The tech company you are working for regularly develops its own software for use internally. Recently, it has decided to also start providing this computer software to clients and is decidin
accounting writing question and need the explanation and answer to help me learn.
The tech company you are working for regularly develops its own software for use internally. Recently, it has decided to also start providing this computer software to clients and is deciding how to account for the costs of this internally-developed software. Please discuss the costs and benefits (advantages and disadvantages) of this scenario in accounting. I have given an example of the structure of an accounting writing mini-case. Please notice to the question #1.
Requirements: 3 pages
George RuizLong LamMichelle SchultzQuynh NguyenGroup 2Mini-Case 1Question 1This company is trading securities, which is another form of a debt investment, so throughaccounting standards we treat it as a debt investment. The company must first record the purchase of thedebt investment, so they are recorded at the cost of the amount paid as well as any fees. Most of the timethere will either be a premium, which signals the company purchased for more than its maturity rate, or adiscount, which signals the company bought it at an amount less than the maturity date.Investmentxx,xxxDiscount on investmentxx,xxxCash (price paid)xx,xxxORInvestmentxx,xxxPremium on investmentxx,xxxCashxx,xxxWith any investment, there is going to be interest the company must account for. The companyshould calculate interest by taking the outstanding balance and multiplying it by the market rate of interestdivided by the amount of payments in a period if there is more than one payment annually. Once theyhave found the amount of interest revenue, they would record it as stated below:Cash (stated rate x face amount)Discount on investmentInterest revenue (market rate x outstanding balance)ORCash (stated rate x face amount)
Premium on investment (difference)Interest revenue (market rate x outstanding balance)They are carried at fair value on the balance sheet. Their fair value must be adjusted by the end ofeach reporting period, which could possibly increase or decrease the carrying value. The journal entry torecord any adjustments to the fair value would be a debit to Fair Value Adjustment and a credit to Gain oninvestments. If there was a loss on investments, the company would debit Loss on investments and creditFair Value Adjustment.Fair Value Adjustmentxx,xxxGain on investments (unrealized)xx,xxxORLoss on investmentsxx,xxxFair Value Adjustmentxx,xxxSummary of These InvestmentsASC 815 deals with the definition of the derivative instrument and different ways toaccount for such instruments. These include derivatives that may be embedded in hybridinstruments. ASC 815 is also concerned with establishing how to report entities in specificlimited, accurately defined scenarios and ways to apply hedge accounting to a relationship thatinvolves designated hedging exposure and hedging instruments. Hedging accounting givesunique alternatives to dealing with relationships in such a manner. ASC 815 stipulates howreporting entities determine whether an instrument is (1) recorded to the reporting entity’s stock(2) seen as settled in reporting own entity stock, and this will determine whether the instrumentis accounted for as an equity or debt and the specific accounting practice to be performed.Finally, ASC 815 explains on non-exchange-trade weather derivative. The topic also establishesdifferent industry-specific hedging and derivative guidance, but they are found in the industrysection of the codification.ASC 815-20- 05-4:This topic requires that an entityrecognize derivative instruments,including specific instruments embedded in other contracts, as assets or liabilities in thestatement of financial position and measure them at fair value. If certain conditions are met, an
entity may elect, under this topic, to designate a derivative instrument in any one of the followingways:a. A hedge of the exposure to changes in the fair value of a recognized asset or liability or of anunrecognized firm commitment that is attributable to a particular risk (referred to as afair valuehedge)b. A hedge of the exposure to variability in the cash flows of a recognized asset or liability or ofa forecasted transaction that is attributable to a particular risk (referred to as a cash flow hedge)c. A hedge of the foreign currency exposure of any one of the following:1. An unrecognized firm commitment (a foreign currency fair value hedge)2. An available-for-sale debt security (a foreign currency fair value hedge)3. A forecasted transaction (a foreign currency cash flow hedge)4. A net investment in a foreign operation.?InterpretationA hedge is a financial instrument that is often used to avoid risk. Investors incorporatedifferent unique hedging techniques to offset risks that may be linked to their investment orassets. We often purchase insurance for most of our properties, and this is a simple example of ahedge. Thus, this helps us avoid the risk associated with our personal properties. Companies andorganizations face various risks in their day-to-day operations, so they use hedging andderivatives in their risk management strategies. A fair value hedge can be employed in reducingthe risk of change in the fair market value of assets, liabilities, or other firm commitments. Afinancially fair value hedge helps in the cancelation of losses associated with liability or asset asit moves in the opposite direction of the hedged item.Cash flow hedges are financial instruments applicable when sudden changes in cash flowand are used to mitigate risks in the cash flow of a liability or asset instead of a liability or assetitself. Sudden change in cash flow can be brought about by a decrease or increase in foreignexchange rates, variation in asset prices, and variation in interest rates. The derivative is usually
recorded at a fair value in conjunction with the variation in fair value of the derivative, whichincludes its effectiveness recorded in other comprehensive income. When the hedging instrumentaffects earning, the accumulated amounts are categorized as earning from other comprehensiveincome in the same income statement as the one used to show the earning effect of the hedgeditem. Net investment hedge is used to avoid financial risks in terms of exposure to variation inchange of an entity’s value of its net investment in foreign operations that may happen due tovariation in foreign exchange rates between an investor reporting currency and the foreigninvestee’s currency.ASC 815-15-83:A derivative instrument is a financialinstrument or other contracts with all ofthe following characteristics:a. Underlying, notional amount, payment provision. The contract has both of the followingterms, which determine the amount of the settlement or settlements, and, in some cases, whetheror not a settlement is required:1. One or more underlying2. One or more notional amounts or payment provisions or both.b. Initial net investment. The contract requires no initial net investment or an initial netinvestment that is smaller than needed for other types of contracts that would be expected tohave a similar response to changes in market factors.c. Net settlement. The contract can be settled net by any of the following means:1. Its terms implicitly or explicitly require or permit net settlement.2. It can readily be settled net by a means outside the contract.3. It provides for the delivery of an asset that puts the recipient in a position notsubstantially different from the net settlement.?Interpretation
A derivative is defined as a contact that is between two or more two parties. The value ofthe contract is based on a financial asset that has been agreed upon by the parties. Also, thefinancial assets could be securities or index examples of underlying instruments may includecommodities, bonds, interest rates, currencies, stocks, and market indexes. The notation amountor provision payment of a derivative is usually a fixed amount used to determine the size ofvariation caused by the change in underlying even though the derivative can be based on an assetbut does not necessarily mean owning the asset. The initial net investment of derivatives shouldnot be smaller than what is expected for other derivatives of similar nature. Net settlement ofderivative term is allowed, which can happen by other means besides what is indicated in thecontract or a way that provides for the delivery of an asset that the same as on differ by a smallmargin from the net settlement in the contractASC 815-35-1:Gains and losses on a qualifying fairvalue hedge shall be accounted for asfollows:a. The gain or loss on the hedging instrument shall be recognized currently in earnings.b. The gain or loss (that is, the change in fair value) on the hedged item attributable to thehedged risk shall adjust the carrying amount of the hedged item and be recognized currently inearnings.?InterpretationChange in market prices of a particular hedge instrument will be under earnings. Inaddition, all changes in fair value are presented on the same income statement line item as theeffect of earning of the hedging instrument in hedging accounting. Gain and loss associated withthe hedged risk of a hedged instrument will change the carrying amount of the hedged item.Question 2The Accounting Standards Codification (ASC) topic 350 describes goodwill as the assetthat represents the future economic benefit coming from other assets acquired in business thatcannot be identified individually or recognized separately. This implies that goodwill is the
excess amount that the acquirer of a business is willing to pay for the fair value of the acquireefrom the perspective of an appropriate market participant. The accounting for goodwill allowsinvestors to examine the acquisition of an existing business entity and make future progression.It is obtained as the purchase cost subtracts the fair market value of tangible assets, identifiableintangible assets, and any other liability associated with the purchases. The ASC 350 examinesthe accounting of goodwill in the US GAAP.The Financial Accounting Standards Board (FASB) issued the Accounting StandardsUpdate (ASU) number 2017-04 on January 2017 concerning Goodwill and Intangibles (Topic350).Under the ASC 2017-04, the new version is requireda single step of the quantitativeimpairment test by which the loss of goodwill is calculated as the difference between the fairvalue and the reporting unit. Moreover,the ASU 2017-04provides effective dates forimplementing the new updates, so it is important to learn them when moving from investmentfirms to the tech sector. For the public companies that are SEC filters, the implementation beganon Dec 15, 2019. However, for the public companies that are not SEC filters, the implementationstarted after Dec 15, 2020. For other organizations such as non-profit organizations, theimplementation is set to begin on Dec 15, 2021. It is important to notice that early adoption ofthe FASB-ASU 2017-04 is allowed for the interim goodwill impairment tests done after Jan 1,2017 (Rashty, 2018). Early adoption of the new ASU updates can be considered due tocomplexities in the current guidance.ASC 350-20-35-3:An entity may first assess qualitativefactors, as described in paragraphs350-20-35-3A through 35-3G, to determine whether it is necessary to perform the two-stepgoodwill impairment test discussed in paragraphs 350-20-35-4 through 35-19. If determined tobe necessary, the two-step impairment test shall be used to identify potential goodwillimpairment and measure the amount of a goodwill impairment loss to be recognized.?InterpretationIn the current guidance, FASB provides that companies need first to assess anyimpairment of the goodwill based on the qualitative factors. This allows companies to assess theimportant factors to determine if reporting the fair value will affect the intangibles. In the nextstep, the company compares the fair value to the carrying value (step 1). If the fair value is low,
the company needs to calculate the impairment charges of the goodwill by comparing the fairvalue to the carrying amount (step 2). According to the ASC, goodwill impairment result if thefair value is lower than the carrying amount. ASC provides the current guidance for entities tocalculate the fair value in step 2 by calculating the value of all company assets and liabilities andsubtracting the value from the fair value calculated in step 1.Example of obtaining the GoodwillWhen calculating goodwill, the fair value of assets and liabilities of the entity acquired isdeducted from the purchasing price. For instance, if Company Z acquired 100% of Company Y,but paid more than the fair value of Company Y, goodwill is realized. If the account receivableswere $20 million, inventory $10 million, and accounts payable $ 8 million, it will be important tohave a list of Company Y?s assets and liabilities based on fair market value.Assets and LiabilitiesFair Market ValueAccounts receivables$20,000,000Inventory10,000,000Accounts payable(8,000,000)Net assets$22,000,000If company Z paid $30 million to acquires company Y, the goodwill would be $8 million($30,000,000 – $22,000,000).ASC 350-20-35-67:Upon the occurrence of a triggeringevent, an entity may assess qualitativefactors to determine whether it is more likely than not (that is, a likelihood of more than 50percent) that the fair value of the entity (or the reporting unit) is less than it carrying amount,including goodwill.?InterpretationThe section provides that in performing the test for the goodwill impairment,management needs to complete a qualitative analysis to establish if it is more likely than not that
the fair market value is less than the carrying value. This is provided in the ASU 2017-04,whereby entities need to record the charges for the goodwill impairment if the reporting unit’scarrying value is higher than the fair market value. The impairment charges for the goodwill arebased on the difference between the reporting and fair value and are limited to the amountallocated to that unit. Entities have continued to have an option of conducting the qualitativeassessment of goodwill impairment. However, if an entity performs the qualitative assessment ofgoodwill unsuccessfully, it needs to proceed and conduct a quantitative impairment test.Under the new ASU 2017-04 update, the impairment charges for goodwill can differfrom the current guidance because the difference between the carrying value and the fair marketvalue (unit difference) overrides the goodwill difference. This means that if the unit differenceunder the new ASU 2017-04 updates is higher or lower when compared to the goodwilldifference, it will replace the goodwill difference. Therefore, creating high or low impairmentcharges (Rashty, 2018). In addition, while there are companies that do not recognize the goodwillimpairment charges under the existing guidance, if the carrying unit value is higher than the fairvalue under the new update, there will be an amount of goodwill impairment.ASC 350-20-35-79:If goodwill and another asset (orasset group) of the entity (or thereporting unit) are tested for impairment at the same time, the other asset (or asset group) shallbe tested for impairment before goodwill. For example, if a significant asset group is to be testedfor impairment under the Impairment or Disposal of Long-Lived Assets Subsections of Subtopic360-10 on property, plant, and equipment (thus potentially requiring a goodwill impairmenttest), the impairment test for the significant asset group would be performed before the goodwillimpairment test. If the asset group is impaired, the impairment loss would be recognized prior togoodwill being tested for impairment.?InterpretationThe section provides that if the goodwill and another asset of a company are tested forimpairment concurrently, the other asset needs to be tested for the impairment before testing thegoodwill. If the asset is impaired, the associated loss with the asset impairment needs to berecognized before testing the goodwill. This provision applies to all assets in the entity tested forimpairment, not only the assets included Disposal of Long-Lived Assets?. Moreover, under the
ASC 350, the FASB indicates that the goodwill of a private company should be amortized on astraight-line basis of over 10 years if the entity demonstrates another useful life. Based on thisprovision, intangible assets and goodwill should not be amortized for public companies, andimpairment testing needs to be performed once every year. It is important to notice that theimpairment test should be done before the goodwill test if there is a triggering event and whenthe company believes that its assets are impaired.Example of Goodwill Impairment ReviewIf Company Z has an asset carrying amount of $900 million. This asset is subject to animpairment review before the goodwill. If the asset was sold at $710 million, and there is anassociated selling cost of $10 million. The fair market value subtracts costs, which is $700million ($710,000,000 – $10,000,000). Assuming the present value of future cash flows to begenerated by the asset is $800 million.Carrying amount$900,000,000Recoverable amount(800,000,000)Impairment Loss$100,000,000Thus, the impairment loss of the asset is recorded so that the value of the asset is written down.ASC 350-20-35-63: Goodwill relating to each businesscombination or reorganization eventresulting in fresh-start reporting (amortizable unit of goodwill) shall be amortized on astraight-line basis over 10 years, or less than 10 years if the entity demonstrates that anotheruseful life is more appropriate.?InterpretationUnder the US GAAP, public companies that report goodwill in their balance sheet cannotamortize it. Instead, it must be tested annually for the impairment and note down the reportedvalue of goodwill. However, the Accounting Standards Update (ASU) number 2014-02 givesprivate companies the option of amortizing the acquired goodwill for up to 10 years. Theimpairment test should occur when there is a triggering situation risk that can lower the value of
the goodwill. Some of the triggering events that lead to the impairment tests for goodwill includecustomer loss, negative cash flows, stiff competition, economic downturns, and stock marketcrashes.Discussion on the accounting for Goodwill under USGAAPThe accounting for Goodwill under US GAAP falls under ASC Code 350-20. The FASB states ontheir website regarding Concepts Statements:The FASB Concepts Statements are intended to serve the public interest by setting theobjectives, qualitative characteristics, and other concepts that guide the selection of economic phenomenato be recognized and measured for financial reporting and their display in financial statements or relatedmeans of communicating information to those who are interested. Concepts Statements guide the Board indeveloping sound accounting principles and provide the Board and its constituents with an understandingof the appropriate content and inherent limitations of financial reporting. A Statement of FinancialAccounting Concepts does not establish generally accepted accounting standards.? (FASB, 2021).Because Goodwill is an intangible asset, and since it was not acquired through regular businesspractices like purchasing assets (for example, purchasing land, equipment, buildings, inventory, orpatents), it has to be treated differently. According to ASC Code 350-20-35-1, goodwill will not beamortized, but will instead be tested for impairment at a level of reporting referred to as a reporting unit?(ASC 350-20-35-1). FASB also explains what a reporting unit is The level of reporting at whichgoodwill is tested for impairment. A reporting unit is an operating segment or one level below anoperating segment (also known as a component) (FASB, reporting unit?). ASC 350-20-35-2 explainswhat impairment is regarding goodwill, as it states that impairment is the condition that exists when thecarrying amount of goodwill exceeds its fair value? (ASC 350-20-35-2). This means that impairment isthe condition of a goodwill asset when it suffers a loss to the asset that drastically reduces its value inways that are not normal business practices. For example, a building catching fire or a company vehiclebeing damaged in an accident would result in impairment of those assets. ASC 350-20-35-28 states thatthe goodwill of a reporting unit should be tested for impairment annually, at the same time in the fiscalyear, and in certain circumstances (ASC 350-20-35-28). In addition, ASC 350-20-35-30 states that testingfor impairment shall take place if an event occurs that reduces the fair value of the reporting unit below itscarrying amount (ASC 350-20-35-1). This means that if a goodwill asset suddenly loses its fair value,then it must be tested for impairment to determine whether its fair value has been reduced or not. Thistesting is performed separately from the annual impairment test that a goodwill asset must receive.
These codes do fit within the framework of the FASB because it helps to define what shouldhappen with goodwill on a regular basis (annual testing) as well as what happens if it suddenly loses itsvalue (impairment testing under certain circumstances). By requiring annual and special impairment tests,it helps maintain the requirements for goodwill to be included in an entity?s financial statements. It alsohelps define the potential limitations and useful life of each specific case of goodwill because eachgoodwill asset has to be tested separately from each other (they must all be tested annually, but they donot all have to be tested on the same date). By requiring impairment tests, this gives goodwill theopportunity to be recognized as a valid economic phenomena and can be measured and quantified.However, there could be improvements made to FASB coding regarding goodwill assets. Thecodes just say that impairment tests need to be conducted annually and in certain circumstances, and itdoes not mention that impairment is not the same as depreciation. It could help future accountants andfirms reviewing FASB codes that have explicit details regarding goodwill and impairment differ from anasset being depreciated. While there are codes that do define depreciation, in the case of goodwill andimpairment it should at least have some extra details added to explain to the reader that using depreciationin the place of impairment is a mistake. This mistake might not happen in companies that have largeaccounting departments or rely on accounting firms that are detailed in their work, but for neweraccountants, smaller businesses and newly formed firms who receive goodwill assets there could be thepossibility of making such a mistake.References
FASB accounting standards codification?. (n.d.). FASB Accounting StandardsCodification?. https://asc.fasb.org/advancedsearchresults?query_text=accounting%20for%20GoodwillRashty, J. (2018, September 24).The new guidancefor goodwill impairment. The CPAJournal. https://www.cpajournal.com/2018/09/26/the-new-guidance-for-goodwill-impairment/FASB Accounting Standards Codification. (n.d.). Retrieved October 5, 2021, fromhttps://asc.fasb.org/.ASB Accounting Standards Codification. (n.d.). ASC 350-20-20.Glossary – Reporting unit.Retrieved October 6, 2021, from https://asc.fasb.org/.FASB Accounting Standards Codification. (n.d.). ASC 350-20-35-1.Overall Accounting forGoodwill. Retrieved October 5, 2021, from https://asc.fasb.org/.FASB Accounting Standards Codification. (n.d.). ASC 350-20-35-2.Overall Accounting forGoodwill. Retrieved October 6, 2021, from https://asc.fasb.org/.FASB Financial Accounting Standards Board.ConceptsStatements. Retrieved on October 6,2021, from https://www.fasb.org/jsp/FASB/Page/PreCodSectionPage&cid=1176156317989Ramirez, J. (2015).Accounting for derivatives: advancedhedging under IFRS 9. John Wiley &Sons.Triantis, A. J. (2005). Corporate risk management: Real options and financial hedging. InRiskManagement(pp. 591-608). Springer, Berlin, Heidelberg.
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