FARE 2 Matching (Revenue & Expenses), Foreign Currency Accounting, and

1. FARE 2 Matching (Revenue & Expenses), Foreign Currency Accounting, and Other Financial Statement Presentations

2. Terminology and Basic Concepts(page 2-3) • Assets • Liabilities • Revenues Increase in Assets or Decrease in Liabilities from rendering a service, delivering of goods or any other activity that constitutes the major ongoing or central operations of an entity. Cash or Accounts Receivable Revenue Unearned Revenue Revenue

3. Revenue Recognition (US GAAP) (pages 2-3 to 2-4) • Revenue should be recognized: • when it is earned and • when it is realized or realizable. • Revenue from the sale of products or the disposal of other assets is recognized on the date of sale. • The exchange has taken place. • Cash is realized or realizable. • Revenue from the performance of services is recognized when the services have been rendered and cash is realized or realizable.

4. Revenue Recognition (IFRS) (pages 2-4 to 2-5) • Under IFRS, Revenue transactions are divided into four categories. • Sale of Goods • Rendering of Services • Revenue from Interest, Royalties and Dividends • Construction Contracts

5. Revenue Recognition (IFRS) (page 2-4) • Under IFRS, Revenue from Sale of Goods is recognized when all of the following conditions have been met • Revenues and costs incurred for the transaction can be measured reliably. • It is probable that economic benefits from the transaction will flow to the entity. • The entity hastransferred to the buyer the significant risks and rewards of ownership. • The entity does not retain managerial involvement to the degree associated with ownership or control over the goods sold.

6. Revenue Recognition (IFRS) (page 2-4) • Under IFRS, Revenue from Rendering of Services is recognized using percentage of completion method when all of the following conditions have been met • Revenues and costs incurred for the transaction can be measured reliably. • It is probable that economic benefits from the transaction will flow to the entity. • The stage of completion of the transaction at the end of the reporting period can be measured reliably.

7. Revenue Recognition (IFRS)(pages 2-4 to 2-5) • Under IFRS, Revenue from Interest, Royalties, and Dividends is recognized when all of the following conditions have been met • Revenues can be measured reliably. • It is probable that economic benefits from the transaction will flow to the entity. • Under IFRS, Revenue from Construction Contracts is recognized using the percentage of completion when all of the following conditions have been met • Contract Revenues and Costs attributable to the transactioncan be measured reliably. • It is probable that economic benefits from the transaction will flow to the entity. • Both the contract costs to complete the contract and the stage of contract completion at the end of the reporting period can be measured reliably.

8. Revenue Recognition • On May 28, 2014, the FASB and the IASB issued converged guidance on recognizing revenue in contracts with customers. • Core Principle for revenue recognition • Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. • Five steps should be apply to achieve the core principle • Identify the contract with a customer. • Identify the performance obligations in the contract. • Determine the transaction price. • Allocate the transaction price to the performance obligations in the contract. • Recognize revenue when (or as) the reporting organization satisfies a performance obligation. • The new guidance is effective for annual reporting periods beginning after December 15, 2016 for public organizations and after December 15, 2017 for nonpublic organizations.

9. Revenue Recognition (US GAAP)(page 2-5) • Multiple Element Arrangements • When a sale contract includes multiple products and services, the fair value of the contract must be allocated to the separate contract elements. • Revenue is recognized separately for each element. • Exception and Other Special Accounting Treatments

10. Terminology and Basic Concepts(page 2-6) • Expenses Decrease in Assets or Increase in Liabilities from rendering a service, delivering of goods or any other activity that constitutes the major ongoing or central operations of an entity. Expenses Cash or Accounts Payable Expense Prepaid Expense

11. Expenses(page 2-6) Matching Principle • Cause and Effect Relationship • Example: Cost of Goods Sold • Systematic and Rational Allocation • Example: Depreciation • Immediate Recognition • Example: Selling and Administrative Expenses

12. Costs(page 2-7) • Capitalized • Future Benefit = Asset • When sold, used or consumed = Expense • Throughout • Cause and Effect • Systematic and Rational Allocation • Not Capitalized • No future benefit • Immediate recognition as expense

13. Accrual Basis versus Cash Basis(page 2-7) • Deferral = A transaction that impacts cash but has not impacted income. • Prepaid Expense • Unearned Revenue • Accrual = A transaction that impacts income but has not impacted cash flow. • Accrued Revenue (Asset) • Accrued Expense (Liability) • Estimated Liability ( Contingency)

14. Revenue Recognition Examples • Example 1- Accrued Revenue (page 2-8) Cash Collected April 30 October 31 (from July- December Sales)(from January – June Sales) Year 1 $14,000 $17,000 Year 2 12,000 15,000 Sales = July – December Year 2 $80,000 Royalty Revenue = 25% of Sales

15. Example 1- Accrued Revenue(page 2-8) Year 2 Jan 1 Dec. 31 /___________________/___________________/ $15,000 $80,000 X 25%= $20,000 Total Royalty Revenue for Year 2 = $35,000

16. Example 2- Accrued Revenue & Unearned Revenue(page 2-9) Year 1 Year 2 Difference Royalty Receivable 100,000 95,000 (5,000) Unearned Royalties 70,000 45,000 (25,000) Revenue (accrual basis) $200,000 Plus: Decrease in current asset + 5,000 Less: Decrease in current liability - 25,000 Revenue (cash basis) $180,000

17. Example 3 - Unearned Revenue(page 2-10) Unearned Subscription Revenue I 1,200,000 Balance December 31 year 1 I 1,400,000 Cash Received 1,000,000 I I 1,600,000 Balance December 31 year 2

18. Revenue Recognition when the right of return exists(page 2-10) Revenue Recognition when the right of return exists Recognize the revenue at the time of sale if ALL the following conditions are met. • Fixed sales price at date of sale. • Buyer assumes all risks of loss. • Buyer has paid. • The product sold is substantially complete. • The amount of future returns can be reasonably estimated.

19. Other revenue considerations(page 2-11) Franchises Franchisor Accounting • Initial Franchise Fees • Revenue when all material conditions of the sale have been substantially performed. • Continuing Franchise Fees • Continuing Franchise Fees should be reported by the franchisor as revenue when earned. Example on page 2-12

20. Franchise Example(page 2-12) Peter signed an agreement on July 1, Year 1 with Disco Records. The initial franchisee fee was $75,000 and was paid by a $25,000 down payment with the balance payable in 5 equal annual payments of $10,000 beginning July 1, Year 2. Peter’s borrowing rate is 10% and the present value factor of an ordinary annuity $1, n=5, 10% is 3.7908. Present Value = 25,000 + (10,000 X 3.7908) = 25,000 + 37,908 = $62,908

21. Franchise Example(page 2-12) Franchisor Journal entry at July 1, Year 1 Cash 25,000 Notes Receivable 50,000 Discount on Notes Receivable 12,092 Unearned Franchisee Fee Revenue 62,908 Journal entry at December 31, Year 1 • Amortization of discount $37,908 X .10 X 6/12 = 1,895 Discount on Notes Receivable 1,895 Interest Revenue 1,895

22. Intangible Assets (pages 2-12 to 2-13) Intangible assets are long-lived legal rights and competitive advantages developed or acquired by an enterprise to be used in operations. • If purchased, The intangible asset should be recorded at COST. COST= Cash paid + FMV of other assets given + PV of liability incurred + FMV stocks issued + legal and registration fees • If internally developed Costs of intangible assets internally developed = Expense as Research and Development Expense under U.S. GAAP Costs that are specifically identifiable can be capitalized = legal fees + registration costs + consulting fees + other direct costs to secure the asset

23. Intangible Assets (IFRS)(page 2-13) • If internally developed • Under IFRS, research costs related to an internally developed intangible assets must be expensed. • Under IFRS, intangible asset arising from development is capitalized is the entity can demonstrated all of the following: • Technological feasibility has been established. • The entity intends to complete the intangible asset. • The entity has the ability to use or sell the intangible asset. • The intangible asset will generate future economic benefits. • Adequate resources are available to complete the development and sell or use the asset.

24. Intangible Assets(pages 2-12 to 2-13) Costs subsequent to acquisition • Costs of developing, maintaining, or restoring the intangible assets = Expense • Costs that increase the useful life = Capitalized • Legal fees incurred in defending an intangible assets • Successful = Capitalize • Unsuccessful = Expense

25. Intangible Assets(pages 2-13 to 2-14) • The classification of the intangible asset depends upon whether the economic life (useful life) can be: • Determinable (finite life), or • Indeterminable (indefinite life) • Amortization of Intangible Assets with finite life • Amortized over the estimated period of benefit or legal life, whichever is shorter. • Straight-line method • Goodwill and assets with indefinite life • No amortized • Impairment approach

26. Intangible Assets (page 2-14) • Worthless Intangible Assets Write off the entire remaining cost to expense. • Impairment If the full Carrying Value of the Intangible Asset may not be recoverable, write down the intangible asset and recognized an impairment loss. • Sale Selling Price Less: Carrying Value or Book Value Gain or Loss • Income Tax Goodwill amortized over 15 years period Temporary Difference

27. Valuation of Intangible Assets(U.S. GAAP) (page 2-15 ) • U.S. GAAP • Finite life (determinable) intangible asset Cost less: amortization and impairment • Indefinite life (indeterminable) intangible asset Cost less: impairment

28. Valuation of Intangible Assets(IFRS) (pages 2-15 to 2-16) • Under IFRS, intangible assets can be reported under either the cost model or the revaluation model • Cost model • Finite life (determinable) intangible asset Cost less: amortization and impairment • Indefinite life (indeterminable) intangible asset Cost less: impairment • Revaluation model • Under the revaluation model, intangible assets are initially recognized at cost and then revaluated to the fair value at a subsequent revaluation date.

29. Valuation of Intangible Assets(IFRS) (pages 2-15 to 2-16) • Under IFRS, intangible assets can be reported under either the cost model or the revaluation model • Revaluation model (continued) • Finite life (determinable) intangible asset Fair value on the revaluation date less: subsequent amortization and impairment • Indefinite life (indeterminable) intangible asset Fair value on the revaluation date less: subsequent impairment

30. Valuation of Intangible Assets(IFRS)(pages 2-15 to 2-16) • Revaluation model (continued) • Revaluation losses • Revaluation losses reported on the IS, unless the loss reverses a previously recognized revaluation gain. • A revaluation loss that reverses a previously recognized revaluation gain is recognized in OCI and reduces the revaluation surplus in accumulated OCI. • Revaluation gains • Revaluation gains are reported in OCI and accumulated in equity as revaluation surplus, unless the revaluation gain reverses a previously recognized revaluation loss. • A revaluation gain that reverses a previously recognized revaluation loss is reported on the IS.

31. Valuation of Intangible Assets(IFRS)(pages 2-15 to 2-16) • Under IFRS, intangible assets can be reported under either the cost model or the revaluation model • Revaluation model (continued) • Impairment • The impairment is recorded by first reducing any revaluation surplus in equity to zero with further impairment losses reported on the IS. Example on page 2-16 and multiple choice 6

32. Example of Intangible Asset(page 2-16) Franchises Franchisee Accounting • Initial Franchise Fee Present Value of the amount paid is recorded as an intangible asset and amortized over the expected period of benefit. • Continuing Franchise Fees The continuing franchise fee should be recorded by the franchisee as an expense in the period incurred.

33. Franchise Example(page 2-16) Peter signed an agreement on July 1, Year 1 with Disco Records. The initial franchisee fee was $75,000 and was paid by a $25,000 down payment with the balance payable in 5 equal annual payments of $10,000 beginning July 1, Year 2. The expected life of the franchise is 10 years. Peter’s borrowing rate is 10% and the present value factor of an ordinary annuity $1, n=5, 10% is 3.7908. Present Value = 25,000 + (10,000 X 3.7908) = 25,000 + 37,908 = $62,908

34. Franchise Example(page 2-16) Franchisee Journal entry at July 1, Year 1 Franchises 62,908 Discount on Notes Payable 12,092 Cash 25,000 Notes Payable 50,000

35. Franchise Example(page 2-16) Franchisee Journal entries at December 31, Year 1 • Amortization of franchise $62,908 / 10 years = 6,290 X 6/12 = $3,145 Franchise Amortization Expense 3,145 Franchises 3,145 • Amortization of discount $37,908 X .10 X 6/12 = 1,895 Interest Expense 1,895 Discount of Notes Payable 1,895

36. Start-Up Costs(page 2-17) Start-Up Costs • Costs incurred in the formation of a corporation . • Start-up costs should be expensed when incurred. Start-Up Costs include costs of the one-time activities associated with: • Organizing a New entity. • Opening a New facility. • Introducing a New product or service. • Conducting business in a New territory or with a new class of customer • Initiating a New process. Income tax = Deduct up to $5,000 of organizational expenditures and start-up costs. Each $5,000 is reduced by the amount by which organization expenditure or start-up cost exceeds $50,000. Any excess is amortized over 180 months.

37. Research and Development Costs (pages 2-17 to 2-19) Goodwill Excess of the acquired entity’s fair value over the fair value of the entity’s net assets. Research and Development Costs = Expense • Research = Costs to create a new product, service, process, or technique or improve the one in current use. • Development = Costs to takes the findings generated by research and formulates a plan to create the desired item or to improve the existing one. • Under U.S. GAAP, research and development costs are directly charged to expense, except for: • Materials, equipment or facilities that have alternate future use should be capitalize and depreciate over their useful lives. Example of Research and Development Costs on page 2-19

38. Computer Software Development Costs(pages 2-19 and 2-20) Computer Software developed to be sold, leased or licensed • Costs incurred until technological feasibility has been established are recorded as expense. • Capitalized costs incurred after technological feasibility has been established. • Technological feasibility is established upon completion of a detailed program design or a working model. • Amortization of Capitalized Software Costs is the greater of : • Straight-line, or • Percentage of Revenue • Capitalized software costs are reported on the balance sheet at the lower of cost or market (net realizable value). Example multiple choice 5

39. Computer Software Development Costs(page 2-20) Computer Software Developed internally or obtained for internal use only • Costs incurred for the preliminary project state and for training and maintenance are recorded as expense. • Costs incurred after the preliminary project state are capitalized. • Capitalized costs should be amortized on a straight-line basis. IFRS does not provide separate guidance regarding computer software development costs. Under IFRS, computer software development costs are internally generated intangible.

40. Impairment of intangible assets and long-lived assets(page 2-21) • Impairment test for fixed assets to be held for use and for intangible assets with finite lives 1. If the total Undiscounted Future Cash Flows are less than the Carrying Value 2. Fair value of asset - Carrying Value Impairment Loss • Impairment test for intangible assets with indefinite lives Fair value of asset - Carrying Value Impairment Loss

41. Impairment of intangible assets(pages 2-22 to 2-23) • The Impairment Loss is reported as a component of income from continuing operations. • Restoration of previously recognized impairment loss is prohibited, unless the asset is held for disposal. • Illustration on page 2-22 • Examples on page 2-23

42. Impairment of intangible assets(page 2-22) Under IFRS, an impairment loss for an intangible asset other than goodwill is calculated as follows • The carrying value of the asset is compared to the intangible asset recoverable amount. Recoverable amount is the greater of • asset’s fair value less costs to sell or • the asset’s value in use (present value of the future cash flows expected from the intangible asset). IFRS allows the reversal of impairment loss. Example multiple choice 7

43. Impairment of goodwill (U.S. GAAP)(page 2-24) • Impairment of goodwill • Goodwill impairment is calculated at a reporting unit level (operating segment). Two steps test. 1. Identify potential impairment by comparing the fair value of each reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit is less than its carrying value, there is a potential goodwill impairment. 2. Measure the amount of the goodwill impairment loss by comparing the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. Example on page 2-25

44. Impairment of goodwill (U.S. GAAP)(page 2-24) • Under U.S. GAAP, the goodwill and indefinite life intangible assets impairment tests have been simplified by allowing companies to test qualitative factors to determine whether it is necessary to perform the quantitative impairment tests. • An entity may choose to assess qualitative factors to determine whether it is more likely than not (>50%) that the FV of the reporting unit is less than the CV, including goodwill. • If after assessing the relevant qualitative factors, an entity determines that it is not more likely than not that the FV of the reporting entity is less than the CV, the two-steps impairment test is not necessary. • An entity has an option to bypass the qualitative assessment and proceed directly to the first step of the impairment test.

45. Impairment of goodwill (US GAAP)(page 2-24) • Examples of qualitative factors include: • Macroeconomic conditions • Overall financial performance • Entity specific events such as bankruptcy, litigation or changes in management strategy or customers • Industry and market conditions • Sustained decrease in share-prices • Cost factors that could have a negative effect on earnings and cash flows

46. Alternative accounting for Goodwill for Private Company(page 2-25) • Under U.S. GAAP, a private company (not a public entity or not-for-profit entity) may elect to apply the following alternative method of goodwill accounting: • Amortize goodwill on a straight-line basis over 10 years or less if it can demonstrate that another useful life is more appropriate. • Make an accounting policy election to test goodwill for impairment at either the entity level or the reporting unit level when a triggering event occurs that indicates that the fair value of an entity may be below its carrying amount.

47. Impairment of goodwill (IFRS)(page 2-25) Under IFRS, goodwill impairment testing is done at the cash-generating unit (CGU) level. A CGU is defined at the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or group of assets. The impairment loss of goodwill is calculated as follows • The carrying value of the CGU is compared to the CGU’s recoverable amount. Recoverable amount is the greater of • CGU’s fair value less costs to sell or • the CGU’s value in use (present value of the future cash flows expected from the CGU).

48. Correcting and Adjusting Accounts(page 2-25) Counterbalancing error Inventory Error Year 1Year 2 End. Inventory OVER Beg. Inventory OVER CGS UNDER CGS OVER NI OVER NI UNDER R/E OVER R/E OK

49. Correcting and Adjusting Accounts Prepaid Expense Error (2 years) Year 1Year 2 Expense OVER UNDER Prepaid UNDER NI UNDER OVER R/E UNDER OK

50. Example(page 2-26)