Accounting and Finance for Lawyers in a Nutshell
Author:
Meyer, Charles H.
Edition:
7th
Copyright Date:
2021
26 chapters
have results for accounting nutshell
Chapter 1 The Basic Financial Statements 15 results (showing 5 best matches)
- In addition to the actual financial statements described above, a complete set of financial statements includes certain additional information. Financial statements include numerous “notes.” One critical note describes the significant accounting policies adopted by the issuer of the financial statements. As we will see in subsequent chapters in this Nutshell, there are many areas where alternative accounting treatments are available for material items included in the financial statements. The note on accounting policies alerts the readers to which of the alternative accounting procedures have been adopted by the issuer in question.
- The main subject matter of this Nutshell is financial accounting. Financial accounting involves the process of recording in the accounting records of a business the financial impact of transactions and events that affect the business and periodically extracting, sorting, and summarizing this information to produce a set of financial statements. Financial statements are the primary means by which businesses communicate financial information to various users. When a business issues a complete set of financial statements, there are four individual statements that are typically prepared. This chapter will introduce and describe the basic financial statements. Various items and concepts introduced briefly in this chapter will be discussed in more detail in later chapters. A general familiarity with the output of the financial accounting process should assist in understanding the accounting process and the issues that arise in the preparation of the financial statements.
- The second adjustment modifies income for changes in certain current assets and liabilities. For example, net income includes all sales for the year. But not all sales are immediately collected in cash. If the business extends credit to its customers, some sales will be represented by accounts receivable (cash to be received in the future). If the balance in accounts receivable has increased during the period covered by the financial statements, this increase must be subtracted from net income to convert the sales component of net income to an amount reflecting the actual on account of sales, which is the correct amount to include in the cash flow from operations. Similar adjustments are made for changes in inventory, accounts payable, and other current asset and liability accounts.
- ., failure to apply the appropriate accounting principles) and were not corrected by management, the auditor’s report sets forth information about the items that the auditor believes should be handled differently and, if possible, the effect that the items have on the financial statements. If the failure to follow appropriate accounting principles is so extensive that the auditors believe they cannot rectify the matter with a disclosure in their report, the auditor would be required to issue an adverse opinion stating in effect that the failure to follow required accounting principles precludes even a qualified opinion.
- Finally, the audit report is a key element of audited financial statements. When financial statements are audited, an independent auditor must include with the financial statements a report or opinion. The audit report first sets forth the auditor’s opinion about whether the financial statements are presented fairly in accordance with “generally accepted accounting principles.” For publicly traded companies whose audits are now governed by the Public Company Accounting Oversight Board, there will also be an opinion on the company’s internal controls.
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Chapter 19 International Accounting Issues 22 results (showing 5 best matches)
- This Nutshell is based on generally accepted accounting principles in the United States. In most developed countries the basics of accounting would be similar. However, the actual accounting principles and practices for many transactions will differ among countries (which is understandable given that even in the U.S., there are situations where companies can choose from alternative acceptable accounting practices). While efforts are underway to harmonize the accounting principles followed in different countries, differences still exist. Just as there is no international tribunal or body that can create law applicable in all countries around the world, there is no single, all-powerful accounting body that can set mandatory accounting principles for all countries. The process for harmonizing accounting around the world essentially involves countries participating in international projects the goal of which is to reach agreement on consistent accounting practices and principles that...
- U.S.-based businesses that operate in foreign markets have special issues for their accounting and preparation of financial statements in accordance with generally accepted accounting principles in the United States. Aside from the political and legal issues presented by such operations, which are beyond the scope of this Nutshell, foreign operations create significant accounting issues because of the need to present financial information in a single currency, which is the U.S. dollar for financial
- International accounting introduces two primary issues (looking at accounting from the perspective of the United States). One issue focuses on U.S. businesses and addresses the special accounting problems that such businesses face when they operate in foreign markets. The other issue focuses on the fact that capital markets have become increasingly global with companies from many countries raising capital by issuing debt or selling stock in securities markets other than in their home country. The accounting rules that apply to these global companies may vary depending on the jurisdictions in which the companies are raising capital because not all countries have the same accounting principles and policies.
- When the functional currency is a foreign currency, the foreign branch or subsidiary would maintain its financial books and records in that foreign currency. When it is necessary for the parent to issue financial statements, several steps must be completed. If the financial records are maintained in accordance with accounting rules in the foreign country and those accounting rules differ from the U.S. accounting rules, adjustments must first be made to convert the financial statements to a U.S. accounting basis.
- The FASB has been working with the IASB to make their financial reporting standards compatible on a standard by standard basis. When the FASB adopts new accounting standards, it now includes a statement regarding the extent to which adoption of the new standard contributes to convergence of U.S. accounting standards with international accounting standards.
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Chapter 3 Generally Accepted Accounting Principles 31 results (showing 5 best matches)
- Throughout this Nutshell, references will be made to topics, subtopics, sections, or paragraphs in the Accounting Standards Codification or ASC ( , ASC 740 on Income Taxes or ASC 730–10–25 on recognition of research and development costs). These references are to the FASB Accounting Standards Codification, which can be found on the FASB’s website at
- The foregoing discussion of GAAP relates primarily to how accountants determine whether a specific accounting treatment must be used for a particular transaction or event. From time to time, the accounting profession has also tried to establish a broader set of fundamental accounting principles (sometimes referred to as concepts, pervasive principles, conventions, postulates, axioms, etc.) that could be used primarily in two ways. These fundamental principles serve as the conceptual basis for the official standard-setting bodies when they are considering adopting a new accounting standard. A new standard is expected to be in conformity with the underlying, fundamental principles. Alternatively, when an accountant is trying to determine the accounting for a specific transaction or event and there is no specific guidance in any of the sources described above, the accountant should presumably be guided by the fundamental underlying principles in developing a solution to the particular
- The Financial Accounting Standards Board (the “FASB”) is an independent body that was created to establish and improve standards for financial accounting and reporting. The FASB’s seven members are selected by the Financial Accounting Foundation Board of Trustees. Funding for the FASB comes from revenues from the sale of publications (like the Accounting Standards Codification, discussed
- The Securities and Exchange Commission (“SEC”), which regulates the sale of securities and the securities markets in the United States, has a significant interest in the development of accounting principles since issuers of securities subject to the jurisdiction of the SEC must file audited financial statements with the SEC. For the most part, however, the SEC has elected to leave the development of accounting principles to the private sector. An exception to this occurs when the SEC is concerned that the private sector is not acting fast enough regarding a particular issue. On those occasions, the SEC issues its own guidance on accounting principles for financial statements filed with the SEC. The usual response when this happens is prompt action by the private sector with the SEC then withdrawing its own pronouncement. The SEC thus acts as a catalyst in these situations. Aside from these limited situations, the SEC treats the FASB’s accounting pronouncements as generally accepted
- The rules and regulations of various federal and state regulatory agencies that require financial statements to be filed with them is another source of authoritative accounting guidance for those financial statements. In some cases, these agencies have established accounting rules or procedures for issues that have not been addressed by the official private sector accounting standard setting bodies and to this extent, the regulatory rules can be an additional source of guidance for GAAP. However, these agencies frequently issue their own accounting procedures and rules that in some cases conflict with GAAP. In those cases, the companies subject to the jurisdiction of the regulatory agencies will prepare one set of financial statements for filing with the regulatory agencies and another set of financial statements prepared in conformity with GAAP for use by shareholders, creditors, and other users and for filing with the SEC, where appropriate. It may not be possible for an auditor...
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Chapter 2 The Accounting Process 63 results (showing 5 best matches)
- offset to the left of the credit entries in the journal. An actual journal entry would also have associated with it the date of the entry and in some cases, a description of the transaction that produced the entry. In a similar manner, all the other transactions of the business and other events affecting the accounting records would be recorded in the journal with the debits always equaling the credits. This format for journal entries will be used throughout this Nutshell to illustrate accounting for different events and transactions.
- The transactions that have been recorded in the journals are “posted” to various ledger accounts. A separate ledger account is maintained for each account maintained by the business. The ledger is used to consolidate all the accounting entries that have been made in each of the accounts of the business. Thus, the ledger for the cash account includes all the entries increasing or decreasing the cash account. For illustrative purposes, the separate ledgers for each account can be represented by “T-accounts.” The journal entry for the land purchase transaction recorded above would be posted to the ledger (as represented here by T-accounts) as follows:
- By convention, debit or left-hand entries are used to show an increase in an asset account or a decrease in a liability or owners’ equity account. The debit entry to Land means that the Land account has been increased, which would be the expected result of a purchase of land. Credit or right-hand entries are used to show a decrease in an asset account or an increase in a liability or owners’ equity account. The credit entry to Cash, an asset account, means that the Cash account has been decreased. The credit entry to Notes Payable, a liability account, means that Notes Payable has been increased as result of the purchase of the land.
- The expense of $5,000 will be included in the determination of net income for the year. The accumulated depreciation account is an example of a “contra account.” A contra account is an offsetting account to some other account. In this case, the accumulated depreciation account is a contra account to the buildings account. To determine the remaining carrying cost or book value of the buildings owned by the business, you subtract the amount in the accumulated depreciation account from the amount in the buildings account. On the December 31, 202x, balance sheet the remaining book value of the building purchased in 202x would be $95,000 ($100,000 minus $5,000). The contra account is used to retain in the financial records the original cost of
- The other unique feature of the revenue and expense accounts is that they are temporary accounts that exist for a certain period (usually one year) and are then closed out at the end of the year. Balance sheet accounts (the accounts for assets, liabilities, and owners’ equity) are permanent accounts. While the balances in these permanent accounts are computed at the end of the year and entered in the balance sheet, the next year’s entries are made in the same accounts. Each permanent (balance sheet) account starts with the balance in that account as of the end of the immediately preceding period. Thus, if the cash account, after all the debit and credit entries for 202x, has a debit balance on December 31, 202x, of $40,000, then the cash account for the next year will begin with a balance on January 1 of $40,000 before any transactions in the new year have been recorded.
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Chapter 10 Accounting for Long-Term Debt 21 results (showing 5 best matches)
- Unsecured traded bonds are frequently referred to as debentures. Mortgage notes or bonds are secured by a mortgage on the debtor’s real property. Long-term debt may also be secured by personal property such as equipment, in which case they may be in the form of equipment trust certificates. These are the basic forms. The financial markets have developed additional specialized forms of debt. For accounting purposes, the legal form of the debt is not important. The accounting treatment will be based on the substantive terms of the debt and the market conditions at the time of issuance. In this Nutshell, bonds will be used to illustrate the accounting for long-term debt because bonds generally present all the significant issues related to such debt.
- After initial issuance, the accounting for the debt would follow the normal rules. With respect to the warrants, if they are exercised, the amount in the stock warrants account would be added to the cash received and recorded in the common stock and regular additional paid-in-capital accounts. If stock warrants lapse unexercised, the amount in the stock warrants account would be reclassified as additional paid-in-capital from stock warrants lapsed. For example, assume that one-half of the warrants described above are exercised. The company would
- Accounting by the debtor for long-term debt such as bonds payable and mortgages payable is like the accounting by investors in debt securities that are intended to be held to maturity (discussed in Chapter 9). This chapter will review the principal accounting rules applicable to long-term debt from the borrower’s perspective. In appropriate places, reference will be made to the discussion of investments in debt securities in Chapter 9 for more detail regarding certain computations.
- Companies may issue bonds or other debt instruments that are convertible at the option of the holder into stock of the issuing corporation. Financial theory indicates that the amount paid by the purchaser of convertible debt consists of two components, (1) the value of the debt exclusive of the conversion feature and (2) the value of the conversion option. In accounting for the issuance of convertible debt, however, the convertibility feature is generally ignored. The proceeds are all recorded in the convertible debt account, which is reported as a liability in the balance sheet at least where the debt is issued at a price not significantly more than the face amount of the debt. ASC 470–20–25–12. Any discount or premium from face value is accounted for in the normal manner. In certain situations, a portion of the proceeds from the issuance of ...the time of issuance. ASC 470 does include certain additional situations where it is necessary to account for the convertible feature...
- Accounting for Long-Term Debt Issued at Par Value
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Chapter 5 Current Assets and Liabilities 69 results (showing 5 best matches)
- One audit issue related to the cash account is the concept of check “kiting.” Kiting generally involves writing a check on one account for an amount greater than the actual funds in that account and then depositing the check in another bank account. The deposited amount is immediately withdrawn from the second account before the check clears the first account. To avoid detection, the excess must be deposited back in the first account before the check clears that account.
- There are few accounting issues related to the cash account. Because of its highly liquid status and the exposure to theft, embezzlement, or other loss, the cash account is subject to extensive internal control procedures and stringent audit procedures to be certain that the amount of cash reported in the balance sheet is in existence and that cash is not being used for unauthorized purposes. Bank reconciliations are prepared on a regular basis to compare the company’s reported cash in its bank accounts with the reported bank balances and to identify items that may have been entered directly into the bank accounts but for which accounting entries have not yet been made. Auditors will confirm with the banks the amounts reported in the accounts at the end of the year. At the same time, the auditors will confirm with the banks the absence of any
- When a specific account is determined to be uncollectible, no additional bad debt expense is recorded. The identified account is removed from the receivables account and a like amount is removed from the allowance account with no net effect on income or on the balance sheet (since the net receivables reported in the balance sheet are unchanged). Thus, if a $5,000 receivable were determined to be uncollectible, the following entry would be made:
- The second approach for determining the bad debt expense for the period is the aged accounts receivable analysis. In an aging analysis, the accounts receivable balance is periodically divided into categories based on the age of the receivables. The amount in each aging category is examined and a determination is made, based on experience, how much of the receivables in each category will eventually be uncollectible. The total amount expected to be uncollectible is then computed and compared to the amount currently in the allowance account. The difference is recorded as an adjustment to bad debt expense and the allowance account. This aged accounts receivable analysis is also used as a periodic check on the amount computed under the percentage of sales method.
- Another accounting issue related to receivables arises from the practice of converting receivables into cash prior to collection either by borrowing using the receivables as security for the loan or by “selling” the receivables. If the receivables are assigned or pledged as collateral for a loan, the loan is recorded as a liability and accounted for in the normal manner. Generally, the assignor of the receivables (the borrower) retains the responsibility for collecting the receivables. The assigned receivables remain as current assets, although they may be transferred to an account called “Assigned Accounts Receivable” to facilitate segregation of the assigned accounts from accounts that have not been assigned.
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Chapter 17 Special Reporting Issues 22 results (showing 5 best matches)
- ASC 250–10–45 governs the reporting for changes in accounting principles. A change in accounting principle is the decision to adopt one accepted accounting approach for an accounting issue in place of the accounting approach previously utilized where both of the methods are generally accepted accounting principles. A change can only be made if it is required by an amendment to the ASC or it can be justified as being clearly preferable to the prior accounting treatment. ASC 250–10–45–2. There is a general presumption that accounting principles once adopted should not be changed.
- Previously, the general rule for reporting most changes in accounting principles required a determination of the cumulative effect of the change in accounting principle as of the beginning of the period in which the change occurred. The cumulative effect of the change in accounting principle was the amount that retained earnings would change as of the beginning of the year in which the change is adopted if the new accounting principle had been applied in all prior periods ( the cumulative change in income net of tax). This cumulative effect was reported as a separate item in the income statement. The new accounting principle was then
- Under ASC 250–10–45–18, certain changes in accounting principles are treated as “changes in accounting estimates effected by a change in accounting principle.” For these types of changes in accounting principles, the changes are implemented prospectively as in the case of changes in estimates. ASC 250–10–45–18 indicates that a change in the method of depreciating long-lived assets, for example from a straight-line method to an accelerated method (see Chapter 7 B.3.), would be an example of a change in accounting estimate effected by a change in accounting principle.
- Under ASC 250–10–45–5, the appropriate reporting for a change in accounting principle now generally requires “retrospective application” of the new accounting principle to all prior periods. Retrospective application requires that the balances of affected assets and liabilities be adjusted for the cumulative effect that the change would have had to those assets and liabilities as of the beginning of the earliest period for which financial statements are presented. If the new accounting principle would have affected the net income of the company for periods prior to the earliest period presented, the cumulative effect of the change in accounting principle on net income as of that date (net of income tax effects) would be recorded as an adjustment to retained earnings. The financial statements for each separate period presented would then be adjusted for the effects in that period of the changed accounting principle.
- Note that a change in accounting principle may have certain indirect effects on profit sharing plans or other contractual arrangements calculations that are based on net income in prior periods. The accounting impact of such indirect effects is not applied retroactively. These indirect effects are reported in the period in which the change in accounting principle giving rise to such indirect effects occurs. ASC 250–10–45–8.
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Chapter 14 Partnership Accounting 41 results (showing 5 best matches)
- Alternatively, separate partner accounts could be used to record income and loss and distributions during the year. For example, distributions during the year could be recorded in a “drawing account.” At the end of the year, the debit balance in the drawing account would be deducted from the capital account by crediting the drawing account and debiting the capital account for each partner. Similarly, a separate account could be used to record the share of income or loss that accrues to the partner. If such separate accounts are maintained, each partner’s capital in the partnership would be the total of the amounts in these accounts.
- Partnerships maintain a separate capital account for each partner. Each partner’s capital account is used to record that partner’s contributions to the partnership, that partner’s share of income or loss, and any distributions made to the partner. This differs from the accounting for stockholders’ equity of a corporation, which generally does not maintain separate accounts for each shareholder in the corporation but only for separate classes of stock.
- A partnership may use a single account for each partner’s capital. That account may be called, for example, “Partner X, Capital Account.” This capital account could be used to record all entries affecting the capital of the partner. Contributions by partners are credited to their capital accounts. Contributions of assets other than cash should be recorded at their fair market values at the time of contribution unless the partnership agreement provides otherwise.
- Issues like those raised by the admission of new partners also arise in connection with the retirement or withdrawal of a partner. If the retiring partner is entitled to receive the book value of the departing partner’s capital account, the accounting for the retirement is simple. The distribution to the retiring partner credited to one or more asset accounts would be debited to the partner’s capital account, which would then have a zero balance.
- The alternative approach to dealing with the retiring partner is the bonus method. Under the bonus method, amounts in the capital accounts of the partners are reallocated among them to adjust the retiring partner’s capital account to the amount to be distributed to the retiring partner. In this case, T’s capital account must be increased by $15,000. If the book value of the net assets is to remain the same, this additional capital must come from the capital accounts of the other partners. The $15,000 will be charged against the capital accounts of the continuing partners in the ratio in which they share partnership losses. Since R and S share income and loss in a 2:1 ratio (50% for R and 25% for S), $10,000 will be debited to R’s capital account and $5,000 will be debited to S’s capital account. The entry would be as follows:
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Chapter 16 Earnings per Share and Financial Ratios 9 results (showing 5 best matches)
- Aside from questionable accounting policies, the analyst is also sensitive to the fact that many acceptable accounting practices are choices from available alternatives. Since most securities analysis involves comparison of the financial data for several companies, the existence of multiple acceptable accounting practices makes the analysis difficult. The financial statements of companies using different accounting practices are not necessarily comparable even if the companies are in the same industry. For example, one company may use LIFO in accounting for inventory and another company may employ FIFO in accounting for inventory. In this situation, the analysts will attempt to adjust the financial statements in such a way as to reflect comparable accounting policies for all the companies under review.
- If the net income for the year includes separately reported items such as effects of changes in accounting principles or gain or loss from the disposal of a business (see Chapter 17), EPS is calculated and reported separately for each of these components (as well as for the net income before these items and the overall net income).
- Stock options (as well as warrants and other similar arrangements) are taken into account in determining diluted EPS. To calculate the effect of the options on diluted EPS, a technique called the “treasury stock method” is used. ASC 260–10–45–22. The treasury stock method is a procedure for giving effect to the proceeds that would be received upon exercise of the stock options. The proceeds receivable upon exercise of the stock options are assumed to be used to purchase currently outstanding shares of common stock on the open market. ASC 260–10–45–23. These repurchased shares reduce the number of net additional shares assumed to be issued under the options. These purchases are assumed to be made at the average market price for the accounting period.
- As noted above, the basic and diluted EPS numbers are shown at the bottom of the income statement. If the income statement includes the effect of changes in accounting principles, or amounts attributable to the disposal of a business, basic and diluted EPS amounts would also be shown for these separately disclosed items.
- Before computing financial ratios, most analysts undertake a careful review of the financial statements. This review is necessary to determine if any questionable accounting policies are being applied. If that is the case, the analyst will attempt to adjust the financial statements to remove the effect of the questionable practices.
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Chapter 7 Property, Plant, and Equipment and Depreciation 29 results (showing 5 best matches)
- In the noncurrent asset section of the balance sheet, the principal component for most businesses is the property, plant, and equipment account, also called the fixed asset account. The property, plant, and equipment account is generally composed of the tangible property other than inventory that is used in the operations of the business and expected to be used for more than one year. It includes land used in the business (but not land held for investment), machinery and equipment, furniture and fixtures, and buildings and other structures. There are five principal issues in accounting for property, plant, and equipment. These issues relate to recording the initial acquisition, allocating the cost of the property to expense over the life of the property through a process called depreciation accounting, reporting post-acquisition costs incurred to keep the property operational, accounting for the disposal of the property, and accounting for any permanent impairments.
- Historical cost accounting is generally used to account for fixed assets. There is no attempt to revalue the assets and maintain them at their fair market values. An exception to this applies when an asset has experienced a reduction in value to an amount below the current book value of the asset and that loss of value is not temporary. Such a reduction in value would be recorded as a loss in the financial statements.
- The construction in progress account is an asset account used to accumulate the cost of the construction until the asset is ready for use in the business. The effect of the foregoing entry capitalizing interest is to increase income for the year by the amount of the interest transferred to the construction account. This interest will eventually be deducted as part of the depreciation expense (and eventually any gain or loss on disposition) when the asset is completed and put in service.
- Accumulated depreciation is a contra asset account. That means that the accumulated depreciation is an offset to (reduction in) the related asset account in the balance sheet. Maintaining a separate accumulated depreciation account permits the business to retain a record of, and report, the original cost of the fixed assets separately from the amount of depreciation that has been recognized, which gives some indication of the relative age of the assets. This also results in reporting information about depreciable assets in the financial statements even when those assets are fully depreciated.
- The third principal accounting issue related to fixed assets is the accounting treatment for expenditures made on fixed assets after they are acquired and placed in service. When a post-acquisition expenditure is made in connection with a fixed asset, two possible accounting treatments are available. The expenditure could be immediately expensed (such an expenditure is sometimes referred to as a revenue expenditure). To expense an item means to recognize it as an expense in full in
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Chapter 9 Accounting for Investments 47 results (showing 5 best matches)
- This chapter will address issues related to accounting for investments. Accounting for short-term investments in securities that are reported as current assets was discussed briefly in Chapter 5. Expanding on that discussion, Section A will discuss the appropriate accounting for investments in bonds. Section B will discuss the methods for accounting for investments in the stock of other companies. Section C will address the accounting for certain other investments.
- This chapter will discuss in detail the rules for reporting investments including the requirement for certain investments be reported at market value. These rules apply to current assets and noncurrent assets. The accounting described in this chapter represents the general rules for accounting for investments for most businesses. Certain specialized industries, particularly finance and investment companies, have special rules for accounting for investments.
- When bonds are acquired as an investment, there are several steps in the accounting process. The bonds are initially recorded at their cost. The business that invests in the bonds must then account for the receipt of interest revenue and the accrual of interest revenue when interest is not paid currently through the date of the financial statements. Finally, bonds are often acquired at a price that differs from the face amount of the bonds. When this occurs, the business must account for the resulting discount or premium on the bonds. This section will review first the accounting for bonds acquired at face value and then will discuss the accounting treatment when bonds are acquired at a discount or premium. There will then be a discussion of the accounting for changes in market value of the bonds.
- In its own accounting records, the parent company would account for the subsidiary using the cost method or the equity method (the method used is not critical because the accounting for the investment will be converted to the consolidated method as described below). At year end, the separate balance sheets of the parent and subsidiary are consolidated through a worksheet process that combines the asset, liability, and equity accounts of the two entities and eliminates certain “reciprocal” accounts on the books of the two companies to avoid double counting of certain items. Similarly, the income statements, cash
- Viewed as a single economic entity, the balance in the Investment in S account of $16,000 is really a duplication of the net assets (assets minus liabilities) of S. Also, since the stock of S is owned by P and not by outside shareholders, the stockholders’ equity accounts of S should really be ignored (remembering that the retained earnings of S are already included in the retained earnings of P as a result of applying the equity method of accounting for the investment in S on P’s separate accounting records). To prepare appropriate consolidated financial statements and avoid double-counting, the following elimination entry would be recorded not in the actual accounting books of either company but on a worksheet used to prepare the consolidated financial statements:
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Chapter 11 Accounting for Leases 26 results (showing 5 best matches)
- Leveraged lease accounting was a special form of accounting by a lessor for leases that met certain requirements (this special accounting treatment did not apply to lessees). The most significant feature of leveraged lease accounting was that the lessor reported its investment in the leased property net of the nonrecourse financing on the property (nonrecourse financing was an essential element of leveraged leases).
- For leases commencing after the effective date of the new lease accounting rules adopted in 2016, the concept of a leveraged lease no longer applies. Leases that would have been treated as leveraged leases will be subject to, and be accounted for, under the current rules applicable to leases generally. Leveraged leases entered into prior to the effective date of the new rules will continue the special accounting for leveraged leases.
- Closely related to the topic of accounting for long-term debt is the accounting treatment of leases. Long-term leases, sometimes called finance leases, are an alternative to the use of debt financing for the acquisition of assets. Until recently, if the acquisition of an asset was accomplished by properly structured leases rather than with debt, the financial accounting consequences were quite different. While differences still exist on the earnings statement, the statement of financial position treatment of leases as opposed to debt-financed purchases is no longer significantly different, with minor exceptions. While the accounting differences are minimized, there are still different income tax consequences for the two forms of financing and there are different legal rights of the parties under commercial law including bankruptcy.
- To understand why the issue of accounting for leases is so significant, it is helpful to illustrate the difference in the accounting that resulted if the lease was treated as a “true” lease (a lease not required to by capitalized under the rules prior to the 2016 changes) for accounting purposes as compared to the accounting that would apply if the asset were acquired with borrowed funds. Assume that a piece of equipment with a cost of $100,000 is being acquired. The seller offers two alternatives for financing the acquisition of the asset. The “buyer” could sign a lease giving the buyer the right to use the asset for twenty years in return for the payment of a monthly rental in the amount of $1,101.09. Alternatively, the buyer could sign a twenty-year note payable with an interest rate of 12% per annum payable in 240 equal monthly payments. The monthly payment on this note would be $1,101.09.
- For purposes of classifying the lease as a finance lease or an operating lease, the rules are generally the same for the lessee and the lessor but there are some differences. Different terminology is also used for lessees and lessors. The discussion below will first look at the lease accounting from the standpoint of the lessee. After that, the lease accounting for the lessor will be discussed.
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Chapter 13 Accounting for Stock and Stockholders’ Equity 48 results (showing 5 best matches)
- The dividends declared account is a temporary account in which the dividends for the year are recorded. At the end of the year, the amount in the dividends declared account would be transferred to, and deducted from, retained earnings. If the total amount in the dividends declared account at the end of the year were $1,000,000, the following entry would be made:
- Similar accounting applies to the issuance of preferred stock. The par or stated value of the preferred stock would be recorded in an account called “Preferred Stock.” Any additional amount received for the stock would be recorded in an additional paid-in-capital account for the preferred. Thus, if 10,000 shares of $100 par value preferred stock are issued for $105 per share, the entry to record the issuance would be as follows:
- The third principal component of the stockholders’ equity in a corporation is the account called “Retained Earnings.” This account includes the accumulated net income of the corporation reduced by dividends, other distributions to stockholders, and certain miscellaneous items that are charged or credited directly to retained earnings. If the balance in the retained earnings account is a negative or debit balance (because the corporation has experienced losses), the account is usually called “Accumulated Deficit” in the statement of financial position.
- At the end of each year in connection with the closing of the books, the net income or loss for the year is transferred from the temporary revenue and expense accounts to the retained earnings permanent account. If a corporation has net income for the year of $150,000 and the corporation used an “income summary” account to summarize the net income for the year, the entry to transfer the net income to retained earnings would be:
- There are several accounting issues related to the owner’s equity section of the statement of financial position. Owners’ equity in corporations is usually referred to as stockholders’ equity. This chapter will discuss the principal accounting issues for stockholders’ equity. Stockholders’ equity includes items in addition to the traditional contributed capital and retained earnings.
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Chapter 6 Accounting for Inventories 19 results (showing 5 best matches)
- An accounting entry is made at the end of the year to update the inventory account, close out the purchases account, and enter the appropriate amount in the cost of goods sold account. That entry would be as follows:
- ASC 330 generally governs the accounting for inventory. Accounting for inventory involves three primary steps. First, there must be a procedure for determining the physical quantities of goods included in the inventory at the balance sheet dates and typically at certain interim points during the accounting year. Second, items that are included in inventory are acquired from time to time at different prices or costs. In addition to determining the number of items on hand, businesses must determine the appropriate unit cost to be assigned to the items that are still on hand and the units that have been sold during the period. Third, generally accepted accounting principles require that inventory be periodically evaluated to determine if its “value” is less that its cost. Where that is the case, the lower of cost or market rule requires that the carrying amount or book value of the inventory be written down to its lower value.
- To determine cost of goods sold under this system, one more item of information is necessary. The business will have maintained a temporary account during the year called “Purchases” (assuming that we are dealing with a retail or wholesale operation) and all the purchases of inventory items during the year will have been recorded in that account. Assume that the balance in the Purchases account for the year is $400,000 (
- Accounting for inventory requires a determination of the actual quantities of items on hand from time to time. Several celebrated cases of fraudulent or misleading financial statements have involved the overstatement of inventory quantities on hand. Overstating inventory translates into a corresponding overstatement of income.
- The periodic inventory system employs a periodic physical count of the inventory on hand from time to time. This count will usually be performed at the end of the accounting period, but businesses may conduct more frequent counts particularly where inventory is highly valuable. A separate count is made of each type, size, or other characteristic of the inventory.
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Foreword to the Seventh Edition 4 results
- Other changes include refinements in the accounting for goodwill and investments. I have added additional references to relevant sections of the Accounting Standards Codification throughout the book for those who want to go to the source for additional detail on the accounting rules.
- The accounting world and accounting rules continue to change reflecting both changes in the business environment and refined thinking about how transactions and events should be presented in financial statements. The seventh edition reflects the key developments that have occurred since the sixth edition.
- As always, I trust that this seventh edition will continue to provide law students, lawyers, and other readers with a sufficient understanding of the basics of accounting and finance so that they can better appreciate the significance of accounting and its importance in the commercial and legal world.
- The significant changes in the accounting for leases issued by the FASB in 2016 are now fully effective for most companies (the required implementation for private companies and certain other issuers is delayed to 2021). The changes primarily affect the balance sheet presentation for operating leases requiring almost all such leases to be capitalized. Since the changes are now being implemented by most companies, Chapter 11 has been reorganized and revised to focus on the new rules.
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Chapter 18 Corporate Finance— Valuation 6 results (showing 5 best matches)
- The market interest rates to be used in valuing bonds are determined by several factors. The primary determinants of the market interest rates for a bond issue are discussed in this section. This Nutshell does not discuss the determinants of the overall level of interest rates in the economy since these factors are not specific to the bond issue.
- Financial accounting information is critical to the valuation of business enterprises and the valuation of the individual securities issued by businesses. The information from the financial statements may be used directly in the valuation process or the accounting information may be used indirectly in projecting such items as earnings or cash flow or in determining the risk associated with the securities of the business. Risk is reflected in the discount rate or required rate of return that is a central element of many valuation techniques used in corporate finance.
- multiples are unreliable because of the use of historical costs in accounting for inventory and property, plant, and equipment. Different businesses may have widely disparate book values solely as the result of historical cost accounting.
- Other multiples would be based on the relationship between the price paid for comparable businesses and the earnings or cash flow of those businesses. The earnings multiple analysis would be like the use of price/earnings ratios to compute the value of the common stock of a company as discussed in Section A.3 above. To apply a meaningful earnings multiple analysis, the earnings for the comparable companies must be “cleaned up.” This cleanup process involves converting the companies under consideration to common bases of accounting where multiple acceptable accounting approaches exist ( ...accounting) and eliminating from the earnings any unusual or nonrecurring items that would distort the comparisons. Earnings multiples can be based on net income or they may be based on some partial earnings number such as operating earnings before or after interest expense. Cash flow multiples are like earnings multiples except that the multiples are based on an appropriate cash flow number such as...
- A more sophisticated variation of this approach is to use a model called the capital asset pricing model to determine appropriate rates of return. The theoretical and conceptual basis for the capital asset pricing model is beyond the scope of this Nutshell. A simplified application of this model will, however, illustrate its use in determining common stock values. Analysts determine the expected rate of return for a “market portfolio of stocks” consisting, for example, of all the stocks in the Standard & Poors 500 index. This rate of return for a broad-based market index is composed of two elements, a risk-free interest rate and a risk premium. The expected rate of return for individual stocks is then computed by determining how risky an individual stock is compared to the market as a whole. This relationship is stated as follows:
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Chapter 12 Accounting for Other Long-Term Liabilities 29 results (showing 5 best matches)
- Accounting for income taxes is the subject of ASC Topic 740. The principal accounting issues related to income taxes arise from the fact that the rules for determining income for income tax purposes are different from the rules of GAAP used in determining income before tax for financial reporting. There are two types of differences. “Temporary differences” arise when an item of income or expense is taken into account in determining financial or book income before tax in a different period from the period in which the item is taken into account in determining taxable income. “Permanent differences” arise because some items that are income for one purpose are never treated as income for the other purpose and similarly some items that are deducted as expenses for one purpose are never deducted as expenses for the other purpose.
- There are four basic categories of temporary differences in accounting for deferred income taxes that we will discuss. Certain types of temporary differences can also arise related to accounting for investment tax credits, tax effects from changes in foreign currency and business combinations. ASC 740–10–25–20.
- Measuring the amount of compensation expense associated with defined benefit plans and the amount of liabilities or assets to be recorded in connection with defined benefit plans is much more complicated than the related issues for defined contribution plans. The accounting rules related to these plans are extremely technical. The discussion below only highlights the key elements and accounting issues for these types of plans.
- ASC 715–60–35 sets forth requirements to account for these arrangements on an accrual basis similar in many ways to the accounting for defined benefit pension plans. Accrual of the expense related to these plans will now occur over the service lives of the employees that are entitled to the benefits.
- In addition to temporary and permanent differences, accounting for income taxes is complicated by the fact that income tax reporting often requires judgment regarding tax filing positions where the application of tax laws to transactions or matters are not certain. Companies must take a position on these issues for their tax reporting jurisdictions in which they file tax returns. From a financial accounting standpoint, the company must consider how these uncertain tax positions should be reflected in the financial statements.
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Chapter 15 Accounting for Business Combinations 15 results (showing 5 best matches)
- The accounting for a business combination is similar in many respects to any purchase of assets. The assets, liabilities, and any non-controlling interest in the acquired entity are recorded on the acquirer’s books at their fair value. The acquirer’s stock or some types of noncash consideration for the acquisition will be measured at their fair value. The book values of the assets and liabilities of the target are not carried over. There is no carryover of any accounting attributes from the seller as was the case under an old method of accounting for business combinations called the pooling of interests method.
- Under the acquisition method of accounting for a business combination, the acquiring company records the acquired net assets at their fair values at the date of acquisition. In illustrating the accounting for business combinations, I will assume an acquisition of stock of the target rather than an acquisition of the target’s assets. The rules for acquisitions of assets are essentially the same. The following simplified statements of financial position of the purchaser and the target will be used to illustrate acquisition accounting.
- Certain “acquisition” transactions are characterized as “reverse acquisitions.” This occurs when the “legal acquiror” is, from an accounting standpoint, really the acquiree and the “legal acquiror” is, from an accounting standpoint, the acquiree. An example of this situation would be where a privately held company is “acquired” by a much smaller publicly registered entity. This could be done to allow the larger privately held company to get publicly registered status without going through the initial registration process. Reverse acquisitions will not be discussed except to note that typically, the accounting basis of the assets and liabilities of the legal acquiree will not be remeasured to their fair value as would be the case if this were a true business combination. The legal acquiror’s assets and liabilities may be revalued, however, since it is really the acquiree.
- In the case of a business combination in the form of an acquisition of stock, the adjustments to the fair value of the assets and the liabilities of the acquired business under the acquisition method of accounting are often recorded in the process of preparing consolidated financial statements, as discussed in Chapter 9. These adjustments are not generally recorded in the regular books of the target. In certain situations where the acquired subsidiary must issue its own separate financial statements, a procedure called “push down accounting” is employed. Under push down accounting, the assets and liabilities of the acquired subsidiary are adjusted based on the fair values at the time of the acquisition in the same manner that those values are adjusted in the preparation of the parent company’s consolidated financial statements.
- The accounts in the target’s statement of financial position and the fair value of its assets and liabilities are as follows:
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Chapter 4 Recognition of Revenues and Expenses 12 results (showing 5 best matches)
- Two concepts address these issues. The “revenue recognition principle” guides the determination of when to recognize for accounting purposes the revenue from the various transactions of a business. The “matching principle” determines when expenses should be recognized for accounting purposes.
- Certain types of costs can be directly related with revenue. These costs are recognized as expense when the related revenues are recognized. The cost of goods sold is an example of this approach to expense recognition. A retailer incurs costs in acquiring inventory that is held for sale. When the inventory is acquired, the cost is not treated as an expense but is reported in a current asset account called inventory. When sales occur and revenue is recognized, the appropriate cost of the items sold is removed from the inventory account and recognized as an expense called cost of goods sold.
- In the limited cases described in the previous section, the accounting recognition of changes in market value occurs regardless of the cause of the change. The changes could be the result of fundamental changes in the economy that have a
- On the other hand, expenses may be recognized in some cases before any identifiable costs are actually incurred by the business. For example, when a business sells goods subject to a warranty, the normal practice is to report an estimated warranty expense at the time of the sale of the goods. The offsetting entry to the warranty expense (which is a debit entry) is a credit to a liability account for future warranty costs. The actual warranty costs will not be incurred until some later time. When warranty costs are incurred, the warranty costs will be debited to the liability account rather than being deducted as an expense. Contingent expenses like the possible loss from litigation in which the business is a defendant may have to be recognized as expenses prior to the actual resolution of the lawsuit. Thus, expense is recognized prior to any actual costs being incurred. It is the matching principle and the expense recognition rules derived therefrom that determine when “costs” are...
- Once the revenue recognition method is determined, the business must decide how to associate the expenses that are incurred in generating the revenues with the revenues that are recognized. Some costs or expenses may be easily identified with their related revenues. For example, the costs of the raw materials that were used in producing an order can be easily identified and associated with the appropriate revenue from that order. On the other hand, many expenses do not bear such a direct relationship to a specific revenue generating transaction and there is a need to determine when such expenses should be recognized for accounting purposes.
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Chapter 8 Intangible Assets 11 results (showing 5 best matches)
- Amortization is generally on a straight-line basis unless a different pattern can be reliably determined. ASC 350–30–35–6. The amount subject to amortization is the full capitalized cost of the intangible but may be reduced by an estimated residual value for the intangible in relatively rare situations. When amortization is recognized for intangible assets, there are two ways for recording the credit entry to reduce the book value of the intangible asset. The credit entry could be to an accumulated amortization account like the accumulated depreciation account used for tangible property. For intangible assets, however, the amortization is frequently credited directly to the asset account. Under this approach, the entry to record $100,000 of amortization expense related to a patent would be as follows:
- The accounting for intangible assets is a function of the method by which the intangibles are acquired (whether they are purchased or whether they are internally developed) and by the nature of the intangible assets (including whether they are specifically identifiable, whether they have indeterminate lives, and whether they are inherent in a continuing business). The accounting for goodwill and other intangible assets is now governed by ASC 350 and by ASC 805–30 (which addresses the original recognition of goodwill and other intangibles acquired as part of a business combination, as discussed in Chapter 15).
- Accounting for the Purchase of Identifiable Intangible Assets
- Initial Accounting for Internally Created Identifiable Intangible Assets
- Accounting for Identifiable Intangible Assets After Acquisition
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Appendix Time Value of Money 1 result
- This appendix will discuss the concept of the time value of money (also known as future value and present value (discounting) analysis). Time value of money concepts are employed extensively in the areas of accounting and corporate finance. This appendix will introduce the concepts of present and future value for those who are not familiar with them and will serve as a convenient review for those who are familiar with these concepts.
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Outline 41 results (showing 5 best matches)
Index 60 results (showing 5 best matches)
- Publication Date: October 29th, 2020
- ISBN: 9781647083007
- Subject: Accounting
- Series: Nutshells
- Type: Overviews
- Description: This product provides a well-rounded summary of the relevant accounting areas from basic financial statements to complex earnings-per-share ratios and corporate finance and valuation. Learn how to recognize revenue, expenses, assets, and liabilities. It reviews accounting principles for many different areas, including acquisitions, investments, long-term debt, leases, stocks, and partnerships. It also discusses recent developments such as adoption of new requirements to place most operating leases on the lessee’s balance sheet, a new principles based approach to accounting for revenue, and refinements in the accounting for stock options.
