CMA® > CMA® Part 1 > A.2. Liabilities and Equity Transactions > Flashcards

A.2. Liabilities and Equity Transactions Flashcards

Explore reclassification of liabilities, warranties, income taxes, leases, and equity transactions including dividends and treasury stock. (78 cards)

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1
Q

When a company expects to refinance some or all of its short-term liabilities by means of new long-term debt or by issuing equity, what is required for the company to reclassify those short-term obligations as long-term obligations on its balance sheet?

A
  • It must have the intent to refinance them
  • It must be able to demonstrate the ability to refinance them

The ability to refinance can be demonstrated by completing the refinancing transaction or entering into a financing agreement before the financial statements are issued.

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2
Q

What are the two types of warranties?

A
  • Assurance-type warranty
  • Service-type warranty

Assurance-type warranties provide assurance that the product meets agreed-upon specifications, while service-type warranties offer additional services beyond product assurance.

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3
Q

How are assurance-type warranties accounted for?

A

As liabilities under ASC 460, as they assure that the product meets agreed-upon specifications.

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4
Q

How should a service-type warranty be accounted for according to ASC 606?

A

As a separate performance obligation.

Service-type warranties are accounted for under ASC 606, with revenue recognized over the warranty period. Expenses incurred in fulfilling the contract should be expensed as period costs when incurred.

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5
Q

What factors determine if a warranty is a separate performance obligation under ASC 606?

A
  • Whether the warranty is required by law
  • Length of the warranty coverage period
  • Nature of the tasks promised by the company

A warranty that provides services beyond assuring product compliance with specifications is likely a separate performance obligation.

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6
Q

What is the journal entry to record estimated assurance-type warranty expense?

A

Dr Assurance-type warranty expense

Cr Assurance-type warranty liability

This entry matches the expense of future warranty claims with revenues recognized from the sale of those items.

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7
Q

How is revenue from a service-type warranty recognized?

A

On a straight-line basis over the life of the warranty contract.

However, if historical evidence indicates costs are incurred on a different basis, revenue should be recognized in proportion to expected costs.

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8
Q

What is the accounting treatment for costs incurred under service-type warranties?

A

Expensed as period costs when incurred.

Service-type warranty expenses are recognized as they are incurred, aligning with the recognition of revenue over the contract term.

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9
Q

What is taxable income?

A

The amount of income on which the company’s income tax due to the government is computed.

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10
Q

What causes permanent differences between financial income and taxable income?

A

Certain revenues and gains that are never taxable, and some expenses and losses that are never deductible on the tax return.

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11
Q

What are temporary timing differences?

A

Differences between when revenues or gains are recognized on the income tax return and when they are recognized in financial income, and between when expenses or losses are deducted on the tax return and when they are recognized in financial income.

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12
Q

What gives rise to deferred taxes?

A

The difference between financial income and taxable income caused by temporary timing differences.

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13
Q

What is a deferred tax asset?

A

An estimate of the amount of income tax that will not need to be paid in the future because it will have already been paid due to current differences between financial income and taxable income that will reverse in the future.

It arises when an item causes current taxable income to be higher than current financial income, so the income tax is paid “in advance” of when it would be due according to financial income.

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14
Q

What is a deferred tax liability?

A

An estimate of the amount of income tax that will need to be paid in the future because it does not need to be paid currently due to current differences between financial income and taxable income that will reverse in the future.

It arises when an item causes current taxable income to be lower than current financial income. Future financial income will be lower than future taxable income, so that in the future, the company will have to pay income taxes on a taxable income that is higher than its financial income.

Deferred tax liabilities are based on future tax rates and represent future taxable amounts.

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15
Q

Using deferred tax assets and deferred tax liabilities to account for temporary timing differences and to allocate the income tax expense to the correct period is called?

A

The asset-liability method

Because a deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and carryforwards.

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16
Q

What is the effect of the Tax Cuts and Jobs Act of 2017 on corporate tax rates?

A

It changed the corporate income tax rate to a flat 21%, effective January 2018.

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17
Q

What is “book-tax conformity”?

A

The alignment between tax reporting and financial reporting.

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18
Q

What is a conditional contract asset under ASC 606?

A

A company’s right to receive consideration for which it has satisfied one of, or some of, the performance obligations in a contract.

However, the company must satisfy another performance obligation or obligations before it can invoice the customer, so it does not yet have a receivable representing the contract.

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19
Q

What is a future deductible amount?

A

An item that will cause future taxable income to be lower than future financial income.

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20
Q

What is a future taxable amount?

A

An item that will cause future taxable income to be higher than future financial income.

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21
Q

What creates a deferred tax asset?

A
  • An item recognized as revenue or gain on the tax return before as financial income.
  • An item recognized as an expense or loss in financial income before it is deductible on the tax return.
  • A net operating loss carried forward to offset future taxable income.
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22
Q

What creates a deferred tax liability?

A
  • An item recognized as revenue or gain in financial income before it is recognized on the tax return.
  • An item recognized as an expense or loss deductible on the tax return before it is recognized in financial income.
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23
Q

How are deferred tax assets and liabilities presented on the balance sheet?

A

All deferred tax assets and liabilities, along with any related valuation allowance, are classified as non-current.

For a particular tax-paying component of a company and within a particular taxing jurisdiction, all deferred tax assets, related valuation allowance, and deferred tax liabilities are offset and classified as either a net non-current asset or a net non-current liability.

Deferred tax positions attributable to different tax-paying components of a company or to different tax jurisdictions are not offset.

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24
Q

What is current income tax expense?

A

The tax amount due to the government for the period based on current taxable income and the current tax rate.

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25
What is the **deferred income tax expense or benefit** that is included in income tax expense on the income statement?
The amount of **change** in the net deferred tax asset or liability position of the company during the year.
26
How is **total income tax expense** (also called the provision for income taxes) that is recognized on the income statement calculated?
Current income tax expense (tax payable currently) plus the deferred tax expense for the period or minus the deferred tax benefit for the period ## Footnote The deferred tax expense or benefit that is included in income tax expense on the income statement is the **amount of change** in the net deferred tax asset or liability position of the company during the year.
27
What happens if a company has a **taxable loss**?
The current income tax expense will be **zero**, and the loss may be carried forward as a **deferred tax asset**. ## Footnote For tax years beginning after December 31, 2017, losses may be carried forward indefinitely, subject to a limitation: the amount of the loss used to offset taxable income in a future period is limited to a maximum of 80% of that future period’s taxable income (without regard to the NOL deduction).
28
What is the journal entry to record **current income tax expense**?
Dr Current income tax expense Cr Income taxes payable
29
How is a **net deferred tax asset or liability** determined?
By subtracting the deferred tax liability amounts and any valuation allowance from the deferred tax asset amounts. ## Footnote If the net result is positive, it is reported as a non-current asset; if negative, as a non-current liability.
30
What are permanent differences in **tax accounting**?
Items that cause differences between **taxable income** and **financial income** but do not reverse over time. ## Footnote Permanent differences do not give rise to deferred tax assets or liabilities.
31
Which items are commonly tested as **permanent differences**?
* Municipal bond interest * Dividends-received deduction ## Footnote These items are recognized for financial income purposes but not for tax purposes.
32
What is the tax treatment of **municipal bond interest**?
It is **tax-exempt** and recognized in **financial income** but not included in taxable income. ## Footnote This creates a permanent difference.
33
What is the **dividends-received deduction** under the Tax Cuts and Jobs Act of 2017?
The amount of the deduction depends on the investor's percentage of ownership in the company, as follows: * Less than 20% ownership: 50% deduction * 20% to 80% ownership: 65% deduction * More than 80% ownership: 100% deduction ## Footnote Because in most cases some of the dividend will still be taxable, the dividends-received deduction is usually only partially a permanent difference.
34
What is a **net operating loss** (NOL) carryforward?
A **taxable loss** that can be applied to **offset future taxable income**. The loss can be carried forward indefinitely, limited to 80% of that future period’s taxable income. ## Footnote This rule applies to tax years beginning after December 31, 2017.
35
What is a **valuation allowance** for deferred tax assets?
A **contra-asset account** that reduces the deferred tax asset to its expected realizable value. ## Footnote It is established if it is more likely than not that some or all of the deferred tax asset will not be realized. A company's ability to realize a deferred tax asset depends on whether the company expects to have enough taxable income in the future to be able to use the deferred tax asset to offset income tax expense on the future income.
36
What is the basic principle of the accounting standard on **leases** in **ASC 842**?
A lessee should recognize in its financial statements: * a right-of-use asset, an intangible asset, representing its right to use the leased asset for the term of the lease, and * the liability to make lease payments over the lease term.
37
What are the two main types of **leases** for lessees?
* Finance leases * Operating leases ## Footnote Both require recognition of a right-of-use asset and a lease liability.
38
What criteria classify a lease as a **finance lease**?
A finance lease is one that meets **one or more** of the following: * It transfers ownership to the lessee by the end of the lease term * It grants the lessee an option to purchase, and the lessee is reasonably certain to exercise it * The lease term is a major part of the asset's economic life * The present value of payments equals or exceeds substantially all of the asset's fair value * The asset is specialized with no alternative use ## Footnote A "major part" of the asset's economic life is typically 75% or more, and "substantially all" of the fair value of the underlying asset is 90% or more.
39
What is the lessee's **incremental borrowing rate**?
The **rate of interest** the lessee would pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments. ## Footnote The lessee's incremental borrowing rate is used as the discount rate for calculating the present value of the lease payments not yet paid, if the rate implicit in the lease is not determinable.
40
How is the initial **lease liability** calculated for a finance lease?
It is the **present value** of the **lease payments not yet paid** at the commencement date using the lessee's incremental borrowing rate as the discount rate.
41
What are the recognition requirements for a **finance lease** by the lessee?
* Recognize a right-of-use asset and a lease liability. * Recognize interest expense and separately recognize amortization of the right-of-use asset in the lessee’s income statement. * Recognize any variable lease payments in the period incurred. * Recognize any impairment of the right-of-use asset. * In the statement of cash flows, recognize repayments of the principal portion of the lease liability as cash flows from financing activities and payments of interest on the lease liability and any variable lease payments as cash flows from operating activities.
42
What are the recognition requirements for an **operating lease** by the lessee?
* Recognize a right-of-use asset and a lease liability. * Recognize a single lease cost, calculated so that the total cost of the lease is allocated on a generally straight-line basis over the term of the lease. * Recognize any variable lease payments in the period incurred. * Recognize any impairment of the right-of-use asset. * Recognize payments as cash flows from operating activities in the statement of cash flows.
43
What is a **short-term lease**?
A lease with a term of **12 months or less** at its commencement date, that does not include a **purchase option** that the lessee is reasonably certain to exercise.
44
Under IFRS, how is the **right-of-use asset** measured differently from its measurement under U.S. GAAP?
Alternative measurement bases are allowed, including the **revaluation model** as permitted by IAS 16, ***Property, Plant, and Equipment***.
45
What is **owners' equity**?
The **residual interest** in the assets of a company after deducting its liabilities.
46
What are the **main** classifications of corporate shareholders' equity?
* Contributed capital, which includes capital stock and additional paid-in capital, and * Retained earnings
47
What does **contributed capital** represent?
**Assets** put into the company by the owners in return for their **share of ownership**.
48
What is the purpose of the **additional-paid-in-capital** (APIC) account?
To record the value received for shares over and above the **stated, or par, value**.
49
What is the definition of **retained earnings**?
The **undistributed profits** of the company that have been reinvested in the company.
50
What are **non-controlling interests**?
**Ownership interests** held by owners other than the **parent** in a partially owned subsidiary.
51
What are the two types of **common stock** based on par value?
* Par (or Stated) Value * No-Par Value
52
What is the journal entry for issuing **common shares with a par value**?
Dr Cash (cash received) Cr Common shares (par value of shares issued) Cr Additional paid-in capital – common shares (balancing amount)
53
What is the most common form of **dividend**?
Cash dividend
54
What are the **three key dates** related to the payment of a cash dividend?
* Date of declaration * Date of record * Date of payment
55
What is the **ex-dividend date**?
The date when a stock begins selling **without** the purchaser having the **right to the dividend**.
56
What determines which **shareholders** will receive a **dividend**?
The **ex-dividend date** determines which shareholders will receive the dividend. ## Footnote The established standard in the U.S. for the ex-dividend date is one business day prior to the date of record.To receive the dividend, an investor must own the stock **before** this date.
57
What is a **liquidating dividend**?
A liquidating dividend is a return **of** capital rather than a return **on** capital. Any dividend or portion of a dividend paid that would exceed the balance in retained earnings is a liquidating dividend because it is not a distribution of profits ## Footnote A liquidating dividend reduces the Additional Paid-In Capital (APIC) account.
58
How is a **property dividend** recognized?
By first restating the property to **fair value** and recognizing a **gain or loss** for the difference between the fair value and carrying value. The property dividend declaration is recorded by debiting **retained earnings** and crediting **property dividends payable** for the fair value of the property. ## Footnote A property dividend is a distribution of an asset other than cash, such as inventory or fixed assets, as a dividend.
59
What is the accounting treatment for a **small stock dividend**?
For a small stock dividend, shares are valued at fair value on the declaration date. The journal entry on the declaration date is: Dr Retained earnings for the fair value of the shares Cr Common shares issuable as a dividend for the par value of the shares Cr Additional paid-in capital for the balancing amount On the date the stock is issued: Dr Common shares issuable as a dividend for the par value of the shares Cr Common stock for the par value of the shares ## Footnote A small stock dividend is typically less than 20-25% of the total shares outstanding.
60
What is the purpose of a **stock split**?
It reduces the **market price per share** to make the stock more attractive to investors. In a **2-for-1 split**, the owner of each share becomes the owner of **twice as many shares**, but each share will have a market price that is **half** what it was before the split. ## Footnote In a stock split, the number of shares increases, and the par value per share decreases proportionally, without changing the total equity.
61
What are the **preferences** of preferred stock over common stock?
* Preference in the claims to assets in a liquidation. * Preference in the payment of dividends. * Dividends are usually a fixed percentage of the par value.
62
What happens to **cumulative preferred dividends** in arrears?
They must be **paid in full** before any **common dividends** can be paid. ## Footnote These dividends are not recognized as a liability but are disclosed in a note to the financial statements.
63
What does the **retained earnings** account represent?
The retained earnings account represents the **accumulated undistributed income** of the corporation from its inception. ## Footnote It is decreased by the declaration of dividends and increased by net after-tax income.
64
What is the purpose of appropriating **retained earnings**?
It communicates to **shareholders** that these **earnings** are not available for distribution as **dividends**. ## Footnote Reasons for appropriation include creating reserves for future needs, such as plant building or debt reduction.
65
What is **treasury stock**?
**Shares** of a company that have been sold to **investors** and later **reacquired** by the company.
66
What are some reasons a company might purchase **treasury shares**?
* To temporarily provide a market for its shares. * To reconsolidate ownership. * As an investment if the company thinks its shares are undervalued. * To use the shares for a stock dividend, to re-sell them, or to use them as share-based payment.
67
# True or False: Treasury stock is considered an asset.
False ## Footnote Treasury stock is not an asset, nor is it a liability or equity.
68
How is **treasury stock** recognized in financial statements?
By **reducing owners’ equity**, either by debiting a treasury stock account or the common stock account directly. ## Footnote The specific account debited depends upon the method of accounting being used.
69
Do treasury shares receive cash dividends or voting rights?
No
70
What are **authorized shares**?
The **maximum number of shares** the company can issue, as specified in the company’s charter or articles of incorporation.
71
What must a company do to change the number of **authorized shares**?
**File an amendment** to the articles of incorporation with the state, usually requiring prior shareholder approval.
72
What are **issued shares**?
Shares that have been **sold to investors** at any point in the past and that have not been retired. ## Footnote Note that treasury shares are issued shares but they are not outstanding shares.
73
What are **outstanding shares**?
Shares that are currently **owned by other parties**, equal to issued shares minus treasury shares.
74
Which classifications of **shares** are affected by **stock splits**?
* Issued * Outstanding
75
Which classifications of **shares** are affected by **stock dividends**?
* Issued * Outstanding
76
Which classifications of **shares** are affected by **treasury share transactions**?
Outstanding
77
# True or False: Treasury stock is included in issued shares but not in outstanding shares.
True ## Footnote Treasury shares are shares that are issued but are not outstanding.
78
What is the **difference** between treasury stock and retired stock?
* **Treasury stock** is included in issued shares but not in outstanding shares * **Retired stock** is not included in issued shares
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