UPDATE TO 2010 WILEY CPA EXAM REVIEW

FINANCIAL ACCOUNTING AND REPORTING

MODULE 7A

SFAS 168—The FASB Accounting Standards Codification and the Hierarchy of Generally
Accepted Accounting Principles—A Replacement of FASB Statement No. 162 (ASC Topic 105)
A. Establishes the Codification as the single source of US GAAP for nongovernmental entities, except
for SEC authoritative literature which applies to SEC registrants
B. Content in SEC Sections of the Codification is provided for convenience and is not the complete SEC
literature.

This results in a revision of the section on page 41 of Module 7A as presented below.

1. Basic Accounting Theory

The foundation of financial accounting is generally accepted accounting principles (GAAP).
GAAP is the conventions, rules, and procedures necessary to define accepted practice at a
particular time. Prior to July 1, 2009, the accounting principles were included in several sources:
SFAS, FASB Interpretations, APB Opinions, ARB and SEC releases. Consequently, a hierarchy
of GAAP was developed for business enterprises as shown below. If the accountant/auditor
could not find a specified accounting treatment in Category A, s/he should proceed to the next
lower category.
• Category (A), officially established accounting principles, consists of Financial
Accounting Standards Board (FASB) Statements of Financial Accounting Standards and
Interpretations, Accounting Principles Board (APB) Opinions, and AICPA Accounting
Research Bulletins.
• Category (B) consists of FASB Technical Bulletins and, if cleared by the FASB, AICPA
Industry Audit and Accounting Guides and AICPA Statements of Position.
• Category (C) consists of AICPA Accounting Standards Executive Committee (AcSEC)
Practice Bulletins that have been cleared by the FASB and consensus positions of the
FASB Emerging Issues Task Force.
• Category (D) includes AICPA accounting interpretations and implementation guides (“Qs
and As”) published by the FASB staff, and practices that are widely recognized and
prevalent either generally or in the industry.
In addition, the above four categories were supplemented by “other accounting literature”
which included practice, textbook, and articles. In cases of conflict between the accounting
treatment suggested by the categories, the higher category normally prevailed over lower
categories.
Effective July 1, 2009, the FASB’s Accounting Standards Codification is the single source of
US GAAP for nongovernmental entities. The Accounting Standards Codification (ASC) replaced
all previously issued non-SEC accounting literature. The Codification did not change GAAP, but
merely restructured the existing accounting standards to provide one cohesive set of accounting
standards. Included in the Codification is all Category A-D level GAAP, as well as relevant
literature issued by the SEC. In the future, the FASB will issue Statements to update the
Codification.
To help the CPA candidate transition to the Accounting Standards Codification, the
Codification citation is shown first, and the cross-reference to previous GAAP citations are
shown in parentheses. The research component for each module is organized as “Prior to
2 Update to 2010 Financial Accounting and Reporting

Codification” and “Accounting Standards Codification” which will provide the candidate with the
appropriate study materials for both literature infobases. The Codification research database is
scheduled to be included on the CPA exam beginning January 1, 2011. Candidates testing before
January 1, 2011 will be tested on the standards in existence before the Codification became
effective.
Although GAAP is the current basis for financial reporting, it does not constitute a cohesive
body of accounting theory. Generally, SFAS and the other authoritative pronouncements have
been the result of a problem-by-problem approach. The pronouncements have dealt with specific
problems as they occur and are not predicated on an underlying body of theory.
Theory can be defined as a coherent set of hypothetical, conceptual, and pragmatic principles
forming a general frame of reference for a field of inquiry; thus, accounting theory should be the
basic principles of accounting rather than its practice (which GAAP describes or dictates).
Accounting has a definite need for conceptual theoretical structure. Such a structure is necessary
if an authoritative body such as the FASB is to promulgate consistent standards. A body of
accounting theory should be the foundation of the standard-setting process and should provide
guidance where no authoritative GAAP exists.
There have been efforts to develop such a frame of reference. The most recent attempt to
develop accounting theory led to the establishment of the Statements of Financial Accounting
Concepts (SFAC), of which seven have been issued. The purpose of this series is “to set forth
fundamentals on which financial accounting and reporting standards will be based.” In other
words, the SFAC attempt to organize a framework that can serve as a reference point in
formulating SFAS. However, it is important to note that the SFAC do not constitute authoritative
GAAP, and, therefore, are not included in the Codification. They merely serve as a theoretical
framework for the development of accounting standards.

ASC Update 2010-17

Add to discussion in Module 7A on page 55

Research or Development Accounted for on the Milestone Basis

The milestone method of accounting may be elected in accounting for research and
development arrangements in which revenue (payments) to the vendor contingent on achieving
one or more substantive milestones related to deliverables or units of accounting. A substantive
milestone is an uncertain event that can only be achieved based on the vendor’s performance and
it is commensurate with the vendor’s performance or enhancement of value resulting from the
vendor’s performance.
a. It relates solely to past performance.
b. It is reasonable relative to all of the deliverables and payment terms.
If these circumstances are met the vendor may recognize the contingent revenue in its entirety
in the period in which the milestone is achieved.
The notes to the financial statements should disclose its accounting policy for the recognition
of milestone payments. In addition the following should be disclosed:
a. A description of the overall arrangement
b. A description of each milestone and related contingent consideration
c. A determination of whether each milestone is considered substantive
d. The factors considered in determining whether the milestones are substantive
e. The amount of consideration recognized during the period for the milestone or milestones
 Update to 2010 Financial Accounting and Reporting 3

MODULE 7D

ASC 2010-06
Module 7D, page 137
Disclosures about Fair Value Measures
1. For classes of assets measured at fair value on recurring basis
a. The fair value measurement at the reporting date
b. Identify level of hierarchy or measurements used, including
(1) Quoted prices in active markets for identical assets or liabilities (Level 1)
(2) Significant other observable inputs (Level 2)
(3) Significant unobservable inputs (Level)
c. The amounts of significant transfers between Level 1 and Level 2 of the hierarchy and the
reasons for the transfers
d. If Level 3 used, the effect of measurements on earnings for the period, purchases, sales,
issuances, and settlements, and amounts of any transfers in or out of Level 3 and the reasons
for the transfers are disclosed
2. The amount of total gains or losses that are attributable to the change in unrealized gains or losses
3. For fair value measurements using Level 2 and Level 3, a description of the valuation technique
used, changes in techniques, and reasons for the changes.
4. For equity and debt securities, class shall be determined on the basis of the nature and risks of the
investment
5. For assets and liabilities measured at fair values on a nonrecurring basis (i.e., impaired assets),
identify the following:
a. The fair value measurements used
b. The reasons for the measurements
c. The level within the hierarchy
d. A description of the inputs used for Level 3 measurements
e. The valuation techniques used
f. If Level 3 is used, the effect of measurements on earnings for the period, purchases, sales,
issuances, and settlements, and amounts of any transfers in or out of Level 3 and the reasons
for the transfers are disclosed.
6. Fair value measurement disclosures for each class of assets and liabilities often will require
greater disaggregation than the reporting entity’s line items in the statement of financial position.
The entity shall determine the appropriate classes on the basis of the nature of the risks of the
assets and liabilities and their classification in the fair value hierarchy.

ASC Update 2010-09

Module 7D Page 138
SFAS 165—Subsequent Events (ASC Topic 855)
A. Scope—applies to accounting and disclosure for subsequent events not addressed in other GAAP
B. Defines subsequent events as transactions that occur after the balance sheet date but before financial
statements are issued or available to be issued
1. Two types of subsequent events
a. Recognized subsequent events are conditions that existed as of the balance sheet date
b. Unrecognized subsequent events are conditions that did not exist as of the balance sheet date
C. Effects of recognized subsequent events should be recognized at the balance sheet date (warranty
estimates, litigation settlement, and bankruptcy of client with receivables)
4 Update to 2010 Financial Accounting and Reporting

D. Effects of nonrecognized subsequent events should be disclosed in a footnote if the financial

statements would be misleading if not disclosed
E. Entity (other than SEC filers) must disclose the date through which the subsequent events have been
evaluated and the date the financial statements were issued or available to be issued
1. An SEC filer and entities that are conduit obligors for conduit debt securities that are traded in the
public market should evaluate subsequent events through the date the financial statements are
issued. An SEC filer is an entity that is required to file or furnish its financial statements with
either the SEC or, with respect to an entity subject to Section 12(i) of the Securities Exchange Act
of 1934. An SEC filer is not required to disclose the date to which subsequent events have been
evaluated.
2. Other entities should evaluate subsequent events through the date that the financial statements are
available to be issued.
3. The standard also clarifies that revised financial statements include financial statements revised
either as a result of correction of an error or retrospective application of U.S. generally accepted
accounting principles.

MODULE 10

Update to Module 10, section beginning on page 285

SFAS 166—Accounting for Transfers of Financial Assets—An Amendment of FASB Statement No.
140 (ASC Topic 860)
A. Modifies SFAS 140 and eliminates the concept of a qualifying special-purpose entity
B. Limits the portions of financial assets that are eligible for derecognition
Transfers of financial assets under ASC Topic 860. The FASB uses a financial-
components approach for these transfers of financial assets. Under the financial component
approach, financial assets are viewed as having a variety of components with a focus on
whether control has changed with a given transaction.
Transfers of financial assets includes the transfer of an entire financial asset, a group of
financial assets, or a participating interest in an entire financial asset wherein the transferors
surrenders control over the assets. A participating interest must have four characteristics: (1) it is
a proportionate ownership interest in an entire financial asset; (2) all cash flows received from the
asset are divided proportionately among the participating interest holders based upon their share
of ownership; and (3) the rights of each participating interest holder have the same priority (i.e.,
in transfers, bankruptcy, or receivership); and (4) no party has the right to pledge or exchange the
financial asset unless all participating interest holders agree. A transfer of a financial asset may
be accounted for as a sale only when the transferor surrenders control and all of the following
conditions are met:
1. The transferred financial assets are isolated and beyond the reach of the transferor and its
creditors, even in bankruptcy or receivership.
2. The transferee can pledge or exchange the assets without unreasonable constraints or
conditions.
3. The transferor does not maintain effective control over the transferred financial assets or
third-party beneficial interests. For example, the transferor may not have a repurchase or
redemption agreement, an agreement to cause the holder to return the asset (other than a
cleanup call), or an agreement that requires the transferor to repurchase the financial
assets at a favorable price wherein it is probable that the repurchase will occur.
Under SFAS 140, transfers of financial assets are disaggregated into separate assets and
liabilities. Each entity involved in the transaction:
1. Recognizes only the assets it controls and liabilities it incurs after the transaction has
occurred, and
 Update to 2010 Financial Accounting and Reporting 5

2. Derecognizes assets where control has been given up or lost, and liabilities where
extinguishment has occurred.
The chart below summarizes the accounting for the transfer of receivables.
Transfers of Receivables

Control Control not

surrendered surrendered

No continuing Continuing
involvement involvement

Record as a sale Record as a sale Record as a

borrowing

Cash due from factor 1,300 Cash/due from factor 1,300

Factor’s holdback 300 Factor’s holdback 300
Loss from factoring 400 Loss 500
Accounts receivable 2,000
Accounts receivable 2,000
Recourse liability 100

Cash 1,600
Interest expense 400
Note payable 2,000

In these transactions, the “factor’s holdback” account provides a margin of protection against
sales discounts, sales returns and allowances, and disputed accounts. It may also be referred to as
“Due from factor” or “Receivable from factor.” Additionally, when a recourse obligation exists,
an amount is included as protection for the transferee against uncollectible accounts.
Accounting for transfers of participating interests. When a transfer of a participating
interest qualifies as a sale, the following accounting rules apply:
1. Allocate the carrying amount of the entire financial asset between the participating
interest sold and the participating interest that continues to be held by the transferor.
Relative fair values at the date of transfer are used to allocate the carrying amount.
2. Derecognize the participating interest(s) sold.
3. Recognize and measure at fair value servicing assets, servicing liabilities, and any other
assets obtained or liabilities incurred in the sale.
4. Recognize any gain or loss on the sale in earnings.
5. Report any participating interest or interests that continue to be held as the difference
between the previous carrying amount and the amount derecognized.
Interests that continue to be held. In most cases, the outright transfer of assets and/or
liabilities result(s) in changes in control that are obvious from the nature of the transaction.
Problems generally only occur when there is some sort of continuing involvement by the
transferor. Interests that continue to be held include undivided interests for which control has not
been given up by the transferor, servicing rights, recourse or guarantee arrangements, agreements
to purchase or redeem financial assets, pledges of collateral, and the transferor’s beneficial
interests in assets transferred. In general, the more interest in the assets the transferor retains, the
less likely the transaction will be classified as a sale. It will more likely be classified as a secured
borrowing. The basic principle is that in a sale, the transferor should give up control of the asset.
Interests in assets that continue to be held by the transferor (retained interests) are measured
at their previous carrying value before the transfer through an allocation at the date of sale based
on relative fair values of the assets sold and the assets retained. It should be noted that this fair
value allocation may result in a relative change in basis unless the fair values are proportionate to
their carrying values. Thus, the gain or loss from any sale component could also be affected.
6 Update to 2010 Financial Accounting and Reporting

EXAMPLE: Interests that continue to be held

Sale of receivable with servicing
Facts given:
Receivable’s fair value $16,500
Receivable’s book value 15,000
Servicing asset 700
Partial sale of receivables with servicing asset retained. Seller sells 80% of receivables.
Allocated Allocated
FV 80% FV 20% FV 80% BV 20% BV
Receivables sold $16,500 $13,200 $11,520
Servicing asset 700 560 480
Retained amount (20%) _____ _____ $3,440 _____ $3,000
$17,200 $13,760 $3,440 $12,000 $3,000
Journal entry
Cash 13,200
Servicing asset 480
Receivables 12,000
Gain 1,680
Seller reports retained amount at $3,000. Note that the servicing asset is 4% of the FV of the total FV of both
components. The book value of the servicing asset is 4% × $12,000 book value of the receivables. The book
value of receivables sold is 96% × $12,000.
ASB Update page 96 and 97. Strike out call options page 98 80%
Interests that continue to be held remain as the transferor’s assets since control of these assets
has not been transferred. They are carried at the allocated book value without recognition of any
gain or loss. Thus, the retained interest is considered continuing control over a previous asset
(although the form may have changed) and it is not remeasured at fair value.
Servicing of financial assets. Servicing of financial assets may involve any one or all of the
following activities:
1. Collecting payments
2. Paying taxes and insurance
3. Monitoring delinquencies
4. Foreclosing
5. Investing
6. Remitting fees
7. Accounting
Although inherent in transfers of most financial assets, servicing is a distinct asset or liability
only when separated contractually from the underlying financial asset. The servicing asset
usually results either from separate purchase or assumption of rights, or from securitization with
retained servicing. The servicer’s obligations are specified in the contract.
Typically, the servicing contract results in an asset because the benefits are more than
adequate compensation for the cost of servicing. The benefits include
1. Fees
2. Late charges
3. Float
4. Other income
If the benefits do not provide fair compensation, the contract results in a liability. The fair
value of a servicing contract is based on its value in the market and is not based on the internal
cost structure of the servicer. Thus, the concept of adequate compensation is judged by re-
quirements that would be imposed by a new or outside servicer. In cases where there is not a
reliable market for the contract, present value methods may be used to value the servicing
contract.
In summary, the servicer should classify the components into one of the following categories:
 Update to 2010 Financial Accounting and Reporting 7

1. More than adequate—resulting in a recorded asset

2. Adequate compensation (no asset or liability)
3. Less than adequate—resulting in a recorded liability
If, under a servicing contract, the transferor transfers assets to an unconsolidated entity that
qualifies as a sale and obtains securities and classifies them as held-to-maturity debt securities
under SFAS 115, the asset or liability can be reported together with the asset being serviced.
However, if the entity sells or securitizes the assets with servicing retained, or if the entity
purchases or assumes servicing, a servicing asset or liability results. If servicing is retained, the
resulting assets are measured by allocating the previous carrying amount between the assets sold
and the interests that continue to be held by the transferor based on relative fair values at the date
of transfer. On the other hand, servicing liabilities undertaken, servicing assets purchased, and
servicing liabilities assumed are initially measured at fair value.
Specifically, servicing assets or servicing liabilities are to be accounted for separately as
follows:
1. Assets are reported separately from liabilities. They are not netted.
2. Initially measure servicing assets that continue to be held by the transferor by allocating
the carrying amount based on relative fair values at the date of transfer.
3. Initially measure at fair value all purchased assets, assumed liabilities, and liabilities
undertaken in a sale or securitization.
4. Account separately for interest-only strips (future interest income from serviced assets
that exceed servicing fees).
5. Measure servicing assets and servicing liabilities with one of two methods: amortization
method, or fair value method. An election must be made to use the fair value method for
each class of servicing assets and servicing liabilities. Once the election is made to value
using the fair value method, the election cannot be reversed.
6. Report servicing assets and servicing liabilities on the balance sheet in one of two ways
a. Display separate line items for amounts valued at fair value and amounts to be
measured by amortization method, or
b. Display aggregate amounts for all servicing assets and servicing liabilities, and
disclose parenthetically the amount that is measured in fair value that is included in
the aggregate amount.
The amortization method requires that servicing assets and servicing liabilities are initially
recorded at fair value. Assets are then amortized in proportion to and over the period of estimated
net servicing income or net servicing loss. At the end of each period, the assets are assessed for
impairment or increased obligation based on fair value. Evaluate and measure impairment by
stratifying recognized assets based on predominant risk (asset size, type, interest rate, terms,
location, date of organization, etc.). Individual stratum should have impairment recognized
through a valuation allowance account, and the valuation account is adjusted to reflect needed
changes. Excess fair value for a stratum should not be recognized. Liabilities are amortized in
proportion to and over the period of net servicing loss. In cases where changes have increased the
fair value above the book value, an increased liability and a loss should be recognized.
Under the fair value method, servicing assets and servicing liabilities are initially recorded
at fair value. The fair value is measured at each reporting date. Changes in fair value are
reported in earnings in the period in which the change in fair value occurs.
Required disclosures for all servicing assets and servicing liabilities include management’s
basis for determining its classes, a description of risks, the instruments used to mitigate income
statement effect of changes in fair value, and the amount of contractually specified servicing fees,
late fees, and ancillary fees for each period on the income statement should be reported, and the
quantitative and qualitative information about assumptions used to estimate fair value.
8 Update to 2010 Financial Accounting and Reporting

For servicing assets and liabilities subsequently measured at fair value, disclosures must also
be provided showing the beginning and end balances, additions, disposals, and changes in fair
value inputs or assumptions used, and changes in fair value.
For servicing assets and liabilities that use the amortization method, disclosures must include
the beginning and ending balances, additions, disposals, amortization, application of valuation
allowance to adjust carrying value, other than temporary impairments, and other changes that
affect the balance, as well as a description of the changes. In addition, the fair value at the
beginning and end of each period should be disclosed if practicable to estimate the value. The risk
characteristics of the underlying financial assets used for measuring impairment should be
disclosed. The activity in the valuation account, including beginning and ending balances,
recoveries made, and write-downs charged against the allowance for each period should also be
disclosed.
Securitizations. Securitization is the transformation of financial assets into securities (asset-
backed securities). Various assets including mortgages, credit cards, trade receivables, loans, and
leases are grouped and securitized. These groupings of relatively homogeneous assets are then
pooled and divided into securities with cash-flows that can be quite different from those of the
original assets. With an established market, most of these securities cost less than the alternative
use of the assets as collateral for borrowing. Thus, the benefits of most securitizations include
lower financing costs, increased liquidity, and lower credit risk.
The transferor (also called issuer or sponsor) forms a securitization mechanism to buy the
assets and to issue the securities. Sometimes, another transfer is made to a trust and the trust
issues the securities. These different structures are generally referred to as one-tier or two-tier.
The securitization mechanism then generates beneficial interests in the assets or resulting cash
flows which are sold. The form of the securities chosen depends on such things as the nature of
the assets, income tax considerations, and returns to be received.
Payments by the securitization mechanism are usually classified as pay-through, pass-
through, or revolving-period. In a pay-through, cash flows from the assets pay off the debt
securities. The assets are essentially collateral. In a pass-through, undivided interests are issued
and the investors share in the net cash flows. In a revolving-period, undivided interests are
issued, but until liquidation, the net cash flows are split between buying additional assets and
paying off investors.
Various financial components arise from securitizations. Examples include servicing
contracts, interest-only strips, retained interests, recourse obligations, options, swaps, and forward
contracts. All controlled assets and liabilities must be recognized.
EXAMPLE: Sale of loans
Facts given:
Loan’s fair value $16,500
Loan’s book value 15,000
Fair value of recourse obligation (900)
Fair value of call option 800
Fair value of interest rate swap 700
1. Sale with recourse obligation, call and swap (seller provides floating interest rate return although the
basic sale is at fixed interest rate terms).
Journal entry
Cash 16,500
Call option 800
Interest rate swap 700
Loans 15,000
Recourse obligation 900
Gain 2,100
 Update to 2010 Financial Accounting and Reporting 9

2. Partial sale with recourse obligation, call and swap. Seller sells 80% of loans.
Allocated Allocated
FV 80% FV 20% FV 80% BV 20% BV
Cash $16,500 $13,200 $12,000
Call option 800 640
Interest rate swap 700 560
Resource obligation (900) (720)
Retained amount (20%) _____ _____ $3,420 _____ $3,000
$17,100 $13,680 $3,420 $12,000 $3,000
Journal entry
Cash 13,200
Call option 640
Interest rate swap 560
Loans 12,000
Recourse obligation 720
Gain 1,680
Seller reports retained amount at $3,000.
The transferor generally desires for the assets to be taken off the balance sheet. This result
can be accomplished if the transaction results in a sale. The key criterion in this case is to be sure
that the assets are beyond control of the transferor even in bankruptcy.
Accounting for collateral. The method of accounting for a collateral agreement depends
both on control of the assets and on the liabilities incurred under the agreement. Ordinarily, the
transferor should carry the collateral as an asset and the transferee should not record the pledged
asset.
If the transferee, however, has control, the secured party should record the asset at fair value
and also the liability to return it. The transferor-debtor should reclassify the asset (probably as a
receivable) and report it separately in the balance sheet. If the debtor’s rights to the collateral are
impaired by the transferee’s sale or repledge of the collateral, the secured party should recognize
the proceeds and also the liability to return the collateral to the extent it hasn’t done so.
If the transferor defaults and is not entitled to the return of the collateral, it should be
derecognized. If not already recognized, the transferee should record its asset at fair value.

MODULE 19

GASB 54
Update to Module 19, page 814
GASB 54 provides guidance on how fund balances should be segregated in the financial
statements. Note that fund balances are segregated into nonspendable, restricted, committed,
assigned and unassigned balances. The nonspendable fund balance classification includes amounts
that cannot be spent because they are either not in spenable form, or they are legally or contractually
required to be maintained intact. Items that are not in spendable form are those that are not expected
to be converted to cash, such as inventories and prepaid amounts. It also includes the noncurrent
portion of long-term receivables and property held for resale unless proceeds are restricted,
committed or assigned, and amounts that must be maintained intact legally or contractually, such as
the principal of a permanent fund. Restricted fund balances are those restricted by agreement with
creditors, grantors, or by law and regulation. Committed fund balances are those that can only be
used for specific purposes based on action by the government’s highest level of decision-making
authority. The assigned category includes amounts that are constrained by the government’s intent to
be used from the general fund for a specific purpose but are neither committed nor restricted. It also
includes any positive amounts that are not classified as nonspendable, restricted, or committed in
funds other than the general fund. Finally, the unassigned fund balance is the residual classification
for the general fund. The balance sheet or the notes to the financial statements would have to show
the details of the items in each of the 5 categories of funds.
10 Update to 2010 Financial Accounting and Reporting

GASB 58
Going concern considerations. The guidance regarding going concern for state and local
governments is similar to that for commercial business under GAAP. The financial reporting model
assumes that the entity will be a going concern for a reasonable period of time (i.e., 12 months from
the financial statement date). Indicators that there may be substantial doubt about the entity’s ability
to continue as a going concern include
1. Negative trends (e.g., recurring losses).
2. Other indicators of financial difficulties (e.g., defaults on loan agreements).
3. Internal matters (e.g., work stoppages).
4. External matters (e.g., legal proceedings).
If it is determined that there is substantial doubt about a governmental entity’s ability to continue
as a going concern for a reasonable period of time, the notes to the financial statements should
disclose details of the sources of the concerns and the government official’s plan for dealing with
those concerns.
GASB Statement No. 58 provides guidance when a governmental unit has been granted relief un-
der the provisions of Chapter 9 of the US Bankruptcy Code. The standard provides that assets and
liabilities should be remeasured in accordance with the court’s Plan of Adjustment. In addition, the
statement requires disclosure of the details of the bankruptcy and how users can obtain a copy of the
Plan of Adjustment.