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    Notes Chapter 2 FAR

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    - Revenue is generally recognized when goods are delivered or services are performed. Revenue from allowing use of assets is recognized as the assets are used. - Expenses must be recognized in the same period as the associated revenue under the matching principle. Costs are either expired, recognized currently as expenses, or unexpired and capitalized. - For franchisors, initial franchise fees are recorded as unearned revenue and recognized over time as obligations to franchisees are fulfilled. Franchisees capitalize initial fees as intangible assets. - Most costs associated with internally developed intangible assets are expensed as incurred, while certain external costs may be capitalized.

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    Notes Chapter 2 FAR

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    - Revenue is generally recognized when goods are delivered or services are performed. Revenue from allowing use of assets is recognized as the assets are used. - Expenses must be recognized in the same period as the associated revenue under the matching principle. Costs are either expired, recognized currently as expenses, or unexpired and capitalized. - For franchisors, initial franchise fees are recorded as unearned revenue and recognized over time as obligations to franchisees are fulfilled. Franchisees capitalize initial fees as intangible assets. - Most costs associated with internally developed intangible assets are expensed as incurred, while certain external costs may be capitalized.

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    CPA Study Notes - FAR

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    - Revenue is generally recognized when goods are delivered or services are performed. Revenue from allowing use of assets is recognized as the assets are used. - Expenses must be recognized in the same period as the associated revenue under the matching principle. Costs are either expired, recognized currently as expenses, or unexpired and capitalized. - For franchisors, initial franchise fees are recorded as unearned revenue and recognized over time as obligations to franchisees are fulfilled. Franchisees capitalize initial fees as intangible assets. - Most costs associated with internally developed intangible assets are expensed as incurred, while certain external costs may be capitalized.

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    Notes Chapter 2 FAR

    Uploaded by

    cpacfa
    - Revenue is generally recognized when goods are delivered or services are performed. Revenue from allowing use of assets is recognized as the assets are used. - Expenses must be recognized in the same period as the associated revenue under the matching principle. Costs are either expired, recognized currently as expenses, or unexpired and capitalized. - For franchisors, initial franchise fees are recorded as unearned revenue and recognized over time as obligations to franchisees are fulfilled. Franchisees capitalize initial fees as intangible assets. - Most costs associated with internally developed intangible assets are expensed as incurred, while certain external costs may be capitalized.

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    FAR - Notes Chapter 2

    http://www.cpa-cfa.org
    Timing Issues
    • Revenue from the sales of products or the disposal of assets is recognized on the date of sale
    • Generally for a sale to take place: delivery of goods and or transfer of title must occur
    • Revenue that stems from allowing others the use of the entity’s assets (interest rev, royalty rev, rental rev)
    is recognized with the assets are used
    Cash xx
    Unearned royalty xx

    Unearned royalty xx
    Earned royalty xx
    • Revenue from services is recognized in the period the services have been performs and are able to be billed

    Expenses should be recognized according to the matching principles

    Matching principle – expenses must be recognized in the same period as revenue

    Expired costs (expenses) – costs that expire during the period and have no future benefit

    Unexpired costs (expenses) – should be capitalized and matched against revenue (PPE, depreciation)

    Franchisor Accounting (Mcdonalds HQ)


    • The PV of future services (to be performed by the franchisor) should be recorded as unearned revenue. The
    unearned revenue is recognized once substantial performance has occurred.
    • Substantial performance means that all of the following have been met
    1. Franchisor has no obligation to refund any payment received from franchisee
    2. Initial services required of the franchisor have been performed
    3. All other conditions of the sale have been met

    Franchisee accounting
    • The PV of the amount paid (or to be paid) by a franchisee is recorded as an intangible asset on the B/S and
    amortized over the expected period of benefit for the franchise
    • Fees should be reported by the franchisee as an expense and as revenue by the franchisor in the period
    incurred

    Expense recognition
    The cost of intangible assets not required from others should be expenses against income incurred, examples:
    - Trademarks; goodwill from advertising; the cost of developing, maintaining and restoring goodwill
    Exception, certain costs associated with intangibles that can be capitalized, examples:
    - Legal fees in successful defense of the asset (litigation for patents and trademarks); registration or
    consulting fees; design costs (of a trademark); other direct costs to secure the asset

    A patent is amortized over the shorter of its estimated life (useful life) or remaining legal life.
    FASB 142, Test goodwill and adjust for impairments

    Startup costs – expenses incurred in the formation of a corporation (legal fees) and are considered
    organizational costs

    Organizational costs are not capitalized but expensed immediately

    Capitalize legal and registration fees incurred to obtain an intangible asset


    Capitalize legal fees incurred in successfully defending intangible assets as future benefit will be derived

    1
    FAR - Notes Chapter 2
    http://www.cpa-cfa.org
    When purchasing goodwill, the excess cost over the FMV is goodwill
    As a general rule, R&D is expensed immediately
    Exceptions:
    - Materials and PPE that have alternative future uses; depreciate over the assets useful life, not
    the life of the R&D project
    - R&D undertaken on the behalf of others
    Items not considered R&D
    Routine periodic design changes to old products
    Marketing research
    Quality control testing
    Reformulation of a chemical compound

    Computer software development costs, developed to be sold, leased or licensed


    Expense costs incurred until technological feasibility has been established for the product
    Capitalized costs incurred after technological feasibility has been established

    Technological feasibility is established upon the completion of either


    A detailed program design
    Completion of a working model

    Annual amortization of capitalized software costs is the greater of:


    a. Percentage of revenue= total capitalized amount * (current gross revenue for period ÷ total projected
    gross revenue for product)
    b. Straight line = total capitalized amount * (1 ÷ estimate of economic life)

    Computer software developed internally or obtained for internal use only


    Expense costs incurred for the preliminary project state and costs incurred for training and maintenance
    Capitalize costs incurred after the preliminary project state and for upgrades and enhancements including:
    - Direct costs of materials, services, employees
    - Interest costs incurred for project
    Capitalized costs should be amortized on a straight line basis

    Begin bal prepaid insurance + payments – expense = ending bal prepaid insurance

    Beg bal rent receivable + rental revenue – cash collections – writeoffs = end bal rent receivable

    Beg bal accrued salaries payable + salaries expense – salaries paid = end bal accrued salaries payable

    Sales revenue = credit sales to revenue ÷ (1 + sales tax rate)

    Long Term Construction Contracts


    Completed contract method
    • Completed contract method recognizes income only on completion or substantial completion of the contract
    • Applicable overhead and direct costs should be charged to “construction in progress” account (an asset)
    • Billing and/or cash received should be credited to “advances on construction” in progress account (liability)
    • Losses should be recognized in full the year they are discovered
    Losses = contract price – costs incurred – estimated costs to complete

    Percentage of completion method


    • Use this method when collection is assured and
    - Can reasonably estimate profitability
    2
    FAR - Notes Chapter 2
    http://www.cpa-cfa.org
    - Provide reliable measure of progress toward completion
    • Income recognized is the percentage of estimated total.
    - Incurred costs to date bear to total estimated costs based on the most recent cost information
    - Example: Contract price is 10mil; estimated costs are 8mil; incurred 2mil of costs; therefore we
    recognize 2.5mil of revenue
    = (2/8)*10mil

    Installment Sales
    • The installment method is used only when there is no reasonable basis for estimating collectibility.
    • Revenue is recognized when cash is collected
    Gross profit = sale – COGS
    Gross profit % = gross profit ÷ sales
    Gross profit earned/realized = gross profit % * cash collections
    Deferred gross profit = gross profit % * installment receivable
    B/S A/R = A/R – deferred gross profit
    Deferred gross is a contra asset account so shown on the balance sheet

    Cost recovery method - no profit is recognized on sale until all costs have been recovered

    Accounting for Non-monetary Exchanges


    SFAS No. 153 requires nonmonetary exchanges be classified into two group, resulting in two different acctg
    rules
    1. Those that have “commercial substance”
    - an exchange has commercial substance is the future cash flows change as a result of the
    transaction. If the economic position of the two parties changes because of the exchange, then
    the exchange has commercial substance.
    2. Those that lack “commercial substance”

    Exchanges having commercial substance


    The FMV of assets given up is assumed to be equal to the fair market value of the assets received
    Cash given up does not enter into the calculation of gain on an exchange.
    New Asset xx (FMV)
    Accum Dep xx (of asset given up)
    Cash received xx (if any)
    Loss xx (if any)
    Old asset xx (at historical cost)
    Cash given xx (if any)
    Gain xx (if any)

    F2-32 & 33 examples

    Exchanges lacking commercial substance (or when FMV is not determinable)


    • If no boot (cash) is received, no gain is recognized
    • If boot is paid, no gain is recognized
    • If boot is received, gain is recognized
    - All gain is recognized if boot received equals or is greater than 25% of the total consideration
    - Recognize a proportional gain if boot received is less than 25%of the total consideration
    Recognized gain = total gain * (boot received ÷ total consideration received)

    3
    FAR - Notes Chapter 2
    http://www.cpa-cfa.org
    Whenever a nonmonetary asset is involuntary converted (fire loss, theft, condemnation) to cash, the entire gain
    is recognized

    Partnerships
    Exact method questions will ask how much should the new partner contribute to have an X% interest in the new
    partnership?
    Existing P/S total equity ÷ (1 - % interest desired) = New total P/S equity
    New total P/S equity – Existing P/S equity = new partner contribution amount

    Bonus method question will state that the partnership has decided not to recognize goodwill
    When the new partner pays more than the book value of the interest credit the old owners
    When the new partner pays less than the book value of the interest credit the new partner

    New total P/S equity * new partner % interest = book value


    Book value – amount contributed = bonus

    Goodwill method question will state that the partnership has decided to recognize goodwill
    Implied value = new partner contribution * total number of partners including the new partner
    Goodwill = Implied value – new partnerships total capital accounts
    Allocate goodwill to existing partners based on profit/loss terms

    F2-37-39 examples of all three methods

    Liquidation of a partnership – pg 57 example


    • Step 1: Liquidate assets
    • Step 2: Pay creditors (insiders or outsiders); if the liquidation of assets do not cover the costs to pay the
    creditors, then the losses are split
    • Step 3: If there is leftover after paying creditors, return capital to partners or split losses
    • Step 4: If there is anything left, divide profits

    Financial Reporting and changes prices


    • Monetary assets and liabilities fixed or denominates in dollars (A/R)
    • In periods of inflation, monetary assets will erode in value, while monetary liabilities will result in gain
    • Non-monetary assets and liabilities will fluctuate with inflation (bonds, inventory)
    • Contra accounts (allowance for doubtful accounts/accumulated dep) are classified based on the related
    account’s classification

    Foreign Currency Accounting SFAS 52


    FX transactions – transactions with a foreign entity denominated in a foreign currency
    FX translation – the conversion of F/S of a foreign entity to F/S expressed in the domestic currency

    Functional currency – currency of the primary economic environment in which the entity operates (usually the
    local currency or the US dollar)

    Remeasurement (temporal method) – from 3rd currency to functional currency


    Foreign company F/S must be translated/ remeasured to the functional currency of the company
    Any remeasurment gains/losses are recognized currently in the income statement

    4
    FAR - Notes Chapter 2
    http://www.cpa-cfa.org

    Translation (current method) – from functional currency to the reporting currency


    Any unrealized gains/losses are reported in other comprehensive income

    Remeasurement method (temporal method): US dollars = Functional currency =


    B/S
    • Monetary = year end FX rate
    • Non-monetary = historical FX rate
    • Plug retained earnings and use that amount as NI
    I/S
    • Non balance sheet related items (COGS) = weighted avg
    • B/S related items (Depreciation, Bond Amortization) = historical FX rate
    • Equity = historical fx rate
    • Currency gain/loss = plug
    - report in net income from continuing operations

    Translation method: foreign currency = functional currency


    I/S
    • Income = weighted avg FX rate
    • Expenses = weighted avg FX rate
    • Transfer NI to retained earnings
    B/S
    • Assets = Year end FX rate
    • Liabilities = year end FX rate
    • Equity = historical fx rate
    • Retained earnings = calculated NI from translation
    • Accumulated Translation adjustment = plug
    - report in other comprehensive income in the PUFE section

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