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62 Cards in this Set
- Front
- Back
- 3rd side (hint)
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Objective of Accrual Accounting
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Matching revenues with related expenses in the accounting period
Allows for revenue and expense recognition w/o having to wait for cash to actually trade at arm's length |
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When are revenues and gains recognized?
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When they are realizable, meaning the goods/svcs have been delivered or exchanged for cash or claims to cash (aka receivables)
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Revenues vs. Gains
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Revenues are central to the co's ongoing operations and therefore, central to the earnings process
Gains result from tranxs NOT related to earnings process |
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Accrued revenues
Accrued expenses |
Revenues earned, but not yet collected in cash
Expenses incurred, but not yet settled in cash |
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When should expenses be recognized?
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When directly related to specific revenues; through allocation on systematic basis (e.g. depreciation); or immediately in the period (periodic cost)
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Hint: It depends on when benefits expire.
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How should periodic cost be handled and why?
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Expense periodic cost immediately to the period it was incurred b/c the future benefits related with the periodic cost are either not readily identifiable or already consumed.
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Hint: Periodic is self-explanatory
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Accrued vs. Deferrals
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Accrued = hits Income even though no cash has been touched
Deferral = no effect on income b/c delaying the Rev/Exp/G/L, but cash is affected |
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Deferrals
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Represents tranxs where cash was exchanged, but the event has not occurred yet, e.g. deferred compensation, deferred ("unearned") revenue
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Deferred rent revenue = rent paid in advance
Prepaid insurance = premiums paid ahead of expense |
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Who has the title to the goods on consignment?
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Only the consignor until sold to the customer.
Consignee NEVER owns the title b/c just acts as an agent |
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How is sales revenue on goods sold on consignment recognized?
Consignor's view |
Consignor records sales revenue at the selling price
Any commissions paid to consignee are SG&A costs and NOT netted against Sales Rev |
Cash
SG&A (no netting!!!) ______Consignment Sales Revenues HINT: think of the consignment as outsourcing your sales efforts. |
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How is sales revenue on goods sold on consignment recognized?
Consignee's view |
A/R
Remittances Pay Revenue |
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Franchise Accounting from Franchisee's View
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Capitalize all costs incurred to acquire franchise, include any future pmts due to the franchisor at Present Value (b/c represent future benefits)
Periodic service fees = expense immediately in period incurred |
Franchise = intangible asset as a right to operate under and receive services f/ another entity
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Franchise Accounting from Franchisor's View
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Recognize revenue f/ initial franchise fees when services were substantially performed
If continuing fees to be earned will not cover franchisor's cost for providing its services, then defer the excess as unearned revenue and amortize over franchise's life. |
Initial FranchFees Rec
_____Franchise Revenue Cont'g FranchFees Rec _____Revenues _____Deferred Rev (for excess) Deferred Rev (thru amortization) _____Revenues |
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What should be disclosed in FS about revenues and expenses?
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-Accounting principles and methods on revenue recognition, periodic cost, and allocation of costs to future periods
-Acceptable alternatives -Unusual applications of GAAP -Risks and uncertainties |
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What are the various frameworks that can be used for financial reporting?
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US GAAP
IFRS Other Comprehensive Basis of Accounting (OCBOA) |
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Bases for OCBOA
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-Regulatory
-SME (Small/Medium Entities) -Income Tx (cash/accrual basis) -Liquidation -Cash/Modified Cash Basis |
HINT: "(R) you happy? SM(I)(L)E '(C)ause you don't have to mess with GAAP.
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Contrast cash/modified cash basis against accrual accounting
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Pure cash = income and cost only when cash is physically exchanged, NO matching of REVS & EXPs (no capitalization, no depreciation)
Modified = blends cash w/ accrual by capitalizing assets and accruing taxes |
HINT: Accrual matches revenues w/ the expenses associated w/ the revenues in the *time period* to which they relate
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Why do we care about having a Modified Cash basis as one of the OCBOA bases?
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Can provide more information to financial users than FS using the cash basis, yet avoid all the GAAP complexities
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Financial Reporting Framework for Small/Medium Entities (FRF-SMEs)
What's the logic for FRF-SMEs? |
-FRF developed by AICPA specifically for privately held Small and Medium Entities (SMEs) as an OPTION to avoid onerous requirements of GAAP because SMEs are so small that all they have are bank loans and very little else to show (no hedges, derivatives, OCI items, etc)
-MOST cost-beneficial for SMEs -Blends accrual accounting w/ historical cost -Income tx returns pretty much tie to the FRF-SMEs-type FS |
fancy word: "onerous" - to be burdensome
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Define liquidation
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The process of having the entity sell off its assets to raise cash or get other assets and use these proceeds to settle laibs w/ creditors then distribute the remaining proceeds to investors/other claimants
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How are liquidation-based FS items measured?
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Assets @ est'd net cash proceeds
Liabs @ presently measured |
Entity can't assume it will be released from all of its liabilities (STRICT). Have to be formally discharged before can take the liabs off its books.
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How are changes in liquidation-based FS items presented?
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-Accrue and present liquidation costs expected to incur
-Income expected to earn via liquidation |
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When must an entity use liquidation BoA? When does it not have to use it?
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-Entity MUST use liquid BoAg under ASU 2013-07 when entity's liquidation is IMMINENT (no plans to return f/ liquidation)
-IFRS does not require entities to use liquid BoA. Up to mgmt's discretion on when & how |
GAAP is vague, So, FASB issued ASU 2013-07 to give specify when and how liquid BoA should be applied
(ASU = Accounting Std Update, issued by FASB) |
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What is a completed set of financial statements? Does it matter which BoA used?
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No, ALL BoA's used whether it's GAAP, IFRS, OCBOA,, every org must provide a complete set of FS, which are:
Stmt of Finanical Position (BS) Stmt of Changes in Net Worth (Equity) Related Notes SCF is optional |
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What should OCBOA not have in its FS?
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Anything to do w/ income tax effects, current value basis (b/c using historical cost)
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What d/s should be in OCBOA financials?
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SAP(nonGAAP) + GROSS
(S)ummary of Sig Acct Policies & clarify for users that FS are non-GAAP (G)oing concerns (R)elated party tranxs (O)bligations = liabilities, including contingencies (S)ignificant risks/uncertainities (S)ubsequent events |
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How should finances presented for individuals?
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Financial Condition = Required
Changes in Net Worth = Optional! |
HINT:
ONE stmt is required, the other isn't |
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How are Financial Condition items measured and presented? What's the logic for that presentation?
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Assets and liabilities in Financial Condition are listed in order of liquidity and maturity, but NO classifying into CA, NCA, CL, NCL since Working Captial concept does not apply to individuals.
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HINT: We are our own working capital.
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What basis is used for presenting personal financials?
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Accrual, even though the FS items are not explicitly listed as CA, NCA, CL... (recall that WC isn't applicable to folks)
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Describe layout of Stmt of Financial Condition for individuals (personal FS)
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Assets @ est'd current values & by liquidity
Liabs @ est'd current amts & by maturity (Est'd Income Tx)* = Net Worth *Ext'd Income Tx = (Asset Tx - Liabs Tx) x Tx% |
Tricky - remember:
TA - TL - Est'd Inc Tx = Net Worth |
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Can an individual list an real estate investment at net of its mortgage on his/her Stmt of Financial Condition?
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No, GAAP says must list the investment (Asset) separately from the mortgage (Liab)
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What d/s can we anticipate in personal FS?
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Even though there is no comprehensive list of what to include, expect the garden variety of: SAP + GROSS
Can include Supplemental Info if desired |
Simply need adequate info to be useful for decision making.
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What methods are used for recognizing income on long-term construction contracts? How do you know which one to use?
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Revs, ETC's, and % of progress are reasonably estimable and no dangers = use % of Compl Method
Revs, ETC's and % of progress are NOT reasonably estimable and in danger = use Completed Contract Method |
EX- Got a contract to build an airport overseas and all hell breaks loose, which endangers our contract. Better off using completed contract b/c we can't reasonable depend on our estimates anymore
Bottom line: Analyze the circumstances for each kt on a case-by-case basis to pick the appropriate method |
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Is income recognition under the % of Compl method restricted to only one basis for measuring progress?
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-No, can use whichever measures of progress as long as they are appropriate for the circumstances. -Apply consistently to kts w/ similar circumstances
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Think of the latest situation in the Ukraine. What if we had a contract to build a hotel there and we run the risk of being interrupted? Better off using Completed Contract b/c we don't know if we get to finish the building it before hell breaks loose.
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What's the logic for % of completion?
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-Income recognized on work as contract progress is charged to "(C)onstruction (I)n (P)rogress", an Asset account (Advantage = books revenue that is EARNED)
-Have to continually recompute CIP's as kt progresses towards completion (disadvantage = undertainty) |
CIP = Construction In Progress is:
(C)osts (I)ncurred and (P)rofit |
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How come we can't use Progress Billings and collections on the PB for recognizing our income?
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PBs do not relate to the actual progress on the contract. PBs are based on whatever we think that we will need to get as WC to get going with our projects, so we speed up the PBs at the beginning to our clients rather than burn a hole in our pockets instead of the client's.
Bottom line is the name "Progress" in PBs is misleading b/c it really has nothing to do with the ACTUAL progress. It is just to force the client to put the WC upfront, so we can work without touching our own money. Hence, we use PB's as a contra-account to CIP. |
HINT: Clients provide the Working Capital that we need for completing the construction project, so we use "PBs" to get the WC.
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How is the amount of income to recognize for the period is computed under % of Compl method?
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[(Actual YTD/TEC) X (TPrice-TC*)] - Prev Income Booked = New Income
TC = YTD + ETC TPrice-TC = Total Est'd Income, be sure to recompute the income at every caluclation b/c will true up the cost at each period |
HINT: Actual YTD/TEC is our % of completion
The numerator is what we have completed so far, the denominator is what we anticipate to complete in TOTAL . (T)otal (E)stimated (C)ost Do NOT use ETC in the denominator, that's only for the kt |
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What happens if actual (YTD) costs exceed our total estimated cost to complete on long term construction contracts?
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It is a LOSS - recognize immediately.
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Benefits of using % of Compl Method
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-Periodic recognition of income as actual work is done, hence more comparability b/w periodic FS
-Readily id's status of contracts' completion vs. incompletion |
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Disadvantage of using % of Compl Method?
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-Relies on estimates of the final contract costs, which can skew the amount of income accrued
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Under % of Compl method, when do we have a:
________CA? ________CL? |
PB's < costs and income = CA
(CIP) Logic: CA b/c the PB's are UNDERbilled to client PB's > costs and income = CL (CIP) Logic: CL b/c PB's are OVERbilled to client |
HINT:
CIP = Construction In Progress is really: (C)osts (I)ncurred and (P)rofits |
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Can we net CA and CL for multiple contracts on our FS when using % of Compl?
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No, never net CA w/ CL because it is misleading to users of FS and obscures the info.
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Rules for applying Completed Contract method
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-Recognize income only at the COMPLETION of the kt
-Any costs exceed the kt price = expense LOSS immediately -Accumulated PB's < costs = CA -Accumulated PB's > costs = CL |
HINT: Same logic for BS presentation
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JE for losses under Completed Contract method
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Loss f/ Kt XX
_____CIP XX |
HINT: CIP is an asset, just like WIP
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Advantage and disadvantage of using Completed Contract method
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+ Recognizes income as accurate by not relying on any estimates and waiting until the very end
-Gives no status on progress towards completion and hence, no comparability of FS across periods |
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What's the basic presumption about contracts in the accounting sense?
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-Each kt is a profit center for revenue recognition, cost accumulation, and income measurement
-Can be combined if negotiated as a single package -Can be segmented if negotiated separately, even w/ the same customer |
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How are insurance contracts accounted for?
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-Capitalize acquisition costs as "Deferred Acquisition Costs" = asset then amortize over whatever the insurance kt uses
-Examples are underwriting costs, policy issuance and processing, sales force kt selling costs, advertising |
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What acquisition-related costs on insurance contracts are not capitalized?
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-Soliciting potential customers, market research, training, admin, unsuccessful acquisition, product development = SG&A
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HINT: SG&A related activities except for successful sales
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Rules for Software Revenue Recognition
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SW Rev aka license revenues
Recognize revenue when ALL are met: 1) Persuasive Evidence of the arrangement (e.g. contract, PO, online auth) 2) Delivery HAS occurred 3) Vendor's fee is Fixed/Determinable |
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What are the scenarios for determining whether delivery and acceptance has occurred?
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1) Customer takes immediate possession of the software via download or received access codes to enable IMMEDIATE possession
2) Destination is the customer's place of business or the customer's site 3) Delivered to an intermediate site specified by the customer 4) When the delivery agents gets the SW to the CUSTOMER |
Do not recognize revenue when SW is with the delivery agent, but has not reached the customer.
(Think of this like goods on consignment. Revenue doesn't occur until customer/end user takes legal title) |
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When should software revenue not be recognized?
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When delivery and acceptance of SW is UNCERTAIN
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When is a vendor's fee is NOT fixed or determinable?
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Definitely not fixed/determinable when:
# of units distributed/copied OR expected # of users OR extended payment terms (potentially) Brings too much uncertainty |
Potentially not fixed/determinable when:
Rights of returns/refunds Extended payment terms eg - Reseller (the customer)'s payment is contingent on its success in distributing the SW |
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If contract accounting does not apply, what is the alternative for recognizing vendor's fee (revenue) for software arrangements?
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-Allocate vendor's fee to the elements based on Fair Value
-No Fair Value ava? Defer vendor's fee until items have been delivered |
SW arrangements are add'l SW products, upgrades, customer support, deliverable only on when-if basis (note: uncertainty arises)
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When does GAAP allows for the installment method? What about cost recovery?
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GAAP allows installment method ONLY if collection on sales price is not reasonably assured
GAAP allows cash recovery as a very LAST resort where collections are uncertain to where installment method can't even be used |
Recall: Revenues = recognized at POS as actual OR expected cash inflows (meaning it's realizable as a claim to the customer's cash)
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How are revenues recognized under the installment method ?Cost recovery method?
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"On an installment basis" - revenues are deferred and recognized each period proportionally to collections on receivables during the period
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HINT: the name of the method is self-explanatory
"When costs are recovered" - defer the revenue until 100% of the costs are collected ("recovered") then recognize. Most CONSERVATIVE approach. |
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Installment Method formula for computing amount of revenue to recognize
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GP/SALES = GP%
GP% x Collections = Realized REV GP% x Uncollected = Deferred REV |
GP - Realized REV = Deferred GP
Recall: Sales - COGS = GP |
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What is an example of a circumstance that can cause us to use cost recovery method even though we already know our collections are uncertain?
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when the final sales price is to be determined by future events.
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LONG: Name the alternative revenue recognition methods other, whether they are allowed by GAAP or IFRS, and when are we allowed to apply
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Percentage of Completion -Required under US GAAP presuming you can estimate costs on the contract /Required for IFRS presuming you can estimate costs on the contract
Completed Contract - Required under US GAAP if you cannot estimate costs on the contract/ NOT allowed for IFRS |
Installment Method-Required under US GAAP if collection of the sales price is not reasonably assured/ NOT allowed under IFRS
Cost Recovery Method- Required under US GAAP if collection of the sales price is so uncertain that even the installment method is not allowed/Required under IFRS if cost estimates on long term contracts cannot be made such that the percentage of completion method is not allowed |
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The milestone method is...
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Used for R&D contracts where a portion of payment (revenue) is contingent on meeting "milestone events" (recognizing revenue proportionally to performance)
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The milestone must be the result of the vendor's performance
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Completion of production can be used when...
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-stable market for the product
-marketing costs are minimal -homogeneous |
HINT: corn, dairy, ore
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"Bill and hold" is when
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seller "bills" the customer, but the seller physically "holds" the goods until customer asks for for the items to be shipped
Not a true sale b/c delivery hasn't happened. |
However, SEC allows for "bill and hold" tranx for revenue recognition if meet very strict criteria, especially the risks of ownership must be passed to the buyer, evidence that the buyer authorized the tranx, etc.
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Channel stuffing is when
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suppliers manipulate their sales numbers by convincing distributors to overbuy inventory well beyond their ability to resell and not giving them the appropriate rights for sales returns
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Purposely book tomorrow's revenue today to boost bottom line
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