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(1)CPA REVIEW. 1 Financial Accounting and Reporting by Vincent W. Lambers, MBA, CPA, Donald T. Hanson, MBA, CPA, William A. Grubbs, MBA, CPA.

(2) 1. Financial Accounting and Reporting by Vincent W. Lambers, MBA, CPA Donald T. Hanson, MBA, CPA William A. Grubbs, MBA, CPA. Published by. Copyright © 2015 by LearnForce Partners, LLC. All rights reserved. No part of this publication may be reproduced in any form without the written permission of the publisher. 12.0.

(3) ACKNOWLEDGMENTS It would be impossible to write a CPA examination preparation book of any kind without the assistance of the American Institute of Certified Public Accountants, and their various operating divisions, in granting permission to use various materials. We respectfully acknowledge and thank those persons in the American Institute who promptly answered our inquiries. Those areas of the set for which we received perm ission to use copyrighted material from the American Institute are: CPA Examination Questions, Problems and Solutions Opinions of the Accounting Principles Board and The Financial Accounting Standards Board Statements on Auditing Standards The Code of Professional Ethics and Interpretations Thereof Vincent W. Lambers, CPA Donald T. Hanson, CPA William A. Grubbs, CPA North Andover, Massachusetts.

(4) Chapter Subjects of Volume 1—FINANCIAL ACCOUNTING AND REPORTING Chapter One PARTNERSHIPS Chapter Two STOCKHOLDERS' EQUITY AND INVESTMENTS IN STOCK Chapter Three INVENTORIES Chapter Four CONSOLIDATED FINANCIAL STATEMENTS Chapter Five EARNINGS PER SHARE, SEGMENT REPORTING Chapter Six PRICE LEVEL—FOREIGN EXCHANGE Chapter Seven ACCOUNTING THEORY Chapter Eight STATEMENT OF CASH FLOWS (ASC 230), FINANCIAL STATEMENT ANALYSIS Chapter Nine BONDS, ACCOUNTING FOR DEBT Chapter Ten REVENUE AND EXPENSE RECOGNITION, MISCELLANEOUS ITEMS Chapter Eleven OTHER ASSETS, LIABILITIES, AND DISCLOSURES Chapter Twelve REPORTING THE RESULTS OF OPERATIONS Chapter Thirteen ACCOUNTING FOR INCOME TAXES Chapter Fourteen ACCOUNTING FOR LEASES, PENSION AND POSTRETIREMENT PLANS Chapter Fifteen GOVERNMENTAL ACCOUNTING Chapter Sixteen NOT-FOR-PROFIT ACCOUNTING. Material from Uniform CPA Examination Questions and Unofficial Answers, copyright 1977 through 2014 by the American Institute of Certified Public Accountants, Inc., is reprinted (or adapted) with permission..

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(6) Welcome to the CPA Exam! If you have taken the CPA exam before, you are now facing a new exam format, including some new material. However, you should know that overall the exam content has not changed very much, probably less than 20%. The new CPA Exam is call CBT-e, or CBTevolution. Starting in 2011 the CPA Exam will also be offered in selected countries overseas.. The CPA Examination The CPA exam is a computer-based test (CBT-e). There are four sections: Auditing & Attestation (AUD), Financial Accounting & Reporting (FAR), Regulation (REG), and Business Environment & Concepts (BEC). Each section includes sets of multiple-choice questions (testlets). In addition, the last testlet in each section contains a case study component called “simulations.” Simulations provide a set of facts and require candidates to complete related tasks and access authoritative literature.. Signing up and taking the exam: Candidates have significant flexibility in where and when they take the CPA examination. The exam is administered at Prometric Test Centers. There are some 300 test centers throughout the United States; however, not all of them offer CPA exam testing. Candidates may take the exam five days a week during any testing window. Weekday hours are 9am to 6pm. Many locations have extended hours, and some test centers offer weekend testing. There are four testing windows per year: January-February, April-May, July-August and October-November. In most jurisdictions, candidates are able to take any or all sections of the exam during any testing window; however, the candidate is not allowed to take the same section more than once during any testing window. The Application Process. Requirements to take the CPA examination vary from state to state. Therefore, candidates should contact the state board in their jurisdiction when requesting an application to sit for one or more parts of the CPA exam. After being determined by a state board to be eligible to take the exam, the candidate will receive a Notice to Schedule (NTS) and can then make an appointment with Prometric on their web site, www.prometric.com/cpa, or by phone, or in person at a test center. Candidates are encouraged to schedule at least 45 days in advance. No candidate will be scheduled fewer than five days before testing. Call 1-800-CPA-EXAM if you are applying to: Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Indiana, Iowa, Kansas, Louisiana, Maine, Massachusetts, Michigan, Minnesota, Missouri, Montana, Nebraska, New Hampshire, New Jersey, New Mexico, New York, Ohio, Pennsylvania, Puerto Rico, Rhode Island, South Carolina, Tennessee, Utah, Vermont, Virginia,Washington or Wisconsin. Call the Board of Accountancy if you are applying to: Alabama, Alaska, Arizona, Arkansas, California, District of Columbia, Guam, Idaho, Illinois, Kentucky, Maryland, Mississippi, Nevada, North Carolina, North Dakota, Oklahoma, Oregon, South Dakota, Texas, U.S. Virgin Islands, West Virginia, or Wyoming.. Notice to Schedule (NTS). Your NTS will contain an “examination password” that you must enter on the computer as part of the log-in process. You will not be admitted to the test center without the NTS, and all exam fees will be forfeited for that section. Be sure your identification exactly matches the name on the NTS. Also, do not apply for the exam until you are ready to take it, because the NTS could expire in six months, won’t be extended. 1.

(7) and all fees lost. A six-month NTS validation period has been established in all jurisdictions except the following: TEXAS 3 MONTHS. CALIFORNIA 9 MONTHS. NORTH DAKOTA 12 MONTHS. SOUTH DAKOTA 12 MONTHS. LOUISIANA 18 MONTHS. EXAMINATION SECTIONS. Section Auditing and Attestation Regulation (1) Financial Accounting and Reporting (2) Business Environment & Concepts (3). Length in Hours 4.0 3.0 4.0. Exam Structure 90 MC Questions, 7 TBS 72 MC Questions, 6 TBS 90 MC Questions, 6 TBS. 3.0. 72 MC Questions, 3 CR’s. The entire CPA examination length is 14 hours. (1) Includes Federal Income Tax 60%, Law and Professional Responsibility 40% (2) Includes Fund Accounting and Not-for-Profit Organizations 20% (3) BEC now includes Communication Simulations. Candidates take different, equivalent exams consisting of items from a pool of test questions according to defined specifications. The specifications ensure that the results are comparable. The test package delivered to the test centers contains the test items, and also the rules for administering the tests. All items are classified according to content and statistical properties before they are administered in an operational test. The testing software ensures that each candidate’s test contains appropriate content coverage and difficulty.. 2.

(8) RELEASE OF GRADES Distribution of grades is the responsibility of the state boards of accountancy. Advisory grades and diagnostic information will be provided to state boards at the end of the third month of each testing cycle or testing window. For example, grades should be available to state boards for the April-May testing period at the end of June. The passing standard for the computer-based version of the Uniform CPA Examination is set at a scaled score of 75. Once you pass a section(s) of the examination, you will be allowed a maximum of 18 months to pass all remaining sections in order to retain credit on the passed section(s).. AICPA EXAM TUTORIAL A CPA examination tutorial prepared and tested by the CBT-E exam Steering Group is available at www.cpa-exam.org. The tutorial covers the revised exam’s look, feel, and functionality, as well as offers both guided and self-directed instructions. The tutorial does not replace practice materials according to the CBT-E Steering Group of the AICPA. Candidates are strongly advised to review the tutorial before taking the computer-based CPA examination.. TYPES OF QUESTIONS ON THE CPA EXAMINATION MULTIPLE-CHOICE QUESTIONS AND SIMULATIONS I. The majority of the computer-based CPA exam (60-85 percent) is made up of multiplechoice questions. Each section of the examination consists of “testlets” which are the multiple-choice questions (24-30 questions), and simulation exercises.” Business Environment and Concepts (BEC), now offers communication type simulations in addition to multiple choice questions. The testlets will be “tracked” in that the second and third testlet will be adjusted by the computer to an easier or harder version. This will be based on the candidate’s performance on the first testlet. The candidate won’t know what version is on his/her computer screen. The third testlet may or may not be adjusted up or down. The system is equitable because the grading is also adjusted according to the track of the questions; if the student has a hard track, fewer questions need to be answered correctly; likewise, an easy track requires that more answers be correct. During the exam, within each testlet, you may review and change any of your answers. Once you have exited the testlet, you will not be able to access your answers to any of the questions. The same is true for the simulations portion of the exam. Note that the time clock on the screen is “cumulative” and indicates the time left for the entire exam, not just a portion. II. While the majority of the test is multiple-choice questions, a key part of the exam is the “simulation” question. According to the AICPA web site, simulations “are condensed case studies that will test candidates’ knowledge and skills using real life work-. 3.

(9) related situations.” The CPA exam candidate can expect 6 or 7 simulations to appear in each section with the exception of Business Environment and Concepts, where the candidate will receive 3 communication based simulations. The simulations will take an estimated 15 minutes to complete, and will require the following: “CPA candidates are expected to know how to use common spreadsheet and word processing functions, including writing formulae for spreadsheets. They must also have the ability to use a four-function calculator or a spreadsheet to perform standard financial calculations. For the CBT-e exam, the calculator will have a tape function that will allow candidates to see their work more easily. In addition, candidates will be asked to use online authoritative literature. Many of the question types used in the simulations are based on familiar computer interface controls (e.g., text entry, mouse clicks, highlighting, copy and pasting). In order to become familiar with the electronic tools provided for research questions, further practice may be required.” 1 Available resources during the test will depend on the simulation that the candidate receives. Incorporated into the simulation portion of the exam is an assessment of written communication skills. The exam tests typical communications an entry-level CPA would write on the job, such as memoranda, client letters, etc. The AICPA web site displays “screen shots” utilized for the simulations. The work tabs on top of the screen direct the tasks to be performed and are highlighted by a pencil which becomes shaded once the task is complete. Simulations typically include multiple-choice questions and/or written elements such as correspondence to a client. To become familiar with navigating the computerized exam screen, it is strongly advised that the candidate visit the AICPA web site tutorial. In the Lambers textbooks you will find simulation practice problems in the back of each chapter CPA Exam Written Communication Exercises: Simulations in the BEC section of the CPA Exam contain a written communication component in the form of a letter to a client or a memorandum to a co-worker. Each CPA candidate will be asked to answer three communication simulations. Only two will be graded, the third communication will be a test question for future use. Candidates will not know which simulation exercise is a test question. Below is a list of writing skills to be graded and two practice written communication exercises. The unshaded pencil is what will appear next to unanswered questions on the computer based simulations. A shaded pencil on the screen will appear once a question has been answered.. 1. AICPA web site. 4.

(10) Writing skills to be graded: 1. Coherent Organization. Candidates should organize responses so ideas are arranged logically and the flow of thought is easy to follow. Generally, short paragraphs composed of short sentences, with each paragraph limited to the development of one principal idea, can best emphasize the main points in the answer. Each principal idea should be placed in the first sentence of the paragraph, followed by supporting concepts and examples. 2. Conciseness. Candidates should present complete thoughts in the fewest possible words while ensuring important points are covered adequately. Short sentences and simple wording also contribute to concise writing. 3. Clarity. A clearly written response prevents uncertainty about the candidate’s meaning or reasoning. Clarity involves using words with specific meanings, including proper technical terminology. Well-constructed sentences also contribute to clarity. 4. Use of Standard English. Responses should be written using Standard English. Standard English is used to carry on the daily business of the nation. It is the language of business, industry, government, education, and the professions. Standard English is characterized by exacting standards of punctuation and capitalization, by accurate spelling, by exact diction, by an expressive vocabulary, and by knowledgeable choices. Note: On the AICPA sample test spell check is available in the written communication exercise. However, it is important to read through your answer in addition to using the spell check to make sure no spelling or grammatical errors have occurred. The CPA Exam graders will deduct points for errors in spelling, punctuation, word usage, capitalization and grammar. 5. Responsiveness to the Requirements of the Question. Answers should address the requirements of the question directly and demonstrate the candidate’s awareness of the purpose of the writing task. Responses should not be broad expositions on the general subject matter. 6. Appropriateness for the Reader. Writing appropriate for the reader takes into account the reader’s background, knowledge of the subject, interests and concerns. Some questions may ask candidates to prepare a document for a certain reader, such as an engagement memorandum for a CPA’s client.. 5.

(11) Written Communication- Sample Wyatt, CPA, is meeting with Brown, the controller of Emco, a wholesaler, to discuss the following accounting issue: Brown is aware that Statement of Financial Accounting Standards, ASC 715-60, Employers' Accounting for Postretirement Benefits Other Than Pensions, is effective for years beginning after December 15, 2009. Brown is uncertain about the benefits and beneficiaries covered by this Statement. Brown believes that, regardless of ASC 715-60, no estimate of postretirement obligation can be reasonable because it would be based on too many assumptions. For this reason, Brown wishes to continue to account for the postretirement benefits that Emco pays to its retirees on the pay-as-you-go (cash) basis. Brown has asked Wyatt to write a brief memo to Brown that Brown can use to explain this issue to Emco's president. Required: Write a brief advisory memo from Wyatt to Brown to: State the principal benefit covered by ASC 715-60 and give an example of other benefits covered by ASC 715-60. Explain the reasoning given in ASC 715-60 for requiring accruals based on estimates. Indicate the primary recipients of postretirement benefits other than pensions.. Solution to Written Communication To: Mr. Brown, Controller of Emco From: Wyatt, CPA Re: ASC 715-60, Employers' Accounting for Postretirement Benefits Other Than Pensions. The primary recipients of postretirement benefits other than pensions are retired employees, their beneficiaries, and covered dependents. The principle benefit covered by ASC 715-60 is postretirement health care benefits. Examples of other benefits include tuition assistance, legal services, life insurance benefits, day care, and housing subsidies. The reasoning given in ASC 715-60 is that accrual of the obligation based on best estimates is superior to implying, by a failure to accrue, that no obligation exists prior to the payment of benefits.. 6.

(12) Written Communication-Sample Andrew Jones is the president of Jones Corp., a client, which is a closely held family corporation. Jones Corp. has operated as a “C” corporation since its incorporation in 1970. Mr. Jones has a vague understanding of what an “S” corporation is, but would like some basic information from you prior to discussing the subject with family members.. Solution to Written Communication Andrew Jones Jones Corp 1234 Main Street Anytown USA Dear Mr. Jones: An S corporation pays no Federal income tax. Instead, the corporation reports each shareholder’s allocable share of income, deductions, gains, losses and credits on Schedule K-1 which each shareholder uses to prepare an individual return. In general, the flowthrough items would be any items of income or expense which require separate treatment on an individual return. The more common of these items would be charitable contributions, interest expense and income, dividend income, capital gains and losses and Section 179 depreciation. An S corporation can have only one class of stock, the number of shareholders is limited to 75. All shareholders must give their consent to operate as an S corporation. If all shareholders agree to operate as an S corporation, an election must be filed (2553) by the 15th day of the third month of the year in which the election is to be valid. Ordinarily, the IRS will not consent to a fiscal year ending for an S corporation. The CPA Exam consists of the following: Auditing & Attestation: Regulation: Financial Accounting & Reporting: Business Environment & Concepts: *Task Based Simulations (in 4th testlet) ** Communication Simulations (in 4th testlet). 3 3 3 3. MCQ MCQ MCQ MCQ. testlets testlets testlets testlets. and and and and. 7 6 7 3. TBS* TBS* TBS* CR’s**. AICPA web site on simulations: Visit this site to become familiar with the computer format of simulated problems on the new CPA exam: http://www.cpa-exam.org/lrc/exam_tutorial.html. 7.

(13) Entry-level CPA skills to be measured: • • • • •. Analysis: The ability to organize, process, and interpret data to develop options for decision making. Judgment: The ability to evaluate options for decision-making and provide an appropriate conclusion. Communication: The ability to effectively elicit and/or express information through written or oral means. Research: The ability to locate and extract relevant information from available resource materials. Understanding: The ability to recognize and comprehend the meaning and application of a particular matter.. MENTAL AND TECHNICAL PREREQUISITES FOR SUCCESS ON THE CPA EXAM The exam is a test of your overall technical competency, a test to measure judgment and intelligence in the application of accounting principles, auditing standards, and procedures to practical problems, and to evaluate professional ethics. You are being tested on a basic level of knowledge in a broad spectrum of areas. Your preparation should be geared to obtaining three things: . A Basic Technical Knowledge in All Areas. The emphasis here is on basics. You don’t need to know all the intricacies involved in any particular subject. What you do need to know are the major issues involved and you need to have a solid understanding of the underlying principles and concepts so you can respond to different types of questions and unfamiliar fact patterns.. . Exam-Taking Skills. You need weapons. You need exam-taking skills and techniques for each subject area. These will allow you to win the maximum amount of points in the shortest amount of time. The only way you can develop your skill is to PRACTICE by working hundreds of exam questions in each topic area so that answering them correctly becomes second nature. Also, don’t forget to demonstrate good writing skills on all essay responses.. . Confidence. When you walk into that exam, you must be confident. This confidence will come as a by-product of the above two elements. To quote a former successful Lambers student, “Study the material,……solve as many multiple-choice questions as your schedule permits. Although this is a very difficult exam, do not get discouraged. If you are prepared….you will pass this exam.”. 8.

(14) Strategies for Answering Objective Questions 1.). Cover (or do not look) at the answers. They are sometimes misleading and may confuse you before you have worked the question. Covering the answers keeps you from turning one simple question into four true or false questions. Also, in many cases, two or more choices may look plausible (and in fact, both may be technically correct), but you are asked to pick the best answer. For these reasons, it is critical that you cover the answers so you can think and formulate your own response first.. 2.). Read the last sentence first. Generally, this will tell you the requirements.. 3.). Decide on your answer or perform the appropriate calculations if a numerical response is required--still not looking at the answers.. Read the alternatives. If one agrees with yours, select it and move on. If your answer is close, see if it is due to a procedural error. If your answer is totally out of line, reread the requirements and body to see what was missed. If all else fails, try to eliminate any answer choices and make your best guess.. General Comments and Pitfalls to Avoid 1.) 2.) 3.). Work individual questions in order. Make sure you answer everything. Remember, there is no penalty for guessing. Watch for wrong-choice indicators; words like, “always,” “never,” “only,” “under no circumstances,” “identical,” etc. These words are usually there for a reason…and that’s to indicate the incorrect answer. Watch for negatively stated questions. For example, “Which of the following is not a characteristic of effective internal control?”. Goal Setting: Your goal is to become a CPA, a professional. That will mean financial security, the opportunity for more fulfilling positions, possibly the opportunity to start your own firm. Keep your ultimate goals in mind as you begin. You must stay focused throughout your preparation period, and work every day to make that goal a reality. Visualize your Goal: In the flux of daily life, it’s easy to lose sight of your goals. As the saying goes, “When you’re knee-high in alligators, it’s easy to forget your objective was to drain the swamp.” You need to visualize your goals on a daily basis. Picture yourself sitting in a plush office as the CFO of a major company, or imagine yourself owning your own firm. Expect to achieve your goal; keep a positive attitude.. 9.

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(16) Benefits of Becoming a CPA First, a little background on the Certified Public Accountant (CPA) designation. The first CPA examination was offered in the state of New York in 1896* and shortly thereafter other states offered an examination for candidates aspiring to be CPA’s. Now all states and territories offer examinations for those wishing to become CPA’s. Unlike many other professional designations, CPA’s are licensed by the state(s) to practice the “attest to” function. This allows the CPA to attest, in the form of an opinion, as to the condition of the financial statements provided by management. The CPA’s opinion may vary from outright refusal to be associated with the statements to acceptance of the statements as fairly representing the financial condition of the enterprise. In carrying out the attest function and other work, the CPA must adhere to certain auditing standards of performance including, but not limited to, independence and designated audit procedures. The attest function carries with it a heavy responsibility because the CPA’s opinion is heavily relied upon by leaders, investors and others who have an interest in the condition of a particular enterprise. Besides the attest function, the CPA’s association with other work, such as tax work, carries with it a presumption of excellence because of the standards that are required of CPA’s. Individuals who are CPA’s are looked up to in the world of finance and industry especially where accountability is a factor, which is almost always the case. Whether the CPA is in public practice or in an executive position, the designation is recognized as a standard of excellence. Naturally, enterprises in general are willing to pay for the presumption of excellence that the CPA demonstrates, which for the individual results in increased income. Using the world-famous cliché, the “bottom line” is that the CPA enjoys prestige, higher income, financial security and independence to a much greater extent than the same person without it. Vincent W. Lambers President, Lambers CPA Review *An excerpt from the New York State Certified Public Accountant Examination, December 1896, a Theory of Accounts question with full answer: I. State the essential principles of double entry bookkeeping and show wherein it differs from single entry bookkeeping. The essential principles of double entry bookkeeping are, (1) The record of every transaction involving the transfer of money or its equivalent must appear on both the debit and credit side of the ledger, thus maintaining it in balance. (2) Provision must be made for the constant differentiation under properly classified accounts of capital and revenue income and expenditure. (3) As resulting therefrom, the profit or loss determined from the collection of the preponderance of the balance of the revenue accounts must be proved by the excess of the assets over the liabilities as exhibited in the balance sheet. The fundamental difference between single and double entry bookkeeping is this: In single entry the income and expenditure accounts are not kept, and the profit or loss for any given period is determinable solely from a comparison of the assets with the liabilities—the excess of the one over the other showing the profit or loss; the proof of the accuracy of same, though the same result being arrived at through the profit and loss account being entirely wanting. Of minor importance also is the fact that the mathematical accuracy of the posting is in single entry bookkeeping undemonstrable in trial balance form, as in double entry.. 11.

(17) CPA EXAMINATION:. CONTENT SPECIFICATION OUTLINE. AUDITING & ATTESTATION CONTENT SPECIFICATION OUTLINE. I.. Auditing and Attestation: Engagement Acceptance and Understanding the Assignment (12% - 16%) A. Determine Nature and Scope of Engagement B. Consider the Firm's System of Quality Control for Policies and Procedures Pertaining to Client Acceptance and Continuance, including: 1. The CPA firm's ability to perform the engagement within reporting deadlines 2. Experience and availability of firm personnel to meet staffing and supervision requirements 3. Whether independence can be maintained 4. Integrity of client management 5. Appropriateness of the engagement's scope to meet the client's needs C. Communicate with the Predecessor Auditor D. Establish an Understanding with the Client and Document the Understanding Through an Engagement Letter or Other Written Communication with the Client E. Consider Other Planning Matters 1. Consider using the work of other independent auditors 2. Determine the extent of the involvement of professionals possessing specialized skills 3. Consider the independence, objectivity, and competency of the internal audit function F. Identify Matters and Prepare Documentation for Communications with Those Charged with Governance. II.. Auditing and Attestation: Understanding the Entity and Its Environment (including Internal Control) (16% - 20%) A. Determine and Document Materiality Levels for Financial Statements Taken as a Whole B. Conduct and Document Risk Assessment Discussions Among Audit Team, Concurrently with Discussion on Susceptibility of the Entity's Financial Statement to Material Misstatement Due to Fraud C. Consideration of Fraud 1. Identify characteristics of fraud 2. Document required discussions regarding risk of fraud 3. Document inquiries of management about fraud 4. Identify and assess risks that may result in material misstatements due to fraud D. Perform and Document Risk Assessment Procedures 1. Identify, conduct and document appropriate inquiries of management and others within the entity 2. Perform appropriate analytical procedures to understand the entity and identify areas of risk 3. Obtain information to support inquiries through observation and inspection (including reading corporate minutes, etc.) 12.

(18) E. Consider Additional Aspects of the Entity and its Environment, including: Industry, Regulatory and Other External Factors; Strategies and Business Risks; Financial Performance F. Consider Internal Control 1. Perform procedures to assess the control environment, including consideration of the COSO framework and identifying entity-level controls 2. Obtain and document an understanding of business processes and information flows 3. Perform and document walkthroughs of transactions from inception through recording in the general ledger and presentation in financial statements 4. Determine the effect of information technology on the effectiveness of an entity's internal control 5. Perform risk assessment procedures to evaluate the design and implementation of internal controls relevant to an audit of financial statements 6. Identify key risks associated with general controls in a financial IT environment, including change management, backup/recovery, and network access (e.g. administrative rights) 7. Identify key risks associated with application functionality that supports financial transaction cycles, including: application access control (e.g. administrative access rights); controls over interfaces, integrations, and e-commerce; significant algorithms, reports, validation, edit checks, error handling, etc. 8. Assess whether the entity has designed controls to mitigate key risks associated with general controls or application functionality 9. Identify controls relevant to reliable financial reporting and the period-end financial reporting process 10. Consider limitations of internal control 11. Consider the effects of service organizations on internal control 12. Consider the risk of management override of internal controls G. Document an Understanding of the Entity and its Environment, including Each Component of the Entity's Internal Control, in Order to Assess Risks H. Assess and Document the Risk of Material Misstatements 1. Identify and document financial statement assertions and formulate audit objectives including significant financial statement balances, classes of transactions, disclosures, and accounting estimates 2. Relate the identified risks to relevant assertions and consider whether the risks could result in a material misstatement to the financial statements 3. Assess and document the risk of material misstatement that relates to both financial statement level and specific assertions 4. Identify and document conditions and events that may indicate risks of material misstatement I. Identify and Document Significant Risks that Require Special Audit Consideration 1. Risk of fraud 2. Significant recent economic, accounting, or other developments 3. Related parties and related party transactions 4. Improper revenue recognition 5. Nonroutine or complex transactions. 13.

(19) 6. Significant management estimates 7. Illegal acts III.. Auditing and Attestation: Performing Audit Procedures and Evaluating Evidence (16% - 20%) A. Develop Overall Responses to Risks 1. Develop overall responses to risks identified and use the risks of material misstatement to drive the nature, timing, and extent of further audit procedures 2. Document significant risks identified, related controls evaluated, and overall responses to address assessed risks 3. Determine and document level(s) of tolerable misstatement B. Perform Audit Procedures Responsive to Risks of Material Misstatement; Obtain and Document Evidence to Form a Basis for Conclusions 1. Design and perform audit procedures whose nature, timing, and extent are responsive to the assessed risk of material misstatement 2. Integrating audits: in an integrated audit of internal control over financial reporting and the financial statements, design and perform testing of controls to accomplish the objectives of both audits simultaneously 3. Design, perform, and document tests of controls to evaluate design effectiveness 4. Design, perform, and document tests of controls to evaluate operating effectiveness 5. Perform substantive procedures 6. Perform audit sampling 7. Perform analytical procedures 8. Confirm balances and/or transactions with third parties 9. Examine inventories and other assets 10. Perform other tests of details, balances, and journal entries 11. Perform computer-assisted audit techniques (CAATs), including data query, extraction, and analysis 12. Perform audit procedures on significant management estimates 13. Auditing fair value measurements and disclosures, including the use of specialists in evaluating estimates 14. Perform tests on unusual year-end transactions 15. Audits performed in accordance with International Standards on Auditing (ISAs) or auditing standards of another country: determine if differences exist and whether additional audit procedures are required 16. Evaluate contingencies 17. Obtain and evaluate lawyers' letters 18. Review subsequent events 19. Obtaining and placing reliance on representations from management 20. Identify material weaknesses, significant deficiencies, and other control deficiencies 21. Identify matters for communication with those charged with governance. 14.

(20) IV.. Auditing and Attestation: Evaluating Audit Findings, Communications, and Reporting (16% - 20%) A. Perform Analytical Procedures B. Evaluate the Sufficiency and Appropriateness of Audit Evidence and Document Engagement Conclusions C. Evaluate Whether Audit Documentation is in Accordance with Professional Standards D. Review the Work Performed by Others to Provide Reasonable Assurance that Objectives are Achieved E. Document the Summary of Uncorrected Misstatements and Related Conclusions F. Evaluate Whether Financial Statements are Free of Material Misstatements G. Consider the Entity's Ability to Continue as a Going Concern H. Consider Other Information in Documents Containing Audited Financial Statements (e.g. Supplemental Information and Management's Discussion and Analysis) I. Retain Audit Documentation as Required by Standards and Regulations J. Prepare Communications 1. Reports on audited financial statements 2. Reports required by government auditing standards 3. Reports on compliance with laws and regulations 4. Reports on internal control 5. Reports on the processing of transactions by service organizations 6. Reports on agreed-upon procedures 7. Reports on financial forecasts and projections 8. Reports on pro forma financial information 9. Special reports 10. Reissue reports 11. Communicate internal control related matters identified in the audit 12. Communications with those charged with governance 13. Subsequent discovery of facts existing at the date of the auditor's report 14. Consideration after the report date of omitted procedures. V.. Accounting and Review Services Engagements (12% - 16%) A. Plan the Engagement 1. Determine nature and scope of engagement 2. Decide whether to accept or continue the client and engagement including determining the appropriateness of the engagement to meet the client's needs and consideration of independence standards 3. Establish an understanding with the client and document the understanding through an engagement letter or other written communication with the client 4. Consider change in engagement 5. Determine if reports are to be used by third parties B. Obtain and Document Evidence to Form a Basis for Conclusions 1. Obtain an understanding of the client's operations, business, and industry 2. Obtain knowledge of accounting principles and practices in the industry and the client. 15.

(21) 3. 4. 5. 6. 7.. Obtain knowledge of stated qualifications of accounting personnel Perform analytical procedures for review services Obtain representations from management for review services Perform other engagement procedures Consider departures from generally accepted accounting principles (GAAP) or other comprehensive basis of accounting (OCBOA) 8. Prepare documentation from evidence gathered 9. Retain documentation as required by standards 10. Review the work performed to provide reasonable assurance that objectives are achieved C. Prepare Communications 1. Reports on compiled financial statements 2. Reports on reviewed financial statements 3. Restricted use of reports 4. Communicating to management and others 5. Subsequent discovery of facts existing at the date of the report 6. Consider degree of responsibility for supplementary information VI.. Professional Responsibilities (16% - 20%) A. Ethics and Independence 1. Code of Professional Conduct (AICPA) 2. Public Company Accounting Oversight Board (PCAOB) 3. U. S. Securities and Exchange Commission (SEC) 4. Government Accountability Office (GAO) 5. Department of Labor (DOL) 6. Sarbanes-Oxley Act of 2002, Title II 7. Sarbanes-Oxley Act of 2002, Title III, Section 303 8. Code of Ethics for Professional Accountants (IFAC) B. Other Professional Responsibilities 1. Sarbanes-Oxley Act of 2002, Title IV 2. Sarbanes-Oxley Act of 2002, Title I. 16.

(22) FINANCIAL ACCOUNTING & REPORTING CONTENT SPECIFICATION OUTLINE. I.. Conceptual Framework, Standards, Standard Setting, and Presentation of Financial Statements (17% - 23%) A. Process by which Accounting Standards are Set and Roles of Accounting StandardSetting Bodies 1. U. S. Securities and Exchange Commission (SEC) 2. Financial Accounting Standards Board (FASB) 3. International Accounting Standards Board (IASB) 4. Governmental Accounting Standards Board (GASB) B. Conceptual Framework 1. Financial reporting by business entities 2. Financial reporting by not-for-profit (nongovernmental) entities 3. Financial reporting by state and local governmental entities C. Financial Reporting, Presentation and Disclosures in General-Purpose Financial Statements 1. Balance sheet 2. Income statement 3. Statement of comprehensive income 4. Statement of changes in equity 5. Statement of cash flows 6. Notes to financial statements 7. Consolidated and combined financial statements 8. First-time adoption of IFRS D. SEC Reporting Requirements (e.g. Form 10-Q, 10-K) E. Other Financial Statement Presentations, including Other Comprehensive Bases of Accounting (OCBOA) 1. Cash basis 2. Modified cash basis 3. Income tax basis 4. Personal financial statements 5. Financial statements of employee benefit plans/trusts. II.. Financial Statement Accounts: Recognition, Measurement, Valuation, Calculation, Presentation, and Disclosures (27% - 33%) A. B. C. D. E.. Cash and Cash Equivalents Receivables Inventory Property, Plant, and Equipment Investments 1. Financial assets at fair value through profit or loss 2. Available for sale financial assets 3. Held-to-maturity investments 4. Joint ventures 5. Equity method investments (investments in associates) 6. Investment property 17.

(23) F. G. H. I.. J. K. L. M.. N. III.. Intangible Assets – Goodwill and Other Payables and Accrued Liabilities Deferred Revenue Long-Term Debt (Financial Liabilities) 1. Notes payable 2. Bonds payable 3. Debt with conversion features and other options 4. Modifications and extinguishments 5. Troubled debt restructurings by debtors 6. Debt covenant compliance Equity Revenue Recognition Costs and Expenses Compensation and Benefits 1. Compensated absences Deferred compensation arrangements 2. 3. Nonretirement postemployment benefits 4. Retirement benefits 5. Stock compensation (share-based payments) Income Taxes. Specific Transactions, Events and Disclosures: Recognition, Measurement, Valuation, Calculation, Presentation, and Disclosures (27% - 33%) A. B. C. D. E. F. G. H. I. J. K. L. M. N. O. P. Q. R. S. T. U. V.. Accounting Changes and Error Corrections Asset Retirement and Environmental Obligations Business Combinations Consolidation (including Off-Balance Sheet Transactions, Variable-Interest Entities and Noncontrolling Interests) Contingencies, Commitments, and Guarantees (Provisions) Earnings Per Share Exit or Disposal Activities and Discontinued Operations Extraordinary and Unusual Items Fair Value Measurements, Disclosures, and Reporting Derivatives and Hedge Accounting Foreign Currency Transactions and Translation Impairment Interim Financial Reporting Leases Distinguishing Liabilities from Equity Nonmonetary Transactions (Barter Transactions) Related Parties and Related Party Transactions Research and Development Costs Risks and Uncertainties Segment Reporting Software Costs Subsequent Events 18.

(24) W. Transfers and Servicing of Financial Assets and Derecognition IV.. Governmental Accounting and Reporting (8% - 12%) A. Governmental Accounting Concepts 1. Measurement focus and basis of accounting Fund accounting concepts and applications 2. 3. Budgetary accounting B. Format and Content of Comprehensive Annual Financial Report (CAFR) 1. Government-wide financial statements 2. Governmental funds financial statements 3. Proprietary funds financial statements 4. Fiduciary funds financial statements 5. Notes to financial statements 6. Management's discussion and analysis 7. Required supplementary information (RSI) other than Management's Discussion and Analysis 8. Combining statements and individual fund statements and schedules 9. Deriving government-wide financial statements and reconciliation requirements C. Financial Reporting Entity, Including Blended and Discrete Component Units D. Typical Items and Specific Types of Transactions and Events: Recognition, Measurement, Valuation, Calculation, and Presentation in Governmental Entity Financial Statements 1. Net assets and components thereof 2. Fund balances and components thereof 3. Capital assets and infrastructure assets 4. General long-term liabilities 5. Interfund activity, including transfers 6. Nonexchange revenue transactions 7. Expenditures 8. Special items 9. Encumbrances E. Accounting and Reporting for Governmental Not-for-Profit Organizations. V.. Not-for-Profit (Nongovernmental) Accounting and Reporting (8% - 12%) A. Financial Statements 1. Statement of financial position 2. Statement of activities 3. Statement of cash flows 4. Statement of functional expenses B. Typical Items and Specific Types of Transactions and Events: Recognition, Measurement, Valuation, Calculation, and Presentation in Financial Statements of Notfor-Profit Organizations 1. Support, revenues, and contributions 2. Types of restrictions on resources 3. Types of net assets 19.

(25) 4. 5.. Expenses, including depreciation and functional expenses Investments. 20.

(26) REGULATION CONTENT SPECIFICATION OUTLINE. I.. Ethics, Professional, and Legal Responsibilities (15% -19%) A. Ethics and Responsibilities in Tax Practice 1. Treasury Department Circular 230 2. AICPA Statements on Standards for Tax Services Internal Revenue Code of 1986, as amended, and Regulations related to tax return 3. preparers B. Licensing and Disciplinary Systems 1. Role of state boards of accountancy 2. Requirements of regulatory agencies C. Legal Duties and Responsibilities 1. Common law duties and liability to clients and third parties 2. Federal statutory liability 3. Privileged communications, confidentiality, and privacy acts. II.. Business Law (17% - 21%) A. Agency 1. Formation and termination 2. Authority of agents and principals 3. Duties and liabilities of agents and principals B. Contracts 1. Formation 2. Performance 3. Third party assignments 4. Discharge, breach, and remedies C. Uniform Commercial Code 1. Sales contracts 2. Negotiable instruments 3. Secured transactions 4. Documents of title and title transfer D. Debtor-Creditor Relationships 1. Rights, duties, and liabilities of debtors, creditors, and guarantors 2. Bankruptcy and insolvency E. Government Regulation of Business 1. Federal securities regulation 2. Other federal laws and regulations (antitrust, copyright, patents, money-laundering, labor, employment, and ERISA) F. Business Structure (Selection of a Business Entity) 1. Advantages, disadvantages, implications, and constraints 2. Formation, operation, and termination 3. Financial structure, capitalization, profit and loss allocation, and distributions 4. Rights, duties, legal obligations, and authority of owners and management. 21.

(27) III.. Federal Tax Process, Procedures, Accounting, and Planning (11% - 15%) A. Federal Tax Legislative Process B. Federal Tax Procedures 1. Due dates and related extensions of time 2. Internal Revenue Service (IRS) audit and appeals process 3. Judicial process 4. Required disclosure of tax return positions 5. Substantiation requirements 6. Penalties 7. Statute of limitations C. Accounting Periods D. Accounting Methods Recognition of revenues and expenses under cash, accrual, or other permitted 1. methods 2. Inventory valuation methods, including uniform capitalization rules 3. Accounting for long-term contracts 4. Installment sales E. Tax Return Elections, Including Federal Status Elections, Alternative Treatment Elections, or Other Types of Elections Applicable to an Individual or Entity's Tax Return F. Tax Planning 1. Alternative treatments 2. Projections of tax consequences 3. Implications of different business entities Impact of proposed tax audit adjustments 4. 5. Impact of estimated tax payment rules on planning 6. Role of taxes in decision-making G. Impact of Multijurisdictional Tax Issues on Federal Taxation (Including Consideration of Local, State, and Multinational Tax Issues) H. Tax Research and Communication 1. Authoritative hierarchy 2. Communications with or on behalf of clients. IV.. Federal Taxation of Property Transactions (12% - 16%) A. B. C. D. E. F. G.. Types of Assets Basis and Holding Periods of Assets Cost Recovery (Depreciation, Depletion, and Amortization) Taxable and Nontaxable Sales and Exchanges Amount and Character of Gains and Losses, and Netting Process Related Party Transactions Estate and Gift Taxation 1. Transfers subject to the gift tax 2. Annual exclusion and gift tax deductions 3. Determination of taxable estate 4. Marital deduction. 22.

(28) 5. V.. Unified credit. Federal Taxation of Individuals (13% - 19%) A. Gross Income 1. Inclusions and exclusions 2. Characterization of income B. Reporting of Items from Pass-Through Entities C. Adjustments and Deductions to Arrive at Taxable Income D. Passive Activity Losses E. Loss Limitations F. Taxation of Retirement Plan Benefits G. Filing Status and Exemptions H. Tax Computations and Credits I. Alternative Minimum Tax. VI.. Federal Taxation of Entities (18% - 24%) A. Similarities and Distinctions in Tax Treatment Among Business Entities 1. Formation 2. Operation 3. Distributions 4. Liquidation B. Differences Between Tax and Financial Accounting 1. Reconciliation of book income to taxable income 2. Disclosures under Schedule M-3 C. C Corporations 1. Determination of taxable income/loss 2. Tax computations and credits, including alternative minimum tax 3. Net operating losses 4. Entity/owner transactions, including contributions and distributions Earnings and profits 5. 6. Consolidated returns D. S Corporations 1. Eligibility and election 2. Determination of ordinary income/loss and separately stated items 3. Basis of shareholder's interest 4. Entity/owner transactions, including contributions and distributions 5. Built-in gains tax E. Partnerships 1. Determination of ordinary income/loss and separately stated items 2. Basis of partner's/member's interest and basis of assets contributed to the partnership 3. Partnership and partner elections 4. Transactions between a partner and the partnership 23.

(29) 5. Treatment of partnership liabilities 6. Distribution of partnership assets 7. Ownership changes and liquidation and termination of partnership F. Trusts and Estates Types of trusts 1. 2. Income and deductions 3. Determination of beneficiary's share of taxable income G. Tax-Exempt Organizations 1. Types of organizations 2. Obtaining and maintaining tax-exempt status 3. Unrelated business income. 24.

(30) BUSINESS ENVIRONMENT & CONCEPTS CONTENT SPECIFICATION OUTLINE. I.. Corporate Governance (16% - 20%) A. Rights, Duties, Responsibilities, and Authority of the Board of Directors, Officers, and Other Employees 1. Financial reporting 2. Internal control (including COSO or similar framework) 3. Enterprise risk management (including COSO or similar framework) B. Control Environment 1. Tone at the top – establishing control environment Monitoring control effectiveness 2. 3. Change control process. II.. III.. Economic Concepts and Analysis (16% - 20%) A. Changes in Economic and Business Cycles – Economic Measures/Indicators B. Globalization and Local Economies 1. Impacts of globalization on companies 2. Shifts in economic balance of power (e.g. capital) to/from developed from/to emerging markets C. Market Influences on Business Strategies D. Financial Risk Management 1. Market, interest rate, currency, liquidity, credit, price, and other risks 2. Means for mitigating/controlling financial risks Financial Management (19% - 23%) A. Financial Modeling, Projections, and Analysis 1. Forecasting and trends 2. Financial and risk analysis 3. Impact of inflation/deflation B. Financial Decisions 1. Debt, equity, leasing 2. Asset and investment management C. Capital Management, including Working Capital 1. Capital structure 2. Short-term and long-term financing 3. Asset effectiveness and/or efficiency D. Financial Valuations (e.g. Fair Value) 1. Methods for calculating valuations 2. Evaluating assumptions used in valuations E. Financial Transaction Processes and Controls. IV.. Information Systems and Communications (15% - 19%) A. Organizational Needs Assessment 25.

(31) B.. C. D.. E. F. V.. 1. Data capture 2. Processing 3. Reporting 4. Role of information technology in business strategy Systems Design and Other Elements 1. Business process design (integrated systems, automated, and manual interfaces) 2. Information Technology (IT) control objectives Role of technology systems in control monitoring 3. 4. Operational effectiveness 5. Segregation of duties 6. Policies Security 1. Technologies and security management features 2. Policies Internet – Implications for Business Electronic commerce 1. 2. Opportunities for business process reengineering 3. Roles of internet evolution on business operations and organization cultures Types of Information System and Technology Risks Disaster Recovery and Business Continuity. Strategic Planning (10% – 14%) A. Market and Risk Analysis B. Strategy Development, Implementation, and Monitoring C. Planning Techniques 1. Budget and analysis 2. Forecasting and projection 3. Coordinating information from various sources for integrated planning 4. Develop a time-phased project plan showing required activities, task dependencies, and required resources to achieve a specific deliverable. 5. Evaluate business operations and quality control initiatives to understand its use of best practices and the ways to measure and manage performance and costs.. VI.. Operations Management (12% - 16%) A. Performance Management and Impact of Measures on Behavior 1. Financial and nonfinancial measures 2. Impact of marketing practices on performance 3. Incentive compensation B. Cost Measurement Methods and Techniques C. Process Management 1. Approaches, techniques, measures, and benefits to process-management-driven businesses 2. Roles of shared services, outsourcing, and off-shore operations, and their implications on business risks and controls 3. Selecting and implementing improvement initiatives 26.

(32) 4. 5.. Business process reengineering Management philosophies and techniques for performance improvement such as Just in Time (JIT), Quality, Lean, Demand Flow, Theory of Constraints, and Six Sigma D. Project Management 1. Project planning, implementation, and monitoring 2. Roles of project managers, project members, and oversight or steering groups 3. Project risks, including resource, scope, cost, and deliverables. 27.

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(34) Chapter One Partnerships DEFINED .......................................................................................................................................................... 1-1 AGREEMENTS ................................................................................................................................................ 1-1 DIVISION OF PROFITS .................................................................................................................................. 1-1 ADMISSION OF A PARTNER........................................................................................................................ 1-1 PURCHASE OF AN INTEREST...................................................................................................................... 1-1 Payment to an Existing Partner Payment to More Than One Partner INVESTMENT IN A PARTNERSHIP BY CONTRIBUTION TO THE FIRM'S CAPITAL............................................................................................................................................. 1-3 No Goodwill or Bonus Goodwill Recognized to Old Partners Bonus Allowed to Old Partners Goodwill Allowed to New Partner Bonus Allowed to New Partner DIVISION OF PROFITS .................................................................................................................................. 1-4 Interest on Capital Partners' Salaries RETIREMENT OF A PARTNER..................................................................................................................... 1-4 Goodwill Recorded Implied Bonus or Goodwill DISSOLUTION AND LIQUIDATION ............................................................................................................ 1-5 Causes of Dissolution Liquidation LIQUIDATION IN INSTALLMENTS............................................................................................................. 1-6 CASH DISTRIBUTION PLANS ...................................................................................................................... 1-7 INCORPORATION OF A PARTNERSHIP ..................................................................................................... 1-9 BONUS COMPUTATIONS ............................................................................................................................. 1-9 IFRS…………………………………………………………………………………………………………….1-10 SIMULATION EXERCISES .....................................................................................................................1 Sim-1.

(35) Chapter One Partnerships DEFINED "Association of two or more persons to carry on, as co-owners, a business for profit.". AGREEMENTS Can be expressed (oral or written contract) or implied (actions). Should be in writing for protection of partners. The agreement governs the formation, operation, distribution of income or loss, and dissolution of the partnership.. DIVISION OF PROFITS • Profits can be shared in any way agreeable to the partners. • If the agreement is silent, the law assumes that profits and losses will be shared equally. • Amount of capital contributed has no effect on profit division unless specified in the agreement.. ADMISSION OF PARTNER • Admission or withdrawal of a partner generally dissolves the partnership and brings into being a new partnership. • New articles of partnership should be drawn up. • A new partner can purchase an interest or invest in the partnership. Care should be taken to distinguish between a purchase of an interest and the investment in a partnership. The difference is critical to the proper procedure to follow in partnership problems. 1. Purchase of interest. Example: A purchases interest of X in XYZ partnership or part of interest of XYZ in XYZ partnership. The amount A paid for his interest is outside the partnership and not recorded in the books. 2. Investment. Example: A invests $10,000 in XYZ partnership, thereby increasing the capital of the partnership.. PURCHASE OF AN INTEREST 1. Payment to an existing partner No cash transaction is to be entered on the books in the purchase of an interest. X, Y, and Z have capitals of $10,000, $15,000 and $20,000 respectively. Z sells half of his capital interest to P for the sum of $12,000. Entry:. Z, Capital P, Capital. $10,000. $10,000. Transaction is between Z and P as to amount and Z has merely transferred one-half of his interest to P. 2. Payment to more than one partner Purchase at book value: P purchases a one-fourth interest for $11,250. Entry:. X, Capital Y, Capital Z, Capital P, Capital. $2,500 $3,750 $5,000. $11,250. (25% × $10,000) (25% × $15,000) (25% × $20,000). Purchase at more than book value: Where purchase is at more than book value, goodwill may or may not be recognized.. 1-1.

(36) Example: P pays $15,000 for a one-fourth interest and XYZ share profits on a 4:3:3 basis. a. Goodwill not recognized. Transfer of capital same as above. The existing partners will divide the $15,000 cash on some agreed basis or as follows: For Capital Amount in Excess of Capital in P&L Ratio. X(40) $2,500. Y(30) $3,750. Z(30) $5,000. Total $11,250. 1,500 $4,000. 1,125 $4,875. 1,125 $6,125. 3,750 $15,000. b. Goodwill recognized. If P is willing to pay $15,000 for a one-fourth interest, the implied value of the partnership is $60,000 ($15,000 × 4). Goodwill must be placed on the books prior to the admission of P to bring total capital to $60,000. Goodwill X, Capital Y, Capital Z, Capital. $15,000. $6,000 4,500 4,500. ($60,000 – $45,000 XYZ total capital) ($15,000 × 40%) ($15,000 × 30%) ($15,000 × 30%). To recognize goodwill and increase total capital to $60,000. (1) X, Capital (2) Y, Capital (3) Z, Capital P, Capital. $4,000 4,875 6,125. (1) $16,000 × 1/4 (2) $19,500 × 1/4 To record transfer of capital to P.. $15,000. (3) $24,500 × 1/4. Purchase at less than book value: P pays $10,000 for a one-fourth interest. a. No adjustment of the old partner's capital account. The same journal entry as in #2 above will be recorded since P will receive $11,250 in capital for $10,000. The existing partners will divide the $10,000 cash on some agreed basis or as follows: Capital Loss: $11,250 – 10,000 in P&L ratio Division of Cash. X(40) $2,500 (500) $2,000. Y(30) $3,750 (375) $3,375. Z(30) $5,000 (375) $4,625. Total $11,250 (1,250) $10,000. b. Adjustment of old partner's capital account: In this situation the partners are giving recognition to the loss in value of their interest. Total capital is reduced to $40,000 implied value ($10,000 × 4), with the resulting asset write-down of $5,000. Original Capitals Asset write-down $45,000 – $40,000 in P&L ratio Capital transfers. X(40) $10,000. Y(30) $15,000. Z(30) $20,000. (2,000) 8,000 (2,000) $ 6,000. (1,500) 13,500 (3,375) $10,125. (1,500) 18,500 (4,625) $13,875. 1-2. P. 10,000 $10,000. Total $45,000 (5,000) 40,000 -$40,000.

(37) INVESTMENT IN A PARTNERSHIP BY CONTRIBUTION TO THE FIRM'S CAPITAL Asset values may be adjusted before admission of any new partner(s). An investment may result in the following: • Recognition of either goodwill or bonus to the old partners. Goodwill is placed on the books before admission of a new partner. Bonus--part of the capital contributed is credited to the account of the old partners. • Recognition to the incoming partner in the form of either goodwill or bonus. 1. No goodwill or bonus. A and B have capitals of $10,000 and $20,000 respectively, share profits and losses equally, and C is to be admitted to the firm by making a contribution to the firm's capital. C is to invest $10,000. Entry:. Cash. $10,000. C, Capital. $10,000. Note that C's profit sharing ratio is not determined by the amount of capital contributed, but must result from agreement with the original partners. 2. Goodwill recognized to old partners C is to invest $12,000 for a one-fourth interest. Analysis: Implied value is $48,000 (4 × $12,000). C's contribution plus A and B's capital equals $42,000; therefore, $6,000 in goodwill must be added to total capital. Entries:. Goodwill A, Capital B, Capital Cash C, Capital. $6,000 12,000. $3,000 3,000 $12,000. 3. Bonus allowed to old partners C is to invest $18,000; capital of A and B plus C's contribution equals $48,000. Since C is contributing $18,000 but is to receive only a one-fourth interest of $12,000 (1/4 × $48,000), a bonus of $6,000 is given to A and B. Entry:. Cash. $18,000. A, Capital B, Capital C, Capital. $ 3,000 3,000 12,000. Note that in bonus situations total capital equals the old capital plus the partner's contribution. 4. Goodwill allowed to new partner C is to invest $9,000 of miscellaneous business assets and agreed total capital is to be $40,000. Entry:. $1,000 ($40,000 – $30,000 – $9,000) 9,000 $10,000 (1/4 × 40,000). Goodwill Misc. Assets C, Capital. 5. Bonus allowed to new partner C is to invest $9,000; a bonus is allowed to C. Entry:. Cash A, Capital B, Capital C, Capital. $9,000 375 375. 1-3. $9,750 (1/4 × 39,000).

(38) DIVISION OF PROFITS Division of profits is governed by the partnership agreement. Profits may be divided: 1. Equally 2. On some other fractional basis 3. In capital ratio 4. On average capital ratio 5. By allowing interest on capitals and dividing remainder, and 6. By allowing salaries to the partners and dividing remaining profit. If the agreement makes no provision for the division of profit and losses, the law assumes they will be shared equally. 1. Interest on Capital • Partner cannot claim interest on capital unless provided for in the partnership agreement. • Interest on capital should not be included in income statement as an expense. • Interest paid on partners' loans may be treated as a financial expense. 2. Partners' Salaries: Treated as a division of profits. Allocation of partners' "salaries" may exceed partnership income and create a loss to be allocated to all partners according to the partnership agreement. Method of Distribution • Allocate salaries, interest first • Distribute remaining profit (loss) per agreement Example: A, B, and C agreed to the following distribution of profit: Annual salary Interest on average capital Remainder Average capital. A $10,000 0 40% $50,000. B $ 8,000 4% 40% $50,000. C 0 10% 20% $200,000. A --0-$10,000 $10,000. B $ 2,000 8,000 $10,000. C $20,000 -0-$20,000. Total $22,000 18,000 $40,000. 4,000. 4,000. 2,000. 10,000. (8,000). (8,000). (4,000). (20,000). (20,000). (20,000). (10,000). (50,000). Profit distribution under three different assumptions: Interest allocation Salary allowance 1. Assume $50,000 profit Remainder ($50,000 – $40,000) 2. Assume $20,000 profit Remainder ($20,000 – $40,000) 3. Assume $10,000 loss Remainder (– $10,000 – $40,000). RETIREMENT OF A PARTNER Adjustment of asset values may be required to determine the fair equity of a retiring partner. This may be necessary to: a. Correct improper operating charges of prior periods (bad debts, accruals, depreciation and recognition of inventories). b. Give recognition to the existence of goodwill. c. Give recognition to changes in market values.. 1-4.

(39) Problem: C is to retire from A, B, C partnership. A goodwill value of $6,000 has been agreed upon. 1. Goodwill recorded on the books for (1) all partners or (2) only the retiring partner. (1) Goodwill. (2) Goodwill. $6,000. A, Capital B, Capital C, Capital. $2,000. C, Capital. $2,000 2,000 2,000 $2,000. 2. Implied bonus or goodwill Assume that A, B and C have capitals of $10,000 each and share profits equally. C is to retire and is to be paid $12,000 from partnership assets. The $2,000 excess of the payment to C over his capital may be recorded as a bonus or as goodwill. Bonus. Goodwill:. A, Capital B, Capital C, Capital Cash. $ 1,000 1,000 10,000. Goodwill C, Capital C, Capital Cash. $ 2,000 12,000. $12,000 $ 2,000 12,000. DISSOLUTION AND LIQUIDATION 1. Causes of Dissolution Dissolution occurs when the existing partnership arrangement is altered for some reason. Liquidation may follow dissolution but often outsiders would be unaware of the end of one partnership and the start of another. 2. Liquidation—Terminating the Affairs of a Business A. Procedure: (1) Realization of assets—convert assets into cash (2) Division of loss or gain on realization, by charges or credits to partner's capital (3) Payment of the liabilities (4) Payment of the partner's interest B. Order of distribution in liquidation (1) Outside creditors (a) Priority claims such as artisans, government, liquidation expenses. (b) Secured creditors to the extent covered by proceeds from sale of pledged assets. Excess claim treated as unsecured credit. (c) Unsecured credit to the extent covered by proceeds from sale of unpledged (or free) assets. (2) Partners for loan accounts (right of "offset" reserved, however) (3) Partners' capital As a practical matter partners' loans and capital are considered as one. Any known gain or loss should be distributed before any payments are made to partners.. 1-5.

(40) Problem: A and B have non-cash assets of $40,000, liabilities of $5,000 and capital of $20,000 and $15,000 respectively. Assets are sold for $32,000. Determine amount distributable to A and B in liquidation. A and B Statement of Partnership Liquidation Assets Non-Cash $40,000 (40,000) $32,000 $32,000 --0-(5,000) (27,000) Cash. Realization and Loss Payment of Liabilities Payment to Partners. Liabilities $(5,000) ______ $(5,000) 5,000. Partners' Capitals A 50% B 50% $(20,000) $(15,000) 4,000 4,000 $(16,000) $(11,000) 16,000. 11,000. Problem: Debit balance in partner's capital account. Assets were sold for $50,000.. Real. and Loss Combine Loan and Capital Acct. Pay Liabilities Pay Partners. Cash --0-$50,000 50,000 ______ 50,000 (15,000) (35,000). Assets Non-Cash $80,000 (80,000) --0-______. Liabilities $(15,000) ______ (15,000) ______ (15,000) 15,000. Partners' Loans X Y $(10,000) $(17,000) ______ ______ (10,000) (17,000) 10,000 --0--. 17,000 --0--. Partners' Capitals X 80% Y 20% $(20,000) $(18,000) 24,000 6,000 4,000 (12,000) (10,000) ( 6,000). (17,000) (29,000). 6,000. 29,000. NOTE: Right of offset exercised. Neither partner would be paid any cash until there is no danger that possible loss could exceed his capital account and loan account combined.. LIQUIDATION IN INSTALLMENTS -- MAXIMUM POSSIBLE LOSS (MPL) Where a partnership is liquidated and the full amount to be paid to a partner is determined before any distributions are made, losses have already been distributed to the partners. In these situations it is assured that no partner will receive more than he will be entitled to receive. However, where a liquidation occurs in stages and disbursements are made periodically, there must be assurance that no partner will receive more than he could possibly be entitled to receive. This can be done by distributing the maximum possible loss to the partners and the remaining capital balance(s) can safely be paid. The maximum possible loss is the total of the non-cash assets. The procedure to determine the safe distribution is: A. Determine the maximum possible loss that the partnership could suffer. MPL = Total Assets - Cash (or Non-Cash assets) B. Distribute the MPL to the partners in P and L ratio. C. The remaining balance is the amount that can be distributed to each partner. D. Distribute the amount determined in C. E. The same calculation must be made each time a distribution is made. NOTE: Remember, MPL's are not actual losses, only theoretical losses; therefore, the determination of MPL should be done on a separate schedule.. 1-6.

(41) ABC Partnership has the following balance sheet as of December 31st: Assets Cash Receivables Other Assets. $ 35,000 14,000 85,000. ______ $134,000. Liabilities and Capital Liabilities $ 21,000 Partners' Loans A 5,000 8,000 C Partners' Capital A 50,000 35,000 B C 15,000 $134,000. A, B and C share profits and losses on a 5:3:2 basis. Determine the amount the partner(s) will receive by distributing the maximum possible loss. Solution: The maximum possible loss is $99,000 ($14,000 receivables + $85,000 other assets). Capital balance Additional loans MPL—$99,000 Amount distributed. A (50%) $50,000 5,000 55,000 49,500 $ 5,500. B (30%) $35,000 -35,000 29,700 $ 5,300. C (20%) $15,000 8,000 23,000 19,800 $ 3,200. NOTE: The cash to be distributed—$14,000—is equal to the cash available—$35,000—less the liabilities of $21,000.. CASH DISTRIBUTION PLANS Another method of determining the amount(s) that can be distributed to a partner is by preparation of a cash distribution plan. An accountant may be asked by a partnership to devise such a plan, if the partnership should subsequently choose to liquidate, showing how any cash generated by the sale of assets should be distributed. This is similar to the ordinary procedures in liquidation where, as cash is accumulated, the accountant calculates the payments which can safely be made to partners in installments. Once the plan is prepared it may be used to determine all subsequent distributions unless the mix of partners' capital is changed by investment or withdrawal. The use of MPL and the cash distribution plan is necessary because the partners' capital account ratios differ from their P and L ratios. The plan will eventually equalize the partners' capital accounts. The procedure for a plan for distribution of cash is as follows: 1. Add the loan accounts to the partners' capital accounts. 2. Determine the amount of loss which will extinguish the weakest partner's capital balance. 3. Distribute the loss in (2) to all partners. After one partner is eliminated, repeat the same process with the remaining partners. 4. After all but one of the partners' capital accounts are eliminated, cash distributions are determined by starting with the remaining partner's final balance (which becomes the first cash distribution) and working backwards.. 1-7.

(42) ILLUSTRATION 1: The ABCD Partnership is being dissolved. All liabilities have been liquidated. The balance of assets on hand is being realized gradually. Following are details of partners' accounts:. A B C D. Capital Account (Original Investment) $30,000 36,000 16,000 22,000. P and L Ratio 4 3 2 1. PREPARE a schedule showing how cash payments should be made to the partners as assets are realized. Capital balance Loss (1) $75,000 Loss to eliminate C $1,000 ÷ 2/6 = $3,000 Loss to eliminate B $12,000 ÷3/4 = $16,000 First cash payment Cash distribution plan-(Liabilities must be paid or cash reserved before payments are made to partners). A (40%) $30,000 30,000 --0--. B (30%) $36,000 22,500 13,500 1,500 (3/6) 12,000. C (20%) $16,000 15,000 1,000 1,000 (2/6) --0--. 12,000 (3/4) --0--. D (10%) $22,000 7,500 14,500 500 (1/6) 14,000 4,000 (1/4) 10,000. 1st $10,000 to D Next $16,000—3/4 to B; 1/4 to D Next $3,000—3/6 to B; 2/6 to C; 1/6 to D All remaining cash in P and L ratio. (1) To determine the weakest partner, compare the capital account balance with the P and L ratio. A is weaker than B because A would be charged with 40% of any loss. A is also weaker than C and D even though A has greater total capital. Another method of determining the weakest partner is to divide the capital account by the loss ratio. A=. 30,000 .4. = 75,000 loss will eliminate A. B=. 36,000 .3. = 120,000 loss will eliminate B. C=. 16,000 .2. = 80,000 loss will eliminate C. D=. 22,000 .1. = 220,000 loss will eliminate D. We can see from this that D will receive the first cash distribution made to the partners, followed by B, C, and then A. (2) After each partner is eliminated, the loss which eliminates the next weakest partner is determined by using the loss ratio of the remaining partners, or after A is eliminated 3:2:1. Assume that $20,000 in cash is available for distribution but $5,000 is reserved for payment of liabilities. Following the plan the cash would be distributed as follows:. 1-8.

(43) To D To B and D. $10,000 5,000 $15,000. A. B. C. $3,750 (3/4) $3,750. D $10,000 1,250 (1/4) $11,250. Assume that next month $20,000 is to be distributed. The plan would continue at the point reached last month. $16,000 – $5,000 = Next Next. $11,000 3,000 6,000 $20,000. A $2,400 $2,400. B $ 8,250 (3/4) 1,500 (3/6) 1,800 $11,550. C $1,000 (2/6) 1,200 $2,200. D $2,750 (1/4) 500 (1/6) 600 $3,850. Observe that when all partners have received some cash, the capital accounts are in the same percentage as the P and L ratio and that future distributions can be made in the P and L ratio.. INCORPORATION OF A PARTNERSHIP Procedures A. Adjust asset values to bring balances into conformity with values agreed upon for the purpose of transfer to the corporation. The net effect of these adjustments will be carried to the partners' capital accounts in their respective P and L ratios. B. Change from a partnership to corporation is made by debiting the partners' capital accounts and crediting capital stock account for the shares issued to the partners.. BONUS COMPUTATIONS Frequently accountants are asked to compute the amount of bonus to be paid a corporate executive, a partner or employee under a profit sharing plan. The factors which may affect the bonus are: • Net income before tax and/or bonus • Tax rate—The bonus itself affects the tax since the bonus is deductible. The bonus may be computed before or after the tax depending on the profit sharing arrangement. Partnerships as entities do not pay taxes; however, an imputed tax rate may be used to compute the bonus. • Bonus percentage—May be before or after bonus and may be applicable to income above a certain amount. In solving such problems, a good approach is to write the particular problem in equation form with no attempt to quantify the elements of the equation. Then substitute known quantities in the equation and solve for B (Bonus). Example: A company's bonus plan provides that the company will pay a bonus of one-third of its net income after taxes each year. Income before taxes and before deducting the bonus for the year is $600,000. The tax rate is 40%. What amount is the bonus? Start with a simple expression of the situation 1. Bonus = Bonus Percent × Net Income Now begin to substitute quantities 2. B = 33 1/3% (NI – Tax – Bonus) 3. B = 33 1/3% (600,000 – .40 [600,000 – B] – B) Multiply the factors using the rules of algebra 4. B = 33 1/3% (600,000 – 240,000 + .4B – B) 5. B = 200,000 – 80,000 + 13 1/3% B – 33 1/3% B. 1-9.

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