Quick FAR Notes by Hercules CPA

Cash and Receivables Essentials

Ever wondered what actually counts as "cash" in accounting? Cash includes physical currency (PCF), bank deposits, traveler's checks, bank drafts, and unrestricted compensating balances. A compensating balance is money you must keep in your account—if it's unrestricted, it counts as cash; if restricted, it's either a current or non-current asset depending on the timeframe.

Cash equivalents are investments that can be quickly converted to cash. They must mature within 3 months of acquisition to qualify. This includes 3-month time deposits, money market funds, and treasury bills. Important to note: equity securities are never cash equivalents, even if they're highly liquid.

When managing receivables, the Allowance for Doubtful Accounts method (AWERA) helps track potential uncollectible accounts. The basic formula works like this:

• Beginning allowance
• Less write-offs of uncollectible accounts
• Plus expense for bad debts
• Plus recovery of previously written-off accounts
• Equals ending allowance

For Notes Receivable, you'll encounter different financing arrangements:

• Secured borrowing (pledging or assignment of receivables)
• Sale of receivable (factoring or discounting)

💡 When discounting a note, remember that proceeds equal the maturity value minus the discount. The discount is calculated using: Maturity Value × Discount Rate × Discount Period.

Proof of Cash reconciliations help identify errors between bank and book records. Common errors include:

• Checks from another depositor charged to your account (understates bank balance)
• Deposits credited to your account by mistake (overstates bank balance)
• Incorrect recording of check amounts (affects book balance)

For expected credit losses on loans, the three-stage model is used:

1. Stage 1: No significant increase in risk (12-month ECL)
2. Stage 2: Significant increase in risk (lifetime ECL)
3. Stage 3: Credit-impaired (lifetime ECL with interest on amortized cost)

Inventory and Property Management

Inventory valuation is crucial for accurate financial reporting. The Lower of Cost and Net Realizable Value (LCNRV) principle requires you to value inventory at whichever is lower—its cost or what you can sell it for minus completion and selling costs.

When determining inventory cost, include purchase price, import duties, transport costs, and handling fees, but subtract trade discounts and rebates. Remember that shipping terms dramatically affect who records inventory when:

The Gross Profit Method is super helpful for estimating inventory when a physical count isn't possible:

1. Calculate COGS (Net Sales - Gross Profit)
2. Determine required inventory (Beginning Inventory + Purchases - COGS)
3. Compare with actual inventory to find shortage/overage

💡 When using the Retail Inventory Method, the conservative approach adds markdowns back for ending inventory, resulting in a lower cost rate.

For Property, Plant, and Equipment (PPE), initial measurement includes purchase price, import duties, non-refundable taxes (minus trade discounts), and dismantling costs. When acquiring assets through exchange, use fair value if the exchange has commercial substance.

For land and buildings purchased together, allocation depends on intended use:

• If the old building is usable: allocate based on fair value
• If the old building is demolished for land use: demolition cost is capitalized to land
• If the old building is demolished for a new building: depends on intended use of new building

Depreciation methods vary by asset type:

• Straight-line: equal expense over asset's life
• Sum-of-Years-Digits: higher expense in early years
• Declining Balance: percentage of remaining book value

For land improvements (fences, sidewalks, drainage systems), remember they're subject to depreciation, unlike land itself which is never depreciated.

Managing Long-Term Assets and Agriculture

When purchasing machinery and equipment, capitalize all costs needed to prepare the asset for use—this includes purchase price, freight, installation, and testing costs. Just remember that VAT is typically not capitalized.

The revaluation model allows you to increase an asset's value to its fair value. The difference between fair value and carrying amount creates a revaluation surplus in equity. This surplus can be:

• Derecognized when you dispose of the asset
• Amortized over the asset's remaining useful life

Leasehold improvements are changes made by a tenant to a leased property. These improvements are depreciated over the shorter of:

1. The useful life of the improvements
2. The remaining term of the lease

When a company borrows money to construct an asset, borrowing costs should be capitalized as part of the asset's cost. For specific borrowings, capitalize the actual interest expense minus any income earned from temporarily investing those funds. For general borrowings, use the weighted average expenditures and capitalization rate to determine the capitalizable amount.

💡 When dealing with both specific and general borrowings, combine them for weighted average expenditure calculations, then subtract specific borrowings to find the amount allocable to general borrowing.

For agricultural assets, classification is important:

• Plants: Bearer plants are PPE, while produce is a biological asset until harvest, then inventory
• Animals: Can be either consumable or bearer biological assets
• Biological assets are measured at fair value less costs to distribute (FVLCD)

Intangible assets with finite useful lives (like patents and trademarks) are amortized, while those with indefinite lives are tested annually for impairment. For internally-generated intangibles:

• Research phase costs are always expensed
• Development phase costs can be capitalized if technical feasibility is demonstrated

When testing assets for impairment, group them into Cash Generating Units and compare the recoverable amount (higher of value in use or FVLCD) to the carrying amount. Any impairment loss first reduces goodwill, then is allocated to other assets proportionally.

For segment reporting, a segment is reportable if it meets any of these thresholds:

• Revenue test: 10% of total revenue
• Asset test: 10% of total assets
• Profit test: 10% of absolute profit/loss
• Overall size test: reportable segments must represent at least 75% of total external revenue

Discontinued Operations and Investments

Discontinued operations represent a major business component that has been disposed of or is classified as "held for sale." When reporting discontinued operations, present their results separately from continuing operations in the income statement.

Investments in equity securities fall into several categories depending on the level of influence:

When investing in equity securities, remember these key points:

• Cash and property dividends are recognized as income
• Share dividends from the same class of shares require only a memo entry
• Share dividends from different classes require allocation based on market value

For investments in associates (20-50% ownership), use the equity method:

1. Start with acquisition cost
2. Add share of profits and OCI
3. Subtract dividends received and share of losses
4. Calculate goodwill as the difference between acquisition cost and share in fair value of identifiable net assets

💡 When an associate's assets are under or overvalued, adjust your share of their profits by the amortization of these valuation differences.

If you discontinue using the equity method, recognize any gain or loss:

• On sold shares: difference between proceeds and carrying value
• On retained shares: difference between fair value and carrying value

Investment property is property held for capital appreciation or rental income, not for:

• Sale as inventory
• Use in production or administration
• Occupation by employees

You can measure investment property using either:

• Cost model: Cost less accumulated depreciation and impairment losses
• Fair value model: Fair value at year-end (not depreciated; changes recognized in P/L)

When reclassifying property (between inventory, investment property, and owner-occupied), the difference between carrying amount and fair value is generally recognized in profit or loss.

Investment in Debt Securities and Government Grants

Debt securities are classified into three categories, each with different accounting treatments:

*SPPI = Solely Payments of Principal and Interest **EIR = Effective Interest Rate

When accounting for debt securities, remember:

• FVPL: Transaction costs are expensed immediately
• FVOCI and Amortized Cost: Transaction costs are capitalized
• Interest income is calculated differently for each classification (FVPL uses stated interest rate, while FVOCI and Amortized Cost use effective interest rate)

Reclassification between categories is permitted only when your business model changes:

• Reclassification occurs on the first day of the reporting period following the change
• When moving to or from FVPL, use fair value at reclassification date
• When moving between FVOCI and Amortized Cost, maintain the same effective interest rate

💡 When reclassifying from FVOCI to FVPL, cumulative unrealized gains or losses in OCI are reclassified to profit or loss.

For natural resource accounting, different costs are treated as follows:

• Acquisition costs: Capitalized (cost + directly attributable costs)
• Exploration costs: Either capitalized if successful (Successful Effort Method) or always capitalized (Full Cost Method)
• Development costs: Intangible costs are capitalized; tangible costs are accounted for separately
• Restoration costs: Recognized at present value

Depletion accounts for using up natural resources:

• Depletable base = Cost - Residual Value (Land)
• Depletion rate = Depletable base ÷ Estimated Output
• Depletion = Rate × Units Produced
• Depletion in COGS = Rate × Units Sold

Government grants are transfers of resources from the government that require compliance with certain conditions. They're recognized at fair value when there's reasonable assurance that:

1. The entity will comply with conditions
2. The grants will be received

Grants related to assets can be accounted for as:

• Deferred income (liability) recognized over useful life
• Deduction from asset cost

Grants related to income can be:

• Recognized as "Other Income"
• Deducted from related expenses

If you have to repay a government grant, treat the repayment as a change in accounting estimate.

Financial Liabilities and Income Tax

Financial liabilities are generally measured at amortized cost, except when designated at fair value through profit or loss (FVPL) or held for trading. When accounting for Accounts Payable, you can use either:

• Gross method: Records purchase at invoice price; purchase discounts are recognized when taken
• Net method: Records purchase minus all available discounts; "discounts lost" are recognized when payments are late

When dealing with debt modifications, determine if they're substantial or non-substantial:

• Substantial (≥10% difference): Extinguish old debt and recognize new debt
• Non-substantial (<10% difference): Adjust carrying amount and recalculate effective interest rate

For bonds payable:

• Initial measurement is at fair value (less transaction costs)
• Subsequently measured at amortized cost
• When retiring bonds before maturity, recognize gain or loss as the difference between retirement price and carrying amount

💡 For compound financial instruments (like convertible bonds), separate the liability component and equity component. The equity component is the residual amount after determining the liability component's fair value.

Income tax accounting recognizes both current and deferred taxes:

• Current tax is based on taxable income for the period
• Deferred tax accounts for temporary differences between accounting and tax treatments

Temporary differences create either:

• Deferred tax assets (DTA): Future deductible amounts (tax base > carrying amount for assets; carrying amount > tax base for liabilities)
• Deferred tax liabilities (DTL): Future taxable amounts (carrying amount > tax base for assets; tax base > carrying amount for liabilities)

Permanent differences (like non-taxable income or non-deductible expenses) affect current tax but don't create deferred taxes because they never reverse.

For debt refinancing, classification depends on when refinancing occurs:

• If completed by reporting date: Non-current if maturity is >12 months
• If completed after reporting date but before issuance: Current unless entity has discretion to refinance or unconditional right to defer payment

When restructuring debt, you might encounter:

• Asset swap: Recognize gain/loss as difference between liability's carrying amount and asset's carrying amount
• Equity swap: Measure equity at fair value of equity, fair value of liability, or carrying amount of liability (in that order)
• Debt forgiveness: Recognize as gain on extinguishment

Leases

Leases are contracts that convey the right to use an asset for a period of time in exchange for payment. For lessors (property owners), leases are classified as either operating or finance.

In an operating lease:

• The lessor records rent income on a straight-line basis
• Direct acquisition costs (DACS) are capitalized
• Security deposits are recorded as liabilities
• Lease bonuses are recognized as unearned income initially, then recognized over the lease term

For a finance lease, the lessor records:

• Gross investment: Total lease payments + termination penalties + residual value + exercise price
• Net investment: Present value of lease payments (may include residual value if guaranteed)

Finance leases fall into two categories:

1. Direct financing lease: Records net investment equal to cost of asset + direct acquisition costs
2. Sales-type lease: Records sales, cost of goods sold, and gross profit

💡 For a sales-type lease, the gross profit will be the same whether the residual value is guaranteed or unguaranteed, but the components of the calculation will differ.

For lessees (tenants), finance leases require recording:

• Lease liability: Present value of lease payments + termination penalties + guaranteed residual value + exercise price
• Right-of-Use Asset (RUA): Lease liability + initial direct costs + dismantling costs

Depreciation of the leased asset is calculated over the shorter of:

• Useful life of the asset
• Lease term

In a sale and leaseback transaction, measurement depends on whether the transaction is at fair value:

• If selling price equals fair value: Calculate RUA proportionally and recognize partial gain
• If selling price exceeds fair value: Excess is deducted from lease liability and RUA
• If selling price is less than fair value: Shortfall is added to lease liability and RUA

Operating leases can only be recorded as expenses (not RUA) if:

1. The underlying asset is of low value, and
2. The lease term is 12 months or less

Indicators that a lease is a finance lease include:

• Transfer of ownership at end of term
• Bargain purchase option
• Lease term covers major part of asset's economic life
• Leased assets are specialized in nature

Employee Benefits and Financial Statements

Employee benefits include all forms of compensation provided to employees. Short-term benefits (like salaries, wages, and paid absences) are generally expensed when employees provide services, unless they qualify for capitalization as part of an asset's cost.

For paid absences, the accounting treatment depends on their nature:

• Accumulating: Carried forward to future periods (accrue liability)
• Non-accumulating: Use or lose (no accrual necessary)
• Vesting: Employees entitled to payment upon leaving
• Non-vesting: Not entitled to payment upon leaving

Post-employment benefits fall into two categories:

1. Defined contribution plans: Employer provides fixed contributions; employee bears investment risk
2. Defined benefit plans: Employer guarantees specific benefits; employer bears investment risk

For defined benefit plans, accounting involves:

• Fair Value of Plan Assets (FVPA): Tracks investments held by the plan
• Defined Benefit Obligation (DBO): Present value of expected future payments

The defined benefit cost includes components recognized in:

• Profit or Loss: Service costs, net interest, settlement gains/losses
• Other Comprehensive Income: All remeasurement gains/losses

💡 Interest components and service costs affect profit/loss, while all remeasurements (actuarial changes) go to OCI.

Financial statements provide information about an entity's financial position, performance, and changes in financial position. The qualitative characteristics that make financial information useful include:

• Fundamental: Relevance and faithful representation
• Enhancing: Verifiability, comparability, understandability, timeliness

The complete set of financial statements includes:

1. Statement of Financial Position (Balance Sheet): Shows assets, liabilities, and equity
2. Statement of Comprehensive Income: Includes profit/loss and other comprehensive income
3. Statement of Changes in Equity: Reconciles beginning and ending equity balances
4. Statement of Cash Flows: Shows cash inflows and outflows by activity
5. Notes to Financial Statements: Provides additional information and disclosures

The Statement of Cash Flows can be prepared using either:

• Direct method: Shows actual cash receipts and payments
• Indirect method: Starts with net income and adjusts for non-cash items and changes in working capital

Shareholders' Equity

Shareholders' equity represents the residual interest in assets after deducting liabilities. Its components include:

1. Share capital: The par or stated value of issued shares
2. Share premium: Amount received in excess of par value
3. Retained earnings: Accumulated profits not distributed to shareholders
4. Other comprehensive income: Unrealized gains/losses not in profit/loss
5. Treasury shares: Company's own shares that have been repurchased

When a company issues share dividends (additional shares instead of cash), the amount transferred from retained earnings depends on the size:

• Small share dividends (<20% of outstanding shares): Fair value at declaration
• Large share dividends (≥20% of outstanding shares): Par/stated value

Treasury shares are recorded at cost and reduce total shareholders' equity. When reissuing treasury shares:

• Gains are credited to "Share Premium - Treasury Shares"
• Losses are debited first to "Share Premium - Treasury Shares," then to share premium of the original shares, and finally to retained earnings

💡 When calculating shares outstanding, remember: Issued shares - Treasury shares = Outstanding shares. For share splits, multiply all share counts by the split ratio.

For companies with preference shares, calculating Book Value Per Share requires:

1. Subtracting preference shares' liquidation value and dividends (including arrears for cumulative shares) from total equity
2. Dividing the remaining amount by the number of ordinary shares outstanding

Earnings Per Share (EPS) measures each ordinary share's interest in company performance:

• Basic EPS = (Net Income - Preference Dividends) ÷ Weighted Average Number of Ordinary Shares Outstanding
• Diluted EPS adjusts for potential dilution from convertible securities and stock options

Share-based payments compensate employees with equity instruments or cash based on share prices:

• Equity-settled: Measured at fair value of options at grant date, expensed over vesting period
• Cash-settled: Measured at fair value of liability at each reporting date, remeasured until settled

When accounting for these plans, recognize compensation expense over the vesting period, adjusting for expected forfeitures and actual outcomes.

Book Value Per Share and Share-Based Payments

Book Value Per Share (BVPS) tells you the net asset value behind each share. The formula is:

BVPS = Shareholders' Equity ÷ Outstanding Shares

For companies with preference shares, you must adjust the equity:

1. Subtract the liquidation value of preference shares
2. Subtract preference dividends (including arrears if cumulative)
3. Divide by the number of ordinary shares outstanding

When dealing with participating preference shares, remember:

• These shares receive their stated dividend rate first
• Ordinary shares then receive dividends up to the preference rate
• Any excess dividends are distributed proportionally based on par values

For example, if a company has 10% participating preference shares and 12% non-participating preference shares:

1. The 10% preference shares receive their dividend plus any arrears
2. The 12% preference shares receive their stated dividend (if declared)
3. Ordinary shares receive dividends at the lower preference rate (10%)
4. Remaining amounts are distributed proportionally based on par values

💡 For book value calculations, subscription receivables are included in outstanding shares, but for calculating dividends, they may be excluded depending on company policy.

Share-based payments are transactions where entities issue equity instruments or incur liabilities based on share prices. There are two main types:

1. Equity-settled: Employees receive shares or options (measured at fair value at grant date)
2. Cash-settled: Employees receive cash based on share price (measured at fair value of liability at each reporting date)

For equity-settled plans, follow these steps:

• Estimate the number of employees who will meet vesting conditions
• Multiply by options per employee and fair value at grant date
• Recognize expense over vesting period
• Adjust annually for changes in estimated forfeitures

For cash-settled plans:

• Calculate fair value of share appreciation rights (SARs) at each year-end
• Recognize liability and expense over vesting period
• Remeasure liability until settled (with changes to profit/loss)

When options are exercised, record:

• Cash received (exercise price × number of options)
• Reduction in share options outstanding account
• Increase in ordinary share capital (par value)
• Increase in share premium (excess over par)

If employees have a choice between cash and shares (compound instruments), use the residual approach: measure the liability component first, then the equity component.