Explain the reporting of off-balance-sheet financing arrangements. Indicate how to present and analyze long-term debt. Describe the accounting for a debt restructuring. Simple 15—20 E Classification. Simple 15—20 E Entries for bond transactions.
Simple 15—20 E Entries for bond transactions—straight-line. Simple 15—20 E Entries for bond transactions—effective-interest. Simple 15—20 E Amortization schedule—straight-line. Simple 15—20 E Amortization schedule—effective-interest.
Simple 15—20 E Determine proper amounts in account balances. Moderate 15—20 E Entries and questions for bond transactions. Moderate 20—30 E Entries for bond transactions. Moderate 15—20 E Information related to various bond issues. Simple 20—30 E Entry for redemption of bond; bond issue costs.
Simple 15—20 E Entries for redemption and issuance of bonds. Simple 12—16 E Entries for redemption and issuance of bonds. Simple 10—15 E Entries for zero-interest-bearing notes. Simple 15—20 E Imputation of interest. Simple 15—20 E Imputation of interest with right. Moderate 15—20 E Fair value option. Simple 10—15 E Long-term debt disclosure. Moderate 20—25 P Analysis of amortization schedule and interest entries.
Simple 15—20 P Issuance and redemption of bonds. Moderate 25—30 P Negative amortization. Moderate 20—30 P Issuance and redemption of bonds; income statement presentation. Simple 15—20 P Comprehensive bond problem.
Moderate 50—65 P Issuance of bonds between interest dates, straight-line, retirement. Moderate 20—25 P Entries for life cycle of bonds. Moderate 20—25 P Entries for zero-interest-bearing note.
Simple 15—25 P Entries for zero-interest-bearing note; payable in installments. Moderate 20—25 P Comprehensive problem; issuance, classification, reporting.
Moderate 20—25 P Effective-interest method. Moderate 40—50 4. Complex 40—50 CA Bond theory: balance sheet presentations, interest rate, premium. Moderate 25—30 CA Bond theory: price, presentation, and redemption. Moderate 15—25 CA Bond theory: amortization and gain or loss recognition. Simple 20—25 CA Off-balance-sheet financing. Moderate 20—30 CA Bond issue, ethics. Moderate 23—30 5. CE According to FASB ASC Disclosure of Long-Term Obligations : The combined aggregate amount of maturities and sinking fund requirements for all long-term borrowings shall be disclosed for each of the five years following the date of the latest balance sheet presented.
See Section for disclosure guidance that applies to securities, including debt securities. See Example 3 Paragraph for an illustration of this disclosure requirement. If a covenant violation occurs that would otherwise give the lender the right to call the debt, a lender may waive its call right arising from the current violation for a period greater than one year while retaining future covenant requirements.
Unless facts and circumstances indicate otherwise, the borrower shall classify the obligation as noncurrent, unless both of the following conditions exist: a A covenant violation that gives the lender the right to call the debt has occurred at the balance sheet date or would have occurred absent a loan modification. See Example 1 paragraph for an illustration of this classification guidance. The bond indenture contains covenants or restrictions for the protection of the bondholders.
The mortgage accompanies a formal promissory note and becomes effective only upon default of the note. If the entire bond matures on a single date, the bonds are referred to as term bonds. Mortgage bonds are secured by real estate. Debenture bonds are unsecured. The interest payments for income bonds depend on the existence of operating income in the issuing company. Callable bonds may be called and retired by the issuer prior to maturity.
Registeredbonds are issued in the name of the owner and require surrender of the certificate and issuance of a new certificate to complete the sale. A bearer or coupon bond is not recorded in the name of the owner and may be transferred from one investor to another by mere delivery. Convertible bonds can be converted into other securities of the issuing corporation for a specified time after issuance. Commodity-backed bonds alsocalledasset-linkedbonds are redeemable in measures of a commodity.
A discount on bonds payable results when investors demand a rate of interest higher than the rate stated on the bonds. The investors are not satisfied with the nominal interest rate because they can earn a greater rate on alternative investments of equal risk.
They refuse to pay par for the bonds and cannot change the nominal rate. However, by lowering the amount paid for the bonds, investors can alter the effective rate of interest. A premium on bonds payable results from the opposite conditions. That is, when investors are satisfied with a rate of interest lower than the rate stated on the bonds, they are willing to pay more than the face value of the bonds in order to acquire them, thus reducing their effective rate of interest below the stated rate.
Discount premium on bonds payable should be reported in the balance sheet as a direct deduction from addition to the face amount of the bond.
Both are liability valuation accounts. Bond discount and bond premium may be amortized on a straight-line basis or on an effective- interest basis. The profession recommends the effective-interest method but permits the straight- line method when the results obtained are not materially different from the effective-interest method. The straight-line method results in an even or average allocation of the total interest over the life of the notes or bonds.
The effective-interest method results in an increasing or decreasing amount of interest each period. This is because interest is based on the carrying amount of the bond issuance at the beginning of each period. The straight-line method results in a constant dollar amount of interest and an increasing or decreasing rate of interest over the life of the bonds. The effective- interest method results in an increasing or decreasing dollar amount of interest and a constant rate of interest over the life of the bonds.
The annual interest expense will decrease each period throughout the life of the bonds. Under the effective-interest method the interest expense each period is equal to the effective or yield interest rate times the book value of the bonds at the beginning of each interest period.
When bonds are sold at a premium, their book value declines to face value over their life; therefore, the interest expense declines also. Bond issuance costs should be debited to a deferred charge account for Unamortized Bond Issue Costs and amortized over the life of the issue, separately from but in a manner similar to that used for discount on bonds.
Amortization of Discount on Bonds Payable will increase interest expense. However, by lowering the amount paid for the bonds, investors can increase the effective rate of interest. The call feature of a bond issue grants the issuer the privilege of purchasing, after a certain date at a stated price, outstanding bonds for the purpose of reducing indebtedness or taking advantage of lower interest rates. The call feature does not affect the amortization of bond discount or premium; because early redemption is not a certainty, the life of the bonds should be used for amortization purposes.
It is sometimes desirable to reduce bond indebtedness in order to take advantage of lower prevailing interest rates. Also the company may not want to make a very large cash outlay all at once when the bonds mature. Bond indebtedness may be reduced by either issuing bonds callable after a certain date and then calling some or all of them, or by purchasing bonds on the open market and then retiring them.
When a portion of bonds outstanding is going to be retired, it is necessary for the accountant to make sure any corresponding discount or premium is properly amortized. When the bonds are extinguished, any gain or loss should be reported in income. Prepare an income statement. Explain how to report various income items. Identify where to report earnings per share information. Understand the reporting of accounting changes, and errors. Prepare a retained earnings statement.
Explain how to report other comprehensive income. Simple 18—20 E Compute income measures. Simple 10—15 E Income statement items. Simple 25—35 E Single-step income statement. Moderate 20—25 E Multiple-step and single-step. Simple 30—35 E Multiple-step and extraordinary items. Moderate 30—35 E Multiple-step and single-step. Simple 15—20 E Multiple-step statement with retained earnings. Simple 30—35 E Earnings per share. Simple 20—25 E Condensed income statement—periodic inventory method. Moderate 20—25 E Retained earnings statement.
Simple 20—25 E Earnings per share. Moderate 15—20 E Change in accounting principle. Moderate 15—20 E Comprehensive income. Simple 15—20 E Comprehensive income. Moderate 15—20 E Various reporting formats. Moderate 30—35 P Multiple-step income, retained earnings. Moderate 30—35 P Single-step income, retained earnings, periodic inventory.
Simple 25—30 P Irregular items. Moderate 30—40 P Multiple- and single-step income, retained earnings. Moderate 45—55 P Irregular items. Moderate 20—25 P Retained earnings statement, prior period adjustment. Moderate 25—35 P Income statement, irregular items. Moderate 25—35 CA Identification of income statement deficiencies.
Simple 20—25 CA Earnings management. Moderate 20—25 CA Earnings management. Simple 15—20 CA Income reporting items. Moderate 30—35 CA Identification of income statement weaknesses. Moderate 30—40 CA Classification of income statement items.
Moderate 20—25 CA Comprehensive income. Simple 10—15 4. Changes in accounting estimates result from new information. Examples of items for which estimates are necessary are uncollectible receivables, inventory obsolescence, service lives and salvage value of depreciable assets, and warranty obligations. A change in accounting estimate is a necessaryconsequence of the assessment,in conjunction with the periodic presentation of financial statements, of the present status and expected future benefits and obligations associated with assets and liabilities.
A change in the method of applying an accounting principle also is considered a change in accounting principle. An example of a change in estimate effected by a change in principle is a change in the method of depreciation, amortization, or depletion for long-lived, nonfinancial assets. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Following this link yields the following paragraph: Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence.
Thus, both of the following criteria shall be met to classify an event or transaction as an extraordinary item: a. Unusual nature. The underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates see paragraph Infrequency of occurrence.
The underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates see paragraph In determining materiality, extraordinary items shall be related to the estimated income for the full fiscal year. Effects of disposals of a component of an entity and unusual and infrequently occurring transactions and events that are material with respect to the operating results of the interim period but that are not designated as extraordinary items in the interim statements shall be reported separately.
In addition, matters such as unusual seasonal results and business combinations shall be disclosed to provide information needed for a proper understanding of interim financial reports. Extraordinary items, gains or losses from disposal of a component of an entity, and unusual or infrequently occurring items shall not be pro-rated over the balance of the fiscal year.
Facts: A registrant has various classes of preferred stock. Dividends on those preferred stocks and accretions of their carrying amounts causeincome applicable to commonstockto be less than reported net income. Question: In ASR , the Commission stated that although it had determined not to mandate presentation of income or loss applicable to common stock in all cases, it believes that disclosure of that amount is of value in certain situations.
In what situations should the amount be reported, where should it be reported, and how should it be computed? The amount to be reported should be computed for each period as net income or loss less: a dividends on preferred stock, including undeclared or unpaid dividends if cumulative; and b periodic increases in the carrying amounts of instruments reported as redeemable preferred stock as discussed in Topic 3.
C or increasing rate preferred stock as discussed in Topic 5. FN1 If a registrant elects to follow the encouraged disclosure discussed in paragraph 23 of Statement , and displays the components of other comprehensive income and the total for comprehensive income using a one-statement approach, the registrant mustcontinue to follow the guidance set forth in the SAB Topic.
One approach may be to provide a separate reconciliation of net income to income available to common stock below comprehensive income reported on a statement of income and comprehensive income. FN2 The assessment of materiality is the responsibility of each registrant. However, absent concerns about trends or other qualitative considerations, the staff generally will not insist on the reporting of income or loss applicable to common stock if the amount differs from net income or loss by less than ten percent.
The income statement is important because it provides investors and creditors with information that helps them predict the amount, timing, and uncertainty of future cash flows. It helps investors and creditors predictfuture cash flows in a number of different ways. First, investors and creditors can use the information on the income statement to evaluate the past performance of the company. Second, the income statement helps users of the financial statements to determine the risk level of uncertainty of income—revenues, expenses, gains, and losses—and highlights the relationship among these various components.
It should be emphasized that the income statement is used by parties other than investors and creditors. Information on past transactions can be used to identify important trends that, if continued, provide information about future performance. If a reasonable correlation exists between past and future performance, predictions about future earnings and cash flows can be made.
For example, a loan analyst can develop a prediction of future performance by estimating the rate of growth of past income over the past several periods and project this into the next period. Additional information about current economic and industry factors can be used to adjust the trend rate based on historical information.
Some situations in which changes in value are not recorded in income are: a Unrealized gains or losses on available-for-sale investments, b Changes in the fair values of long-term liabilities, such as bonds payable, c Changes increases in value of property, plant and equipment, such as land, natural resources, or equipment, d Changes increases in the values of intangible assets such as customer goodwill, brand value, or intellectual capital.
Note that some of these omissions arise because the items e. Some situations in which application of different accounting methods or estimates lead to comparison problems include: a Inventory methods—LIFO vs. The transaction approach focuses on the activities that have occurred during a given period and instead of presenting only a net change, a description of the components that comprise the change is included.
In the capital maintenance approach, only the net change income is reflected whereas the transaction approach not only provides the net change income but the components of income revenues and expenses. The final net income figure should be the same under either approach given the same valuation base. Earnings management is often defined as the planned timing of revenues, expenses, gains and losses to smooth out bumps in earnings. In most cases, earnings management is used to increase income in the current year at the expense of income in future years.
For example, companies prematurely recognize sales in order to boost earnings. Earnings management can also be used to decrease current earnings in order to increase income in the future. Earnings management has a negative effect on the quality of earnings if it distorts the information in a way that is less useful for predicting future cash flows. Within the Conceptual Framework, useful information is both relevant and representationally faithful.
Caution should be exercised because many assumptions and estimates are made in accounting and the net income figure is a reflection of these assumptions. If for any reason the assumptions are not well-founded, distortions will appear in the income reported. The objectives of the application of generally accepted accounting principles to the income statement are to measure and report the results of operations as they occur for a specified period without recognizing any artificial exclusions or modifications.
Companies that use aggressive accounting policies report higher income numbers in the short-run. In such cases, we say that the quality of earnings is low. Similarly, if higher expenses are recorded in the current period, in order to report higher income in the future, then the quality of earnings is also considered low.
The major distinction between revenues and gains or expenses and losses depends on the typical activities of the company. Gains also can arise from many different sources, but these sources occur from peripheral or incidental transactions of an entity.
The same type of distinction is made between expenses and losses. The advantages of the single-step income statement are: 1 simplicity and conciseness, 2 probably better understood by the layperson, 3 emphasis on total costs and expenses, and net income, and 4 does not imply priority of one revenue or expenseover another. The disadvantages are that it does not show the relationship between sales revenue and cost of goods sold and it does not show other important relationships and information, such as income from operations, income before income tax, etc.
Operating items are the expenses and revenues which relate directly to the principal activity of the concern; they are revenues realized from, or expenses which contribute to, the sale of goods or services for which the company was organized.
The nonoperating items result from secondary activities of the company. They are not directly related to the principal activity of the company but arise from incidental activities. The modified all-inclusive income statement includes most items including irregular ones, as part of net income.
Moderate 20—25 E Retail inventory method. Simple 12—17 E Retail inventory method. Simple 20—25 E Analysis of inventories. Simple 10—15 P Lower-of-cost-or-market. Moderate 25—30 P Entries for lower-of-cost-or-market—cost-of-good- sold and loss. Moderate 30—35 P Gross profit method. Moderate 20—30 P Gross profit method. Complex 40—45 P Retail inventory method. Moderate 20—30 P Retail inventory method. Moderate 20—30 4. Moderate 30—40 P Lower-of-cost-or-market.
Complex 40—50 CA Lower-of-cost-or-market. Moderate 15—25 CA Lower-of-cost-or-market. Moderate 20—30 CA Lower-of-cost-or-market.
Moderate 15—20 CA Retail inventory method. Moderate 15—25 CA Purchase commitments. Moderate 10—15 5. Held for sale in the ordinary course of business 2. In process of production for such sale 3. To be currently consumed in the production of goods or services to be available for sale. The term inventory embraces goods awaiting sale the merchandise of a trading concern and the finished goods of a manufacturer , goods in the course of production work in process , and goods to be consumed directly or indirectly in production raw materials and supplies.
This definition of inventories excludes long-term assets subject to depreciation accounting, or goods which, when put into use, will be so classified. The fact that a depreciable asset is retired from regular use and held for sale does not indicate that the item should be classified as part of the inventory.
Raw materials and supplies purchased for production may be used or consumed for the construction of long-term assets or other purposes not related to production, but the fact that inventory items representing a small portion of the total may not be absorbed ultimately in the production process does not require separate classification.
By trade practice, operating materials and supplies of certain types of entities such as oil producers are usually treated as inventory. Market shall not exceed the net realizable value 2. Market shall not be less than net realizable value reduced by an allowance for an approximately normal profit margin. Estimated selling price in the ordinary course of business less reasonably predictable costs of completion and disposal.
Valuation of inventories at estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.
The second definition provides a link to guidance for lower-of-cost-or-market in the agricultural industry FASB ASC Growing Crops Costs of growing crops shall be accumulated until the time of harvest. Growing crops shall be reported at the lower-of-cost-or-market.
The product has a reliable, readily determinable, and realizable market price. The product has relatively insignificant and predictable costs of disposal. The product is available for immediate delivery. Inventories of harvested crops and livestock held for sale and commonly referred to as valued at market are actually valued at net realizable value.
Where there is evidence that the utility of goods, in their disposal in the ordinary course of business, will be less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes,the difference shall be recognized as a loss of the currentperiod.
This is generally accomplished by stating such goods at a lower level commonly designated as market. Thus, in accounting for inventories, a loss shall be recognized whenever the utility of goods is impaired by damage, deterioration, obsolescence, changes in price levels, or other causes.
The measurement of such losses shall be accomplished by applying the rule of pricing inventories at the lower-of-cost-or-market. This provides a practical means of measuring utility and thereby determining the amount of the loss to be recognized and accounted for in the current period. However, utility is indicated primarily by the current cost of replacement of the goods as they would be obtained by purchase or reproduction. In applying the rule, however, judgment must always be exercised and no loss shall be recognized unless the evidence indicates clearly that a loss has been sustained.
Replacement or reproduction prices would not be appropriate as a measure of utility when the estimated sales value, reduced by the costs of completion and disposal, is lower, in which case the realizable value so determined more appropriately measures utility. In addition, when the evidence indicates that cost will be recovered with an approximately normal profit upon sale in the ordinary course of business, no loss shall be recognized even though replacement or reproduction costs are lower.
This might be true, for example, in the case of production under firm sales contracts at fixed prices, or when a reasonable volume of future orders is assured at stable selling prices. In summary, the determination of the amount of the write-off should be based on factors that relate to the net realizable value of the inventory, not the amount that will maximizethe loss in the current period.
By writing the inventory down to an unsupported low value, the company can report higher gross profit and net income in subsequent periods when the inventory is sold. And, according to b , gains and losses on a qualifying fair value hedge shall be accounted for as follows: The gain or loss that is, the change in fair value on the hedged item attributable to the hedged risk shall adjust the carrying amount of the hedged item and be recognized currently in earnings.
If cost is used to determine any portion of the inventory amounts, the description of this method shall include the nature of the cost elements included in inventory. Elements of cost include, among other items, retained costs representing the excess of manufacturing or production costs over the amounts charged to cost of sales or delivered or in-process units, initial tooling or other deferred startup costs, or general and administrative costs.
If the estimated average cost per unit is used as a basis to determine amounts removed from inventory under a total program or similar basis of accounting, the principal assumptions including, where meaningful, the aggregate number of units expected to be delivered under the program, the number of units delivered to date and the number of units on order shall be disclosed.
Contracts or programs of shorter duration may also be included, if deemed appropriate. In addition, if practicable, disclose the amount of deferred costs by type of cost e. Where there is evidence that the utility of goods to be disposed of in the ordinary course of business will be less than cost, the difference should be recognized as a loss in the current period, and the inventory should be stated at market value in the financial statements.
The upper ceiling and lower floor limits for the value of the inventory are intended to prevent the inventory from being reported at an amount in excess of the net realizable value or at an amount less than the net realizable value less a normal profit margin.
The maximum limitation, not to exceed the net realizable value ceiling covers obsolete, damaged, or shopworn material and prevents overstatement of inventories and understatement of the loss in the current period.
The minimum limitation deters understatement of inventory and overstatement of the loss in the current period. The usual basis for carrying forward the inventory to the next period is cost.
Departure from cost is required when the utility of the goods included in the inventory is less than their cost. This loss in utility should be recognized as a loss of the current period, the period in which it occurred.
Furthermore, the subsequent period should be charged for goods at an amount that measures their expected contribution to that period. In other words, the subsequent period should be charged for inventory at prices no higher than those which would have been paid if the inventory had been obtained at the beginning of that period.
Historically, the lower-of-cost-or-market rule arose from the accounting convention of providing for all losses and anticipating no profits. The rule is usually applied to each item, but if individual inventory items enter into the same category or categories of finished product, alternative procedures are suitable.
The arguments against the use of the lower-of-cost-or-market method of valuing inventories include the following: a The method requires the reporting of estimated losses all or a portion of the excess of actual cost over replacement cost as definite income charges even though the losses have not been sustained to date and may never be sustained. Under a consistentcriterion of realization a drop in replacement cost below original cost is no more a sustained loss than a rise above cost is a realized gain.
Furthermore, if the charge for the inventory write-downs is not made to a special loss account, the cost figure for goods actually sold is inflated by the amount of the estimated shrinkage in price of the unsold goods.
Its effect on the income statement, however, may be the opposite. Although the income statement for the year in which the unsustained loss is taken is stated conservatively, the net income on the income statement of the subsequent period may be distorted if the expected reductions in sales prices do not materialize. The lower-of-cost-or-market rule may be applied directly to each item or to the total of the inventory or in some cases, to the total of the components of each major category.
The method should be the one that most clearly reflects income. The most common practice is to price the inventory on an item-by-item basis. Companies favor the individual item approach because tax requirements require that an individual-item basis be used unless it involves practical difficulties. In addition, the individual item approach gives the most conservative valuation for balance sheet purposes. One approach is to record the inventory at cost and then reduce it to market, thereby reflecting a loss in the current period often referred to as the loss method.
The loss would then be shown as a separate item in the income statement and the costof goods sold for the year would not be distorted by its inclusion. An objection to this method of valuation is that an inconsistency is created between the income statement and balance sheet.
In attempting to meet this inconsistency some have advocated the use of a special account to receive the credit for such an inventory write-down, such as Allowance to Reduce Inventory to Market which is a contra account against inventory on the balance sheet. It should be noted that the disposition of this account presents problems to accountants. Another approach is merely to substitute market for cost when pricing the new inventory often referred to as the cost-of-goods-sold method.
Such a procedure increases cost of goods sold by the amount of the loss and fails to reflect this loss separately. For this reason, many theoretical objections can be raised against this procedure.
An exception to the normal recognition rule occurs where 1 there is a controlled market with a quoted price applicable to specific commodities and 2 no significant costs of disposal are involved. Certain agricultural products and precious metals which are immediately marketable at quoted prices are often valued at net realizable value market price. Relative sales value is an appropriate basis for pricing inventory when a group of varying units is purchased at a single lump-sum price basket purchase.
The purchase price must be allocated in some manner or on some basis among the various units. When the units vary in size, character, and attractiveness, the basis for allocation must reflect both quantitative and qualitative aspects. A suitable basis then is the relative sales value of the units that comprise the inventory. The drop in the market price of the commitment should be charged to operations in the current year if it is material in amount. The account credited in the above entry should be included among the current liabilities on the balance sheet with an appropriate note indicating the nature and extent of the commitment.
This liability indicates the minimum obligation on the commitment contract at the present time—the amount that would have to be forfeited in case of breach of contract. The major uses of the gross profit method are: 1 it provides an approximation of the ending inventory which the auditor might use for testing validity of physical inventory count; 2 it means that a physical count need not be taken every month or quarter; and 3 it helps in determining damages caused by casualty when inventory cannot be counted.
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