New User Special Price Expires in

Let's log you in.

Sign in with Facebook


Don't have a StudySoup account? Create one here!


Create a StudySoup account

Be part of our community, it's free to join!

Sign up with Facebook


Create your account
By creating an account you agree to StudySoup's terms and conditions and privacy policy

Already have a StudySoup account? Login here

ACC 312 Notes

by: Nick Castillo

ACC 312 Notes ACC 312

Nick Castillo
GPA 3.76

Preview These Notes for FREE

Get a free preview of these Notes, just enter your email below.

Unlock Preview
Unlock Preview

Preview these materials now for free

Why put in your email? Get access to more of this material and other relevant free materials for your school

View Preview

About this Document

These are the notes for Intermediate Accounting II. Each document is the notes for the chapter in the textbook.
Intermediate Accounting II
Pietro Bianchi
Accounting, financial accounting, financial statements, GAAP, financial reporting
75 ?




Popular in Intermediate Accounting II

Popular in Accounting

This 134 page Bundle was uploaded by Nick Castillo on Sunday August 21, 2016. The Bundle belongs to ACC 312 at University of Miami taught by Pietro Bianchi in Spring 2016. Since its upload, it has received 5 views. For similar materials see Intermediate Accounting II in Accounting at University of Miami.


Reviews for ACC 312 Notes


Report this Material


What is Karma?


Karma is the currency of StudySoup.

You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!

Date Created: 08/21/16
Notes 1 Three primary forms of business organization Proprietorship Partnership Corporation Special characteristics of the corporate form: 1. Influence of state corporate law. 2. Use of capital stock or share system. 3. Development of a variety of ownership interests. The Corporate Form of Organization  Corporation must submit articles of incorporation to the state in which incorporation is desired.  State issues a corporation charter.  Advantage to incorporate in a state whose laws favor the corporate form of business organization (Delaware).  Accounting for stockholder’s equity follows the provisions of each state’s business incorporation act. Capital Stock or Share System: Each share represents an ownership right with privileges: 1. To share proportionately in profits and losses. 2. To vote for directors. 3. To share proportionately in assets upon liquidation. 4. Preemptive right to subscribe to new share issue. Common stocks:  Bears ultimate risks of loss.  Receives the benefits of success.  Not guaranteed dividends nor assets upon dissolution. Preferred stock:  Generally no voting rights.  But preference in dividend distributions and return of capital.  Has both equity and debit-like features. Issuance of Stock:  Par value stock.  No-par stock.  Stock issued in combination with other securities.  Stock issued in noncash transactions.  Costs of issuing stock. Par Value Stock  “Par” value per share is an arbitrary amount chosen by the company  Has no relation to the issue price of the shares  Low par values help companies avoid a contingent liability.  Corporations maintain accounts for: – Preferred Stock or Common Stock. – Paid-in Capital in Excess of Par (also called Additional Paid-in Capital) EXAMPLE 1: Issuing stock with par value On December 15, 2015, Cane Company issued 1,500 shares of its $3 par common stock for $50 per share. Make Cane’s journal entry on December 15, 2015 to record the issuance of the stock. No-Par Value Stock  Avoids contingent liability.  Avoids confusion over recording par value versus Fair Market Value.  Disadvantages: – Some states levy a high tax on these issues. – In some states the total issue price for no-par stock may be considered legal capital, thus reducing the flexibility in paying dividends. – some states require to have a “stated value” per share… which is, for accounting purposes, just like par value. EXAMPLE 2: Issuing stock with no par value On December 15, 2015, Cane Company issued 1,500 shares of its no-par common stock for $50 per share. Make Cane’s journal entry on December 15, 2015 to record the issuance of the stock. EXAMPLE 3: Issuing stock with no par value but with stated value On December 15, 2015, Cane Company issued 1,500 shares of its no-par common stock for $50 per share. The no-par stock has a stated value of $1 per share. Make Cane’s journal entry on December 15, 2015 to record the issuance of the stock. Stock Issued With Other Securities  When there is the simultaneous issue of different classes of stock, there are two methods of allocating proceeds: – Proportional Method: when the market value of all securities are known – Incremental Method: when the market value of at least one, but not all securities, is known. EXAMPLE 4A : Issuing more than one class of stock On April 17, 2015, Cane sold 100 shares of $5 par common stock and 500 shares of $15 par preferred stock for a total of $16,000. The market value of the common stock was $50 and the market value of the preferred stock is $40. Make Cane’s journal entry to record the sale of these two types of securities using the proportional method. EXAMPLE 4B: FMV of not all securities are known Continue Example 4, but now assume that the market value for the preferred stock is unknown, and the rest of the information is the same as above. Make Cane’s journal entry to record the sale of these two types of securities using the incremental method. Stock Issued in non-cash transactions  Companies should record stock issued for services or property other than cash at the: – fair value of the stock issued, or – fair value of the noncash consideration received, (Whichever is more clearly determinable)  Hidden risks: – Watered stock: overvaluation of assets – Secret reserves: undervaluation of assets EXAMPLE 5A : On August 3, 2015, Cane Company issued 1,000 shares of its $1 par common stock in exchange for land. The land was appraised to have a fair market value of $100,000. Assume that Cane is not a publicly traded corporation so the fair market value of the stock is not easily determined. Make Cane’s journal entry to record the issuance of the stock in exchange for the land. EXAMPLE 5B : Use the same facts as in Example 5, but now assume that the fair value of the land is unknown, but the market value of the stock is $95 per share. Make Cane’s journal entry to record the issuance of the stock in exchange for the land. Cost of Issuing Stock  Direct costs incurred to sell stock, such as: – underwriting costs, – accounting and legal fees, – printing costs, and – taxes,  Should be reported as a reduction of the amounts paid in (Paid-in Capital in Excess of Par). EXAMPLE 6: Accounting for stock issue costs On December 15, 2015, Cane Company issued 1,500 shares of its $3 par stock for $50 per share. Cane incurred $6,000 in underwriting and other direct costs related to the share issue. Make Cane’s journal entry on December 15, 2015 to record the issuance of the stock. Reacquisition of Stocks  Motivations: – Provide tax-efficient distributions of excess cash to stockholders. – Increase earnings per share and return on equity. – Provide stock for employee stock compensation contracts or to meet potential merger needs. – Thwart takeover attempts or to reduce the number of stockholders. – Make a market in the stock.  Two acceptable methods: – Cost method (more widely used). – Par (Stated) value method.  Treasury stock reduces stockholders’ equity  Use the Cost Method (we will not use the par-value method): EXAMPLE 7A: Purchase of Treasury Stock On March 23, 2015, Cane Company acquired 5,000 shares of its $3 par common stock for $55 per share. Assume that Cane has no other treasury shares. Make Cane’s journal entry to acquire the treasury shares. EXAMPLE 7B: Sale above Cost On August 23, 2015, Cane Company sold 500 shares of its treasury stock (acquired above) for $70 per share. Make Cane’s journal entry to sell the treasury shares. EXAMPLE 7C: Sale below Cost On October 7, 2015, Cane Company further sold 800 shares of its treasury stock for $42 per share. Make Cane’s journal entry to sell the treasury shares.  After eliminating Paid-in Capital from Treasury Stock, debit any excess of cost over selling price to Retained Earnings. Treasury stock transactions can never increase retained earnings, but can only reduce it. Also remember, transactions in treasury stock can never increase or decrease earnings (i.e., never affects net income).  NOTE: If Cane had purchased treasury stock multiple times at different costs per share, an inventory costing method (FIFO, specific identification, or weighted average) would need to be used to account for the cost of the treasury stock when sold. EXAMPLE 7 D: Retirement of Treasury Stock Assume Cane Company retired 100 shares of its treasury stock. The treasury stock was acquired by Cane at $55 per share. The stock was originally issued at $45 per share and has a par value of $3. Make Cane’s entry to record the retirement of the treasury stock. Preferred Stock  Unlike common stock, preferred stock usually has the following features: – fixed dividend – preference as to dividends – preference as to assets in the event of liquidation – absence of voting rights  Other features preferred stock may have: – cumulative – participating – convertible – callable – redeemable (debt-like securities). EXAMPLE 8: Cane’s Board of Directors declares a cash dividend of $100,000. Cane has 900 shares of 10%, $100 par preferred stock and 10,000 shares of $1 par common stock outstanding. Cane has not paid a dividend for the past 2 years. 1. Calculate the dividends to preferred and common stockholders assuming the preferred stock is noncumulative and nonparticipating. 2. Calculate the dividends to preferred and common stockholders assuming the preferred stock is cumulative and nonparticipating. 3. Calculate the dividends to preferred and common stockholders assuming the preferred stock is noncumulative but fully participating. 4. Calculate the dividends to preferred and common stockholders assuming the preferred stock is cumulative and fully participating. Dividend Policy  Is the dividend legally permissible? – Dividends are generally paid out of retained earnings – Need not have profits in the current year to pay dividends – Dividends cannot be paid out of legal capital • Most states define legal capital as only the par value of outstanding common stock • A few states define legal capital as all contributed capital  Few companies pay dividends in amounts equal to their legally available retained earnings. Why? – Maintain agreements with creditors. – Meet state incorporation requirements. – To finance growth or expansion. – To smooth out dividend payments. – To build up a cushion against possible losses. Types of Dividends 1. Cash dividends 2. Property dividends 3. Liquidating dividends 4. Stock Dividends All dividends, EXCEPT for stock dividends, reduce total stockholders’ equity Cash Dividends EXAMPLE 9: MM Inc. declared a cash dividend (from retained earnings) of $2 per share on its 3 million outstanding shares. The dividend was declared on August 1 and payable on September 9 to all stockholders of record on August 15. Prepare necessary journal entries on all three dates. 1. On declaration date (August 1) 2. On record date (August 15) 3. On payment date (September 9) Property Dividends  Payable in assets (other than cash) of the company  On declaration date, restate the property to be  distributed to its fair value, recognizing any gain or loss. EXAMPLE 10: At December 31, 2016, R Inc. owns available-for-sale securities with cost of $900,000, which equals their market value. On September 21, 2017, when the market value of the securities was $1,200,000, R Inc. declared a property dividend whereby the securities will be distributed on October 23 to stockholders of record on October 8. Prepare journal entries to record the property dividend. Liquidating Dividends  Dividends not based on retained earnings  Return of stockholders’ capital EXAMPLE 11: On April 20, K Corp. declares dividend of $500,000 payable on June 1. Of this amount, $100,000 should be considered as return on capital. Journal Entries: Stock Dividends  Issuance by a company of its own stock to stockholders on a pro rata basis, without receiving any consideration.  Used when management wishes to “capitalize” part of earnings.  If stock dividend is less than 20–25 percent of the common shares outstanding, company transfers fair market value from retained earnings (small stock dividend). Small Stock Dividend EXAMPLE 12: M Corp declares a 10% stock dividend on 500,000 outstanding shares of $1 par value common stock. The fair value of the stock on the declaration date is $30 per share. Prepare the journal entries related to the stock dividend on the declaration date and the issue date. Large Stock Dividend  Accounting based on par value of stock issued  When declared, transfer amount equal to par value of stock issued from retained earnings to contributed capital EXAMPLE 13: M Corp declares a 40% stock dividend on 500,000 outstanding shares of $1 par value common stock. The fair value of the stock on the declaration date is $30 per share. Prepare the journal entries related to the stock dividend on the declaration date and the issue date. Stock Split  Issue additional shares of stock to stockholders based on number of shares currently owned. EXAMPLE : if Dee Company declares a 5-for-4 stock split, and stockholder A owns 500 shares of the company, she will receive an additional 125 shares from Dee Company.  No effect on total paid-in capital, retained earnings, or total stockholders’ equity  Number of shares ↑ and par or stated value per share ↓ EXAMPLE 14: A 2-for-1 stock split on 500 shares of $20 par value stock. Before split: – Number of Shares: – Par value per share: After split: – Number of Shares: – Par value per share: No journal entry (only a memorandum entry recording increase in number of shares and decrease in par value) Presentation of Stockholders’ Equity Capital stock (Par value of issued stock) + Additional paid-in capital (amounts received in excess of par value on shares issued) + Retained earnings or accumulated deficit (undistributed, cumulative profits [or losses] of company) (-) Treasury Stock (at cost) +/- Other adjustments e.g., Comprehensive Income (temporary fluctuations that affect value of the company, but are not currently accounted for in the income statement – direct adjustment to equity) Stockholders’ Equity – Analysis  Analysts use stockholders’ equity ratios to evaluate a company’s profitability and long-term solvency.  Three ratios: – Rate of return on common stock equity. – Payout ratio. – Book value per share. Notes 2 – Chapter 16 Dilutive Securities and Earnings per Share Dilutive Securities  Convertible securities which upon exercise may increase/reduce EPS: o Convertible debt o Convertible preferred stock o Stock warrant o Stock compensation plans Convertible Debt  A convertible bond is a bond that can be exchanged for common stock at the holder’s option.  Investors purchase convertible bonds because of: o benefit of a bond (guaranteed interest) o privilege of exchanging it for stock (at the holder’s option).  Companies issue convertible bonds because o desire to raise equity capital without giving up more ownership control o to obtain debt financing at cheaper rates.  At time of issuance: o Record the same as issuance of any other bond, with any discount and premium amortized over the life of the debt. o No need to separately account for the value of the conversion feature. EXAMPLE 1: On January 1, 2015 ABC Inc. issued $3,000,000 par value, 9% convertible bonds at 98 for cash. Without the conversion feature, the bonds would have sold for 92.  At time of conversion: o Use book value method o Recognize no gain or loss when converted EXAMPLE 2: Use the same facts as in Example 1. Each $1,000 bond is convertible into 50 shares of $10 par value common stock. The bonds are converted on December 31, 2017, when the unamortized discount is $20,000 and the market price of the stock is $23 per share.  Induced conversion: o Issuer wishes to encourage prompt conversion, o Issuer offers additional consideration, called a “sweetener” o Sweetener is an expense of the period. EXAMPLE 3: Use the previous example and assume that ABC wants to reduce its annual interest cost and agrees to pay the bond holders $100,000 to convert.  Retirement of convertible debt: o Record the same as any other bond o Difference between the acquisition price and carrying amount should be reported as gain or loss on the income statement. Convertible Preferred Stock  Convertible preferred stock includes an option for the holder to convert preferred shares into a fixed number of common shares.  Classified as part of stockholders’ equity, unless mandatory redemption exists.  Use book value method.  Recognize no gain or loss when converted. EXAMPLE 4: MNO Corp. issued 5,000 shares of $2 par value common stock upon conversion of 1,000 shares of $20 par value preferred stock. The preferred stock was originally issued at $25 per share. The common stock is trading at $7 per share at the time of conversion. Stock Warrants  Warrants are certificates entitling the holder to acquire shares of stock at a certain price within a stated period.  Normally arises under three situations: 1. To make the security more attractive. 2. Existing stockholders have a preemptive right to purchase common stock first. 3. To executives and employees as a form of compensation. Stock Warrants Issued with Other Securities  Long-term options to buy common stock at a fixed price.  Generally, life of warrants is five years, occasionally ten years.  Proceeds allocated between the two securities.  Allocation based on fair market values.  Two methods of allocation: 1. Proportional method 2. Incremental method  Detachable warrants involves two securities: o a debt security o a warrant to purchase common stock.  Non-detachable warrants o do not require an allocation of proceeds between the bonds and the warrants o companies record the entire proceeds as debt.  The amount of stock warrants is credited to Paid-in Capital. Proportional Method  Determine: o value of the bonds without the warrants, and o value of the warrants.  The proportional method allocates the proceeds using the proportion of the two amounts, based on fair values. EXAMPLE 5: Cane LTD issued 2,000, $1,000 bonds at 101. Each bond was issued with one detachable stock warrant. After issuance, the bonds were selling in the market at 98, and the warrants had a market value of $40. Incremental Method  Where a company cannot determine the fair value of either the warrants or the bonds: o Use the security for which fair value can be determined. o Allocate the remainder of the purchase price to the security for which it does not know fair value. EXAMPLE 6: Cane LTD issued 2,000, $1,000 bonds at 101. Each bond was issued with one detachable stock warrant. After issuance, the bonds were selling in the market at 98. Market price of the warrants, without the bonds, cannot be determined. Stock Rights  Preemptive privilege of existing stockholders to purchase newly issued shares in proportion to their holdings.  Price is normally less than current market value.  Companies make only a memorandum entry. Stock Compensation Plans  Stock Options gives key employees option to purchase common stock at a given price over extended period of time.  Effective compensation programs are ones that: o Base compensation on performance. o Motivate employees. o Help retain executives and recruit new talent. o Maximize employee’s after-tax benefit. o Use performance criteria over which employee has control.  Stock Option: History of the Standard o In 1993 FASB issued an exposure draft on share based compensation (FASB 123) to make option-reporting consistent with reporting for other forms of compensation. This exposure draft met with immense opposition The final ruling required a pro forma presentation of earnings as if the value of the current period’s option grants had been reported as an expense. o In December 2004 FASB revised FASB 123, issuing FASB 123 (R) which requires a public entity to measure the cost of employees services received in exchange for an award of equity instruments based on the grant date fair value of the award (effective date June 15, 2005).  Are Stock Options an expense?  Relevant Dates o Grant date: Date on which options are given to employees. o Vesting date: Date prior to which employees cannot exercise their options – minimum length of service required from the grant date (also known as “service period”) for the employee to earn the right to exercise the options. o Exercise date: Date on which employees utilize their options and purchase company stock at the agreed upon (exercise/strike) price. o Expiration date: Date beyond which employees cannot exercise their option to buy shares.  Two main accounting issues (SFAS No. 123 and 123R) o What is the value? o When should it be recognized as an expense? Value of Stock Options  Intrinsic value method: Compensation expense = (MP of stock @ grant date – Exercise price @ grant date) x number of options  Fair value method: Compensation expense = FMV of the options expected to vest on the grant date  All companies have to now use the Fair Value method Accounting for Stock Options  Allocate over the periods in which employees perform the service—the service period  On the grant date: No accounting entry – but the fair value of the option is measured on this date. This is the total compensation cost related to the stock option granted.  Over the service period: Portion of the total compensation cost (fair value as determined on the grant date) “earned” during the period is accounted for as an expense. Compensation Expense xxxxxxxx Paid-in-Capital – Stock Options xxxxxxxx  Upon Exercise: Employee pays cash, equal to the exercise price times the number of shares purchased. Close out the Paid-in-Capital – Stock Options account proportionately (total compensation cost related to the shares purchased); credit common stock for the par value of shares purchased; Credit balance to APIC. Cash xxxxxxxx Paid-in-Capital – Stock Options xxxxxxxx Common Stock xxxxxxxx Additional Paid in Capital xxxxxxxx  Upon Termination: If employees leave during service period (i.e., before earning the rights to exercise options), the options are terminated. Reverse the journal entry for cumulative compensation expense related to the options forfeited. Paid-in-Capital – Stock Options xxxxxxxx Compensation Expense xxxxxxxx  Upon Expiry: If the options expire (i.e., are no longer valid), cannot adjust previously recorded compensation related to the options. However, close out Paid-in-Capital – Stock Options: Paid-in-Capital – Stock Options xxxxxxxx Paid-in-Capital - Expired Stock Options xxxxxxxx EXAMPLE 7: On January 1, 2015, ABC Co. granted stock options to its five top executives. The stock options were to purchase five million of the company’s $5 par common shares (one million shares per executive) at $20 per share. The options vest after two years of service. The fair value of the options on the grant date was $12 million. On January 1, 2016, the CFO of the company left the company to pursue an academic career in accounting. On March 1, 2018, the CEO of the company exercised her option and purchased 800,000 shares when the prevailing market price of the stock was $30 per share. No further options were exercised prior to the expiry of the options on Dec 31, 2018. Provide journal entries on all relevant dates. Restricted Stocks  Restricted-stock plans transfer shares of stock to employees, subject to an agreement that the shares cannot be sold, transferred, or pledged until vesting occurs.  Major Advantages: o Never becomes completely worthless. o Generally results in less dilution to existing stockholders. o Better aligns employee incentives with company incentives.  Unearned Compensation represents the cost of services yet to be performed, which is not an asset.  Unearned Compensation is reported as a component of stockholders’ equity in the balance sheet. EXAMPLE 8: On January 1, 2015, ABC LTD issues 1,000 shares of restricted stock to its CEO. ABC’s stock has a fair value of $20 per share on January 1, 2015. Additional information is as follows.  The service period related to the restricted stock is five years.  Vesting occurs if the CEO stays with the company for a five-year period.  The par value of the stock is $1 per share. Record the journal entries:  on the grant date (January 1, 2015)  at December 31, 2015. Assume that the CEO leaves on February 3, 2017 (before any expense has been recorded during 2017). Record the journal entry. Earnings per Share (EPS)  Earnings per share indicates the income earned by each share of common stock.  Companies report earnings per share only for common stock.  When the income statement contains intermediate components of income (such as discontinued operations or extraordinary items), companies should disclose earnings per share for each component.  Simple Structure – Common stock; no potentially dilutive securities.  Complex Structure – Includes securities that could dilute earnings per common share.  “Dilutive” means the ability to influence the EPS in a downward direction. EPS – Simple Capital Structure  Subtracts the current-year preferred stock dividend from net income to arrive at income available to common stockholders.  Preferred dividends are subtracted on cumulative preferred stock, whether declared or not.  Weighted-Average Number of Shares Outstanding: o Companies must weight the shares by the fraction of the period they are outstanding. o When stock dividends or share splits occur, companies need to restate the shares outstanding before the share dividend or split. EXAMPLE 9: ABC Inc. has the following changes in its common stock during the period. Compute the weighted-average number of shares outstanding. EXAMPLE 10 A: Assume the following data related to common shares for the DEF Co. for the year ended June 30, 2015. July 1, 2014 180,000 shares outstanding Nov 1 issued 60,000 shares Dec 1 purchased 30,000 treasury shares Apr 1 reissued 15,000 treasury shares Apr 15 split stocks 2-for-1 May 1 repurchased 75,000 treasury shares The company has net income of $660,000 for the current year. The company also has 6% cumulative preferred stock with a par value of $1 million. No dividends were declared or paid during the year. Compute basic EPS for the DEF Co. for the year ended June 30, 2015. EPS – Complex Capital Structure  Complex Capital Structure exists when a business has: o convertible securities o options, warrants, or other rights o that upon conversion or exercise could dilute earnings per share.  Company generally reports both basic and diluted earnings per share.  Diluted EPS includes the effect of all potential dilutive common shares that were outstanding during the period.  Diluted EPS is a very conservative measure of EPS; “worst case scenario” – if all convertibles are converted, what will happen to EPS because of the dilution?  Companies will not report diluted EPS if the securities in their capital structure are antidilutive.  Diluted EPS can never be greater than Basic EPS (remember Diluted EPS is supposed to be more conservative!!!).  For convertible securities, use if-converted method: o Always assume that the conversion happens at the beginning of the reporting period (or at time of issuance, if issued during the period). o Eliminate related interest, net of tax. o Do not deduct preferred dividend in the numerator, if convertible is preferred stock. o Both numerator and denominator of EPS calculation will be affected by convertibles. EXAMPLE 10 B: Continue Example 10, and assume that the company also has 10% convertible bonds with a par value of $1 million outstanding throughout the year. The bonds are convertible into 50,000 shares of common stock. The tax rate is 35%. What is DEF’s diluted EPS for the year ended June 30, 2015?  For options and warrants, use the treasury stock method: o Always assume company exercises the options or warrants at the beginning of the period (or at time of issuance, if issued during the period) o Assume company uses those proceeds to buy back shares at the average market price for the period o For options and warrants to be dilutive, the average market price during the year should be higher than the exercise price (otherwise the options are antidilutive) o Adjustment for options and warrants only affects the denominator; therefore, options are always dilutive when they are “in-the-money” (unless company has a net loss, in which case diluted EPS is set equal to basic EPS – all adjustments are antidilutive) EXAMPLE 10 C: Continue Example 10 (ignore the additional information in Example 10b), and assume that executives of DEF have options outstanding to purchase 200,000 shares of the company at a price of $15 per share. The average market price of DEF’s stock during the fiscal year ended June 30, 2015 was $30. What is DEF’s diluted EPS for the year ended June 30, 2015? Complex Capital Structure with Multiple Potentially Dilutive Securities  When there are multiple potentially dilutive securities that need to be adjusted for, then the adjustments have to be made sequentially (i.e., adjust EPS for each individual security one by one)  Becomes more complicated because at every stage, we have to check whether the next adjustment is dilutive or antidilutive.  Steps in computing Diluted EPS with complex capital structure and multiple potentially dilutive securities: 1. Compute basic EPS 2. Identify all potentially dilutive securities and compute the ratio of the numerator and denominator adjustment (for each individual security). Let’s call this ratio the “dilution ratio.” 3. Rank the dilution ratios from most dilutive to least dilutive. Securities that have zero numerator adjustment (e.g., “in-the- money” options and warrants) are always the most dilutive. 4. Compute diluted EPS using the most dilutive security first. 5. Compare the dilution ratio of the next most dilutive security to the diluted EPS from Step 4. If the dilution ratio is less than the diluted EPS from Step 4, then that security is potentially dilutive. Recompute diluted EPS by adjusting the diluted EPS from Step 4 for this security. 6. Compare the dilution ratio of the next most dilutive security to the diluted EPS from Step 5. Adjust if dilutive. Repeat this step, until there are no more dilutive securities. EXAMPLE 11: Combine the information in Examples 10, 10b and 10c and compute diluted EPS for the DEF Company for the fiscal year ended June 30, 2015. Notes 3 Investment in Debt Securities  Different motivations for investing: o To earn a high rate of return. o To secure certain operating or financing arrangements with another company.  Companies account for investments based on o the type of security (debt or equity) and o their intent with respect to the investment.  Types o U.S. government securities o Municipal securities o Corporate bonds o Convertible debt o Commercial paper  Accounting Category o Held-to-maturity o Trading o Available-for-sale  Amortized cost is the acquisition cost adjusted for the amortization of discount or premium, if appropriate. Held-to-Maturity Securities  Classify a debt security as held-to-maturity only if it has both 1. the positive intent and 2. the ability to hold securities to maturity.  Accounted for at amortized cost, not fair value.  Amortize premium or discount using the effective-interest method unless the straight-line method yields a similar result. E XAMPLE 1: On January 1, 2015, ABC Co. bought 2-year 8% bonds issued by XYZ Co. with a par value of $100,000. Interest on the bond is paid yearly on December 31 and the bond matures on December 31, 2016. The bonds were priced to yield 10% on the issue date. ABC has the capacity as well as the intent to hold the bond until maturity. Provide journal entries related to the investment in the books of ABC for 2015 and 2016. Trading Securities  Companies report trading securities at o fair value, with o unrealized holding gains and losses reported as part of net income.  Any discount or premium is amortized.  A holding gain or loss is the net change in the fair value of a security from one period to another, exclusive of dividend or interest revenue recognized but not received. E XAMPLE 2: Use the same information as in Example 1, but assume that ABC intends to actively trade the XYZ bonds. The fair value of the bonds on December 31, 2015 was $99,123. On April 1, 2016 ABC sold the bonds for $100,944. Provide journal entries on all relevant dates and show how the investment will be presented on ABC’s balance sheet on December 31, 2015. Available-for-Sale Securities  Companies report available-for-sale securities at o fair value, with o unrealized holding gains and losses reported as other comprehensive income, a separate component of stockholder’s equity, until realized.  Any discount or premium is amortized. EXAMPLE 3: Same details as in Example 2, except assume that the company classifies the securities as "available for sale." Investments in Equity Securities  Represent ownership of capital stock.  Cost includes: o price of the security o + broker’s commissions and fees related to purchase.  The degree to which one corporation (investor) acquires an interest in the common stock of another corporation (investee) generally determines the accounting treatment for the investment subsequent to acquisition. 0 ----------------------------------20% ---------------------------------- 50% ------------------------- 100% No significant Significant influence usually influence usually Control usually exists exists exists Investment Investment Investment valued on parent’s valued using Fair valued using Equity books using Cost Value Method Method Method or Equity Method (investment eliminated in Consolidation) Holding of Less than 20% Accounting Subsequent to Acquisition  Market Price Available o Value and report the investment using the fair value method.  Market Price Unavailable o Value and report the investment using the cost method.*  * Securities are reported at cost. Dividends are recognized when received and gains or losses only recognized on sale of securities. Available-for-Sale Securities  Upon acquisition, companies record available-for-sale securities at cost. E XAMPLE 4: On November 3, 2014, Republic Corporation purchased common stock of three companies, each investment representing less than a 20 percent interest. Record the following transactions: 1. investments on November 3, 2. On December 6, 2014, Republic receives a cash dividend of $4,200 from Campbell Soup Co. 3. Republic’s available-for-sale equity security portfolio on December 31, 2014: 4. On January 23, 2015, Republic sold all of its Northwest Industries, Inc. common stock receiving net proceeds of $287,220. Prepare the entry to record the sale. 5. On February 10, 2015, Republic purchased 20,000 shares of Continental Trucking at a price of $12.75 per share plus brokerage commissions of $1,850 (total cost, $256,850). Prepare the entry that Republic would make at December 31, 2015, to adjust its available-for- sale portfolio to fair value Holding Between 20% and 50%  An investment (direct or indirect) of 20 percent or more of the voting stock of an investee should lead to a presumption that in the absence of evidence to the contrary, an investor has the ability to exercise significant influence over an investee.  In instances of “significant influence,” the investor must account for the investment using the equity method. Equity Method  Record the investment at cost and subsequently adjust the amount each period for o the investor’s proportionate share of the earnings (losses) and o dividends received by the investor.  If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor ordinarily should discontinue applying the equity method and not recognize additional losses. EXAMPLE 5: On 1/1/2015, P Co. buys 250 shares of S Co. at a price of $30 per share. S has 1,000 shares outstanding. P is assumed to have significant influence over the operations of S. On 6/30/2015, S pays dividends of $1 per share. The net income of S for the year-ended 12/31/2015 is $800. Provide journal entries for all investment related transactions in the books of P for 2015. Present the investment account in the balance sheet of P as of 12/31/2015. Holding of More than 50%  Controlling Interest: when one corporation acquires a voting interest of more than 50 percent in another corporation o Investor corporation is referred to as the parent. o Investee corporation is referred to as the subsidiary. o Investment in the subsidiary is reported on the parent’s balance sheet as a long-term investment. o Parent generally prepares consolidated financial statements. Fair Value Option  Companies have the option to report most financial instruments at fair value, with all gains and losses related to changes in fair value reported in the income statement. o Applied on an instrument-by-instrument basis. o Generally available only at the time a company first purchases the financial asset or incurs a financial liability. o Company must measure this instrument at fair value until the company no longer has ownership. EXAMPLE 6: McCollum Company purchases stock in Fielder Company during 2014 that it classifies as available-for-sale. At December 31, 2014, the cost of this security is $100,000; its fair value at December 31, 2014, is $125,000. If McCollum chooses the fair value option to account for the Fielder Company stock, it makes the following entry at December 31, 2014. EXAMPLE 7: Sullivan Company holds a 28 percent stake in Suppan, Inc. Sullivan purchased the investment in 2014 for $930,000. At December 31, 2014, the fair value of the investment is $900,000. Sullivan elects to report the investment in Suppan using the fair value option. The entry to record this investment is as follows. Impairment of Value  A company should evaluate every investment, at each reporting date, to determine if it has suffered impairment.  Impairments represent a o loss in value that is other than temporary. o realized loss that is included in net income.  Companies base impairment for debt and equity securities on a fair value test. E XAMPLE 8: Strickler Company holds available-for-sale bond securities with a par value and amortized cost of $1 million. The fair value of these securities is $800,000. Strickler has previously reported an unrealized loss on these securities of $200,000 as part of other comprehensive income. In evaluating the securities, Strickler now determines that it probably will not collect all amounts due. It records this impairment as follows. Comprehensive Income  FV accounting has placed a strain on income reporting. Because FVs are continually changing, reporting gains and losses on income statement would be misleading.  This is the reason why unrealized gains and losses on AFS securities have to be excluded from net income, and have to be reported in other comprehensive income.  Comprehensive income includes: o all revenues and gains, expenses and losses reported in net income, and o all gains and losses that bypass net income but affect stockholders’ equity (eg., unrealized gains and losses on AFS securities), i.e., other comprehensive income. Reclassifications and Transfers  The reporting of changes in unrealized gains or losses in comprehensive income is straightforward unless a company sells securities during the year.  In that case, double counting results when the company reports realized gains or losses as part of net income but also shows the amounts as part of other comprehensive income in the current period or in previous periods.  To ensure that gains and losses are not counted twice when a sale occurs, a reclassification adjustment is necessary. E XAMPLE 9: Open Company has the following two available-for-sale securities in its portfolio at the end of 2013 (its first year of operations).  If Open Company reports net income in 2013 of $350,000, it presents a statement of comprehensive income as follows.  During 2014, Open Company sold the Lehman Inc. common stock for $105,000 and realized a gain on the sale of $25,000 ($105,000 – $80,000). At the end of 2014, the fair value of the Woods Co. common stock increased an additional $20,000, to $155,000.  In addition, Open realized a gain of $25,000 on the sale of the Lehman common stock. Comprehensive income includes both realized and unrealized components. Therefore, Open recognizes a total holding gain (loss) in 2014 of $20,000, computed as follows:  Open reports net income of $720,000 in 2014, which includes the realized gain on sale of the Lehman securities. Transfers Between Categories EXAMPLE 10: Assume that Cane Ltd. decides to transfer its municipal bonds held in trading portfolio to its AFS portfolio as of the end of the current year: Assume that Cane Ltd. decides to transfer its municipal bonds held in its HTM portfolio to its  AFS portfolio. The fair value of municipal bonds is 90,000 Notes 4 Revenue Recognition Overview of Revenue Recognition  Revenue recognition is a top fraud risk and regardless of the accounting rules followed (GAAP or IFRS), the risk or errors and inaccuracies in revenue reporting is significant.  Revenue from Contracts with Customers, adopts an assetliability approach. Companies: o Account for revenue based on changes in assets and liabilities arising from contracts with customers. o Are required to analyze contracts with customers  Contracts indicate terms and measurement of consideration.  Without contracts, companies cannot know whether promises will be met. New Standard The Five-Step Process  Assume that GE corporation signs a contract to sell generators to FPL for $500 million.  Step 1: Identify the contract with customers  Step 2: Identify the separate performance obligations in the contract.  Step 3: Determine the transaction price.  Step 4: Allocate the transaction price to the separate performance obligations  Step 5: Recognize revenue when each performance obligation is satisfied Step 1: Identify Contract with Customers  Contract is an agreement between two or more parties that creates enforceable rights or obligations.  It can be: o Written o oral, or o implied from customary business practice.  Company applies the revenue guidance to a contract according to the following criteria.  Revenue cannot be recognized until a contract exists.  Company obtains rights to receive consideration and assumes obligations to transfer goods or services.  Rights and performance obligations gives rise to an (net) asset or (net) liability. Contract asset = Rights received > Performance obligation Contract liability = Rights received < Performance obligation E XERCISE 1: On May 10, 2014 Cosmo Co. enters into a contract to deliver a product to Greig Inc. on June 15, 2014. Greig agrees to pay the full contract price of $2,000 on July 15, 2014. The cost of the goods is $1,300. Cosmo delivers the product to Greig on June 15, 2014, and receives payment on July 15, 2014. Prepare the journal entries for Cosmo related to this contract.  Accounts for as a new contract if both of the following conditions are satisfied: 1. Promised goods or services are distinct (i.e., company sells them separately and they are not interdependent with other goods and services), and 2. The company has the right to receive an amount of consideration that reflects the standalone selling price of the promised goods or services. Step 2: Identify Separate Performance Obligations  To determine whether a company has to account for multiple performance obligations, it evaluates a second condition.  Whether the product is distinct within the contract. o If performance obligation is not highly dependent on, or interrelated with, other promises in the contract, then each performance obligation should be accounted for separately. O If each of these services is interdependent and interrelated, these services are combined and reported as one performance obligation. EXERCISE 2: Mauer Company licenses customer-relationship software to Hedges Inc. for 3 years. In addition to providing the software, Mauer promises to provide consulting services over the life of the license to maintain operability within Hedges’ computer system. The total transaction price is $200,000. Based on standalone values, Mauer estimates the consulting services have a value of $75,000 and the software license has a value of $125,000. Upon installation of the software on July 1, 2014, Hedges pays $100,000; the contract balance is due on December 31, 2014. Required: Identify the performance obligations and the revenue in 2014, assuming (a) the performance obligations are interdependent and (b) the performance obligations are not interdependent. Step 3: Determining Transaction Price  Amount of consideration that company expects to receive from a customer.  In a contract is often easily determined because customer agrees to pay a fixed amount.  Other contracts, companies must consider: o Variable consideration o Time value of money o Noncash consideration o Consideration paid or payable to the customer  Variable Consideration o Price dependent on future events.  May include discounts, rebates, credits, performance bonuses, or royalties. o Companies estimate amount of revenue to recognize.  Expected value – probability-weighted amount in a range of possible consideration amounts  Most likely amount – the single most likely amount in a range of possible consideration outcomes.  Only allocate variable consideration if it is reasonably assured that it will be entitled to the amount.  Companies only recognizes variable consideration if 1. they have experience with similar contracts and are able to estimate the cumulative amount of revenue, and 2. based on experience, they do not expect a significant reversal of revenue previously recognized.  If these criteria are not met, revenue recognition is constrained. EXERCISE 3: Nair Corp. enters into a contract with a customer to build an apartment building for $1,000,000. The customer hopes to rent apartments at the beginning of the school year and provides a performance bonus of $150,000 to be paid if the building is ready for rental beginning August 1, 2015. The bonus is reduced by $50,000 each week that completion is delayed. Nair commonly includes these completion bonuses in its contract and, based on prior experience, estimates the following completion outcomes: Completed by: Probability August 1, 2015 70% August 8, 2015 20% August 15, 2015 5% After August 15 5% Required: Determine the transaction price for this contract.  Time Value of Money o When contract (sales transaction) involves a significant financing component.  Interest accrued on consideration to be paid over time.  Fair value determined either by measuring the consideration received or by discounting the payment using an imputed interest rate.  Company reports as interest expense or interest revenue. EXERCISE 4: On March 1, 2014, Parnevik Company sold goods to Goosen Inc. for $660,000 in exchange for a 5-year, zero-interest-bearing note in the face amount of $1,062,937. The goods have an inventory cost on Parnevik’s books of $400,000. Required: Prepare the journal entries on (a) March 1, 2014 and (b) December 31, 2014.  Consideration Paid or Payable to Customers o May include discounts, volume rebates, coupons, free products, or services. o In general, these elements reduce the consideration received and the revenue to be recognized. EXERCISE 5: Manual Company sells goods to Nolan Company during 2014. It offers Nolan the following rebates based on total sales to Nolan. If total sales to Nolan are 10,000 units, it will grant a rebate of 2%. If it sells up to 20,000 units, it will grant a rebate of 4%. If it sells up to 30,000 units, it will grant a rebate of 6%. In the first quarter of the year, Manual sells 11,000 units to Nolan at a sales price of $110,000. Manual, based on past experience, has sold over 40,000 units to Nolan, and these sales normally take place in the third quarter of the year. Required: Prepare the journal entry that Manual should make to record the sale of the 11,000 units in the first quarter of the year Step 4: Allocating the Transaction Price to Separate Performance Obligations  Based on their relative fair values.  Best measure of fair value is what the company could sell the good or service for on a standalone basis.  If not available, companies should use their best estimate of what the good or service might sell for as a standalone unit. EXERCISE 6: Sanchez Co. enters into a contract to sell Product A and product B on January 2, 2014, for an upfront cash payment of $150,000. Product A will be delivered in 2 years (January 2, 2016) and Product B will be delivered in 5 years (January 2, 2019). Sanchez Co. allocated the $150,000 to Products A and B on a relative standalone selling price basis as follows: Standalone Selling Price % Allocated Allocated Amounts $40,000 25% $37,500 $120,000 75% $112,500 $160,000 100% $150,000 Sanchez Co. uses an interest rate of 6%, which is its incremental borrowing rate. Required: 1. Prepare journal entries necessary on Jan 2, 2014 and Dec 31, 2014. 2. Prepare journal entries necessary on Dec 31, 2015. 3. Prepare journal entries necessary on Jan 2, 2016 Step 5: Recognizing Revenue when each Performance Obligation is Satisfied  Company satisfies its performance obligation when the customer obtains control of the good or service.  Change in Control Indicators 1. Company has a right to payment for asset. 2. Company has transferred legal title to asset. 3. Company has transferred physical possession of asset. 4. Customer has significant risks and rewards of ownership. 5. Customer has accepted the asset.  When recognizing revenue from a performance obligation over time, measure progress toward completion o Method for measuring progress should depict transfer of control from company to customer. o Most common are cost-to-cost and units-of-delivery methods. o Objective of methods is to measure extent of progress in terms of costs, units, or value added. Other Revenue Recognition Issues o Right of return o Consignments o Repurchase agreements o Warranties o Bill and hold o Nonrefundable upfront fees o Principal-agent relationships  Right of Return o Right of return is granted for product for various reasons (e.g., dissatisfaction with product). o Company returning the product receives any combination of the following. 1. Full or partial refund of any consideration paid. 2. Credit that can be applied against amounts owed, or that will be owed, to the seller. 3. Another product in exchange. EXAMPLE 7: Organic Growth Company is presently testing a number of new agricultural seed that it has recently harvested. To stimulate interest, it has decided to grant to five of its largest customers the unconditional right of return to these products if not fully satisfied. The right of return extends for 4 months. Organic Growth sells these seeds on account for $1,500,00 (cost $800,000) on Jan 2, 2014. Customers are required to pay the full amount due by March 15,2014. Required: 1. Prepare the journal entry at Jan 2, 2014, assuming estimated returns of 20% based on prior experience. 2. Assume that one customer returns the seed on March 1, 2014, due to unsatisfactory performance. Prepare the journal entry to record this transaction, assuming this customer purchased $100,00 of seeds. 3. Briefly describe the accounting for these sales if Organic Growth is unable to reliably estimate returns.  Repurchase Agreements o Transfer control of (sell) an asset to a customer but have an obligation or right to repurchase. o If obligation or right to repurchase is for an amount greater than or equal to selling price, then transaction is a financing transaction. EXAMPLE 8: Cramer Corp. sells idle machinery to Enyart Company on July 1, 2014, for $40,000. Cramer agrees to repurchase this equipment from Enyart on June 30, 2015, for a price of $42,400 (an imputed interest rate of 6%). Required: 1. Prepare journal entries for Cramer for the transfer of the asset to Enyart on July 1, 2014. 2. Prepare any other necessary journal entries in 2014. 3. Prepare the JE for Cramer when the machinery is repurchased on June 30, 2015.  Bill-and-Hold Arrangements o Contract under which an entity bills a customer for a product but the entity retains physical possession of the product until a point in time in the future. o Result when buyer is not yet ready to take delivery but does take title and accepts billing. EXAMPLE 9: Wood Moder recently completed a large contract for Stadium Inc., which consisted of building 35 different types of concession counters for a new soccer arena under construction. The terms of the contract are that upon completion of the counters, Stadium would pay $2,000,000. Unfortunately, due to the depressed economy, the completion of the new soccer arena is now delayed. Stadium has therefore asked Wood Mode to hold the counters for 2 months at its manufacturing plant until the arena is completed. Stadium acknowledges in writing that it ordered the counters and that they now have ownership. The time that Wood Mode must hold the counters is totally dependent on when the arena is completed. Because Wood Mode has not received additional progress payments for the arena due to the delay, Stadium has provided a deposit of $300,000. Required: 1. Explain this type of revenue recognition transaction 2. What factors should be considered in determining when to recognize revenue in this transaction? 3. Prepare the journal entries that Wood Mode should make, assuming it signed a valid sales contract to sell the counters and received at the time the $300,000 deposit.  Principle-Agent Relationship o Agent’s performance obligation is to arrange for principal to provide goods or services to a customer. o Examples:  Travel Company (agent) facilitates booking of cruise for Cruise Company (principal).  Priceline (agent) facilitates sale of various services such as car rentals at Avis (principal). o Amounts collected on behalf of the principal are not revenue of the agent.  Revenue for agent is amount of commission received.  Consignments o Manufacturers (or wholesalers) deliver goods but retain title to the goods until they are sold. o Consignor (manufacturer or wholesaler) ships merchandise to the consignee (dealer), who is to act as an agent for the consignor in selling the merchandise. o Consignor makes a profit on the sale.  Carries merchandise as inventory. o Consignee makes a commission on the sale. EXAMPLE 10: On May 3, 2014, Eisler Company consigned 80 freezers, costing $500 each, to Remmers Company. The cost of shipping the freezers amounted to $840 and was paid by Eisler. On December 30, 2014, a report was received from the consignee, indicating that 40 freezers had been sold for $750 each. Remittance was made by the consignee for the amount due after deducting a commission of 6%, advertising of $200, and total installation costs of $320 on the freezers sold. Required: 1. Compute the inventory value of units unsold in the hands of consignee. 2. Compute the profit for the consignor for the units sold. 3. Compute the amount of cash that will be remitted by the consignee  Warranties o Two types of warranties to customers:   Product meets agreed­upon specifications in contract at time product is  sold.  Warranty is included in sales price (assurance­type warranty).   Not included in sales price of product (service­type warranty).  Recorded as a separate performance obligation. E XAMPLE 11: On Dec 31, 2014 Grando Company sells production equipment to Fargo Inc. for  $50,000. Grando includes a 1­year assurance warranty service with the sale of all its equipment.  The customer receives and pays for the equipment on Dec 31, 2014. Grando estimates the price  to be $48,800 for the equipment and $1,200 for the cost of the warranty. Required: 1. Prepare the journal entry to record this transaction on Dec 31, 2014. 2. Repeat the requirement for (1),  assuming that in addition to the assurance warranty, Grando sold an extended warranty (service  type warranty) for an additional 2 years (2016­2017) for $800. Notes 5 Accounting for Income Taxes  Corporations must file income tax returns following the guidelines developed by the Internal Revenue Service (IRS).  Because GAAP and tax regulations differ in a number of ways, the amounts reported for the following will differ: o income tax expense (GAAP) o income tax payable (Internal Revenue Code). Differences in Financial Reporting and Tax Reporting  Objective of reporting for financial statement users is different from objective of reporting for tax purposes  Financial reporting is dictated by GAAP o Important principles are matching (accrual), conservatism  Tax reporting is based on IRS (or applicable tax authority) rules o Conservatism and matching may not be the main issue o Equity (fairness), revenue generation, providing incentives (or penalties) to further social/economic/political objectives may be more important  Items of revenues and expenses in any given period may not be the same for financial reporting and tax reporting  For financial reporting: full accrual basis: revenue and expense amounts are derived based on GAAP  For tax reporting: modified cash basis: revenues and expenses amounts are determined based on IRS tax rules E XAMPLE 1: In 2014, Amirante Corporation had pretax financial income of $168,000 and taxable income of $120,000. The d


Buy Material

Are you sure you want to buy this material for

75 Karma

Buy Material

BOOM! Enjoy Your Free Notes!

We've added these Notes to your profile, click here to view them now.


You're already Subscribed!

Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'

Why people love StudySoup

Steve Martinelli UC Los Angeles

"There's no way I would have passed my Organic Chemistry class this semester without the notes and study guides I got from StudySoup."

Allison Fischer University of Alabama

"I signed up to be an Elite Notetaker with 2 of my sorority sisters this semester. We just posted our notes weekly and were each making over $600 per month. I LOVE StudySoup!"

Jim McGreen Ohio University

"Knowing I can count on the Elite Notetaker in my class allows me to focus on what the professor is saying instead of just scribbling notes the whole time and falling behind."


"Their 'Elite Notetakers' are making over $1,200/month in sales by creating high quality content that helps their classmates in a time of need."

Become an Elite Notetaker and start selling your notes online!

Refund Policy


All subscriptions to StudySoup are paid in full at the time of subscribing. To change your credit card information or to cancel your subscription, go to "Edit Settings". All credit card information will be available there. If you should decide to cancel your subscription, it will continue to be valid until the next payment period, as all payments for the current period were made in advance. For special circumstances, please email


StudySoup has more than 1 million course-specific study resources to help students study smarter. If you’re having trouble finding what you’re looking for, our customer support team can help you find what you need! Feel free to contact them here:

Recurring Subscriptions: If you have canceled your recurring subscription on the day of renewal and have not downloaded any documents, you may request a refund by submitting an email to

Satisfaction Guarantee: If you’re not satisfied with your subscription, you can contact us for further help. Contact must be made within 3 business days of your subscription purchase and your refund request will be subject for review.

Please Note: Refunds can never be provided more than 30 days after the initial purchase date regardless of your activity on the site.