External Financial Reporting: Why?

There's this organization called FASB, which is an acronym for the Financial Accounting Standards' Board. They exist to create and monitor the rules surrounding financial reporting for the main purpose of consistency. 

Back to the Basics - A Few Forgotten Accounting Principles

Things to not forget about, when studying for the CMA:

• The Entity principle, which is that each entity is to be accounted-for as separate and distinct. No co-mingling. 
• The Going Concern principle, which is the assumption that operations will continue;
• The necessity of Approximation/Management Estimates, since there's so many complexities going on at all times;
• Conservatism, which is the general preference to understate net income and net assets where/when given the choice. 

Recognition & Measurement in Financial Statements

For revenues and gains:

• Earned being the most important one, for revenues, meaning that the work's been done and you now have a right to be compensated. 
• Realized/Realizable on the gains side. 

For expenses and losses:

• With expenses, the concern is consumption of benefit
• With losses, the concern is loss or lack of benefit

For financial statements in general, a "full" set of financials includes:

• Balance Sheet
• P&L
• Statement of Comprehensive Income
• Cash Flows
• Owner Activity (Contributions, Withdrawals)

The Statement of Comprehensive Income is similar to the P&L, except that it includes accounting adjustments from prior periods. Inclusions, relative to the P&L, are:

• Recognized changes in equity of the entity except for those from owner contributions/withdrawals.
• Gains & losses

Elements of Financial Statements

7 basic elements of financials, for all org's:

• Assets
• Liabilities
• Equity
• Revenues
• Expenses
• Gains
• Losses

3 additional elements, only relevant to for-profit business:

• Owner investments
• Owner distributions
• Comprehensive income

You're probably going to want your financials to be accrual-based, where non-cash events and liability-imposing circumstances are recognized as they occur. This also includes deferrals, allocations, and amortizations. Accrual accounting helps match up revenues and expenses better than cash accounting. You recognize the event in the books as it happens; it's then realized when the cash comes in or goes out. 

Leases

​In a lease, the lessor gives the lessee the right to use property in exchange for cash. The lessor keeps the title. 

From the POV of the lessee, there's no asset or liability recorded, but there are footnotes with detailed info about commitments and the like. Leasing is the same thing as "off-balance sheet financing," since they get control of the asset but they don't need to record the debt on their books. From an accounting POV, it's pretty simple; DR Expense, CR Cash. 

If it's a capital lease, the lessee does then record the asset and the liability on their books, since they're effectively being transferred the risks/benefits of ownership. 4 tests exist to determine whether the lease is capital in nature:

• Title - does it pass to the lessee at the end?
• BPO - can the lessee buy the asset @ sub-market price @ the lease's end?
• Economic Life - is the lease term > 75% of the asset's life?
• FMV - do the PV of minimum lease payments > 90% of the PV of the asset?

Why do lessees lease? A few advantages:

• Less cash required, up front
• Easier to get credit
• Payments are deductible
• Balance sheet appearance

From the POV of the lessor, the leased asset remains on their books, classified separately as "Assets Leased to Others," and they're also depreciated. Leasehold costs are expensed. Payments collected are revenue. 

For capital leases, the leased asset is removed from the books, replaced by a receivable. From their POV, there are 2 additional tests, in addition to the lessee's 4:

• Collectibility - will they get their $? How certain?
• Uncertainties - are there any performance-related contingencies, for example?

A few advantages to the lessor in this situation:

• You've basically made a sale, and you get to defer taxes
• You get to depreciate the asset like it's still yours

There are a few types of Lessor Capital Leases:

• Sales Type: a dealer's profit is recognized at inception. The profit is the excess of PV Minimum Lease Payments > Cost of Leased Asset. 
• Direct Financing - no profit. Lease Receivable, Unearned Interest Revenue. Leased asset removed. 

In both of these leases, you'll need to consider initial direct costs. These are commissions, legal fees, credit checks. In an operating lease, these are capitalized and amortized separately. For sales-types, they're immediately expensed; for direct financing's, they're capitalized separately and considered part of the net investment in the lease. 

A Sale-And Leaseback is when an owner sells an asset to a buyer, and then leases it right back. Used as a financing device, basically. Same capital/operating rules apply, could be either. In terms of a gain:

• If it's a capital lease, defer and amortize the gain over the lease term. 
• If it's an operating lease, defer recognition of the gain, recognize in proportion to rental payments. When FV < BV, recognize a loss immediately. 

​INCOME TAX ACCOUNTING

The issue with income tax accounting is that accounting income and taxable income have two different sets of rules. Accounting is based off of GAAP, tax is based off of the IRS. The difference between the timing of revenues and expenses leads to deferred taxes, which can be either an asset or a liability. Classification of current or noncurrent tax asset or liability is based upon the underlying instrument. 

Goals of accounting for income taxes:

• Current Taxes - figure out the amount payable or refundable in the current year.
• Future Consequences - recognize deferred assets or liabilities in the financials

Basic income tax accounting principles:

• Current Liability/Asset - recognition for estimated taxes payable/receivable on current year returns
• Deferred Liability/Asset - recognition for estimated future tax effects due to temporary differences and carryforwards

Temporary differences can arise between:

• Taxable v. Accounting Income - in amount
• Tax Basis v. Book Value 

Deferred tax assets/liabilities represent the increase/decrease in taxes payable/refundable in future years due to temporary differences and carryforwards. 


DEBT EXTINGUISHMENT - CALCULATION & PRESENTATION OF GAIN/LOSS

If bonds are paid off early, the gain/loss will need to be computed. This is determined by subtracting the carrying value of the bonds at the redemption date from the reacquisition price. 

Carrying value is the face value +/- the unamortized bond premium - the unamortized bond issuance costs. 


LONG-TERM INVESTMENTS

​An investment in the common shares of another company is accounted-for in 1 of 2 ways:

• Fair Value Method, used when < 20% is acquired
• Equity Method, used when > 20% is acquired, since it's now assumed that the investor has significant influence. On the balance sheet, the original investment is recorded at cost. It's then adjusted for changes in the net assets of the investee that occur when income is earned or dividends are paid. Both adjustments are based on percentage-ownership. 

So let's say an investor's been acquiring 2% of the company a few times, and he's now up to 20% total ownership. When that occurs, the periods from when the cost method was used will need to be restated retroactively to show the equity method. 

In terms of financial statement presentation, there are two different methods:

• 50% or Less Control: asset on the books of the investor, "Investment in Company X," regardless of cost/equity method.
• 50% or More: the financials are now consolidated, as the investor now has effective control over the investee. One exception to this is that if the future's in doubt, there aren't any consolidated financials. 

​