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CMA Part 1 - Section A

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0% found this document useful (0 votes)

701 views139 pages

CMA Part 1 - Section A

Uploaded by

Aqeel Hanjra

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CMA Part 1: Financial Reporting,

Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 1: At what value are fixed assets initially recorded?
Answer: Fixed assets should be initially recorded in the
accounting records at the amount paid for the asset and all other
costs that are necessary to get the asset ready for use.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 2: How are gains or losses from discontinued
operations reported?
Answer: All gains or losses that are incurred by the discontinued
segment are reported in the period in which the gain or loss
occurred and the gains or losses are reported net of associated
taxes.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 3: How are in transit goods counted in inventory?
Answer: In transit goods are goods that have been shipped prior
to year end but had not yet been received by the buyer as of year
end. To whom the goods belong is determined by the terms of
shipping.
Goods sent FOB Shipping Point belong to the buyer from the
moment the seller gives them to the shipping company. Thus,
while the goods are in transit they belong to the buyer because
title was transferred at the shipping point.
Goods sent FOB Destination belong to the shipper until the buyer
receives them. While the goods are in transit, they belong to the
seller and title is transferred at the destination point only when they
are received by the buyer.

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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 4: How are short-term receivables valued for the
financial statements?
Answer: For financial statement presentation, short-term
receivables are valued and reported at net realizable value, or the
net amount of cash expected to be received. The net amount the
firm expects to receive is most likely different from the amount that
is legally due. This difference between these two amounts is
because some customers will not pay what they owe and there
may be returns expected in the future.

Therefore, determining the net realizable value of accounts

receivable involves estimation of uncollectible
receivables and any returns or allowances to be granted.

Section A: External Financial Reporting

Decisions
Study Note # 5: How do LIFO and FIFO impact inventory
calculations under rising and falling prices?
Answer:

How do LIFO and FIFO impact Cost of

Ending Gross
inventory calculations under rising Goods
Inventory Profit
and falling prices? Sold

FIFO LIFO FIFO

Rising Prices
Higher Higher Higher

LIFO FIFO LIFO

Falling Prices
Higher Higher Higher

Section A: External Financial Reporting

Decisions
Study Note # 6: How does IFRS differ from US GAAP?
Answer: While IFRS is principles-based, US GAAP is rules-based
with extensive interpretive guidance for individual industries and
specific examples for auditors and practitioners.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 7: How does the cost recovery method of profit
recognition differ from the installment method?
Answer: Like the installment method, all of the profit on the sale
is deferred at the time of the sale. However, the cost recovery
method is more conservative because the seller recognizes no
gross profit until the amount of cash that has been collected
exceeds the cost of the sale.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 8: How does the percentage of receivables
method calculate potentially collectible receivables?
Answer: Under the percentage of receivables method, the
company estimates what percentage of its outstanding
receivables will not be collected and then calculates what
the ending balance in the allowance account needs to be so that
the net receivables balance will be equal to the amount that the
company expects to collect.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 9: How does the percentage of sales
method calculate potentially collectible receivables?
Answer: The percentage of sales method uses the amount of
credit sales made during the period to estimate the percentage of
those credit sales that will not be collectible. The company may
use historical data or any other method that makes sense to
determine the percent of sales that will not be collected.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 10: How is double declining balance
depreciation calculated?
Answer: In double declining balance (DDB) method we use a rate
that is two times the percentage that would be recognized under
the straight-line method. In addition, that percentage is applied to
the net book value of the asset at the beginning of each year. The
annual depreciation expense is calculated as:

Double declining rate × book value of the asset at the beginning

of the year

Section A: External Financial Reporting

Decisions
Study Note # 11: How is inventory valued?
Answer: Inventory should be recorded in the books at the amount
that includes all of the costs paid for getting the inventory ready
and available for sale. Costs include the cost of the inventory,
shipping costs to receive the inventory, insurance, taxes and
tariffs, duties, storage, and all other expenses related to receiving
the inventory to sell to the customer.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 12: How is straight-line depreciation calculated?
Answer: Straight-line depreciation (STL) is the simplest method
and results in an equal amount of depreciation expense charged
to the income statement each period. It is calculated as:

Depreciable Amount ÷ Estimated Useful Life

Section A: External Financial Reporting

Decisions
Study Note # 13: How is sum-of-the-years'-digits
depreciation calculated?
Answer: In the sum-of-the-years’-digits method, the amount of
depreciation to be recorded for any given period is calculated
using fractions based on the estimated useful life of the asset.
Under the sum-of-the-years’-digits method the depreciable base
is multiplied by a fraction that is determined using the useful life of
the asset. The denominator (bottom number) is a sum of all of its
expected years of life.

Sum of the Years’ Digits = [n(n + 1)] ÷ 2

Section A: External Financial Reporting

Decisions
Study Note # 14: How is units of production
depreciation calculated?
Answer: Under the units of production method, the number of
units the asset will be able to produce over its useful life is
determined. Then the appropriate ratio of the depreciable amount
is recognized as depreciation expense for each year of the asset’s
estimated useful life, based on the actual production of the asset
during that period.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 15: Summarize the steps for preparing the
operating activities section under the indirect method.
Answer: Add all depreciation and amortization expense back to net income.
Add all non-operating losses on the income statement back to net income.

Subtract all non-operating gains on the income statement from net income.

Add and subtract the changes in balance sheet accounts that are related to
operating activities – net accounts receivable, accounts payable, inventory,
other payables and receivables, bond discount or premium, and other assets
and liabilities.

If purchases, sales and maturities of trading securities are being classified as

operating activities, subtract cash used to purchase trading securities and add
cash received for trading securities that were sold or that matured.

In addition to the above adjustments, the cash amounts for income taxes
paid and interest paid need to be disclosed in a supplemental schedule.

Section A: External Financial Reporting

Decisions
Study Note # 16: Under what conditions is revenue
recognized immediately upon completion of production?
Answer: The item is readily saleable as soon as it is completed.
There is a known market price for the item and there are minimal
selling costs.
The units are homogeneous (that is, identical to each other).

Section A: External Financial Reporting

Decisions
Study Note # 17: What are appropriated retained earnings and
what are some examples?
Answer: Appropriated retained earnings are retained earnings
that are not distributed to the shareholders. A company may
decide to appropriate retained earnings for several reasons:
Creating a reserve to build a plant.
Acquisitions.
Debt reduction.
Meeting the requirements of a bond or a restriction on the payment
of dividends imposed by a loan covenant.
Providing for research and development or new product
development.
Marketing campaigns.
As a reserve against an expected loss.
Simply providing for the future.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 18: What are assets, liabilities, and equity?
Answer: Assets are probable future economic benefits that have
been obtained or are controlled by an entity as a result of past
transactions or events.

Liabilities are probable future sacrifices of economic benefits due

to present obligations of an entity to transfer assets or provide
services in the future, resulting from past transactions or events.

Equity is net assets, or the residual (remaining) interest in the

assets of an entity after deducting its liabilities from its assets. For
a business entity, equity is the ownership interest.

Section A: External Financial Reporting

Decisions
Study Note # 19: What are authorized shares, issued shares,
and outstanding shares?
Answer: The number of authorized shares is the total number of
shares that the company has registered. The number of
authorized shares is the maximum number that can be sold.
Authorized shares can be issued or unissued, or outstanding or
not outstanding.

The number of issued shares is the number of shares that have

been sold to an outside party at any point in the past. Issued
shares may currently be held either by others or by the company
itself as treasury shares.

The number of outstanding shares is the number of shares that

are currently owned by other parties. Outstanding shares will be
equal to the number of issued shares minus the number of shares
held as treasury shares by the company itself.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 20: What are callable preferred shares?
Answer: Callable preferred shares can be retired at the option of
the corporation.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 21: What are cash equivalents?
Answer: Cash equivalents are defined as very short-term, highly-
liquid investments that have a maturity of three months or
less when acquired by the company. It is important that the
calculation in respect to the time to maturity is made from the time
that the company acquired the item, not from its original maturity
period when issued.

Money market accounts in banks and money market mutual funds

are included in the definition of cash equivalents because they are
immediately accessible.

Section A: External Financial Reporting

Decisions
Study Note # 22: What are consigned goods and how are
they accounted for in inventory?
Answer: Consigned goods are given by one company (the consignor)
to another company (the consignee) for that second company to sell to
the end consumer. Goods may be consigned because the consignee is
physically closer to the consumer or because consignment enables the
consignor to get a wider distribution of goods than the company could
achieve on its own.
Goods out on consignment belong in the inventory of the company that
has put the goods out on consignment (the consignor). The goods should
be carried on the consignor’s balance sheet at the cost the consignee
paid for the goods plus any shipping costs the consignor paid to get the
goods to the consignee company that will sell the goods. The shipping
costs to the consignee are costs of making the goods available for sale
to the customer and thus are inventoriable costs.
Goods held on consignment do not belong to the company that holds
them (consignee) and therefore should not be included in the
consignee’s inventory.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 23: What are convertible preferred shares?
Answer: These shares may be converted into common shares at
the option of the shareholder. If they are converted, the newly
issued common shares are recorded at the book value of the
preferred shares that were converted. There is no gain or
loss recorded on this transaction, as the newly issued common
shares replace the preferred shares on the books.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 24: What are current and noncurrent assets?
Answer: Current assets are assets that will be converted into
cash or sold or consumed within 12 months or within one operating
cycle if the operating cycle is longer than 12 months.

Noncurrent assets are assets that will not be converted into cash
within one year or during the operating cycle if the operating cycle
is longer than one year.

Section A: External Financial Reporting

Decisions
Study Note # 25: What are current liabilities?
Answer: Current liabilities are obligations that will be settled
through the use of current assets or by the creation of other current
liabilities.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 26: What are direct and indirect users of financial
information?
Answer: Direct users are directly affected by the results of a
company. Direct users include investors and potential investors,
employees, management, suppliers, and creditors. Direct users
stand to lose money if the company has financial problems.

Indirect users are people or groups who represent direct users.

They include financial analysts and advisors, stock markets, and
regulatory bodies.

Section A: External Financial Reporting

Decisions
Study Note # 27: What are discontinued operations?
Answer: A discontinued operation is defined as a disposal of a
component or group of components that is either disposed of or
held for sale and represents a strategic shift that has or will have
a major effect on the entity’s operations and financial results. A
strategic shift that has or will have a major effect on operations
and financial results could include disposing of operations in a
major geographical area or disposing of a major line of business,
a major equity investment, or other major parts of the entity.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 28: What are dividends?
Answer: Dividends are the distribution of current profits and/or the
retained earnings of the company to its owners. The declaration of
cash or property dividends reduces total stockholders’ equity as a
result of either the distribution of an asset (cash or other property)
or the incurrence of a liability (dividends payable if the dividend is
not immediately distributed).
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 29: What are equity securities?
Answer: Equity securities are accounted for using the fair value
method when the investor owns less than 20 percent of the
investee company’s outstanding common stock and has little or no
influence over the investee. Equity securities under the fair value
method are classified as either trading securities or available-for-
sale securities. Equity securities cannot be classified as held-to-
maturity since equity has not maturity date.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 30: What are examples
of noncash investing and financing transactions?
Answer: Debt converted to equity.
Borrowing money to purchase a fixed asset when the lender pays
the loan proceeds directly to the seller of the asset to make sure
the loan proceeds are used as intended.
Buying or selling fixed assets for something other than cash (for
example, stock).
Obtaining a building or other item by gift.
Exchanging noncash assets or liabilities for other noncash assets
or liabilities.

Section A: External Financial Reporting

Decisions
Study Note # 31: What are expenses?
Answer: Expenses are outflows of cash or other assets or the
incurrence of liabilities as a result of purchasing goods or services
that are necessary to provide the entity’s main or central
operations.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 32: What are fixed assets (property, plant, and
equipment)?
Answer: Property, plant, and equipment (PP&E) are tangible
assets used in operations and which will continue to be used
beyond the end of the current period. When the fixed assets are
purchased, they are recorded at their cost, including installation
costs needed to bring the asset to usable condition. The cost is
then expensed over the life of the asset through depreciation,
amortization, or depletion (except for land, which is not
depreciated).
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 33: What are four potential events that will cause
a difference between book and taxable income?
Answer: An revenue item is recognized as taxable income before
it is recognized in the accounting records as revenue.
An expense item is deductible from taxable income before it is
deducted in the accounting records as an expense.
An revenue item is recognized in the accounting records as a
revenue before it is recognized as taxable income on the tax
return.
An expense item is deducted in book income as an expense
before it is deductible in taxable income.

Section A: External Financial Reporting

Decisions
Study Note # 34: What are gains?
Answer: Gains are increases in equity as a result of transactions
that are not part of the company’s main or central operations and
that do not result from revenues or investments by the owners of
the entity.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 35: What are goods out on approval?
Answer: Goods out on approval are goods that are currently held
by the customer but which the same customer has not yet
purchased. The customer physically has the product and has
some period of time to decide either to purchase it or return it.
Goods-out-on-approval items should be included in inventory by
the seller at the original cost until either the customer accepts the
goods or the time to return the goods expires. Only when either of
these events occurs will the sale be recognized and the goods
removed from the seller’s inventory.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 36: What are intangible assets?
Answer: Intangible assets do not have physical substance but
they provide benefit to the firm over a period of time. Intangible
assets may be either purchased or developed internally. However,
because an asset that is recorded on the balance sheet comes
about only as a result of a prior transaction, internally-generated
intangible assets are generally not recorded on the balance sheet.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 37: What are internal and external users of
financial information?
Answer: Internal users make decisions within the firm. External
users make decisions from outside of the firm about whether or
not to begin a relationship, continue a relationship, or change their
relationship to it.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 38: What are leasehold improvements and how
are they accounted for?
Answer: Leasehold Improvements are additions a lessee makes
to a building or property that the lessee cannot remove when the
lease period is over. For example, if a lessee purchases an air
conditioning system for a leased building, it is considered a
“leasehold improvement” and cannot be uninstalled and taken
away once the lease expires.

The cost of leasehold improvements should be amortized over

the shorter of the following: the remaining lease term or the useful
life of the improvements.

Section A: External Financial Reporting

Decisions
Study Note # 39: What are liquidating dividends?
Answer: Liquidating dividends are those dividends that are a
return of capital rather than a return on capital. These occur when
the dividend distributed is greater than the amount in retained
earnings. Any dividend paid in excess of the balance in retained
earnings will be classified as a liquidating dividend because there
are no profits to distribute.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 40: What are losses?
Answer: Losses are decreases in equity as a result of
transactions that are not part of the company’s main or central
operations and that do not result from expenses or distributions
made to owners of the entity.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 41: What are noncurrent liabilities?
Answer: Noncurrent liabilities are liabilities that will not be settled
within one year or the operating cycle if the operating cycle is
longer than one year.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 42: What are permanent accounts?
Answer: Permanent accounts are not closed out at the end of
each accounting period but rather their balances are cumulative.
They keep on accumulating transactions and changing with each
transaction, year after year.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 43: What are permanent timing differences with
regards to income tax?
Answer: Permanent timing differences are items that cause
differences between taxable income and book income but do not
reverse over time. Permanent differences do not give rise to
deferred tax assets or liabilities because of the fact that by
definition a permanent timing difference is something that will be
recognized for either book or tax purposes, but not both.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 44: What are redeemable preferred shares?
Answer: These preferred shares may be sold back to the
company at a specified price at the option of the shareholder.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 45: What are some examples of
reasons that book and taxable income differ?
Answer: Prepaid rental income and service contract revenue are
recognized for tax purposes when received but for financial reporting purposes
they are recognized when they are earned

If a company uses MACRS depreciation for tax purposes and a depreciation

method such as straight-line for financial reporting purposes, depreciation
expensed will be greater for tax purposes than for book purposes in the early
years of the asset’s life.

The investor recognizes earnings from investments that are accounted for
under the equity method when earned by the investee for financial reporting
purposes but for tax purposes only when received as dividends.

For tax purposes, expense accrued for financial reporting for estimated liability
for warranties and pending litigation is not allowed as a tax deduction until the
amounts are paid.

Section A: External Financial Reporting

Decisions
Study Note # 46: What are temporary accounts?
Answer: The accounts that record revenues, expenses, gains and
losses are temporary accounts. They are also closed to a
permanent account (that is, retained earnings on the balance
sheet) at the end of each period (that is, for a fiscal year). At the
beginning of each fiscal year, the balances in the income
statement accounts are zero.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 47: What are the criteria for classification
as extraordinary items?
Answer: Unusual nature. The event or transaction should be
highly abnormal and be clearly unrelated to the ordinary and
typical activities of the company.
Infrequency of occurrence. The event or transaction should be
something the company does not reasonably expect to recur in
the foreseeable future.

Section A: External Financial Reporting

Decisions
Study Note # 48: What are the five adjustments to net income
using the indirect method of preparing the statement of cash
flows?
Answer: Eliminate noncash income and expense items, such as
depreciation, included in the income statement.

Eliminate investing and financing activity events whose results are included in
the income statement, for example gains and losses on the income statement.

Include the effect of any operating activities that were not included in net
income but did have a cash effect and exclude (eliminate) the effect of any
events that are included in net income but did not have a cash effect.
Examples of these adjustments are those that must be made for changes in
receivables, payables, inventory, and other assets and liabilities.

Cash flows from the purchase, sale, and maturity of trading securities will
usually be classified as operating activities, not investing activities. If those
cash flows are classified as operating activities on the SCF, those cash flows
must be included as an adjustment to reconcile net income to net cash from
operating activities.

Specific disclosures required with the indirect method.

Section A: External Financial Reporting

Decisions
Study Note # 49: What are the five financial statements used
under US GAAP?
Answer: Balance Sheet (also called the Statement of Financial
Position)
Income Statement
Statement of Cash Flows
Statement of Comprehensive Income
Statement of Changes in Stockholders’ Equity

Section A: External Financial Reporting

Decisions
Study Note # 50: What are the four basic principles of
accounting for recording and reporting transactions?
Answer: Measurement
Revenue recognition
Expense recognition
Full disclosure

Section A: External Financial Reporting

Decisions
Study Note # 51: What are the four criteria for determining
a capital lease?
Answer: There are four criteria to determine if the lease is or is
not a capital lease. If any one of these four criteria is met, it is a
capital lease:
The lease provides for the transfer of ownership of the asset to the
lessee at the end of the lease.
The lease includes a written bargain purchase option by which the
lessee may purchase the asset at the end of the lease for an
amount expected to be less than the fair market value of the asset
at the end of the lease.
The present value of the minimum lease payments is equal to or
more than 90% of the fair market value of the asset at the time the
lease is entered into.
The lease term is 75% or more of the remaining estimated
economic useful life of the asset at the time the lease is entered
into.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 52: What are the four main inventory cost flow
assumptions?
Answer: First in First Out (FIFO), in which we assume that the item sold to
the customer is the earliest unit purchased by the seller that has not yet been
sold (that is, the oldest item in inventory).

Last in First Out (LIFO), in which we assume that the item sold to the customer
is the latest unit purchased by the seller (that is, the newest item in inventory).

Average Cost, in which we sum the costs paid for all the individual units of a
given item in inventory and divide by the number of units purchased to find the
average cost for each unit.

Specific Identification, in which we actually keep track of each unit of inventory

individually. The specific identification method is used for low quantity, high
value inventory items, such as merchandise in a jewelry store or serialized
electronic merchandise where records are kept by serial number.

Section A: External Financial Reporting

Decisions
Study Note # 53: What are the limitations of financial
statements?
Answer: Measurements are made in terms of money, so qualitative aspects
of a firm are not included. Only transactions recorded in the accounting
records are in the financial statements.

Information supplied by financial reporting involves estimation, classification,

summarization, judgment, and allocation.

Financial statements primarily reflect transactions that have already occurred;

consequently, many aspects of them are based on historical cost.

Only transactions involving the entity being reported on are reflected in that
entity’s financial reports. However, transactions of other entities, such as
competitors, may be very important.

Financial statements are based on the going-concern assumption. If that

assumption is invalid and the business is facing liquidation, the appropriate
attribute for measuring financial statement items is liquidation value. If a
business will be liquidated, it is not appropriate to use historical cost, fair value,
net realizable value, or any other valuation measure for a going-concern’s
financial statements.

Section A: External Financial Reporting

Decisions
Study Note # 54: What are the main adjustments that need to
be made to eliminate intercompany transactions?
Answer: Eliminating intercompany receivables and payables
Eliminating the effect of intercompany sales of inventory
Eliminating the effect of intercompany sales of fixed assets
Eliminating the parent’s investment account

Section A: External Financial Reporting

Decisions
Study Note # 55: What are the rules for adjusting net income for
changes in assets and liabilities?
Answer: Assets:
The amount of an increase in an asset should be deducted from
net income.
The amount of a decrease in an asset should be added to net
income.
Liabilities:
The amount of an increase in a liability should be added to net
income.
The amount of a decrease in a liability should be deducted from
net income.

Section A: External Financial Reporting

Decisions
Study Note # 56: What are the six categories of equity?
Answer: Capital stock. The par or stated value of the shares issued.
Additional paid-in capital. The excess of amounts contributed by owners from
the sale of shares over and above the par or stated value of the shares issued.

Retained earnings. Profits of the company that have not been distributed as
dividends.

Accumulated other comprehensive income items. Specific items that are not
included in the income statement but are included in equity and adjust the
balance of equity, even though they do not flow to equity by means of the
income statement as retained earnings do.

Treasury stock. The amount of shares repurchased (that is, a contra-equity

account that reduces equity on the balance sheet).

Non-controlling interest. A portion of the equity of subsidiaries that the

reporting entity owns but does not own wholly. (Formerly known as “minority
interest”).

Section A: External Financial Reporting

Decisions
Study Note # 57: What are the specific items classified
as financing activities?
Answer: Issuance of stock
Treasury stock transactions
Paying dividends (note that dividends paid are a financing activity,
but dividends received are an operating activity)
Issuing debt (such as bonds)
Obtaining a loan and repayment of principal on debt obligations,
including repayment of the principal portion of capital lease
payments for fixed assets (note that the interest portion of
payments on capital leases and loans is classified as cash flows
from operating activities)

Section A: External Financial Reporting

Decisions
Study Note # 58: What are the specific items classified
as investing activities?
Answer: Purchasing and selling property, plant, and equipment
(that is, fixed assets)
Making and collecting loans to other parties
Acquiring and disposing of available-for-sale or held-to-maturity
securities (such as equities and debt instruments)

Section A: External Financial Reporting

Decisions
Study Note # 59: What are the specific items classified
as operating activities?
Answer: Cash received from customers and cash paid to
suppliers in the course of the company’s primary business activity.
Interest paid on bonds and other debt (such as loans, leases, and
mortgages).
Interest received and dividends received from debt and equity
investments.
Cash paid to the government for taxes and cash received
back from the government as tax refunds are generally operating
activities.
Cash flows from the purchase, sale, and maturity of trading
securities usually will be classified as operating activities, not
investing activities.

Section A: External Financial Reporting

Decisions
Study Note # 60: What are the steps in the percentage of
receivables method of calculating allowance for doubtful
accounts?
Answer: Calculate what the ending balance in the allowance
account should be using some percentage of ending accounts
receivable.
Determine what the “plug figure” in the allowance account needs
to be in order for the ending balance in the account to be as
calculated in Step 1. This “plug figure” is the bad debt expense for
the period.
Debit bad debt expense for the amount calculated as bad debt
expense in Step 2 and credit the allowance for doubtful debts
account for the same amount.

Section A: External Financial Reporting

Decisions
Study Note # 61: What are the steps in the percentage of sales
method of calculating allowance for doubtful accounts?
Answer: Calculate the bad debt expense for the period as a
percentage of total credit sales. When the company makes this
calculation, it ignores any previous balance in the allowance
account or any previously recognized bad debt expense. The
company is calculating the amount of this period’s credit sales that
it will not collect and that should therefore be recognized as
expense for this period.
Debit bad debt expense for the calculated bad debt expense
amount and credit the allowance for doubtful debts for the same
amount.
Calculate the ending balance in the allowance account.
Check the reasonableness of the allowance account balance. If it
is not reasonable (for example, if the resulting balance is a debit
balance), reappraise.

Section A: External Financial Reporting

Decisions
Study Note # 62: What are the three categories of debt
securities?
Answer: Trading: Securities bought and held principally for the
purpose of selling them in the near term (generally within hours or
days) with the objective of generating profits from short-term price
changes. These are accounted for at fair value.
Held-to-Maturity: Debt securities that are purchased with the intent
to hold them to maturity. These are accounted for at amortized
cost.
Available-for-Sale: Securities not classified as either trading or
held-to-maturity. These are accounted for at fair value.

Section A: External Financial Reporting

Decisions
Study Note # 63: What are the three classifications of
inventory for a manufacturing company?
Answer: Raw materials – the individual parts and pieces that will
be assembled to make the finished goods.
Work-in-process – units of inventory for which production has
started, but has not yet been completed.
Finished goods – units that have been completed but not yet sold.

Section A: External Financial Reporting

Decisions
Study Note # 64: What are the three main categories of
activities in the statement of cash flows?
Answer: Operating activities: cash inflows and outflows that result
from the company's main business activities and central
operations.
Investing activities: activities that the company undertakes to
generate a future profit, or return, from investments.
Financing activities: activities that a company undertakes to raise
capital to finance the business.

Section A: External Financial Reporting

Decisions
Study Note # 65: What are the three methods of accounting for
investments?
Answer: The fair value method, used for marketable debt and equity
securities. The fair value method is used for debt securities and for certain
equity securities.

The equity method, used generally when an investor corporation owns less
than 50% of the outstanding stock of the investee but has the ability to exercise
significant influence over the operations of the investee company.

The consolidation method, used when the investor corporation owns more
than 50% of the investee corporation’s outstanding common stock. With
greater than 50% of the outstanding common stock, the investor corporation
has a controlling interest in the investee and the investee is a subsidiary of the
investor. The investor consolidates the financial results of the investee with its
own financial results and prepares consolidated financial statements.

Section A: External Financial Reporting

Decisions
Study Note # 66: What are the three types of journal
entries made that involve the allowance account?
Answer: To write off a specific receivable when it becomes
uncollectible.
To collect a previously written-off receivable.
To record the bad debt expense for the period.

Section A: External Financial Reporting

Decisions
Study Note # 67: What are the two methods for recognizing
profit earned on a long-term contract?
Answer: Completed contract method: Under the completed
contract method, profit is recognized only at the completion of the
contract. Any expected losses that may be incurred must be
recognized in the period when they become known. This method
is prohibited under IFRS.
Percentage-of-completion method: Under the percentage-of-
completion method, profit is recognized as it is earned throughout
the process of completing the project. Like the completed contract
method, any expected losses that may be incurred must be
recognized in the period when they become known.

Section A: External Financial Reporting

Decisions
Study Note # 68: What are the two models for
reporting consolidated investments in equity securities?
Answer: The voting-interest model: When an acquirer has a
controlling financial interest in the acquiree, the financial statements of
the acquirer and the acquiree should be consolidated. The usual
condition for a controlling financial interest is ownership by one
reporting entity (directly or indirectly) of more than 50% of the
outstanding voting shares of the acquiree.
The variable interest entity (VIE model): A “variable interest entity” is a
legal entity that is financially controlled by one or more entities that do
not hold a majority voting interest. The entity holding the majority of the
financial control is called the VIE’s primary beneficiary. The definition
of a “parent” in a consolidation includes a VIE’s primary beneficiary,
and the definition of “subsidiary” includes a VIE that is consolidated by
its primary beneficiary.

Section A: External Financial Reporting

Decisions
Study Note # 69: What are the two systems for the frequency of
making inventory entries?
Answer: In the periodic system, average cost is called the weighted
average method. At the end of the period, the company determines the
total number of units that it had available for sale (beginning inventory
+ purchased during the period) and also the total cost that it paid for
all of the units available for sale.
Under the perpetual system, the calculation of the cost of the unit of
inventory sold is made after each individual sale. For LIFO and the
average cost methods, the perpetual system leads to a larger number
of calculations. While the calculations are not difficult, it is important to
keep track of all of the necessary information for these types of
questions. The effects of the perpetual method on the three main
methods of tracking physical units of inventory are outlined below.

Section A: External Financial Reporting

Decisions
Study Note # 70: What are two important
differences between preferred shares and bonds?
Answer: A company not paying dividends on the preferred shares
in a certain period does not constitute a default. While preferred
shares have a preference in dividends over common shares, the
receipt of dividends is not guaranteed for preferred shareholders.
Preferred shares do not have a face amount that needs to be
repaid at a maturity date in the future the way bonds do.

Section A: External Financial Reporting

Decisions
Study Note # 71: What are unappropriated retained earnings?
Answer: All retained earnings start out classified as
unappropriated retained earnings. The term “unappropriated”
simply means that the dividends are available to be distributed to
shareholders in the form of dividends.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 72: What conditions must be met to recognize
revenue when the right of return exists?
Answer: The price of the transaction is substantially fixed or
determinable at the time of the sale.
The buyer has paid for the item or is obligated to pay for the item,
and this obligation is not contingent upon the resale of the item.
The buyer’s obligation is not changed in the case of theft,
destruction or damage.
The buyer is a separate entity from the seller.
The seller does not have future obligations to assist in the resale
of the item.
The amount of future returns can be estimated.

Section A: External Financial Reporting

Decisions
Study Note # 73: What costs are included in the cost
of buildings?
Answer: The purchase price, costs of renovating or preparing the
building, cost of permits, any taxes assumed by the purchaser,
insurance paid during the construction of the building, materials,
labor, and overhead of construction.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 74: What costs are included in the cost of land?
Answer: The land purchase price, including any mortgages that
the purchaser assumed, transaction costs, site preparation costs,
the cost of purchasing and razing (destroying) an existing
structure, the amount of any delinquent real estate taxes the
purchaser assumes, permanent improvements, and other costs
necessary to prepare the land for use. The costs of destroying an
existing building are included in the land cost because the land is
not ready for its intended use until the building is removed.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 75: What costs are included in the cost
of machinery and equipment?
Answer: The cost of the machine, freight-in, handling, taxes,
testing the machinery, installation, and any other costs of getting
the machinery ready for its intended use. Partial destruction of
property can be included if, for example, a wall needed to be torn
down in order to install machinery onto a factory floor. In this case,
the destruction of the wall and the rebuilding of the wall will be
included in the cost of the machinery.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 76: What happens when the value of inventory
declines?
Answer: When inventory’s value declines, it should be written
down to its lower market value. For inventory, the evaluation is
done by comparing the cost of the inventory (what is recorded on
the books) to the market value of the inventory. The value of the
inventory on the balance sheet will then be adjusted to the lower
of its cost or its market value. The term for this inventory valuation
is lower of cost or market, or just LCM.

The general rule for the “market value” is the price a reseller would
have to pay to replace the inventory item or the cost to a
manufacturer to reproduce the item.

Section A: External Financial Reporting

Decisions
Study Note # 77: What is a copyright and how is it accounted
for?
Answer: A copyright (©) is granted for intellectual property
consisting of original works and is effective for the life of the author
plus 70 years. A purchased copyright is recorded at its purchase
price. An internally generated copyright can be recorded only at its
registration costs.

Because it is difficult to assess the useful life of a copyright,

companies usually write off amounts capitalized for copyrights
over a fairly short period of time.

Section A: External Financial Reporting

Decisions
Study Note # 78: What is a cumulative preferred dividend?
Answer: A cumulative dividend is one that is earned each year by
the preferred share. This does not mean that company actually
distributes the dividend each period; rather, the shareholder has
earned the dividend and has a right to receive that dividend in the
future. If the dividend is paid, it is accounted for just like a common
cash dividend.

For those years when the dividend is not paid, the amount not paid
is “in arrears,” meaning that the company is behind schedule in
the payment of preferred, cumulative dividends and has missed at
least one payment of dividends. Dividends in arrears must be paid
in full before common dividends are paid.

Section A: External Financial Reporting

Decisions
Study Note # 79: What is a deferred tax asset and how is one
created?
Answer: An item that causes taxable income in the current period to be
greater than book income in the current period creates a deferred tax
asset. Because taxable income is higher than book income, the company
has had to pay more in taxes than its book income indicates. Therefore,
for book purposes the “overpayment” is a prepaid tax, or a deferred tax
asset.

A deferred tax asset is created by either:

A revenue that is taxable in the current period but is not included in book
income for the current period. For example, a deposit received for work
to be performed in the future, rental income received in advance of the
period covered, or subscription payments received in advance.
Or an expense that is included in book income but is not deductible for
tax purposes in the current period. For example, warranty expense
debited to the income statement and credited to estimated warranty
liabilities.

Section A: External Financial Reporting

Decisions
Study Note # 80: What is a deferred tax liability and how is one
created?
Answer: An item that causes taxable income in the current period to be
lower than book income in the current period creates a deferred tax liability.
Because taxable income is lower than book income, the company does not
pay as much in taxes as its book income indicates it should pay in the current
period. However, because the company knows that these temporary timing
differences will reverse, it understands that the tax that was not paid this year
will need to be paid in the future. Therefore, for book purposes this difference
is recorded as a deferred tax liability.

A deferred tax liability is created by either:

A revenue that is included in book income but not in taxable income in the
current period. For example, interest income accrued monthly for book
purposes on a debt security investment when the interest is received only
semi-annually.

Or an expense that is deductible for tax purposes but is not an expense for
book purposes in the current period. For example, payment of an insurance
premium in advance for insurance coverage during the coming year or the
early years of an asset’s life when accelerated depreciation is used for tax
purposes while straight-line depreciation is used for book purposes.

Section A: External Financial Reporting

Decisions
Study Note # 81: What is a lease and what are the two types of
leases?
Answer: A lease is an agreement between a lessor (the owner of
an asset) and a lessee (the person who is going to use the asset)
that conveys the right to use specific property for a stated period
of time in exchange for a stated payment. There are currently two
different types of leases for financial accounting purposes:
A rental agreement, also known as an operating lease.
A purchase/sale agreement, also known as a capital lease.

Section A: External Financial Reporting

Decisions
Study Note # 82: What is a LIFO layer?
Answer: A LIFO layer arises when a company purchases more
inventory before it sells all of its previously purchased inventory.
The assumption underlying LIFO—the most recently purchased
(newest) inventory item is always the first unit sold—leads to many
different individual prices for the units in ending inventory. Each
time the company buys more inventory before selling all the
inventory it previously had on hand, a layer is added.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 83: What is a noncumulative preferred dividend?
Answer: Dividends that are noncumulative are “lost” if they are
not declared for any given year. These are simply dividends that
are payable at the discretion of the company.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 84: What is a patent and how is a patent
accounted for?
Answer: A patent is the right of exclusive use granted by a government.
Patents in the US are valid for 20 years and they are amortized over the
shorter of two possible time frames, either the patent’s legal life or the
economic useful life of the patent. It is very possible that the economic useful
life will be shorter than the legal life because of changing technologies.

For patents that are purchased, the patent should be recorded on the books
at the purchase price. The purchase price is also the amount that should be
amortized over the useful life of the patent.

For internally developed patents, the capitalized and amortized amount is

generally limited to registration fees and legal fees for filing the patent. This
accounting treatment is related to the accounting treatment for research and
development. Research and development costs are generally expensed as
incurred and thus they cannot be capitalized and amortized.

Section A: External Financial Reporting

Decisions
Study Note # 85: What is a property dividend?
Answer: A property dividend refers to an asset other than cash
being distributed as the dividend. For example, the company may
distribute inventory, fixed assets, or shares in another company
that it holds. To declare a property dividend does not mean that a
company does not have cash. A property dividend may be
declared because the company is using its cash to finance an
expansion or some other investment opportunity.

When a property dividend is declared, the company restates to fair

value as of that date the property it will distribute and recognizes
a gain or loss for the difference between the property’s fair and
carrying values.

Section A: External Financial Reporting

Decisions
Study Note # 86: What is a sale with buyback agreement?
Answer: Sometimes a company may sell its product in one period
and at the same time agree to buy it back in a later period. Even
though legal title to the product is transferred, the seller may
actually retain the risks of ownership. The terms of the agreement
need to be analyzed to determine whether or not the seller has
transferred the risks and rewards of ownership to the buyer.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 87: What is a self-correcting error?
Answer: A self-correcting error is one that will correct itself in time,
even if it is not discovered. The miscounting of inventory is a self-
correcting error. While the error in ending inventory will have an
effect on two balance sheets and two income statements, if
inventory is correctly counted at the end of the next year, then
there will be no further errors as a result of the miscounting.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 88: What is a stock dividend?
Answer: A stock dividend occurs when the company distributes a
dividend in the form of additional shares. . The total value of the
equity of the company is not changed by a stock dividend. The
amounts in the various equity accounts are just redistributed.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 89: What is a stock split?
Answer: A stock split is initiated by a company as the result of the
market price for a share becoming too high. In order to reduce the
market price of the share, the company essentially cuts all of their
shares into smaller pieces. As a result more shares are
outstanding and each share is worth a lower market price.

In a stock split, the par value of each share of the stock is also
reduced in the same ratio.

Section A: External Financial Reporting

Decisions
Study Note # 90: What is a the date of declaration in a stock
dividend?
Answer: The date of declaration is the day the board formally
declares the dividend. The board also announces the date of
record and the date of payment. On the date the dividend is
declared, the first journal entry is made. In this entry the retained
earnings account is debited, thus reducing the retained earnings
balance, and a liability is set up. The amount in the journal entry is
an estimated number because the exact number of shares to
which the dividend will be paid is not yet known.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 91: What is a trademark and how is accounted
for?
Answer: A trademark (®) or trade name is a distinctive sign, word,
or symbol. Trademarks can be registered for 20 years and
renewed for longer time periods. The costs that should be
capitalized include legal and registration fees, design costs, and
any cost of successfully defending the name. A trademark should
be amortized over its useful life, but the amortization period should
not exceed 40 years.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 92: What is a warranty and what are the two types
of warranties?
Answer: A warranty is a promise that a company makes to a buyer
that if the product breaks during a specific time period, the
company will pay to fix or replace the defective product. There are
two types of warranties:
An expense warranty is a manufacturer’s warranty given along
with the sale of the product, without any additional payment being
required from the customer.
A sales warranty is an extended warranty that is sold separately
from the product. Sales warranties may be offered by the
manufacturer but also may be offered by either the reseller or by
a third party.

Section A: External Financial Reporting

Decisions
Study Note # 93: What is accumulated depreciation?
Answer: Accumulated Depreciation is a valuation account that
decreases the carrying value of fixed assets, recorded at their
historical cost, to their book value.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 94: What is an impaired asset?
Answer: If the asset’s book value > undiscounted future cash
flows, then the asset is considered to be impaired. An impaired
asset is written down to its fair value. The amount by which the
asset is written down is reported as a loss during that period.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 95: What is an intangible asset and how are
they accounted for?
Answer: Intangible assets are assets that are not physical or that
cannot be touched. The accounting for intangibles is very similar
to that for PPE with many of the same issues:
Initial recording of the intangible asset.
Amortization of the cost of the intangible asset (for intangibles,
amortization is the equivalent to depreciation of tangible assets).
Adjusting the value of the asset to recognize any permanent
decreases in its value (impairment).

Section A: External Financial Reporting

Decisions
Study Note # 96: What is book income and what is taxable
income?
Answer: Book income is the pre-tax financial income reported in
the financial statements calculated using the rules of GAAP. Book
income is the “correct” income because it is calculated according
to GAAP.

Taxable income is a tax accounting term and it is used for the

amount upon which the company’s income tax payable is
computed. Taxable income is calculated by following the tax code
of the IRS.

Section A: External Financial Reporting

Decisions
Study Note # 97: What is channel stuffing (trade loading)?
Answer: Channel stuffing (trade loading) is when a manufacturer
induces a wholesaler or distributor to purchase more product than
the wholesaler or distributor is able to sell in a timely manner. A
manufacturer may do this by offering deep discounts or other
incentives. These actions enable the manufacturer to recognize
additional revenue and profits in the current period.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 98: What is comprehensive income?
Answer: Comprehensive income includes all transactions of the
company except for those transactions that are made with the
owners of the company (such as distribution of dividends or the
sale of shares). It is a little closer to being an economic measure
of income than net income is.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 99: What is contributed capital?
Answer: Contributed capital consists of the assets that are put
into the company by the owners in return for their share of
ownership of the company. The fair value of what is received in
exchange for the shares (whether it is cash or another asset) will
be recorded in two different equity accounts.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 100: What is depreciable amount (depreciable
base)?
Answer: This is the amount to be depreciated over the asset’s
useful life equal to the capitalized amount (that is, the cost of the
asset) minus its salvage value.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 101: What is equity?
Answer: Equity is the remaining balance of assets after the
subtraction of all liabilities. Equity is the portion of the company’s
assets owned by and owed to the owners. If the company were to
be liquidated, equity represents the amount that would
theoretically be distributable to the owners.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 102: What is estimated salvage value?
Answer: Also known as “residual value,” estimated salvage value
refers to the value an asset is expected to have at the end of its
useful life. The book value may not be depreciated below the
salvage value. Some companies have an accounting policy that
salvage value is always $0.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 103: What is estimated useful life?
Answer: Also known as “service life,” estimated useful life refers
to the length of time an asset is expected to be useful and it is the
period of time over which depreciation expense is recognized. At
the end of its useful life, the asset should have a book value equal
to the expected salvage value.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 104: What is factoring with recourse?
Answer: Factoring with recourse means that if a customer does
not pay the receivable, the seller of the receivable is liable to the
factor for the uncollectible amount. When a factor purchases
receivables with recourse, their risk of “uncollectibility” is limited.
Because of the lower level of risk to the factor, they will pay more
when buying receivables with recourse.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 105: What is factoring without recourse?
Answer: Traditionally, factoring is without recourse, which means
that the factor assumes the risk of any inability to collect the
receivables. If a sold receivable proves to be uncollectible, the
purchaser (that is, the factor) has no recourse against the seller—
the loss is the factor’s loss. Some companies factor their
receivables to transfer the bad debt risk in this manner. However,
the greater the risk of bad debt, the less cash the selling company
will receive from the factor.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 106: What is factoring?
Answer: Factoring is selling accounts receivable to a third party.
A commercial finance company, called a “factor,” essentially
makes a loan guaranteed (that is, collateralized) by the
receivables to the seller of the receivables. The factor notifies the
seller’s customers that they should begin remitting their payments
directly to the factor, which receives repayment of the loan as it
collects the receivables.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 107: What is fair value?
Answer: Fair value is the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. Therefore, fair value
is market-based. US GAAP has increasingly recommended the
use of fair value to measure items in financial statements,
particularly financial instruments.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 108: What is financial flexibility?
Answer: Financial flexibility is the ability of a business to take
actions to alter the amounts and timing of its cash flows that enable
the business to respond to unexpected needs and take advantage
of opportunities.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 109: What is goodwill and how is it accounted
for?
Answer: Goodwill is defined as the amount that a purchaser has
paid for a company that is greater than the fair value of the net
identifiable assets. Purchased goodwill must be reported as
a separate line item on the balance sheet. Generally, other
intangibles are combined and reported as one figure on the
balance sheet.
Goodwill can be acquired or developed internally, but the only
goodwill recognized in the accounting records is purchased
goodwill. The amount of goodwill purchased is equal to the
difference between the purchase price paid for a business and
the fair value of the net assets received.

Section A: External Financial Reporting

Decisions
Study Note # 110: What is historical cost?
Answer: The historical cost of an asset is its acquisition cost. The
historical cost of a liability, such as a bond payable or an account
payable, is its cost when issued. A company issues a liability in
exchange for an asset or a service at a price that is agreed upon
and that price is the liability’s historical cost.

The advantage of using historical cost is that it is verifiable.

However, it may not provide a good representation of an asset’s
or a liability’s current cash value.

Section A: External Financial Reporting

Decisions
Study Note # 111: What is IFRS?
Answer: IFRS stands for “International Financial Reporting
Standards,” a widely accepted set of accounting principles used in
many countries around the world. IFRS is primarily a principles-
based set of accounting standards with few practical examples
and limited interpretative guidance. Neither acting as a tax
standard nor applying to government organizations, IFRS is
intended for multiple countries with different cultural, legal, and
commercial standards.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 112: What is liquidity?
Answer: Liquidity refers to the time expected to elapse until an
asset is converted into cash or until a liability needs to be paid.
The greater a company’s liquidity is, the lower its risk of failure.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 113: What is matching?
Answer: Expenses should be recognized not when payment is
made but when the work for which the payment is made
contributes to revenue. That is to say, expenses should be
matched with revenues.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 114: What is obsolete inventory?
Answer: Inventory that is obsolete can no longer be sold and
should not be included in the inventory balance on the balance
sheet. Any inventory that becomes obsolete should be written off
as a loss in the period in which it is determined to be obsolete.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 115: What is off-balance sheet financing?
Answer: Off-balance sheet financing is any form of funding that
avoids placing owners' equity, liabilities or assets on a firm's
balance sheet. Off-balance sheet financing can be accomplished
through the use of:
Operating leases
Selling receivables (factoring)
Joint ventures
Non-consolidated subsidiaries
Variable interest entities

Section A: External Financial Reporting

Decisions
Study Note # 116: What is preferred stock?
Answer: Even though preferred shares do not have the right to
vote, there are three preferences over common stock that make
stock "preferred:"
Preference in the claims to assets in a liquidation
Preference in the payment of dividends
A difference in how dividends are calculated. Preferred shares
usually have a higher par value than common shares, and the
dividend that is paid is usually a percentage of that par (or stated)
value. Therefore, the preferred dividend is more of a fixed amount
than the common dividend because the common dividend is
dependent on earnings and management decisions.

Section A: External Financial Reporting

Decisions
Study Note # 117: What is retained earnings?
Answer: Retained earnings represent the undistributed profits of
the company that have been reinvested in the company. These
may also be called undistributed earnings.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 118: What is revenue?
Answer: Revenues represent inflows of assets or reductions in
liabilities as a result of delivering goods or providing services that
are the entity’s main or central operations. Revenues are usually
recognized when the earnings process (that is, providing the
goods or services to the customer) is complete and an exchange
has taken place. The exchange usually includes cash or a promise
to pay in the future (e.g., a receivable).
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 119: What is risk?
Answer: Risk refers to the unpredictability of future events,
transactions and circumstances that can affect the company’s
cash flows and financial results.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 120: What is solvency?
Answer: Solvency refers to the company’s ability to pay its
obligations when they are due. A company with a high level of
long-term debt relative to its assets has lower solvency than a
company with a lower level of long-term debt.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 121: What is the date of payment in a stock
dividend?
Answer: The date of payment is the date on which the dividend is
paid. On this date, the liability is eliminated and the cash account
is decreased.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 122: What is the date of record in a stock
dividend?
Answer: The date of record is the date that is used to determine
who actually will receive the dividend. Anyone who owns shares
on the date of record receives the dividend when it is paid.
Theoretically, no journal entry is made on this date because the
entry on the date of declaration recognized the liability and the
reduction in retained earnings. However, a company may need to
make an entry on the date of record to correct the estimate that
was made regarding the number of shares that will receive the
dividend.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 123: What is the definition of depreciation?
Answer: Depreciation is the systematic and rational allocation of
the costs of a fixed asset over its expected useful life.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 124: What is the direct method for preparing the
statement of cash flows?
Answer: The direct method shows each item that affected cash
flow, such as cash collected from customers. Each item is
calculated by starting with the relevant item on the income
statement and adjusting it using the balances in the relevant
balance sheet account(s) at the beginning of the period and at the
end of the period covered by the income statement. Each
individual line on the income statement is also adjusted to remove
the effect of noncash transactions and non-operating activity
transactions.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 125: What is the equity method for investment
in equity securities?
Answer: The equity method is used when the investor
has significant influence over the investee. Owning between 20%
and 50% of the outstanding voting stock usually indicates
significant influence.
The investment is initially recorded at cost, but the investor
corporation subsequently adjusts the balance in the investment
account for changes in the investee’s net assets. The investor’s
portion of the investee’s earnings (or losses) periodically increases
(or decreases) the investment’s carrying amount on the balance
sheet of the investor.

Section A: External Financial Reporting

Decisions
Study Note # 126: What is the fair value option for reporting a
security?
Answer: An investor may choose to report a specific security
using the fair value option, with all gains and losses related to
changes in its fair value reported on the income statement. The
option is applied to a specific instrument on an instrument-by-
instrument basis, and it is available only when the investor first
purchases the financial asset. If an investor chooses the fair value
option, it must apply that option consistently as long as it continues
to own that security.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 127: What is the formula for profit to recognize in
the current period under the percentage-of-completion method?
Answer: [Costs Incurred to Date ÷ (Total Casts Incurred to Date
+ Estimated Costs to Complete) × Expected Profit] - Profit
Previously Recognized
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 128: What is the full disclosure principle?
Answer: The full disclosure principle states that companies
should provide information that is of sufficient importance to
influence the judgment and decisions of an informed user. The full
disclosure principle recognizes that the information included in
financial reports reflects judgment and trade-offs. These trade-offs
attempt to provide sufficient detail to disclose information that will
make a difference to users while providing sufficient condensation
so that the information is understandable, keeping in mind the
costs of preparing the information and using the information.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 129: What is the income statement?
Answer: The income statement reports the results of a company’s
operations during a given period of time. The income statement
provides information to help predict the amounts, timing, and
uncertainty of (or prospects for) future cash flows.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 130: What is the indirect method for preparing the
statement of cash flows?
Answer: Under the indirect method, all adjustments are made to
the net income figure from the income statement. The adjustments
that are made will be the same as they are for the direct method:
adjustments for changes in balance sheet accounts and the
elimination of noncash and non-operating activity transactions.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 131: What is the installment method of profit
recognition?
Answer: The installment method is used when an item is sold on
credit and will be paid over a period of time in the future and
the amount that will actually be collected is not certain. Under this
method, profit is recognized only when the cash is received from
the customer. The installment method is a conservative approach
to the recognition of profit when the collectibility of future amounts
is uncertain.

A receivable is recognized as soon as the sale takes place, but a

valuation account is used as well.

Section A: External Financial Reporting

Decisions
Study Note # 132: What is the objective of financial reporting?
Answer: The objective of financial reporting is to provide financial
information about the entity that is useful for decision-making.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 133: What is the par value of stock?
Answer: Par value is the specified value printed on the share
itself. This is the legal capital of the company that cannot be
distributed as a dividend.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 134: What is the primary purpose of the statement
of cash flows?
Answer: The primary purpose of the statement of cash flows is to
provide information regarding receipts and uses of cash for the
company during a period of time.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 135: What is the purpose of the balance sheet?
Answer: The balance sheet, also called a statement of financial
position, provides information about an entity’s assets, liabilities,
and owners’ equity at a point in time (usually the end of a reporting
period). The balance sheet shows the entity’s resource structure
(that is, the major classes and amounts of assets) and its financing
structure (that is, the major classes and amounts of liabilities and
equity).
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 136: What is the statement of changes in
stockholders' equity?
Answer: The statement of changes in stockholders’ equity reports
the changes in each stockholders’ equity account and in total
stockholders equity during the year and reconciles the beginning
balance in each account with the ending balance. Since
stockholders’ equity accounts are permanent accounts that
accumulate balances from year to year, information about the
sources of changes in the separate accounts is required to make
the financial statements sufficiently informative.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 137: What is treasury stock?
Answer: Treasury stock is shares of a company that have been
sold to other parties and reacquired by the company. The
company has become a holder of its own shares and may either
retire these shares or hold them for sale at a later time. Treasury
stock is the reacquired shares that have not yet been reissued or
retired.
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CMA Part 1: Financial Reporting,
Planning, Performance and Control

Section A: External Financial Reporting

Decisions
Study Note # 138: What three main items are classified
as cash?
Answer: The three main items that are classified as cash and are
included as cash on the balance sheet are:
Cash (of any currency)
Savings accounts
Checking accounts

Section A: External Financial Reporting

Decisions
Study Note # 139: When is revenue recognized?
Answer: Revenue is recognized when it is
(1) realized or realizable and (2) earned.
Revenue is realized when product (goods or services),
merchandise or other assets have been exchanged for cash or
claims to cash. Revenue is realizable when goods or services
have been exchanged for assets that are readily convertible into
cash or claims to cash.
Revenue is earned when the entity has substantially
accomplished what it must do to be entitled to receive the benefits
represented by the revenues.

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