The FAR section: oh the agony

So tomorrow will be the one week anniversary of when I took the FAR exam. There is a lot to learn between passing the BEC section in the summer and taking the FAR section a week ago. The contrast between the two sections is so great, you may as well obtain two different certifications.

First off, time played a major role. To say I managed my time poorly is a little bit of an understatement. The BEC section is only 2.5 hours long - the shortest of the four exams. Going into it, I was very time-conscious and it paid off. I probably had a good half hour at the end to check over the last testlet. The FAR section, on the other hand, is 4 hours long - only the Auditing exam is longer at 4.5 hours. With three testlets (of 30 multi-choice each) and two simulations, you're asked to do a lot in that amount of time. Whereas I should have been spending maybe 60 to 90 seconds on a multiple choice problem, I was spending up to 5 minutes on a single problem. By the time I was finished with the 3rd testlet, I only had 45 minutes to complete the two simulation problems.

Upon this realization, I was not only fighting the clock, I was fighting myself. I was flustered and panicked. I tried taking a deep breathe and relaxing, so as to fight the anxiety that had set in, but it was a futile effort. I tried guessing the accounts in the debits and credits that should have been the journal entries and skipped on calculating the amounts. For the Communication tab, I fired off two quick sentences summarizing something that vaguely related to what the mock-client wanted to know and left it at that (something I would never do to a real client).

What I learned from the whole thing was not just how important knowing the material is, but how valuable time is during the exam. The CPA exam isn't just testing if you know the material, but how well you know the material.

The only redeeming factor in all this is knowing that the three testlets got progressively more difficult as I took them. This is a good sign since the CPA exams are adaptive. How well you do in the earlier testlets determines how difficult the later testlets are, and the more difficult testlets weigh more for correct answers. Even assuming all of this, I have to expect to take it again 2011. Given my non-calculations of journal entries in the simulations and poor communication in the written section, I am prepared to see a grade of less than 75 when the grades are released in December.

Moving on, I have scheduled the Audit and Attestation (AUD) section for mid-November. This time will be different. For the AUD section, which is 4.5 hours, I will not take time for granted.

Happy studying.

Capitalizing software costs

On the date of the balance sheet, software should be valued at the lower of: unamortized cost OR net realizable value. 'Unamortized cost' of software is similar to 'carrying amount' of depreciable assets. Take the total software cost and divide it by the economic life (useful life), and that is your amortization expense. Unamortized cost is simply original cost minus accumulated amortization. SFAS 142 tells all about intangible assets, while SFAS 86 talks about software development for sale or lease.

Impairment losses

For long-lived assets, you test impairment by comparing undiscounted cash flows of the asset to the carrying amount of the asset. If undiscounted cash flows is less than carrying amount, recognize impairment. The asset must now be reported at fair value. So the impairment is the carrying amount minus the fair value of the asset. You would think it would be carrying amount minus undiscounted cash flows, since that's what you originally compared to determine whether to recognize an impairment in the first place, but it's not. It's seems inconsistent; it's like saying since undiscounted CF < carrying amount, you get to subtract FV from carrying amount. But that's the way SFAS 144 goes. Just remember you have to report the asset at fair value on the balance sheet.

Capitalizing interest

Let's think philosophically for a moment: what is capitalized interest? Well capitalizing is when something is reported as an asset instead of as an expense. And interest is of course the charge for borrowing money. So capitalizing interest is when a company gets to report the charge they pay on debt (interest) as an asset on the balance sheet instead of an expense on the income statement (capitalize). Only certain situations allow this sort of accounting treatment, and they are addressed in SFAS 34 (paragraphs 9 and 10).

Actual or avoidable interest, that is the question...
As SFAS 34 says, the amount of interest to capitalize is the lower of: actual interest OR avoidable interest. Actual interest is easy: it's the actual interest rate a business pays for capitalizable debt. Avoidable interest is a little tricker because it's calculated. It's the average accumulated expenditures times the incremental borrowing rate. Remember that in accounting, averages are calculated as the beginning balance plus the ending balance divided by two. Also remember to pick the lower of the two.

Remember that whichever rate you use, you can only capitalize up until the moment that asset is ready for use. Once it goes into use, starting expensing that interest just like all other interest.

Foreign Exchange Transactions

Gains and losses from foreign exchange transactions are reported on the income statement under "Other Income".

When a US company makes a sale in another country, they usually use that country's local currency. When they make a sale on account, the receivable is affected by fluctuations in the exchange rate.

More Stockholders' Equity

I guess the best place to start out would be to see what a Stockholders' Equity (SE) Section looks like. Book examples are always nice, but the companies are always made up, so it's hard to trust them. Here's a screenshot of Google's SE section (what does it say that that was the first company to come to mind?):

Here's a link to Google's entire 10-Q filing with the SEC for reference. I'm looking at the bottom of page 3.

First up, is Convertible preferred stock with outstanding shares and balance of 0 (glad that's there). Next is Common stock separated into Class A and B stock and what looks to be combined with Additional pain-in capital (APIC). Some companies combine their APIC accounts, and some separate it from among their sources. The CPA exam seems to like separating it.

Stockholders' Equity Section - EPS calculations

Remember to apply stock splits and stock dividends retroactively. This matters for the denominator of the EPS (basic and dilutive) calculation.

The Stockholders' Equity section. No big deal, actually...

There's a lot more to the Stockholders' Equity section than just Common Stock, Preferred Stock and Retained Earnings. The Additional Paid-in Capital (APIC) accounts can get pretty tricky, especially when dealing with the fact that each type of equity account has its own APIC account. I'm not talking about the ones that relate to the good old-fashioned Common and Preferred Stock accounts; looking back at it - that was easy. There are APIC accounts for every type of equity account you can imagine (and some you can't): stock options, stock subscriptions, stock appreciation rights, stock dividends, scrip dividends and probably a few others I'm leaving out.

Keeping track of the nuances between the Par and Fair Value method also requires an extra cup of coffee, but that's actually not that hard with a few practice problems (I just like coffee). I haven't even gotten to the Basic and Diluted EPS calculations yet. Looks like I have my day set for tomorrow.

Keep studying.

Deferred Taxes - No Big Deal

I am starting on deferred taxes today. No big deal.

PV Concepts - Leases

Under sales-type leases and direct-financing leases, gains and interest revenue are recognized using the interest method. The difference between the PV of lease payments and book value of leased asset is your profit. Amortized that over the life of the lease (or life of the asset, whichever is shorter) by multiplying the interest rate by monthly lease payment and applying that to interest, take the remainder and apply that to the carrying value of the lease, like it's no big deal.

Knowing the difference between Operating and Capital leases seems like an important distinction the AICPA wants to test. There are four criteria that you should know that make a lease "Capital". I'm dying to provide this link to a Roger CPA video I found on youtube. I wish there were more, but that's all they posted.

Leases and the SFAS's that cover it

Just for reference here are the key SFAS's that cover leases:
SFAS 13 - Accounting for Leases (Nov 1976)
SFAS 23 - Inception of the Lease
SFAS 27 - Classification of Renewals or Extensions of Existing Sales-Type or Direct Financing Leases
SFAS 28 - Accounting for Sales with Leasebacks
SFAS 29 - Determining Contingent Rentals
SFAS 91 - Nonrefundable Fees & Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases
SFAS 98 - Accounting for Leases
SFAS 145 - Rescission of FASB Statements 4, 44, and 64 Ammendment of FASB No. 13, and Technical Corrections (Apr 2002)
SFAS 146 - Accounting for Costs Associated with Exit or Disposal Activities

I included the issue dates for SFAS 13 and SFAS 145 above because they were the only ones Wiley did that for. I'm about to start the module, and I guess I'll find out soon why, or if, that's important.

More Present Value - Pensions

SFAS 87, SFAS 112, SFAS 88, SFAS 106, SFAS 132(R) and SFAS 158 all cover pensions and postretirement benefits.

To get started here are a few terms, these may not make sense now, but will show up on a few CPA problems:

• Defined Contribution Plan - A plan that specifies a company's contribution. The accounting for this is apparently simple. The sponsor company only needs to make one journal entry. Out of 41 practice problems in the Pensions module in my Wiley book, not a single one involved defined contribution plans. That's probably because it's not as complex as...
• Defined Benefit Plan - It's a plan that specifies the benefits paid to employees at retirement. Contributions are calculated based on actuarial estimates. The accounting for this is very complex. A sponsor company needs to make multiple journal entries. Out of 41 practice problems, about half involved this type of plan. The other half involved other postretirement plans which share a lot of common characteristics.
• Accumulated Benefit Obligation (ABO) - PV of benefits based on current and past compensation levels. Not future.
• Projected Benefit Obligation (PBO) - PV of benefits based on future compensation levels.
• Fair Value of Plan Assets - market value of the securities and other investments in the pension fund
• Vested Benefits - benefits already earned by employees by reason of retiring or meeting some other requirement. The employee has a right to these benefits whether she continues working or not.
• Prior Service Cost - costs of benefits based on past service. When a new plan is implemented or an existing plan is amended, the company has to go back and add past costs to current balances as if they had those costs on the books all along.
• Service Costs - PV of all pension benefits earned by a company's employees in the current year. This increases PBO. Usually given in a problem.
• Interest Cost - Increases PBO by passage of time. Usually the problem will give you a discount rate and a beginning PBO. Multiply these to get interest cost.
• Actual or Expected Return on Plan Assets - They'll usually give you a rate of return and the FV of plan assets. Multiply these to get return.

Net Periodic Pension Expense - this is a fancy name for pension expense. A lot goes into NPPE, so I looked at an old Becker book, and I found the mnemonic "SIR-AGE" helpful.

• S - Service cost (current), usually given
• I - Interest cost. discount rate * beginning PBO
• (R) - Return on plan assets. This will decrease NPPE (it's a return on the market).
• A - Amortization of Prior Service Costs.
• (G) - Gain or loss amortization. A gain will decrease NPPE (just like a return).
• E - Existing net obligation (liability) or net asset amortization

These are the six components that go into Net Periodic Pension Expense. Here's a little more detail about each:

• Service Cost - Usually given, but is simply the difference between beginning and ending Unrecognized Prior Service Cost
• Interest Cost - Discount rate * FV of plan assets
• Return on Plan Assets - Expected rate of return * beginning PBO. Remember to subtract the return on plan assets from NPPE. A return decreases expense, just like a gain.
• Amortization of Prior Service Cost - Usually given, but if the problem gives 12/31/yr. 2 unrecognized PSC and 12/31/yr. 1 unrecognized PSC, simply subtract these to get the amortization of the PSC
• Gain/Loss Amortization - A gain will decrease expense and a loss will increase it. For example, one of the problems in my Wiley book gives unrecognized net loss, market-related asset value (M-RAV), and PBO. Take the larger of PBO and M-RAV. Whichever is larger, multiply it by 10%. Got it? Then subtract the unrecognized net loss from that number. Take the difference and divide it by the average remaining service period (usually given). This is a summary of the "Corridor Approach" confusingly described in SFAS 87, para. 187-189. Do a problem to get a better idea. Agree?
• Existing Net Obligation/Net Asset Amortization - If PBO > FV of plan assets, you have an obligation; if FV > PBO, you have an asset. If PBO > FV, then take the difference and divide it by EITHER 15 years OR the average employee job life, whichever is greater.

That's a summary that may not make sense until after studying the Pensions module.

Disclosures

Under SFAS 87 and SFAS 106, the funded status of pension plans was only required to be reported in the footnotes. SFAS 158 came out in Sept. 2006 (finally, I know) to require funded status to be reported right on the Balance Sheet. SFAS 158 also eliminated delayed recognition of certain components allowed under 87 and 106. Lastly, 158 requires a company to consider tax effects.

I was surprised to learn that a company must disclose the effects of a one-percentage-point (not two or ten, some questions seriously try to throw you off this way...) increase or decrease in the trend rates for health care costs for the aggregate of the service and interest coasts components and the accumulated postretirement benefit obligation for the following year and years after. I haven't seen a practice problem that actually requires that to be computed, but there are a few that simply ask if you know that. This is required under SFAS 132(R) starts on pg. 24. SFAS 132(R) requires a list of disclosures including: amount of unrecognized prior service cost and fair value of plan assets.

I should add that this post is meant for people who have already studied this module and would like a summary or regular person's interpretation. It's also meant for me to see if I have retained the information well enough. If there are any mistakes, please point them out.

Thanks to the four people who may have read this far.

Present Value of Bonds

The accounting treatment for bonds is covered mostly by APB 21, SFAS 157 and SFAS 159. I say mostly because the accounting treatment for bonds is scattered across a few standards. APB 21 covers interest for long-term payables and the presentation of discounts and premiums. The Appendix illustrates the present value concept (we'll go over that shortly). SFAS 157 provides guidance on measuring the fair value of liabilities. (we'll go over that in some detail). SFAS 159 covers the Fair Value Option (I haven't read that, I'll have to come back and edit this). SFAS 47 addresses what should be included in the footnotes about long-term obligations in general. SFAS 91 tells you what should be included in origination costs (most likely everything).

A big thing this section on the CPA exam seems to emphasize is buying bonds between interest payment dates. This involves calculating interest payments (easy), premium/discount (still easy), amortization of the premium/discount (not bad with practice), interest accrual (sucks), and amortization of the interest accrual based on either the interest method or straight-line method (this is why CPAs get paid so much).

The CPA exam also tests on disclosure.

SFAS 47 is pretty easy. In the footnotes, you want to include the balances for sinking fund requirements and outstanding long-term payables for 5 years out. So if the year-end financials are for 12/31/10, you want to include sinking fund balance requirements AND outstanding long-term payables for 12/31/10 through 12/31/14. We'll worry about 12/31/15 next year, but don't skip on 12/31/14.

First post

This is my first post, and I'm jumping in without introducing anyone to what I'm trying to accomplish. Breifly, my name is Daniel Nemec, and I'm studying for the CPA. I'm going to post things on this blog to sort of practice talking about what I've learned so far. If anyone wants to read or respond, that's up to them, but this is mainly for me to reinforce what I'm learning and maybe help a few people along the way. I will not just summarize, but I will dare to dig into the technical details of accounting treatments. I won't always be right (I am just learning this stuff after all), but that's where I reserve the right to go back and edit blog posts (you can help too).

I am on the Financial Accounting and Reporting section, and right now it's present value of bonds. I'm using 2009 Wiley CPA study material (yes I realize we're in 2010, but let's focus on bonds for now)...