Question

You are the Manager of Financial Reporting for your company. Your company is facing a number of reporting challenges as a result of an acquisition, COVID-19 and other activities. Although the CFO makes the final decision on accounting standard applications, the CFO relies heavily on your expertise (acquired in the Aurora University MSA program) and your years of research and experience.

In a meeting (brainstorming session), a list of potential reporting issues is developed and are listed below. You have been asked to select the three you feel may be most important and prepare a memo to be reviewed and to guide proper accounting treatment for each.

Your memo should include:

Organization-Appears neat and organized; logical; no spelling or grammar errors; guides the reader to the point(s).

Facts/Issues-States area being reviewed and identifies importance (“issue”) to a company.

Applicable Literature-Identifies all applicable literature. It is properly linked to the issue noted above. Citations are to adequate depth that it represents support, not the start of a new search.  Please remember, some areas have guidance in more than one area of ASC. Some topics have conflicting direction. These should all be identified.

Remember as you prepare your memo to be complete but concise.  Like most executives, the CFO has the attention span of an ant. Your goal is to get the key points summarize and supported, having a significant impact on the decision-making process.

Here is the list of topics developed in the brainstorming session:

1. Balance Sheet classifications
2. Valuation of Assets and Liabilities in an acquisition
3. Valuation accounts
4. Impairment of long-term assets
5. Contingent liabilities
6. Non-recurring items
7. Cash flow impact of refinancing
8. Related party transactions
9. Revenue recognition-over time (maintenance agreement)
10. Principal/Agent definition

You can answer any three BUT your answers must be in numerical order (eg. 4, 7, 10). DO NOT submit your answers out of order (eg. 7, 4 , 9).

Answer 1

4. Impairment of ling term assets

An impaired asset is an asset that has a market value less than the value listed on the company's balance sheet. When an asset is deemed to be impaired, it will need to be written down on the company's balance sheet to its current market value. Assets should be tested for impairment on a regular basis to prevent overstatement on the balance sheet. Assets that are most likely to become impaired include accounts receivable, as well as long-term assets such as intangibles and fixed assets. When an impaired asset's value is written down on the balance sheet, there is also a loss recorded on the income statement.

The total dollar value of an impairment is the difference between the asset’s carrying cost and the lower market value of the item. The journal entry to record an impairment is a debit to a loss, or expense, account and a credit to the related asset. A contra asset impairment account, which holds a balance opposite of the associated asset account, may be used for the credit in order to maintain the historical cost of the asset on a separate line item. In this situation, the net of the asset, its accumulated depreciation, and the contra asset impairment account reflect the new carrying cost. Upon recording the impairment, the asset has a reduced carrying cost. In future periods, the asset will be reported at its lower carrying cost.

Goodwill impairment is an accounting charge that is incurred when the fair value of goodwill drops below the previously recorded value from the time of an acquisition. A test for goodwill impairment aligned with generally accepted accounting principles (GAAP) must be undertaken, at a minimum, on an annual basis.

IAS 36 requires assets within its scope to be tested for impairment when indicators of impairment exist at the end of a reporting period (IAS 36.9). Many of the indicators of impairment noted in IAS 36.12(a)-(h) may exist due to the effects of COVID-19, including declines in quoted asset values, operational disruptions to supply chains, and decreases in revenue and profitability. Many entities will have to perform impairment calculations in accordance with IAS 36, and these calculations may need to be significantly more detailed than have been prepared at previous period ends.

5. Contingent liabilities

A contingent liability is a liability that may occur depending on the outcome of an uncertain future event. A contingent liability is recorded if the contingency is likely and the amount of the liability can be reasonably estimated. The liability may be disclosed in a footnote on the financial statements unless both conditions are not met.

Contingent liabilities are recorded to ensure that the financial statements are accurate and meet GAAP or IFRS requirements.

The requirements in IAS 37 do not apply in determining which contingent liabilities to recognise as of the acquisition date. Instead, the acquirer shall recognise as of the acquisition date a contingent liability assumed in a business combination if it is a present obligation that arises from past events and its fair value can be measured reliably. Therefore, contrary to IAS 37, the acquirer recognises a contingent liability assumed in a business combination at the acquisition date even if it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation.

At the inception of an executory contract, both parties to the contract expect to receive benefits that are equal to or greater than the costs to be incurred under the contract. Because of the impacts of COVID-19, unavoidable costs of meeting the obligations under the contract may exceed the benefits expected to be received, resulting in an onerous contract. IAS 37 Provisions, Contingent Liabilities, and Contingent Assets requires recognition of a provision in respect of an onerous contract.

6. Non recurring items

In accounting, a non-recurring item is an infrequent or abnormal gain or loss that is reported in the company’s financial statements. Unlike other items reported by a company, non-recurring items do not arise from the normal company’s operations. The items are generally caused by unusual and infrequent events that are not likely to happen again in the future.

Types of Non-Recurring Items

1. Discontinued operations: Relates to the disposal of a company’s segment or division distinct from the continuous company’s operations that generate recurring net income.
2. Extraordinary items: Non-recurring items that are both unusual and infrequent in their nature. The best example of extraordinary items is losses from natural disasters.
3. Unusual or infrequent items: Non-recurring items that are either unusual or infrequent in their nature. They include various items such as gains/losses on a sale of a subsidiary, restructuring costs, and asset impairments.
4. Changes in accounting policies: This refers to the company’s decision to voluntarily change its accounting policies or make changes in accounting principles that may change the values of certain recurring items reported by a company. The impact of the changes is recorded as a gain or loss.

Non-recurring items are reported by a company on the income statement. Depending on the type of item, it may be reported as before-tax or after-tax. Generally, unusual or infrequent items are reported before tax.