Accounting Principle Changes

Type of Change	What to Do
Accounting Estimate	Prospective (affects the future)
Accounting Principle	Retrospective (affects the past)
Accounting Entity (GAAP only, not IFRS)	Retrospective (Restate)

Easy enough? Let’s pretend….

Your Story #1 – Change in Accounting Principle

Since 2001, you have been using a GAAP accounting method that calculates expense of $10,000 per year. However, in 2005, you decide to change to a different GAAP accounting method that calculates the same expense as $30,000 per year. In the current year, you are showing the income statements from 2004 and 2005. With this change, what amount do you report in the earliest retained earnings figure being shown?

Changes in accounting principles are handled retrospectively, meaning the expense for each year should be changed to $30,000. Since 2001, 2002, and 2003 are not reported, the accumulated change from these 3 years will need to be reported as a change in the earliest retained earnings.
($30,000 - $10,000)*3 = $60,000.

$60,000 will be the amount that you will report in the beginning retained earnings for 2004.

Your Story #2 – Change in Depreciation Method (Estimate)

You bought a store for $100,000 in Year 2001. You expected it to last for 10 years, and you believed that there is a salvage value of $20,000. During Year 2004, you realize that the total life of the store is actually 6 years, and there is no salvage value. Assume that you use straight-line. What is the net book value of your store on the December 31, 2004 balance sheet?

A change in depreciation method is a change in accounting principle that is inseparable from a change in estimate; thus, this must be handled prospectively.

1) Calculate the accumulated depreciation before the change took place.
([$100,000 - $20,000]/10 years)*3 years = $24,000

2) Use the new estimate method to calculate the deprecation going forward:
6 years (new estimate) – 3 years passed = 3 years remaining
$100,000 - $24,000 = $76,000 (book value at the beginning of 2004)
$76,000/3 = $25,333 (depreciation expense for 2004)
$76,000 - $24,000 (accumulated depreciation) = $52,000 (net book value)

The net book value at the end of 2004 is $52,000.

Other Notes:
- 2 ways to present changes in accounting principle

1. 1 year financial statement presentation: adjust beginning Retained Earnings number with the cumulative change
2. 2 years financial statement presentation: adjust the prior year opening balance for retained earnings. Use new method number for current year.

- Change in accounting entity – pretend that you’ve always had it and just restate your financial statements

Investment Keyword - VC

 Venture Capital (noun):

• Funds given to early stage, high potential, high risk, startup companies with no access to capital markets
• High risk for the investor, but potential for above-average returns

Venture capital fund makes money by owning equity in the companies that it invests in.

“In exchange for the high risk that venture capital investors take on in investing in smaller companies, venture capitalists usually get significant control over company decisions and also a significant portion of the company's ownership (and consequently value).”

Reference, read more: http://www.investopedia.com/terms/v/venturecapital.asp#ixzz2Ap9hIX93

Extraordinary Items

Ultimate definition of being “out of the ordinary” - Material, Unusual, AND Infrequent!

All of these qualities must be considered based on the context of the location and operations of your company though! If you are located in a place that will constantly have earthquakes, then an earthquake will not be considered an extraordinary item.

If something material happens that is either unusual OR infrequent, then it is considered part of your income/loss under continuing operation – non-operating item, before tax.

Reporting an extraordinary item only impacts the placement of the gains and losses, not the overall net income. Keep in mind that numbers are not changed, but the position of the item reported on the income statement does change. When it is not an extraordinary item, it is listed under non-operating, before tax. When it is an extraordinary item, the item is net of tax and shown at the bottom of the income statement.

*IFRS does not allow the reporting of extraordinary items on the income statement or notes to financial statements.

Examples of Extraordinary Items:

• abandonment/damage due to infrequent natural disaster
• "theft" by government
• Illegal products due to new laws

Report a Discontinued Operation

In order of a component of a company to be reported in discontinued operations, it has to either be (1) disposed or (2) classified as “held for sale.”

Steps to calculate a discontinued operation:

1. Impairment loss (BV – FV)
2. Gain/loss from operations (Held for sale – annual; Disposed – up to the sale)
3. Gain/loss from sale of discontinued operation
4. Net of tax 

Let’s Pretend – Your Story
During 2011, you decide to sell a component of your company, “Bees,” that was losing $100 per month. Its carrying value is $1000, and the fair value less costs to sell is $500. “Bees” sold for $800 on May 31, 2012. “Bees” is still losing $100 per month. Tax rate is 30% for both years. How do you record the disposal for 2011 and 2012?

Year 2011: 

1. Impairment loss = $1000 - $500 = $500
2. Gain/loss from operations = $100*12 = $1200
3. Tax from discontinued operations = ($500 + $1200)*30% = $510
4. Total loss from discontinued operations = ($500 + $1200) - $510 = $1190

Year 2012:

1. Gain/loss from operation: $100*5 = ($500)
2. Gain/loss from sale = $800 - $500 = $300
3. Total loss from discontinued operations (net of tax) = [$300 – ($500)]*(1 – 70%) = $140

Other things to remember:

• Whether or not the sale of an asset qualifies as a discontinued operation fully depends on the internal reporting of the company. If the cash flows and operating results are clearly distinguished, then it must be reported on the income statement as a discontinued operation.
• If comparative statements are presented and an item is classified a discontinued operation in the current fiscal year, prior year income statement will be rearranged to separate out the operations from the discontinued asset for comparison purposes (net income does not change).

Elements of the Income Statement and RE

Income Statement
1) Income from Continuing Operations (before tax & after tax): includes operating, non-operating, & income tax
2) Income from Discontinued Operations (after tax)
3) Extraordinary Items (after tax)

Statement of Retained Earnings
4) Cumulative effect of Change in Accounting Principle (after tax)

We need the income statement to tell us (1) how the company's funds are use and (2) what money is actually coming into the company because of how we spend our funds. It helps us determine the profitability, performance, and the value of the company.


Image taken from: http://thexorb.com/Finance/Income/IncomeStatement.aspx




Investment Keywords

Rollfoward (verb):
Establish new beginning account balances by using data from prior accounting period

1. Roll forward both assets and liabilities on a consistent basis from a consistent earlier date (i.e. last annual review)
2. Take the most current asset and liability numbers as a starting point to prepare rollforward estimates of assets and liabilities
    
   When referring to securities rollforward, it is when an old options position gets replaced with a new one having a later expiration date (and same strike price)

Escrow (noun):

A 3rd party holds money/funds/other assets for two parties in a transaction

 

For example, an escrow service will hold funds for the investee and investor until all obligations are fulfilled for the transaction, such as when all necessary documents for the completion of the investment are obtained by the investee and investor and possibly to the escrow as well.

Net Present Value (noun):

NPV = Present Value of Cash Inflows – Present Value of Cash Outflows

• Compares the value of the dollar today to the value of that same dollar in the future (considering inflation and returns)
• + NPV = positive cash flow (good inflow)
• (- NPV) = negative cash flow (too much outflow)
• Used to analyze profitability of an investment

Internal Rate of Return (noun):
The rate of growth that a project is expected to generate

• NPV of cost (negative cash flow) = NPV of benefits (positive cash flow)
• Used to compare profitability of an investment
• The higher the IRR = The more desirable the investment = better chance of strong growth
• If IRR is > cost of capital = acceptable project

Reference, read more: http://www.investopedia.com/

The 1st IFRS Adoption!

Do you know what reports you need after you decide to adopt IFRS? 

Your 1st set of IFRS annual financials statements must have: 

• 3 Balance Sheets (beginning of prior period, end of prior period, & end of current period)
• 2 Statements of Comprehensive Income
• 2 Income Statements 
• 2 Statements of Cash Flows
• 2 Statements of Changes in Equity
• Related notes

**Date of transition to IFRS 

= Date of Opening Balance Sheet 

= Date of "Beginning of Prior Period" Balance Sheet

Let's Pretend - Your Story:

You first decided to adopt IFRS back in 12/31/10, which means a date of transition equaling to 1/1/11. The end of your first IFRS reporting period is 12/31/12. 

You will need an opening IFRS balance sheet at 1/1/11, a balance sheet for 12/31/11, and one for 12/31/12. You will also need both year 2011 and 2012 statements for comprehensive income, income, cash flow, changes in equity, and related notes. 

Interim Financial Reporting

Who: Public & private companies
(Public companies must file with SEC but not required by GAAP)
What: An integral part of the annual financial statements 
When: Every quarter (generally)
Why: Timeliness

Income Tax Expense
Calcuation: (YTD income x estimated tax rate) - prior quarter(s) estimated tax expense
*Always use effective tax rate, not statutory tax rate

GAAP vs. IFRS Presentation Requirements:
GAAP: no presentation minimums, but SEC provides guidance

IFRS:

1. Balance Sheet as of end of the current interim period and prior year end
2. Statements of Comprehensive Income of current interim period & cumulative YTD with comparative statements for comparable periods in prior year
3. Statements of Changes in Equity for YTD current fiscal year and YTD prior year
4. Statements of Cash Flow for YTD current fiscal year and YTD prior year

Operating or Reportable Segment?

You are an operating segment if you:

1. Have discrete financial information
2. Earn revenues & incur expenses
3. Are reviewed regularly by COO

But are you a reportable operating segment?

Test yourself! You are reportable if you are pass one of the following:

1. 10% size threshold: Your revenue/net income/asset is > 10% of the respective items mentioned for the company as a whole
2. 75% reporting sufficiency: if you and other segments combined revenue amount to at least 75% of the total external revenue

Please remember that only public companies are required to disclose such information as well as the following:

• Existence of major customers (over 10% of sales)
• Revenues by product line
• Amount of sales generated in foreign country 

Sign Up!

It's not really official until you've set the date to take a part of the CPA exam, well besides actually taking the test.

This October - November window is super packed! Better hurry up and look for a spot now before you're left with a time/day you don't like or worse - no free days at all!

I've scheduled mine, have you?

Hello to CPA exam!

Oh, how I wish this was goodbye instead! I am sure that many of you feel the same way as I do when you're thinking about the CPA exam. Even the idea of studying for it is just plain dreadful, not to mention getting started!

And thus, the birth of this blog.

I intend to post notes and reviews on the topics that I come across during my studies. Hopefully, this will keep me on track and be useful to you as well! I am currently using Becker materials and some online resources as a guide. I will try to be as updated as possible, but please feel free to offer your own updates in the comments below.

Stay tune for the many different and exciting subjects that will help both you and me to study!