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Study guide · Area II

Select Balance Sheet Accounts

30 to 40% of FAR · 9 groups · 40 tasks

Select Balance Sheet Accounts tests how each major asset, liability and equity account is measured, recorded and proved. Expect to compute a carrying amount, write the journal entry, roll a balance forward and reconcile a subledger to the general ledger, then decide whether a difference needs an adjustment.

A study feature written by ExamDragon, not part of the real exam. Each heading is one of the AICPA's content groups for this area, in our own words. US GAAP as codified in the FASB Accounting Standards Codification, cited by topic; for-profit business entities unless a section says otherwise.

At a glance

Area II
30 to 40%

of the FAR section (AICPA)

Groups
9
Tasks
40
Key terms
29

What this guide covers, group by group

  1. ACash and bank reconciliations
  2. BTrade receivables
  3. CInventory
  4. DProperty, plant and equipment
  5. EInvestments
  6. FIntangibles and software
  7. GPayables and accruals
  8. HNotes and bonds payable
  9. IEquity transactions

ACash and bank reconciliations

  • Cash includes currency, demand deposits and checks received. Cash equivalents are short-term, highly liquid investments with an original maturity to the holder of three months or less (ASC 230 and ASC 305).
  • Postdated checks are receivables, a bank overdraft is a current liability, and legally restricted balances are shown apart from cash; the cash flow statement total still includes restricted cash (ASC 230).
  • Bank side of the reconciliation: add deposits in transit, subtract outstanding checks, correct bank errors.
  • Book side: add collections and interest the bank credited, subtract service charges and NSF checks, correct book errors.
  • Only book-side items need journal entries; bank-side items clear by themselves once the bank processes them.
  1. Worked exampleMarsh Creek Co.'s bank statement shows $48,200; deposits in transit are $6,300 and outstanding checks are $9,850, so the adjusted bank balance is $44,650. Books show $43,890; the bank charged a $40 fee, returned a $1,200 NSF check and collected a $2,000 note. Adjusted book balance = $43,890 - $40 - $1,200 + $2,000 = $44,650. Three book entries are needed; none for the bank-side items.
  2. Where questions turnRecording a journal entry for a deposit in transit or an outstanding check. Those are timing items on the bank side only.
Deposit in transit
Cash recorded in the books that the bank has not yet credited.
Outstanding check
A check written and recorded that has not yet cleared the bank.
Cash equivalent
A highly liquid investment with an original maturity of three months or less to the holder.
The 3 tasks of this group, in our words
  1. BSA.1.1Work out the reported cash and cash equivalents
  2. BSA.1.2Reconcile the bank balance to the books
  3. BSA.1.3Decide whether reconciling items need a book entry
Practise group A

BTrade receivables

  • Credit losses follow the current expected credit loss model: an allowance for losses expected over the life of the receivables, set up from the start using history, current conditions and supportable forecasts, often through an aging or loss-rate schedule (ASC 326-20).
  • A write-off debits the allowance and credits the receivable, with no expense; a recovery reinstates the receivable and records the cash.
  • Expected sales returns are a refund liability (with an asset for goods expected back), and revenue is reduced (ASC 606).
  • A transfer of receivables is a sale only if the transferor gives up control: legal isolation, the transferee's right to pledge or exchange, and no effective control kept. Otherwise it is a secured borrowing (ASC 860).
  • Factoring that qualifies as a sale removes the receivables and records a loss for the fee and any recourse obligation. Pledging or assigning receivables as collateral keeps them on the books, records the loan and is disclosed.
  • Rollforward: beginning balance + credit sales - collections - write-offs (+ recoveries) = ending balance.
  1. Worked exampleSilverpine Co. starts with receivables of $210,000, makes credit sales of $1,500,000, collects $1,420,000 and writes off $18,000, ending at $272,000. Expected losses are 5%, so the allowance must be $13,600. The allowance started at $15,000 credit and the write-offs leave a $3,000 debit balance, so credit loss expense = $13,600 + $3,000 = $16,600.
  2. Where questions turnBooking expense equal to the target allowance without looking at the balance already in the account.
Current expected credit loss
The lifetime loss expected on financial assets at amortized cost, recognized from the start.
Factoring
Selling receivables to a third party, with or without recourse.
Secured borrowing
A transfer that fails sale accounting; the receivables stay and a liability is recorded.
The 4 tasks of this group, in our words
  1. BSA.2.1Measure receivables, credit loss and return allowances, with entries
  2. BSA.2.2Record factoring, pledging, assignment or borrowing against receivables
  3. BSA.2.3Roll receivables forward from several data sources
  4. BSA.2.4Reconcile the receivables subledger to the ledger
Practise group B

CInventory

  • Cost methods: specific identification, FIFO, LIFO and weighted average (periodic) or moving average (perpetual). Cost includes purchase price, freight in and costs to bring goods to a saleable condition.
  • Inventory measured by FIFO or average cost is carried at cost or net realizable value, whichever is lower (NRV: selling price less reasonably predictable costs of completion, disposal and transport) (ASC 330).
  • Inventory measured by LIFO or the retail method uses lower of cost or market: market is replacement cost, capped at NRV and floored at NRV less a normal profit margin.
  • A year-end write-down is not reversed later. Ownership follows title: goods shipped FOB shipping point belong to the buyer once shipped, FOB destination once delivered, and consigned goods stay with the consignor.
  • Rollforward: beginning inventory + purchases - cost of goods sold = ending; a perpetual record above the physical count signals shrinkage, cutoff errors or unrecorded transfers.
  1. Worked exampleAshby Outdoor holds 1,200 tents costing $80 each; the selling price is $95 and costs to sell are $20, so NRV is $75. Under FIFO it writes down $5 a tent, $6,000 in total. If it used LIFO with a replacement cost of $70 and a normal margin of $10, market would be $70 (between the $65 floor and the $75 ceiling), a write-down of $12,000.
  2. Where questions turnApplying the replacement-cost ceiling and floor test to FIFO or average cost inventory; that test is for LIFO and the retail method only.
Net realizable value
Estimated selling price less reasonably predictable costs of completion, disposal and transport.
FOB shipping point
Title passes to the buyer when goods leave the seller.
Consignment
Goods held by an agent for sale; they remain the owner's inventory.
The 4 tasks of this group, in our words
  1. BSA.3.1Cost inventory under FIFO, LIFO or averages, with entries
  2. BSA.3.2Apply the net realizable value or market test to inventory
  3. BSA.3.3Roll inventory forward from several data sources
  4. BSA.3.4Reconcile the inventory subledger to the ledger
Practise group C

DProperty, plant and equipment

  • Cost is every outlay needed to get the asset ready for use: price, freight, installation and testing; interest during construction of a qualifying asset is capitalized on average accumulated expenditures (ASC 835-20).
  • On disposal, first record depreciation to the date of sale; the gain or loss is proceeds less carrying amount.
  • Assets held and used are tested for impairment when events signal a problem: if undiscounted future cash flows are below the carrying amount, the loss is carrying amount less fair value. The loss is never reversed (ASC 360).
  • Held for sale needs all of: a committed plan, availability for immediate sale, an active buyer search, a sale probable within one year, a reasonable price and a plan unlikely to change.
  • Held-for-sale assets are measured at the lower of carrying amount and fair value less costs to sell and are not depreciated; later increases are gains only up to losses previously recognized.
  • Rollforward: beginning cost + additions - disposals = ending cost; accumulated depreciation: beginning + expense - disposals = ending.
  1. Worked exampleGranite Falls Bottling has a line with cost $1,500,000 and accumulated depreciation $600,000 (carrying amount $900,000). Undiscounted cash flows are $820,000 and fair value is $700,000. Because $820,000 < $900,000, it is impaired; the loss is $900,000 - $700,000 = $200,000. Had the line met the held-for-sale criteria with costs to sell of $30,000, the loss would be $900,000 - $670,000 = $230,000.
  2. Where questions turnComparing carrying amount with fair value in step one. The recoverability test uses undiscounted cash flows; fair value only measures the loss.
Recoverability test
Comparing carrying amount with undiscounted future cash flows to decide if an asset is impaired.
Held for sale
A long-lived asset meeting all six criteria, carried at the lower of carrying amount and fair value less costs to sell.
Capitalized interest
Interest during construction added to the cost of a qualifying asset.
The 7 tasks of this group, in our words
  1. BSA.4.1Measure gross and net fixed assets, with entries
  2. BSA.4.2Compute the gain or loss when a long-lived asset is sold
  3. BSA.4.3Measure impairment of long-lived assets
  4. BSA.4.4Decide if an asset is classified as held for sale
  5. BSA.4.5Remeasure held-for-sale assets and the resulting loss
  6. BSA.4.6Roll fixed assets forward from several data sources
  7. BSA.4.7Reconcile the fixed asset subledger to the ledger
Practise group D

EInvestments

  • Equity securities with a readily determinable fair value are measured at fair value through net income. Those without one may use the measurement alternative: cost less impairment, adjusted for observable price changes in the same or a similar security (ASC 321).
  • Debt securities are trading (fair value through net income), available for sale (fair value through OCI) or held to maturity (amortized cost, which needs positive intent and ability to hold) (ASC 320). The fair value option may be elected, irrevocably, at initial recognition (ASC 825).
  • Amortized cost uses the effective interest method: interest income = carrying amount x effective rate, and the premium or discount amortizes by the difference from cash interest.
  • Held-to-maturity securities carry a lifetime expected credit loss allowance (ASC 326-20). For available-for-sale debt, an intent or likely need to sell writes the security down to fair value in earnings; otherwise a credit loss allowance is limited to the amount fair value is below amortized cost, and the rest goes to OCI (ASC 326-30).
  • The equity method applies with significant influence, presumed at 20% to 50% of voting stock (ASC 323): add the investor's share of income, subtract dividends, and amortize any excess paid for depreciable assets; goodwill is not amortized.
  1. Worked exampleRidgecrest Corp. buys 30% of Lowfield Inc. for $1,200,000. Its share of Lowfield's $3,500,000 book value is $1,050,000; of the $150,000 excess, $100,000 relates to equipment with 10 years left and $50,000 is goodwill. Lowfield earns $400,000 and pays $100,000 of dividends. Carrying amount = $1,200,000 + $120,000 - $30,000 - $10,000 = $1,280,000.
  2. Where questions turnRecording an equity-method investee's dividends as income. They are a return of investment and reduce the carrying amount.
Held to maturity
Debt securities the holder has the positive intent and ability to hold to maturity, at amortized cost.
Available for sale
Debt securities at fair value, with unrealized changes in OCI apart from credit losses.
Significant influence
Power to take part in an investee's policy decisions, presumed at 20% to 50% of voting stock.
Measurement alternative
Cost less impairment, adjusted for observable price changes, for equity without a readily determinable fair value.
The 9 tasks of this group, in our words
  1. BSA.5.1Know which investments go, or may go, to fair value
  2. BSA.5.2Measure investments carried at fair value
  3. BSA.5.3Record income and entries on fair value investments
  4. BSA.5.4Measure credit impairment on debt held as available for sale
  5. BSA.5.5Know which investments may be held at amortized cost
  6. BSA.5.6Measure amortized cost investments, with entries
  7. BSA.5.7Measure credit losses on amortized cost investments
  8. BSA.5.8Know when significant influence calls for the equity method
  9. BSA.5.9Carry an equity method investment, with entries
Practise group E

FIntangibles and software

  • Purchased intangibles are recorded at cost. In a business combination an intangible is recognized apart from goodwill if it arises from contractual or legal rights or is separable (ASC 805). Internal research and development is expensed (ASC 730).
  • Finite-lived intangibles are amortized over the shorter of legal and useful life and tested for impairment like other long-lived assets (ASC 360). Indefinite-lived intangibles are not amortized and are tested at least annually by comparing fair value with carrying amount (ASC 350).
  • Goodwill is not amortized by public business entities; a goodwill impairment equals carrying amount of the reporting unit less its fair value, capped at the goodwill. Private companies may elect to amortize goodwill over 10 years or less.
  • Internal-use software: costs in the preliminary project stage and after implementation are expensed; application development costs are capitalized and amortized once the software is ready for use (ASC 350-40). ASU 2025-06 replaces the stages with a probable-to-complete threshold, effective for annual periods beginning after December 15, 2027.
  • A cloud computing arrangement that is a service contract is expensed over its term, but implementation costs that would be capitalized for internal-use software are deferred as an asset, amortized over the hosting term and shown in the same lines as the hosting fees. If the customer may take possession of the software, it is a software license (an intangible).
  • Software to be sold is expensed until technological feasibility, then capitalized until general release (ASC 985-20).
  1. Worked exampleBluefin Labs buys a patent on January 1, Year 1 for $480,000; 12 years of legal life remain but it expects 8 years of benefit, so amortization is $60,000 a year. At the end of Year 3 the carrying amount is $300,000. Undiscounted cash flows of $270,000 fail the recoverability test and fair value is $220,000, so the impairment loss is $80,000.
  2. Where questions turnAmortizing over the legal life when the expected useful life is shorter, or expensing application development costs that must be capitalized.
Indefinite-lived intangible
An intangible with no foreseeable limit on its useful life; tested for impairment, not amortized.
Cloud computing arrangement
Hosted software accessed over the internet; a service contract unless the customer can take the software.
Application development stage
Design, coding, installation and testing of internal-use software, when costs are capitalized.
The 3 tasks of this group, in our words
  1. BSA.6.1Know when an intangible is recognized and its life type
  2. BSA.6.2Measure, amortize and impair finite-lived intangibles
  3. BSA.6.3Account for purchased software and cloud hosting costs
Practise group F

GPayables and accruals

  • An asset retirement obligation is recognized at fair value (usually expected cash flows discounted at a credit-adjusted risk-free rate) when the legal obligation arises, with the same amount added to the asset. The liability accretes each year (accretion expense) and the added cost is depreciated (ASC 410-20).
  • Accrue wages earned but unpaid, bonuses earned, and compensated absences that relate to services already rendered, vest or accumulate, and are probable and estimable; nonvesting sick pay need not be accrued (ASC 710). Dividends become payable on the declaration date.
  • Self-insurance accrues claims incurred, including those incurred but not reported, when probable and estimable (ASC 450).
  • Exit costs are recognized at fair value when incurred, not when a plan is approved (ASC 420). One-time termination benefits are recognized when the plan is communicated if no service beyond the minimum retention period is required; if more service is required, they are spread over that service period. Contract termination costs are recognized when the contract is ended or its use ceases.
  • Unrecorded liabilities are found by matching receiving reports and invoices after year end to the period the goods or services arrived.
  1. Worked exampleDunmore Mining installs a platform on January 1, Year 1 that it must remove in 10 years at an expected cost of $500,000. At a 6% credit-adjusted rate (factor 0.5584), the obligation is $279,200, also added to the asset. Year 1 accretion is $279,200 x 6% = $16,752, so the liability is $295,952 at year end, and depreciation of the added cost is $279,200 / 10 = $27,920.
  2. Where questions turnRecognizing severance when management approves a plan. The liability waits until the plan is communicated to employees, and is spread over future service if employees must stay beyond the minimum retention period.
Accretion expense
The yearly increase in a discounted obligation such as an asset retirement obligation.
Minimum retention period
The longest notice period required by law or contract before termination; service beyond it spreads the cost.
IBNR
Claims incurred but not reported, accrued under self-insurance.
The 4 tasks of this group, in our words
  1. BSA.7.1Know how asset retirement obligations are recognized and measured
  2. BSA.7.2Measure payables and accrued expenses, with entries
  3. BSA.7.3Measure and time exit costs such as severance
  4. BSA.7.4Reconcile payables and accruals subledgers to the ledger
Practise group G

HNotes and bonds payable

  • A change in debt terms is an extinguishment if the present value of the new cash flows differs by at least 10% from the present value of the remaining old cash flows, both at the original effective rate; the old debt is removed, the new recorded at fair value and a gain or loss recognized. Otherwise it is a modification and a new effective rate applies going forward (ASC 470-50).
  • A troubled debt restructuring is one where the creditor grants a concession to a debtor in financial difficulty (ASC 470-60). If total future undiscounted payments are less than the carrying amount, the debtor reduces the debt to that total and records a gain; otherwise no gain and a new effective rate.
  • Bond issue price = present value of principal + present value of interest, both at the market rate. Interest expense = carrying amount x market rate; the difference from cash interest amortizes the discount or premium.
  • Debt issuance costs are a direct deduction from the carrying amount and are amortized into interest expense (ASC 835-30).
  • Covenant tests use the definitions in the agreement. A breach that makes long-term debt callable moves it to current unless the lender waives the right for more than a year from the balance sheet date (ASC 470-10).
  1. Worked exampleOakhaven Corp. issues $1,000,000 of 5-year, 6% bonds with annual interest when the market rate is 8%. Price = $1,000,000 x 0.6806 + $60,000 x 3.9927 = $680,600 + $239,562 = $920,162. Year 1 interest expense = $920,162 x 8% = $73,613; cash interest is $60,000, so $13,613 of discount amortizes and the carrying amount becomes $933,775.
  2. Where questions turnComputing interest expense at the stated rate. The stated rate sets the cash; the market rate on the carrying amount sets the expense.
Effective interest method
Interest at the market rate on the carrying amount, so the rate is constant over the life.
Extinguishment
Removal of a debt by payment or by a substantially different exchange, with a gain or loss.
Troubled debt restructuring
A concession granted to a debtor in financial difficulty.
Debt issuance costs
Costs to issue debt, deducted from its carrying amount and amortized as interest.
The 5 tasks of this group, in our words
  1. BSA.8.1Tell a debt modification from an extinguishment
  2. BSA.8.2Know when a debt change is a troubled restructuring
  3. BSA.8.3Compute interest with discounts, premiums and issue costs
  4. BSA.8.4Carry notes and bonds payable, with entries
  5. BSA.8.5Test compliance with loan covenants
Practise group H

IEquity transactions

  • Issuing stock: debit cash, credit common stock at par and additional paid-in capital for the excess; stock issued for noncash assets is recorded at the more clearly evident fair value.
  • A small stock dividend (under about 20% to 25%) moves the shares' fair value from retained earnings; a large one moves par value (ASC 505-20). A stock split changes par and share count with no entry beyond a memo.
  • Treasury stock under the cost method is debited at cost. Reissue above cost credits paid-in capital from treasury stock; below cost debits that account first, then retained earnings. No gain or loss reaches net income (ASC 505-30).
  • Cash dividends are a liability on the declaration date; property dividends are remeasured to fair value first, with a gain or loss.
  • Partnership capital accounts: contributions at fair value net of liabilities assumed, income shared per the agreement (interest on capital, salaries, then the ratio), and drawings. A new partner is admitted under the bonus or goodwill method.
  1. Worked examplePinecrest Inc. buys back 2,000 shares at $30 ($60,000). It reissues 1,200 at $36: cash $43,200, treasury stock $36,000, paid-in capital from treasury stock $7,200. It reissues the other 800 at $25: cash $20,000, paid-in capital from treasury stock debit $4,000, treasury stock $24,000.
  2. Where questions turnReporting a gain or loss on treasury stock in net income. Transactions in an entity's own shares go through equity only.
Treasury stock
An entity's own shares reacquired and not retired, shown as a reduction of equity.
Small stock dividend
A stock dividend under about 20% to 25% of shares, recorded at fair value.
Bonus method
Admitting a partner without recording goodwill; capital is reallocated among partners.
The 1 tasks of this group, in our words
  1. BSA.9.1Record stock issues, dividends, splits, buybacks and partner capital
Practise group I

After this guide: Check yourself: can you reconcile a bank account, set a credit loss allowance, apply the right inventory write-down test, test an asset for impairment, carry an equity method investment, amortize a bond discount and record treasury stock reissues?

Practise Select Balance Sheet Accounts

ExamDragon is independent exam preparation. It is not affiliated with, endorsed by or reviewed by the American Institute of Certified Public Accountants (AICPA), the National Association of State Boards of Accountancy (NASBA), any state board of accountancy or Prometric. Uniform CPA Examination and CPA Exam are names of the AICPA, used here only to name the exam. Every question and simulation here is our own, written from the AICPA's published Blueprints; none is adapted from the AICPA's released questions or any review course.