Wiley GAAP 2015: Interpretation and Application of Generally Accepted Accounting Principles

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PREFACE

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Wiley GAAP 2015: Interpretation and Application provides analytical explanations, copious illustrations, and nearly 300 examples of all current generally accepted accounting principles. The book integrates principles promulgated by the FASB in its Accounting Standards Codification.™

This edition of Wiley GAAP is organized to align fully with the structure of the FASB Codification. Each chapter now begins with a list of the Subtopics included within the Topic, major scope and scope exceptions, technical alerts of FASB Updates, and an overview of the Topic. The remainder of each chapter contains a detailed discussion of the concepts and practical examples and illustrations. This organization facilitates the primary objective of the book—to assist financial statement preparers and practitioners in resolving the myriad practical problems faced in applying GAAP.

Meaningful, realistic examples abound, guiding users in the application of GAAP to complex fact situations that must be dealt with in the real world practice of accounting. In addition to this emphasis, a major strength of the book is that it explains the theory of GAAP in sufficient detail to serve as a valuable adjunct to accounting textbooks. Much more than merely a reiteration of currently promulgated GAAP, it provides the user with the underlying conceptual bases for the rules. It facilitates the process of reasoning by analogy that is so necessary in dealing with the complicated, fast-changing world of commercial arrangements and transaction structures. It is based on the author's belief that proper application of GAAP demands an understanding of the logical underpinnings of all its technical requirements.

As a bonus, a comprehensive disclosure checklist, following the main text, offers practical guidance to preparing financial statements in accordance with GAAP. For easy reference and research, the checklist follows the order of the codification.

The following FASB Accounting Standards Updates were issued since the Wiley GAAP 2013. Their requirements are incorporated in this edition of Wiley GAAP, as and where appropriate. Information on ASU 2014-09 is included in the chapter on ASC 605.

Significant accounting changes are on the horizon. In the next year, the FASB is expected to make strides on the following major projects and others:

Consolidation

Going Concern

Insurance Contracts

Financial Instruments—Classification and Measurement

Readers are encouraged to check the FASB website for status updates to the above and other FASB projects.

In response to the 2011 report of the Blue Ribbon Panel on Standard Setting for Private Companies, the AICPA and the FASB began separate initiatives. In July 2013, the AICPA released its Financial Reporting Framework for Small- and Medium-sized Entities. The AICPA has positioned the Framework as an alternative to U.S. GAAP and one that will provide consistent, reliable information for small- and medium-sized entities that are not required to prepare financial statements in accordance with U.S. GAAP. The FASB created the Private Company Council to address the Blue Ribbon Panel's report. The FASB issued a framework for the FASB and the PCC to use in determining whether alternatives to existing and proposed U.S. GAAP are warranted for private companies. In 2014, FASB issued three ASUs that are consensuses of the PCC. Those are listed on the table above.

The author's wish is that this book will serve preparers, practitioners, faculty, and students, as a reliable reference tool to facilitate their understanding of, and ability to apply, the complexities of the authoritative literature.

Joanne M. Flood

June 2014

ABOUT THE AUTHOR

Joanne M. Flood, CPA, is an author and independent consultant on accounting and auditing technical topics and e-learning. She has experience as an auditor in both an international firm and a local firm and worked as a senior manager in the AICPA's Professional Development group. She received her MBA Summa Cum Laude in Accounting from Adelphi University and her Bachelor's degree in English from Molloy College.

While in public accounting, Joanne worked on major clients in retail, manufacturing, and finance and on small business clients in construction, manufacturing, and professional services. At the AICPA, Joanne developed and wrote e-learning, text, and instructor-led training courses on US and International Standards. She also produced training materials in a wide variety of media, including print, video, and audio, and pioneered the AICPA's e-learning product line. Joanne resides on Long Island, New York with her daughter, Elizabeth. Joanne is the author of the following Wiley publications:

Financial Disclosure Checklist

Wiley GAAP 2014: Interpretation and Application of Generally Accepted Accounting Principles

Wiley Practitioner's Guide to GAAS 2014: Covering all SASs, SSAEs, SSARSs, and Interpretations

Wiley GAAP: Financial Statement Disclosures Manual (Wiley Regulatory Reporting)

Wiley Revenue Recognition

And the following AICPA online and live CPE programs:

Audit Staff Essentials, Level 1 – New Hire

Audit Staff Essentials, Level 2 – Experienced Staff

Audit Staff Essentials, Level 3 – Audit Senior/In-Charge

CODIFICATION TAXONOMY

¹ ASU 2014-09 added the Codification section. For more information on ASU 2014-09, see the Preface.

Chapter 1

ASC 105 GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

PERSPECTIVES AND ISSUES

What Is GAAP?

DEFINITIONS OF TERMS

CONCEPTS, RULES, AND EXAMPLES

History of GAAP

GAAP Codification

Standards-setting Process

Researching GAAP Problems

Research Procedures

Search Authoritative Literature (Step 6)—Further Explanation

The Concept of Materiality

The Conceptual Framework

CON 8—Chapter 1: The Objective of General Purpose Financial Reporting

CON 8—Chapter 3: Qualitative Characteristics of Useful Financial Information

CON 5: Recognition and Measurement in Financial Statements of Business Enterprises

CON 6: Elements of Financial Statements

CON 7: Using Cash Flow Information and Present Value in Accounting Measurements

PERSPECTIVES AND ISSUES

What Is GAAP?

The FASB Accounting Standards Codification™ (ASC) is the

…source of authoritative generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. In addition to the SEC's rules and interpretive releases, the SEC staff issues Staff Accounting Bulletins that represent practices followed by the staff in administering SEC disclosure requirements, and it utilizes SEC Staff Announcements and Observer comments made at Emerging Issues Task Force meetings to publicly announce its views on certain accounting issues for SEC registrants. ASC 105-10-05-1

In the absence of authoritative guidance, the FASB Codification (the Codification) offers the following approach.

If the guidance for a transaction or event is not specified within a source of authoritative GAAP for that entity, an entity shall first consider accounting principles for similar transactions or events within a source of authoritative GAAP for that entity and then consider nonauthoritative guidance from other sources. An entity shall not follow the accounting treatment specified in accounting guidance for similar transactions or events in cases in which those accounting principles either prohibit the application of the accounting treatment to the particular transaction or event or indicate that the accounting treatment should not be applied by analogy. ASC 105-10-05-2

Nonauthoritative Sources. The Codification lists some possible nonauthoriative sources:

Practices that are widely recognized and prevalent either generally or in the industry

FASB Concepts Statements

American Institute of Certified Public Accountants (AICPA) Issues Papers

International Financial Reporting Standards of the International Accounting Standards Board

Pronouncements of professional associations or regulatory agencies

Technical Information Service Inquiries and Replies included in AICPA Technical Practice Aids

Accounting textbooks, handbooks, and articles.

(ASC 105-10-05-3)

GAAP establishes

The measurement of economic activity,

The time when such measurements are to be made and recorded,

The disclosures surrounding this activity, and

The preparation and presentation of summarized economic information in the form of financial statements.

GAAP develops when questions arise about how to best accomplish those items. In response to those questions, GAAP is either prescribed in official pronouncements of authoritative bodies empowered to create it, or it originates over time through the development of customary practices that evolve when authoritative bodies fail to respond. Thus, GAAP is a reaction to and a product of the economic environment in which it develops. As such, the development of accounting and financial reporting standards has lagged the development and creation of increasingly intricate economic structures and transactions. There are two broad categories of accounting principles—recognition and disclosure.

Recognition Principles. Recognition principles determine the timing and measurement of items that enter the accounting cycle and impact the financial statements. These are quantitative standards that require economic information to be reflected numerically.

Disclosure Principles. Disclosure principles deal with factors that are not always quantifiable. Disclosures involve qualitative information that is an essential ingredient of a full set of financial statements. Their absence would make the financial statements misleading by omitting information relevant to the decision-making needs of the reader. Disclosure principles complement recognition principles by expanding on some quantitative data and explaining assumptions underlying the numerical information and providing additional information on accounting policies, contingencies, uncertainties, etc., which are essential to fully understand the performance and financial condition of the reporting enterprise.

DEFINITIONS OF TERMS

Source: ASC 105-10-20 Glossary

Nongovernmental Entity. An entity that is not required to issue financial reports in accordance with guidance promulgated by the Governmental Accounting Standards Board or the Federal Accounting Standards Advisory Board.

Nonpublic Entity. Any entity that does not meet any of the following conditions:

Its debt or equity securities trade in a public market either on a stock exchange (domestic or foreign) or in an over-the-counter market, including securities quoted only locally or regionally.

It is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets).

It files with a regulatory agency in preparation for the sale of any class of debt or equity securities in a public market.

It is required to file or furnish financial statements with the Securities and Exchange Commission.

It is controlled by an entity covered by criteria (a) through (d).

CONCEPTS, RULES, AND EXAMPLES

History of GAAP

From time to time, the bodies given responsibility for the promulgation of GAAP have changed, and indeed more than a single such body has often shared this responsibility. In response to the stock market crash of 1929, the AICPA appointed the Committee on Accounting Procedure. This was superseded in 1959 by the Accounting Principles Board (APB) created by the AICPA. Because of operational problems, in 1972 the profession replaced the APB with a three-part organization consisting of the Financial Accounting Foundation (FAF), Financial Accounting Standards Board (FASB), and the Financial Accounting Standards Advisory Council (FASAC). Since 1973 the FASB has been the organization designated to establish standards of financial reporting.

FASB is recognized as authoritative by the SEC, reaffirmed through the Sarbanes-Oxley Act of 2002, and by the AICPA through Rule 203 of the AICPA Code of Professional Conduct. FASB is an independent body relying on the FAF for selection of its members and approval of its budgets. FASB is supported by the sale of its publications and by fees assessed on all public companies based on their market capitalizations as mandated by the Sarbanes-Oxley Act.

From its inception through the mid-2009 implementation of the Accounting Standards Codification, FASB issued several types of pronouncements and used the following GAAP hierarchy (FAS 162, The Hierarchy of Generally Accepted Accounting Principles).

Pre Codification GAAP Hierarchy

Other sources. Not all GAAP has resulted from the issuance of pronouncements by authoritative bodies. For example, depreciation methods such as straight-line and declining balance have both long been acceptable. There are, however, no definitive pronouncements that can be found to state this. Furthermore, there are many disclosure principles that evolved into general accounting practice because they were originally required by the SEC in documents submitted to them. Even much of the content of statements of financial position and income statements has evolved over the years in the absence of adopted standards.

GAAP Codification

FASB completed its project to codify GAAP and, on July 1, 2009, the Codification became the single official source of authoritative, nongovernmental US generally accepted accounting principles. It superseded all nongrandfathered (see ASC105-10-70-2 for a list of grandfathered guidance), non-SEC accounting guidance, that is, extant FASB, AICPA, EITF, and related literature. After that date, only one level of authoritative GAAP existed, excluding the guidance issued by the Securities and Exchange Commission (SEC). All other literature is nonauthoritative. In effect, therefore, all former Category A-D GAAP was compressed to two levels.

The Codification did not change GAAP, but rather introduced a new structure—one that is organized into an easily accessible, user-friendly online research system. The Codification reorganizes the large number of discrete US GAAP pronouncements into roughly 90 accounting Topics, and displays all Topics using a consistent structure.

SEC Guidance in the Codification. To increase the utility of the Codification for public companies, relevant portions of authoritative content issued by the SEC and selected SEC staff interpretations and administrative guidance are included for reference in the Codification. The sources include:

Regulation S-X,

Financial Reporting Releases (FRR)/Accounting Series Releases (ASR),

Interpretive Releases (IR), and

SEC staff guidance in:

Staff Accounting Bulletins (SAB),

EITF Topic D and SEC Staff Observer comments.

The Codification does not, however, incorporate the entire population of SEC rules, regulations, interpretive releases, and staff guidance, such as content related to matters outside of the basic financial statements, including Management's Discussion and Analysis (MD&A), or to auditing or independence matters.

Standards-setting Process

The FASB has long adhered to rigorous due process when creating new guidance. The goal is to involve constituents who would be affected by the newly issued guidance so that the standards created will result in information that reports economic activity as objectively as possible without attempting to influence behavior in any particular direction. Ultimately, however, the guidance is the judgment of the FASB, based on research, public input, and deliberation. The FASB's due process procedures are described below.

The FASB receives requests for new standards from all parts of its diverse constituency, including auditors, industry groups, the EITF, and the SEC. Requests for action include both suggestions for new topics and suggestions for reconsideration of existing pronouncements. In consultation with the FASB Members and others, and subject to FAF oversight, the FASB Chairman decides whether or not to add a project to the technical agenda. The FASB begins by appointing an advisory group, which may be a task force or advisory committee of outside experts. Care is taken to ensure that various points of view are represented in the advisory group. The group meets with and advises the Board and staff on the definition and scope of the project and the nature and extent of any additional research that may be needed. The FASB and its staff then debate the significant issues in the project and arrive at tentative conclusions. As it does so, the FASB and its staff study existing literature on the subject and conduct or commission any additional research as needed. The advisory group meetings and the Board meetings are open to public observation, and a public record is maintained. Many of these proceedings are also available by live or archived audio Webcast as well as via telephone. The basis of discussion for the meetings may be a Discussion Paper or an Exposure Draft.

Any individual or organization may request to speak at the public hearing, which is conducted by the FASB and the staff assigned to the project. Public observers are welcome. After each individual speaks, the FASB and staff ask questions. Questions are based on written material submitted by the speakers prior to the hearing as well as on the speaker's oral comments. In addition to the hearing, the staff analyzes all the written comments submitted. The FASB members study this analysis and read the comment letters to help them reach conclusions. The hearing transcript and written comments become part of the public record.

After the comment letters and oral presentations responding to the discussion document are considered, formal deliberations begin. (If the accounting problem is not as complex and no discussion document was issued, the due process begins at this point.) The FASB deliberates at meetings that are open to public observation, although observers do not participate in the discussions. The agenda for each meeting is announced in advance. Prior to each Board meeting, the staff presents a written analysis and recommendations of the issues to be discussed. During the meeting, the staff presents orally a summary of the written materials and the Board discusses each issue presented. The Board meets as many times as is necessary to resolve the issues.

When the Board has reached tentative conclusions on all the issues in the project, the staff prepares an Exposure Draft. The Exposure Draft sets forth the Board's conclusions about the proposed standards of financial accounting and reporting, the proposed effective date and method of transition, background information, and an explanation of the basis for the Board's conclusions. The Board reviews, and if necessary, revises, the Exposure Draft. A majority of the Board members must vote to approve an Exposure Draft for issuance for public comment. If the votes are not obtained, the FASB holds additional meetings and redrafts the Exposure Draft.

Any individual or organization can provide comments about the conclusions in the Exposure Draft during the exposure period, which is generally sixty days or more. The Board may also decide to have a public hearing to hear constituents' views. At the conclusion of the comment period, all comment letters and oral presentations are analyzed by the staff, and the Board members read the letters and the staff analysis. Then, the Board re-deliberates the issues, with the goal of issuing a final Accounting Standards Update (ASU).

All Board meetings are open to the public. During these meetings, the Board considers the comments received and may revise their earlier conclusions. If substantial modifications are made, the Board will issue a revised Exposure Draft for additional public comment. If so, the Board also may decide that another public hearing is necessary. When the Board is satisfied that all reasonable alternatives have been adequately considered, the staff drafts the proposed provisions. The Board deliberates the provisions and, if approved, the Board issues an Accounting Standards Update describing amendments to the Accounting Standards Codification. Once issued, the provisions become GAAP after the stated effective date.

Emerging Issues Task Force. The Emerging Issues Task Force (EITF) was formed in 1984 by the FASB to assist the Board in identifying current or emerging issues and implementation problems before divergent practices become entrenched. The guidance provided has often been restricted to narrow issues that were of immediate interest and importance. Task Force members are drawn primarily from public accounting firms but also include individuals who would be aware of issues and practices that should be considered by the group.

For each EITF agenda item, an issues paper is developed by members, their firms, or the FASB staff. These issues may be in especially narrow areas having little broad-based interest. Occasionally, FASB may include a narrow issue in the scope of a broader project and reaffirm or supersede the work of the Task Force. After discussion by the Task Force, a consensus may be reached on the issue, in which case the consensus is referred to the FASB for ratification. If the EITF consensus is approved by the FASB, it amends the FASB Codification through an ASU.

Accounting Standards Updates. Accounting Standards Updates (ASUs) are composed of:

A summary of the key provisions of the project that led to the changes,

The specific changes to the Codification, and

The Basis for Conclusions.

The title of the combined set of new guidance and instructions is Accounting Standards Update YY-XX, where YY is the last two digits of the year and XX is the sequential number for each update. All authoritative GAAP issued by the FASB is issued in this format.

The FASB organizes the content of ASUs using the same Section headings as those used in the Codification. The ASU instructions display marked changes to the pertinent sections of the Codification. ASUs are not deemed authoritative in their own right; instead, they serve only to update the Codification and provide the historical basis for conclusions.

The content from updates that is not yet fully effective for all reporting entities appears in the Codification as boxed text and is labeled as pending content. The pending content text box includes the earliest transition date and a link to the related transition guidance, also found in the Codification.

For reference purposes, the Codification permits backward tracing to the actual literature from which the Codification was derived. Accounting Standards Updates add to or amend the Codification only, and no stand-alone FASB Statements or other guidance are promulgated. (ASC 105-10-05-5)

Maintenance Updates. As with any publishing practice, irregularities occur. To make necessary corrections, the FASB staff issues Maintenance Updates. These are not addressed by the Board and contain nonsubstantive editorial changes and link-related changes.

American Institute of Certified Public Accountants. Although it currently plays a greatly reduced standards-setting role, the American Institute of Certified Public Accountants (AICPA) has authorized the Financial Reporting Executive Committee (FinREC) to determine the AICPA's policies on financial reporting standards and to speak for the AICPA on accounting matters. FinREC, formerly the Accounting Standards Executive Committee (AcSEC), is the senior technical committee at the AICPA. It is composed of sixteen volunteer members, representative of industry, analysts, and both national and regional public accounting firms. All FinREC members are CPAs and members of the AICPA.

Researching GAAP Problems

The research procedures presented here are intended to serve as a general model for approaching research on accounting issues or questions you may have. These procedures should be refined and adapted to each individual fact situation.

Codification Structure. The FASB has compiled the Codification into a Web site, located through fasb.org. The site is intended to be easily searchable for research purposes. This section provides an overview of the site's contents and search functionality.

Areas. On all pages of the site, all categories of the Codification are listed down the vertical menu bar on the left side of the page, revealing the following Areas, and the numbering series for each one:

General Principles (100) (Establishes the Codification as the source of GAAP.)

Presentation—(200) (Topics in this area relate only to presentation matters; they do not address recognition, measurement, and derecognition matters. Examples of these topics are income statement, balance sheet, and earnings per share.)

Assets (300).

Liabilities (400).

Equity (500).

Revenue (600).

Expenses (700). (Clusters all types of expense-related GAAP into five broad categories, which are cost of goods sold, research and development, compensation, income taxes, and other expenses.)

Broad Transactions (800). (Contains the major transactional topics, such as business combinations, derivatives, and foreign currency matters.)

Industry (900). (Itemizes GAAP for specific industries, such as entertainment, real estate, and software.)

Master Glossary.

Topics. The Codification content is arranged by Area and then further divided by Topics, Subtopics, Sections, and Subsections. FASB has developed a classification system specifically for the Codification. The following is the structure of the classifications system: XXX-YY-ZZ-PP, where

XXX = topic,

YY = subtopic,

ZZ = section, and

PP = paragraph.

An S preceding the section number denotes SEC guidance. At the most granular level of detail, the Codification has a two-digit numerical code for a standard set of categories.

Below are the Codification Topics by Area. The entire numbering system is noted in the Codification Taxonomy section that precedes Chapter 1.

Subtopics. Subtopics represent subsets of a topic and are typically identified by type or by scope. For example, operating leases and capital leases are two separate subtopics of the leases topic. Each topic contains an overall subtopic (designated -10) that generally represents the pervasive guidance for the topic, which includes guidance that applies to all other subtopics. Each additional subtopic represents incremental or unique guidance not contained in the overall subtopic.

Sections. Sections represent the nature of the content in a subtopic—for example, recognition, measurement, and disclosure. The sectional organization for all subtopics is the same. In a manner similar to that used for topics, sections correlate closely with sections of individual International Accounting Standards. Sections are further broken down into subsections, paragraphs, and subparagraphs, depending on the specific content of each section.

Finding Information. By drilling down through the various topics and subtopics in the sidebar of the online Codification, a researcher can eventually locate the relevant GAAP information. However, there are other ways to access GAAP information through the Codification site that may prove to be easier.

Cross-referencing. If the researchers know the reference number of an original GAAP source document, such as an EITF consensus or a FASB Staff Position, then they can enter this information through the Cross-Reference tab, which is located at the top center of the Codification home page.

Codification search. If the researchers are searching for specific words or phrases, then the best search tool is the Codification search bar, which is located in the upper right corner of any page on the site. To use it for a precision search, enter quotes around the search text; for a less precise search that returns individual words within the search text, do not use quotes.

Codification Terminology. With issuance of the Codification, the FASB standardized on the term entity to replace terms such as company, organization, enterprise, firm, preparer, etc. So, too, the Codification uses shall throughout to replace should, shall, is required to, must, etc. The FASB believes these terms all represent the same concept—the requirement to apply a standard. Would and should are used to indicate hypothetical situations. To reduce ambiguity, the Codification also eliminated qualifying terminology, such as usually, ordinarily, generally, and similar terms.

Research Procedures

Step 1: Identify the problem. Most often it is found that incorrect answers (e.g., regarding the proper way to report revenue-producing activities) flow from improper definition of the actual question to be resolved. The process to be employed is to

Gain an understanding of the problem or question.

Challenge the tentative definition of the problem and revise, as necessary.

Problems and research questions can arise from new authoritative pronouncements, changes in a firm's economic operating environment, or new transactions, as well as from the realization that the problem had not been properly defined in the past.

If proposed transactions and potential economic circumstances are anticipated, more deliberate attention can be directed at finding the correct solution, and certain proposed transactions having deleterious reporting consequences might be avoided altogether or structured more favorably.

If little is known about the subject area, it may be useful to consult general reference sources to become more familiar with the topic, that is, the basic what, why, how, when, who, and where. Web-based research vastly expands the ability to gather useful information.

Ensure that the issue you are researching is a GAAP issue or is an auditing issue so that your search is directed to the appropriate literature.

Step 2: Analyze the problem.

Identify critical factors, issues, and questions that relate to the research problem.

What are the options? Brainstorm possible alternative accounting treatments.

What are the goals of the transaction? Are these goals compatible with full and transparent disclosure and recognition?

What is the economic substance of the transaction, irrespective of the manner in which it appears to be structured?

What limitations or factors can impact the accounting treatment?

Step 3: Refine the problem statement.

Clearly articulate the critical issues in a way that will facilitate research and analysis.

Step 4: Identify plausible alternatives.

Plausible alternative solutions are based upon prior knowledge or theory.

Additional alternatives may be identified as Steps 5–7 are completed.

The purpose of identifying and discussing different alternatives is to be able to respond to key accounting issues that arise out of a specific situation.

The alternatives are the potential methods of accounting for the situation from which only one will ultimately be chosen.

Exploring alternatives is important because many times there is no single cut-and-dried financial reporting solution to the situation.

Ambiguity often surrounds many transactions and related accounting issues and, accordingly, the accountant and business advisor must explore the alternatives and use professional judgment in deciding on the proper course of action.

Step 5: Develop a research strategy.

Determine which literature to search.

Generate keywords or phrases that will form the basis of an electronic search.

Consider trying a broad search to