Kpmg Alpfa 2006 Solutions

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2006 ALPFA Case Studies SOLUTIONS

Case 1: CB Manufacturing

Discussion Material

Objective: This case exposes students to issues dealing with leasehold improvements. More specifically it looks at the amortization periods for leasehold improvement from business combinations and those that are placed in service significantly after the start of the lease term.

Answers:

1. Leasehold improvements that are placed in service significantly after and not contemplated at or near the beginning of the lease term should be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured (as defined in paragraph 5 of Statement 13) at the date the leasehold improvements are purchased. In this case, the leasehold improvements should be amortized over approximately four years, which is the time period remaining on the lease.

2. Leasehold improvements acquired in a business combination should be amortized over the shorter of the useful life of the assets or a term that includes required lease periods and renewals that are deemed to be reasonably assured (as defined in paragraph 5 of Statement 13) at the date of acquisition. In this case, the acquired leasehold improvements should be amortized over the period remaining of the initial five-year term (approximately two years) plus the two year renewal period because renewal is reasonably assured as of the date of the business combination (approximately four years in total). The resulting amortization period for the acquired leasehold improvements (approximately four years) would be less than the remaining useful life of the related asset (approximately five years).

References:

EITF No. 05-6, Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination.

FASB Statement No. 13, Accounting for Leases

FASB Statement No. 98, Accounting for Leases: Sale-Leaseback Transactions Involving Real Estate, Sales-Type Leases of Real Estate, Definition of the Lease Term, and Initial Direct Costs of Direct Financing Leases

FASB Statement No. 141, Business Combinations

FASB Interpretation No. 21, Accounting for Leases in a Business Combination




Case 2: Christopher’s Computers, Inc.

Discussion Material

Objectives: Students must determine the proper way to account for the assets involved in the restructuring for Christopher’s Computers, Inc.’s quarter-end financial statements. A decision must be made on whether to classify the assets to be disposed of as long-lived assets to be held and used or long-lived assets to be disposed of by sale. A determination must also be made on whether an impairment charge is necessary for the asset group.

Answers:

1. The Seattle manufacturing facility along with the related television equipment and special interior building configuration constitute an asset group and will be classified as long-lived assets to be held and used. This group does not meet the criteria to be classified as held for sale since it will continue to be used during the ten month phaseout period and therefore is not available for immediate sale. Therefore, the asset group does not meet the held for sale criteria of paragraph 30(b) of FAS 144.

2. To record an impairment loss, the carrying value of an asset cannot be recoverable and must exceed fair value. The carrying value of an asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. In this case, the estimated future cash flows from the television manufacturing operations are $25.5 million ($3.5 million cash flows from the television manufacturing operations and $22 million from the sale of the manufacturing plant and related assets), which does not exceed the $28 million carrying value of the asset group($8 million for the television equipment and special interior building configuration and $20 million for the manufacturing facility); therefore an impairment loss should be recorded. The amount of the loss is measured as the amount by which the carrying value of a long-lived asset group exceeds its fair value. The carrying value is $28 million and the fair value is $22 million, so Christopher’s Computers, Inc. will record a $6 million impairment loss for the asset group. If the fair value of the individual assets of the asset group is not determinable without undue cost and effort, the impairment loss should be allocated to the individual assets of the asset group on a pro-rata basis in accordance with Example 1 of Appendix A of FAS 144. The Company should continue to monitor the situation of its assets to see when they should be classified as assets held for sale or for further impairment indicators. If the held for sale criteria is ultimately determined to be met at some point it the future, an evaluation would need to be performed to as to whether the asset group met the criteria to be presented as discontinued operations.

References:

FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-lived Assets




Case 3: Dave’s Auto Mart

Discussion Material

Objective: This case exposes students to two main types of accounting issues. The first issue deals with how to account for two or more inventory purchase and sales transactions with the same counterparty. The second issue deals with whether or not the nonmonetary exchange of inventory should be recognized at fair value.

Answers:

1. Dave’s inventory sales transaction was entered into in contemplation of a reciprocal inventory purchase transaction from Amy because, as a condition of selling SUVs to Amy, Dave must accept delivery of trucks from Amy at a later date, if Amy chooses to make such a delivery. Consistent with past history, when Dave enters into this kind of arrangement with Amy, Dave fully expects to purchase the trucks. Therefore, the sale of the SUVs should be considered combined with the purchase of the trucks. Indicators that purchase and sale transactions may have been “in contemplation” include:

• Specific legal right of offset of obligations• Entered into simultaneously• Transactions entered into with off-market terms at inception• Relative certainty of reciprocal inventory transactions

2. A nonmonetary exchange within the same line of business involving (a) the transfer of raw materials or WIP inventory in exchange for the receipt of raw materials, WIP, or finished goods inventory or (b) the transfer of finished goods inventory for the receipt of finished goods inventory should not be recognized at fair value but rather as an exchange of equal value. Accordingly, no gain or loss should be recognized as the exchange effectively facilitates the fulfillment of inventory, not the culmination of an earnings process. Students might also consider issues associated with lower of cost or market for the inventory as well if they argue that the market value of the exchanged vehicles is lower that when the respective dealers first received the vehicles.

References:

EITF No. 04-13, Accounting for Purchases and Sales of Inventory with the Same Counterparty.

FASB Statement No. 153, Exchanges of Nonmonetary Assets

AICPA Accounting Research Bulletin No. 43, Chapter 4, “Inventory Pricing”

APB Opinion No. 29, Accounting for Nonmonetary Transactions




Case 4: Faulk’s Phone Group

Discussion Material

Objective: Students are expected to determine the appropriate accounting treatment for the revenues and costs associated with training employees. They must differentiate between recognizing the revenues and expensing the costs as incurred or deferring and recognizing straight-line or proportionately over the life of the contract.

Answer:

1. FPG is appropriately accounting for its call revenues but not appropriately accounting for its training revenues or training costs. Since call revenue is earned as the telephone service representatives perform their services, revenues should be recognized based on when the service is performed. The training revenue, while received up front, is an advance that benefits customers as services are provided during the contract life. Since the arrangements between FPG and its clients constitute one unit of accounting, revenue should be recognized in one manner; therefore, if call volume and related revenue is not level, it is not appropriate to recognize training revenue on a straight-line basis (while call revenue is not). Instead, training revenue should be deferred and recognized in the same manner as the proportion of call revenue recognized (as a percentage of total call revenue expected to be recognized over the life of the contract). The training costs incurred by FPG help it earn revenue over the life of each of their contracts. Since the training revenue is recognized in proportion to call revenue over the life of the contract, it is appropriate that these training costs should be deferred and recognized in the same manner as the revenue. These costs should not be expensed as incurred because FPG is not receiving the economic benefit associated with these training costs until the revenue is recognized. FPG should begin deferring the costs of training TSRs and recognize the expenses in proportion to the call revenue recognized.

References:

Statement of Financial Accounting Concepts 5, Recognition and Measurement in Financial Statements of Business Enterprises

Statement of Financial Accounting Concepts 6, Elements of Financial Statements

Accounting Terminology Bulletins 4, Cost, Expense, and Loss

Financial Accounting Standards Board Technical Bulletins 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts

Emerging Issues Task Force 00-21, Change in Accounting Principle: Revenue Arrangements with Multiple Deliverables

SEC Staff Accounting Bulletin 104, Revenue Recognition




Case 5: Floyd’s Flyers, Inc.Discussion Material

Objective: The purpose of this case is to expose students to financial reporting for point and loyalty programs. Students are asked to evaluate whether a company’s current policy is in accordance with GAAP and to consider whether an alternative method of accounting for a point and loyalty program would be more appropriate and more advantageous to the company.

Answer:

1. To classify the frequent-flyer obligations as a liability, the liability must be probable and estimable. If one or both of these conditions are not met but there is at least a reasonable probability that a loss or an additional loss will be incurred, a disclosure should be made in the financial statements. Floyd’s Flyers should be able to estimate the mileage to be redeemed to report a liability. Since the nature of a frequent-flyer program is to stimulate traffic by rewarding frequent flyers, there is a reasonable probability that a material proportion of frequent flyer points issued will be redeemed. Therefore, reporting frequent flyer miles as liability on the balance sheet normally is appropriate since there is enough information to predict a reasonable estimate of the value of the awards to be redeemed by Floyd’s Flyers.

2. Under the deferred revenue method, a part of each ticket price purchased by an FFP member should be deferred until such time as a ticket associated with the use of the frequent-flyer award is used. In most circumstances, the amount allocated to the FFP travel award would be that normally derived from a discounted ticket with similar restrictions. Alternatively, the incremental cost method can be used to account for the frequent-flyer program. Under this method, the liability amount is the total additional costs of servicing customers when there otherwise would be an empty seat. Incremental costs typically include the cost of food, drink, fuel, ticket delivery costs and certain types of insurance. The deferred revenue method is acceptable in virtually all circumstances, while the incremental cost method would be inappropriate (and deferred revenue method therefore appropriate) in circumstances in which (a) a significant number of paying passengers are displaced by passengers redeeming awards and (b) the award is significant in comparison to the value of the amount paid to accumulate the award. The incremental cost method is used by a majority of the airlines in the industry for accounting for frequent flyer programs and results in a smaller liability than the deferred revenue method. Given the facts of this case, Floyd’s Flyers should continue to use the incremental cost method of accounting for the FFP.

References:

FASB Statement No. 5, Accounting for Contingencies

Statement of Financial Accounting Concepts 5, Recognition and Measurement in Financial Statements of Business Enterprises

SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements

International Air Transport Association Airline Accounting Guideline No. 2, Frequent Flyer Program Accounting

EITF Issue No. 00-22, Accounting for “Points” and Certain Other Time-Based Sales Incentive Offers, and Offers for Free Products or Services to be Delivered in the Future




Case 6: Mills Machines, Inc.Discussion Material

Objective: Students are expected to consider the appropriateness of a company’s policy of accruing product recall costs at the date the recall campaign is announced to the public and the appropriateness of changing this policy to one of accruing product recall costs at the time of sale. This case involves accounting for contingencies, disclosure requirements for guarantees, and changes in accounting policy vs. change in accounting estimate or correction of an error.

Answers:

1. Mills’ current policy of accruing product recall costs on the date it is announced to the public is not an appropriate policy and is a departure from GAAP. According to paragraph 8 of SFAS No. 5, Accounting for Contingencies (FAS 5), when there is a high probability that a future event, such as a product recall, will occur and the amount of loss can be reasonably estimated, a liability should be recorded. Therefore, assuming that Mills has appropriate evidence to provide a reasonable estimate of future probable product recalls, a liability should be recorded at the date of sale. If future product recalls at the date of sale are not probable, the criteria in paragraph 8(a) of FAS 5 is not met and accordingly, a liability is not recorded. If future product recalls at the date of sale are probable but a reasonable estimate of the amount cannot be made, the criteria in paragraph 8(b) of FAS 5 is not met and accordingly, a liability is not recorded. Inability to make a reasonable estimate of the amount of a warranty obligation at the time of sale because of significant uncertainty about possible claims may raise a question about whether a sale should be recorded prior to expiration of the warranty period or until sufficient experience has been gained to permit a reasonable estimate of the obligation. The date the recall campaign is announced should have no bearing on the date that the related liability is accrued. Although, the timing of a recall announcement could coincide with the date both conditions of paragraph 8 of FAS 5 are met, the event triggering the recognition of a liability is the date the criteria under FAS 5 are met and not the date a company decides to make a public announcement regarding a recall program. Paragraphs 24-26 of FAS 5 provide additional information on product warranties.

2. a. Yes, this is a guarantee related to product performance. b. No, according to paragraph 7(b) of FASB Interpretation No. 45, Guarantor’s Accounting and

Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, product warranty guarantees are not subject to the initial recognition and initial measurement provisions of this interpretation. However, Mills Machines, Inc. would be subject to the disclosure requirements of this Interpretation which are discussed in paragraphs 13-16.

2006 ALPFA Case Studies Solutions (continued)



As noted in part 1, Mills’ guarantee is recorded at estimated cost, not fair value, once both criteria in paragraph 8 of FAS 5 are met.

This change should be treated as a correction of an error as Mills’ previous policy was not in accordance with paragraph 8 of FAS 5 and thus represented a departure from GAAP. If the error that resulted from Mills’ GAAP departure was material to prior period financial statements, those prior period financial statements would need to be restated to correct this error in accordance with SFAS No. 154, Accounting Changes and Error Corrections.

References:


FASB Statement No. 154, Accounting Changes and Error Corrections

FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others




Case 7: Moyer Banking Enterprise

Discussion Material

Objective: This case exposes students to issues dealing with aggregating operating segments into a single reportable segment. This case focuses on those operating segments that do not meet the quantitative threshold required by paragraph 18 of Statement 131.

Answers:

1. Paragraph 17 of Statement 131 permits two or more operating segments to be aggregated into a single operating segment if aggregation is consistent with the objective and basic principles of Statement 131, if the segments have similar economic characteristics, and if the segments are similar in each of the following areas:

a. The nature of the products and servicesb. The nature of the production processesc. The type or class of customer for their products and servicesd. The methods used to distribute their products or provide their servicese. If applicable, the nature of the regulatory environment, for example, banking, insurance, or

public utilities.

EITF 04-10 clarifies when operating segments that do not meet the quantitative thresholds can be aggregated. Aggregation is permitted only if it is considered to be consistent with the objective and basic principles of Statement 131, the segments have similar economic characteristics, and the segments share a majority of the aggregation criteria listed in (a)–(e) of paragraph 17 of Statement 131. Since the operating segments have similar economic characteristics and are similar in areas c, d, and e, they may be combined.

2. There are a number of conditions which would change the decision that these two operating segments can be combined into one reportable segment:

a. Should any of the conditions in c, d, or e change for the savings and investing operating segments, the segments would no longer be able to be combined because they would not meet a majority of the conditions. These distinctions are important for combining operating segments because financial statement users need to be able to evaluate segments of a business that are significantly different, separately. Different operating segments face different risks, both external and internal. Users need to assess financial information attributed to segments impacted by these different risks, which is difficult to do when dissimilar business’ financial results are combined.




b. If either or both of the savings and investments operating segments achieved growth such that the individual operating segment now met the quantitative threshold the segments would need to be reported as separate segments. This would also require comparative data to be restated to show the newly reportable segment as a separate segment in the comparative period even if that segment did not satisfy the quantitative criteria in the prior period.

c. Operating segments that do not meet any of the quantitative thresholds may be considered reportable, and separately disclosed, if management believes that information about the segment could be useful to readers of the financial statements. Therefore, even though the investments and savings operating segments do not meet the quantitative criteria management may determine in a future period that there is information that would be of interest to the readers of the financial statements that requires separate disclosure of these two operating segments.

References:

EITF No. 04-10, Determining Whether to Aggregate Operating Segments That Do Not Meet the Quantitative Thresholds

FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information




Case 8: Speedy Dry-Cleaning AcquisitionDiscussion Materials

Objective: This case focuses on two different accounting issues that Speedy needs to consider after acquiring Home Dry-Cleaning. Those two issues include determining useful life of an acquired intangible asset and performing the annual goodwill impairment test pursuant to FASB Statement No. 142.

Answers:

1. The useful life of Home Dry-Cleaning’s trademark should be deemed indefinite because cash flows are expected for an indefinite period of time, Speedy has the intent and ability to renew the trademark for the foreseeable future without incurring substantial cost, and Speedy does not believe that there are any competitive, contractual, regulatory, or obsolescence factors that will impact the cash flow generation of the trademark. No amortization should take place until the trademark no longer has an indefinite useful life, at which time it will be amortized. The trademark should also be tested annually for impairment in accordance with Statement 142.

2. F.V. indicates Fair ValueIndicating Impairment

Fair Value of Reporting Unit (Including $200,000 F.V. of internally developed intangibles)

$ 850,000

Carrying amount of reporting unit’s net assets, including goodwill

(1,000,000)

Indicator of impairment $ (150,000)Measurement of Impairment

F.V. of reporting unit $ 850,000F.V. of Tangible Assets (450,000)F.V. of recognized intangibles (100,000)F.V. of unrecognized intangibles (200,000)Implied F.V. of goodwill 100,000Carrying amount of goodwill (350,000)Impairment $ (250,000)

References:

FASB Statement No. 142. Goodwill and Other Intangible Assets




Case 9: T-Shirts by Tommy

Discussion Material

Objective: This case exposes students to the accounting impacts of business interruption, which became an important issue subsequent to the terrorist attacks of September 11, 2001. This case helps students understand the issues involving FASB Statement No. 5, Accounting for Contingencies, related to being able to estimate and record contingent losses but not be able to record gains until realized. While EITF 01-10, Accounting for the Impact of the Terrorist Attacks of September 11, 2001, is the best reference to utilize for this case, students might refrain from using it as a precedent because the source of business interruption is not terrorist related. However, the expectation of storm-related damage is reasonable for a business in Panama City, Florida, making it a similar context for students.

Answers:

1. T-Shirts by Tommy should recognize an immediate loss reserve and an associated liability as of March 1, 2003, for its operating lease payments on the design equipment not being utilized, provided that Tommy believes the three-month down time is a reasonable estimate (which is the only condition necessary). In this case, T-Shirts by Tommy should recognize a liability for its operating lease rentals through June 1 (the minimum period of time that the company will not have space to continue t-shirt production). If Tommy believes he is unable to determine even a minimum period of time before they secure an alternate location, he would not recognize a liability for future operating lease payments because the period of time during which the equipment is unusable could not be reasonably estimated. However, T-Shirts by Tommy should disclose the loss situation, noting that losses are not reasonably estimable. This evaluation is also applicable for operating lease payments on temporarily unusable facilities.

2. One course of loss mitigation is purchasing business interruption insurance. Had T-Shirts by Tommy been insured, only losses not covered by insurance would need to be accrued at the date of business interruption. However, if any disputes related to recovery of losses from the insurer exist, a loss reserve should be accrued for the full amount of the estimable loss as of the date of interruption. This reserve could later be reversed when the claim is settled. This scenario highlights that only contingent losses can be accrued before actual losses are realized; contingent gains can not be accrued under any condition. They can only be recorded when realized.

3. T-Shirts by Tommy should not accrue a loss reserve and associated liability at the date the equipment is idled due to the lack of demand or the date of the disaster because a condition of business interruption has not been established. Instead, operating lease expense should continue to be recognized in accordance with paragraph 15 of Statement 13 and related interpretive guidance.




References:

EITF 01-10, Accounting for the Impact of the Terrorist Attacks of September 11, 2001



FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss

APB Opinion No. 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions




Case 10: Can Cola CompanyDiscussion Material

Objective: This case exposes students to the challenging topic of revenue recognition for complex sales transactions, which are becoming more common in today’s economy. Here, students must take into consideration multiple deliveries of separable components to a complete system. The critical issue for whether revenue can be recognized on partial shipments is whether the separable components can be purchased from an unrelated buyer without requiring alterations to the shipped components.

Answers:

1. Cola Can Company should account for the deliverables as separate units for revenue recognition purposes. The first condition for separation is met for the rollit and cutit. Although the shapeit is essential to the functionality of the rollit and cutit, it could be acquired by the customer from an unrelated entity without altering the capabilities of the rollit and cutit. The second condition for separation also is met because sufficient objective, reliable, and verifiable evidence of fair value exists to allocate the consideration to the rollit, shapeit, and cutit based on the prices charged for the separate pieces of equipment by other unrelated vendors. The general right of return should be accounted for in accordance with FASB Statement No. 48, Revenue Recognition When Right of Return Exists. Since the contract for sale of the rollit, shapeit, and cutit does not provide the customer any refund rights if the shapeit is not delivered, it is not necessary to alter the accounting treatment based on the requirements of Statement No. 48 (paragraphs 17–19) to this case.

2. If the shapeit could not be obtained from an outside source or a machine obtained from an outside source inhibited the performance of the rollit and cutit, the first criteria for separation would not be met. The second condition would not be met if all three pieces of equipment were not offered individually in the open market. For example, if Ballotab Inc. could only purchase the shapeit separately, there would be no reliable mechanism for determining the individual values of the rollit, cutit, or shapeit.

References:

EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables


FASB Technical Bulletin No. 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts


FASB Statement No. 48, Revenue Recognition When Right of Return Exists




Case 11: Gofaast Engines

Discussion Material

Objective: This case exposes students to the implications surrounding long-term strategic alliances with suppliers, under which suppliers incur the responsibility of design and development costs for the manufacturer/purchaser. By structuring contracts in this fashion, suppliers are protected from designing a customer’s unique component and not being able to recover the associated costs. Ordinarily, research and development costs are expensed as incurred. However, these types of contracts are unique in that research and design costs potentially can generate specific revenues for the process of design and development (as opposed to the asset created by the design and development), making the process a “product” for sale by the supplier in the event costs are not recovered.

Answers:

1. Gofaast Engines should capitalize the design and development costs (as an asset) as costs are incurred, up to a maximum of $100,000,000. Under this agreement, the amount of reimbursement for design and development costs can be objectively measured and verified. For example, if 190,000 engines are produced and delivered under the supply arrangement, in addition to the $5,500 per engine received for the engines produced and delivered (valued at $1.05 billion), Gofaast Engines would be reimbursed for design and development costs incurred under the arrangement of $5,000,000 [$100,000,000 - ($500 × 190,000)].

2. Absent a reimbursement arrangement, design and development costs should be expensed as incurred under FASB Statement No. 2, Accounting for Research and Development Costs. If the reimbursement was dropped to $50,000,000, Gofaast Engines could only record the first $50,000,000 of costs as assets. Any additional costs should be expensed as incurred under FASB Statement No. 2.

References:

EITF 99-5: Accounting for Pre-Production Costs Related to Long-Term Supply Arrangements

FASB Statement No. 2, Accounting for Research and Development Costs

FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long- Lived Assets to Be Disposed Of

FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets

APB Opinion No. 20, Accounting Changes AICPA Statement of Position 98-5, Reporting on the Costs of Start-Up Activities




Case 12: HealthNorte

Discussion Material

Objective: This case illustrates to students how derivative instruments can be used as option payments to employees when cash is deemed to be unavailable. The objective of the accounting treatment is to ensure that the income statement properly reflects the matched expense to the revenues generated by the employee when earning the compensation. Students will be tempted to use the value of the stock on HealthNorte’s financial statements instead of the fair market value on the award date. However, the value of the stock as compensation to Peters is the appropriate perspective to consider when valuing the transaction.

Answers:

1. HealthNorte should account for the option granted as a derivative instrument. According to FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, derivatives such as the ones granted to Russ Peters in the case should be recorded at fair value at inception. If, for example, Hillyer Medical’s stock was selling for $17 per share, the option would have a fair value to HealthNorte of $1,700 in recording the related compensation expense. The option award in the case is not within the scope of FASB Statement No. 123, Accounting for Stock-Based Compensation, because the underlying stock is not an equity instrument of the employer. The option award also is not subject to APB Opinion No. 25, Accounting for Stock Issued to Employees, because FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation, states that “Opinion 25 does not apply to the accounting by an employer for awards based on stock of an entity other than the employer…”

2. The option effectively lowers HealthNorte’s net income by $1,700. Any changes in value of Hillyer Medical’s stock should be characterized as compensation expense in HealthNorte’s income statement. After the option has vested, however, changes in fair value may be reflected elsewhere in HealthNorte’s income statement.

References:

EITF 02-8, Accounting for Options Granted to Employees in Unrestricted, Publicly Traded Shares of an Unrelated Entity

FASB Statement No. 57, Related Party Disclosures FASB Statement No. 123, Accounting for Stock-Based Compensation FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation APB Opinion No. 25, Accounting for Stock Issued to Employees




Case 13: Kay Pee and Gee Play in Peoria

Discussion Material

Objective: This case exposes students to the accounting associated with service providers, which often have a significant portion of their expenses associated with travel, meals, and lodging. While manufacturers and retailers tend to consider such expenses as administrative expenses, these costs are fundamental for many service providers and thus are part of revenues and cost of services provided. Students will be tempted to consider revenues as only being amounts directly related to the service provided.

Answers:

1. The reimbursement received for out-of-pocket expenses incurred should be characterized as revenue in the income statement. The substance of the transaction relates to the fee paid from the customer perspective. PeoriaBanc is paying for audit services. It could have engaged a local firm to perform the audit but instead chose an out-of-town auditor. The expenses incurred to offset the fees paid are inconsequential to the decision made by PeoriaBanc in contracting its audit with Kaypee and Gee LLP. Thus, all amounts are paid for services rendered, making them revenues to Kaypee and Gee LLP.

2. The treatment of the out-of-pocket expenses on Kaypee and Gee LLP’s income statement is not affected based on how the billing amounts are classified. The recovery of the expenses will still be considered revenue related to the audit because the client is purchasing audit services, regardless of how the expenses associated with that service are incurred by the provider of those services. The accounting treatment would only differ if one of two conditions were present. First, the provider had no latitude in establishing the reimbursement price for out-of-pocket expenses, which likely would not be the case for Kaypee and Gee LLP. Second, the service provider earns no margin on out-of-pocket expenses because the contract states that those expenses are to be billed based on the actual costs incurred, which likely would not be the case for Kaypee and Gee LLP given their desire to enter a new market. Had either one of these two conditions been met, Kaypee and Gee LLP could reduce their out-of-pocket expenses by the amount reimbursed and not classified amounts received from PeoriaBanc as revenue.

3. Should Kaypee and Gee “low ball” PeoriaBanc and earn less in revenues than their out-of-pocket expenses to gain a foothold in Peoria, all out-of-pocket expenses in excess of revenues received from the fixed fee would still be considered operating expenses and lead to a loss on the engagement. The ramifications of this arrangement could have negative implications for the firm. Reviews of the firm’s performance by peer institutions (assuming the bank is not publicly traded)




likely would question the quality of work performed given the inability to perform the audit in a profitable manner. Further, Kaypee and Gee will be faced with a difficult challenge in subsequent years to increase the fees charged. Difficulties in subsequent years will continue to put pressure on the firm to reduce costs, which could lead to actual quality deficiencies (or continued perceived deficiencies from reviewers).

4. Should Kaypee and Gee be forced to resign as auditors due to a conflict of interest (i.e., the firm discovers that it is not independent from the bank), recoverability of any of the agreed-upon fee is negotiable and likely based on the party at fault for not discovering the lack of independence. Likely, Kaypee and Gee are at fault and therefore would not be able to recover any of the engagement fees. In that case, all incurred expenses to-date are recorded, leading to a loss on the engagement for all amounts incurred. Any fees determined to be reimbursable would be considered revenues that would reduce the loss. This scenario highlights the importance of thoroughly investigating the extent to which any conflicts of interest might exist with a prospective audit client. In addition, the reputation effects could cause further damage. For example, Kaypee and Gee might have difficulty finding other clients in Peoria because of a perception of sloppiness in their performance.

References:

EITF 01-14, Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred

AICPA Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts

AICPA Audit and Accounting Guide, Brokers and Dealers in Securities




Case 14: Lucky’s Lobsters.comDiscussion Material

Objective: This case presents an interesting accounting issue for student discussion, the substance underlying shipping and handling fees charged by companies doing business over the Internet. A common technique used by companies is to reduce selling prices and increase shipping and handling fees. This case highlights that there should be no distinction when recording revenues. However, classification of costs does not have to be consistent, as long as accompanying disclosures are provided. Students likely will be tempted to recognize shipping and/or handling costs as SG&A expenses.

Answers:

1. Lucky’s Lobsters.com should classify the full amount billed to customers for shipping and handling as revenue on its income statement. The entire $1.20 charged for each pound of lobster represents revenues earned for the goods provided and should therefore be treated accordingly. It might seem reasonable to net the shipping and handling revenues against the cost of the process, and in turn only record $0.15 for every pound shipped as revenue. This option is erroneous, however, and could be misleading to users regarding overall revenue generated.

2. Lucky’s Lobsters.com actually has options when deciding how to record the costs associated with shipping and handling. Companies are provided flexibility in this decision but are required to disclose their policy in the matter if shipping and handling fees are not included in cost of sales. Both the amount of such costs and the line items on the income statement that include them should be disclosed. Note once again that a deduction of shipping and handling costs from revenues is not allowed.

3. Although their would be zero margin associated with the amount billed for shipping and handling if Ben was to cut his fee to $1.05, the classification of the billed amount and the recording of costs generated would not be subject to change.

References:

EITF 00-10, Accounting for Shipping and Handling Fees and Costs FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises

FASB Concepts Statement No. 6, Elements of Financial Statements AICPA Accounting Research Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins APB Opinion No. 22, Disclosure of Accounting Policies SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements SEC Staff Accounting Bulletin No. 101B, Second Amendment: Revenue Recognition in Financial

Statements




Case 15: Speaks’ and Barker’s Barter

Discussion Material

Objective: Students examine accounting for barter transactions in which similar, non-barter transactions might be utilized to value the barter transactions. Students will be tempted to use comparison transactions to value the barter transactions. However, this case incorporates parameters associated with comparison transactions to illustrate the limitations associated with using similar, non-barter transactions to value barter transactions.

Answers:

1. Although SS Inc. historically receives cash and/or stock for advertisement space, it will not be able to reference the original transaction listed in the case. There are two reasons for this. First, the prior transaction with BB Inc. took place eight months earlier, and although the advertisement surrendered is “in the same media and of the same advertisement vehicle,” the allotted period for comparison purposes may not be extended past six months. Second, both transactions are between SS Inc. and BB Inc. Computing the fair value of such a barter transaction would require SS Inc. to reference its “historical practice of receiving cash for similar advertising from buyers unrelated to the counter party in the barter transaction.” In other words, it would need to look for a sale of similar advertisement space to a company other than BB Inc. Only then could it recognize the fair value and expense of the barter. If the original transaction had taken place within the past month and was worth five times the size of the original transaction, then once again the prior case cannot be used to help determine fair value, even if it was with another company. “The characteristics of the advertising surrendered for cash must be reasonably similar to that being surrendered in the barter transaction with respect to a number of things.” One aspect relates to size, with particular emphasis on prominence and duration. Therefore according to the criteria in EITF 99-17, SS Inc. could not simply recognize five times the revenue and expense of the previous transaction referenced even if the transaction was with a different company.

2. A corporation is not allowed to consider cash transactions subsequent to a barter transaction in determining fair value. Despite the substantial difference in the amount of the sale and the trade of the BB commercial spot, the fair value of the revenue and expense recognized in the barter transaction with SS should not be adjusted.




References:

EITF 99-17, Accounting for Advertising Barter Transactions

FASB Statement No. 53, Fin. Reporting by Producers and Distributors of Motion Picture Films

FASB Statement No. 63, Financial Reporting by Broadcasters

FASB Concepts Statement No. 6, Elements of Financial Statements

APB Opinion No. 29, Accounting for Non-monetary Transactions

AICPA Statement of Position 75-5, Accounting Practices in the Broadcasting Industry




Case 16: Tom’s Tractor Harvests an Acquisition

Discussion Material

Objective: This case provides students with an opportunity to consider separable intangible assets involved in an acquisition. FASB Statement No. 141 requires that certain separable intangible assets be recorded separate from goodwill and evaluated for impairment separate from goodwill in future years. Students will be tempted either to lump all transactions in with goodwill or all separately without appropriately considering the specifics associated with the transaction.

Answers:

1. The accounting issues to be considered for this transaction first are whether to recognize any contract and/or customer relationship intangible assets resulting from the acquisitions. To help determine whether separate intangible asset(s) should be recorded, the following two criteria should be considered, and a separate intangible asset should be recorded if either criterion is met.

• First, a contractual-legal relationship has been established and the intangible asset arises from those contractual or legal rights, regardless of whether they are separable from the entity (the contractual-legal criterion).

• Second, the intangible asset is capable of being separated from the Company and sold, licensed, transferred, etc. either alone or as part of a related contract, asset, or liability (the separability criterion).

2. For the acquisitions of RLS and Tractor Heaven, several separable intangible assets should be recognized at their fair value. The excess of the cost of RLS over the net of the amounts assigned to assets acquired and liabilities assumed is recorded as goodwill. The following separable intangible assets should be recognized:

Acquisition of RLS.• The contract with Farming Depot to be the exclusive provider of farming power equipment

meets the contractual-legal criterion and should be recorded as a separate intangible asset at fair value apart from goodwill. Additionally, because RLS establishes its relationship with Farming Depot through a contract, the customer relationship with Farming Depot meets the contractual-legal criterion and must also be recorded at fair value apart from goodwill. Since there is only one customer relationship with Farming Depot, the fair value of that relationship would incorporate assumptions regarding RLS’s relationship with Farming Depot related to both farming power equipment and power tools.

• The contract with Cattle Caller to be the exclusive provider of power tools should be recorded as a separate intangible asset for similar reasons as the contract with Farming




Depot. The purchase orders with Cattle Caller for farming power equipment (whether cancelable or not) meet the contractual-legal criterion and, therefore, must also be recorded at fair value apart from goodwill. Additionally, because RLS establishes its relationship with Cattle Caller through contracts, the customer relationship with Cattle Caller meets the contractual-legal criterion and must also be recorded at fair value apart from goodwill. Since there is only one customer relationship with Cattle Caller, the fair value of that relationship would incorporate assumptions regarding RLS’s relationship with Cattle Caller related to both farming power equipment and power tools.

Acquisition of Tractor Heaven.• No implied contract with Bonanza exists from what was provided, so no separate asset

should be recorded, assuming the customer relationship with Bonanza cannot be separated (e.g., sold, transferred, licensed, rented or exchanged) from the entity.

• Finally, the half of the customer lists (the lists not under confidentiality agreements) should be recorded as a separate intangible asset at fair market value.

3. In the case of any contracts with a planned termination date with no plans for renewal, the asset should be amortized over the life of the contract. The customer relationship intangible assets should be amortized over the expected period of the customer relationship. Any goodwill arising from the transaction should not be amortized. Additionally, long-lived assets created from the transaction (including contract and customer relationship intangibles) would need to be tested for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Any goodwill arising from the transaction must be examined each year to understand the extent to which any asset impairment has occurred (or between annual tests upon occurrence of an event or change in circumstances that indicates an impairment of goodwill may have occurred).

References:

EITF 02-17, Recognition of Customer Relationship Intangible Assets Acquired in a Business Combination

FASB Statement No. 141, Business Combinations F

ASB Statement No. 142, Goodwill and Other Intangible Assets

FASB Statement No. 144, Accounting for the Impairment of Disposal of Long-Lived Assets

FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements




Case 17: Bussell Leaves Bear Creek

Discussion Material

Objective: Students examine a situation in which a plant closing is accompanied by a commitment to compensate employees for remaining with the operation from the time of the announcement to the actual closing. In many cases, this time period is quite lengthy, enabling the Company to make changes to the plan. Students will be tempted to record a liability as of the announcement date, which the FASB decided in many cases, including this one, was not consistent with the definition of a liability in the Concept Statements.

Answers:

1. One-time termination benefits are benefits provided to current employees that are involuntarily terminated under the terms of a one-time benefit arrangement. A onetime benefit arrangement exists at the date the plan of termination meets all of the following criteria and has been communicated to employees: (1) Management, having the authority to approve the action, commits to a plan of termination, (2) The plan identifies the number of employees to be terminated, their job classifications or functions and their locations, and the expected completion date, (3) The plan establishes the terms of the benefit arrangement, including the benefits that employees will receive upon termination (including but not limited to cash payments), in sufficient detail to enable employees to determine the type and amount of benefits they will receive if they are involuntarily terminated, and (4) Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn. (a) Because Bussell could make significant changes to the plan prior to the date of closure, which is still more than one year in the future, they should not record a liability as of the date of the commitment. (b) In accordance with FAS 146, paragraph 11, a liability for the termination benefits would be measured but not recorded initially at the communication date based on the fair value of the liability as of the termination date and recognized ratably over the future service period (e.g., if the fair value of the commitment approximates the present value of the future payments, the present value will be recognized as a liability in equal increments over the ensuing 18 month period (from July 2004 until December 2005). (c) The fair value of the liability as of the termination date would be adjusted cumulatively for changes resulting from revisions to estimated cash flows over the future service period, measured using the credit-adjusted risk-free rate that was used to measure the liability initially.

2. Bussell should adjust the fair value of the liability as of the termination date to reflect the revised expected cash flows, discounted for 15 months at the credit-adjusted risk-free rate that was used to measure the liability initially. Based on that revised estimate, a liability (expense) would be




recognized in each month during the future service period. Thus, the liability recognized to date would be reduced to reflect the cumulative effect of that change. A liability would be recognized in each month during the remaining future service period (12 months). Accretion expense would be recognized after the termination date in accordance with FAS 146, paragraph 6.

References:

FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities.

FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements.

FASB Concepts Statement No. 6, Elements of Financial Statements.




Case 18: CapTown Covers its Seasonal Risk

Discussion Material

Objective: This case is designed to challenge students to consider alternative revenue recognition issues associated with forming alliances with suppliers that can result in the seller serving in the role as an intermediary between the supplier and the end customer. Students will be tempted to show revenues on a net basis because of the structure of the transactions, particularly in the consignment condition. However, the decision criteria in EITF 99-19 suggest that the gross method would be more applicable for both scenarios. This case highlights the challenges associated with revenue recognition in a dynamic, complex environment.

Answers:

1. EITF 99-19 addresses the issue of revenue recognition involving companies who employ a “middleman” to sell and/or distribute their product. EITF 99-19 explores the issue of whether a

company should report its revenue based on the gross amount billed to a customer (gross method), or the net amount of revenue that it actually will receive (net method). In this case, students must decide whether CapTown is a retailer or intermediary based on the terms of the agreements with Hatz and Coverall.

Indicators of the gross method reporting include:• The company is the primary obligor in the arrangement• The company has general inventory risk• The company has latitude in establishing price• The company changes the product or performs part of the service• The company has discretion in supplier selection• The company is involved in the determination of product or service specifications• The company has physical loss inventory risk• The company has credit risk

Indicators of the net method include:• The supplier is the primary obligor in the arrangement• The amount the company earns is fixed• The supplier has credit risk

2. There is a fairly strong argument for reporting revenues for products supplied by Hatz under the gross method. Although, CapTown can return unsold hats for full credit if the contractual terms are met, the seller owns the inventory and bears the physical risk, sets the prices, and has credit risk. All of these conditions suggest




3. While the agreement to sell hats on consignment for coverall implies that the net method might be appropriate because the supplier bears physical inventory risk, overall the elements of the transactions suggest that the gross method is more appropriate because the seller continues to be the primary obligor, set prices and bear credit risk.

References:

EITF 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent


SEC Staff Accounting Bulletin No. 101B, Second Amendment: Revenue Recognition in Financial Statements

FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments

FASB Statement No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts

FASB Concepts Statement No. 2, Qualitative Characteristics of Accounting Information





Case 19: Energen Hedges the Weatherman

Discussion Material

Objective: For this case, students must consider the challenges associated accounting for derivative instruments entered into by companies not operating instruments as trading activities. Specifically, this issue involves a degree-day swap common with companies adversely affected by winter temperatures. Many students have never been exposed to these types of instruments, and this case enables students to gain a clearer understanding of the gain and loss recognition when managing risk utilizing derivatives.

Answers:

1. Because Energen and the construction company are entering into the contract to manage operating risks of their respective companies, this transaction is not considered a trading activity. EITF 99-2 lists factors that suggest a derivative is a trading activity and not subject to the accounting required under EITF 99-2. Some of the indicators of trading activities include: the operation’s primary business is not inherently exposed to the specific weather-related risk, the volume of weather derivative contract exceeds a reasonable level of weather-related risk inherent in the primary business, the change in value of the weather derivative contract is expected to move in a direction that does not mitigate or offset the risk of the underlying exposure, and the operation develops and utilizes its own proprietary models to price the weather derivative contracts it offers or trades.

2. According to EITF 99-2, a non-exchange-traded forward-based weather derivative in connection with nontrading activities should account for the contract by applying an “intrinsic value method.” The intrinsic value method computes an amount of gain or loss based on the difference between the expected results from an upfront allocation of the cumulative strike and the actual results during a period, multiplied by the contract price (for example, dollars per heating degree day). The intrinsic value method first requires that the reporting entity allocate the cumulative strike amount to individual periods within the contract term (which are given for Energen as 400, 800, 1000, 1000, and 800 HDDs per month). That allocation should reflect reasonable expectations at the beginning of the contract term of normal or expected experience under the contract. That allocation should be based on data from external statistical sources, such as the National Weather Service. The “intrinsic value” (or “intrinsic value measure”) of the contract at interim dates would then be calculated based on cumulative differences between actual experience and the allocation through that date. The initial allocation of the cumulative strike amount should not be adjusted over the term of the contract to reflect actual results.




3. For November, actual HDDs exceeded allocated HDDs by 100, meaning that there were more HDDs than allocated. Thus Energen records a gain of $12,000 multiplied by 100 (HDDs in excess of allocation) for a total of $120,000. For December, actual HDDs were 200 less than allocated HDDs. Thus Energen records a loss of $12,000 multipled by 200 for a total of $240,000. Thus, a cumulative loss for the year of $120,000 ($240,000 loss - $120,000 gain) is recorded for the year ended December 31.

References:

EITF 99-2, Accounting for Weather Derivatives FASB Statement No. 5, Accounting for Contingencies

FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments

FASB Statement No. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments

FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities

FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss




Case 20: Glow’s Website MakeoverDiscussion Material

Objective: Students are exposed to the major steps involved in developing a website and are challenged to determine the proper accounting for the costs associated with each developmental step. This case presents interesting challenges because the Company is developing a website as a communication device, marketing tool, and customer service versus as a means of distributing its products. Students will be tempted to unilaterally expense or capitalize most items, when both treatments are appropriate depending on the transaction.

Answers:

1. Accounting treatments for the events, based primarily on EITF 00-2 and SOP 98-1, are as follows. Transactions related to planning and research should be expensed (1/5, 1/20). Purchases of developmental software should be capitalized under SOP 98-1 (1/22, 1/29). The costs associated with contracting with a web services provider should be expensed over the benefit period (1/31). Testing and graphics design should be capitalized in accordance with SOP 98-1 because they are part of the development process (2/3, 2/5). However, the loading of content is to be expensed; although, no consensus was ever reached as to what is appropriate (2/10). Finally, all operating type expenses, including registering with search engines (a form of marketing, 2/16), training (2/18), launching (2/21), and routine checks and backups (2/22) should be expensed as incurred as they all relate to normal operations.

2. Costs incurred in the operation stage that involve providing additional functions or features to the website should be accounted for as, in effect, new software. That is, costs of upgrades and enhancements that add functionality should be expensed or capitalized based on the general model of SOP 98-1 (which requires certain costs relating to upgrades and enhancements to be capitalized if it is probable that they will result in added functionality). Thus, costs associated with adding functionality should be capitalized, assuming that they can be separated from any costs that are associated with routine maintenance.

References:

EITF 00-2: Accounting for Web Site Development Costs FASB Statement No. 61, Accounting for Title Plant FASB Statement No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise

Marketed FASB Concepts Statement No. 6, Elements of Financial Statements APB Opinion No. 20, Accounting Changes AICPA Statement of Position 93-7, Reporting on Advertising CostsAICPA Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained

for Internal Use




Case 21: Just-For-Teens and MassRetail Share the Risk

Discussion Material

Objective: The objective of this case is to demonstrate to students how organizations manage risks through structuring of relationships with customers. To help entice customers to its property, the lessor in this case includes contingent rent clauses to its tenants in which it makes more when tenants are successful and less when they are not successful. Given the high levels of risk in retail, particularly when operating in strip-mall outlets, organizations have become increasingly creative in attracting tenants by sharing risk utilizing mechanisms such as contingent rent. Students might be tempted to treat each scenario in (1) and (2) the same because the expected revenues are the same (i.e., $2.4 million).

Answers:

1. MassRetail should account for base of the lease in the same fashion as any operating lease by recognizing the same amount of revenue each month ($166,666). The “contingent rental income” should be recognized as revenue when the established criteria for earning the revenue is met (i.e., Just-For-Teens’ sales eclipse $40 million for the year). SFAS No. 29, Determining Contingent Rentals, amended SFAS No. 13 and clarifies that “lease payments that depend on a factor that does not exist or is not measurable at the inception of the lease, such as future sales volume, would be contingent rentals in their entirety and, accordingly, would be excluded from minimum lease payments and included in the determination of income as they accrue.” SEC Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, clarifies that contingent rental income “accrues” (i.e., it should be recognized as revenue) when the changes in the factor(s) on which the contingent lease payments are based actually occur. It is not appropriate to recognize revenue based upon the probability of a factor being achieved.

2. Under this scenario, MassRetail would recognize revenue in equal amounts over the life of the lease (i.e., $200,000 per month) because the lease covers a time period and is not tied to any future event. The reason for the difference in accounting for the two scenarios is that there are risks associated with the scenario given in the case that are not present in the scenario for this problem. In developing the basis for why scheduled rent increases should be recognized on a straight-line basis, the FASB distinguishes the accounting for scheduled rent increases from contingent rentals. Paragraph 13 states “There is an important substantive difference between lease rentals that are contingent upon some specified future event and scheduled rent increases that are unaffected by future events; the accounting under Statement 13 reflects that difference. If the lessor and lessee eliminate the risk of variable payments by agreeing to scheduled rent increases, the accounting should reflect those different circumstances.”




3. Just-For-Teens should record rent expense in equal amounts throughout the lease term for the expected value of the lease, which includes the 2 percent of sales in excess of $40 million (i.e., $20 million X .02 = $400,000). Thus, their rent expense should be $200,000 per month. In EITF 98-9 the Task Force reached a consensus that a lessee should recognize contingent rental expense prior to the achievement of the specified target that triggers the contingent rental expense, provided that achievement of that target is considered probable, which is the case for Just-For-Teens. Previously recorded rental expense should be reversed into income at such time that it is probable that the specified target will not be met.

References:


SFAS No. 13, Accounting for Leases

SFAS No. 29, Determining Contingent Rentals

FASB Technical Bulletin 85-3, Accounting for Operating Leases with Scheduled Rent Increases

EITF 98-9, Accounting for Contingent Rent




Case 22: Mayberry Zoo Plays the Market

Discussion Material

Objective: This case enables students to gain experience with transactions common to not-for-profit organizations. In this situation, students determine how donations should be recorded on financial statements, as well as the proper accounting treatment when a financial management organization sets up an endowment fund so that the not-for-profit organization does not have to manage securities.

Answers:

1. MZS would recognize the fair value of the gift of securities from Fred Howard as contribution revenue and establish a corresponding investments asset. When it transfers the securities to TCF, it would recognize the transfer as a decrease in investments and an increase in another asset representing the rights to the endowment (e.g., as a beneficial interest in assets held by TCF under FAS 136, paragraph 17(d)).

2. TCF would recognize the fair value of the transferred securities as an increase in investments and a liability to MZS because MZS transferred assets to TCF and specified itself as beneficiary (FAS 136, paragraph 17(d)). The transfer is not an equity transaction because TCF and MZS are not financially interrelated organizations (FAS 136, paragraph 18(b)). MZS is unable to influence the operating or financial decisions of Community Foundation (FAS 136, paragraph 13(a)).

3. MZS would disclose in its financial statements the identity of TCF, the terms under which TCF will distribute amounts to MZS, a description of the variance power granted to TCF, and the aggregate amount reported in the statement of financial position and how that amount is described (FAS 136, paragraph 19).

4. Variance power is the unilateral power to redirect the use of donated assets away from a specified beneficiary or beneficiaries. In this case, TCF acts as a donation recipient under which MZS has explicitly granted TCF variance power. TCF then has unilateral power to override the donor’s instructions without approval from the donor, specified beneficiary, or any other interested party (FAS 136. paragraph 12).

References:

FASB Statement No 136, Transfers of Assets to a Not-for-Profit Organization or Charitable Trust That Raises or Holds Contributions for Others

FASB Statement No 116, Accounting for Contributions Received and Contributions Made FASB Interpretation No. 42, Accounting for Transfers of Assets in Which a Not-for-Profit Organization Is

Granted Variance Power




Case 23: TCB Corp. and Stock-Based Employee Compensation

Discussion Material

Objective: The objective of this case is to have students better understand the current reporting requirements related to stock-based employee compensation. Also, they are required to understand the changes to the reporting requirements that have occurred between 2002 and 2004. Options available for reporting and disclosure of the impact of such transactions are brought to the students’ attention as they respond to the questions in the case.

Answers:

1. TCB Corp. may choose to disclose the pro forma effects of the fair value based method in the notes to the financial statements.

2. The following three options were available prior to 2004.• Prospective method: The fair value method of expensing options is applied only to options

granted in the year of adoption and subsequently. This was the method originally required by FAS No. 123.

• Modified prospective method: The fair value method of expensing options is applied to all unvested options and options granted in the year of adoption and subsequently.

• Retroactive restatement method: The fair value method of expensing options is applied to all years presented as if it had been adopted for option grants after December 15, 1994.

3. The Prospective Method noted above is not an option for TCB Corp. after December 15, 2003.

4. Reported net income for 2004 would be increased by the stock-based employee compensation expense included in reported net income, net of related tax effects. Reported net income for 2004 would be decreased by the total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects. Prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results are required.

References:

SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure – An Amendment of FASB Statement No. 123

SFAS No. 123, Accounting for Stock-Based Compensation.APB Opinion No. 25, Accounting for Stock Issued to Employees.




Case 24: Bunyan Lumber Goes Green

Discussion Material

Objective: This case asks students to consider the accounting treatment for several difficult but increasingly common environment-oriented issues. For the EPA issues, students might be tempted to treat both transactions the same. However one is capitalized and one is expensed. For the reforestation agreement, students must consider the complex thinking associated with contractual relationships associated with agreeing to change an asset at the end of scheduled operations.

Answers:

1. In the case of the reforestation agreement, Bunyan must create a liability and associated expense equal to the fair value of the reforestation obligation. Bunyan is able to factor in the likelihood that Plaid will require reforestation in determining the amount recorded. For this example, Bunyan would multiply the total cost projected to reforest of $250,000 by the probability of reforesting, which is 20 percent. Thus a total of $50,000 ($250,000 x 20%) should be reserved. However, Bunyan should discount the computed amount by a rate representing the number of years remaining in the agreement at a credit-adjusted risk free interest rate. During the term of the lease, Bunyan should reassess both (1) the likelihood that Plaid will require reforestation and (2) the total projected cost to reforest, and the liability should be adjusted accordingly.

2. For expenses associated with air pollution caused by manufacturing activities, items should be expensed unless they improve the safety or efficiency of the property or mitigate or prevent environmental contamination that is yet to occur. In the case of the agreement with the EPA, the $1.6 million related to acquiring and installing pollution control equipment can be capitalized because the expenditures satisfy both conditions. However, the $1.2 million fine does not satisfy either condition, so the entire amount should be expensed.

References:

FAS 143, Accounting for Asset Retirement Obligations

EITF 90-8, Capitalization of Costs to Treat Environmental Contamination


AICPA Statement of Position 96-1, Environmental Remediation Liabilities




Case 25: Sandlot’s Symbiotic Relationship

Discussion Material

Objective: Students are exposed to various types of accounting treatments by Sandlot, Inc.s for considerations received from Bambino Baseballs, Inc. This case involves vendor rebate accounting, which has become a major accounting issue for retailers and consumer product manufacturers.

Answers:

1. If the customer meets the required level of purchases or remains a customer for the specified period of time, rebates/refunds are treated as a reduction of the cost of sales to each transaction towards the goal. If the rebate/refund is not probable and reasonably estimable, it should be recognized as the milestones are achieved. In this case, Sandlot will purchase 50,000 or 100,000 balls from Bambino and reduce its cost of goods sold by $10,000 or $20,000 (depending on the amount purchased), which will increase its net profit by the same amount.

2. If the customer meets the required terms of the advertising and promotion agreement, the full amount of the advertising allowance should be taken as a reduction to advertising and promotion expenses, unless the amount exceeds total advertising expenses, in which case the excess amount is taken as a reduction of cost of sales. In this case, the allowance is 2 percent of the $280,000 purchase price ($300,000 full price less $20,000 cash-back arrangement), resulting in a $5,600 reduction in advertising expenses. Bambino also benefits from this arrangement because its products are actively being promoted, which increases its prospects with other customers.

References:

EITF 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.


FASB Statement No. 116, Accounting for Contributions Received and Contributions Made

FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information

FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises

APB Opinion No. 29, Accounting for Nonmonetary Transactions




Case 26: North Beach Diet Makes Bigger Inc. Better

Discussion Material

Objective: The case tests students’ ability to determine if a concession has been given by a lessor to a lessee. Students are encouraged to understand the implications of reimbursements and other benefits given by vendors to a lessee’s income statement, and the importance of recognizing concessions correctly.

Answers:

1. The moving expense paid to North Beach is a rental concession that should be treated by North Beach as an adjustment to the rental expense on a straight-line basis over the term of the new lease. $5,500 / 24 months = $229.17 per month reduction in the rental expense for North Beach (and a $229.17 per month reduction in Bigger’s rental revenue).

2. Since Bigger is not able to find a new tenant or use the department store property, a ($63,000 / 12 = $5,250 per month * 10 months =) $52,500 loss would be recognized as consideration given by Bigger to North Beach. This lease incentive is recognized straight-line over the lease term.

3. The concession is calculated as follows: $63,000 lease / 12 months = $5,250 per month * 10 months = $52,500 remaining on lease – $25,000($2,500 per month * 10 months) = $27,500 loss / 24 months new lease term = $1,145.83 per month reduction in Bigger’s rental revenue.

References:

FASB Statement 146, Accounting for Costs Associated with Exit or Disposal Activities


FASB Interpretation No. 27, Accounting for a Loss on a Sublease

FASB Technical Bulletin No. 88-1, Issues Relating to Accounting for Leases Proposed

FASB Technical Bulletin No. 88-b, Issues Relating to Accounting for Leases, issued April 14, 1988




Case 27: Texas Hold’em

Discussion Material

Objective: By introducing the realistic scenario of the decision whether or not to renew an intangible asset, the student is forced to think not only of the decision itself, but the repercussions involved for the financial statements. Additionally, the student gains an understanding of indefinite intangible assets and the amortization issues surrounding them.

Answers:

1. The gaming license is considered an intangible asset. The initial value of the asset is $47,500 because license and market entry costs associated with obtaining a gaming license generally are capitalized after it is probable that a license will be acquired.

2. To estimate the useful life of the gaming license, the expected use of the license must be determined. Assuming Miguel does not plan to renew the license after the seven-year period, and there are no legal/regulatory provisions that may limit the useful life, the $47,500 intangible asset should be amortized over the seven-year span that it contributes to Miguel’s cash flows. Since the intangible asset relating to the gaming license is a necessary part of operations, amortization would be included in the income statement as an operating expense.

3. Paragraph 11 of Statement 142 states that “If no legal, regulatory, contractual, economic, or other factors limit the useful life of an intangible asset to the reporting entity, the useful life of the asset shall be considered indefinite. The term indefinite does not mean infinite.” In this case, there is no limitation of Miguel’s ability to renew his gaming license annually. According to Paragraph 16 of Statement 142, “If an intangible asset is determined to have an indefinite useful life, it shall not be amortized until its useful life is determined to be no longer indefinite.” In this case, the gaming license would not be amortized. However, the valuation of the $47,500 intangible asset would be based on a fair value estimate of the asset, subject to tests for impairment under FASB Statement No. 142. For example, if there was evidence that the commission would not renew the license, impairment losses associated with the capitalized intangible asset likely would need to be recognized.

References:

EITF 03-9, Determination of the Useful Life of Renewable Intangible Assets under FASB Statement No. 142


FASB Statement No. 142, Goodwill and Other Intangible Assets




Case 28: A Titanic Proposal

Discussion Material

Objective: The case tests students’ ability to understand a possible defense to a corporate takeover. In addition, students must determine at what value treasury stock should be treated in the equity section when repurchased as a takeover defense mechanism. Finally, students are challenged to understand how the premium paid for treasury stock is treated when related to a takeover defense scheme.

Answers:

1. FASB Technical Bulletin 85-6 indicates that the quoted market price of treasury shares purchased represents the fair value, and that only the amount representing the fair value of the treasury shares should be accounted for as the cost of the shares acquired. In this case, the current market value and thus fair value of the 2,000 treasury shares is (2,000*$38/share) $76,000.

2. FASB Technical Bulletin 85-6 indicates that the purchase of shares at a price significantly in excess of the current market price creates a presumption that the purchase price includes amounts attributable to items other than the shares purchased and should be accounted for based on the substance of the transaction. FASB Technical Bulletin No 85-6 indicates that in general, the excess over market price paid for treasury shares is expensed as incurred. The Bulletin states that payments such as these do not give rise to recognition as assets.

References:

EITF 85-2, Classification of Costs Incurred in a Takeover Defense

FASB Technical Bulletin No. 85-6, Accounting for a Purchase of Treasury Shares at a Price Significantly in Excess of the Current Market Price of the Shares and the Income Statement Classification of Costs Incurred in Defending against a Takeover Attempt A

PB Opinion No. 30, Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions




Case 29: A Hardy Investor

Discussion Material

Objective: The case challenges students’ ability to understand which accounting method to use when recording investments in cases where the investor does and does not exercise significant influence over the operating and financial policies of an investee. Additionally, it provides some background on the differences between Limited Partnerships, Limited Liability Companies, and Corporations.

Answers:

1. Limited liability companies (LLCs) have characteristics of both corporations and partnerships but are dissimilar from both in certain respects. Like a corporation, the owners of an LLC generally are not personally liable for the liabilities of the LLC. However, like a partnership, the members of an LLC—rather than the entity itself—are taxed on their respective shares of the LLC’s earnings. Unlike a limited partnership, it is generally not necessary for one owner (for example, the general partner in an LP) to be liable for the liabilities of the LLC. Also, unlike an LP in which the general partner manages the partnership, or a corporation in which the board of directors and its committees control the operations, owners may participate in the management of an LLC. Members may participate in an LLC’s management but generally do not forfeit the protection from personal liability afforded by the LLC structure. In contrast, the general partner of a limited partnership is presumed to have control but also has unlimited liability, whereas the limited partners have limited liability like the members of an LLC. Additionally, all partners in a general partnership have unlimited liability. Like a partnership, financial interests in most LLCs may be assigned only with the consent of all of the LLC members. Like a partnership, most LLCs are dissolved by death, bankruptcy, or withdrawal of a member.

2. According to EITF 03-16, investments in LLC’s maintain a “specific ownership account” for each investor, and thus should be treated as similar to an investment in a limited partnership for the purposes of determining which accounting method to use. Opinion 18 states that investments that allow the investor to exercise significant influence over the operating and financial policies of an investee should be accounted for using the equity method. If this does not apply, the cost method should be used. SOP 78-9 dictates that limited partnership investments of more than 3 to 5 percent are considered to be more than minor, and therefore, should be accounted for using the equity method. In this case, the Larry’s Limited Partnership and Curly’s Limited Liability Corporation should be recorded using the equity method, and Moe’s Corporation should be recorded using the cost method since ownership is only 4 percent and there is no involvement with the Company.




3. Curly’s Limited Liability Corporation’s investment of only 2% should likely be considered minor, and therefore should be accounted for using the cost method. As discussed in answer 2 above, LLCs are generally treated like LPs for accounting purposes. Because L. Hardy Company now owns less than 3 to 5 percent of the LLC its investment would likely fall below the “more than minor” threshold.

References:

EITF 03-16, Accounting for Investments in Limited Liability Companies

APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock

APB Opinion No. 20, Accounting Changes

AICPA Accounting Interpretation 2, “Investments in Partnerships and Ventures,” of APB Opinion No. 18




Case 30: Two Great Tastes Get Together

Discussion Material

Objective: To introduce students to the issues involved in a business combination in which the parties have an existing relationship, including outstanding debt that is effectively settled as a result of the combination. This case also exposes students to common business incentives for a business combination, integration of the supply chain and synergies that result in new product offerings.

Answers:

1. The assets acquired in a business combination should be accounted for by valuing all assets at fair values based on the marketplace perspective—the price that would paid for them if acquired by a third party, including established market prices when available.

2. The excess of the purchase price for Peanut Butter Inc. over the fair value of net assets generally is recorded as goodwill is subject to tests for impairment on an annual basis. However, if any portion of that excess amount can be separated into specific intangible assets that meet the conditions for separation contained in FASB 141 (e.g., if Peanut Butter Inc. is subject to an operating lease under favorable market conditions), a separate intangible asset can be established that also is evaluated for impairment on an annual basis, unless there is an established useful life of the intangible (e.g., a patent), in which case the amount should be amortized over its useful life.

3. Since the business combination results in the settlement of an existing receivable (because all intercompany receivables must be eliminated), EITF 04-1 requires the settlement to be accounted for in the same manner as if the settlement occurred with a third party. In this case, Chocolate Company no longer owes the $300,000, so ChocolatePeanutButter Co. should recognize a $300,000 gain from settlement with a third party.

References:

EITF 04-1, Accounting for Preexisting Relationships between the Parties to a Business Combination



EITF 98-3, Determining whether a Nonmonetary Transaction Involve Receipt of Productive Assets or of a Business




Case 31: Can You Dig It?

Discussion Material

Objective: This case introduces students to the concept of intangible versus tangible assets. It also helps students understand that tangible assets are not necessarily physically tangible at the time they are recognized as such.

Answers:

1. The mineral rights are tangible assets. Mineral rights are defined as “the legal right to explore, extract, and retain at least a portion of the benefits from mineral deposits.” The Task Force reached a consensus in EITF 04-2, Whether Mineral Rights are Tangible or Intangible Assets, that mineral rights under the above definition are tangible assets and should be accounted for as tangible assets.

2. Diggin’ It should report the aggregate carrying amount of mineral rights as a separate component of Property, Plant and Equipment either on the financial statements or in the notes. In this case, the aggregate carrying amount is the $250,000 paid for the right to mine contract. No future payments or obligations pertaining to the mineral rights exist. The $250,000 should be shown as a separate component of PP&E on the financial statements or in the notes to the financial statements.

References:

EITF 04-2, Whether Mineral Rights are Tangible or Intangible Assets


FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies

FASB Statement No. 25, Suspension of Certain Accounting Requirements for Oil and Gas Producing Companies






Case 32: Computer Connections

Discussion Material

Objective: This case exposes students to the challenging topic of revenue recognition for complex sales transactions, involving multiple deliveries of separable components to a complete system. The critical issue for whether revenue can be recognized on partial shipments is whether the separable components can be purchased from an unrelated buyer without requiring alterations to the shipped components.

Answer:

1. Computer Connections should account for the deliverables as separate units for revenue recognition purposes. The first condition for separation is met for the CPU and keyboard. Although the monitor is essential to the functionality of the CPU and keyboard, it could be acquired by Skolar from another computer supplier without altering the capabilities of CPU or keyboard. The second condition for separation also is met because sufficient objective, reliable, and verifiable evidence of fair value exists to allocate the contract price to the CPU, monitor, and keyboard based on the prices charged for the separate pieces of equipment by other unrelated vendors. The general right of return should be accounted for in accordance with FASB Statement No. 48, Revenue Recognition When Right of Return Exists. Since the contract for sale of the CPU and keyboard does not provide the customer any refund rights if the monitor is not delivered, it is not necessary to alter the accounting treatment based on the requirements of Statement No. 48 to this case.

2. If the monitor could not be obtained from an outside supplier or a monitor obtained from an outside source inhibited the performance of the CPU or keyboard, the first criteria for separation would not be met and revenue could not be recognized until the monitors were delivered.

References:

EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables


FASB Technical Bulletin No. 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts


FASB Statement No. 48, Revenue Recognition When Right of Return Exists




Case 33: The Pulverized Pizzeria

Discussion Material

Objective: This case exposes students to the concept of extraordinary items and helps them understand when a transaction can be classified as extraordinary. Additionally, students will learn what impact extraordinary items can have on an income statement, focusing on the reported net income.

Answer:

1. Al’s decision to pay the idle employees is voluntary, and thus should be treated as employee expenses would normally be treated in the course of everyday business. The salary expense should be expensed as incurred and cannot be recorded as a liability (which is the case in EITF 01-10 which deals with employee salary expense as a result of the September 11th terrorist attacks).

2. Extraordinary items are events and transactions that are distinguished by their unusual nature and by the infrequency of their occurrence. Thus, both of the following criteria should be met to classify an event or transaction as an extraordinary item:

a. Unusual nature—the underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates.

b. Infrequency of occurrence—the underlying event or transaction should be of a type that would not reasonably be expected to recur in the foreseeable future, taking into account the environment in which the entity operates.

According to the definition above, the building damage qualifies as an extraordinary event. Extraordinary items should be segregated in the financial statements. Accounting treatment of the extraordinary event is as follows:

Income before extraordinary items $523,000 Extraordinary items (Note_____) $135,000 Net income $388,000

References:

APB Opinion No. 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions

EITF 01-10, Accounting for the Impact of the Terrorist Attacks of September 11, 2001

Kpmg Alpfa 2006 Solutions

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