CHE-WAHLEN1E-11-0303-FASB-Sup_Ch 1..14



THE FASB ACCOUNTING STANDARDS CODIFICATION:

A USER-FRIENDLY GUIDE

Understanding the structure and contents of the FASB Accounting Standards Codification and how to use it for research are vital for sharpening your knowledge and skills as an accountant. Using the Codification to research and find relevant portions of U.S. GAAP will help you determine proper recording and reporting procedures for many different transactions, events, and arrangements. This supplement provides a discussion of the Codification, a step-by-step guide to walk you through how to use the Codification, and a few practice exercises to help familiarize you with its structure, content, and use. You may find it beneficial to refer to this supplement when completing the ‘‘Using Codification’’ cases in Wahlen, Jones, and Pagach’s Intermediate Accounting, which will require you to use the Codification to determine proper accounting treatment for various complex issues discussed in each chapter.

WHAT IS THE FASB ACCOUNTING STANDARDS CODIFICATION?

The FASB Accounting Standards Codification (or, simply, the Codification) is an electronic database that integrates and topically organizes U.S. GAAP into one coherent body of literature. Over 200 people worked on the Codification project team from 2004 through mid-2009 to incorporate the more than 2,000 standards from the original pronouncements into this database. The Codification became effective on July 1, 2009. The FASB developed the Codification to achieve three goals:

• Simplify user access by codifying all authoritative U.S. GAAP in one database.

• Ensure the codified content accurately represented all authoritative U.S. GAAP.

• Create a codification research system that is up to date and includes the most recently released standards.

The FASB Accounting Standards Codification is now the only source of authoritative GAAP for U.S. companies to determine how to record their transactions, events, or arrangements and how to report them in their financial statements.1 The Codification does not change GAAP. However, in contrast to the hierarchy of GAAP that preceded the Codification, all GAAP in the Codification now has an equal level of authority.

Structure of the Codification

The framework of the Codification contains the following six levels of increasing specificity:2

• Areas: Areas is comprised of nine broad and general accounting subjects, which include General Principles, Presentation, Assets, Liabilities, Equity, Revenue, Expenses, Broad Transactions, and Industry.

• Topics: Topics involve a collection of related guidance on a particular subject area. For example, within the Assets Area, Topics include Cash and Cash Equivalents, Receivables, Investments, Inventory, and various others.

• Subtopics: Subtopics are subsets of a Topic and generally are distinguished by type or by scope. For example, under the Investments Topic, there are Subtopics for different types of investments.

• Sections: Sections characterize the nature of the content in a Subtopic. For example, Scope, Recognition, Measurement, and Disclosure.

• Subsections: Subsections, if necessary, refine and break down Sections into narrower and more specific items. If a Subsection is necessary, it is not numbered but does include the Paragraphs that contain the guidance that constitutes GAAP.

• Paragraphs: Paragraphs contain the specific text of the guidance that constitutes GAAP.

Topics, Subtopics, Sections, Subsections, and Paragraphs are descending ‘‘levels’’ within the Codification, as shown in Exhibit 1, and each item in each level is numbered for reference and search purposes.

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Using the Codification

As future professionals, it is critical that you develop the research and analytical skills necessary to uphold the reputation of accounting professionals. Accountants are charged with creating (and auditors are charged with verifying) relevant and representationally faithful financial information that people use to make informed decisions about companies. Using the Codification should help you to:

• Reduce the amount of time and effort needed to solve an accounting research issue.

• Improve your ability to use the accounting literature and comply with GAAP.

In this section, we will walk through an example to help you get started.

Step 1: Logging In To begin, go to the FASB Codification website at http:// asc., as shown in Exhibit 2.

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Login If you already have an account, you can login by clicking the ‘‘Login’’ link in the upper right of the screen and entering your username (email address) and password.

Creating an Account: The Professional or Basic View If you do not have an account, you can create an account for either the Basic or Professional Views. Both versions provide access to U.S. GAAP.

• Basic View is free of charge but somewhat restricted. For example, there is no search functionality, navigation is limited, and sections cannot be joined for simplified viewing.

• Professional View includes full access, including search functionality and the ability to combine different subsections. There is a fee for Professional access unless your institution participates in the American Accounting Association’s academic access initiative.

To create an account providing Basic access, you’ll need to complete a form providing the required information (largely contact information). After completing the form, you will need to read and agree to the License Agreement, after which, you will receive an email confirmation.

American Accounting Association Access If your institution participates in the American Accounting Association’s academic access initiative, you have access to the Professional View and can login using the ‘‘Academic Accounting Access’’ link. In the future, you may access the Codification at . You will need to provide the username and password specific to your school or institution’s accounting department.

Step 2: The Home Page When you have successfully logged in, you will arrive at the FASB Accounting Standards Codification home page, as shown in Exhibit 3.

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On this page, you’ll see the following main links:

• About the Codification: This link provides a brief overview of what the Codification is. For information regarding the structure, content, style, and history of the Codification, you’ll want to read the Notice to Constituents.

• Tutorials, Help, and Research: Find step-by-step animated tutorials and help pages.

• Providing Feedback: Use this link to submit feedback related to content-specific or platform issues.

• What’s New: Read about recent updates and enhancements to the Codification.

The Tutorials, Help, and Research links will help you become familiar with conducting research using the Codification.

On the navigation bar on the left, you’ll see a Go To search box for users familiar with the Codification numbering system, along with the nine Areas, a Notice to Constituents, a Master Glossary, and some resources regarding updates and exposure drafts under Other Sources. At the top of the page, you’ll see a Search box.

Step 3: The Codification Search Process Suppose you want to determine the dollar amount a company should record for a purchase of inventory. Exhibit 4 shows the process (steps) to find the answer (GAAP) in the Codification, as well as the reference numbers. We discuss each of the steps and provide screenshots to help walk you through this process.

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After logging in, go to the Area links in the left column of the home page and click on Assets, as shown in Exhibit 5.

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This brings you to a menu of Topics of assets, as shown in Exhibit 6.

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Click on Inventory (Codification number 330), as shown in Exhibit 7.

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This brings you to a menu containing one Subtopic, Overall (number 10, so the combined Topic/Subtopic Codification number is 330-10), along with numerous links relating to various industries. Click on Overall for a menu containing more than a dozen Sections, as shown in Exhibit 8.

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Here, you decide which Section is most likely to contain the answer to your question. In this case, click on Initial Measurement (note that it is number 30) which brings you to the paragraphs containing the answer (GAAP) to your question, as shown in Exhibit 9.

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Note that paragraph 30-1 indicates that ‘‘The primary basis of accounting for inventories is cost, which has been defined generally as the price paid or consideration given to acquire an asset….’’ Further information related to the application of the historical cost principle to inventory valuation is contained in later paragraphs, and links to other sections are provided, where appropriate. To reference this answer, you would refer to ‘‘FASB ASC 330-10-30-1’’. Now, suppose you left this screen and then wanted to go back to this paragraph. To save time, enter 330-10-30-1 in the Go To box on the home page and you go directly to the paragraph.

Alternatively, instead of the search process discussed above, you can find the same guidance by entering ‘‘inventory initial measurement’’ in the Search box (if you are using the Professional View). However, our example involved a relatively simple question. Even this simple search would result in numerous ‘‘inventory’’ references that you would have to sort through to determine the answer. The more specific your query, the more specific the results will be from this search.

PRACTICE EXERCISES

1. Asset Classification Your manager, Jane Murphy, is reviewing the preliminary balance sheet you compiled for your company. She asks, ‘‘We prepaid six months of next year’s rent. Why is prepaid rent classified as a current asset? We’re not converting rent payments into cash. Shouldn’t it be noncurrent?’’

Research the appropriate Codification and prepare a memo to Jane explaining why prepaid expenses are current assets even though no cash will be received. Cite your references.

2. Other Comprehensive Income Items Your company, Flancrest Enterprises, sells merchandise around the world. As a result, the company often incurs foreign currency translation adjustments. Flancrest’s current practice is to report these adjustments separately from net income in a statement of comprehensive income and to accumulate the resulting effects on shareholders’ equity within the company’s retained earnings balance.

Is the practice of combining other comprehensive income items with retained earnings appropriate under U.S. GAAP? Research the appropriate Codification and draft a letter to Flancrest’s CEO explaining your response and cite your sources.

3. Loan Impairment Alexander Inc. routinely loans money to individuals and small businesses. While most clients repay their debt obligations, some do not. Burr Company took a $20,000 loan from Alexander in 2012, but has since fallen on hard times. In December 2013, the president of Burr placed a call to Alexander letting them know that full repayment is unlikely. Based on this conversation, Alexander estimates the present value of the expected future cash flows of the loan to be $12,000.

Research the related GAAP and prepare a short memo to explain how Alexander should account for this probable loss on its 2013 financial statements. Be sure to provide appropriate support for you answer and cite specific paragraph numbers from the FASB Accounting Standards Codification. In addition, prepare any necessary journal entries and discuss any alterations which this information will cause on the financial statements.

4. Fixed Overhead Allocated to Inventory Tri-Axis Corporation manufactures aircraft components. Over the past year, demand for Tri-Axis’s products has experienced an abnormal decline. This led to a temporary decrease in production at the Tri-Axis facility while fixed overhead costs have remained unchanged. The CFO of Tri-Axis has asked you to determine whether the fixed overhead cost allocated to each unit of inventory should be increased as a result of this decrease in production.

Prepare a memo detailing appropriate treatment of this issue and citing specific paragraph numbers.

5. Inventory Valuation AgroCo operates several farms that produce a variety of agricultural products, including corn. At any given time, AgroCo has a significant amount of corn in its warehouses ready for sale to third party food product manufacturers. AgroCo currently values its agricultural inventory using an average cost system. The president of AgroCo asks, ‘‘Since the price of corn has risen recently, is it possible for us to reflect our corn stocks at market prices, rather than at historical cost?’’

Research the relevant GAAP and prepare a memo advising the president of his options.

6. Financial Instrument Classification Titanic Co. has recently issued a 1%, $10,000,000 debt obligation to Tria Investment Group. The obligation has no maturity date; rather, the $10,000,000 will only be redeemed to Tria if and when Titanic is liquidated, either through bankruptcy or sale. The CFO of Titanic believes that, since it contains most of the features of a debt obligation, the $10,000,000 should be classified as a liability on Titanic’s balance sheet. The CEO believes that, since it does not have a certain redemption date, it should be classified as equity.

Research the relevant GAAP and determine who is correct. Explain your answer, cite the Codification where appropriate, and journalize the inception of the liability.

7. Maintenance Costs Fargo Co. has recently acquired a new stamping machine for use in its manufacturing facility. Certain components of this machine are prone to wear and must be replaced, on average, once every three years at a cost of $120,000. The CFO of the company has elected to accrue that maintenance activity in advance, debiting Maintenance Expense at a rate of $40,000 per year.

Research the appropriate GAAP and prepare a memo to the CFO indicating whether this treatment is appropriate and citing the Codification. If it is not appropriate, illustrate the proper journal entry.

8. Aircraft Overhaul Costs Skywing Inc. is a small, domestic passenger airline with a fleet of several dozen jet airplanes. Federal regulations require the replacement of certain structural components of the aircraft at fixed intervals. Until recently, Skywing’s policy has been to immediately expense all overhaul costs as incurred. The CFO of Skywing says, ‘‘These are some major overhaul costs we’re incurring. Is there any way we can capitalize overhaul costs on our fleet?’’

Prepare a short memo to answer the CFO’s question.

9. Loan Receivables Don Irving runs a loan syndicate. He acquires money from lenders and uses that money to fund capital ventures. When loans are repaid, the money is collected by Irving, who then repays the other members of the syndicate. Irving currently accounts for the full amount of outstanding loans, including the portion provided by other syndicate members, as a loan receivable on the company’s balance sheet. He is about to be audited for the first time and wants to make sure that all of his accounting practices follow GAAP.

Research the appropriate GAAP and prepare a memo to Irving stating whether this treatment is appropriate and citing your sources.

10. Treasury Stock Clockman Corporation has recently become the target of a takeover attempt by William Face, one of its larger shareholders. Face currently owns 1,000 shares of Clockman, giving him a 40% stake in the company. The current value of Face’s shares totals $100,000. After negotiations, Clockman and Face have entered into an arrangement whereby Clockman will buy half of Face’s stake in the company for $75,000, and Face will agree not to buy any more shares of Clockman on the open market.

You are an accountant at Clockman. In discussing this transaction with you, the CEO of Clockman says, ‘‘Even though we’ve paid $25,000 above market value for Face’s shares, we can still allocate the full purchase price to our Treasury Stock account.’’

Is the CEO correct? Research the appropriate Codification and describe proper treatment of this situation.

11. Revenue Recognition You work for Tiger’s Door, a publicly traded movie production company. Tiger’s Door plans to release ‘‘Star Fight,’’ a children’s action movie, toward the beginning of the next period. To promote the film, Tiger’s Door has arranged to include promotional toys in children’s meals sold by Cluckin’ Hen, a national fast food chain. The CEO wants to recognize licensing fee revenue from the fast food arrangement as it is realized, explaining that he sees no reason to delay such recognition. The CFO wants to delay recognition until the release of the film, reasoning that toy revenue is a ‘‘byproduct’’ of the related film, and recognition of that revenue should wait until release of the film.

Research the appropriate Codification and draft a memo explaining whether either the CEO’s or the CFO’s proposals are valid under U.S. GAAP and citing your references.

12. Uncertain Tax Positions RTZ Corporation is a financial sponsor of a hospital that occupies the adjacent property lot. RTZ donates $500,000 per year to the hospital. It ordinarily treats these payments as tax-deductible charitable donations. Recently, the two companies have elected to share the construction costs of a parking garage. The garage will remain the property of the hospital, but one level of the garage is available for use by RTZ’s employees. RTZ has paid a total of $1,250,000 to the hospital in the year in which the parking garage was constructed, and it wants to allocate the full amount as a tax-deductible donation.

RTZ’s tax lawyers determine that if the IRS investigates this transaction, only $500,000 is very likely to be sustained. The remaining $750,000 is very likely to be reclassified as a capitalized asset. The CFO asserts, ‘‘Until we’re told otherwise, we are going to include the full $1,250,000 as a charitable deduction in determining our income tax this year.’’

Is the CFO’s proposal GAAP-compliant? Research the appropriate Codification and draft a short memo explaining why or why not.

13. Pension Plan Classification Your employer, Zant Industries, is beginning to offer its employees a pension plan. The plan requires a certain predetermined percentage of employee salary for annual contributions, and it guarantees a benefit based on years of service and company rank upon retirement

The CEO, Susan Wilkes, believes that this plan should be accounted for as a defined benefit plan, since the level of employee benefit is guaranteed upon retirement. The CFO, Dwight Kurt, believes that it should be accounted for as a defined contribution plan, since the amount of each employee’s contribution is fixed and determinable.

Research the appropriate Codification and determine whether the CFO or the CEO is correct.

14. Lease Classification Two years ago, Wolfram Group entered into a 4-year lease of a welding machine from Tungsten Industries. At the inception of the lease, there was no bargain purchase option, the present value of the rents were 50% of the market value of the asset, ownership reverted to Tungsten at the end of the lease, and the economic life of the machine was estimated to be 10 years. Wolfram initially classified this arrangement as an operating lease.

Recent advancements in welding technology have curtailed the economic life of this asset. It is now estimated to have a total useful life of 6 years. Stanley Carter, the CEO of Wolfram, asks, ‘‘Since the market has changed, we’re now holding on to this asset for at least 75% of its useful life. That makes this a capital lease, so I want you to put the asset on our books.’’

Research the appropriate Codification and determine whether the CEO’s plan of action is appropriate under GAAP.

15. Cash Flow Statement Disclosure You have been hired as a staff accountant by a small company that recently completed an initial public offering (IPO) of its common stock. At its inception, the company had been financed by Pegasus, an investment group. Pegasus had bought a significant amount of the company’s debt (equal to a third of its total assets) in the form of convertible bonds. The stock price has appreciated significantly since the IPO, and Pegasus has decided to convert its debt securities into equity, giving Pegasus a 28% stake in the company. Your CEO, Dane Hathaway, argues that this conversion should not be reported on the cash flow statement. ‘‘It didn’t involve any cash either way, and it’s not like the structure of our business has changed. We haven’t increased or changed our fixed assets, and we haven’t given anything up.’’

Research the appropriate Codification and draft a memo to Dane explaining whether his reasoning is correct and citing your references.

1 The only exceptions are the rules and interpretive releases of the SEC, which are sources of authoritative GAAP for publicly traded companies that are required to file their financial statements with the SEC. For convenience, the Codification includes selected portions of GAAP issued by the SEC for publicly traded companies. The Codification does not contain all the SEC’s rules and regulations that constitute GAAP.

2 The following discussion is a summary of that presented in the Codification’s Notice to Constituents (v4.1), April 30, 2010.

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