CPA Exam: Related Events
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BEC Study Notes 1
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BEC - Notes Chapter 1 http://cpacfa.blogspot.com Sole Proprietorship and Joint Venture Sole Proprietorship • Filing not required - simplest form of business ownership • Sole proprietor not considered a separate entity from the business, so will have to personally file for bankruptcy • Personally liable for all obligations of the business • Life of entity limited to the life of the sole proprietor • Sole proprietor can transfer interests at will Joint Ventures An association of persons or entities for a single transaction or project. JV's are treated as a partnership (P/S) General Partnership General Partnership - an association of two or more persons who agree to carry on as co-owners of an ongoing business for profit • Filing not required • At least two owners of the partnerships • Personally liable for all obligations of the business • A partnership may be dissolved after a partner dies or otherwise dissociates from the partnership unless the partners have agreed otherwise, or vote to continue the partnership • Taxes flow through the P/S to the partners (taxed at their rates) • A partner cannot transfer his P/S interest without unanimous consent of the other partners • A general P/S may file for bankruptcy as a separate entity In a general P/S • All partners are general partners • All partners share equally in mgmt, profits and losses unless agreed otherwise (even when capital contributions are not equal) • Within the ordinary course of business a majority vote is needed • Matters outside the ordinary course of business require unanimous consent - Admitting new partners - Confessing a judgement or submitting a claim for arbitration - Making a fundamental change in the business (sale of goodwill) - Changing the P/S agreement - Assignment of P/S property to others • All partners have unlimited personal liability for obligations of the P/S • All partners (individually) have the actual or apparent authority to bind the P/S with respect to all normal partnership business transaction (except when a third party knows the partner lacks actual authority) - Actual authority - all authority that a principal expressively gives to an agent plus any authority that is reasonable implied from the express grant (Partner is store manager, reasonable to imply the partner has the authority to hire employees, buy merchandise, etc) - Apparent authority extends only to the ordinary course of business (sign a lease, hire/fire employees, purchasing equipment, granting warranties) - The P/S may ratify an unauthorized act (if the P/S likes an unauthorized act by partner) • All partners must approve major business decisions • A partner who acts outside the scope of his actual authority will be liable to the P/S for any damages caused by the unauthorized act (breach of contract) 1 BEC - Notes Chapter 1 http://cpacfa.blogspot.com Intent to form a P/S (either Express, orally or in writing, or Implied, in conduct) is the key to general P/S formation. No express agreement is necessary. An agreement can be implied from conduct showing intent to enter into a business for profit together. However, if the P/S wants to exist for mare than a year, an agreement is required under the statue of frauds Dissociation (P/S may or may not continue) of a partner does not necessarily cause a dissolution (business it wound up and then terminated) Events of a dissociation: • A partner wants to withdraw • An event set forth in the P/S agreement that causes a dissociation • A partner is expelled by unanimous vote • A partner becomes a debtor in bankruptcy • A partner dies When a partner dissociates actual authority ends but apparent authority continues for two years until 3rd party is given notice. For debts prior to dissociation, partners remain liable unless released by creditors (novation) For debts incurred after dissociation, partners are not liable if notice is filled with the state or each 3rd party Liability of an incoming partner is limited to financial contribution to P/S for debts prior to his/her arrival, and is personally liable of all debts incurrent by the partnership after he becomes a partner Events that may cause a dissolution: • A partner withdraws • A P/S lasts for a specified length of time • An event set forth in the P/S agreement that causes a dissolution • Issuance of judicial decree on application of a partner • Issuance of a judicial decree on application of a transferee Distribution of assets • Step 1: Liquidate assets • Step 2: Pay creditors (insiders or outsiders); if the liquidation of assets do not cover the costs to pay the creditors, then the losses are split • Step 3: If there is leftover after paying creditors, return capital to partners or split losses • Step 4: If there is anything left, divide profits Financial Structure of a general partnership • Partners are not required to make any particular contribution to their P/S • Unless otherwise agreed, partners are required to devote themselves full-time and are not entitled to remuneration (salary) • As a general rule, partners have no right to use P/S property for anything other than P/S business • Partners do not have the right to assign P/S property • An individual partner's creditors can not use P/S property to settle debts (credit card debt can't be settled with P/S property) • Partners right in a P/S do not pass to his estate • P/S interest is completely different that P/S Property - Interest in P/S (profit and losses) is assignable, but no mgmt right come with the assignment 2 BEC - Notes Chapter 1 http://cpacfa.blogspot.com - Individual's creditors may go after the P/S interest, not the P/S property - P/S interest is passes on to a partners heirs Partners are generally liable for all contracts entered into and all torts committed by other partners within the scope of the P/S business The partners' liability is joint and several for the entire amount. Meaning if the other partners flee the country, you are liable for all P/S obligations Limited Liability P/S A limited liability P/S (LLP) is similar to a G/P in most respects, including sharing of profits/losses, and all the general advantages and disadvantages of a G/P Differences • Not personally liable for debts of the P/S or acts/torts committed by another partner, employee or agent, but you can lose your investment. But you are still liable for your own acts\ • Must file with the sate Limited Partnership • Is comprised of at least 1 general partner who manages the business and is personally liable (for all P/S debts) and at least one limited partner (whose liability is limited to capital contribution) • Unanimous consent required for either the GP or LP to sell their interest, or a new partner be added • Partners must make some type of capital contribution • Absent an agreement, profit and loss allocation is based on capital contribution • A LP is like a shareholder, no control power, may assign interest, does not owe fiduciary duty, is not an agent, has not apparent authority • A LP may be dissolved by - Occurrence of time or stated time in the P/S agreement - Written consent of all general partners - Withdrawal or death of a general partner - Judicial decree • A LP has a right to vote on fundamental changes, inspect the P/S books, transact business with P/S, bring derivative action • A LP can lose limited liability is they do any 1 of the following - Serve as a general partner - Allowing name to be used in P/S name - Participate in control (3rd party has reason to believe that the LP is a general partner) A limited partnership and corporation are both created under a state statute and require filing with the state Limited Liability Company/Corporation • Must file with the state articles of organization which includes - A statement that the entity is an LLC - The name of the LLC - The address of the LLC's registered office and registered agent (usually a corporate lawyer) - Statement about management duties, otherwise all share equally in mgmt [Similar to articles of incorporation except there is no stock information] • The owners or members are not personally liable for the obligations of the company • Income flows through to members 3 BEC - Notes Chapter 1 http://cpacfa.blogspot.com • • • • • • • Members may not sell ownership interest in the LLC without consent of other members All members have right to manage, but may adopt agreement to centralize management (manager managed) Like a corporation an LLC is a distinct legal entity, it can own land, sue, file for bankruptcy Each member is an agent and has the actual and apparent authority to bind the LLC. Members owe a fiduciary duty If the LLC is Manager managed, each manager is an agent, but the other members are not agents and does not have the power to bind the LLC Voting strength based on capital, ownership interest [while in GP, LLP, LP voting strength is equal unless agreed otherwise] Events that may cause a termination or dissolution [similar to a GP]: • Consent of all members • A partner withdraws, death, retirement, bankruptcy (this cause dissociation and may lead to dissolution] • A P/S lasts for a specified length of time • An event set forth in the P/S agreement that causes a dissolution • Issuance of judicial decree Profit and loss allocated based on members contributions Corporation • Must file with state called articles of incorporation - Name of corporation - Name and addresses of the corporations registered agent - Name and addresses of each of the incorporators - Number of shares authorized to be issued - One of more classes of shares must have unlimited voting rights • Directors are elected by shareholders, directors select executive officers to manage day-to-day operations • Stockholders, directors, and officers are not personally liable for obligations of the corporation (just lose investment), but may be liable for torts the individual commits • Perpetual life, can continue after the death of resignation of owners or managers • Stock holders free to transfer ownership interest whenever they want to whomever they want\ C Corp - double taxation (if income is distributed to stockholders), corporate tax rates lower than personal rates S Corp - taxed like a partnership, flowthrough; however there are restrictions on S Corps - Stock can not be held by more than 100 persons - Shareholders must be individuals, estates or certain trusts - The corporation must be domestic - Can only be one class of stock - Foreign shareholders are generally prohibited Certain types of businesses (insurance companies and savings institutions) cannot file for bankruptcy regardless of what type of entity they are formed as Most aspects of corporate law are governed by state law, but some aspects (federal tax, securities regulation) are governed by federal law. The state statue is called Revised Model Business Corporation Act (RMBCA) Promoters, who raise capital for the corporation, enter into contracts with third parties who are interested in becoming shareholders (stock subscription) - Promoters are generally personally liable on the contracts (B1-33 more detail on this) 4 BEC - Notes Chapter 1 http://cpacfa.blogspot.com - Even if the corporation adopts a promoters contract, the promoter remains liable unless the promoter is released by the third party (novation) Ultra Vires Act - If the corporation has a narrow purpose cause (some states do not require it) and the corporation undertakes business outside the clause, it is said to be acting "ultra vires" and may effect the firm. • A shareholder may seek an injunction (order from the court) prohibiting the corp from the action • The corp or shareholders may sue to recover damager from the directors or officers who authorized the ultra vires act • The state (usually the attorney general) may bring an action to have the corp dissolved for committing the act Bylaws - rules for running the entity. They are not part of the articles of incorporation and are not required to be filed with the state • Bylaws may not contain rules that conflict with the articles of incorporation • Can be amended by board of directors or the shareholders De jure - all of the requirements for incorporation are met and it will be recognized for all purposes De facto corporation doctrine - requirements for incorporation are not met, but the business might still be treated as a corporation, if the incorporators made a good faith attempt to incorporate and operated as if they had incorporated, the business will be treated as a corporation in all aspects Doctrine of incorporate Estoppel - requirements for incorporation are not met, but the business might still be treated as a corporation, if a party who treats a business as if it were a validly formed corporation will be estopped (legally barred) from claiming in a legal proceeding that the corporation was not validly formed [if the 3rd party reasonably believes that they were dealing with a corp {not fraud}, then the party can not claim the corp was not valid] Defective corporation - entity did not make a good faith attempt to incorporate so shareholders are personally liable Piercing the corporate veil - courts hold shareholders, officers or directors, active in operation of the business, of a de jure (properly formed) corporation will be held liable (because the legislative privilege of conducting business is being abused). There are three reasons the corporate veil will be pierced: 1. Commingling personal funds with corporate funds 2. Inadequate capitalization - corporation is under capitalized at the time of formation 3. Committing fraud on existing creditors - if the corporation was formed to defraud existing personal creditors Foreign corporation - a corporation not incorporated within the state (Cali corp going to NY to do business) Domestic corporation - incorporated within the state A foreign corporation may not transact business (maintain an office within the state or conduct regular intrastate business) within a state it has registered with the state and has obtained a certificate of authority. [So you don't need to file twice for incorporation] Quorum - a majority in attendance, so if there are 10 board members, 6 must be present at a meeting to have a quorum Operation of a corporation • A corporation only needs only one director 5 BEC - Notes Chapter 1 http://cpacfa.blogspot.com • The articles of incorporation usually name the initial director, who hold office until the first annual meeting. • Directors may be removed by shareholder vote with or without cause • Director's meetings are only valid if a quorum is present, and action may be taken with a majority of vote of those present, so if 4 of the 6 approve the action, it would be valid • Individually, directors have no right or power to act, they are not agents, they owe a fiduciary duty • Directors may not vote by proxy, must be there physically • Individually, officers have powers, they are agents and have fiduciary duties Fundamental changes require both board and shareholder approval, examples are: • Amendments to the articles of incorporation • Mergers A+B=A; both A&B's boards and shareholders must approve the fundamental change • Consolidations A+B=C; both A&B's boards and shareholders must approve the fundamental change • Share exchanges A acquires all the outstanding shares of B; A needs only the board approval, B's boards and shareholders must approve the fundamental change • Sale of all or substantially all of the corporations assets (purchasing company, buy side, only needs board approval) • Dissolutions - termination of corporate existence (could be involuntary through judicial proceedings) Procedures for fundamental changes 1. Board adopts resolution by majority vote, setting forth the proposed action for shareholder approval 2. Notice to shareholders given whether they are entitled to vote 3. Eligible shareholders vote, need majority 4. Filing of articles, setting forth the action taken, with the state Merger of a subsidiary (parent owning 90% or more of a subsidiary) - Parent needs only boards approval. Parent's board makes decision unilaterally Authorized shares - shares described in the articles of incorporation Outstanding shares - authorized shares issues to shareholders Treasury shares - outstanding shares repurchases by the corporation Par value - minimum price the stock can be issued for legally (to ensure the corporation would be capitalized to a certain level Under RMBCA, board of directors can issue the stock price at any level and be issued in exchange for any benefit to the corporation (services rendered, services to be performed, real estate, etc) If property is accepted for stock, the board must value the land in good faith Unpaid stock - a subscriber has promised, but failed, to pay for stock, the subscriber may be liabel to either the corporation or its creditors Watered stock - stock that has been issued in exchange for property worth less than the part value A corporation has no obligation to allocate profits and losses to among shareholders. However, if dividends are declared by the board of directors, shareholders are treated as unsecured creditors Cumulative Preferred shares - gets paid dividends in arrears. Gets paid before noncumulative preferred 6 BEC - Notes Chapter 1 http://cpacfa.blogspot.com Noncumulative Preferred shares - gets paid before common stockholders, if a dividend is declared but not paid within the year, the noncumulative shares lose out Stock dividends - authorized shares owned by the corporation but unissued, because no assets are issued, shareholder do not owe federal taxes Cumulative voting - each share is entitled to one vote for each director position being filled in any way, so can cast all votes for one single candidate (protects minority shareholder) B1-46 example of cumulative voting Shareholders may vote only is a quorum is present, and they may vote by proxy (appointment valid for 11 months) Shareholders may enter into several agreements to protect voting power • Voting trust - all shared owned by the party are transferred to a trustee, who votes and distributed dividends in accordance with provisions of the voting trust • Voting agreements - less formalistic, shareholders simple agree among themselves to vote a certain way Shareholders in small corporations (closely held corporations) can put restriction on the transfer of stock, but they can not put an absolute bar against selling shares. Examples of restrictions include: • Right of first refusal - giving specified persons the option to buy shares before selling to an outsider • Requiring that specified persons approve the transfer of stock • Prohibiting the transferring of shares to a certain type of persons, such as competitors Shareholders have the right to inspect the books and records upon request if its for a proper purpose. Improper purposes to personally benefit the inspecting shareholder include obtaining the contact information of shareholders to create a commercial mailing list Pre-emptive rights - the right to purchase additional shares to maintain their proportionate voting strength. No pre-emptive right unless articles of incorporation provide for them Dissenting shareholder - vote on a fundamental change and lose. The shareholder may dissent and demand that the corporation pay them fair value of their shares (buy them out) Derivative action - the corporation has legal cause of action but refuses to bring action, the shareholder may that the right to bring derivative action to enforce the corporations rights if three prerequisites are met: 1. Shareholder must have been a shareholder during time of the alleged wrong 2. The shareholder must be suing in the best interests of the corporation 3. The shareholder must have made a demand on the board Board of directors • Job to initiate fundamental changes • Declare dividends • Uses good faith (talks and relies on the officers, auditors, consultants to make decisions) • Should not profit from material inside information • Can not serve on the board of a competitor • Should disclose conflicts of interest and abstain from voting - Only liable of the deal is unfair and causes damage to the corporation • Directors may remove officers with or without cause. The removal can occur even if it breaches the officers' contract, but the corporation may be liable for damages (not the stockholders or directors) 7 BEC - Notes Chapter 1 http://cpacfa.blogspot.com Corporations are allowed to indemnify (repay) directors for expenses for any lawsuit (for accidents or negligence, not intentional torts) brought against them in their corporate capacity Limitation on director's liability - breach of fiduciary duty intentional act • Financial benefits received by the director for which he was not entitled • Intentional harm inflicted upon the corporation or shareholders • Unlawful distributions authorized by the director (pay dividends which renders the corp. insolvent) • Intentional violations of criminal law • Breaches of duty of loyalty For tax purposes, if a company desires a fiscal year (instead of calendar year), that year end must be approves by the IRS Corporations may defer taxes, up to three months, by switching from calendar year end to fiscal year end, must be approves by IRS 8
BEC - Notes Chapter 1 http://cpacfa.blogspot.com Sole Proprietorship and Joint Venture Sole Proprietorship • Filing not required - simplest form of business ownership • Sole proprietor not considered a separate entity from the business, so will have to personally file for bankruptcy • Personally liable for all obligations of the business • Life of entity limited to the life of the sole proprietor • Sole proprietor can transfer interests at will Joint Ventures An association of persons or entities for a single transaction or project. JV's are treated as a partnership (P/S) General Partnership General Partnership - an association of two or more persons who agree to carry on as co-owners of an ongoing business for profit • Filing not required • At least two owners of the partnerships • Personally liable for all obligations of the business • A partnership may be dissolved after a partner dies or otherwise dissociates from the partnership unless the partners have agreed otherwise, or vote to continue the partnership • Taxes flow through the P/S to the partners (taxed at their rates) • A partner cannot transfer his P/S interest without unanimous consent of the other partners • A general P/S may file for bankruptcy as a separate entity In a general P/S • All partners are general partners • All partners share equally in mgmt, profits and losses unless agreed otherwise (even when capital contributions are not equal) • Within the ordinary course of business a majority vote is needed • Matters outside the ordinary course of business require unanimous consent - Admitting new partners - Confessing a judgement or submitting a claim for arbitration - Making a fundamental change in the business (sale of goodwill) - Changing the P/S agreement - Assignment of P/S property to others • All partners have unlimited personal liability for obligations of the P/S • All partners (individually) have the actual or apparent authority to bind the P/S with respect to all normal partnership business transaction (except when a third party knows the partner lacks actual authority) - Actual authority - all authority that a principal expressively gives to an agent plus any authority that is reasonable implied from the express grant (Partner is store manager, reasonable to imply the partner has the authority to hire employees, buy merchandise, etc) - Apparent authority extends only to the ordinary course of business (sign a lease, hire/fire employees, purchasing equipment, granting warranties) - The P/S may ratify an unauthorized act (if the P/S likes an unauthorized act by partner) • All partners must approve major business decisions • A partner who acts outside the scope of his actual authority will be liable to the P/S for any damages caused by the unauthorized act (breach of contract) 1 BEC - Notes Chapter 1 http://cpacfa.blogspot.com Intent to form a P/S (either Express, orally or in writing, or Implied, in conduct) is the key to general P/S formation. No express agreement is necessary. An agreement can be implied from conduct showing intent to enter into a business for profit together. However, if the P/S wants to exist for mare than a year, an agreement is required under the statue of frauds Dissociation (P/S may or may not continue) of a partner does not necessarily cause a dissolution (business it wound up and then terminated) Events of a dissociation: • A partner wants to withdraw • An event set forth in the P/S agreement that causes a dissociation • A partner is expelled by unanimous vote • A partner becomes a debtor in bankruptcy • A partner dies When a partner dissociates actual authority ends but apparent authority continues for two years until 3rd party is given notice. For debts prior to dissociation, partners remain liable unless released by creditors (novation) For debts incurred after dissociation, partners are not liable if notice is filled with the state or each 3rd party Liability of an incoming partner is limited to financial contribution to P/S for debts prior to his/her arrival, and is personally liable of all debts incurrent by the partnership after he becomes a partner Events that may cause a dissolution: • A partner withdraws • A P/S lasts for a specified length of time • An event set forth in the P/S agreement that causes a dissolution • Issuance of judicial decree on application of a partner • Issuance of a judicial decree on application of a transferee Distribution of assets • Step 1: Liquidate assets • Step 2: Pay creditors (insiders or outsiders); if the liquidation of assets do not cover the costs to pay the creditors, then the losses are split • Step 3: If there is leftover after paying creditors, return capital to partners or split losses • Step 4: If there is anything left, divide profits Financial Structure of a general partnership • Partners are not required to make any particular contribution to their P/S • Unless otherwise agreed, partners are required to devote themselves full-time and are not entitled to remuneration (salary) • As a general rule, partners have no right to use P/S property for anything other than P/S business • Partners do not have the right to assign P/S property • An individual partner's creditors can not use P/S property to settle debts (credit card debt can't be settled with P/S property) • Partners right in a P/S do not pass to his estate • P/S interest is completely different that P/S Property - Interest in P/S (profit and losses) is assignable, but no mgmt right come with the assignment 2 BEC - Notes Chapter 1 http://cpacfa.blogspot.com - Individual's creditors may go after the P/S interest, not the P/S property - P/S interest is passes on to a partners heirs Partners are generally liable for all contracts entered into and all torts committed by other partners within the scope of the P/S business The partners' liability is joint and several for the entire amount. Meaning if the other partners flee the country, you are liable for all P/S obligations Limited Liability P/S A limited liability P/S (LLP) is similar to a G/P in most respects, including sharing of profits/losses, and all the general advantages and disadvantages of a G/P Differences • Not personally liable for debts of the P/S or acts/torts committed by another partner, employee or agent, but you can lose your investment. But you are still liable for your own acts\ • Must file with the sate Limited Partnership • Is comprised of at least 1 general partner who manages the business and is personally liable (for all P/S debts) and at least one limited partner (whose liability is limited to capital contribution) • Unanimous consent required for either the GP or LP to sell their interest, or a new partner be added • Partners must make some type of capital contribution • Absent an agreement, profit and loss allocation is based on capital contribution • A LP is like a shareholder, no control power, may assign interest, does not owe fiduciary duty, is not an agent, has not apparent authority • A LP may be dissolved by - Occurrence of time or stated time in the P/S agreement - Written consent of all general partners - Withdrawal or death of a general partner - Judicial decree • A LP has a right to vote on fundamental changes, inspect the P/S books, transact business with P/S, bring derivative action • A LP can lose limited liability is they do any 1 of the following - Serve as a general partner - Allowing name to be used in P/S name - Participate in control (3rd party has reason to believe that the LP is a general partner) A limited partnership and corporation are both created under a state statute and require filing with the state Limited Liability Company/Corporation • Must file with the state articles of organization which includes - A statement that the entity is an LLC - The name of the LLC - The address of the LLC's registered office and registered agent (usually a corporate lawyer) - Statement about management duties, otherwise all share equally in mgmt [Similar to articles of incorporation except there is no stock information] • The owners or members are not personally liable for the obligations of the company • Income flows through to members 3 BEC - Notes Chapter 1 http://cpacfa.blogspot.com • • • • • • • Members may not sell ownership interest in the LLC without consent of other members All members have right to manage, but may adopt agreement to centralize management (manager managed) Like a corporation an LLC is a distinct legal entity, it can own land, sue, file for bankruptcy Each member is an agent and has the actual and apparent authority to bind the LLC. Members owe a fiduciary duty If the LLC is Manager managed, each manager is an agent, but the other members are not agents and does not have the power to bind the LLC Voting strength based on capital, ownership interest [while in GP, LLP, LP voting strength is equal unless agreed otherwise] Events that may cause a termination or dissolution [similar to a GP]: • Consent of all members • A partner withdraws, death, retirement, bankruptcy (this cause dissociation and may lead to dissolution] • A P/S lasts for a specified length of time • An event set forth in the P/S agreement that causes a dissolution • Issuance of judicial decree Profit and loss allocated based on members contributions Corporation • Must file with state called articles of incorporation - Name of corporation - Name and addresses of the corporations registered agent - Name and addresses of each of the incorporators - Number of shares authorized to be issued - One of more classes of shares must have unlimited voting rights • Directors are elected by shareholders, directors select executive officers to manage day-to-day operations • Stockholders, directors, and officers are not personally liable for obligations of the corporation (just lose investment), but may be liable for torts the individual commits • Perpetual life, can continue after the death of resignation of owners or managers • Stock holders free to transfer ownership interest whenever they want to whomever they want\ C Corp - double taxation (if income is distributed to stockholders), corporate tax rates lower than personal rates S Corp - taxed like a partnership, flowthrough; however there are restrictions on S Corps - Stock can not be held by more than 100 persons - Shareholders must be individuals, estates or certain trusts - The corporation must be domestic - Can only be one class of stock - Foreign shareholders are generally prohibited Certain types of businesses (insurance companies and savings institutions) cannot file for bankruptcy regardless of what type of entity they are formed as Most aspects of corporate law are governed by state law, but some aspects (federal tax, securities regulation) are governed by federal law. The state statue is called Revised Model Business Corporation Act (RMBCA) Promoters, who raise capital for the corporation, enter into contracts with third parties who are interested in becoming shareholders (stock subscription) - Promoters are generally personally liable on the contracts (B1-33 more detail on this) 4 BEC - Notes Chapter 1 http://cpacfa.blogspot.com - Even if the corporation adopts a promoters contract, the promoter remains liable unless the promoter is released by the third party (novation) Ultra Vires Act - If the corporation has a narrow purpose cause (some states do not require it) and the corporation undertakes business outside the clause, it is said to be acting "ultra vires" and may effect the firm. • A shareholder may seek an injunction (order from the court) prohibiting the corp from the action • The corp or shareholders may sue to recover damager from the directors or officers who authorized the ultra vires act • The state (usually the attorney general) may bring an action to have the corp dissolved for committing the act Bylaws - rules for running the entity. They are not part of the articles of incorporation and are not required to be filed with the state • Bylaws may not contain rules that conflict with the articles of incorporation • Can be amended by board of directors or the shareholders De jure - all of the requirements for incorporation are met and it will be recognized for all purposes De facto corporation doctrine - requirements for incorporation are not met, but the business might still be treated as a corporation, if the incorporators made a good faith attempt to incorporate and operated as if they had incorporated, the business will be treated as a corporation in all aspects Doctrine of incorporate Estoppel - requirements for incorporation are not met, but the business might still be treated as a corporation, if a party who treats a business as if it were a validly formed corporation will be estopped (legally barred) from claiming in a legal proceeding that the corporation was not validly formed [if the 3rd party reasonably believes that they were dealing with a corp {not fraud}, then the party can not claim the corp was not valid] Defective corporation - entity did not make a good faith attempt to incorporate so shareholders are personally liable Piercing the corporate veil - courts hold shareholders, officers or directors, active in operation of the business, of a de jure (properly formed) corporation will be held liable (because the legislative privilege of conducting business is being abused). There are three reasons the corporate veil will be pierced: 1. Commingling personal funds with corporate funds 2. Inadequate capitalization - corporation is under capitalized at the time of formation 3. Committing fraud on existing creditors - if the corporation was formed to defraud existing personal creditors Foreign corporation - a corporation not incorporated within the state (Cali corp going to NY to do business) Domestic corporation - incorporated within the state A foreign corporation may not transact business (maintain an office within the state or conduct regular intrastate business) within a state it has registered with the state and has obtained a certificate of authority. [So you don't need to file twice for incorporation] Quorum - a majority in attendance, so if there are 10 board members, 6 must be present at a meeting to have a quorum Operation of a corporation • A corporation only needs only one director 5 BEC - Notes Chapter 1 http://cpacfa.blogspot.com • The articles of incorporation usually name the initial director, who hold office until the first annual meeting. • Directors may be removed by shareholder vote with or without cause • Director's meetings are only valid if a quorum is present, and action may be taken with a majority of vote of those present, so if 4 of the 6 approve the action, it would be valid • Individually, directors have no right or power to act, they are not agents, they owe a fiduciary duty • Directors may not vote by proxy, must be there physically • Individually, officers have powers, they are agents and have fiduciary duties Fundamental changes require both board and shareholder approval, examples are: • Amendments to the articles of incorporation • Mergers A+B=A; both A&B's boards and shareholders must approve the fundamental change • Consolidations A+B=C; both A&B's boards and shareholders must approve the fundamental change • Share exchanges A acquires all the outstanding shares of B; A needs only the board approval, B's boards and shareholders must approve the fundamental change • Sale of all or substantially all of the corporations assets (purchasing company, buy side, only needs board approval) • Dissolutions - termination of corporate existence (could be involuntary through judicial proceedings) Procedures for fundamental changes 1. Board adopts resolution by majority vote, setting forth the proposed action for shareholder approval 2. Notice to shareholders given whether they are entitled to vote 3. Eligible shareholders vote, need majority 4. Filing of articles, setting forth the action taken, with the state Merger of a subsidiary (parent owning 90% or more of a subsidiary) - Parent needs only boards approval. Parent's board makes decision unilaterally Authorized shares - shares described in the articles of incorporation Outstanding shares - authorized shares issues to shareholders Treasury shares - outstanding shares repurchases by the corporation Par value - minimum price the stock can be issued for legally (to ensure the corporation would be capitalized to a certain level Under RMBCA, board of directors can issue the stock price at any level and be issued in exchange for any benefit to the corporation (services rendered, services to be performed, real estate, etc) If property is accepted for stock, the board must value the land in good faith Unpaid stock - a subscriber has promised, but failed, to pay for stock, the subscriber may be liabel to either the corporation or its creditors Watered stock - stock that has been issued in exchange for property worth less than the part value A corporation has no obligation to allocate profits and losses to among shareholders. However, if dividends are declared by the board of directors, shareholders are treated as unsecured creditors Cumulative Preferred shares - gets paid dividends in arrears. Gets paid before noncumulative preferred 6 BEC - Notes Chapter 1 http://cpacfa.blogspot.com Noncumulative Preferred shares - gets paid before common stockholders, if a dividend is declared but not paid within the year, the noncumulative shares lose out Stock dividends - authorized shares owned by the corporation but unissued, because no assets are issued, shareholder do not owe federal taxes Cumulative voting - each share is entitled to one vote for each director position being filled in any way, so can cast all votes for one single candidate (protects minority shareholder) B1-46 example of cumulative voting Shareholders may vote only is a quorum is present, and they may vote by proxy (appointment valid for 11 months) Shareholders may enter into several agreements to protect voting power • Voting trust - all shared owned by the party are transferred to a trustee, who votes and distributed dividends in accordance with provisions of the voting trust • Voting agreements - less formalistic, shareholders simple agree among themselves to vote a certain way Shareholders in small corporations (closely held corporations) can put restriction on the transfer of stock, but they can not put an absolute bar against selling shares. Examples of restrictions include: • Right of first refusal - giving specified persons the option to buy shares before selling to an outsider • Requiring that specified persons approve the transfer of stock • Prohibiting the transferring of shares to a certain type of persons, such as competitors Shareholders have the right to inspect the books and records upon request if its for a proper purpose. Improper purposes to personally benefit the inspecting shareholder include obtaining the contact information of shareholders to create a commercial mailing list Pre-emptive rights - the right to purchase additional shares to maintain their proportionate voting strength. No pre-emptive right unless articles of incorporation provide for them Dissenting shareholder - vote on a fundamental change and lose. The shareholder may dissent and demand that the corporation pay them fair value of their shares (buy them out) Derivative action - the corporation has legal cause of action but refuses to bring action, the shareholder may that the right to bring derivative action to enforce the corporations rights if three prerequisites are met: 1. Shareholder must have been a shareholder during time of the alleged wrong 2. The shareholder must be suing in the best interests of the corporation 3. The shareholder must have made a demand on the board Board of directors • Job to initiate fundamental changes • Declare dividends • Uses good faith (talks and relies on the officers, auditors, consultants to make decisions) • Should not profit from material inside information • Can not serve on the board of a competitor • Should disclose conflicts of interest and abstain from voting - Only liable of the deal is unfair and causes damage to the corporation • Directors may remove officers with or without cause. The removal can occur even if it breaches the officers' contract, but the corporation may be liable for damages (not the stockholders or directors) 7 BEC - Notes Chapter 1 http://cpacfa.blogspot.com Corporations are allowed to indemnify (repay) directors for expenses for any lawsuit (for accidents or negligence, not intentional torts) brought against them in their corporate capacity Limitation on director's liability - breach of fiduciary duty intentional act • Financial benefits received by the director for which he was not entitled • Intentional harm inflicted upon the corporation or shareholders • Unlawful distributions authorized by the director (pay dividends which renders the corp. insolvent) • Intentional violations of criminal law • Breaches of duty of loyalty For tax purposes, if a company desires a fiscal year (instead of calendar year), that year end must be approves by the IRS Corporations may defer taxes, up to three months, by switching from calendar year end to fiscal year end, must be approves by IRS 8
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FARE Study Notes 1
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FAR - Notes Chapter 1 http://cpacfa.blogspot.com Sources of GAAP GAAP are those accounting principles that have substantial authoritative support The power to establish GAAP rests with the SEC however, it has essentially allowed the accounting profession to establish GAAP and self regulate. Statements of Financial Accounting Concepts (SFAC) - establish the objectives and concepts for FASB standards. Serve as the foundation or basic reasoning of a standard Four most authoritative GAAP B Accounting Research Bulletins (ARBs) O Accounting Principles Board Opinions (APBOs) I FASB Interpretations (clarify GAAP) S FASB Statements of Financial Accounting Standards (not concepts) Objectives of financial reporting: 1. Disclose the entity’s performance 2. Focus on the informational needs of the external users The Objectives provide information useful in - investment and credit decisions - assessing future cash flows - assessing resources, debt and equity claims Characteristics of accounting information - Material – could make a difference in decisions made by users - Benefits of the information > Costs of providing it - Understandable to decision makers - Decision usefulness – broken into 2 primary categories, Relevance and Reliability and 2 secondary characteristics, Comparability and Consistency Relevance – PFT Predictive Value Feedback Value Timeliness Reliability – NRFV Neutrality – free from bias Representational Faithfulness – information is valid Verifiability – the results could be duplicated using same techniques Comparability – Apple vs Microsoft Consistency – 2006 vs 2005, trend analysis Full Set of Financial Statements include - Statement of Financial Position (B/S) - Statement of Earnings (I/S) - Statement on Comprehensive Income - Statement of Cash Flows - Statement of Changes in Owners Equity Fundamental Assumptions - Entity assumption – separate corporation - Going concern assumption – entity will continue to operate in the foreseeable future - Monetary unit assumption – inflation is not reflected in the F/S - Historical cost assumption – as a general rule info based on cost no current market value 1 FAR - Notes Chapter 1 http://cpacfa.blogspot.com Revenue recognition principle – revenue should be recognized (recorded) when it is earned and when it is realized (you’ve been paid) or realizable (believe you’re going to get paid). 1. Earned – Goods – transfer of title, not possession Services – Are the services substantially complete 2. Realized or Realizable – claims to cash readily convertible to known amounts Matching Principle – all expenses incurred to generate revenue in a period are matched against that revenue Accrual Accounting – to record without an exchange of cash Full Disclosure principle – information that would make a difference in the decision process Conservatism principle – defer estimated gains until realized; and; record estimated losses immediately Elements of financial statements Comprehensive Income = Net income + PUFE Normal “recurring” operations Revenues – recognize revenue at gross amount (less allowances for returns and discounts given) Expenses – incurred Non-operating, unusual or infrequent Gains – selling price or net realizable value > book value Loss – selling price or net realizable value < book value; impairments and write downs Assets – probable future economic benefit; capable of generating revenue in the future Liabilities – Probable future sacrifices Investment of Owners – not a revenue or gain (excluded from comprehensive income) Distributions to Owners – not an expense or loss (excluded from comprehensive income) SFAC No. 7 provides a framework for accountants to employ when using future cash flows as a measurement basis for assets and liabilities. There are five elements 1. Estimate future cash flow 2. Expectations of cash flow timing 3. Time value of money (risk free rate, discount rate) 4. Price for bearing uncertainty, risk premium 5. other factors (liquidity issues, market imperfections SFAC No. 7 allows the use of two approaches to determine present value • Traditional approach – one discount rate used (bonds, scheduled known payments) • Expected Cash flow approach – more complex cases (warrants, uncertain future payments Reporting Net Income Reported on income statement I Income (or loss) from continuing operations (gross of tax) D Income (or loss) from discontinued operations (net of tax) E Extraordinary items (net of tax) – unusual and infrequent Reported on statement of retained earnings A Cumulative effect of change in accounting principle (net of tax) Pg 17 & 18 show single step and multiple step income statement Discontinued operations 2 FAR - Notes Chapter 1 http://cpacfa.blogspot.com If you decide to sell a division within the next year, until its sold, the rev/exp are moved to discontinued operations To report in discontinued operations must - be eliminated from ongoing operations - no significant continuing involvement Assets within the discontinued operation are no longer depreciated or amortized A component classified as held for sale is measured at the lower of its carrying amount or fair value less costs to sell (no longer at historical costs) Extraordinary Items Must be both unusual and infrequent Examples: An expropriation (foreign govt seizes your business, nationalism), infrequent earthquake. So hurricanes in Florida are not considered and extraordinary item Cumulative effect of change in accounting principle Accounting changes are broadly classified into 3 categories: estimate, principle and entity Change in accounting estimate Apply prospectively – do not restate prior periods Not an error Affects current and future year income from continuing operations Examples - Change in fixed asset useful life - Adjustments of year-end accrual of officers salaries and bonuses - Write-downs of obsolete inventory - Material non-recurring IRS adjustments - Settlement of litigation - Change from instalment method to immediate recognition because uncollectible accounts can now be estimated Change in accounting principle Apply retroactively – restate prior periods financial statements Can change accounting principle only if the alternative principle is preferable and more fairly presents the information Cumulative effect – difference between the amount of beginning retained earnings in the period of change and what retained earnings would have been if the accounting change had been retroactively applied. Exceptions, examples - Change in inventory method to LIFO (change in estimate) - Change in depreciation methods (change in estimate) - Change from non-GAAP to GAAP (error, change in entity) Change in accounting entity Apply retroactively Examples - Corrections of an error - Retroactive restatements required by new GAAP pronouncement - Change from non-GAAP to GAAP 3 FAR - Notes Chapter 1 http://cpacfa.blogspot.com Comprehensive Income = net income (per I/S) + Other comprehensive income (PUFE) Change in equity from non-owner sources Net income = income from continuing operations + discontinued operations + extraordinary items (IDE) Not reported on a per share basis Other comprehensive income includes those items excluded from net income P Pension minimum liability adjustment U Unrealized gains/losses F Foreign currency items E Effective portion of cash flow hedge Reclassification adjustment – items once displayed as other comprehensive income but now displayed as part of net income Accumulated other comprehensive income – includes the total of other comprehensive income for the period and previous periods. Shown in stockholders equity Disclosures (notes to the financial statements) GAAP requires a description of all significant policies should be included as an integral part of the financial statements. The remaining notes contain all other information relevant to decision makers Interim Financial Reporting Public companies must file quarterly reports Quarterly reports are unaudited For interim reporting only, timeliness is emphasized over reliability Interim F/S must be viewed as an integral part of the annual F/S Income tax expense is estimated each quarter. Use the estimated average effective tax rate that will apply for the entire year. Segment Reporting Objective is to provide information on the business activities and the economic environment of a company Public companies must report segment information about - Operating segments (annual and interim) - Products and services - Geographic areas - Major customers Operating segment – discrete financial information is available (traceable) Must report as segment if it’s greater than 10% of either: A. Revenue - if segment’s revenue comprise more than 10% of all the company’s revenue B. Reported profit or loss C. Assets – if segment’s asset comprise more than 10% of all the company’s assets Until at least 75% of combined revenue is included in reportable segments Do not have to report as a segment if the segment accounts for 90% of company’s A,B or C 4 FAR - Notes Chapter 1 http://cpacfa.blogspot.com Revenues (for that segment including intercompany sales) Less: Directly traceable costs Less: Reasonable allocated costs = Operating profit (loss) for segment Development-Stage Enterprises Start-ups/pioneering development – principal operations have not begun or principal operations have generates a insignificant amount of revenue A development state enterprise must issue the same financial statement as any other enterprise. The additional required disclosures include - In the B/S, describe cumulative net losses as “deficit accumulated during development stage” 5
FAR - Notes Chapter 1 http://cpacfa.blogspot.com Sources of GAAP GAAP are those accounting principles that have substantial authoritative support The power to establish GAAP rests with the SEC however, it has essentially allowed the accounting profession to establish GAAP and self regulate. Statements of Financial Accounting Concepts (SFAC) - establish the objectives and concepts for FASB standards. Serve as the foundation or basic reasoning of a standard Four most authoritative GAAP B Accounting Research Bulletins (ARBs) O Accounting Principles Board Opinions (APBOs) I FASB Interpretations (clarify GAAP) S FASB Statements of Financial Accounting Standards (not concepts) Objectives of financial reporting: 1. Disclose the entity’s performance 2. Focus on the informational needs of the external users The Objectives provide information useful in - investment and credit decisions - assessing future cash flows - assessing resources, debt and equity claims Characteristics of accounting information - Material – could make a difference in decisions made by users - Benefits of the information > Costs of providing it - Understandable to decision makers - Decision usefulness – broken into 2 primary categories, Relevance and Reliability and 2 secondary characteristics, Comparability and Consistency Relevance – PFT Predictive Value Feedback Value Timeliness Reliability – NRFV Neutrality – free from bias Representational Faithfulness – information is valid Verifiability – the results could be duplicated using same techniques Comparability – Apple vs Microsoft Consistency – 2006 vs 2005, trend analysis Full Set of Financial Statements include - Statement of Financial Position (B/S) - Statement of Earnings (I/S) - Statement on Comprehensive Income - Statement of Cash Flows - Statement of Changes in Owners Equity Fundamental Assumptions - Entity assumption – separate corporation - Going concern assumption – entity will continue to operate in the foreseeable future - Monetary unit assumption – inflation is not reflected in the F/S - Historical cost assumption – as a general rule info based on cost no current market value 1 FAR - Notes Chapter 1 http://cpacfa.blogspot.com Revenue recognition principle – revenue should be recognized (recorded) when it is earned and when it is realized (you’ve been paid) or realizable (believe you’re going to get paid). 1. Earned – Goods – transfer of title, not possession Services – Are the services substantially complete 2. Realized or Realizable – claims to cash readily convertible to known amounts Matching Principle – all expenses incurred to generate revenue in a period are matched against that revenue Accrual Accounting – to record without an exchange of cash Full Disclosure principle – information that would make a difference in the decision process Conservatism principle – defer estimated gains until realized; and; record estimated losses immediately Elements of financial statements Comprehensive Income = Net income + PUFE Normal “recurring” operations Revenues – recognize revenue at gross amount (less allowances for returns and discounts given) Expenses – incurred Non-operating, unusual or infrequent Gains – selling price or net realizable value > book value Loss – selling price or net realizable value < book value; impairments and write downs Assets – probable future economic benefit; capable of generating revenue in the future Liabilities – Probable future sacrifices Investment of Owners – not a revenue or gain (excluded from comprehensive income) Distributions to Owners – not an expense or loss (excluded from comprehensive income) SFAC No. 7 provides a framework for accountants to employ when using future cash flows as a measurement basis for assets and liabilities. There are five elements 1. Estimate future cash flow 2. Expectations of cash flow timing 3. Time value of money (risk free rate, discount rate) 4. Price for bearing uncertainty, risk premium 5. other factors (liquidity issues, market imperfections SFAC No. 7 allows the use of two approaches to determine present value • Traditional approach – one discount rate used (bonds, scheduled known payments) • Expected Cash flow approach – more complex cases (warrants, uncertain future payments Reporting Net Income Reported on income statement I Income (or loss) from continuing operations (gross of tax) D Income (or loss) from discontinued operations (net of tax) E Extraordinary items (net of tax) – unusual and infrequent Reported on statement of retained earnings A Cumulative effect of change in accounting principle (net of tax) Pg 17 & 18 show single step and multiple step income statement Discontinued operations 2 FAR - Notes Chapter 1 http://cpacfa.blogspot.com If you decide to sell a division within the next year, until its sold, the rev/exp are moved to discontinued operations To report in discontinued operations must - be eliminated from ongoing operations - no significant continuing involvement Assets within the discontinued operation are no longer depreciated or amortized A component classified as held for sale is measured at the lower of its carrying amount or fair value less costs to sell (no longer at historical costs) Extraordinary Items Must be both unusual and infrequent Examples: An expropriation (foreign govt seizes your business, nationalism), infrequent earthquake. So hurricanes in Florida are not considered and extraordinary item Cumulative effect of change in accounting principle Accounting changes are broadly classified into 3 categories: estimate, principle and entity Change in accounting estimate Apply prospectively – do not restate prior periods Not an error Affects current and future year income from continuing operations Examples - Change in fixed asset useful life - Adjustments of year-end accrual of officers salaries and bonuses - Write-downs of obsolete inventory - Material non-recurring IRS adjustments - Settlement of litigation - Change from instalment method to immediate recognition because uncollectible accounts can now be estimated Change in accounting principle Apply retroactively – restate prior periods financial statements Can change accounting principle only if the alternative principle is preferable and more fairly presents the information Cumulative effect – difference between the amount of beginning retained earnings in the period of change and what retained earnings would have been if the accounting change had been retroactively applied. Exceptions, examples - Change in inventory method to LIFO (change in estimate) - Change in depreciation methods (change in estimate) - Change from non-GAAP to GAAP (error, change in entity) Change in accounting entity Apply retroactively Examples - Corrections of an error - Retroactive restatements required by new GAAP pronouncement - Change from non-GAAP to GAAP 3 FAR - Notes Chapter 1 http://cpacfa.blogspot.com Comprehensive Income = net income (per I/S) + Other comprehensive income (PUFE) Change in equity from non-owner sources Net income = income from continuing operations + discontinued operations + extraordinary items (IDE) Not reported on a per share basis Other comprehensive income includes those items excluded from net income P Pension minimum liability adjustment U Unrealized gains/losses F Foreign currency items E Effective portion of cash flow hedge Reclassification adjustment – items once displayed as other comprehensive income but now displayed as part of net income Accumulated other comprehensive income – includes the total of other comprehensive income for the period and previous periods. Shown in stockholders equity Disclosures (notes to the financial statements) GAAP requires a description of all significant policies should be included as an integral part of the financial statements. The remaining notes contain all other information relevant to decision makers Interim Financial Reporting Public companies must file quarterly reports Quarterly reports are unaudited For interim reporting only, timeliness is emphasized over reliability Interim F/S must be viewed as an integral part of the annual F/S Income tax expense is estimated each quarter. Use the estimated average effective tax rate that will apply for the entire year. Segment Reporting Objective is to provide information on the business activities and the economic environment of a company Public companies must report segment information about - Operating segments (annual and interim) - Products and services - Geographic areas - Major customers Operating segment – discrete financial information is available (traceable) Must report as segment if it’s greater than 10% of either: A. Revenue - if segment’s revenue comprise more than 10% of all the company’s revenue B. Reported profit or loss C. Assets – if segment’s asset comprise more than 10% of all the company’s assets Until at least 75% of combined revenue is included in reportable segments Do not have to report as a segment if the segment accounts for 90% of company’s A,B or C 4 FAR - Notes Chapter 1 http://cpacfa.blogspot.com Revenues (for that segment including intercompany sales) Less: Directly traceable costs Less: Reasonable allocated costs = Operating profit (loss) for segment Development-Stage Enterprises Start-ups/pioneering development – principal operations have not begun or principal operations have generates a insignificant amount of revenue A development state enterprise must issue the same financial statement as any other enterprise. The additional required disclosures include - In the B/S, describe cumulative net losses as “deficit accumulated during development stage” 5
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AUD Study Notes 1
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AUD - Notes Chapter 1 http://cpacfa.blogspot.com Audited F/S – The Basics Company’s mgmt responsible to prepare the F/S Auditors responsible to express an opinion on the F/S and on mgmt’s assertion on internal controls (if public) The primary assertion is whether the statements are “presented fairly” in accordance with GAAP Professional Standards Generally Accepted Accounting Standards – GAAS Generally Accepted Government Auditing Standards – GAGAS The Public Company Accounting Oversight Board – PCAOB - Public accounting firms must register with PCAOB in order to audit public companies - Registered firms are subject to board inspection, disciplinary proceedings, and sanctions GAAS – TIP PIE ACDO General standards – TIP T – Training I – Independence (in fact and appearance) P – Professional Care Standards of Field Work – PIE P – Planning and supervision I – Internal control, entity and environment Strong controls imply the auditor will require less evidence Weak controls imply the auditor will require more evidence (more work) An exam trick; weak internal controls does not equal an adverse opinion E – Evidence Standards of Reporting – ACDO A – Accounting = GAAP Explicit; Opinion must state that the acctg used was GAAP C – Consistency between periods Implicit; Silence is okay cause its implied D – Disclosure Implicit; Silence is okay O – Express Opinion • Explicit; Opinion must state “In our opinion…” • Meant to prevent misinterpretation of the degree of responsibility the auditor is assuming when his/her name is associated with the F/S • The auditor may express different opinions of different sections (B/S, I/S) • The auditor may express an opinion on 1 section and not the others as long as information has not been limited Reports on Audited F/S The Auditors Standard Report (Unqualified Opinion) Title Addressee Introductory Paragraph – R;R • Statement that the F/S as identified in the report were audited • Statement that the F/S are the responsibility of mgmt and the auditors responsibility is to express an opinion Scope Paragraph – APMEAM; APMEAM • Statement that the audit was conducted in accordance with U.S. GAAS 1 AUD - Notes Chapter 1 http://cpacfa.blogspot.com • Statement that the audit was planned and performed to obtain reasonable assurance that the F/S are free from material misstatement • Statement that the audit included examining evidence on a test basis; assessing the accounting principles used and significant estimates made by mgmt; and evaluating the overall presentation • Statement that the audit provides a reasonable basis for an opinion Opinion Paragraph • Statement referring to the F/S specifically identified in the introductory paragraph • An opinion as to the fair presentation of the F/S (ACDO) • Statement regarding conformity with U.S. GAAP (ACDO) Firm Name Report Date • The Report should be dated on or after the date on which appropriate audit evidence sufficient to support the opinion has been obtained Sample unqualified opinion – A1-14 GAAS in referenced to in the Scope paragraph GAAP is referenced to in the Opinion paragraph PCAOB Standards – for publicly traded companies Audits of Issuers (public companies) – PCAOB auditing standard No. 1 requires the auditor’s report to include =a reference to the standards of the PCAOB Audits of nonissuers (private companies) – An auditor may, but is not required to, conduct the audit of a nonissuer in accordance with both GAAS and PCAOD auditing standards Unqualified opinion – clean; F/S presented fairly in all material respects, doesn’t mean good investment Modified Unqualified opinion – additional explanatory language Qualified opinion – states “except for”; material GAAP or GASS problem Adverse opinions – very material GAAP problems Disclaimer of opinion – significant GAAS problem Chart on A1-17 memorize Uncertainties – impairments, intangibles, lawsuits, warranties Management’s responsibility • Estimate the effect of future events on the F/S and record and present this estimate, or • Determine that a reasonable estimate cannot be made and make the required disclosures to that effect Remember under GAAP Both probable and reasonably estimatable record Either probable or reasonably estimatable disclose 2 AUD - Notes Chapter 1 http://cpacfa.blogspot.com If mgmt’s analysis is supported and properly reported or disclosed, the auditor issues and unqualified opinion with no reference to the uncertainty in the report Unqualified opinion: GAAP = ok; GAAS = ok If the auditor is unable to obtain sufficient evidential matter involving an uncertainty and its presentation or disclosure, the auditor should consider expressing a qualified (GAAS) opinion or to disclaim an opinion to scope limitation. Qualified or Disclaimer: GAAP = ?; GAAS = Problem If the auditor concludes that the F/S are materially misstated due to a departure from GAAP related to uncertainty, the auditor should express a qualified (GAAP) or adverse opinion. GAAP departures include inadequate disclosures, use of inappropriate accounting principles, and use of unreasonable acctg estimates Qualified of Adverse: GAAP = problem; GAAS = ok Pass key chart on A1-19 memorize Modified Unqualified opinion – still represents an unqualified opinion. The additional language (modified wording or explanatory paragraph) used to highlight the certain circumstances Modified wording • Division of responsibility; auditors opinion is based in part on the report of another Explanatory paragraph • Justified departure from GAAP • Going concern • To emphasize a matter • Lack of consistency • Other; - Required SEC regulation S-K quarterly financial data has been omitted or has not been reviewed - Supplementary information required by GAAP has been omitted - Other information (stuff in 10-K) is inconsistent with F/S Division of Responsibility (reference in report) – The principal auditor decides to mention the work done by other auditors, the report will express a division of responsibility. The principal auditor will mention this division in all three paragraphs. The name of the other auditor is not mentioned unless the auditor gives express permission and the report of the other auditor is presented. Make other CPA responsible by mentioning them in the Intro, Scope, and Opinion paragraph. Assumption of Responsibility (no reference to other CPA) – The principal auditor must assure on the other auditors, reputation, independence, professional competency, program steps (RIPP). Visit the other auditor to discuss audit procedures and review audit program, documentation, and evaluation of internal controls performed by the other auditor Justified departure from GAAP – The explanatory paragraph should contain a description of the departure, its approximate effects (if possible) and the reasons why adherence to GAAP would make the F/S misleading Going Concern – The auditor should perform the following procedures: A – Analytical procedures D – Debt compliance M – Review board minutes I – Inquiry of client’s legal counsel T – Confirm third party arrangements/agreements S – Subsequent events review 3 AUD - Notes Chapter 1 http://cpacfa.blogspot.com Conditions or events that may indicate substantial doubt: F – Financial difficulties I – Internal matters N – Negative trends E – External matters, legal proceedings, new legislation, loss or expiration of intellectual property The auditor is not precluded from choosing to disclaim an opinion in cases involving uncertainties The explanatory paragraph occurs after opinion paragraph It includes the terms “substantial doubt” and “going concern” Don’t limit it for a time period If, in the auditor’s judgement, the entity’s disclosures are inadequate, a departure from GAAP exists. This may result in either a qualified or adverse opinion Emphasis of a matter – auditor may wish to emphasis a particular matter but still express an unqualified opinion. Emphasis when a company is a RECC • A related party transaction • Significant subsequent events • Entity is a component of a larger business • Items that affect the comparability (except changes in accounting principles) An explanatory paragraph is not required Lack of consistency (justified changes) ACDO – if a change is GAAP has occurred between accounting periods and the effect is material, the auditor should add an explanatory paragraph to the unqualified report. The explanatory paragraph comes after the opinion paragraph When selecting the type of opinion because of a lack of consistency, determine is the change is justified GAAP: Acceptable/Justified = Modified Unqualified Not GAAP: Unacceptable/Unjustified = Qualified or Adverse Qualified “except for” Opinion and Adverse Opinion for very material GAAP problems 1. Non GAAP unjustified/unacceptable change – Issue is consistency (ACDO); an explanatory paragraph should appear before the opinion paragraph to describe the non-GAAP acctg change and the financial impact 2. Inadequate disclosure – when the auditor believes that the omitted items cause the F/S to be deceptive 3. Departure from GAAP GAAP: Acceptable/Justified = Modified Unqualified Not GAAP: Unacceptable/Unjustified = “except for” or Adverse 4. Unreasonable accounting estimates Qualified “except for” Opinion for material GAAS problems 1. Uncertainty 2. Scope limitation – time constraints, in ability to obtain sufficient competent evidential matter, refusal of mgmt to provide mgmt letter which acknowledge their responsibility for the fair presentation of the F/S in conformity with GAAP, refusal of clients attorney to respond to inquiry The scope limitation should be referred to in the scope and opinion paragraph (as an explanatory paragraph preceding before the opinion paragraph: Double “except for” whammy Disclaimer Opinion for significant GAAS problems 1. Uncertainty 2. Scope limitation 3. Lack of independence 4. Unaudited – only an opinion paragraph. States reason of unaudited F/S and “we do not express an opinion” 4 AUD - Notes Chapter 1 http://cpacfa.blogspot.com Changes to the report include Introductory paragraph - Use the words “were engaged to audit” instead of “have audited”, and - Deletion of the reference to the auditor’s responsibility Scope paragraph – omitted Explanatory paragraph – is the middle paragraph and describes the reasons for the disclaimer Opinion paragraph – disclaimer of opinion is given on the F/S taken as a whole Reports on Comparative Statements If the prior year’s financial statements were not audited and that the current year’s financial statements are being audited, the auditor is facing a scope limitation (because the beginning balances may not be correct) and may require a disclaimer opinion. When updating (changing prior) periods the explanatory should disclose the: D – Date of the auditor’s previous report O – Opinion type previously issued R – Reason for prior opinion C – Changes that have occurred S – Statement “opinion…is different” Only DORCS change their mind Update or change opinion when now in conformity with GAAP (restate prior yr F/S) Report of a predecessor auditor – presented The prior (old) CPA should: • Read the current period statements • Compare the statements audited with the current period statements • Obtain a letter of representation from the successor auditor • Obtain a letter of representation from mgmt • If the report is unrevised use the original report date in any reissue • If the report is revised dual date Report of a predecessor auditor – not presented The current (new) CPA should: • Not name the predecessor auditor • The date of the predecessors auditors report • The type of opinion expressed by the predecessor auditor • The substantive reasons for other than an unqualified report Subsequent Events Type I events – conditions on or before balance sheet date, accrue, looking backward Requires a F/S adjustment Type II events – conditions existing after the balance sheet date, disclose in footnotes, looking forward May require footnote disclosure Auditors responsibility for subsequent events – PRIME is included in yr end fieldwork P – Post balance sheet transactions 5 AUD - Notes Chapter 1 http://cpacfa.blogspot.com R – Representation letter should be obtained from mgmt I – Inquiry M – Minutes of stockholders, directors, and other committee meetings should be read E – Examine latest available interim F/S; compare them with the F/S under audit Auditors responsibility after the original date of the auditors report The auditor has no active responsibility. However, if the auditor becomes aware of a subsequent event, auditor must use professional judgement to decide whether to adjust the F/S or disclosures If adjusts are made after the original date of the auditors report, the auditor may dual date the report Ex. “Jan, 21, 2000, except for Note 2, as to which the date is Feb 3, 2000” Facts discovered after report is issued (the auditors missed it) Auditor action • Advise client to issue revised F/S or make additional disclosures • Provide notification that the F/S can not be relied upon If the client refuses to follow procedures • Notify the board of the directors • Dissociate with the client • Inform any regulatory agencies (if applicable) • Notify parties relying on the F/S Omitted audit procedures discovered after submission of the audit program (we forgot to do it) • Auditor should determine whether other audit procedures tended to compensate for the omitted procedures • Apply the omitted procedures (or alternative procedures) Reporting on Other Information Auditor should perform limited procedures on supplementary information and report deficiencies & omissions 1. Inquire of mgmt 2. Determine if the methods uses are consistent with mgmt’s responses, audited F/S and other knowledge 3. Consider whether the client representation letter should refer to the supplementary information Segment information is required by GAAP Material misstatement – GAAP problem qualified or adverse opinion Scope limitation – GAAS problem qualified or disclaimer opinion When an auditor submits a document containing audited F/S to a client or others, the auditor has a responsibility to report on all information in the document The auditor must indicate in the report whether the accompanying information is fairly stated in all material respects in relation to the basic F/S taken as a whole. The report should also describe the character of the auditor examination and the degree of responsibility the auditor is assuming. Condensed F/S The Auditor must indicate: • That the auditor audited and expresses an opinion on the complete F/S • Date of the auditors report on the complete F/S • Type of opinion expressed • Whether the information in the condensed statements is fairly stated, in all material respects Selected financial data 6 AUD - Notes Chapter 1 http://cpacfa.blogspot.com The auditor must indicate whether the selected financial data is fairly stated, in all material respects, in relation to the F/S from which it has been derived. An accountants report should include 1. Brief description of the nature of the engagement 2. Statement that the engagement was performed in accordance with AICPA standards 3. Identification specific entity, descriptions of the transactions, statement about the source of the information 4. A statement describing the appropriate acctg principles (including country of origin) to be applied 5. Statement that mgmt is responsible 6. A statement that any differences in the facts, circumstances or assumptions may change the report 7. Restrict use of report to mgmt, board of directors, prior and current auditors Reporting on F/S prepared for use in other countries Distribution outside U.S. only: auditor may use either - The report of the other country - US style report modified to the accounting principles of another country Distribution within the US: auditors report should be the US standard report modified as appropriate for departures from US GAAP. 7
AUD - Notes Chapter 1 http://cpacfa.blogspot.com Audited F/S – The Basics Company’s mgmt responsible to prepare the F/S Auditors responsible to express an opinion on the F/S and on mgmt’s assertion on internal controls (if public) The primary assertion is whether the statements are “presented fairly” in accordance with GAAP Professional Standards Generally Accepted Accounting Standards – GAAS Generally Accepted Government Auditing Standards – GAGAS The Public Company Accounting Oversight Board – PCAOB - Public accounting firms must register with PCAOB in order to audit public companies - Registered firms are subject to board inspection, disciplinary proceedings, and sanctions GAAS – TIP PIE ACDO General standards – TIP T – Training I – Independence (in fact and appearance) P – Professional Care Standards of Field Work – PIE P – Planning and supervision I – Internal control, entity and environment Strong controls imply the auditor will require less evidence Weak controls imply the auditor will require more evidence (more work) An exam trick; weak internal controls does not equal an adverse opinion E – Evidence Standards of Reporting – ACDO A – Accounting = GAAP Explicit; Opinion must state that the acctg used was GAAP C – Consistency between periods Implicit; Silence is okay cause its implied D – Disclosure Implicit; Silence is okay O – Express Opinion • Explicit; Opinion must state “In our opinion…” • Meant to prevent misinterpretation of the degree of responsibility the auditor is assuming when his/her name is associated with the F/S • The auditor may express different opinions of different sections (B/S, I/S) • The auditor may express an opinion on 1 section and not the others as long as information has not been limited Reports on Audited F/S The Auditors Standard Report (Unqualified Opinion) Title Addressee Introductory Paragraph – R;R • Statement that the F/S as identified in the report were audited • Statement that the F/S are the responsibility of mgmt and the auditors responsibility is to express an opinion Scope Paragraph – APMEAM; APMEAM • Statement that the audit was conducted in accordance with U.S. GAAS 1 AUD - Notes Chapter 1 http://cpacfa.blogspot.com • Statement that the audit was planned and performed to obtain reasonable assurance that the F/S are free from material misstatement • Statement that the audit included examining evidence on a test basis; assessing the accounting principles used and significant estimates made by mgmt; and evaluating the overall presentation • Statement that the audit provides a reasonable basis for an opinion Opinion Paragraph • Statement referring to the F/S specifically identified in the introductory paragraph • An opinion as to the fair presentation of the F/S (ACDO) • Statement regarding conformity with U.S. GAAP (ACDO) Firm Name Report Date • The Report should be dated on or after the date on which appropriate audit evidence sufficient to support the opinion has been obtained Sample unqualified opinion – A1-14 GAAS in referenced to in the Scope paragraph GAAP is referenced to in the Opinion paragraph PCAOB Standards – for publicly traded companies Audits of Issuers (public companies) – PCAOB auditing standard No. 1 requires the auditor’s report to include =a reference to the standards of the PCAOB Audits of nonissuers (private companies) – An auditor may, but is not required to, conduct the audit of a nonissuer in accordance with both GAAS and PCAOD auditing standards Unqualified opinion – clean; F/S presented fairly in all material respects, doesn’t mean good investment Modified Unqualified opinion – additional explanatory language Qualified opinion – states “except for”; material GAAP or GASS problem Adverse opinions – very material GAAP problems Disclaimer of opinion – significant GAAS problem Chart on A1-17 memorize Uncertainties – impairments, intangibles, lawsuits, warranties Management’s responsibility • Estimate the effect of future events on the F/S and record and present this estimate, or • Determine that a reasonable estimate cannot be made and make the required disclosures to that effect Remember under GAAP Both probable and reasonably estimatable record Either probable or reasonably estimatable disclose 2 AUD - Notes Chapter 1 http://cpacfa.blogspot.com If mgmt’s analysis is supported and properly reported or disclosed, the auditor issues and unqualified opinion with no reference to the uncertainty in the report Unqualified opinion: GAAP = ok; GAAS = ok If the auditor is unable to obtain sufficient evidential matter involving an uncertainty and its presentation or disclosure, the auditor should consider expressing a qualified (GAAS) opinion or to disclaim an opinion to scope limitation. Qualified or Disclaimer: GAAP = ?; GAAS = Problem If the auditor concludes that the F/S are materially misstated due to a departure from GAAP related to uncertainty, the auditor should express a qualified (GAAP) or adverse opinion. GAAP departures include inadequate disclosures, use of inappropriate accounting principles, and use of unreasonable acctg estimates Qualified of Adverse: GAAP = problem; GAAS = ok Pass key chart on A1-19 memorize Modified Unqualified opinion – still represents an unqualified opinion. The additional language (modified wording or explanatory paragraph) used to highlight the certain circumstances Modified wording • Division of responsibility; auditors opinion is based in part on the report of another Explanatory paragraph • Justified departure from GAAP • Going concern • To emphasize a matter • Lack of consistency • Other; - Required SEC regulation S-K quarterly financial data has been omitted or has not been reviewed - Supplementary information required by GAAP has been omitted - Other information (stuff in 10-K) is inconsistent with F/S Division of Responsibility (reference in report) – The principal auditor decides to mention the work done by other auditors, the report will express a division of responsibility. The principal auditor will mention this division in all three paragraphs. The name of the other auditor is not mentioned unless the auditor gives express permission and the report of the other auditor is presented. Make other CPA responsible by mentioning them in the Intro, Scope, and Opinion paragraph. Assumption of Responsibility (no reference to other CPA) – The principal auditor must assure on the other auditors, reputation, independence, professional competency, program steps (RIPP). Visit the other auditor to discuss audit procedures and review audit program, documentation, and evaluation of internal controls performed by the other auditor Justified departure from GAAP – The explanatory paragraph should contain a description of the departure, its approximate effects (if possible) and the reasons why adherence to GAAP would make the F/S misleading Going Concern – The auditor should perform the following procedures: A – Analytical procedures D – Debt compliance M – Review board minutes I – Inquiry of client’s legal counsel T – Confirm third party arrangements/agreements S – Subsequent events review 3 AUD - Notes Chapter 1 http://cpacfa.blogspot.com Conditions or events that may indicate substantial doubt: F – Financial difficulties I – Internal matters N – Negative trends E – External matters, legal proceedings, new legislation, loss or expiration of intellectual property The auditor is not precluded from choosing to disclaim an opinion in cases involving uncertainties The explanatory paragraph occurs after opinion paragraph It includes the terms “substantial doubt” and “going concern” Don’t limit it for a time period If, in the auditor’s judgement, the entity’s disclosures are inadequate, a departure from GAAP exists. This may result in either a qualified or adverse opinion Emphasis of a matter – auditor may wish to emphasis a particular matter but still express an unqualified opinion. Emphasis when a company is a RECC • A related party transaction • Significant subsequent events • Entity is a component of a larger business • Items that affect the comparability (except changes in accounting principles) An explanatory paragraph is not required Lack of consistency (justified changes) ACDO – if a change is GAAP has occurred between accounting periods and the effect is material, the auditor should add an explanatory paragraph to the unqualified report. The explanatory paragraph comes after the opinion paragraph When selecting the type of opinion because of a lack of consistency, determine is the change is justified GAAP: Acceptable/Justified = Modified Unqualified Not GAAP: Unacceptable/Unjustified = Qualified or Adverse Qualified “except for” Opinion and Adverse Opinion for very material GAAP problems 1. Non GAAP unjustified/unacceptable change – Issue is consistency (ACDO); an explanatory paragraph should appear before the opinion paragraph to describe the non-GAAP acctg change and the financial impact 2. Inadequate disclosure – when the auditor believes that the omitted items cause the F/S to be deceptive 3. Departure from GAAP GAAP: Acceptable/Justified = Modified Unqualified Not GAAP: Unacceptable/Unjustified = “except for” or Adverse 4. Unreasonable accounting estimates Qualified “except for” Opinion for material GAAS problems 1. Uncertainty 2. Scope limitation – time constraints, in ability to obtain sufficient competent evidential matter, refusal of mgmt to provide mgmt letter which acknowledge their responsibility for the fair presentation of the F/S in conformity with GAAP, refusal of clients attorney to respond to inquiry The scope limitation should be referred to in the scope and opinion paragraph (as an explanatory paragraph preceding before the opinion paragraph: Double “except for” whammy Disclaimer Opinion for significant GAAS problems 1. Uncertainty 2. Scope limitation 3. Lack of independence 4. Unaudited – only an opinion paragraph. States reason of unaudited F/S and “we do not express an opinion” 4 AUD - Notes Chapter 1 http://cpacfa.blogspot.com Changes to the report include Introductory paragraph - Use the words “were engaged to audit” instead of “have audited”, and - Deletion of the reference to the auditor’s responsibility Scope paragraph – omitted Explanatory paragraph – is the middle paragraph and describes the reasons for the disclaimer Opinion paragraph – disclaimer of opinion is given on the F/S taken as a whole Reports on Comparative Statements If the prior year’s financial statements were not audited and that the current year’s financial statements are being audited, the auditor is facing a scope limitation (because the beginning balances may not be correct) and may require a disclaimer opinion. When updating (changing prior) periods the explanatory should disclose the: D – Date of the auditor’s previous report O – Opinion type previously issued R – Reason for prior opinion C – Changes that have occurred S – Statement “opinion…is different” Only DORCS change their mind Update or change opinion when now in conformity with GAAP (restate prior yr F/S) Report of a predecessor auditor – presented The prior (old) CPA should: • Read the current period statements • Compare the statements audited with the current period statements • Obtain a letter of representation from the successor auditor • Obtain a letter of representation from mgmt • If the report is unrevised use the original report date in any reissue • If the report is revised dual date Report of a predecessor auditor – not presented The current (new) CPA should: • Not name the predecessor auditor • The date of the predecessors auditors report • The type of opinion expressed by the predecessor auditor • The substantive reasons for other than an unqualified report Subsequent Events Type I events – conditions on or before balance sheet date, accrue, looking backward Requires a F/S adjustment Type II events – conditions existing after the balance sheet date, disclose in footnotes, looking forward May require footnote disclosure Auditors responsibility for subsequent events – PRIME is included in yr end fieldwork P – Post balance sheet transactions 5 AUD - Notes Chapter 1 http://cpacfa.blogspot.com R – Representation letter should be obtained from mgmt I – Inquiry M – Minutes of stockholders, directors, and other committee meetings should be read E – Examine latest available interim F/S; compare them with the F/S under audit Auditors responsibility after the original date of the auditors report The auditor has no active responsibility. However, if the auditor becomes aware of a subsequent event, auditor must use professional judgement to decide whether to adjust the F/S or disclosures If adjusts are made after the original date of the auditors report, the auditor may dual date the report Ex. “Jan, 21, 2000, except for Note 2, as to which the date is Feb 3, 2000” Facts discovered after report is issued (the auditors missed it) Auditor action • Advise client to issue revised F/S or make additional disclosures • Provide notification that the F/S can not be relied upon If the client refuses to follow procedures • Notify the board of the directors • Dissociate with the client • Inform any regulatory agencies (if applicable) • Notify parties relying on the F/S Omitted audit procedures discovered after submission of the audit program (we forgot to do it) • Auditor should determine whether other audit procedures tended to compensate for the omitted procedures • Apply the omitted procedures (or alternative procedures) Reporting on Other Information Auditor should perform limited procedures on supplementary information and report deficiencies & omissions 1. Inquire of mgmt 2. Determine if the methods uses are consistent with mgmt’s responses, audited F/S and other knowledge 3. Consider whether the client representation letter should refer to the supplementary information Segment information is required by GAAP Material misstatement – GAAP problem qualified or adverse opinion Scope limitation – GAAS problem qualified or disclaimer opinion When an auditor submits a document containing audited F/S to a client or others, the auditor has a responsibility to report on all information in the document The auditor must indicate in the report whether the accompanying information is fairly stated in all material respects in relation to the basic F/S taken as a whole. The report should also describe the character of the auditor examination and the degree of responsibility the auditor is assuming. Condensed F/S The Auditor must indicate: • That the auditor audited and expresses an opinion on the complete F/S • Date of the auditors report on the complete F/S • Type of opinion expressed • Whether the information in the condensed statements is fairly stated, in all material respects Selected financial data 6 AUD - Notes Chapter 1 http://cpacfa.blogspot.com The auditor must indicate whether the selected financial data is fairly stated, in all material respects, in relation to the F/S from which it has been derived. An accountants report should include 1. Brief description of the nature of the engagement 2. Statement that the engagement was performed in accordance with AICPA standards 3. Identification specific entity, descriptions of the transactions, statement about the source of the information 4. A statement describing the appropriate acctg principles (including country of origin) to be applied 5. Statement that mgmt is responsible 6. A statement that any differences in the facts, circumstances or assumptions may change the report 7. Restrict use of report to mgmt, board of directors, prior and current auditors Reporting on F/S prepared for use in other countries Distribution outside U.S. only: auditor may use either - The report of the other country - US style report modified to the accounting principles of another country Distribution within the US: auditors report should be the US standard report modified as appropriate for departures from US GAAP. 7
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REG Study Notes 1
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REG - Notes Chapter 1 http://cpacfa.blogspot.com Individual Taxation – Filing Status Due date April 15th An extension is only for filing your paperwork and not your payments, so with an extension the due date for tax payments remains April 15th Determine filing status based on status as of December 31st. If one spouse dies during the year, a joint return may still be filed Can file as a qualifying widower for two years after spouses death, if they don’t remarry The surviving spouse must maintain a household that for the whole entire taxable year was the principal place of abode of a son/daughter, stepson/step daughter (either by blood or adoption) Head of household – individual maintains a household that for more than half the taxable year is the principal residence of dependents: • Son or daughter – Working families act – child must either be a qualifying child or qualify as the taxpayers dependent • Father or mother – not required to live with, nursing home • Dependent relatives – must live with, not free loading friends Individual Taxation – Exemptions Generally, an individual is entitled to a personal exemption that is indexed annually for inflation, $3,300 Persons eligible to be claimed as dependents on another’s tax return will not be allowed a personal exemption on their own return. If the folks claim you, you lose it. Each spouse receives a personal exemption Spouse as personal exemption on a separate return – a married taxpayer, who files separately, may claim his or her spouses personal exemption if both of the following tests are met: 1. the taxpayers spouse has no gross income 2. the taxpayers spouse was not claimed as a dependent by another taxpayer If a person is born or dies during the year, he or she is entitled to a personal exemption for the entire year. Exemptions are not prorated Dependency exemptions – qualifying child or qualifying relative Qualifying child – CARES • Close relative – direct descendant, legally adopted, foster child • Age limit – Under 19 (24 if full time student), no age limit for permanently disabled • Residency requirements – same household as taxpayer for more than half of the tax year • Eliminate gross income test – the gross income test (SUPORT) does not apply • Support test changes – child did not contribute more than half of his/her support Qualifying relative – SUPORT, could be free loading friend • Support over 50% of the persons needs - if two or more people support more than 50%, only one can claim the dependent (must contribute more than 10%) • Under exemption amount ($3,300) of taxable gross income test (no income test if meet age limit, CARES) • Precludes dependent filing joint tax return test, can’t claim dependent if they file jointly with someone else 1 REG - Notes Chapter 1 http://cpacfa.blogspot.com • Only citizens (residents of U.S/Canada or Mexico) test • Relative test, or • Taxpayer lives with individual for whole year test, if not related, (foster kids and cousins fall here) No additional exemption for being • Over 65 • Blind It’s an increased standard deduction Phaseout of personal and dependency exemptions by 2% of each $2,500 increment (1,250 for married) by which AGI exceeds certain thresholds based on filing status R1-15 (threshold amounts and example) Individual Taxation – Gross Income Event Taxable Non-taxable = = Income FMV N-0-N-E Basis FMV NBV Realization = real world Recognition = record for tax purposes Specific items of income and exclusions • Money • Property – the FMV of all property received is included in GI • Cancellation of debt • Life insurance premiums above the first $50,000 of coverage is TI to the recipient - interest income from life insurance proceeds on a deferred payout is fully taxable • Premium insurance payments made by employer are excludable (Accident, medical and health insurance) • Employer payment of employees educational expenses (up to 5,250) are excluded from TI • Payments made by employer in a qualified pension, profit-sharing and stock bonus plan are excluded - Benefit received from such plans are taxable Taxable interest • Federal and corporate bonds • Premiums received for opening a savings account (prizes and awards) are included at FMV • Interest paid by federal or state govt’s for late payment of tax refunds Tax-exempt interest (reportable but not taxable) • State and local gov’t bond interest • Series EE savings bonds interest (for higher educational expenses), there is a phaseout • Net unearned income (dividends, interest, rents, royalties) of a dependent child under 18 is taxed at the parents tax rate, “Kiddie Tax” Dividend Income • Cash and property = FMV is TI • Special lower tax rate 15% or 5% for the very poor (10%/15% income brackets)– qualifying dividends, stock must be held for 60 days during the 120 day period, beginning 60 days before the ex-dividend date 2 REG - Notes Chapter 1 http://cpacfa.blogspot.com • Capital gain distribution Tax-free distributions • Return of capital • Stock splits • Stock dividend • Life insurance dividend Used itemized deductions in prior year = taxable income Used standard deduction in prior year (1040 EZ) = non taxable income Alimony/Spousal support (income to the person receiving it) • Payments must be legally required pursuant to a written divorce • Payments must be in cash/cash equivalent • Payments cannot extend beyond the death of the payee-spouse Child support • Non-taxable to receiving ex-spouse • Non-deductible by the spouse making the payments • If spouse is required to make both alimony and child support payments, but falls short, the money paid will be allocated first to child support Property Settlements • Non-taxable to receiving ex-spouse • Non-deductible by the spouse making the payments Net income from self employment is computed on schedule C Income from farming activities is computed on schedule F Gross Income = Cash + Property at FMV + Cancellation of debt Business Expenses – need to be incurred and paid for to be tax deductible for a cash basis payer • COGS, salaries, etc • State and local business taxes paid • Employee benefits • Business meals and entertainment expenses at 50% • Interest expense on business loans • Bad debts actually written off for accrual basis tax payer (direct write off method) Non-deductible expenses (on schedule C) • Salaries paid to the sole proprietor (they are considered a “draw”) • Federal income tax • Personal expenses • Bad debt expense of a cash basis tax payer There are two taxes on net taxable income • Income tax, and • Federal self employment tax A business with a loss may deduct the loss against other sources of income 3 REG - Notes Chapter 1 http://cpacfa.blogspot.com • 2-year carry back • 20-year carry forward Uniform Capitalization rules – for inventory, even a sole proprietor will be required to • Capitalize DM, DL and Mfg OH, then expense when sold • Period expenses – SG&A and R&D Gains and losses on disposition of property Amount realized – adjusted basis of asset = g/l Traditional IRA • Taxed as ordinary income when withdrawn at 59 1/2 • 10% additional penalty tax if withdraw early Exceptions to penalty rule • 1st time home buyer – $10,000 max • Medical insurance • Medical expenses in excess of 7.5% of AGI • Permanent disability • Higher education • Death Annuities – treat like depreciation Schedule E is used to calculate passive income from • Rental real estate • Royalties • P/S, Estates, Trusts (from schedule K-1) Passive activity losses (PALs) – can only be deducted to extent of passive activity income • Unlimited carryforward • If sell asset and losses unused, losses become fully tax deductible in the year the property is disposed PAL exceptions • Taxpayers may deduct up to $25,000 per year of net passive losses attributable to rental real estate annually if the individuals actively participate (Mom and Pop exception) • Phase out – the 25,000 allowance is reduced 50% of excess of AGI over $100,000 and eliminated when AGI exceeds $150,000 Unemployment compensation – must include in gross income the full amount received Social security income • Low income (below S $25,000/ MFJ $32,000) – no social security benefits are taxable • Upper income (above S $34,000/ MFJ $44,000) – 85% of social security are taxable Taxable Misc Income • FMV of prizes and awards is TI • Gambling winnings is TI • Gambling losses may be deducted to the extent of gambling winnings. (can be an itemized deduction but are not subject to the 2% of AGI limitation on misc itemized deductions Partially Taxable Misc Items 4 REG - Notes Chapter 1 http://cpacfa.blogspot.com Scholarships and fellowship grants are excludable only on amounts spent of tuition, books and supplies • Taxable is used for room and board or services are required to get scholarship Non-taxable Misc Items • Life insurance proceeds • Gifts and inheritances • Medicare benefits • Workers compensation for personal injury or sickness • Personal (physical) injury award • Accident insurance proceeds (if premiums were paid by taxpayer) Individual Taxation – Capital Gains and Losses Real property – items permanently affixed to the land (land, building, paving, etc) Personal property – all property not classified as real property (machinery and equipment) Non-capital assets • Inventory held for sale in the ordinary course of business • Depreciable personal property and real estate used in trade or business (Section 1231, 1245, 1250) • A/R received in trade or business • Music copyrights • Treasury stock Amount realized – Adjusted basis of asset sold = gain/loss Amount realized • Cash received (boot) • Cancellation of debt (boot) • Property received at FMV • Services received at FMV • Reduce amount realized by any selling expenses (like brokers commissions) Adjusted basis of asset sold • Purchased property basis = cost - increase basis for capital improvements - reduce basis for accumulated depreciation (= NBV) • Gift property basis = donors basis - exception: if at the date of gift, the FMV is lower than the NBV, the basis will depend on the future selling price Sell higher use donor’s basis to calculate gain Donor’s basis ------------------------Sell between no gain or loss Lower FMV at date of gift ---------Sell lower use lower FMV at date of gift to calculate loss Only go to this crazy exception when the FMV of the gift is less than the donor’s basis The recipient of the gift normally assumes the donors holding period Inherited property basis 5 REG - Notes Chapter 1 http://cpacfa.blogspot.com • At date of death, the FMV becomes the basis for the new individual • Alternate valuation date – if validly elected, the asset is valued at FMV at the earlier of: - Distribution date of asset - Alternate valuation date (earlier of 6 months after death or date of distribution/sale 6 months max) A gain is not taxed if the tax payer can HIDEIT Gain to the extent of boot is taxable Homeowners Exclusion – sale of primary residence S $250,000/ MFJ $500,000 • Must have used the home as principal residence for 2 years during a five year period • For joint returns, both spouses have to meet the ownership requirement • No age requirement • No rollover to another house required • The exclusion is renewable Involuntary Conversions – insurance proceeds from destruction, theft, condemnation • Must use proceeds to replace property lost - 2 years from year end for personal property - 3 years from year end for business property Divorced Property Settlement Exchange of Like-Kind Business/Investment Assets (tangible) • Like kind exchange of property used in the trade or business or held for investment - not inventory, stock securities, P/S interests, real property in different countries - There is a gain recognized when boot is received Installement Sale • Recognize when cash is received • Gross profit = Sale – COGS • Gross Proft % = Gross profit/ Sales price • Earned Revenue = Gross profit % * cash collections Treasury and Capital stock transactions (by corporation) • Sale, repurchase and reissuing of stock are exempt from gains Non-deductible losses – WRaP these losses up because they are non-deductible Wash Sale Loss • A security is sold for a loss and is repurchases within 30 days before or after the sale date Related Party Transactions • Entities that are more than 50% owned by individuals, corporations, trusts or P/S • Capital losses on disallowed on most related party transactions even if they were made at an arms-length FMV price • Basis rules are the same as Gift rules And 6 REG - Notes Chapter 1 http://cpacfa.blogspot.com Personal Losses – no deduction is allowed for the loss on a non-business disposal or loss Individual capital gain/loss rules • Long term – held for more than a year and receive 15% tax rate (5% if in 10% or 15% income bracket) • Short tem – held for less than a year, treated as ordinary income • $3000 maximum deduction • Excess net capital loss can be carryforwarded for unlimited time, no carryback Corporation Capital gain/loss rules (applies to C Corps only) • No special tax rate for long term capital gains. Lumped with short term as ordinary income • Can’t deduct any capital losses from ordinary income • Net capital losses are carried back 3 years and forward 5 years Excess Offset income Carryback Carry forward Operating losses yes 2 yrs 20 yrs Indv capital losses $3,000 no Forever Corp capital losses no 3 yrs 5 yrs 7
REG - Notes Chapter 1 http://cpacfa.blogspot.com Individual Taxation – Filing Status Due date April 15th An extension is only for filing your paperwork and not your payments, so with an extension the due date for tax payments remains April 15th Determine filing status based on status as of December 31st. If one spouse dies during the year, a joint return may still be filed Can file as a qualifying widower for two years after spouses death, if they don’t remarry The surviving spouse must maintain a household that for the whole entire taxable year was the principal place of abode of a son/daughter, stepson/step daughter (either by blood or adoption) Head of household – individual maintains a household that for more than half the taxable year is the principal residence of dependents: • Son or daughter – Working families act – child must either be a qualifying child or qualify as the taxpayers dependent • Father or mother – not required to live with, nursing home • Dependent relatives – must live with, not free loading friends Individual Taxation – Exemptions Generally, an individual is entitled to a personal exemption that is indexed annually for inflation, $3,300 Persons eligible to be claimed as dependents on another’s tax return will not be allowed a personal exemption on their own return. If the folks claim you, you lose it. Each spouse receives a personal exemption Spouse as personal exemption on a separate return – a married taxpayer, who files separately, may claim his or her spouses personal exemption if both of the following tests are met: 1. the taxpayers spouse has no gross income 2. the taxpayers spouse was not claimed as a dependent by another taxpayer If a person is born or dies during the year, he or she is entitled to a personal exemption for the entire year. Exemptions are not prorated Dependency exemptions – qualifying child or qualifying relative Qualifying child – CARES • Close relative – direct descendant, legally adopted, foster child • Age limit – Under 19 (24 if full time student), no age limit for permanently disabled • Residency requirements – same household as taxpayer for more than half of the tax year • Eliminate gross income test – the gross income test (SUPORT) does not apply • Support test changes – child did not contribute more than half of his/her support Qualifying relative – SUPORT, could be free loading friend • Support over 50% of the persons needs - if two or more people support more than 50%, only one can claim the dependent (must contribute more than 10%) • Under exemption amount ($3,300) of taxable gross income test (no income test if meet age limit, CARES) • Precludes dependent filing joint tax return test, can’t claim dependent if they file jointly with someone else 1 REG - Notes Chapter 1 http://cpacfa.blogspot.com • Only citizens (residents of U.S/Canada or Mexico) test • Relative test, or • Taxpayer lives with individual for whole year test, if not related, (foster kids and cousins fall here) No additional exemption for being • Over 65 • Blind It’s an increased standard deduction Phaseout of personal and dependency exemptions by 2% of each $2,500 increment (1,250 for married) by which AGI exceeds certain thresholds based on filing status R1-15 (threshold amounts and example) Individual Taxation – Gross Income Event Taxable Non-taxable = = Income FMV N-0-N-E Basis FMV NBV Realization = real world Recognition = record for tax purposes Specific items of income and exclusions • Money • Property – the FMV of all property received is included in GI • Cancellation of debt • Life insurance premiums above the first $50,000 of coverage is TI to the recipient - interest income from life insurance proceeds on a deferred payout is fully taxable • Premium insurance payments made by employer are excludable (Accident, medical and health insurance) • Employer payment of employees educational expenses (up to 5,250) are excluded from TI • Payments made by employer in a qualified pension, profit-sharing and stock bonus plan are excluded - Benefit received from such plans are taxable Taxable interest • Federal and corporate bonds • Premiums received for opening a savings account (prizes and awards) are included at FMV • Interest paid by federal or state govt’s for late payment of tax refunds Tax-exempt interest (reportable but not taxable) • State and local gov’t bond interest • Series EE savings bonds interest (for higher educational expenses), there is a phaseout • Net unearned income (dividends, interest, rents, royalties) of a dependent child under 18 is taxed at the parents tax rate, “Kiddie Tax” Dividend Income • Cash and property = FMV is TI • Special lower tax rate 15% or 5% for the very poor (10%/15% income brackets)– qualifying dividends, stock must be held for 60 days during the 120 day period, beginning 60 days before the ex-dividend date 2 REG - Notes Chapter 1 http://cpacfa.blogspot.com • Capital gain distribution Tax-free distributions • Return of capital • Stock splits • Stock dividend • Life insurance dividend Used itemized deductions in prior year = taxable income Used standard deduction in prior year (1040 EZ) = non taxable income Alimony/Spousal support (income to the person receiving it) • Payments must be legally required pursuant to a written divorce • Payments must be in cash/cash equivalent • Payments cannot extend beyond the death of the payee-spouse Child support • Non-taxable to receiving ex-spouse • Non-deductible by the spouse making the payments • If spouse is required to make both alimony and child support payments, but falls short, the money paid will be allocated first to child support Property Settlements • Non-taxable to receiving ex-spouse • Non-deductible by the spouse making the payments Net income from self employment is computed on schedule C Income from farming activities is computed on schedule F Gross Income = Cash + Property at FMV + Cancellation of debt Business Expenses – need to be incurred and paid for to be tax deductible for a cash basis payer • COGS, salaries, etc • State and local business taxes paid • Employee benefits • Business meals and entertainment expenses at 50% • Interest expense on business loans • Bad debts actually written off for accrual basis tax payer (direct write off method) Non-deductible expenses (on schedule C) • Salaries paid to the sole proprietor (they are considered a “draw”) • Federal income tax • Personal expenses • Bad debt expense of a cash basis tax payer There are two taxes on net taxable income • Income tax, and • Federal self employment tax A business with a loss may deduct the loss against other sources of income 3 REG - Notes Chapter 1 http://cpacfa.blogspot.com • 2-year carry back • 20-year carry forward Uniform Capitalization rules – for inventory, even a sole proprietor will be required to • Capitalize DM, DL and Mfg OH, then expense when sold • Period expenses – SG&A and R&D Gains and losses on disposition of property Amount realized – adjusted basis of asset = g/l Traditional IRA • Taxed as ordinary income when withdrawn at 59 1/2 • 10% additional penalty tax if withdraw early Exceptions to penalty rule • 1st time home buyer – $10,000 max • Medical insurance • Medical expenses in excess of 7.5% of AGI • Permanent disability • Higher education • Death Annuities – treat like depreciation Schedule E is used to calculate passive income from • Rental real estate • Royalties • P/S, Estates, Trusts (from schedule K-1) Passive activity losses (PALs) – can only be deducted to extent of passive activity income • Unlimited carryforward • If sell asset and losses unused, losses become fully tax deductible in the year the property is disposed PAL exceptions • Taxpayers may deduct up to $25,000 per year of net passive losses attributable to rental real estate annually if the individuals actively participate (Mom and Pop exception) • Phase out – the 25,000 allowance is reduced 50% of excess of AGI over $100,000 and eliminated when AGI exceeds $150,000 Unemployment compensation – must include in gross income the full amount received Social security income • Low income (below S $25,000/ MFJ $32,000) – no social security benefits are taxable • Upper income (above S $34,000/ MFJ $44,000) – 85% of social security are taxable Taxable Misc Income • FMV of prizes and awards is TI • Gambling winnings is TI • Gambling losses may be deducted to the extent of gambling winnings. (can be an itemized deduction but are not subject to the 2% of AGI limitation on misc itemized deductions Partially Taxable Misc Items 4 REG - Notes Chapter 1 http://cpacfa.blogspot.com Scholarships and fellowship grants are excludable only on amounts spent of tuition, books and supplies • Taxable is used for room and board or services are required to get scholarship Non-taxable Misc Items • Life insurance proceeds • Gifts and inheritances • Medicare benefits • Workers compensation for personal injury or sickness • Personal (physical) injury award • Accident insurance proceeds (if premiums were paid by taxpayer) Individual Taxation – Capital Gains and Losses Real property – items permanently affixed to the land (land, building, paving, etc) Personal property – all property not classified as real property (machinery and equipment) Non-capital assets • Inventory held for sale in the ordinary course of business • Depreciable personal property and real estate used in trade or business (Section 1231, 1245, 1250) • A/R received in trade or business • Music copyrights • Treasury stock Amount realized – Adjusted basis of asset sold = gain/loss Amount realized • Cash received (boot) • Cancellation of debt (boot) • Property received at FMV • Services received at FMV • Reduce amount realized by any selling expenses (like brokers commissions) Adjusted basis of asset sold • Purchased property basis = cost - increase basis for capital improvements - reduce basis for accumulated depreciation (= NBV) • Gift property basis = donors basis - exception: if at the date of gift, the FMV is lower than the NBV, the basis will depend on the future selling price Sell higher use donor’s basis to calculate gain Donor’s basis ------------------------Sell between no gain or loss Lower FMV at date of gift ---------Sell lower use lower FMV at date of gift to calculate loss Only go to this crazy exception when the FMV of the gift is less than the donor’s basis The recipient of the gift normally assumes the donors holding period Inherited property basis 5 REG - Notes Chapter 1 http://cpacfa.blogspot.com • At date of death, the FMV becomes the basis for the new individual • Alternate valuation date – if validly elected, the asset is valued at FMV at the earlier of: - Distribution date of asset - Alternate valuation date (earlier of 6 months after death or date of distribution/sale 6 months max) A gain is not taxed if the tax payer can HIDEIT Gain to the extent of boot is taxable Homeowners Exclusion – sale of primary residence S $250,000/ MFJ $500,000 • Must have used the home as principal residence for 2 years during a five year period • For joint returns, both spouses have to meet the ownership requirement • No age requirement • No rollover to another house required • The exclusion is renewable Involuntary Conversions – insurance proceeds from destruction, theft, condemnation • Must use proceeds to replace property lost - 2 years from year end for personal property - 3 years from year end for business property Divorced Property Settlement Exchange of Like-Kind Business/Investment Assets (tangible) • Like kind exchange of property used in the trade or business or held for investment - not inventory, stock securities, P/S interests, real property in different countries - There is a gain recognized when boot is received Installement Sale • Recognize when cash is received • Gross profit = Sale – COGS • Gross Proft % = Gross profit/ Sales price • Earned Revenue = Gross profit % * cash collections Treasury and Capital stock transactions (by corporation) • Sale, repurchase and reissuing of stock are exempt from gains Non-deductible losses – WRaP these losses up because they are non-deductible Wash Sale Loss • A security is sold for a loss and is repurchases within 30 days before or after the sale date Related Party Transactions • Entities that are more than 50% owned by individuals, corporations, trusts or P/S • Capital losses on disallowed on most related party transactions even if they were made at an arms-length FMV price • Basis rules are the same as Gift rules And 6 REG - Notes Chapter 1 http://cpacfa.blogspot.com Personal Losses – no deduction is allowed for the loss on a non-business disposal or loss Individual capital gain/loss rules • Long term – held for more than a year and receive 15% tax rate (5% if in 10% or 15% income bracket) • Short tem – held for less than a year, treated as ordinary income • $3000 maximum deduction • Excess net capital loss can be carryforwarded for unlimited time, no carryback Corporation Capital gain/loss rules (applies to C Corps only) • No special tax rate for long term capital gains. Lumped with short term as ordinary income • Can’t deduct any capital losses from ordinary income • Net capital losses are carried back 3 years and forward 5 years Excess Offset income Carryback Carry forward Operating losses yes 2 yrs 20 yrs Indv capital losses $3,000 no Forever Corp capital losses no 3 yrs 5 yrs 7
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Today's Accounting Crop: Spoiled Rotten?
"Finance chiefs try to cope with a new cadre of finance and accounting employees who just can't sit still. Enter the "millennium generation" of finance and accounting professionals. Born in 1982 and later, they're high-maintenance types, requiring a great deal of hand-holding, mentoring, and immediate attention. Even after all that parental supervision, they can be incredibly fickle, choosing to stay at your company just until a better-paying, faster-growing offer comes along. Some may throw a tantrum if they feel like it..."
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Source: CFO.com
Priscilla's Exam Cram: Multiple Choice & More Multiple Choice
"So to anyone who's interested, I can't stress enough how important it is to do repetitions of the multiple choice questions when studying. I've found them to be the best indicator of how you'll perform on the test...and you will see VERY similar questions on the test (similar to what's been released and what's provided by most study guides)..."
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Source: NJSCPA Exam Cram Blog
Priscilla's Exam Cram: So Unreal
"I passed FAR...my first section of the CPA exam!!!!! You can't even imagine how excited I am unless you've experienced it yourself. It is an incredible feeling. Such a weight has been lifted off my shoulders and there is a light at the end of the tunnel (yeah, I know, terribly corny)..."
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Source: NJSCPA Exam Cram Blog
Priscilla's Exam Cram: Phew
"FARE = done. Now the waiting begins. The test went well (or so I think). The material was fair and there really wasn't anything out of left field. About 65% of the questions, I felt assured of the correct answer, and about 25% I felt like I made a reasonable estimate. So there were only about 10% of the questions that were straight up guesses. It wasn't even that the ones I guessed on were "hard," they were either tricky or I felt assured of an answer that wasn't an option (which I'm assuming meant I was wrong, haha)..."
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Source: NJSCPA Exam Cram Blog
Priscilla's Exam Cram: Down to the Wire
"So with about a day to go, I'm pretty relaxed. I'm not sure if it will hit me tomorrow or Thursday, but I'm thinking that I've got to get really nervous at some point. I'd rather get nervous tomorrow (Wednesday)...then I'd get it all out of my system before the test on Thursday morning. Does it work like that though? Can I just release all my nervousness the day before...so I'm calm, cool and collective the morning of? We'll find out. Today I started working through the Becker Final Review course..."
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Source: NJSCPA Exam Cram Blog
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