USCPA (FAR) – (1) Balance Sheet, Income Statement, and Comprehensive Income

I would like to record about the key points of the US CPA exam content.

<Create and note the points based on mainly Becker’s workbook>

Relationship between Net Income, Other Comprehensive Income, and Comprehensive Income

• The relationship is such that “Net Income + Other Comprehensive Income = Comprehensive Income
• Net Income is recorded in Retained Earnings, while Current Other Comprehensive Income (from the P&L) is recorded as Accumulated Other Comprehensive Income (on the BS).
• Regarding prior period accounting correction, As a general rule, prior period adjustments modify the balance of prior period retained earnings (for examination purposes). However, in practice, it is common to reflect these adjustments in the PL of the following period. For example, The adjustment for the prior year understatement of amortization expense is a prior period adjustment that will be reflected in beginning retained earnings, not on the income statement. 
• Net income includes both income from continuing operations and income from discontinued operations, all presented net of tax. 

The accounting treatment for “Freight in” and “Freight out” follows similar principles

• First, identify the company’s functional currency (e.g., USD, EUR, etc.).
• After confirming the company’s functional currency, it is necessary to recognize the foreign exchange gains or losses on transactions denominated in foreign currencies relative to the functional currency.
• In practice, for instance, local salaries paid in EUR in European countries may not seem to carry exchange risk if the company’s functional currency is EUR. However, if the functional currency is USD, accounting rules require that foreign exchange gains or losses on the liabilities for local salary payments be recognized in the Profit and Loss statement.
• Taking a Japanese company as an example, typically, an export company benefits from a weaker yen as it generally increases revenues from foreign currency earnings. However, in examinations, if the settlement currency is not foreign but Japanese yen, the benefits of a weaker yen are not realized.
• For example, A company is a U.S. company, its gains and losses will be recorded in U.S. dollars. However, if the exchange rates are quoted in euros, they must be translated into U.S. dollars.
• Quoting the exchange rate using the direct method involves quoting the domestic price of one unit of another currency. From the perspective of a retailer in Great Britain, the domestic currency is the British pound. So the appropriate quote will be 0.63 British pounds cost 1 U.S. dollar.

The criteria of Held for Sale

1. The component is available for immediate sale in its present condition.
2. An active program to locate a buyer has been initiated.
3. The sale of the component is probable and expected to be completed within one year.
4. The sale of the component is being actively marketed.
5. It is unlikely that a significant change to the plan to sell will be made or the plan will be withdrawn.

• When a decision to classify a business component as Discontinued Operations is made during the period, all results (profits and losses) from the beginning of that fiscal year or reporting period are reported as Discontinued Operations. This aims to provide consistent information throughout the period if the discontinuation of the business component is finally decided within that reporting period.

• If the best estimate of the fair value at the time of sale (necessary costs such as disposal expenses need to be verified for examination purposes) is lower than the current book value, an impairment of the asset is required in the current period. The difference between the actual sale price in subsequent years and the book value after impairment at the time of sale should be recorded as a gain or loss on the sale of the asset.
•  The results of discontinued operations of a component are reported in discontinued operations (for the current period and for all prior periods presented) in the period the component is either disposed of or is held for sale. The results of subsequent operations of a component classified as held for sale are reported in discontinued operations in the period in which they occur. The company would report the amount of the net loss reported Year 1 beneath the heading discontinued operations, $240,000.

Revision of Depreciation Period for Fixed Assets

• The revised depreciation expense for the period is expected to be calculated by subtracting the residual value from the asset’s current book value and then dividing it by the revised remaining useful life (for examination purposes).
• By performing the above calculation, it is possible to change the future amounts recorded as a change in the accounting estimate without revising the depreciation expense already recorded in the past.

The items typically reported in Other Comprehensive Income (OCI)

1. Foreign Currency Translation Adjustments
2. Unrealized Gains and Losses on Available-for-Sale Securities
3. Unrealized Gains and Losses on Derivatives Designated as Cash Flow Hedges
4. Defined Benefit Pension and Other Postretirement Plan Adjustments

These items are recognized in OCI because they represent changes in equity that are not a result of transactions with shareholders and are typically not realized through the income statement until specific future events occur.

Initial Recognition of Prior Service Costs

Debit: Accumulated Other Comprehensive Income (OCI)
Credit: Pension Liability

For example, Initial Recognition of Prior Service Costs. (DR) OCI / (CR) Pension Liability. This entry records the prior service costs arising from a revision of the pension plan. These costs are recorded in OCI and are scheduled to be amortized over future periods. When amortization occurs, the following additional entries are made.

Cash Flow Hedges

• Increase in Fair Value of Hedging Instrument : (DR) Derivative Asset / (CR) OCI
• Decrease in Fair Value of Hedging Instrument : (DR) OCI / (CR) Derivative Liability
• Reclassification when the Hedged Transaction Occurs : (DR) OCI / (CR) Revenue (or Expense)

Defined Benefit Pension

• The company must record the retroactive impact of the increase in retirement benefit for the company’s pension plan. (DR) OCI / (CR) Pension Benefit Liability.
• JE of Periodic amortization: (DR) Pension Expense XX / (CR) OCI

Purchase Order and Accounting Processing

• Issuance of Purchase Order: Issuing a purchase order merely indicates an intent to purchase goods or services and does not trigger direct accounting transactions in financial reporting. At this stage, there is no financial burden or change in assets, so no journal entries are necessary.
• Receipt of Goods: When goods are actually received and ownership is transferred, an accounting entry for “purchase of goods” is made. Typically, this involves recording an increase in “inventory assets” and an increase in “accounts payable” at this point.
• Receipt of Invoice: After the invoice is issued and until payment is made, the liabilities for the purchased goods or services are recorded as “accounts payable” in the accounting books.

Examples of Corrections to Balance Sheet Items

Asset Accounts

• The allowance for doubtful accounts should be deducted from the asset accounts, not shown under liabilities.
• Inventory assets should be classified as current assets, not non-current assets.

Liability Accounts

• Notes payable should be categorized as either short-term or long-term liabilities, depending on basically the payment due date.
• The discount on bonds payable should be netted against the bonds payable account and shown as the net amount under liabilities.

Equity Accounts

• Treasury stock should be shown as a deduction from equity accounts, not as an investment account.
• Unrealized gains and losses on available-for-sale securities should be shown under other comprehensive income in the equity section.
• When correcting prior period errors due to accounting mistakes, ensure that the adjustments at the beginning of the period in retained earnings account after tax.

Accounting correction

• A “cumulative effect” type accounting change is not included in the net income of the period of change; instead, the beginning of the year retained earnings is restated.

Accrual accounting

• The $60,000 in property taxes will benefit the entire calendar year and therefore must be allocated equally to each calendar quarter
• The first payment is not due until mid-January (one month from December 16); therefore, a half month of rent should be accrued at the end of each month over the life of the lease.

Note

• The company will not duplicate the information provided in this note in later footnotes. 
• As this is a note payable that existed as of the balance sheet date, and the refinancing occurred prior to the statements being issued, the liability should be recognized as non-current and a note disclosure should be added to the financial statements explaining the change in classification.

Disclosure of vulnerability to concentration is required if all of the following criteria are met.

• The concentration exists as of the financial statement date.
• The concentration makes the entity vulnerable to the risk of a near-term severe impact.
• It is at least reasonably possible that the events that could cause a severe impact from the vulnerability will occur in the near term.