Financial 1

Source of GAAP and Basic Framework and Concepts

BOSSII: Bulletins, Opinions, SFAS, Staff Positions, Interpretations, Implementation
Issues
Concepts= Basic reasoning
Constraints: Materiality and Cost/Benefit
Relevance: Predictive Value, Feedback Value, Timeliness
Reliability: Neutrality, Representational Faithfulness, Verifiability
Comparability and Consistency
Financial Statements: Balance Sheet, Income Statement, Comprehensive Income,
Statement of Cash Flows, Changes in Owners’ Equity
Assumptions: Entity, Going Concern, Monetary Unit, Periodicity, Historical Cost,
Revenue recognition, Matching, Accrual Accounting, Full Disclosure, Conservatism
Elements: Comprehensive Income (NI+PUFE), Revenue, Expenses, Gains, Losses,
Assets, Liabilities, Equity, Investments by owners, Distributions to owners
Present Value Measurement: Future cash flow, timing variations, time value of money,
uncertainty, other

Reporting Net Income

IDEA: Income from continuing operations (gross), Income from discontinued operations
(net), Extraordinary items (net), Cumulative effect of change in accounting principle (net)
(reported on retained earnings statement)
Single Step: total expenses subtracted from total revenues
Multiple Step: Operating revenues and expenses are separate from non operating
revenues and expenses and other gains and losses

Discontinued
Held for sale= plan to sell, immediate sale, active program to locate buyer, sale is
probable within one year, actively marketed, and unlikely that there will be significant
changes.

Extraordinary: unusual and infrequent: natural disasters (depending on location),

expropriation of a plant by the government, prohibition of a product line by a newly
enacted law or regulation, certain gains or losses from extinguishment of long term debt,
provided they are not part of the entity’s recurring operations. Not: gain or loss from sale
of PPE used in business, large writedowns, gain or loss from foreign currency
transactions or translation, losses from major strike, long term debt extinguishments that
are part of a common management strategy

Comprehensive Income=Net income +OCI (Pension minimum liability adjustments,

Unrealized gains and losses (AFS securities), Foreign currency items, Effective portion
of cash flow hedges)
Presentation: 1. Below total NI, 2. In a separate statement of comprehensive income
beginning with NI, 3. In a statement of changes in equity
Accounting Changes and Prior Period Adjustments
Change in Estimate Change in Change in Prior
Accounting Entity Period
Principle Adjustment
(GAAP to
GAAP)
Prospective Retrospective Retrospective Error
Correction
Adjust accounts so Yes No No No
that only current
and subsequent
income statements
will be affected
If comparative FS, No Yes Yes Yes
restate prior period
FS
If not comparative No Yes N/A Yes
FS, restate Retained
Earnings only
Cumulative Effect No Yes No No
of change of GAAP
should be shown in
the Retained
Earnings Statement
of the earliest period
presented as an
adjustment to
beginning retained
earnings
Examples: Change Exceptions:
in lives, adj. of y/e Impracticable
accrual of officers’ (LIFO, treat
salaries, write prospective),
downs, IRS adj., change in
settlement of depreciation
litigation, changes method (treat
in accounting as estimate)
principle that are
inseparable from a
change in estimate

Interim Financial Reporting

Estimate income tax expense using the estimated average tax rate that will apply for the
entire year.
Segment Reporting
Operating segment= engages in business activities from which it may earn revenues and
incur expenses, operating results are reviewed by chief operating decision maker, has
traceable cash flow
Reportable if:
1. 10% Size test
1. Revenue (10% or more of the combined revenue of all operating segments)
2. Reported Profit or Loss (10% or more of the greater of a) combined reported
profit of all operating segments that did not report a loss or b) the combined reported loss
of all operating segments that did report a loss)
3. Assets (assets = 10% or more of the combined assets of all operating segments)
2. 75% reporting sufficiency test= if total external revenue is less than 75% of external
revenue, additional operating segments need to be identified as reportable segments, even
if they don’t meet above tests.

Development Stage Enterprises

Start up costs= expense immediately under GAAP

Fair Value Measurements

Fair value is an exist price, not an entrance price
Principal market= greatest volume or level of activity
Transaction costs are used to determine the most advantageous market (best price if no
principal market), but they are no included in the final fair value measurement.
Valuation Techniques: 1. market approach (uses prices from market transactions
involving identical or comparable a/l) 2. income approach (converts future amounts to
single discounted amount) 3. cost approach (uses current replacement cost)
Hierarchy of Inputs: 1. quoted prices in active markets for identical a/l 2. similar a/l, not
active markets, other observable inputs 3. unobservable assets
Financial 2
Timing Issues: Matching of Rev and Exp, Correcting and Adjusting Accounts
1. Assets
2. Liabilities
3. Revenues: recognize when earned and realized or realizable.
- Sale of product: date of sale;
- others using asset: as time passes;
- performing services: once services are rendered
Exceptions: Deferred credits, installment sales, cost recovery method, nonmonetary
exchanges, involuntary conversions, net method for trade discounts, percentage of
completion contract
4. Expenses
5. Realization= convert to cash
6. Recognition= record in records
7. Matching= recognize expense in same period as related revenue
8. Accrual= record as events occur
9. Deferral= cash is received or expended, but is not recognizable for f/s purposes
10. Accrued assets and liabilities= assets: revenue recognized but not yet paid to entity;
liabilities: expenses recognized but not yet paid by the entity
11. Costs that may be applicable to past, present, or future periods:
a. Expired costs= have no future benefit, expense on income statement (prepaids)
b. Unexpired costs= capitalized and matched against future revenues, if
uncertain expense (deferred charges)

Royalty Income= recognized when earned; earns royalties based on stated percentage of
sales.
Unearned Revenue= recorded as a liability. i.e. rent received in advance
Revenue Recognition when the right of return exists= only recognize if: sales price is
fixed, buyer assumes risks, buyer has paid consideration, sale is substantially complete,
future returns can be reasonably estimated
Franchises
Initial franchise fees= revenue when substantially performed
Continuing franchise fees= revenue when earned
Expense Recognition
Purchased intangible assets= record at cost
Internally developed intangible assets= expense; exceptions: successfully defended legal
fees, registration fees, design costs, other direct costs to secure an asset= capitalize
Amortize assets over period estimated to be benefited.
Amortize patent over shorter of estimated life or remaining legal life
If deemed worthless= expense
If impairment loss= expense
Change in useful life= recalculate amortization
Sale= compare CV to SP= gain/loss
Franchisee
Initial franchise fees= intangible asset and amortize
Continuing franchise fees= expense as incurred
Start up costs= expense
Legal Fees: to obtain= capitalize; successfully defend= capitalize; unsuccessfully
defend= expense
Goodwill:
Cost-FV= goodwill;
The costs for maintaining, developing, or restoring goodwill are expensed.
Internally generated= expensed
R&D Costs:
General rule: expense
Exceptions: PP&E that have alternate future uses: depreciate over useful life (not life of
R&D project); costs undertaken on behalf of others (expense as cost of sales)
Don’t include: routine design changes; marketing research; quality control testing;
reformulation of chemical compound
Computer Software Development
To be sold: technological feasibility= completion of design/ working model
Expense before TF, capitalize after TF
Amortize: greater of: 1. total capitalized amt * (current gross rev/total project gross rev)
or 2. total capitalized amount * (1/estimate of economic life)
Capitalized costs are reported at LCM (M=NRV)
For internal use: Expense before TF, capitalize after TF
Amortize: straight line
If sell later: proceeds should be applied first to carrying amount of the software, then
recognize as revenue
Impairment
Finite life:
Undiscounted future net cash flows – CV= + (no impairment) – (impairment)
Finite and infinite life:
 FV or PV future net cash flows – CV = impairment loss (add cost of disposal if
applicable)
Goodwill Impairment
Reporting unit FV- reporting unit BV= -
Goodwill FV- Goodwill BV= impairment loss

Long-Term Construction Contracts

Completed Contract Method: Contract price- Total costs= Gross profit or loss
Recognize losses in year they are discovered
Percentage of Completion Method:
Step 1: Contract price- estimated total cost= gross profit
Step 2: Total cost to date/ total estimated cost of contract= % of completion (if loss
recognize immediately)
Step 3: Step 1* Step 2= Profit to date
Step 4: PTD at current FYE – PTD at beginning of period= Current year to date GP
Accounting for Installment Sales
Step 1: Sale- CGS= Gross profit
Step 2: Gross profit/ Sale= GP %
Step 3: Sale on installment- ending installment AR= collections * Step 2= GP earned
Step 4: Ending installment AR * Step 2= Deferred GP

Cost Recovery Method

Collections after all costs have been recovered are recognized as profit.

Accounting for Nonmonetary exchanges

Commercial Substance= if future cash flows change as a result of the transaction.
Always recognize gains and losses (FV-BV). Record at FV
Lacking Commercial Substance=
Recognition of gains depends on several factors (realized losses are always recognized)
If boot is paid, no gain is recognized
If no boot is received, no gain is recognized
If boot is received and the boot is less than 25% of the total consideration received, then a
proportional amount of gain is recognized. A ratio of the total boot received divided by
the total consideration is calculated, and that proportion of the total realized gain is
recognized.
If boot is received and the boot equals or exceeds 25% of the total consideration received,
the transaction is viewed as a monetary exchange, and 100% of the realized gain is
recognized.
Record the asset received on the balance sheet at the NBV of the asset surrendered, minus
any boot received on the transaction, plus any gain recognized on the transaction.

Involuntary Conversions= recognize gain/loss

Partnerships
Admission of New Partner
Assets= FV, Liabilities= PV
Creation of New Partnership
1. Exact Method
2. Bonus Method= A+B+C= Balance * interest= C’s capital – Cash= split between
partners
3. Goodwill Method= C/interest= implied value- A+B+C= Goodwill
P&L distribution
Guaranteed payments: bonus, interest, salary= balances, distribute based on ratios= total
distribution
Withdrawal of a Partner
1. Bonus Method= 1. Revalue assets to reflect FV 2. Pay off withdrawing partner
2. Goodwill Method= 1. Revalue assets 2. Record goodwill 3. Payoff withdrawing
partner
Liquidation= pay off creditors then partners’ capital
Financial Reporting and Changing Prices
Historic Cost and Current Cost (appreciation)
Nominal Dollars and Constant dollars (inflation)
Monetary purchasing power Non-monetary holding
Gain/loss gain/loss
Inflation Appreciation
HC/ND No No
HC/CD Yes No
CC/ND No Yes
CC/CD Yes Yes

Purchasing power gains Purchasing power losses

Holding monetary assets During deflation During inflation
Holding monetary liabilities During inflation During deflation

Foreign Currency Accounting

Transactions= buying/selling with a foreign entity to be settled in foreign currency
Translation= conversion of f/s of foreign entity into f/s expressed in $
Remeasurement= restatement of f/s denominated in a foreign currency to the functional
currency prior to the translation process

Method Step 1 Step 2 Plug Reported

Translation I/S @ weighted B/S @ year end Equity: PUFE
average rate; C/S and Accumulated
APIC @ OCI
historical rate;
roll forward
R/E
Remeasurement B/S: Monetary I/S: @ G/L so I/S is at IDEA
@ year end; weighted amount
Nonmonetary average; necessary for
@ historical historical for RE plug
B/S related
accounts

Individual Foreign Transactions

If purchase on credit, at year end compare purchase rate to year end rate; when pay for
goods compare year end rate to current rate.
Financial 3

Marketable Securities:
1. Trading= current; FV; unrealized g/l on I/S; operating or investing
2. Available for Sale= non current; FV; unrealized g/l to OCI (PUFE); investing
3. Held to Maturity= non current; only bonds; amortized cost; investing

Dr. Unrealized loss on security

Cr. Valuation account (fair value adjustment)

Reclassification
From To TRF Acct For Unrealized Holding
G/L
Trading Any other FV It has already been
recorded in income
so no adjustment is
necessary
Any other Trading FV Recognized in
current earnings
Held to Maturity Available for Sale FV Record in OCI
Available for Sale Held to Maturity FV Amortize gain or
loss from OCI with
any bond
premium/discount
amortization

Impairment of Securities
If the decline in FV is other than temporary (permanent), the cost basis of the individual
security is written down to FV as the new cost basis and the amount of the write down is
accounted for as a realized loss and included in earnings.

Sale of Security
Trading: Dr. Cash Cr. Trading Security Cr. Realized gain on trading security (IDEA)
AFS: Dr. Cash Dr. unreal. gain on AFS (PUFE) Cr. AFS Cr. Real. gain on AFS (IDEA)

Income tax effects= when sold

Business Combinations/ Consolidations

Criteria: Consolidate all majority owned subsidiaries to have one management and one
economic entity (over 50% of the voting interest). Do not consolidate when control is not
with owners. Different year ends= ok

Cost Method (do not consolidate) <20%, does not exercise significant influence
Balance Sheet:
Record at cost: Dr. Investment in investee Cr. Cash
Marketable securities- adjust to FV:
For a decrease in FV Dr. unrealized holding losses Cr. Investment in investee
For an increase in FV Dr. investment in investee Cr. Unrealized holding gains
Reduce Investment in Investee for Return of Capital Distributions:
Dr. Cash Cr. Investment in investee
Income Statement:
Record cash dividends from the investee’s earnings and profits. Do not recognize stock
dividends. Dr. Cash Cr. Dividend Income
Distributions that exceed investor’s share of the investee’s RE: Dr. Cash Cr. Investment
in Investee

Equity Method (do not consolidate) 20-50%, exercise significant influence (i.e. largest
shareholder, majority of board) (Beg bal+ investee’s earnings – dividends= end bal)
Balance Sheet:
Record at cost: Dr. Investment in investee Cr. Cash
Increase by the parent’s ownership % of earnings of investee: Dr. Investment in investee
Cr. Equity in investee income
Decrease by the parent’s ownership % of cash dividends from investee: Dr. Cash Cr.
Investment in investee
Decrease by amortize FV>NBV: Dr. Equity in earnings Cr. Investment in investee
Income Statement:
Investee earnings: Dr. Investment in investee Cr. Equity in investee income
Investee cash dividends: Dr. Cash Cr. Investment in investee
Asset amortize FV>NBV: Dr. Equity in earnings Cr. Investment in investee

Goodwill Excess= $ Purchase price

FV X%= $
NBV X%= $

Amortize Asset FV difference over related asset life: (not for land) Dr. Equity in
investee income Cr. Investment in investee

Change from cost method to equity method:

Apply the new method (equity) to the prior period’s old percentage (1-20%)

Consolidated Financial Statements: Control over 50%

Acquisition Method:
Acquisition for cash; Dr. Investment in subsidiary Cr. Cash
Acquisition for parent common stock: (at date transaction closes) Dr. Investment in sub
Cr. CS Cr. APIC
100% of net assets acquired are recorded at FV with any unallocable balance remaining
creating goodwill
When companies are consolidated, the sub’s entire equity is eliminated
FV= Acquisition price= Investment in Sub

Common Stock- Sub (Dr)

APIC- Sub (Dr)
Retained earnings- Sub (Dr)
Investment in Sub (Cr)
Noncontrolling interest (Cr)
Balance sheet of subsidiary is adjusted to FV (Dr)
Identifiable intangible assets of the subsidiary are recorded at FV (Dr)
Goodwill (or Gain) (Dr)

Sub’s Total (100%) FV

Goodwill NCI
Identifiable Intangible Assets FV Investment in Subsidiary (Acquisition
Balance Sheet FV Adjustment Price)
Book Value (CAR)
Dr Cr

Acquisition Date Calculation of CAR:

Reverse the activity in the sub’s RE in order to squeeze back into BV at the acquisition
date: Beg RE + income – dividends= End RE (work backwards from here).

Investment in Sub: Original cost is measured by FV of the consideration given

Direct out-of-pocket costs= expensed
Stock registration and issuance costs are a direct reduction of the value of the stock
issued (Dr. APIC)
Indirect costs= expensed
Bond issue costs= capitalized and amortized.

Step acquisition- Consolidated to deconsolidated

Owner % change Accounting Treatment
Non control Control -Remeasure previously held equity interests
to FV
-I/S reflects adjustment (g/l)
Control  more or less control Equity transaction (no g/l recognition)
Control non control -Recognize g/l of sale
-Remeasure the remaining non-
consolidating interest to FV
-Recognize adjustment to FV on the I/S

Non-Controlling Interest
Reported at FV
Income Statement: The consolidated income statement will include 100% of the sub’s
revenues and expenses (after the date of acquisition). NCI should be allocated within a
sub account of RE.
Balance Sheet: includes 100% of sub’s assets and liabilities. NCI share should be
presented as part of stockholders’ equity= NCI

Balance sheet adjustment to FV, identifiable intangible asset adjustment to FV and

goodwill is recognized for any excess/ negative in gain
B adjust to FV and recalculate depreciation
I adjust to FV; finite life amortize over remaining life; indefinite life do not
amortize
G subject to impairment test or if negative balance record as Gain

Intercompany Transactions
Eliminate 100% for external reporting
Balance Sheet:
- Dr. accounts payable Cr. Accounts receivable
- Dr. Bonds payable Cr. Bonds investment
- Dr. Accrued bond interest payable Cr. Accrued bond interest receivable
- Dr. Dividends payable Cr. Dividends receivable
Income Statement:
Eliminate all intercompany gross profit sitting in ending inventory and fixed assets of
parent or subsidiary

Do not eliminate intercompany accounts if you do not consddolidate

Workpaper elimination entry for intercompany merchandise transactions:

Dr. Intercompany sales
Dr. Retained earnings
Cr. Intercompany CGS (sales= cost + (% above cost* cost)
Cr. CGS (BI+ purchases-EI=CGS * intercompany profit based on markup on selling
price) (markup on selling price= markup on cost/ 1+ markup on cost)
Cr. Ending inventory (EI* markup)

Intercompany bond transactions: if one member of the consolidated group acquires an

affiliate’s debt from an outsider, the debt is considered to be retired and a gain/loss is
recognized.
Dr. Bonds payable
Dr. Premium
Cr. Investment in parent bonds
Cr. Gain on extinguishment of bonds

Eliminate intercompany accounts such as interest expense, interest income, interest

payable, and interest receivable

Eliminate amortization of the discount or premium. The unamortized discount or

premium on the intercompany bond is eliminated.

The elimination for realized but unrecorded g/l on extinguishment of bonds in subsequent
years would be adjusted to retained earnings. NCI would be adjusted if the bonds were
originally issued by the subsidiary.

Intercompany sale of land= intercompany g/l on the sale of land remains unrealized
until the land is sold to an outsider. Dr. intercompany gain on sale of land Cr. Land
Intercompany profit on sale of depreciable fixed assets: unrealized until sold,
recalculate depreciation; Dr. Intercompany gain on sale of machinery Cr. Machinery Cr.
Accumulated depreciation and Dr. Accumulated depreciation Cr. Depreciation expense

Combined Financial Statements/ Push down accounting

Combined financial statements of a group of related companies= companies under
common control or management or unconsolidated subsidiaries

Push down accounting reports assets and liabilities at fair value in separate financial
statements of the subsidiary. In effect, consolidation adjustments are pushed down into
the records of each subsidiary.

Pooling of Interests Method 90%

Acquisition Pooling
FV Assets NBV
FV Liabilities NBV
Parent only Retained Earnings Both
After Acquisition Income Whole year/retroactive
Expense Acquisition Cost Expense
Yes Goodwill No
Yes (1-49%) Minority Interest Yes (0-10%)
Eliminate Investment in Sub Eliminate
Depreciate Asset Adjustment N/A
Amortize Identifiable Intangible N/A
Assets
Impairment Test Goodwill Adjustment N/A
Eliminate Intercompany Transactions Eliminate
Financial 4

Working Capital= current assets- current liabilities (higher WC= lower risk)
Current ratio= current assets/ current liabilities (higher CR= lower risk)
Quick ratio= cash + net receivables + marketable securities/ current liabilities

Current Assets= cash, trading securities, ST investments, accounts and notes receivable,
trade installment receivables, inventories, ST receivables, prepaid expenses, cash
surrender value of life insurance

Current Liabilities= trade accounts and notes payable, current portions of LT debt, cash
dividends payable, accrued liabilities, payroll liabilities, taxes payable, advance from
customers (deferred revenues)

A ST obligation may be excluded from current liabilities and included in non current debt
if the company intends to refinance it on a LT basis and the intent is supported by the
ability to do so as evidenced either by: the actual refinancing prior to the issuance of the
F/S or the existence of a noncancelable financing agreement from a lender having the
financial resources to accomplish the refinancing.

Cash and Cash Equivalents= currency on hand, petty cash, checking accounts, savings
accounts, money market funds deposits held as compensating balances against borrowing
arrangements with a lending institution that are not legally restricted, negotiable paper
Not= CD’s (if original maturity is over 90 days), legally restricted deposits held as
compensating balances against borrowing arrangements with a lending institution.

Restricted cash= cash that has been set aside for a specific purpose.
Unrestricted cash= used for all current operations.

Bank Reconciliations:
Simple Reconciliation: calculate true balance
Deposits in transit: add to bank balance
Outstanding checks: subtract from bank
Service charges: subtract from books
Bank collections: add to books
Errors: read facts
Nonsufficient funds: subtract from books
Interest income: add to books

Reconciliation of cash receipts and disbursements: 4 column approach, need prior month
ending balance as well as present month information

Accounts Receivable
Beginning balance
+ Credit sales
- write offs
- conversion to note
- cash collected
= ending balance

The NRV of accounts receivable is the balance of the accounts receivable account less
receivables that may be uncollectible determined by an aging of year end receivables.

Valuation of accounts receivable with discounts and returns

Discounts (Speed): 2/10, n/30= 2% discount of the sales price if the payment is made
within 10 days. If the discount is not taken, the entire amount is due in 30 days.
Gross Method: records sales without regard to the available discount, if payment is
received within the discounted period, a sales discount contra account is debited. If
payment received after the period, normal entry (Dr. cash Cr. AR)
Net Method: records sales and AR net of available discount, no adjustment needed if
payment is received within the discount period. If payment is received after the discount
period, a sales discount not taken account must be credited.
Sales Returns and Allowances
Goods returned= deductions form AR and sales. Dr. Sales returns (contra sales) Cr.
Allowance for sales returns (contra AR)

Estimating Uncollectible Accounts Receivable

Direct Write Off Method (Not GAAP) Dr. Bad debt expense Cr. AR
Allowance Method (GAAP)
1. Percentage of sales method: income statement approach, emphasizes matching
Beg + C/Y bad debt (% sales) – Write offs = end (plug)
Question will say, company estimates that x% of its sales on credit will not be collected.
Dr. bad debt expense Cr. Allowance for uncollectible accounts
2. Percentage of Accounts receivable at year end method: balance sheet approach
Beg + C/Y bad debt (plug) – Write offs = end (% of AR)
Question will say, company estimates the balance of the allowance account must be x%
of year end AR.
3. Aging of Receivables Method: balance sheet approach, emphasizes asset valuation
Beg + C/Y bad debt (plug) – Write offs= end (per aging)

Bad Debt Expense

Includes the provision made during the period and an adjustment made at year end to
increase/ decrease the balance in the allowance for uncollectible accounts, if needed.

Write Off of a specific account receivable: Dr. Allowance for doubtful accounts Cr. AR
This entry has no effect on NI or on NRV

Subsequent Collection of Accounts Receivable Written Off

1. Direct Write off method; Dr. Cash Cr. Uncollectible accounts recovered
2. Allowance method
Dr. AR Cr. Allowance for uncollectible accounts
Dr. Cash Cr. AR
Pledging (footnote only)

Factoring of Accounts Receivable:; convert receivables into cash

1. Without Recourse= true sale Dr. Cash Dr. Due from Factor Dr. Loss Cr. AR
2. With Recourse= sale or loan

Transfers and Servicing of Financial Assets

Recognize the assets it has control over
Derecognize those assets only when control has been surrendered
Financial Components approach= Assets and liabilities may be divided into many
components that have different accounting methods
Surrender of Control= assets isolated from transferor, transferee has right to pledge,
transferor doesn’t maintain control
Control surrendered- no continuing involvement: entire transfer is recorded as a sale
Control surrendered- continuing involvement: retained interest is on books of t’or
No control surrendered- account for transfer as a secured borrowing with pledged
collateral
Servicing assets and liabilities: amortized in proportion to estimated net servicing
income. FV determined at regular intervals.

Notes Receivable:
Valuation: at present value
Discounting: holder endorses not to third party and receives cash.
1. With recourse: reported on the balance sheet with corresponding contra account
2. Without recourse: true sale; holder assumes no further liability and removed from the
balance sheet

Inventories
1. Retail inventory; finished goods only
2. Manufacturing inventory; RM, WIP, FG

F.O.B. Shipping point (buyer pays all shipping costs, title passes when goods are
shipped)
F.O.B. Destination (seller pays freight out; title passes when buyer receives the goods)

Sales with a right of return: goods should be included in the seller’s inventory, if the
amount of the goods likely to be returned cannot be estimated. If they can be estimated,
the transaction will be recorded as a sale with an allowance for estimated returns
recorded.

Consigned Goods: Seller includes consigned goods in its inventory because title and risk
of loss is retained. Revenue will be recognized when the goods are sold to a third party.

DM=Raw materials (freight in, insurance for goods in transit, storage, import duties,
purchasing department costs, receiving department costs)
DL= labor
OH= indirect costs
Period costs= marketing costs, freight out, re-handling costs, abnormal spoilage, idle
plant capacity costs
Valuation= inventory should be stated at cost.
Exceptions:
1. LCM: conservative
Market value: median of inventory item’s replacement cost, market ceiling, and market
floor
Replacement cost= cost to purchase the item as of valuation date
Market ceiling (NRV, net of discount)
Market floor (NRV- profit margin, based on selling price only)
Then compare median to cost, take lower of 2
2. Precious metals and farm products: value at NRV

Periodic Inventory System: uses purchases, shortages are part of CGS

BI + purchases (net of returns and discounts) = CGAFS – Ending inventory = CGS
Perpetual Inventory System: no purchases, the actual CGS is determined and recorded
with each sale

GAAP Inventory Cost Flow Assumptions:

Specific Identification: The cost of each item in inventory is uniquely identified to that
item. The cost follows the physical flow of the item in and out of inventory to CGS
FIFO: Prices ↑ A= L+E Rev-Exp ↓ = profit ↑ thus tax liability ↑
Periodic= perpetual
Weighted Average: Periodic, total costs of inventory available/ total number of units of
inventory available
Multiply that by CGS units or EI units
Moving Average Method: Perpetual, computes weighted average cost after each purchase
Total amount/ total units= unit cost
LIFO: periodic is NOT the same as perpetual
Prices ↑ A= L+E Rev- Exp ↑= Profit ↓ thus taxes ↓ EI= old, cheap
Better matching
Dollar Value LIFO: Price index= EI at current year cost/ EI at base year cost
Price index* layer added= LIFO layer added
Beginning inventory + LIFO layer added= ending inventory
When the price index is given in the problem, the year end price index is multiplied by
the LIFO layer at the base year cost to calculate the LIFO layer added at dollar value
LIFO
Gross Profit Method: Periodic, used for interim financial statements
Retail Method: Perpetual; records inventory at the retail price and converts the retail price
to GAAP cost through the application of a cost complement percentage.
1. Conventional Retail Inventory Method: approximates the results that would be
obtained by taking a physical inventory count and pricing the goods at LCM. Subtracting
the markdowns from total AFS results in a lower cost complement percentage, which
leads to lower EI. (Computation of the ratio excludes markdowns) (Beginning inventory
is included in the cost to retail ratio calculation)
2. FIFO/ Cost retail inventory method: EI comes from current period purchases, including
markups and markdowns.
3. LIFO: net markups and net markdowns are included in the cost to retail ratio
calculation; beginning inventory is excluded from the cost to retail ratio calculation
4. LIFO/Cost retail: ratio comes from beginning inventory only
5. Dollar value LIFO/ Cost retail: count inventory at year end as retail; convert year end
balance to base year amounts via price indices; compute the yearly increment; convert
each yearly increment from base year amounts to year end prices; convert retail prices to
cost
6. Retail Method: Freight costs are added to the cost of purchases; purchase returns and
allowances are reductions of both the cost and retail amounts; sales returns and
allowances are subtracted from sales; employee discounts are deducted from retail in a
manner similar to sales discounts; shrinkage is the difference between book EI and the
amount per physical count
Relative Sales Value: used when costs cannot be determined individually. Individual
amount/ total amount * purchase price
Disclosures: inventory detail, significant finance arrangements, pledged inventory,
valuation method, cost flow method

Fixed Assets: for use in operations, LT and subject to depreciation, physical

Land, buildings, equipment, accumulated depreciation account (contra asset), fixed assets
are nonmonetary
Valuation: If purchased= historical cost, if donated= fair value
Cost of equipment= invoice price, less cash discounts, add freight in, add installation
charges, add sales and federal excise taxes, possible addition of construction period
interest
Capitalize vs. Expense:
Summary Chart Expense Capitalize Reduce
Accumulated
Depreciation
Additions: Increase Quantity X
Improvement/ Increase Life X
Replacement Increase X
Usefulness
Ordinary Repair: X
Extraordinary Increase Life X
Repair: Increase X
Usefulness

Cost of Land: All costs incurred up to excavation= purchase price, brokers’ commissions,
title and recording fees, legal fees, draining of swamps, clearing of brush and trees, site
development, existing obligations assumed by buyer, costs of razing, less proceeds from
sale of existing buildings, etc, land improvements, Interest costs during construction
period should be added to cost of land improvement based on weighted average of
accumulated expenditures.
Cost of Buildings: Excavation forward= purchase price, repair charges, alterations and
improvements, architect’s fees, possible addition of construction period interest

Basket Purchase: allocate purchase price based on ratio

Fixed Assets Constructed by a company= DM, DL, repairs and maintenance that add
value, OH, do NOT include profit
General rule: interest is expensed as incurred
Exception: Construction period interest should be capitalized
Interest cost: Do NOT capitalize on: inventory routinely manufactured, fixed assets held
before or after construction period, during intentional delays in construction. Do
capitalize on special order goods on hand for sale to customers and during ordinary
delays in construction.

Computing Capitalized Cost

Rule 1: Only capitalize interest on money actually spent, not on the total amount
borrowed
Rule 2: The amount of capitalized interest is the lower of: 1. Actual interest cost incurred,
or 2. Computed capitalized interest (avoidable interest).

Summary Before Construction During Construction After Construction

Borrowed funds Expense Expense Expense
(not used)
Borrowed funds N/A Capitalize Expense
(weighted average
of accumulated
expense
Excess expenditures N/A Capitalize Expense
(weighted average
interest rate)
Disclose: 1. Total interest cost incurred during the period 2. Capitalized interest cost for
the period

Depreciable Assets and Depreciation

If an asset is put in place during the year it requires computing depreciation for a part of
the year rather than the full year.

Component Depreciation: More accurate

Composite (dissimilar assets) or group (similar) depreciation: depreciates entire class
over a single life= more simple. No g/l is recognized when one asset in the group is
retired. Dr. Cash (sp) Dr./Cr. Accum Dep (plug) Cr. Original Cost
Composite rate= annual depreciation/ total cost

Methods
Straight Line: Cost- SV/ Estimated useful life= depreciation per period
Simple, consistent; does not accurately match
Sum of the Years Digits: ex. For 5 years 5+4+3+2+1= 15 in year 2: 4/15* depreciation
base= depreciation
S= N* (N+1)/ 2
Declining Balance: 1/N *2 (double, or 1.5 for 150%) for assets subject to rapid
obsolescence
Constant rate * Cost- AD= annual expense
Ignore salvage value but do not depreciate below this number
Matches costs to revenues; does not reflect changes in activity, complex
Units of Production: Service potential declines with use Cost-SV/estimated units or
hours= rate per hour * # units produced= depreciation expense
Matches costs with revenues, reflects activities; if no activity, no depreciation, can’t be
used for buildings, complex

Disposals:
1. sale of an asset during its useful life: Dr. Cash received from sale Dr. Accumulated
depreciation of sold asset Cr. Sold asset at cost Cr/Dr. the difference is g/l
2. write-off fully depreciated asset: Dr. Accumulated Depreciation Cr. Old asset at full
cost
3. Total and permanent impairment: Dr. Accumulated depreciation Dr. Loss due to
impairment Cr. Asset at full cost
4. Partial impairment: Dr. Loss due to impairment Cr. Accumulated depreciation

Disclosure: Allowances for depreciation and depletion should be deducted from the
assets to which they relate.

Depletion:
Depletion base= cost + development costs to prepare the land for extraction + any
estimated restoration costs - residual value (REAL)
Methods:
Cost: Depletion base/ current estimated recoverable units= cost depletion
Percentage: based on % of sales; can exceed cost depletion; limited to 50% of NI from
the depletion property computed before the percentage depletion allowance.
Unit depletion rate * units extracted= total depletion

Fixed Asset Impairment

The carrying amounts of fixed assets held for use/ disposal need to be reviewed at least
annually
Step 1: Sum of undiscounted expected cash flows < carrying amount= impairment
Step 2:
a. held for use: FV-CV= impairment loss
Original cost- CV= AD to date
Original cost- (AD to date + impairment loss) = New BV
b. Held for disposal: FV- CV= impairment loss + cost of disposal= total impairment loss
Reporting: as a component of income from continuing operations before income taxes
Financial 5

Present Values and Annuities

Concepts:
1. PV of $1= amount to be invested now at a specific interest rate so that $1 can be paid
or received in the future
2. FV of $1= the amount that would accumulate at a future point in time if $1 were
invested now.
3. PV of an ORDINARY annuity (in arrears)= start later= end of the years= current worth
of a series of identical periodic payments to be made in the future
4. FV of an ordinary annuity= sum to be received at some point in the future, of identical
periodic investments made from the present until that future point
5. PV of an annuity DUE (in advance)= start now
6. FV of an annuity due
Annuity= multiple payments or receipts.
Annuity due- 1= ordinary annuity
Periodic payments: beginning= PV annuity due; ending= PV ordinary annuity
Bargain/ guaranteed residual= PV of $1

Accounting for Leases

Rental Sale (in substance)
Lessee Operating Lease Capital Lease
Lessor Operating Lease Sales type or direct
financing type

Operating Leases= rental= no transfer/risk/benefit of ownership

Lessee:
Records rent expense over the lease term
Prepayment= asset (deferred charge)= amortize it
Leasehold improvements:
1. Value of leasehold improvement should be capitalized and added to PP&E
2. Leasehold improvements should be depreciated over lesser of 1) lease life or
2) asset/ improvement life
Rent kicker= period expense
Refundable security deposit= asset until refunded by the lessor
Free or reduced rent consideration= Lessee must take total rent expense to be paid for the
entire lease term and divide it evenly over each period
Lessor:
The cost of the property is included in PP&E
Depreciate over the asset’s useful life
Rental income= use straight line
Security deposits:
1. Nonrefundable= deferred by lessor and capitalized by lessee until the lessor
considers the deposit earned
2. Refundable= treated as a liability by lessor until deposit is refunded to the
lessee. Lessee treats as receivable.
Revenue is only recognized when the earning process is complete; we never anticipate
revenue.
Temporary Difference: GAAP= report prepaid rental income when earned (tax when
received)
Lease bonus= deferred and amortized over life of the lease
Free or reduced rent consideration= lessor must take total rental income to be received
over the entire lease term and divide it evenly over each period.

Capital Leases= purchase/ ownership

Lessee:
Must meet ONE of the following criteria to CAPITALIZE:
Ownership transfers at end of lease (keep forever); capitalized cost= PV of payments and
required buyout
Written option for bargain purchase (legal transfer of title keep forever); capitalized
cost= PV of payments and bargain buyout
Ninety (90%) percent of leased property FV<PV of lease payments (treat like it’s yours);
capitalized cost= PV of payments
Seventy-five (75%) percent or more of asset economic life is being committed in lease
term (treat like it’s yours during period); capitalized cost= PV of payments

Recording:
Capitalized Amount
The lessee records the lease as an asset and a liability at the lesser of: 1) FV of the asset at
the inception of the lease or 2) Cost= PV of the minimum lease payments
Includes: required payments bargain purchase option, guaranteed residual value
Excludes: Executory costs, optional buyout
Interest rate
Lessee uses incremental borrowing rate, determined as the lesser of: 1) rate implicit in the
lease or 2) rate available in the market to the lessee
Formula for depreciation:
Capitalized lease assets Less salvage value = Depreciable Basis / periods of benefit=
Depreciation Expense per period
O/W=depreciate over asset life N/S= depreciate over lease life

Lease Amortization- Liability and Asset on Lessee’s Books

Date (1) Annual (2) Interest on (3) Reduction (4) Carrying
Lease Payment Unpaid of Lease Amount of
Obligation Liability ((1)- Lease
(%*(4)) (2)) Obligation
Year 0 - - - Lesser of FV or
PV of minimum
lease payments
Year 0 Amount per yr - 1-2 4-3
Year 1 Same as above %*4 1-2 4-3

Asset Retirement Obligation: (ARO)

For lessees: If ARO is included in minimum lease payments, no separate accounting. If
ARO is imposed otherwise, then ARO accounting applies
For lessors: ARO accounting applies
ARO Accounting:
Initial B/S recognition: Dr. asset retirement cost Cr. ARO
Period to period I/S: depreciate expense and accretion expense
If reasonable estimate of FV can be made use FV
If reasonable estimate cannot be made liability will be recognized when it can be
Period to period changes in the ARO liability result from passage of time and revisions in
timing or estimated cash flows (upward= current rate; downward= historical rate)

Disclose everything

Summary of Lessee Capitalization Rules

Capitalize: as PP&E, the leased asset at lesser of:
1. Cost (PV of future lease payments + guaranteed residual and Bargain purchase option
exclude executory cost= insurance, taxes, and repair & maintenance) Discount rate:
incremental borrowing rate is lesser of implicit rate or rate available in market
2. FV (given)

Lessor:
Must meet all 3 of the following criteria to be classified as sales type or direct financing
Lessee “OWNS” the leased property (meets 1 of the 4 lessee’s criteria)
Uncertainties do not exist regarding any unreimbursable costs to be incurred by lessor
Collectibility of the lease payments is reasonably predictable
Sales Type Lease: 2 profits= gain on sale and interest income
Direct Financing Lease: 1 profit= interest income

Recording Sales type:

Gross investment= Lease payment + unguaranteed residual value
Net investment= Gross investment * PV
Unearned Interest revenue= Gross investment – Net investment
Cost of goods sold= Cost of asset- PV unguaranteed residual value
Sales revenue= PV of minimum lease payments: includes guaranteed RV but not
unguaranteed RV
Cost+ profit= PV=SP=FV
Recording Direct Financing Lease:
PV= Carrying amount of receivable= cost of asset sold

Sale-Leaseback
Profit/loss is deferred and amortized
Operating Lease Excess Profit: Sales price- Asset NBV= Tentative gain – PV min. lease
payments= excess gain
Capital Lease Excess Profit: Sales price- Asset NBV= tentative gain – leaseback asset=
Excess gain
Leaseback asset= lesser of 1) FV of leased property or 2) the PV of minimum lease
payments

Rights to Remaining Use of Property Retained by Seller-Lessee:

1. Substantially All rights retained (greater than 90%)= major= PV is =/> 90% of FV=
capital leases.
2. Rights Retained are less than substantially all but greater than minor (between 90-
10%)= middle= PV is less than 90% FV but greater than 10% FV of property at the lease
inception= capital or operating, depending on criteria.
3. Minor portion of rights retained by seller-lessee (Less than 10%)= minor= PV is less
than 10% of FV of property or lease period is 10% or less of asset’s remaining life=
operating leases.
Capital Leaseback= any g/l on sale is deferred and amortized in proportion to
amortization of the leased asset. Deferred gain= unearned profit on sale-leaseback.
Unearned profit on sale leaseback= valuation account
Operating Leaseback= any g/l is deferred and amortized in proportion to the gross rental
expense over the life of the lease. Deferred gain= unearned profit. Unearned profit=
deferred credit in B/S

Major (90% or Middle 90-10% Minor 10% or less

more) (life or sales price)
Gain Defer All (amortize Defer (up to PV of No deferral
over leaseback) leaseback) Gain in
excess= recognize
immediately
Loss (NBV>FV) Recognize Recognize Recognize
(real economic immediately Immediately Immediately
losses)
Other losses Defer all (amortize Defer all (amortize Recognize
(artificial losses) over leaseback) over leaseback) Immediately

Subleases
Lessor classifies in same category as original lease
For lessee: If original lease was operating sub lease is operating
If original lease was capital due to O/W capital lease
If original lease was capital due to N/S operating lease

Investment in Debt Securities

Measured at amortized cost= carrying amount
Bond indenture= contract between issuer and bondholders
Face value= total dollar amount of the bond (basis for periodic interest)
Stated interest rate= interest to be paid to investors, specified in bond contract
Market interest rate= rate actually earned by the bondholder
Treasury bonds= reacquired by issuer
Cost of Investment= 1) PV of principal or 2) Face + PV of series of interest payments to
be received during the term of the bond
PV is calculated based on market rate at date of purchase
Discount= market rate> stated rate. Bonds sell for less than face to make up for lower
return
Premium= market rate < stated rate. Investor will pay more than face due to higher return
offered

Long-Term Liabilities and Bonds Payable

LT liabilities= probable future expenditures associated with current obligations that are
not payable within the current operating cycle or reporting year, whichever is greater.
Debentures= unsecured bonds
Mortgage bonds= secured by real property
Collateral Trust bonds= secured bonds
Convertible Bonds= convertible into common stock of the debtor
1. Nondetachable warrants= bond itself must be converted into capital stock
2. Detachable warrants= bond is not surrendered upon conversion, only warrants
plus cash
Participating Bonds= have stated rate of interest and participate in income if certain
earnings levels are obtained
Term bonds= single fixed maturity date. Entire principal is paid at the end of this period.
Serial bonds= pre-numbered bonds that issuer may call and redeem a portion by serial
number (often redeemed in a series of annual installments)
Income bonds= only pay interest if certain income objectives are met
Zero coupon bonds= sold with no stated interest but rather at a discount and redeemed at
the face value without periodic interest payments
Commodity Backed bonds= redeemable either in cash or a stated volume of a
commodity, whichever is greater.
Bonds payable should be recorded as a LT liability at face and adjusted to the PV of their
future cash outflows by either subtracting unamortized discounts or adding unamortized
premiums.
Coupon rate= stated interest rate
Bond interest= coupon rate* face

When a bond is issued, the price is computed as the sum of the PV of the future principal
payment + the PV of the future periodic interest payment. Both are discounted at the
prevailing market rate of interest
The stated rate of interest is typically printed on the bond, it will not change.
If market rate > stated rate on the bond, the bonds will sell at a discount.
Unamortized Discount is a contra to bonds payable; a direct reduction from face of the
bonds to arrive at CV
Amortization of the discount over the life of the bond, with amortized amounts increasing
interest expense each period.
If market rate < stated interest rate, the bonds will sell at a premium
Unamortized premiums: direct addition to face of the bonds to arrive at bond’s CV
Amortization of the premium: over the life of the bond, with amortized amounts
decreasing interest expense each period.
Carrying value= Face + unamortized premium – unamortized discount
Bond Issue Costs: transaction costs of the bond issue. i.e. legal fees, account fees,
underwriting commissions, printing, etc Record as a deferred charge and amortize from
date of issuance into expense

Methods of Discount and Premium Amortization

Amortize over period bonds are outstanding, not sold
1. Straight line:
Premium or discount/ # of periods bond is outstand= periodic amortization
Interest expense= (face * stated rate)- premium amortization or + discount amortization
2. Effective Interest method:
GAAP interest expense= CV at beginning of the period * effective interest rate
Amortization of discount= GAAP interest – cash paid at the stated rate
Amortization of premium= Cash paid at the stated rate – GAAP interest expense
I/S: Net carrying value * effective interest rate= interest expense
Less: B/S: Bond face * coupon rate= interest paid
= Amortization

Bonds issued between interest dates= the amount of interest that has accrued since the
last interest payment is added to the price of the bond. (If issue on April 1, accrue for 3
months from January to April)
Year End Bond Interest Accrual: When date of scheduled interest payment and year end
do not agree, accrue interest by an adjusting entry on the issuer’s books at year end. Take
into account pro-rated share of discount or premium amortization.
Bond Sinking Funds: A fund that a company contributes money to so that at maturity
they can pay off a liability= non current asset. Only current to extent it offsets current
liability. Use FV of an annuity of $1. Record sinking fund and interest payment to the
fund.
Bond maturity value= periodic payments * FV of an annuity of $1
Serial Bonds:
Alternative to sinking funds. Have principals that mature in installments. PV of each
maturity is calculated separately. When underwriters bid on an entire serial bond issue at
one average interest rate, an average yield can be used for all maturities in the series to
calculate interest expense. 2 methods of amortization: 1. effective interest 2. bonds
outstanding method, like sum of the years digits (premium * fraction of total bonds
outstanding) Interest expense= interest payment- premium amortization

Convertible Bonds: Often issued at more than face because of value of conversion.
1. Book Value Method: no gain or loss recognized. At conversion, bond payable and
premium/discount are written off and CS is credited. APIC is credited for the excess of
the bond’s CV over stock’s par less any conversion costs. 1. Pay accrued interest 2.
amortize bond disc/ prem 3. amortize bond issue costs 4. record difference as APIC

2. Market Value Method: recognize gain/loss. At conversion, bonds payable and related
premium are written off, CS is credited. The credit to APIC is the excess of the market
price of the stock over par. Difference between market value of stock and book value of
bonds is recognized g/l
Bonds Sold with Detachable Stock Purchase Warrants: A conversion feature that is
separate from a security should be accounted for separately, and a value should be
assigned to it= relative FV, credited to APIC- warrants
If FV of only the warrants is known= warrants only method
If FV of both the warrants and bonds are known= market value method
1. Separate warrants from debt at date of issuance of the bonds
2. Allocate amount received upon issuance separately to debt and to the detachable
warrants according to their relative FV at date of issuance. If warrants only method,
allocate the known FV to the warrant, and allocate the remainder of the proceeds to the
debt
3. Amount allocated to warrants is credited to APIC- warrants
4. Any difference between amount allocated to bonds and face is discount or premium on
bonds payable
5. Exercise of the warrants: additional cash is received

Extinguishment of Debt:
Consider extinguished if: debtor pays the creditor and is relieved of its obligation or
debtor is legally released.
In-substance defeasance= arrangement where a company places purchased securities into
an irrevocable trust and pledges them for the future principal and interest payments on its
LT debt. This is not considered extinguished.

1. Adjust items in F/S: bond issue costs, related unamortized disc/prem, difference
between face and reacquisition proceeds
2. Gain/loss= reacquisition price- net carrying amount
Net carrying amount= Face – unamortized discount + unamortized premium –
unamortized issue cost
The g/l can be treated as extraordinary

Troubled Debt Restructurings

Creditor cuts debtor some slack.
Transfer of Assets:
Ordinary g/l= FV asset transferred- NBV asset transferred
Possibly extraordinary gain = (Face of payable + accrued interest) – FV asset transferred
Transfer of Equity Interest:
Possibly extraordinary gain= FV equity transferred – Face of payable
Modification of Terms: Total future cash payments= principal and any accrued interest
Interest Expense: computed by a method that causes a constant effective rate.
Future payments: When total future cash payments are less than the carrying amount, the
debtor should reduce the carrying amount accordingly and recognize the difference as a
gain.
Combination: FV of any asset or equity is used first to reduce CV of payable. Difference
between FV and CV of any assets is transferred and recognized as g/l. No gain on
restructuring can be recognized unless the CV of the payable exceeds total future cash
payments.
Impairment of Loans by Creditors: measured based on PV of expected future cash flows
discounted at the loan’s effective interest rate.
When the creditor receives assets or equity as full settlement of a receivable, they are
accounted for at their FV. The excess of the recorded receivable over the FV of the asset
received is recognized as an ordinary loss.

Liabilities
Current liabilities are valued at settlement values= NRV
Trade Accounts Payable: amounts owed for goods, RM, and supplies that are no
evidenced by a promissory note. Gross: records purchase without regard to discount. Net:
purchases and accounts payable are recorded net of the discount
Dividends Payable: Upon declaration, debit to RE. Upon payment, Debit dividends
payable Cr. Cash
Returnable Deposits: i.e. return of security deposit
Sales and Use Taxes Payable
Property Taxes Payable: accrued prior to receipt of tax invoice and matched in year for
which invoice pertains OR recorded as a payable upon receipt of tax invoice and
expensed in year of receipt.
Accrued Salaries and Wages payable: Unpaid because of pay periods that overlap the
balance sheet date. Accruals are calculated as the ratio of days occurring prior to the B/S
date divided by the total day s in the pay period times the amount of the affected payroll
Payroll Deductions: SS, Medicare, income taxes= withheld from employees out of the
gross pay on their paychecks.
Unemployment taxes and the employer’s share of payroll taxes: should be accrued by the
employer as an expense.
Compensated Absences: accrued if: 1. employee has performed services to which the
vacation or sick pay is attributable; 2. the liability is vested or accumulated; 3. payment is
probable; and 4. the amount can be reasonably estimated.
Employee Bonuses: recorded as an expense and a current liability in the year in which the
services that qualified for the bonus were rendered
One time termination benefits/ contract termination costs: may not be recognized until
the liability is actually incurred. Measured initially at FV on date the liability is incurred.

Imputing Interest on Payables (and Receivables)

Must be recorded at the true PV at the date of issuance. If note is non interest bearing or
rate is unreasonable, the value of the note must be determined by imputing the market
rate of the note and by using the effective interest method. Any discount or premium
resulting from imputing interest on a note must be amortized over the life of the note
using the effective interest method= payment on a note would be divided between an
interest component and principal component. Premium/ discount is inseparable form the
related asset. Discounts/ premiums resulting from imputing interest must not be classified
as deferred charges or credits.

Notes Payable
1. Interest bearing= if at market rate for loans of similar risk: recorded at face, and
interest payable is accrued at stated interest rate. If interest rate varies from market rate:
adjust to true PV and the effective interest method should be used to amortize the
discount.
2. Non-interest bearing= recorded at PV by discounting the face of the note using an
appropriate interest rate and amortizing the difference using the effective interest method.
Financial 6
Pension Plans = an agreement in which the employer provides employees with defined
or estimated retirement benefits in exchange for current or past services.
Accounting for pension plans is concerned primarily with determining the amount of: 1)
pension expense that appears on the sponsor company’s I/S and 2) any related pension
accounts that appear on the sponsor company’s balance Sheet.
Necessary use of estimates and assumptions, which affect the timing and measurement of
pension costs, g/l and liabilities

Types of Plans:
1. Pay-as-you-go: cash basis, not GAAP
2. Terminal funding: lump sum; cash basis, not GAAP
3. Defined Contribution Plan= specifies the periodic amount of contributions to the plan
and the way that the contributions should be allocated to employees. Factors include:
length of service and compensation amounts
4. Defined Benefit Plan= defines the benefits to be paid to employees at retirement.
Factors include: employees’ compensation levels at or near retirement, number of years
of service, number of years until retirement, number of years the plan expects to pay
benefits after the employee retires.

Accumulated Benefit Obligation (ABO): Use current salary

Projected Benefit Obligation (PBO): Use future salary
Vested Benefits: benefits that already belong to employees who have earned their
benefits by reason of having reached retirement age and/or who otherwise meet unique
pension plan requirements.
Prior Service Cost: The cost of benefits based on past service granted for: a) service prior
to the initiation of a pension plan that employees retroactively receive credit for when the
plan is implemented and b) subsequent plan amendment, reflecting new or increased
benefits, that also is applied to service already provided. PSC should be amortized over
the future periods benefited.
Service Cost: PV of all pension benefits earned by company employees in the current
year. Increases the PBO and is unaffected by the funded status of the plan.
Interest Cost: The increase in PBO due to the passage of time. Increases the PBO.
Actual Return on Plan Assets: Returns on all of the assets held by the pension plan.
Calculated based on FV of plan assets at the beginning and ending of the period, adjusted
for contributions and benefit payments (a squeeze).

Income Statement Accounting For The Employer’s Net Periodic Pension Cost
Current Service Cost
Interest Cost
(Expected Return on Plan Assets)
Amortization of prior service cost
(Gain) Loss amortization
Amortization of Existing net obligation or net asset
= Net Pension Expense (current expense)
SIRAGE
TO record the net pension expense on the I/S and record the liability:
Dr. Net periodic pension cost Cr. Pension benefit asset/ liability
Dr. Pension benefit asset/ liability Cr. Cash
Current Service Cost= PV of all benefits earned in the current period
Interest Cost= Beginning of period PBO * discount rate
(Expected Return on Plan Assets)= Beginning FV of plan assets * expected rate of return
on plan assets

Beginning FV of plan assets

+ Contributions
+ Actual return on plan assets (squeeze)
- Benefit payment
= Ending FV of plan assets

Amortization of Unrecognized Prior Service Cost= change in liability/ average remaining

service life
(Gains) or losses (Unrecognized)= arise from difference between expected and actual
return on plan assets and changes in actuarial assumptions
Minimum reportable amount= Unrecognized g/l Less: 10% of PBO or Market related
value (greater)= excess / average remaining service life
Amortization of Existing Net Obligation or Net Asset at Implementation= If PBO>FV=
underfunded, amortization of the difference will increase pension expense
If PBO<FV= overfunded, amortization of the difference will decrease pension expense
PBO- FV= initial unfunded obligation / 15 years OR average employee job life (greater)=
minimum amortization

Accounting for defined benefit pension plans:

- report the funded status of all pension plans on the balance sheet
- recognize changes in the funded status of a pension plan due to g/l, PSC, and
net transition assets or obligation sin OCI in the year the changes occur
- adjust OCI when the g/l, PSC, and net transition assets or obligations are
recognized as components of net period benefit cost through amortization
- measure the funded status of the plan as of the date of the year end statement
of financial position, with limited exceptions

Balance Sheet Reporting for Pension Plans

Funded stats= FV of plan assets- PBO (overfunded= asset, underfunded= liability)
Pension plan asset= noncurrent
Pension plan liability= current, noncurrent, or both
Accumulated OCI
Pension losses, PSC, and net transition obligations will increase pension expense when
recognized for tax purposes. They will result in a deferred tax asset when recorded: Dr.
OCI Dr. Deferred tax asset Cr. Deferred tax benefit- OCI Cr. Pension benefit a/l
Reclassification adjustment: Dr. Net periodic pension cost Dr. Deferred tax benefit- OCI
Cr. Deferred tax benefit- NI Cr. OCI
The beg/ending funded status of a defined benefit pension plan can be reconciled as
follows: Beg funded status + contributions – S – I + R – A+ G – net losses incurred
during the current period= Ending funded status

B/S: Accumulated OCI has unamortized AGE when it is amortized, AGE moves to I/S
which then moves to the liabilities section of the balance sheet and affects NI which in
turn affects RE

Measurement Date: The measurement of the plan assets and benefit obligations of a
defined benefit pension plan must be aligned with the date of the employer’s balance
sheet. EXCEPTIONS: sub with a different year end from parent, measure as of sub’s B/S
date. When a plan is sponsored by an equity method investee that has a different fiscal
year end from the investor’s fiscal year end, then the investee’s plan assets and benefit
obligations can be measured as of the date of the investee’s financial statements used to
apply the equity method.

Settlements: occur when the pension plan assets increase in value to the point that sale of
the pension plan assets allows a company to purchase annuity contracts to satisfy pension
obligations.
Curtailments: events that reduce the expected remaining years of service for present
employees or eliminate accrual of defined benefits for future services of a significant
number of employees
Termination Benefits: arise when employees are paid to terminate their rights to future
pension payments. Lump sum payments + PV termination benefit= special term benefit

Disclosures: Everything, but do NOT 1. repeat information 2. predict/ project good info
Do disclose: reconciliations of beg/end balances; funding and plan assets; components of
net periodic pension cost (SIRAGE + amount of g/l recognized due to a settlement or
curtailment); impact on OCI; rates and assumptions; amortization methods; assumptions
and commitments; termination benefits; disclosure requirements for nonpublic entities

Accounting for Postretirement Benefits other than pensions

Benefits include: health care insurance, life insurance, welfare benefits, tuition assistance,
legal services, day care
Accrual requirement: 1. obligation is attributable to employees’ services already
rendered; 2. employees’ rights accumulate or vest; 3. payment is probable; and 4. the
amount of the benefits can be reasonably estimated.
GAAP Method: cost must be projected and accrued during the period the employee
works= attribution period (date hired to date fully eligible)
Substantive Plan: postretirement plan
Accumulated Postretirement Benefit Obligation (APBO)= PV of future benefits that have
vested as of the measurement date
Expected Postretirement benefit obligation (EPBO)=PV of all future benefits expected to
be paid as of the measurement date= APBO + PV of expected future benefits that have
not yet vested
Income Statement
1. The benefit-years-of-service approach= EPBO is attributed to each year of service in
the attribution period
2. The postretirement benefit obligation is accrued during the period the employee works
(attribution period).

Current Service Cost

Interest Cost (on APBO)= beginning APBO * discount rate, less benefit payments
(Actual Return) (squeeze)
Amortization of PSC= amortization of the cost of retroactive benefits
(Gain) Loss Amortization= result from changes in APBO due to changes in assumptions
or experience
Amortize/ Expense transition amount (net obligation)= APBO- FV= initial unfunded /
(20 years OR average employee job life (greater))= minimum amortization OR expense
full amount
= Net postretirement benefit expense/ cost

Balance Sheet
Funded status= FV- APBO
Postretirement benefit plan asset= noncurrent= overfunded
Postretirement benefit plan liability= current, noncurrent or both = underfunded
Accumulated OCI= companies must report postretirement benefit g/l, PSC, and transition
net assets or net obligations in OCI when incurred.

Disclosures: reconciliations of beg/end balances of the APBO and FV of plan assets;

funded status; components of expense; impact on OCI; assumed discount rate; assumed
healthcare cost trend rate. Do NOT repeat info or predict future contributions

Accounting for Postemployment Benefits= paid by companies to former or inactive

employees during the period after their employment and before their retirement= salary
continuation; severance benefits; continuation of other fringe benefits; job training;
disability related
Criteria: 1. relating to employees’ rights to receive compensation for future absences is
attributable to services already rendered 2. related to rights that vest or accumulate 3.
payment is probable 4. and reasonably estimated. Disclose when all 4 criteria are not met.

Estimated Liability= probable future charge that results from a prior act (warranties,
coupons)= looking forward
Accrued Liability= expense recognized or incurred but not yet paid (accrued interest,
accrued wages, etc)= looking back

Contingencies
Classification:
Probable= record in F/S
Reasonably possible= disclose
Remote= ignore
Loss Contingencies
Probable: Record. Provision should be accrued by a charge to income as long as it is
probable and reasonably estimated
Reasonably Possible: Disclose. Nature and nature of possible loss or range or that
estimate cannot be made
Remote: ignore, unless:
Debts of others guaranteed (officers/ related parties)
Obligations of commercial banks under standby letters of credit
Guarantees to repurchase receivables or (related property) that have been sold or assigned
Unasserted Claims= treat like an other loss contingency
General or Unspecified Business Risks: no loss accrual or disclosure required
Appropriation of Retained Earnings: must be shown within equity section and clearly
identified
Subsequent Events: 2 types: 1. Relates to pre existing event= accrue and disclose 2.
Important new event= disclose

Gain Contingencies
Financial Statements= wait; contingencies are not reflected because this might cause
recognition of revenue prior to its realization
Disclosures= Adequate disclosures should be made of contingencies that might result in
gains, but be careful to avoid misleading implications as to the likelihood of realization.

Contingency Treatments Accrue Disclose Disclose Ignore

Amounts Amount Nature
1. LOSS contingency that is probable and:
a. Amount or range can be reasonably X (or X
estimated minimum)
b. Amount cannot be reasonably X
estimated
2. LOSS contingency that is a reasonable X
possibility
3. LOSS contingency that is remote X
a. but is guaranteed for others X X
4. Gain contingencies that are probable or X X
reasonably possible
5. Gain contingencies that are remote X

Accounting For Income Taxes

Intraperiod Tax Allocation= apportioning the total tax provision for financial
accounting purposes in a period between the income or loss from: IDEA and OCI (PUFE)
and components of stockholders’ equity (RE for prior period adjustments and accounting
principle changes and items of accumulated OCI)
Comprehensive Interperiod Tax Allocation
Current year taxes (payable or refundable) and future year taxes (deferred tax liability/
asset)
B/S liabilities= Owe now + owe later= I/S expense
Differences between pretax GAAP and taxable income:
1. Permanent differences do not affect the deferred tax computation. They do not affect
future financial or taxable income= tax-exempt interest (municipal, state); life insurance
proceeds on officer’s key man policy; life insurance premiums when corporation is
beneficiary; certain penalties, fines, bribes, kickbacks, etc; nondeductible portion of meal
and entertainment expense; dividends-received deduction for corporations; and excess
percentage depletion over cost depletion
2. Temporary differences affect the deferred tax computation. 4 causes:
a. F/S income first, tax return income later future tax liability = installment
sales; contractors account; equity method
b. Tax return income first, F/S income later prepaid tax benefit= prepaid rent;
prepaid interest’ prepaid royalties
c. F/S expense first, tax return expense later future tax benefit = bad debt
expense; estimated liability/ warranty expense; start up expenses
d. Tax return expense first, F/S expense later future tax liability = depreciation
expense, amortization of franchise, prepaid expenses

Comprehensive Allocation
The asset and liability method= B/S approach is required by GAAP
Interperiod tax allocation is applied to all temporary differences.

Accounting for Interperiod Tax Allocation

Total income tax expense or benefit= current income tax expense/benefit + deferred
income tax expense/ benefit

Tax Return Temporary Difference Financial Statement

* Current Tax Rate * Future (enacted) tax rate
Current Liability + Deferred liability = Total Tax Expense
- Deferred Asset

Deferred Tax Liabilities= tax deductible first, financial statement expense later
Tax depreciation > book depreciation addition, because less depreciation will be
deducted on the tax return in future years, compared to the financial statements.

Deferred Tax assets= arise when the amount of taxes paid in the current period exceeds
the amount of income tax expense in the current period. i.e. gift certificates. Subtract

Valuation Allowance (contra account): If it is more likely than not that part or all of the
deferred tax asset will not be realized, a valuation allowance is recognized. The net
deferred tax asset should equal that portion of the deferred tax asset that is more likely
than not to be realized.

Uncertain tax Positions (Fin 48)= aggressive tax positions; uncertainty of the
sustainability of a tax position
Scope= income taxes (not sales or payroll)
Two Step Approach:
Step 1: Recognition of the tax benefit (test more likely than not). The evaluation is based
on the expected outcome in the court of last resort
Step 2: Measurement of the tax benefit (recognize largest amount of tax benefit that has
greater than 50% likelihood of being realized). The evaluation is based on the expected
outcome in a settlement with the taxing authority.

Enacted Tax Rate: used for temporary differences. Do NOT use anticipated, proposed,
unsigned

Treatment of and Adjustment for changes (in future years)

Changes in tax laws or rates are recognized in the period of change (IDEA)

Net Temporary Adjustment (from beginning balance)

Ending balance – current balance= adjustment required

Balance Sheet Presentation= classified based upon what gave birth to it (i.e. deferred
asset related to warranty liabilities is current, deferred tax liability related to asset
depreciation is noncurrent); deferred tax items not related to an asset or liability should be
classified based on the expected reversal date of the temporary difference
All deferred tax assets and liabilities classified as current must be netted and presented as
one amount
All deferred tax liabilities and assets classified as noncurrent must be netter and presented
as one amount

Operating Loss Carrybacks= 100% collectible (no valuation allowance); tax carrybacks
that can be used to reduce taxes due to receive a refund for a prior period are a tax benefit
and should be recognized in the period they occur.
Operating Loss Carryforwards= Valuation allowance may be required
If an operating loss is carried forward, the tax effects are recognized to the extent that the
tax benefit is more likely than not to be realized. Recognized as deferred tax assets in the
period they occur
Deferred tax asset will reduce tax payable in a future period
Tax benefit would reduce the net operating loss of the current period

Investee’s Undistributed Earnings

Income tax return= dividend income
GAAP F/S= percentage of sub’s earnings
Temporary difference: all undistributed earnings will reverse.

Disclosures
B/S: all deferred tax l/a, valuation allowance; net change during year in total valuation
allowance and tax effect of each type of temporary difference and carryforward
I/S: amount of income tax expense allocated to continuing operations and the amounts
separately allocated to other items; significant components of income tax expense
attributable to continuing operations; tax benefits of operating loss carryback or forward;
recognition of income tax expense
Other Liabilities
Premiums: offers to customers for the purpose of stimulating sales. Total number of
coupons issued * Estimated redemption rate= Total estimated coupon redemptions
Warranties: promise to correct any product defects. Sales * total estimated expense= total
liability
Total liability – actual expenditures= balance
Service Contracts: Include cash received prior to the period in which the related expense
occurs= unearned revenue, estimated and accrued in the F/S. When services are
performed, unearned revenue is debited and revenue is credited.
Bonuses: based on company profits. Bonus= % of NI (NI- taxes) Taxes = tax rate (NI-
Bonus)
Bonus= 5 of NI (NI- tax rate (NI-Bonus) Solve for bonus
Compensation for Future Absences Accrued vacation = current salary rate * number of
weeks of accumulated vacation
Dividends Payable classified as current obligations; become a legal liability on the date
dividends are declared
Purchase Commitments Dr. Estimated loss on purchase commitment Cr. Estimated
liability on purchase commitment

Subsequent Events
An event or transaction that occurs after the B/S date but before the F/S are issued.
1. Additional information about conditions that existed at the B/S date. Recognize the
effects of these.
2. Provide information about conditions that occurred after the B/S date and did not exist
at the B/S date. Do not recognize these in the F/S.

Amortization of PSC, g/l, and transition amounts do not affect the PBO in the current
period (even thought they affect pension expense)
Financial 7

Financial Instruments
Types:
Cash, foreign currency, demand deposits; evidence of an ownership interest in an entity
(i.e. stock certificates; contracts which result in an exchange of cash or ownership interest
in an entity (bonds); derivatives (options)

FV disclosures required: in body of F/S or notes; applies to all entities

Disclosures about Concentration of credit risk: Credit risk is the possibility of loss from
the failure of another party to perform according to the terms of a contract. Concentration
of credit risk occurs when an entity has contracts with one or more parties in the same
industry or region. Must disclose.

Disclosure about Market Risk: Market risk is the possibility of loss from changes in
market value; i.e. stock market tanks. Not required to disclose.

Derivative Instruments and Hedging Activities: Derivative instrument= financial

instruments that derives its value form the value of some other instrument and has all 3 of
the following characteristics: 1. one or more underlyings and one or more notional
amounts or payment provisions. 2. It requires no initial net investment 3. its terms require
or permit a settlement

Underlying= specified price, rate (i.e. interest rate, security or commodity price, etc)
Notional amount= unit of measure (currency units, shares, etc) used to calculate g/l
Value or Settlement amount= amount determined by notional amount * underlying
Payment provision= determinable settlement that is to be made if the underlying behaves
in a specified way.
Examples: options, forwards, futures, swaps

Accounting for Derivative instruments including hedges:

Balance Sheet: all derivatives are measured at Fair Value
No hedging designation: gains and losses not designated as a hedging instrument are
recognized currently in earnings
Fair Value Hedge: hedges the exposure to changes in FV of an asset or liability. G/L on
these instruments as well as the offsetting g/l on the hedged item are recognized in
earnings in the same accounting period. (If stock price falls, gain on put option offsets
loss on sale of stock).
Cash Flow Hedge: hedges the exposure to variability in expected future cash flows
attributed to a particular risk. Effective portion  deferred and reported in OCI.
Ineffective potion reported in current earnings
Foreign Currency Hedge: hedges the exposure to variability in foreign currency in a
variety of foreign currency transactions. FV: g/l in earnings; cash flows: g/l effective
OCI, g/l ineffective current earnings; net investment: OCI as part of the cumulative
translation adjustment.
Type of Hedge Instrument Accounting for Changes in FV
No Hedge Designation Included in current earnings
FV hedge Included in current earnings (changes in the
value of the offsetting a/l are also included
in current earnings)
Cash flow hedge:
Effective portion Included in OCI
Ineffective portion Included in current earnings
Foreign exchange hedge:
FV hedge Included in current earnings (changes in the
value of the offsetting a/l are also included
in current earnings)
Cash flow hedge Included in OCI (effective portion)
Net investment hedge Included in OCI, as cumulative translation
adjustment

Stockholders’ Equity
Owners’ claim to the net assets of a corporation. It is generally presented on the statement
of financial position as the last major section.
Capital Stock = the amount of capital that must be retained by the corporation for the
protection of creditors. The par of both PS and CS is legal capital.
Par Value= minimum price stock is to be issued for. Any excess APIC
Authorized Issued and Outstanding: authorized= amount that can legally be issued;
issued= issued; the amount of issued capital stock in the hands of shareholders=
outstanding. Number of shares of each class of stock must be disclosed
Common Stock: basic ownership interest in a corporation. Common shareholders have
the right to vote, the right to share in earnings of the corporation, and the right to share in
assets upon liquidation after satisfaction of creditors’ claims and those of preferred
shareholders.
BV per CS= Common shareholders’ equity/ Common shares outstanding
Total SE – PS outstanding – cumulative preferred dividends in arrears= common SE
Preferred Stock: preferences relating to dividends and liquidation.
Cumulative Preferred Stock: all or part of the preferred dividend not paid in any year
accumulates and must be paid in the future before dividends can be paid to common
shareholders= dividends in arrears. Not a liability, but must be disclosed
Non cumulative Preferred Stock: dividends not paid in any year do not accumulate. The
preferred shareholders lose the right to receive dividends that are not declared
Participating Preferred Stock: First share equally, then pro rate. Fully participating means
that preferred shareholders participate in excess dividends without limit. Partially
participating = participate in excess dividends, but to a limited extent.
Non-participating Preferred Stock: They do not share in excess dividends
Preference Upon Liquidation: PS may include a preference to assets upon liquidation.
Must be disclosed in equity section of the B/S not in the notes
Convertible PS: may be exchanged for common stock (at the option of the stockholder).
Callable PS: may be repurchased at a specified price at the option of the issuing
corporation.
APIC= contributed capital in excess of par. But it can arise from other transactions like
the sale of TS at a gain, quasi-reorganization, the issuance of liquidating dividends,
conversion of bonds and the declaration of a small stock dividend.

RE= accumulated earnings during the life of the corporation that have not been paid out
as dividends.
NI – dividends +/- prior period adjustments +/- accounting changes reported
retrospectively + adjustment from quasi-reorganization = RE

Appropriating retained earnings= disclose to the shareholders that some of the RE are not
available to pay dividends because they have been restricted for legal or contractual
reasons or as a discretionary act of management for specific contingency purposes.

Quasi-reorganization: revises the capital structure of a corporation as though it had been

legally reorganized. If there is a deficit in RE it eliminates that deficit. Revalue assets to
current FVs and liabilities to PVs. Bring RE to zero against APIC. Then RE on B/S must
be dated to show the date of the adjustment and that date must continue to be disclosed.

Accumulated OCI: PUFE, not included in determining NI and do not enter into RE.
Treasury Stock: corporation’s own stock that has been issued to shareholders and
subsequently reacquired. Not considered to be outstanding shares.
2 methods: 1. Cost method: TS are recorded and carried at their reacquisition cost. A g/l
will be determined when the TS is reissued or retired, original issue price and BV of the
stock do not enter into the accounting. APIC is credited or debited when price differs
from original selling price. Losses may also decrease RE if the APIC from TS does not
have a big enough balance. NI or retained earnings will NEVER be increased through TS
stock transactions
Record purchase: Dr. TS Cr. Cash
Record Resale: Dr. Cash Cr. TS Cr. APIC or Dr. Cash Dr. APIC Dr. RE Cr. TS

2. Par Value Method: TS are recorded by reducing the amounts of par value and APIC
received at the time of the original sale.
Record the purchase of TS:
Dr. TS Dr. APIC Dr. RE Cr. Cash or Dr. TS Dr. APIC Cr Cash Cr TS-PIC
Record the resale: Dr Cash Cr. TS Cr. APIC

Retirement of TS Dr. CS Dr. APIC Cr. TS Cr. APIC from TS

Donated Stock: company’s own stock received as a donation from a shareholder. There
is no change in total shareholders’ equity as a result of the donation. Record at Fair
Value. Dr. Donated TS Cr. APIC (no change in total equity)
If sell donated stock: Dr. Cash Dr. APIC Cr. APIC Cr. Donated TS

Accounting for a stock Issuance to Non-employees

Sold above par: APIC will be credited
At par: no entry to APIC
Below par: APIC debited
Stock subscriptions: contractual agreement to sell a specified number of shares at an
agreed upon price on credit. Upon full payment of the subscription, a stock certificate
evidencing ownership in the corporation is issued.
Record subscriptions receivable: Dr. Subscriptions receivable Cr. CS Cr. APIC
Collection of subscriptions: Dr. Cash Cr. Subscriptions receivables
Issuance of stock previously subscribed: Dr. CS subscribed Cr. CS

Stock Rights
Provides an existing shareholder with the opportunity to buy additional shares. Issuance=
memo only
Exercise of stock rights: Dr. Cash Cr. CS Cr. APIC

Other: Stock issued for outside services should be recorded at FV of the stock= trading
price

Distributions to Shareholders= a dividend

Date of declaration= board of directors approves dividend (liability is created and RE is
reduced)
Date of record= no J/E, the date the board of directors specifies as the date the names of
the shareholders to receive the dividend
Date of payment= the date on which the dividend is actually disbursed by the corporation
(Dr. Dividends payable Cr. Cash)

Cash Dividends= distribute cash to shareholders; paid from RE

Property Dividends= distribute non-cash assets. On date of declaration, the property to be
distributed should be restated to FV and any g/l should be recognized in income. The
dividend liability and related debit to RE should be recorded at the FV of the assets
transferred
Scrip Dividends= notes payable
Liquidating Dividends= occur when dividends to shareholders exceed RE; reduce total
PIC
Stock Dividends= no dividend income reported by investor.
Small stock dividend <20-25% reduces retained earnings by FMV
Large stock dividend >20-25% reduces RE by par value of stock
Stock dividends on TS= only done if the company is maintaining a ratio of TS to shares
outstanding in order to meet certain commitments

Stock Splits= No J/E, no change in total BV of the shares outstanding, does not affect
RE or SE
Reverse stock splits= involve reducing the number of shares outstanding and increasing
the par value proportionately.
Stock splits on TS= not usually applied but done when maintaining a ratio of TS to shares
outstanding in order to meet stock option or other commitments.
Disclosure= for all entities; rights and privileges; # shares authorized, issued and
outstanding; liquidation preference of preferred stock; redeemable by issuer

Accounting for stock issued to employees:

1. Non Compensatory stock option: no J/E until options exercised, upon exercise: Dr.
Cash Cr. CS Cr. APIC
Substantially all full time employees meeting limited employee qualifications; stock is
offered to eligible employees equally; time permitted to exercise the rights is limited to a
reasonable period; any discount from the market price is no greater than would be a
reasonable offer of stock to shareholders or others.
2. Compensatory stock option/ purchase plans: given stock options in lieu of cash.
Valued at the FV of the options issued.
Option price: price at which the underlying stock can be purchased pursuant to the option
contract
Exercise date: date by which option holder must use the option to purchase the
underlying
FV: determined by an economic pricing model
Grant date: date the option is issued
Vesting period: the period over which the employee has to perform services in order to
earn the right to exercise the options. Compensation is recognized over the service
period.
Compensation expense=Compensation expense, calculated on the grant date of the
options is allocated over the service period.
Compensation cost= should be recognized as an expense over the periods of employment
attributable to the option. Dr. Compensation Expense Cr. APIC- Stock options = to
allocate. To exercise: Dr. Cash Dr. APIC- Stock options Cr. CS Cr. APIC

Expiration of Options= requires a reclassification of the remaining balance in the APIC-

SO account. Dr. APIC-SO Cr. APIC- expired SO

Stock Appreciation Rights (SARS)= Incentive where officers are given cash if the stock
price increases above a hurdle price. This excess * number of rights outstanding is the
compensation expense of the corporation. Dr. Compensation expense Cr. Liability for
SAR plan
Exercise: Dr. Liability for SAR plan Cr. Cash

Earnings Per Share: required for all public entities to present EPS on the face of the I/S
Simple capital structure= Basic EPS only= no options, warrants, convertible PS, or
convertible bonds
Basic EPS= Income available to common shareholders/ Weighted average number of
common shares outstanding
Income available to common shareholders= NI- preferred dividends
NI less 1) dividends declared in the period on non-cumulative preferred stock (regardless
of whether they have been paid) and 2) dividends accumulated in the period on
cumulative preferred stock (regardless of whether they have been declared)
WACSO: Shares sold or reacquired during the period should be weighted for the portion
of the period they were outstanding.
Shares outstanding at the BEGINNING of the period
+ shares sold during the period
-Shares reacquired during the period
+ stock dividends and stock splits
-reverse stock splits
= WACSO

Stock dividends and stock splits: must be treated as though they occurred at the beginning
of the period. The shares outstanding before the stock dividend or stock split must be
restated for the portion of the period before the stock dividend/split.

Complex Capital structure= basic and diluted EPS= when an entity has securities that
can potentially be converted to CS and would therefore dilute EPS. Convertible
securities; warrants and other options; contracts that may be settled in cash or stock;
contingent shares
Diluted EPS= Income available to CS shareholder + interest on dilutive securities/
WACSO

Dilution from Options, Warrants, and their equivalents

The TS method assumes that the proceeds from the exercise of stock options, warrants
and their equivalents will be used by the company to repurchase treasury shares at the
prevailing market price.
Options and similar instruments are only dilutive when the average market price of the
underlying CS exceeds the exercise price of the option or warrants.
Dilutive= Average price > option price
Antidilutive= Average price < option price  not exercised; out of the money

Number of shares – ((number of shares * exercise price)/ average market price)=

additional shares outstanding (add to WACSO)

Dilution from Convertible Securities (bonds or preferred stock)

The “if converted” method assumes that the securities were converted to CS at the
beginning of the period.
Convertible Bonds:
Add to the numerator the interest expense, net of tax
Add to the denominator the number of CS associated with the assumed conversion
If the convertible bonds were issued during the period assume the stock was issued at that
date for the weighted average calculation
Anti-dilution= use the results of each assumed conversion only if it results in diluation.
Do not include the results of the assumed conversion if it is antidilutive. Basic < Dilutive
means that the bonds are antidilutive and would be excluded.
Convertible Preferred Stock
Just net income
Adjust the numerator (no Preferred dividends)
Add to the denominator the number of shares associated with the assumed conversion
Antidilution rules apply

Disclosures: cash flow per share should not be reported

Weighted Options and Convertible Convertible Contingent

Average Warrants Bond PS Issues
Basic Yes N/A N/A N/A Conditions
have been
fully
satisfied
Diluted Yes Average Any dilutive Any dilutive Based upon
market value If Converted If Converted conditions
> exercise Method Method having been
price “Pretend” “Pretend” met to date
TS Method Adjust Ni Do NOT
“Pretend” for interest reduce
Repurchase expense (not NIAT by the
common incurred) preferred
stock at the reduced by stock
average taxes dividend
price (pretend
they are
converted)

Statement of Cash Flows

Required for all business enterprises. The purpose of the statement of cash flows is to
provide information about the sources of cash and cash equivalents and the uses of cash
and cash equivalents.
3 Categories: Operating, investing, financing

Cash and cash equivalents: Cash= Cash; Cash equivalents= ST, liquid investments

Methods:
Direct: Shows major classes of operating cash receipts and disbursements. A
reconciliation of net income to net cash flows from operating activities is required to be
provided in a separate schedule
Indirect: adjusts net income to reconcile it to net cash flows from operating activities

Operating: CA- other than cash and cash equivalents and CL other than notes, bonds, etc.
=working capital
Direct: reconciliation will appear in a separate schedule to the statement (as opposed to
the body of the formal statement); major classes are presented in their gross amounts and
totaled to arrive at net cash flow provided by operating activities.
Categories: 1. Cash received from customers (increases cash) 2. Interest received
(increases cash) 3. Dividends receipted (increases cash) NOTE: dividends paid=
financing 4. Other operating cash receipts such as the receipt of insurance proceeds and
lawsuit settlements (increases cash) 5. Cash received from the sales of securities
classified as trading securities, if appropriate, based on the nature and purpose for which
the securities were acquired (increases cash) 6. Cash paid to suppliers and employees
(decreases cash) 7. Interest paid (decreases cash) NOTE: paying off principal is financing
8. Income taxes paid (decreases cash) 9. Cash paid to acquire securities classified as
trading securities, if appropriate, based on the nature and purpose for which the securities
were acquired (decreases cash) 10. Other operating cash payments (decreases cash)

Cash Collections= cash from current year’s sales and cash collected from prior yr’s sales
Sales to customers
- increase in receivables
+ Decrease in receivables
+ increase in unearned revenue
- decrease in unearned revenue
= cash collections

Cash sales plus: T account for AR:

Beg Write offs
Credit Sales Cash Collected (plug)
End

Cash Paid to Suppliers and Employees:

CGS
+ Increase in inventory
- Decrease in inventory
+ Expenses
+ Increase in prepaid
- Decrease in prepaid
- Increase in accounts payable or other liability
+ Decrease in accounts payable or other liability
= Cash paid to suppliers and employees

Step 1: BI + purchases= AFS – EI = CGS

Step 2: Cash purchases plus: T account for AP
Cash Paid Beg
Credit purchases
End

Indirect:
Net income is adjusted to arrive at net cash flows from operating activities. Supplemental
disclosure of cash paid for interest and income taxes is required.
The adjustment to net income is performed by removing the effect on NI of: deferrals of
past operating cash receipts and disbursements; accruals of expected future operating
cash receipts and disbursements; all items that are included in net income that do not
affect operating cash receipts and disbursements

NI
+ depreciation and amortization
+ losses (Sales)
- gains/ amortization premiums
- undistributed earnings of affiliate
+ decrease in CA
- Increase in CA
+ increase in CL
- Decrease in CL
= Cash flows from operating activities

An increase to an asset or a debit balance account will have the effect on the statement of
cash flows as a decrease to cash (indirect effect) (accounts receivable)
A decrease to an asset of a debit balance account will have the effect on the statement of
cash flows as an increase to cash (indirect effect) (inventory)
An increase in a liability, an equity, or a credit balance account will have the effect on the
statement of cash flows as an increase to cash (direct effect) (accounts payable)
A decrease in a liability, an equity, or a credit balance account will have the effect on the
statement of cash flows as a decrease to cash (direct effect) (allowance for doubtful
accounts)

Changes in debit balance accounts will have the opposite effect on cash flows (because
cash is a debit balance account).
Changes in credit balance accounts will have the same effect on cash flows

Increase Decrease
Current Assets Subtract Add
Current Liabilities Add Subtract

Gains and losses:

Gains are adjusted out of the operating activities section into the investing activities
section by subtracting their effects from NI
Losses are adjusted out of the operating activities section and into the investing activities
section by adding their effects to NI
Cost- AD= NBV
SP- NBV= gain/loss

Investing Activities
Making loans to other entities (cash outflow)
Purchasing (cash outflow) or disposing of (cash inflow) trading securities, available for
sale securities and held to maturity investment securities of other entities
Acquiring (cash outflow) or disposing of (cash inflow) PP&E
Non current assets: increasing buy- outflow; decreasing sell- inflow

Financing Activities
Principal on notes, bonds, mortgages; your own stock; pay dividend
Owner oriented activities= obtaining resources from owners, such as issuing stock
(inflow); providing owners with a return on their investment, such as paying dividends or
repurchasing stock (outflow)
Creditor oriented activities= obtaining resources from creditors, such as issuing bonds,
notes, and other borrowings (inflow); payments of principal (not interest, which is part of
the operating activities section) on amount borrowed (outflow)

Non-Cash Investing and Financing Activities:

Information about material non cash financing and investing activities should be provided
separately in a supplemental disclosure. Any part of the transaction that does involve cash
would be included in the statement of cash flows. Ex. Purchase of fixed assets by
issuance of stock; conversion of bonds to equity; acquiring assets through the incurrence
of a capital lease obligation; exchange of one non-cash asset for another non-cash asset

Ratio Analysis
Liquidity ratios measure a firm’s ST ability to pay maturing obligations.
Activity ratios measure how effectively an enterprise is using its assets
Profitability ratios are measures of the success or failure of an enterprise for a given time
period.
Investor ratios measure interest to investors
LT debt paying ability= coverage ratios= measures of security for LT creditors/investors

Liquidity:
Working capital= CA- CL
Current ratio= CA/CL
Acid test ratio= Cash equivalents + marketable securities + net receivables/ CL
Cash ratio= cash equivalents + marketable securities/ CL

Activity:
Accounts receivable turnover= net credit sales/ Average net receivables
Accounts receivable turnover in days= 365/accounts receivable turnover
Inventory turnover= CGS/ average inventory
Inventory turnover in days= 365/ inventory turnover
Operating cycle= AR turnover in days + inventory turnover in days
Working capital turnover= sales/ average working capital
Total asset turnover= net sales/ average total assets

Profitability:
Net profit margin= NI/net sales
Return on total assets= NI/ average total assets
DuPont return on assets= Net profit margin * total asset turnover
Return on investment= NI + interest expense (1-tax rate)/ average (LT + equity)
Return on common equity= NI- preferred dividends/ average common equity

Coverage:
Debt/Equity= total liabilities/ common stockholders’ equity
Debt ratio= total liabilities/ total assets
Times interest earned= recurring income before taxes and interest/ interest
Operating cash flow/ total debt= operating cash. Total debt
Financial 8

Governmental Accounting
Resources= governmental entities often derive their revenues from taxes or answer to
public authorities, not for profit entities often derive their income from contributions or
fees and are not taxable and commercial entities usually derive their income from sales or
fees and are usually taxable.

Objective= demonstrate operational accountability for the entity taken as a whole and
their fiscal accountability for specific funding
F/S: 1. timeliness 2. consistency 3. comparability

Purpose= fund accounting enables service and mission-driven organizations to easily

monitor and report compliance with spending purposes (fund restrictions), spending
limits (budget), and other fiscal accountability objectives

Governmental Accounting Principles and Standards are Established by:

The Governmental Accounting Standards Board (GASB)= governmental counterpart to
FASB
Not-for-profit organizations, accounting principles and standards are established by
FASB
The Government Accountability Office (GAO) governs audits under the federal “Single
Audit Act”.

Fund= sum of money or other resource segregated for the purpose of carrying on a
specific activity or attaining certain objectives in accordance with specific regulations,
restrictions or limitations and constituting an independent fiscal and accounting entity.
Each fund is a self-balancing set of account. =like a checkbook

Fund Structure: fund financial statements should be separately presented for:

1. Governmental funds
2. Proprietary funds
3. Fiduciary funds
To report additional and detailed information about the primary government

External reporting: government-wide presentations (consolidated F/S) uses full accrual

accounting, economic resources measurement focus. Major fund F/S= like segment
reporting; presented using the basis of accounting and measurement focus unique to each
category of fund. Reconcile these 2 F/S
Fiduciary funds are excluded from the government-wide presentation.

Governmental funds: modified accrual accounting; current financial resources

measurement focus; no profit motive
1. General Fund: set up to account for the ordinary operations of a governmental unit
that are financed from taxes and other general revenues. Current (no fixed assets or LTD)
2. Special Revenue Funds: set up to account for revenues from specific taxes or other
earmarked sources that are designated to finance particular activities of government.
3. Debt Service Funds: set up to account for the accumulation of resources and the
payment of interest and principal on all general obligation debt other than that serviced
by enterprise funds or by special assessments in another fund.
4. Capital Projects Funds: set up to account for resources used for the acquisition or
construction of major capital assets by a governmental unit, except those projects
financed by an enterprise fund or by a special assessment.
5. Permanent Fund: used to report resources that are legally restricted to the extent that
income and not principal, may be used for purposes that support the reporting
government’s programs (i.e., for the benefit of the public)

B/S= CA-CL= Fund balance

Only current; no fixed assets; no noncurrent liabilities
I/S= Statement of Revenues, Expenditures, and Changes in Fund Balance= Rev-Exp+
Other financing sources (uses)= Net change in fund balance
Revenue is recognized when measurable and available to finance the expenditures of the
current period. Available= collectible within the current period or within 60 days after
year end
Expenditures are recorded when related fund liability is incurred
GRaSSP

Proprietary Funds: treat like customer/ not citizen; full accrual; economic resources
measurement focus
1. Internal Service Funds: set up to account for goods and service provided by designated
departments on a fee basis to other departments and agencies within a single
governmental unit or to other governmental units i.e. central motor pool or building
maintenance department
2. Enterprise Funds: set up to account for the acquisition and operation of governmental
facilities and services that are intended to be primarily (over 50%) self-supported by
user charges i.e. utilities, airports, transit systems. Required when: 1. activity is financed
by debt secured by a pledge of fee revenue, 2. laws require collection fees adequate to
recover costs, or 3. Pricing policies are established to produce fees that recover costs.

B/S= Statement of net Assets= All assets- All liabilities= Net Assets
All assets and liabilities; fixed assets; non current liabilities are reported
I/S= Statement of Revenues, Expenses, and Changes in Fund Net Assets= Operating
revenue- Operating expenses+ Non-operating revenue (expenses)= change in net assets
Revenue is recognized when earned; expenses when incurred
SE

Fiduciary Funds: trust accounts; full accrual; economic resources measurement focus
1. Pension Trust Funds: account for resources of defined benefit plans, defined
contribution plans, post retirement benefit plans, and other LT employee benefit plans
2. Agency Trust Funds: account for resources in the temporary custody of a
governmental unit (e.g. taxes collected for another governmental entity)
3. Private Purposes Trust Funds: designated funds for all other trust fund arrangements
under which principal and income are for the benefit of specific individuals, private
organizations, and other governments. i.e. escheat property= property that has been
forfeited as a result of the passage of time or process of law
4. Investment Trust Funds: account for external investment pools

B/S= Statement of Fiduciary Net Assets= All Assets- All Liabilities= Net Assets
All assets and liabilities; fixed assets; non current liabilities are reported
I/S= Statement of Changes in Fiduciary Net Assets= Additions- Deductions= Change in
Net Assets
Revenue is recognized when earned; expenses when incurred
PAPI

MAC-GRaSPP
SPACE (C= carry fixed asset and LTD)

GRaSPP: Modified Accrual Accounting

No profit motive no I/S no matching  no accrual  use modified accrual
= Budgetary (emphasized in order to control spending); Activity (emphasizes flow of
current financial resources); Encumbrances (used to record purchase orders)
Book and close for same amount each period

Budgetary Accounting:
Revenue: taxes- income and sales; taxes- property and real estate; fines and penalties
Other Financing Sources: Debt proceeds (bonds and notes); interfund transfers
Journal Entries: Budgetary accounts are estimated accounts; posted twice during the year
Dr. Estimated revenue control
Dr. Estimated transfers from other funds (transfer in)
Dr. Budgetary fund balance (negative/ deficit)
Cr. Appropriations control
Cr. Estimated transfers to other funds (transfer-out)
Cr. Budgetary fund balance (positive/surplus)
End of the year the budget is reversed and closed, for the same amount

Activity:
Revenue: recorded when measurable and available.
Billed/Recorded= Revenue (Real estate taxes; fines and penalties)
Received= Revenue (income taxes, sales taxes)
Earned= Revenue; deferred revenue when collected (real estate taxes paid in advance;
restricted grants)
Expenditures: Both capital purchases and operating expenditures are considered spending
of funds and are treated as expenditures.
To record the purchase of a capital item: Dr. Expenditure Cr. Vouchers Payable
2 Alternatives for expenditure recognition: Purchase method (expenditure current assts
when purchases; reverse for items still on hand at end of period) and Consumption
method (set up as a current asset when purchased; expenditure items as consumed)

Purchase Consumption
Buying item Dr. Expenditure Cr. Dr. Supplies inventory Cr.
Vouchers payable Vouchers payable
Use of item No entry Dr. Expenditure Cr.
Supplies inventory
On hand at year end Dr. Supplies inventory Cr. No entry
Reserve for supplies

Transfers between Funds= not an expenditure, but represent the use of financial
resources.
Classification of governmental expenditures: within the fund, the expenditures are further
classified as:
1. Function or Program: overall purpose of the expenditures (i.e. public safety)
2. Organizational Unit: corresponds to the organizational structure of the governmental
entity. (i.e. police department)
3. Activity: economy and efficiency of operations can be measured at this level (i.e. an
event, task or unit of work)
4. Character: refers to determining the basis of the fiscal period the expenditures are
presumed to benefit. Classifications: 1. current expenditures; 2. capital outlays; 3. debt
service; 4. inter-governmental
5. Object classes: expenditure according to the type of items purchased or services
obtained (i.e. personnel services, supplies, and principal and interest pmts for debt service
expenditures)

Fixed Assets: not capitalized on the fund’s books. Considered an expenditure of the
funds. The fixed assets are reported on the government wide financial statements. Dr.
Expenditure Cr. Vouchers payable
SE-PAPI funds will capitalize fixed asset acquisitions and depreciate them consistent
with the economic resources measurement focus

Debts: Recorded in the governmental funds as Other Financing Sources, do not record or
carry the LTD. The LTD is recorded on the government wide financial statements. Dr.
Cash Cr. Other financing sources
The debt service fund will pay the currently due interest and principal
SE-PAPI funds record LTD consistent with the economic resources measurement focus,
and will directly pay the interest and principal

Encumbrances:
Obligations to spend (purchase orders); prevents overspending of appropriations
Set up: Dr. Encumbrances Cr. Reserve of encumbrances  reverse when actually spend
and record actual expenditure with Dr. Expenditure Cr. Vouchers payable
Not used for recurring expenditures
If an encumbrance is still outstanding at year end and appropriations do not lapse: Dr.
Reserved for encumbrance Cr. Encumbrances. Outstanding encumbrances at year end
will be carried forward as a reserve of fund balance with a corresponding reduction of
unreserved fund balance, if the appropriations do not lapse: Dr. Unreserved fund balance
Cr. Fund balance reserved for encumbrances

In the following year, the use of these amount will be recorded as an expenditure of the
prior year: Dr. Expenditure- p/y Cr. Vouchers payable

General Fund:
Revenue:
1. Taxes: property taxes; franchise and public service taxes
2. Public safety and regulation: fees and fines; license and permit revenue
3. Intergovernmental: shared or grant revenues from other governments
4. Charges for services: exchange revenues that support general fund activities
5. Other revenues: investment earnings; miscellaneous earnings
Expenditures:
1. General government: administrative functions such as the city manager, finance, etc
2. Public safety: police, fire, jail and building inspections
3. Culture and recreation: parks, libraries, etc
Accounting: Current items only; no fixed assets (expenditure)
Financial Statements: B/S (CA=CL + Fund balance); Statement of Revenues,
Expenditures, and Changes in Fund Balance: no depreciation expense; required
budgetary comparison schedule

Special Revenue Fund:

Account for revenues and expenditures that are legally restricted for specific purposes.
i.e. Sales tax fund, gasoline tax fund, special fees (school programs), admission fees,
parking fees, grant funds (state grants and federal grants)
Revenue:
1. Intergovernmental Revenues: specific taxes and share taxes; grants
2. Fees: fees; other earmarked revenue sources
Expenditures:
Character: current operating expenditures (street maintenance); capital outlays (highway
construction) or both
Function: consistent with the purpose of the revenue
Accounting:
Expendable trusts= principal and income may be expended in the course of their
designated operations so they are depleted by the end of their designated lives; donations
Dr. cash Cr. Revenue (may be donor/grantor/government restricted)
Grants=recipient government monitors and/or determines eligibility (if nonmonitoring=
agency trust fund); recognize revenues and expenditures equally based on payments of
the grantor
Debt Service Fund:
Created to account for accumulation of resources and the payment of currently due
interest and principal on LT general by setting aside cash and cash equivalents. Only pays
off debt of the GRaSPP funds! i.e. central city development debt service fund;
community redevelopment debt service fund; convention center development bond debt
service fund; general revenue bond debt service fund
Revenue:
Resources for new debt are derived from allocated portions of property taxes and
transfers from other funds. Refinanced debt results in proceeds from general obligation
refunding bonds.
To record transfer from general fund: Dr. Cash Cr. Interfund transfers from the general
fund
Any income from the investment of resources: Dr. Cash Cr. Revenue- Investment Income
Expenditure:
Principal and interest on general obligation LTD. When the interest payment is legally
due, the debt service fund recognizes principal and interest expenditures.
To record payment of interest: Dr. Expenditures Cr. Cash
Encumbrances are not used
To record the payment of principal: Dr. Expenditures Cr. Cash
Closing Entries:
To close budget: Dr. Budgetary fund balance Dr. Appropriations Cr. Estimated revenues
control
To close activity for actual amount: Dr. Bond issue proceeds Dr. Transfers from the
special revenue fund Dr. Transfers from the capital projects fund Dr. Other revenue Cr.
Fund balance, reserved for debt service Cr. Expenditures- Interest Cr. Expenditures-
principal
No encumbrances

Capital Projects Fund:

Established for the construction or purchase or leasing of significant fixed assets. The life
of the capital projects fund is short and is limited to a construction period of 1-3 years.
i.e. Convention center construction fund; municipal stadium construction fund; county
courthouse construction fund; construction fund accounting for a special assessment
project
Revenues and Other Financing Sources:
Funded by bond proceeds, transfer from another fund, specific tax revenues or capital
grants. Investment earnings may also appear in this fund although the disposition of those
earnings may be either to retain them in the fund for the benefit of the project or to
immediately transfer them to a debt service fund for the benefit of the bond holders.
1. Investment Earnings
2. Tax Revenues
3. Capital Grants:
Unrestricted Dr. Cash Cr. Revenue
Restricted Dr. Cash Cr. Deferred revenue
Recognize revenue restricted by a cost reimbursement contract Dr. Expenditure
Cr. Vouchers payable AND Dr. Deferred revenue Cr. Revenue
4. General fund transfers (other financing sources): Dr. Cash Cr. Other financing sources
5. Special Assessments: taxes or fees levied against property owners who will directly
benefit from the project
-Primarily or Potentially liable for debt often associated with the assessment: 1.
account for the capital project and debt related transactions through the appropriate
government or proprietary fund 2. If governmental fund debt proceeds associated with
special assessments for which the governmental unit is either primarily or potentially
liable should be classified as contribution from property owners on the operating
statement to distinguish it from bond proceeds; 3. assets and liabilities should be reported
in the government wide financial statements under the governmental or business type
activities column as appropriate
-Not primarily or potentially liable: 1. transactions should be reported in an
agency fund and 2. assets and liabilities should be excluded from government wide
presentations.
6. Bond Issue Proceeds: presented on I/S as other financing sources
To record bond proceeds: Dr. Cash Cr. Other financing sources- bond issue proceeds Cr.
Other financing sources- premium on bonds
To transfer the bond issue premium to debt service fund: Dr. Interfund transfer debt
service Cr. Cash
To record investment in CD: Dr. Investment in CD Cr. Cash
To record interest revenue earned: Dr. Cash Cr. Revenue- interest income
To record the transfer of the interest to the debt service fund: Dr. Interfund transfer to
debt service fund Cr. Cash

Expenditure and Encumbrance Types:

Expenditures are usually entirely classified as capital outlay. During construction,
encumbrances are recorded as commitments are incurred. Vouchers are recorded when a
liability is incurred. As vouchers are recorded, the encumbrance entry is reversed. Cash is
credited and vouchers payable is debited as payments are made
To record several contracts: Dr. Encumbrances Cr. Reserved for encumbrances
To reverse the encumbrances: Dr. Reserved for encumbrances Cr. Encumbrances
To record purchased assets: Dr. Expenditures Cr. Vouchers Payable
To record capital lease equipment: Dr. Expenditures Cr. Other financing sources

To report fixed assets in government wide financial statements:

Purchase= Cost to buy
Construction= cost to construct
Capital lease= PV lease payments
Donated= FMV
Forfeiture= LCM

Unique Accounting Issues:

Bond liability is not recorded in the capital projects fund

Closing Entries:
1. Close budget: Dr. Appropriations Cr. Estimated revenue
2. Actual activity closed: Dr. Other financing sources—bond issue proceeds Dr.
Investment revenue Dr. Other financing sources- bond premium Cr. Expenditures Cr.
Interfund transfers to debt service, investment revenue Cr. Interfund transfer to debt
service, bond premium Cr. Unreserved fund balance
3. Encumbrances closed: Dr. Fund balance reserved for encumbrances Cr. Encumbrances
3b. Outstanding encumbrances at year end: Dr. Unreserved fund balance Cr. Reserved for
encumbrances

Permanent Funds:
Used to report resources that are legally restricted to the extent that only earnings, and
not principal, may be used for the purposes that support the reporting gov’t’s programs
i.e. a public cemetery perpetual care fund
Revenues: include investment earnings from the trust
Expenditures: related to the operating purpose of the fund (e.g. cemetery maintenance)
Accounting: Investments are accounted for at FV

Proprietary Funds
Internal Service Funds
Finance and account for services and supplies provided exclusively to other departments
within a government unit or to other governmental units, typically on a cost-
reimbursement basis. i.e. Central janitorial departments; central garages and motor pools;
central printing and duplicating services; central purchasing and stores departments;
central repair shops; central computer processing department; self insurance
Revenues:
1. Restricted Grant: recognized as revenues in the year monies are spent
2. Operating revenues: recognized when earned Dr. Cash Cr. Billings to other
departments (operating revenue)
3. Non-operating revenues: i.e. interest earnings
Expense Types: 1. Operating 2. Non-operating
Accounting: Accrual; LT liabilities and fixed assets are recorded in the internal service
funds; fixed assets are recorded and depreciated in the internal service funds; no
budgetary accounts or encumbrances are recorded; net assets are classified in a manner
consistent with other proprietary funds and display 3 categories of equity, unrestricted,
restricted, and invested
Establishing an Internal Service Fund:
To record contributions from other funds: Dr. Cash Cr. Interfund transfer
To record sale of general obligation bonds: Dr. Cash Cr. Long term bond payable
To record a long term payable to another fund: Dr. Cash Cr. Due to other fund
Reconciling Item: S is often combined with GRaSPP for purposes of displaying
governmental activities in the government wide financial statements since they are often
set up to primarily service the governmental funds of the government.

Enterprise Fund:
Public utilities; public hospitals; public universities; public transportation systems;
airports; public benefit corporations; dock and wharf facilities; off street parking lots and
garages; public housing; golf courses and pools; lotteries
Revenue:
Must be presented by major source and distinguished between operating and non-
operating.
Operating Revenues: Defined by main purpose of the fund. i.e. charges for services
(water and sewer billings; greens fees) or miscellaneous operating revenues
Non-operating Revenues: Shared revenues= revenues collected by one government and
shared on a predetermined basis with another gov’t; interest and investment income
Expense Types:
Operating expenses= classified by object to include such major categories as Personal
services, utilities, and depreciation
Non-operating expenses= interest expense
Accounting: Record LT liabilities and fixed assets; depreciate; net assets has 3 parts:
Invested, restricted, unrestricted

Order of presentation of line items on a proprietary fun Statement of Revenues,

Expenses, and Changes in Fund Net Assets:
Income
Non-operating income and expense
Capital contributions
Additions to endowments
Special line items (unusual or infrequent)
Extraordinary items
Transfers
INCASET

Establishing an Enterprise Fund:

To record capital contributions: Dr. Cash Cr. Interfund transfers
To record issuance of general obligation bond to be paid from proprietary fund revenues:
Dr. Cash Cr. LT bond payable

Municipal Landfills:
Cost components:
1. Cost of equipment expected to be installed and facilities expected to be constructed
near or after the date that the MSWLF stops accepting solid waste and during the post
closure period
2. Cost of a gas monitoring and collection system
3. Cost of final cover expected to be applied near or after the date that the MSWLF stops
accepting solid waste
4. This estimate should be adjusted annually.

Statement of Cash Flows:

Cash flows from operating activities
Cash flows from noncapital financing activities
Cash flows from capital and related financing activities
Cash flows from investing activities
Reconciliation of operating income to net cash provided by operating activities
Fiduciary Funds
Pension Trust
Employee retirement plan, deferred compensation plan
Revenue (addition) Sources:
1. Employer and Employee Contributions—Restricted Account: to record the receipt of
money from other funds Dr. Cash Cr. Additions: employer contribution- restricted
2. Other fund transferring money to this fund:
GRaSPP: Dr. Expenditures Cr. Cash
SEPAPI: Dr. Expenses Cr. Cash
3. Income from investments= recorded as revenue and is closed to the proper employee
restricted accounts at year end

Expense (deduction) types:

Expenses of pension trust funds include benefits payments, refunds, and administrative
expense
Accounting:
Accrual; capitalize fixed assets and record related depreciation expense; carry LTD and
pay both principal and interest
Net asset accounting: Dr. Reserve for employer’s contributions Dr. Actuarial deficiency
in reserve Dr. Reserve for employees’ contributions Cr. Pension net assets
Notes: plan description, summary of significant accounting policies, contributions and
reserves including funding policy, required contribution rates under the funding policy,
description of terms or LT contracts, and balances in legally required reserves, and risk
concentrations
Required supplementary information: computation is based on several components:
benefits to be included, actuarial assumptions, economic assumptions, actuarial cost
method, actuarial value of assets, annual required contributions, contribution deficiencies
or excess contributions

Agency Trust Fund= Mailman

No income statement, no statement of cash flows
Collects cash to be held temporarily for an authorized recipient to whom it will be later
disbursed. i.e. tax collection funds, clearance funds, special assessments
Revenues: Not recognized
Expenses: Not recognized
Accounting:
1. Tax collection funds exist when one local government collects a tax for an overlapping
governmental unit and remits the amount collected, less administrative charges, to the
recipient unit. (sales agency fund, payroll withholding agency fund; real estate taxes
agency fund) To record the county collections and retaining a fee: Dr. Cash Cr. Due to
other units Cr. Due to county general fund
2. Clearance funds are used to accumulate a variety of revenues from different sources
and apportion them to various operating funds in accordance with a statutory formula or
procedure. Cash conduit arrangements (no monitoring): passthrough grants, food stamps,
traffic citations, alimony, child support
If monitoring= special revenue fund
3. Special assessments: when the governmental unit is not otherwise obligated for the
debt, the receivables and debt service transaction are appropriately accounted for in the
agency fund. If a governmental unit has liability, accounting is made through the capital
projects and debt service funds
Financial Statements: Statement of Fiduciary Net assets: CA= CL; no year end balance

Private Purpose Trust

Not general public use; designated fund for reporting all other trust arrangements under
which principal and income are for the benefit of one of the following: specific
individuals, private organizations, other governments. i.e. escheat property fund
Revenues:
The income from the principal of a private purpose trust may be placed with another fund
General fund records:
Record the transfer of income to the general fund: Dr. Due from private purpose trust Cr.
Transfer from the private purpose trust
To record transfer of cash to the general fund: Dr. Cash Cr. Due from the private purpose
trust
Private Purpose records:
To record obligation to transfer income to general fund: Dr. Interfund transfer to the
general fund
To record transfer of funds to the general fund: Dr. Due to the general fund Cr. Cash

Expense Types:
Expenses relate to the specific purpose of the trust and may relate to benefits or
administrative charges
Capital gains and losses are recorded as adjustments to fund principal and not to income,
unless the grantor specified otherwise

Accounting for restricted funds:

Fund Use Spending
Special revenue fund Public Interest and principal
(expendable)
Permanent fund Public Interest only
(nonexpendable)
Private purpose fund Private Interest and/or principal
(expendable)

Investment Trust Funds:

Investment trust fund
Revenues (addition) sources: contributions; net appreciation of the FV of the plan assets;
and premiums and discounts on debt securities, which should not be amortized as part of
investment income
Expense (deduction) types: payments to beneficiaries and administrative expenses
Accounting: net assets are reported on a fair value basis
Financial Statements: Statement of Fiduciary Net Assets; Statement of changes in
fiduciary net assets
 Governmental Proprietary Fiduciary
G R S P P S E P A P I
General Reserve Service Projects Permanent Service Enterprise Pension Agency Private Investment
(special (debt) (capital (internal) Purpose
) )
Balance Sheet X X X X X
(CA, CL, fund
balance)
Statement of X X
Net Assets (A,
L, Net assets)
Statement of X X X X
Fiduciary Net
Assets
Statement of X X X X X
Revenues,
Expenditures,
and Changes
in Fund
Balance (Rev,
Expend, Other
Financing
Sources)
Statement of X X
Revenues,
Expenses, and
Changes in
Fund Net
Assets
(operating
Rev, op. exp.,
non-op rev
and exp)
Statement of X - X X
changes in
fiduciary net
assets
(additions,
deductions)
Statement of X X
cash flows
(operating,
investing,
capital
financing,
non-capital
financing)
Full Accrual X X X X X X
Modified X X X X X
Accrual
Budget X X X X X
Activity X X X X X
Encumbrances X X - X -
Financial 9
Governmental Accounting
Operational Accountability: the focus of government-wide F/S is to report the extent to
which the government has met its operating objectives efficiently and effectively.
Financial Accountability: the focus of the fund F/S is to demonstrate that the government
entity’s actions in the current period have complied with public decisions concerning the
raising and spending of public funds in eh ST
Integrated approach:
Management’s discussion and analysis (MD&A),
Basic financial statements=
Gov’t wide (statement of net assets, statement of activities)
Fund F/S (Gov’t funds: B/S, statement of revenues, expenditures, and changes in
fund balances; Proprietary funds: Statement of net assts, statement of revenues, expenses,
and changes in fund net assets, statement of cash flows; Fiduciary funds: statement of
fiduciary net assets, statement of changes in fiduciary net assets)
Notes
Required supplementary information (other than MD&A): pension, budget, infrastructure
Other supplementary information (optional)= combining non major funds statements,
variance between originally adopted budget and final amended budget, variance between
final amended budget and actual
Requires a reconciliation of the fund F/S to the government-wide F/S

Optional: Comprehensive Annual Financial Report (CAFR):

Introductory section; Basic F/S and required supplementary information; Statistical
section

The Financial Reporting Entity

Primary Government Entities: state governments; general purpose local governments;
special purpose local government that meets the following:
1. has a separately-elected governing body
2. is legally separate
3. is fiscally independent of other state and local governments
Component Unit= a legally separate organization for which the elected officials of the
primary government are financially accountable.
Blended Presentation: when component units are so intertwined with the primary
government that they are the same combine financial information
Use when: 1. a board of the component unit is substantively the same as that of the
primary government or 2. the component unit serves the primary government exclusively
or almost exclusively
Discrete Presentation: separate; F/S of the reporting entity should provide an overview of
the entity based on financial accountability; board of education or rescue squad

The Financial Reports

MD&A= required supplementary information
Description:
1. easily readable analysis
2. condensed F/S information
3. analysis of overall financial position and results of operations including reasons for
changes from the prior year
4. analysis of balances and transactions of individual funds including limitations on
future uses of funds
5. analysis of significant variations between original and final budget

Government-wide F/S (statement of net assets)

Fiduciary funds are excluded, component units are included
Assets- Liabilities= net assets
3 components of net assets:
1. invested in capital assets, net of related debt
2. restricted net assets
3. unrestricted net assets
Capital Assets- capitalization and depreciation
Capitalized assets: capital assets, including infrastructure assets, be included in the
government-wide F/S. The term infrastructure asset refers to streets, bridges, gutters, and
other assets of the government. They are only reported on the government-wide financial
statements.
Depreciation:
Required Approach: depreciation expense that can be specifically identified with a
functional category should be included in the direct expenses of that function
Modified Approach: infrastructure assets that are part of a network are not required to be
depreciated provided they meet 2 requirements:
1. inventory is up to date; a summarized condition assessment is performed, each year an
estimate is made of the amount necessary to maintain and preserve the eligible
infrastructure assets at the condition level established and disclosed by the government
2. a complete condition assessment of eligible infrastructure assets must be performed at
least every 3 years; reasonable assurance that the eligible infrastructure assets are being
presented approximately at the condition level established and disclosed by the
government
Under the modified approach, infrastructure expenditures are typically reported as
expenses, unless the outlays result in additions or improvements, in which case they
would be capitalized
Requiredmodified= change in estimate Modified required= change in estimate
Governments are required to determine if impairment of an asset has occurred. Insurance
recoveries are netted against the loss
Artwork and Historical Treasures:
Capitalize at historical cost or FV at date of donation. Governments are encouraged, but
not required, to capitalize a collection, when they meet the following:
1. The collection is held for public exhibition, education, or research in furtherance of
public service, rather than financial gain
2. the collection is protected
3. the collection is subject to an organizational policy that requires the proceeds from
sales of collection items to be used to acquire other items for collections.
Government-wide Financial Statements (statement of activities)
Functions/programs:
1. primary government governmental activities (GRaSPP+S)
2. primary government business type activities (E)
3. component units (rescue squad and/or board of education)
Expenses: reported by function on full accrual basis
Program revenue: full accrual basis
Category types:
1. charges for service: to customers or applicants who directly benefit from goods or
services; to other governments; fines and forfeitures
2. operating grants and contributions: restricted for use in a particular program
3. capital grants and contributions

Net (expense) revenue and changes in net assets: gov’t, bus type, total, component units
Eliminations: elimination of internal transactions that artificially double up on activity
should be prepared
Internal service funds: activity should be reported in the governmental activities column
unless the government’s enterprise funds are the primary recipient of internal service
fund services.

Fund Financial Statements: Government Funds: Balance Sheet

Major fund rules:
1. 10% or more of the corresponding total revenues, expenditures/expenses, assets or
liabilities of: all government funds OR all enterprise funds
And
2. 5% or more of revenues, expenditures/expenses, assets or liabilities of: all government
funds AND all enterprise funds
Aggregate fund balance/ equity is NOT used in either test

Full accrual= modified accrual +/- adjustments

Reconciliation of Governmental Fund F/S to Government-wide F/S

The financial statements must reconcile: 1. the difference in the fund balances of
governmental funds and net assets in the government-wide financial statements and 2. the
differences in the net change in fund balances of governmental funds and the change in
net assets for governmental activities
Balance Sheet:
GRaSPP- fund balance
+ Assets (non current)
- Liabilities (non current)
+ Service (internal) fund net assets
Basis of accounting
Accrued
Revenues and
Expenses
GALS BARE
Fund Financial Statements: Government Funds: Statement of Rev, Exp & Changes
Revenues, Expenditures, Other Financing Sources sections

Reconciliation:
Statement of Revenues, Expenditures, and Changes in Fund Balance
GRaSPP- net change in fund balance
-Other financing sources
+ Expenditure- capital outlay (net of depreciation)
+ Service (internal) fund net income
Basis of accounting
Accrued
Revenues and
Expenses
GOES BARE

Fund Financial Statements: Proprietary Funds: Statement of Net Assets

Assets, liabilities, net assets: invested, restricted, unrestricted sections
Business type activities enterprise funds, governmental activities internal service funds
columns

Fund Financial Statements: Proprietary Funds: Statement of Rev, Exp & Changes
Operating revenue, operating expenses non operating revenues (expenses) sections
Bus type and internal service funds columns

Fund Financial Statements: Proprietary Funds: Statement of Cash Flows

1. Direct method is required
2. A reconciliation of operating income (not net income) to net cash provided by
operations is required
3. 4 categories: operating, investing, capital and related financing activities, non capital
financing activities
4. interest income/ cash receipts are reported as investing activities (not as operating
activities)
5. interest expense/cash payments are either capital and related financing or non capital
financing
6. capital asset purchases are reported as financing activities (not as investing activities)

Fund Financial Statements: Fiduciary Funds: Statement of Fiduciary Net Assets

Assets, liabilities, net assets

Fund Financial Statements: Fiduciary Funds: Statement of changes in fid. Net

assets: Additions, deductions

Notes to Financial Statements:

Essential to fair presentation and considered integral to the financial statements
Generic disclosures should include: a description of government-wide activities noting
the exclusion of fiduciary funds; policies relating to elimination of internal activity;
description of the modified approach for reporting infrastructure, if used

Specific disclosures:
The length of time used to define available in determining revenue recognition under the
modified accrual basis (60 days)
Actions taken to correct material non compliance with finance related or legal
compliance

Required Supplementary Information

Budgetary Information:
-Budgetary comparison schedules that show the original budget, the final amended
budget, and actual amounts (inflows/ outflows and balances) use budgetary basis
-Computation of variances is optional. Computation of differences between original and
final amended budget is optional
-Budgetary comparison may use either GAAP or budgetary formats, or basis of
accounting, but must include a reconciliation to GAAP
-Financial statements prepared in accordance with the provisions of GASB 34 possibly
include budget versus actual comparisons including display of the originally adopted
budget and the changes that resulted in the final amended budget.
Budgeted amounts (original and final), actual amounts columns with an options variance
with final budget positive column

Infrastructure information:
Include schedules that disclose: assessed condition of infrastructure and estimated annual
amount to maintain and preserve infrastructure for each of the past five years

Pension information:
Full pension reporting requires presentation of 6 years of data
Schedule of funding progress; schedule of employer contributions; notes to schedule

Other Supplementary Information (Optional)

Detail is optional
Combining statements for non major funds

Interfund Activity
Represents the flow of resources between funds and between the primary government and
its component units
Reciprocal Interfund Activity
Includes exchange type transactions between funds
Interfund Loans; interfund services provided and used
Non-reciprocal Interfund Activity
Interfund transfers: normally displayed as other financing sources and sues after non-
operating revenues and expenses; interfund reimbursements
Financial Statement Display and Disclosure
Displays:
-Within the governmental activities column of the government-wide FS: activities within
a particular column displayed on the F/S should be eliminated
-Within the business type activities column of the government-wide financial statements:
should be eliminated
-Between the governmental activities and business type activities displayed on the
government wide financial statements: the internal balances should be displayed as an
internal balance on the face of each financial statement and aligned with each other to
eliminate for purposes of total primary government financial statements
-Between the primary government and its fiduciary funds: the transactions should be
reported as if between external parties
Disclosures: Interfund loans and transfers

Not-For-Profit Organizations
Use FASB not GASB
Health care organizations; educational institutions; voluntary health and welfare
organizations; other private (not governmental) NFP organizations (i.e. cemetery
organizations, fraternal organizations, labor unions, museums, libraries, professional
organizations)
Full accrual basis of accounting: the overall emphasis for not for profit F/S is on basic
information for the organization as a whole

Key issues:
Classification of net assets as unrestricted, temporarily restricted and permanently
restricted;
Revenue recognition concepts related to unconditional pledges and support;
Distinguishing between restricted revenue and conditional pledges
Distinguishing between restricted revenues and the absence of variance power

Financial Accounting Statement 117 governs external reporting for private NFP
organizations
Requires Statement of financial position (B/S); statement of activities (I/S); statement of
cash flows and statement of functional expenses= required for voluntary health and
welfare organizations, and encouraged for other organizations

Statement of Financial Position= B/S

Assets, liabilities, and net assets
Current= to be spent soon
Noncurrent= to be permanently held
Net assets:
Unrestricted net assets= not permanently restricted or temporarily restricted; internal
board designated funds are considered unrestricted
Temporarily Restricted Net Assets= donor imposed stipulations either expire by passage
of time or can be fulfilled and removed by actions of the organization
Permanently Restricted Net Assets=limited by donor imposed stipulations that neither
expire by passage of time nor can be fulfilled or otherwise removed by actions of the
organization
“PUT”

Statement of Activities= I/S

4 required elements:
1. Change in total net assets
2. Change in unrestricted net assets
3. Change in temporarily restricted net assets
4. Change in permanently restricted net assets

Permanent Restriction= savings account

Unrestricted= operating checkbook
Temporary restricts= savings account

Timing of Reclassification of Restrictions

1. Contributions with donor imposed restrictions are recorded as restricted revenue in the
period in which they are received. They increase temporarily or permanently restricted
net assets
2. When a donor restriction is satisfied, a reclassification is reported on the statement of
activities. Reclassifications are items that simultaneously increase on net asset class and
decrease another.
3. Donor imposed restrictions that are met in the same period they are received may be
recorded as a unrestricted support (contribution revenue), provided that the organization
discloses and consistently applies this accounting policy.

Expense Classification in the statement of activities

Reported as decreases in unrestricted net assets. Detail functional classification must be
presented either on the face of the financials or the notes to the financial statements.
Categories:
1. Program services: universities (edu and research), hospitals (patient care), union (labor
negotiations), day care (child care)
2. Support services: fund raising, administration, management and general, membership
development
3. Combined Costs: Fund raising and education allocate the combined cost between
functions

Statement of Cash Flows

Either the direct or indirect method may be used
Classification of sources and uses of cash:
Operating activities: when using the direct method, operating activities should be
reported by major class of gross receipts (including contributions, program income, and
interest income or dividend income from investments)
Contributions of unrestricted revenue later earmarked (board designated) for construction
or purchase of long lived assets are classified as operating on the statement of cash flows
Financing activities: cash flows from financing activities include the cash transactions
related to borrowing that are typically found in commercial statements of cash flows but
also include cash transactions related to certain restricted contributions.
Proceeds from restricted contributions: cash received with donor imposed
restrictions limiting its use to long term purposes such as increases to an endowment,
purchases of assets or annuity agreements is displayed as a financing activity.
Disbursements of these restricted contributions for either temporary investments or the
purpose for which they were intended are classified as investing activity.

Investing activities: include proceeds from the sale of works of art or purchases of art;
include investment in equipment; include proceeds form the sale of assets that were
received in prior periods and whose sale proceeds were restricted to investment in
equipment

Cash and cash equivalents: exclude donor restricted securities that may otherwise meet
the cash equivalent definition in commercial accounting.

Statement of Functional Expenses

Required for voluntary health and welfare organizations
Classification of expenses:
1. Program support expenses= directly related to the organization’s program
2. Fund raising expenses= unsolicited merchandise sent out
3. Management and General= expenses for the overall direction of the organization
4. Multiple cost items= allocate the cost on any reasonable basis

Financial Accounting Statement 116

Governs the recognition of most contributions received and contributions made.
1. Resource inflows in NFP organizations are generally classified in the financial
statements as either revenue or other support.
2. Revenues typically represent exchange transactions in which the NFP organization
earns resources in exchange for a service performed (e.g. fees)
3. Other support typically represents operating income that is donated (contributed) or
provided in some way that is anticipated as part of the central ongoing activities of the
organization

Recipients of a foundation or a community-wide fund raising organization that are

specifically intended for another beneficiary organization may represent a liability rather
than revenue. Accounting by the beneficiary organization is also affected

Contributions and Recognition: Full accrual

Cash Contributions: received= revenue, measured at FV at the date of the gift
Unconditional Promises: pledge= revenue Dr. Asset at FMV Cr. Contribution support rev
Conditional Promises: earned= revenue
Multi-year pledges: PV pledge: now= revenue, future= temporarily restricted revenue;
the difference between the previously recorded PV and the current amount collected is
considered contribution revenue, not interest income
Allowance for Uncollectible Pledges: = NRV (full accrual)
Split Interest Agreements: shared with other beneficiaries; measured at FV at the date of
acquisition; displayed as temporarily restricted (unless there is a permanent restriction
established by the donor)

Donated Services= FMV; recorded as contribution revenue and expense at FV if the

services meet the following: 1. they create or enhance a non-financial asset, 2. they
require specialized skills that the provider possesses and would otherwise have been
purchased by the organization
Contributions of services are recognized “some” of the time”: Specialized skills are
required and possessed by the donor, Otherwise needed by the organization, Measurable
Easily
Dr. Expense Cr. Contributions
Donated Collection items= contributed works of art or historical treasures. Not required
to be recorded by the recipient for NFP if the following conditions are met: 1. part of a
collection, 2. collection is cared for, 3. the organization has a policy that requires any
proceeds from the sale of donated items to be reinvested in other collection items.
Donated Materials= revenue

Recording Promises to Contribute and Other Support Transactions

Unrestricted contributions= to contribute in the future reported as restricted support Dr.
Pledge Receivables Cr. Allowance for doubtful accounts Cr. Contributed revenue—
temporarily restricted revenue
Restricted Contributions= spend it to earn it Dr. Pledge receivables Cr. Allowance for
doubtful accounts Cr. Restricted revenue Later: Dr. Reclassification: satisfaction of
restriction Cr. Cash/ restricted net assets Dr. Cash/ unrestricted net assets Cr.
Reclassification: satisfaction of restriction AND Dr. operating expense Cr. Cash/
unrestricted net assets

Agency Transactions= consist of resources received by the NFP over which the NFP has
little or no discretion or variance power
Gifts in kind= non cash contributions, measured at FV
Exchange Transactions= reciprocal transfers in which each party receives and sacrifices
something of approximately equal value are termed exchange transactions; the cost of
premiums given to potential donors as part of a fund raising appeal is classified as a fund
raising expense
Amount transferred- FV of dues= contribution revenue

General principles: Recipient Accounting

Without Variance Power= NFP acts as agent/ no benefit or power
Value at FV; recognized as a liability to the beneficiary Dr. Asset Cr. Refundable
advance
Granted Variance Power= NFP acts as agent/ has power
Value at FV; recognized as contribution revenue when received and expensed when
distributed to the beneficiary Dr. Asset Cr. Contribution Revenue
Financially Interrelated- Granted Variance Power= NFP acts as agent/ has power
Value at FV; assets are recognized as contribution revenue when received and expensed
when distributed to the beneficiary Dr. Asset Cr. Contribution revenue

General Principles: Beneficiary Accounting

Recognition Rule: Specified beneficiaries recognize their rights to assets held by others
(the recipient) unless the recipient is explicitly granted variance power.
Recognized Interest- Financially Interrelated= equity; beneficiaries recognize an interest
in the net assets of the recipient when the organizations are financially interrelated. The
interest in the net assets of the recipient is adjusted for the beneficiary’s share of the
change. Dr. Interest in net assets Cr. Equity transaction (statement of activities)
Recognized Beneficial interest- pools of assets= revenue; beneficiaries recognize a
beneficial interest in an unconditional right to receive specified cash flows from pools of
assets. Measurements and remeasurements serve to present assets at FV using
discounting or other techniques. Dr. beneficial interest Cr. Contribution revenue
Recognized Receivable and Contribution Revenues= revenues; in cases that do not
involve recognition of net assets or beneficial interest, the beneficiary recognizes a
receivable and contribution revenue consistent with treatment of all other unconditional
promises to give Dr. Receivable Cr. Contribution revenue

Assets transferred to recipient organizations are not contributions and are accounted for
as an equity transaction if: resource provider specifies itself as the beneficiary; financially
interrelated; does not expect payment of the transferred assets.

Investment in Securities
FV: all debt securities and those equity securities that have readily determinable FV are
measured at FV in the statement of financial position.
Gains and Losses (realized and unrealized):g/l on investments are reported in the
statement of activities as increases or decreases in unrestricted net assets unless the use of
the investment is restricted.

Derivatives: A NFP organization should recognize the change in FV of all derivatives in

the period of the change
Dividends, Interest, and Other investment income: Investment income (e.g. dividends
and interest) is reported in the period earned as increases in unrestricted net assets unless
the use of the investment is restricted, either temporarily or permanently, by explicit
donor stipulations or by law. Allocate pooled investment income equitably.
Donors Stipulation: the nature of the donor’s stipulation determines how to recognize
both gains and losses and investment income. Donor-restricted investment income is
reported as an increase in temporarily or permanently restricted net assets, depending on
the donor’s stipulation. Gains and losses that are limited to specific uses by donor
stipulations may be reported as increases in unrestricted net assets if the stipulations are
met in the same reporting period as the gains and income are recognized.
Purchased fixed assets are carried at cost
Fixed assets donated to the NFP are recorded at FMV at the date of the gift
Depreciation is recorded in accordance with GAAP for non-governmental NFP
organizations

Endowment Fund= used to account for donated assets, the principal of which must be
retained intact
Permanent Endowment= income is expendable as directed by the donor and recorded
based on donor restrictions. Principal is not permitted to be spent
Term Endowment= consist of assets that must be held for a specified term, in
accordance with the donor’s stipulations. They are reported as temporarily restricted net
assets.
Quasi-endowment= used when the internal governing board of an institution (not the
donor) has determined that funds are to be retained and invested for specified (other than
loan or plant) purposes. They are appropriations of unrestricted net assets.

NFP specific industry applications

Colleges and Universities (Institutions of higher learning)
Revenues: Consist of all increase in unrestricted net assets and all restricted resources
that were actually expended during the period such as: tuition and fees (reported at gross
amount. Scholarships, tuition waivers, and similar reductions are considered either
expenditures or a separately displayed allowance reducing revenue); government aid,
grants, contracts, gifts, etc
Assessed student tuition fees – cancelled classes= gross revenue from tuition and fees
(unrestricted net assets)
Restricted Revenues and Gains:
Reported in the statement of activities. They are reported as changes in temporarily or
permanently restricted net assets
Expenses: scholarships, maintenance, administration, research, teaching, libraries, etc

Health Care Organizations:

Revenues: increases in unrestricted net assets and are reported by their source
1. Patient service revenue= should be accounted for on the accrual basis at established
standard rates, even if the full amount is not expected to be collected. Although patient
service revenue is accounted for on a gross basis, deductions are made from gross
revenue for reporting purposes. Central transactions include medical services such as
doctors, surgery, recovery room, and room and board
Charity Care: not recorded as a receivable or as revenue
Deductions: contractual adjustments for third party payments; policy discounts;
administrative adjustments
Gross patient service revenue- charitable services= patient service revenue
2. Other Operating Revenue: donated supplies and equipment; revenues from educational
programs; cafeteria revenue; parking fees; gift shop revenue; etc
3. Non-operating revenue and support gains and losses: unrestricted interest; UR gifts;
UR grants, etc, donated services
Donated Supplies: contributions of items that are not long lived assets are recognized as
revenue in the period received and as assets or a reduction of liabilities or expenses,
depending on the form of the benefits received. Dr. Supplies inventory or expense Cr.
Unrestricted contributions—other operating revenue

Voluntary Health and Welfare Organizations

Income: to a large extent, voluntary health and welfare organizations depend upon
contributions and pledges from the general public to support the activities of the
organization.
Statement of Functional Expenses= mandatory= a detailed schedule of the expenses of
the voluntary health and welfare organization, divided into functional areas, such as
program services and support services
Fund raising expenses associated with fund raising appeals must be shown separately on
the face of the financial statement either as an expense or as a deduction from revenues.
Fund raising support may not be displayed as a simple net amount

Summary Comparisons of NFP Organizations

Sources of Revenues:
Colleges and Universities:
Tuition and fees
Federal, state, or local grants, and contracts and appropriations
Private gifts, grants, and contracts
Endowment income
Sales and service of educational activities
Sales and services of other activities
Health Care Organizations:
Patient service revenue (gross)
Less: deductions (charity allowances, other allowances, etc)
Net patient service revenue
Premium revenue
Other revenue g/l: tuition from schools, specific purpose grants, revenue from auxiliary
enterprises, etc; unrestricted gifts and grants; unrestricted income from endowment funds
Donated Services
Voluntary Health and Welfare Organizations
Revenue:
Membership dues
Investment income
Realized gains on investment activities
Public Support:
Public contributions
Special Events
Legacies and bequests
Donated material and Services
Expenses:
Colleges and Universities
Instruction
Research
Public service
Academic support
Student services
Institutional support
Operation and maintenance of plant
Scholarships and Fellowships
Auxiliary enterprises
Health Care Organizations:
Nursing services
Other professional services
General services
Fiscal services
Administrative services
Depreciation
Interest expense
Provision for bad debts
Voluntary Health and Welfare Organizations
Program services:
Research
Public education
Professional education and training
Community service
Other
Support Services:
Management and general
Fund raising