should Chang report as note receivable?

a. $45,000b. $46,000c. $62,500d. $67,100 (5544)

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C. Unreasonable Interest Terms (too much or too little interest)

1. Short-Term Rule: When a note is made under customary trade terms and is due in less than one year, there is no requirement to impute interest

2. Long-Term (due in more than one year)

a. Compute the note’s maturity value (principal plus total interest)

b. Discount the maturity value using the fair rate of interest; this represents the Salesamount; the rest is interest


6. On December 31, year 1, Jet Co. received two $10,000 notes receivable from customers inexchange for services rendered. On both notes, interest is calculated on the outstanding principalbalance at the annual rate of 3% and payable at maturity. The note from Hart Corp., made undercustomary trade terms, is due in nine months and the note from Maxx, Inc. is due in five years.The market interest rate for similar notes on December 31, year 1, was 8%. The compound interestfactors to convert future values into present values at 8% follow:

Present value of $1 due in nine months: 0.944Present value of $1 due in five years: 0.680

At what amounts should these two notes receivable be reported in Jet’s December 31, year 1,balance sheet?

Hart Maxxa. $ 9,440 $6,800b. $ 9,652 $7,820c. $ 10,000 $6,800d. $ 10,000 $7,820 (2582)

__________________

FAR Lecture 6—Investments: Part 1

(Approximate video time: 24 minutes)

Read: Chapter 2, Section V

A. Held-to-Maturity Securities (HTM): Debt securities (bonds, mortgages) which management hasboth the intent AND the ability to hold until the debt matures.

1. Carried on the balance sheet at amortized cost; amortize discounts and premiums as part ofthe interest adjustment

2. Classification on the balance sheet depends on maturity date:

a. More than 12 months from balance sheet date, it’s a noncurrent investment

b. Less than 12 months from balance sheet date, it’s a current investment

B. Trading Securities: Debt or equity securities (bonds or stocks) held for the purpose of selling in thenear term

1. Classified on balance sheet as a current asset

2. Carried on the balance sheet at their fair market value

3. Unrealized holding gains or losses reported on the income statement and are included inearnings

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C. Available-for-Sale Securities (AFS): Debt or equity securities (bonds or stocks) not categorized asheld-to-maturity or trading securities

1. Classification on the balance sheet depends on maturity date and management’s intentions:

a. More than 12 months from balance sheet date, it’s a noncurrent investment

b. Less than 12 months from balance sheet date, it’s a current investment

2. Carried on the Balance Sheet at aggregate fair market value

3. Unrealized holding gains or losses go directly to stockholder’s equity as items of OtherComprehensive Income (OCI)

D. Investments in common stock accounted for under the equity method are carried separately on thebalance sheet (i.e., these investments are NOT classified in the above categories).

E. Portfolio Examples

1. Trading Securities

Trading PortfolioDecember 31, year 1

Cost MarketSecurity A (debt) $ 6,000 $ 8,000Security B (equity) 3,000 10,000Security C (debt) 5,000 2,000

$ 14,000 $ 20,000

12/31 Year 1 FMV Adjusting Entry

Investment in A 2,000Investment in B 7,000

Investment in C 3,000Unrealized Hold Gain* 6,000

Trading PortfolioDecember 31, year 2

Cost MarketSecurity D (debt) $ 4,000 $ 10,000Security E (equity) 7,000 6,000Security F (equity) 18,000 17,000

$ 29,000 $ 33,000


Investment in D 6,000Investment in E 1,000Investment in F 1,000Unrealized Hold Gain* 4,000

* Unrealized holding gains and losses recorded on the income statement

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Year 3 Investment in F sold for $12,000

Cash 12,000Realized Loss on Sale 5,000

Investment in F 17,000

2. Available-for-Sale Securities

Available-for-Sale PortfolioDecember 31, year 1

Cost MarketSecurity Q (equity) $ 5,000 $ 3,000Security R (equity) 3,000 12,000Security S (debt) 10,000 15,000

$ 18,000 $ 30,000


Market Adjustment* 12,000OCI** 12,000

* Market Adjustment is a valuation account on the balance sheet used for the aggregate adjust-ment to market

** OCI is an item of stockholders’ equity on the balance sheet

Balance Sheet Year 1: Available-for-sale securities at cost $18,000 plus market adjustment of$12,000 for an aggregate total market value of $30,000

Available-for-Sale PortfolioDecember 31, year 2

Cost MarketSecurity Q (equity) $ 5,000 $ 3,000Security R (equity) 3,000 2,000Security X (debt) 12,000 11,000

$ 20,000 $ 16,000

12/31 Year 2 Adjusting Entry

OCI 16,000Market Adjustment 16,000

Balance Sheet: Available-for-sale securities at cost $20,000 less market adjustment of $4,000 foran aggregate total market value of $16,000

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Editor’s Note: The following T accounts are another way to approach the required year-end adjust-ment entries.

AFS Securities B/S Market Adjmt B/S OCI on B/S

Year 1 cost 18,000

Year 1 FV adjustment 12,000 12,000

Year 1 balances 18,000 12,000 12,000

Year 2 sale of S 10,000

Year 2 purchase of X 12,000

Year 2 pre-adjmt bal. 20,000 12,000 12,000

Year 2 FV adjustment 16,000 16,000

Year 2 balances 4,000 4,000

[Note that Year 2 AFS portfolio would be reflected on the balance sheet as 20,000 – 4,000 = 16,000]

Year 3 Investment in X sold for $8,000

Cash 8,000Realized Loss on Sale 4,000Investment in X (cost) 12,000

F. Permanent Decline in Market

1. Severe or unusual in nature; not temporary increases or decreases

2. Only a problem for HTM or AFS securities; not trading securities

3. Debit a realized loss on the income statement; credit the Investment account

4. Recovery of impairment is not permitted under GAAP

__________________

FAR Lecture 7—Investments: Part 2(Approximate video time: 23 minutes)

Read: Chapter 2, Sections VI & VII


1. The following information pertains to Smoke Inc.’s investments in marketable equity securities, clas-sified as available-for-sale:

• On December 31 of the current year, Smoke has a security with a $70,000 cost and a $50,000fair value. (No Market Adjustment account exists.)

• A marketable equity security costing $50,000, has a $60,000 fair value on December 31 of thecurrent year. Smoke believes the recovery from an earlier lower fair value is permanent.

What is the net effect of the above two items on the balances of Smoke’s Market Adjustment accountfor available-for-sale marketable equity securities as of December 31 of the current year?

a. No effectb. Creates a $10,000 debit balancec. Creates a $20,000 credit balanced. Creates a $10,000 credit balance (4578)

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Items 2 and 3 are based on the following:

Sun Corp. had investments in equity securities classified as trading costing $650,000. On June 30, year 2,Sun decided to hold the investment indefinitely and, accordingly, reclassified them from trading toavailable-for-sale on that date. The investment’s fair value was $575,000 at December 31, year 1;$530,000 at June 30, year 2; and $490,000 at December 31, year 2.

2. What amount of loss from investments should Sun report in its year 2 income statement?

a. $ 45,000b. $ 85,000c. $ 120,000d. $ 160,000 (4045)

3. What amount should Sun report as net unrealized loss on investments in equity securities in othercomprehensive income at the end of year 2?

a. $ 40,000b. $ 45,000c. $ 85,000d. $ 160,000 (4046)

A. Transferring Investments Between Portfolios

1. Rule: On the day of the transfer, write the individual security to its fair market value

2. If trading securities are involved, unrealized gain or loss goes to income statement

3. If trading securities aren’t involved, you would adjust Other Comprehensive Income (OCI) onthe balance sheet

B. Derivative: Investment that derives its value from another security or another commodity (e.g.,foreign currency options and grain futures)

1. Value is driven up or down by prices of the other investments

2. Can be an asset or liability

a. Asset: Gain position

b. Liability: Loss position

C. Hedging: Strategy of investment in a derivative for the purpose of counterbalancing a potential lossfrom another security or transaction

D. Non-Hedge Derivative

1. Carried on balance sheet as an asset or liability at fair market value

2. Unrealized holding gains or losses from adjustments to write up or down to FMV go to theincome statement and included in earnings

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E. Derivative Being Used as a Hedge

1. Fair Value Hedge

a. Hedge against potential losses from the change in fair market value (FMV) of an assetor liability

b. Carried on balance sheet as an asset or liability at FMV

c. Unrealized holding gains or losses are on the income statement and included inearnings

2. Cash Flow Hedge

a. Hedge against potential losses from the future cash flows from an asset or liability

b. Carried on balance sheet as an asset or liability at fair market value

c. Unrealized holding gains from effective hedge (i.e., is successfully making a profit onthe investment and is counterbalancing a loss elsewhere) go directly to stockholders’equity as an item of OCI

d. Unrealized holding losses from an ineffective hedge (i.e., hedge is not making aprofit and is not counterbalancing a loss) go directly to the income statement and areincluded in current earnings

F. Foreign Operations

1. Foreign currency denominated firm commitment hedge or foreign currency denominatedavailable-for-sale securities hedge are accounted for as a fair value hedge

2. Foreign currency denominated forecasted transaction hedge or a foreign currency net invest-ment in foreign operations hedge are accounted for as cash flow hedge

__________________

Additional Notes:

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FAR Lecture 8—Inventory: Part 1(Approximate video time: 20 minutes)

Read: Chapter 3, Sections I & II

A. Costing

1. Primary basis of accounting for inventory is historical cost

2. Historical Cost Rule: Include in the inventory account all the costs incurred to get the mer-chandise into a condition & location for sale (purchasing costs, handling costs, warehousingcosts, taxes, insurance during transit, freight-in)

3. Inventory carried on balance sheet at the lower of historical cost or market

B. Lower of Cost or Market

1. Ceiling

a. Market can never be higher than the ceiling

b. Ceiling is net realizable value (NRV) = selling price less normal disposal costs

2. Floor

a. Market can never be lower than the floor

b. Floor = NRV – normal gross profit

3. Determine Market Value

a. Calculate the ceiling, floor, and replacement cost

b. Market is the one in the middle

4. Compare market value to historical cost and take the lower amount; write inventory down ifnecessary

Illustrative Problem: Lower of Cost or Market

#1Product A

#2Product B

#3Product C

#4Product D

Historical cost 2.50 6.00 10.00 150.00

Replacement cost 2.60 5.25 9.00 175.00

Selling price 4.00 8.50 15.00 200.00

Disposal cost 1.00 3.50 2.00 10.00

Gross profit 0.70 0.80 3.50 80.00

Ceiling (NRV) 3.00 5.00 13.00 190.00

Floor 2.30 4.20 9.50 110.00

Market 2.60 5.00 9.50 175.00

LCM 2.50 5.00 9.50 150.00

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1. The original cost of an inventory item is below the net realizable value and above the net realizablevalue less a normal profit margin. The inventory item’s replacement cost is below the net realizablevalue less a normal profit margin. Under the lower of cost or market method, the inventory itemshould be valued at

a. Original cost.b. Replacement cost.c. Net realizable value.d. Net realizable value less normal profit margin. (6473)

C. Measuring—Periodic System

1. Company uses a Purchases account

2. Beginning Inventory + Purchases = Goods Available For Sale

3. Periodically take a physical inventory to determine ending inventory

4. Goods Available For Sale – Ending Inventory = Cost of Goods Sold

D. Measuring—Perpetual System

1. No Purchases account

2. Two entries when a sale is made

Accounts Receivable XXXSales XXX

Cost of Goods Sold XXXInventory XXX

3. Have a running total of inventory and cost of goods sold

4. Physical count still needed on occasion to verify records (shrinkage can occur due to brea-kage, theft, spoilage)

__________________

Additional Notes:

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Read Chapter 3, Sections III & IV

A. Valuation—Specific Identification

1. Item by item, specifically identifying the cost of each piece of merchandise

2. Time consuming, expensive, not practical, may not even be possible

B. Valuation—Gross Profit Method

1. Used to estimate the value of ending inventory for interim financial statements or whenending inventory has been destroyed (e.g., fire, hurricane)

2. Know difference between gross profit percentage and markup on cost percentage (e.g.,items sold at 125% of their cost have a 25% markup on their cost)

Illustrative Problem: Gross Profit % vs. Markup on Cost %

Cost of one item of inventory $1,000

Markup on costs % 25%

Sold one item at 125% of cost $1,250

Gross Profit $ $250

Gross Profit % ($250 / $1,250) 20%

Illustrative Problem: Gross Profit Method

Beginning inventory $200,000

Purchases in year $450,000

Sales during year $500,000

Markup on costs 25%

Ending inventory was destroyed in a fire ???

Solution:

Sales = Cost + 25% Cost = 125% Cost

Cost = Sales/125% = $500,000/1.25 = $400,000

BI + P – EI = COGS so, EI = BI + P – COGS

EI = $200,000 + 450,000 – 400,000 = $250,000

C. Valuation Illustrative Problem: Gross Profit Method FIFO (First In – First Out)

1. First merchandise purchased is first merchandise sold; older merchandise prices go to COGSon the income statement

2. Newer merchandise prices go to inventory on the balance sheet

3. Weakness: Mismatching of current revenue with older cost

4. FIFO is a balance sheet method

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D. Valuation—LIFO (Last In – First Out)

1. Latest merchandise purchased is the first to be sold; recent merchandise prices go to COGSon the income statement

2. Older merchandise prices go to inventory on the balance sheet

3. Weakness: Inventory is reflected on the balance sheet at older prices which may no longerbe relevant

4. LIFO is an income statement method

Method Rising Prices Falling Prices

LIFO Lower Higher

FIFO Higher Lower


1. A company decided to change its inventory valuation method from FIFO to LIFO in a period of

rising prices. What was the result of the change on ending inventory and net income in the year ofthe change?

Ending inventory Net incomea. Increase Increaseb. Increase Decreasec. Decrease Decreased. Decrease Increase (6091)

E. Valuation—Weighted Average and Moving Average

1. Weighted Average: Cost of goods available for sale ÷ number of units available for sale

2. Moving average: Every time you purchase units, you get a new weighted average cost perunit that day

3. Use a moving average with a perpetual inventory system; use a weighted average with aperiodic inventory system

Illustrative Problem: Moving Average Valuation

Date Units Unit Cost Total Cost Moving Average

1/1 1,000 $6 $ 6,000 $6.00

1/17 200 $12 $ 2,400

Total 1,200 $ 8,400 $7.00

1/23 (500) $(7) $ (3,500)

Total 700 $ 4,900 $7.00

2/6 300 $9 $ 2,700

Total 1,000 $ 7,600 $7.60

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A. Valuation—Retail Method

1. Must know the cost to retail ratio and ending inventory at retail

2. Used to estimate inventory for interim statements


1. Dean Company uses the retail inventory method to estimate its inventory for interim statementpurposes. Data relating to the computation of the inventory at July 31 are as follows:

Cost RetailInventory, 2/1 $ 180,000 $ 250,000Purchases 1,020,000 $1,575,000Markups, net 175,000Sales 1,705,000Estimated normal shoplifting losses 20,000Markdowns, net 125,000

Under the approximate lower of average cost or market retail method, Dean’s estimated inventoryat July 31 is:

a. $ 90,000b. $ 96,000c. $ 102,000d. $ 150,000 (0919)

B. Cost to Retail Ratio (using Dean Company info)

1. Numerator is Goods Available for Sale at cost [GAS at cost = BI + P]

2. Denominator is Goods Available for Sale at retail [GAS at retail = BI + P + Markups]

3. (180,000 + 1,020,000) / (250,000 + 1,575,000 + 175,000) = 60%

C. Ending Inventory At Retail

1. Take goods available at retail and back out sales, shrinkage, and markdowns, if any

2. $2,000,000 – 1,705,000 – 20,000 – 125,000 = $150,000 ending inventory at retail

3. Adjust by the cost to retail ratio: $150,000 * 60% = $90,000 ending inventory at cost

D. Dollar-Value LIFO

1. Rather than count physical units, company counts dollars in inventory ($1 = 1 unit of inventory)

2. Must worry about inflation, because inflation causes the value of a dollar to change

3. Inventory on the date the dollar-value LIFO method was adopted is called the LIFO base

4. LIFO base year index is always 1.00

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5. Steps

a. Year end inventory / price index = inventory at base year dollars

b. Inventory at base year dollars – previous year’s inventory at base year dollars = layer

c. Amount to take to balance sheet is previous years inventory + (layer × price index)

d. Every layer is valued at its own index; always add this year’s dollars

6. When inventory goes down, the last layer added is the first layer you cost out, at the indexfrom the year it is reducing

Illustrative Problem: Dollar-Value LIFO – COMPLETE Year 13

The Acute Company manufactures a single product. On December 31, year 10, Acute adopted thedollar-value LIFO inventory method. The inventory on that date using the dollar-value LIFO inven-tory method was determined to be $300,000.

Inventory data for succeeding years are as follows:

Year EndedDecember 31

Inventory at RespectiveYear-End Prices

Relevant Price Index(base year 2010)

Year 11 $363,000 1.10Year 12 420,000 1.20Year 13 430,000 1.25

Compute the inventory amounts at December 31, years 11 through 13, using the dollar-valueLIFO inventory method for each year using the chart below:

Year Ended12/31

Inv @ YearEnd Prices

PriceIndex

Base YearDollars Layer

Layer Valuedat Its OwnPrice Index

Inventory onBalance Sheet

Year 10 $300,000 1.0 $300,000 -- -- $300,000

Year 11 363,000 1.1 $330,000 $30,000 $33,000 $333,000

Year 12 420,000 1.2 $350,000

Year 13 $349,800

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2. On January 1, year 1, Poe Company adopted the dollar-value LIFO inventory method. Poe’s entireinventory constitutes a single pool. Inventory data for year 1 and year 2 are as follows:

DateInventory at

current year costInventory at

base year costRelevant

price index

01/01, year 1 $150,000 $150,000 1.0012/31, year 1 220,000 200,000 1.1012/31, year 2 276,000 230,000 1.20

Poe’s LIFO inventory value at December 31, year 2, is

a. $230,000b. $236,000c. $241,000d. $246,000 (0916)

Year Ended12/31

Inv @ YearEnd Prices

PriceIndex

Base YearDollars Layer

Layer Valuedat Its OwnPrice Index

Inventory onBalance Sheet

Year 1 $150,000 1.0 $150,000 -- -- $150,000

Year 2 $220,000 1.10

Year 3 $276,000 1.20 $241,000

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FAR Lecture 11—Fixed Assets: Part 1(Approximate video time: 23 minutes)

Read: Chapter 4

A. Fixed Assets

1. Include: land, buildings, machinery, equipment, and furniture and fixtures

2. Capital expenditures benefit more than one accounting period (balance sheet)

3. Revenue expenditures only benefit the current period (expense them)

B. Condition-and-Location-for-Use Rule: Capitalize all costs incurred to bring the fixed asset into acondition and location for use

1. Machinery & equipment costs include: cost, freight, installation, insurance during transit, andcosts incurred during any testing period

2. Land costs include: cost, attorney fees, title search, grading, clearing, draining, and surveying

(all costs incurred to get land in condition for use, including demolition of old buildings)

3. Building costs include: cost, permits, architect fees, engineering fees, and interest incurredon borrowings to construct any asset for entity’s own use

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C. Capitalized Interest

1. Must capitalize during period of construction

2. Calculate capitalized interest based on average expenditures

3. If expenditures incurred evenly, divide by two; if not, create a schedule with weighted amounts

Illustrative Problem: Capitalized Interest

Company borrows $10 million @ 10%Year 1 construction costs are $6 million, incurred evenlyYear 2 construction costs are $1,200,000 on April 1 and $1,200,000 on October 1

Solution:

Year 1 (costs incurred evenly throughout the year)

Construction costs $6,000,000Incurred evenly ÷ 2

Average costs $3,000,000Interest rate .10Capitalized interest $ 300,000

Year 2 (costs NOT incurred evenly; only over 9 months)

Construction costs $6,000,000Interest rate .10Capitalized interest from Year 1 borrowing $ 600,000

Construction costs $1,200,000Interest rate .10

120,000

Weighted Average 9/12Capitalized interest from 4/1 borrowings 90,000

Construction costs $1,200,000Interest rate .10

120,000Weighted Average 3/12Capitalized interest from 10/1 borrowings 30,000

Total year 2 capitalized interest costs $ 720,000

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1. A company is constructing an asset for its own use. Construction began in the previous year. Theasset is being financed entirely with a specific new borrowing. Construction expenditures weremade last year and this year at the end of each quarter. The total amount of interest cost capital-ized in the current year should be determined by applying the interest rate on the specific newborrowing to the

a. Total accumulated expenditures for the asset in both yearsb. Average accumulated expenditures for the asset in both yearsc. Average expenditures for the asset in the current yeard. Total expenditures for the asset in the current year (1847)

D. Capitalize Improvements

1. Betterments are always capitalized. Includes: additions, extensions, enlargements, and extra-ordinary repairs

2. Ordinary Repairs & Maintenance: Expense

3. Capitalization Rule [QEEN]: If an improvement does any of the following four things, capital-ize it; otherwise, expense it:

a. Quality is increased/improved

b. Extends the life of the asset

c. Efficiency is increased/improved

d. Number of units produced increases


2. On July 1, one of Rudd Co.’s delivery vans was destroyed in an accident. On that date, the van’scarrying amount was $2,500. On July 15, Rudd received and recorded a $700 invoice for a newengine installed in the van in May, and another $500 invoice for various repairs. In August, Rudd

received $3,500 under its insurance policy on the van, which it plans to use to replace the van.What amount should Rudd report as gain (loss) on disposal of the van in its year-end incomestatement?

a. $1,000b. $ 300c. $0d. $ (200) (2616)

E. Impairments to Long-Lived Assets & Identifiable Intangibles

1. Held for Use

a. Asset is impaired if carrying value on the books is greater than fair value

b. Loss goes to income statement from continuing operations

c. Write asset down to fair value

(1) Fair value becomes the new basis for the asset

(2) Depreciate from the new basis, on a prospective basis only

(3) Don’t record any recovery

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2. Held for Sale

a. Sale is probable within 12 months and the asset must be available for sale

b. Asset is impaired if the carrying value on the books is greater than the selling price,less disposal costs

c. Loss goes to income statement from continuing operations

d. Write asset down to fair value

e. Depreciation stops

3. Held for Disposal Other Than by Sale: Plan to abandon, distribute to owners, or exchange

a. Treat as held for use until actually disposed of

b. Impaired if carrying value on the books is greater than its fair value

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Additional Notes:

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FAR Lecture 12—Fixed Assets: Part 2(Approximate video time: 17 minutes)

A. Exchange of assets with commercial substance

1. Future cash flows of the companies involved will change significantly

2. In an exchange with commercial substance you use the fair value approach

a. Record new asset at fair value, which is either the fair value of the asset you are receiv-ing, or the fair value of the asset exchanged/sacrificed, whichever is more clearlyevident.

b. If not known, the fair value of the new asset can be inferred

c. Gains or losses are recognized

Illustrative Problem #1: Exchange With Commercial Substance and Boot Paid

$6,000 book value of old asset

$20,000 fair value of old asset$4,000 cash paid for new asset

New asset (FV) 24,000Old Asset (NBV) 6,000Cash 4,000Gain 14,000

Illustrative Problem #2: Exchange With Commercial Substance and Boot Received

$6,000 book value of old asset$20,000 fair value of old asset$8,000 cash received for new asset

Cash 8,000New Asset (FV) 12,000

Old Asset (NBV) 6,000Gain 14,000

Illustrative Problem #3: Exchange With Commercial Substance (Loss Indicated)

$6,000 book value of old asset$1,000 fair value of old asset

New Asset (FV) 1,000

Loss 5,000Old Asset (NBV) 6,000

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1. In an exchange with commercial substance, Vey Co. traded equipment with an original cost of$100,000 and accumulated depreciation of $40,000 for similar productive equipment with a fairvalue of $120,000. In addition, Vey received $30,000 cash in connection with this exchange. Whatshould Vey’s carrying amount for the equipment received on the day of exchange?

a. $ 90,000b. $ 60,000c. $ 48,000d. $120,000 (2586)

Solution:

Cash 30,000New Asset (FV) 120,000 Accm. Depr. 40,000

Old Asset (NBV) 100,000Gain 90,000

B. Exchange of assets with NO commercial substance

1. Use the book value approach in an exchange: with no commercial substance; when the fairvalue of the assets received or surrendered is not determinable within reasonable limits; orwhen the exchange is of a product or property held for sale in the ordinary course of busi-ness for a product or property to be sold in the same line of business to facilitate sales tocustomers.

2. Record new asset at the book value of the old asset, plus any cash paid

3. Generally, gains, if any, reduce the value of the new asset; losses are always recognized

4. If cash is received, there may be a partial realization of the gain (see MCQ #2)

Illustrative Problem #4: Exchange With No Commercial Substance and Boot Paid

$10,000 book value of old asset$18,000 fair value of old asset$2,000 cash paid

New Asset (BV of old) 12,000*Cash 2,000Old Asset (NBV) 10,000

* note that the old asset fair value was $18,000, but it was reduced by the gain of $6,000

Illustrative Problem #5: Exchange With No Commercial Substance (Loss Indicated)

$10,000 book value of old asset$2,000 fair value of old asset

New Asset (FV) 2,000Loss 8,000

Old Asset (NBV) 10,000

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2. In an exchange without commercial substance, Yola and Zaro exchanged ownership of 25 forklifts.Yola paid Zaro $30,000 to compensate for a difference in the forklifts. On the date of the exchange,cost and market values of the forklifts were as follows:

Yola Co. Zaro Co.

Cost $100,000 $126,000Market values 120,000 150,000

In Zaro’s income statement, what amount of gain should be reported from the exchange of theforklifts?

a. $0b. $ 4,800c. $ 24,000d. $ 30,000 (2643)

1. Determine Gain Indicated

New forklifts FV $ 120,000Cash 30,000

Total consideration $ 150,000Old forklifts BV $ (126,000)Gain indicated $ 24,000

2. Compute Recognition Ratio

Cash 30,000 = 20% * $24,000 gain indicated = $4,800 gain recognizedTotal Consideration 150,000

3. Record Journal Entry

Cash 30,000New Forklifts 100,800

Old Forklifts 126,000Gain 4,800

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FAR Lecture 13—Fixed Assets: Simulation(Approximate video time: 13 minutes)

During 2012, Sloan Inc. began a project to construct new corporate headquarters. Sloan purchased landwith an existing building for $750,000. The land was valued at $700,000 and the building at $50,000.Sloan planned to demolish the building and construct a new office building on the site.

For each expenditure in items 1 through 8, select from the list below the appropriate accounting treatment.

Treatment Choices

L. Classify as land and do not depreciate.B. Classify as building and depreciate.E. Expense.

Expenditure Treatment

1. Purchase of land for $700,000.

2. Interest of $147,000 on construction financing incurred after completion ofconstruction.

3. Interest of $186,000 on construction financing paid during construction.

4. Purchase of building for $50,000.

5. $18,500 payment of delinquent real estate taxes assumed by Sloan on purchase.

6. $12,000 liability insurance premium during the construction period.

7. $65,000 cost of razing existing building.

8. Moving costs of $136,000.

Items 9 through 14 represent expenditures by Sloan Inc. for goods held for resale and equipment. Foreach item, determine whether the expenditure should be capitalized (C) or expensed as a period cost (E).

Expenditure Treatment

9. Freight charges paid for goods held for resale.

10. In-transit insurance on goods held for resale purchased F.O.B. shipping point.

11. Interest on note payable for goods held for resale.

12. Installation of equipment.

13. Testing of newly purchased equipment.

14. Cost of current year service contract on equipment.

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Items 15 through 18 represent various depreciation methods and are based on the following information.

On January 2, 2012, Sloan purchased a manufacturing machine for $864,000. The machine has an 8-yearestimated life and a $144,000 estimated salvage value. Sloan expects to manufacture 1,800,000 unitsover the life of the machine. During 2013, Sloan manufactured 300,000 units.

Calculate depreciation expense for 2013 (the second year of ownership) for the machine under the

method listed. Enter the amounts as numeric values in the space provided.

Depreciation Method Amount

15 Straight-line

16 Double-declining-balance

17 Sum-of-the-years’-digits

18 Units of production

A. Straight-Line Depreciation

1. Back out salvage value from cost

2. Divide by estimated useful life

B. Double-Declining-Balance Depreciation

1. All declining-balance methods ignore salvage value in the formula

2. Double the straight line rate times an ever-declining balance

3. Do not depreciate below salvage value

C. Sum-of-the-Years-Digits Depreciation

1. Add up digits of useful life or use shortcut formula: n(n+1)/2


D. Units-of-Production Depreciation


2. Divide by estimated total units of production

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Editor’s Note: Solutions to all questions and problems have been omitted per the instructor’s request.

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