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MODULE 7A
SFAS 168—The FASB Accounting Standards Codification and the Hierarchy of Generally
Accepted Accounting Principles—A Replacement of FASB Statement No. 162 (ASC Topic 105)
A. Establishes the Codification as the single source of US GAAP for nongovernmental entities, except
for SEC authoritative literature which applies to SEC registrants
B. Content in SEC Sections of the Codification is provided for convenience and is not the complete SEC
literature.
Codification” and “Accounting Standards Codification” which will provide the candidate with the
appropriate study materials for both literature infobases. The Codification research database is
scheduled to be included on the CPA exam beginning January 1, 2011. Candidates testing before
January 1, 2011 will be tested on the standards in existence before the Codification became
effective.
Although GAAP is the current basis for financial reporting, it does not constitute a cohesive
body of accounting theory. Generally, SFAS and the other authoritative pronouncements have
been the result of a problem-by-problem approach. The pronouncements have dealt with specific
problems as they occur and are not predicated on an underlying body of theory.
Theory can be defined as a coherent set of hypothetical, conceptual, and pragmatic principles
forming a general frame of reference for a field of inquiry; thus, accounting theory should be the
basic principles of accounting rather than its practice (which GAAP describes or dictates).
Accounting has a definite need for conceptual theoretical structure. Such a structure is necessary
if an authoritative body such as the FASB is to promulgate consistent standards. A body of
accounting theory should be the foundation of the standard-setting process and should provide
guidance where no authoritative GAAP exists.
There have been efforts to develop such a frame of reference. The most recent attempt to
develop accounting theory led to the establishment of the Statements of Financial Accounting
Concepts (SFAC), of which seven have been issued. The purpose of this series is “to set forth
fundamentals on which financial accounting and reporting standards will be based.” In other
words, the SFAC attempt to organize a framework that can serve as a reference point in
formulating SFAS. However, it is important to note that the SFAC do not constitute authoritative
GAAP, and, therefore, are not included in the Codification. They merely serve as a theoretical
framework for the development of accounting standards.
MODULE 7D
ASC 2010-06
Module 7D, page 137
Disclosures about Fair Value Measures
1. For classes of assets measured at fair value on recurring basis
a. The fair value measurement at the reporting date
b. Identify level of hierarchy or measurements used, including
(1) Quoted prices in active markets for identical assets or liabilities (Level 1)
(2) Significant other observable inputs (Level 2)
(3) Significant unobservable inputs (Level)
c. The amounts of significant transfers between Level 1 and Level 2 of the hierarchy and the
reasons for the transfers
d. If Level 3 used, the effect of measurements on earnings for the period, purchases, sales,
issuances, and settlements, and amounts of any transfers in or out of Level 3 and the reasons
for the transfers are disclosed
2. The amount of total gains or losses that are attributable to the change in unrealized gains or losses
3. For fair value measurements using Level 2 and Level 3, a description of the valuation technique
used, changes in techniques, and reasons for the changes.
4. For equity and debt securities, class shall be determined on the basis of the nature and risks of the
investment
5. For assets and liabilities measured at fair values on a nonrecurring basis (i.e., impaired assets),
identify the following:
a. The fair value measurements used
b. The reasons for the measurements
c. The level within the hierarchy
d. A description of the inputs used for Level 3 measurements
e. The valuation techniques used
f. If Level 3 is used, the effect of measurements on earnings for the period, purchases, sales,
issuances, and settlements, and amounts of any transfers in or out of Level 3 and the reasons
for the transfers are disclosed.
6. Fair value measurement disclosures for each class of assets and liabilities often will require
greater disaggregation than the reporting entity’s line items in the statement of financial position.
The entity shall determine the appropriate classes on the basis of the nature of the risks of the
assets and liabilities and their classification in the fair value hierarchy.
MODULE 10
2. Derecognizes assets where control has been given up or lost, and liabilities where
extinguishment has occurred.
The chart below summarizes the accounting for the transfer of receivables.
Transfers of Receivables
No continuing Continuing
involvement involvement
Cash 1,600
Interest expense 400
Note payable 2,000
In these transactions, the “factor’s holdback” account provides a margin of protection against
sales discounts, sales returns and allowances, and disputed accounts. It may also be referred to as
“Due from factor” or “Receivable from factor.” Additionally, when a recourse obligation exists,
an amount is included as protection for the transferee against uncollectible accounts.
Accounting for transfers of participating interests. When a transfer of a participating
interest qualifies as a sale, the following accounting rules apply:
1. Allocate the carrying amount of the entire financial asset between the participating
interest sold and the participating interest that continues to be held by the transferor.
Relative fair values at the date of transfer are used to allocate the carrying amount.
2. Derecognize the participating interest(s) sold.
3. Recognize and measure at fair value servicing assets, servicing liabilities, and any other
assets obtained or liabilities incurred in the sale.
4. Recognize any gain or loss on the sale in earnings.
5. Report any participating interest or interests that continue to be held as the difference
between the previous carrying amount and the amount derecognized.
Interests that continue to be held. In most cases, the outright transfer of assets and/or
liabilities result(s) in changes in control that are obvious from the nature of the transaction.
Problems generally only occur when there is some sort of continuing involvement by the
transferor. Interests that continue to be held include undivided interests for which control has not
been given up by the transferor, servicing rights, recourse or guarantee arrangements, agreements
to purchase or redeem financial assets, pledges of collateral, and the transferor’s beneficial
interests in assets transferred. In general, the more interest in the assets the transferor retains, the
less likely the transaction will be classified as a sale. It will more likely be classified as a secured
borrowing. The basic principle is that in a sale, the transferor should give up control of the asset.
Interests in assets that continue to be held by the transferor (retained interests) are measured
at their previous carrying value before the transfer through an allocation at the date of sale based
on relative fair values of the assets sold and the assets retained. It should be noted that this fair
value allocation may result in a relative change in basis unless the fair values are proportionate to
their carrying values. Thus, the gain or loss from any sale component could also be affected.
6 Update to 2010 Financial Accounting and Reporting
For servicing assets and liabilities subsequently measured at fair value, disclosures must also
be provided showing the beginning and end balances, additions, disposals, and changes in fair
value inputs or assumptions used, and changes in fair value.
For servicing assets and liabilities that use the amortization method, disclosures must include
the beginning and ending balances, additions, disposals, amortization, application of valuation
allowance to adjust carrying value, other than temporary impairments, and other changes that
affect the balance, as well as a description of the changes. In addition, the fair value at the
beginning and end of each period should be disclosed if practicable to estimate the value. The risk
characteristics of the underlying financial assets used for measuring impairment should be
disclosed. The activity in the valuation account, including beginning and ending balances,
recoveries made, and write-downs charged against the allowance for each period should also be
disclosed.
Securitizations. Securitization is the transformation of financial assets into securities (asset-
backed securities). Various assets including mortgages, credit cards, trade receivables, loans, and
leases are grouped and securitized. These groupings of relatively homogeneous assets are then
pooled and divided into securities with cash-flows that can be quite different from those of the
original assets. With an established market, most of these securities cost less than the alternative
use of the assets as collateral for borrowing. Thus, the benefits of most securitizations include
lower financing costs, increased liquidity, and lower credit risk.
The transferor (also called issuer or sponsor) forms a securitization mechanism to buy the
assets and to issue the securities. Sometimes, another transfer is made to a trust and the trust
issues the securities. These different structures are generally referred to as one-tier or two-tier.
The securitization mechanism then generates beneficial interests in the assets or resulting cash
flows which are sold. The form of the securities chosen depends on such things as the nature of
the assets, income tax considerations, and returns to be received.
Payments by the securitization mechanism are usually classified as pay-through, pass-
through, or revolving-period. In a pay-through, cash flows from the assets pay off the debt
securities. The assets are essentially collateral. In a pass-through, undivided interests are issued
and the investors share in the net cash flows. In a revolving-period, undivided interests are
issued, but until liquidation, the net cash flows are split between buying additional assets and
paying off investors.
Various financial components arise from securitizations. Examples include servicing
contracts, interest-only strips, retained interests, recourse obligations, options, swaps, and forward
contracts. All controlled assets and liabilities must be recognized.
EXAMPLE: Sale of loans
Facts given:
Loan’s fair value $16,500
Loan’s book value 15,000
Fair value of recourse obligation (900)
Fair value of call option 800
Fair value of interest rate swap 700
1. Sale with recourse obligation, call and swap (seller provides floating interest rate return although the
basic sale is at fixed interest rate terms).
Journal entry
Cash 16,500
Call option 800
Interest rate swap 700
Loans 15,000
Recourse obligation 900
Gain 2,100
Update to 2010 Financial Accounting and Reporting 9
2. Partial sale with recourse obligation, call and swap. Seller sells 80% of loans.
Allocated Allocated
FV 80% FV 20% FV 80% BV 20% BV
Cash $16,500 $13,200 $12,000
Call option 800 640
Interest rate swap 700 560
Resource obligation (900) (720)
Retained amount (20%) _____ _____ $3,420 _____ $3,000
$17,100 $13,680 $3,420 $12,000 $3,000
Journal entry
Cash 13,200
Call option 640
Interest rate swap 560
Loans 12,000
Recourse obligation 720
Gain 1,680
Seller reports retained amount at $3,000.
The transferor generally desires for the assets to be taken off the balance sheet. This result
can be accomplished if the transaction results in a sale. The key criterion in this case is to be sure
that the assets are beyond control of the transferor even in bankruptcy.
Accounting for collateral. The method of accounting for a collateral agreement depends
both on control of the assets and on the liabilities incurred under the agreement. Ordinarily, the
transferor should carry the collateral as an asset and the transferee should not record the pledged
asset.
If the transferee, however, has control, the secured party should record the asset at fair value
and also the liability to return it. The transferor-debtor should reclassify the asset (probably as a
receivable) and report it separately in the balance sheet. If the debtor’s rights to the collateral are
impaired by the transferee’s sale or repledge of the collateral, the secured party should recognize
the proceeds and also the liability to return the collateral to the extent it hasn’t done so.
If the transferor defaults and is not entitled to the return of the collateral, it should be
derecognized. If not already recognized, the transferee should record its asset at fair value.
MODULE 19
GASB 54
Update to Module 19, page 814
GASB 54 provides guidance on how fund balances should be segregated in the financial
statements. Note that fund balances are segregated into nonspendable, restricted, committed,
assigned and unassigned balances. The nonspendable fund balance classification includes amounts
that cannot be spent because they are either not in spenable form, or they are legally or contractually
required to be maintained intact. Items that are not in spendable form are those that are not expected
to be converted to cash, such as inventories and prepaid amounts. It also includes the noncurrent
portion of long-term receivables and property held for resale unless proceeds are restricted,
committed or assigned, and amounts that must be maintained intact legally or contractually, such as
the principal of a permanent fund. Restricted fund balances are those restricted by agreement with
creditors, grantors, or by law and regulation. Committed fund balances are those that can only be
used for specific purposes based on action by the government’s highest level of decision-making
authority. The assigned category includes amounts that are constrained by the government’s intent to
be used from the general fund for a specific purpose but are neither committed nor restricted. It also
includes any positive amounts that are not classified as nonspendable, restricted, or committed in
funds other than the general fund. Finally, the unassigned fund balance is the residual classification
for the general fund. The balance sheet or the notes to the financial statements would have to show
the details of the items in each of the 5 categories of funds.
10 Update to 2010 Financial Accounting and Reporting
GASB 58
Going concern considerations. The guidance regarding going concern for state and local
governments is similar to that for commercial business under GAAP. The financial reporting model
assumes that the entity will be a going concern for a reasonable period of time (i.e., 12 months from
the financial statement date). Indicators that there may be substantial doubt about the entity’s ability
to continue as a going concern include
1. Negative trends (e.g., recurring losses).
2. Other indicators of financial difficulties (e.g., defaults on loan agreements).
3. Internal matters (e.g., work stoppages).
4. External matters (e.g., legal proceedings).
If it is determined that there is substantial doubt about a governmental entity’s ability to continue
as a going concern for a reasonable period of time, the notes to the financial statements should
disclose details of the sources of the concerns and the government official’s plan for dealing with
those concerns.
GASB Statement No. 58 provides guidance when a governmental unit has been granted relief un-
der the provisions of Chapter 9 of the US Bankruptcy Code. The standard provides that assets and
liabilities should be remeasured in accordance with the court’s Plan of Adjustment. In addition, the
statement requires disclosure of the details of the bankruptcy and how users can obtain a copy of the
Plan of Adjustment.