FAR CPA Exam: In-Depth Analysis of Asset Accounting (F2)

Building upon the foundational principles of the Conceptual Framework, Section F2 of the FAR CPA exam transitions from abstract concepts to the tangible and intangible resources that drive an entity’s operations. This section, often representing a substantial portion of the exam (typically 20-30%), demands a rigorous understanding of the specific accounting treatments for various asset categories. Candidates must demonstrate proficiency not just in rote memorization of rules, but in applying recognition criteria, measurement approaches, valuation adjustments, impairment testing, and derecognition procedures across diverse scenarios involving resources controlled by an entity. Success requires navigating the complexities inherent in valuing future economic benefits under conditions of uncertainty.

Cash and Cash Equivalents: Beyond the Basics

While seemingly the most straightforward asset, cash presents classification and presentation nuances frequently targeted on the FAR exam. The distinction between cash, cash equivalents, and short-term investments hinges on accessibility and risk profile.

Defining Cash Equivalents

Cash equivalents are short-term, highly liquid investments readily convertible to known amounts of cash and so near their maturity that they present an insignificant risk of changes in value due to interest rate fluctuations. The standard maturity threshold is typically three months or less from the date of purchase. Examples include:

• Treasury bills (T-bills) acquired within three months of maturity
• Commercial paper with short maturities
• Money market funds

Exam questions might test the classification of instruments based on their purchase date relative to maturity. An investment purchased with six months remaining until maturity would generally be classified as a short-term investment, not a cash equivalent, even if held at year-end when only two months remain.

Restricted Cash and Compensating Balances

The classification of cash restricted for specific purposes requires careful consideration. Restrictions imposed by external parties dictate reporting:

• Legally restricted deposits: Cash restricted due to loan agreements (compensating balances), escrow arrangements, or specific contractual obligations must be segregated from unrestricted cash.
• Classification: If the restriction relates to a current liability or will be lifted within one year (or the operating cycle, if longer), the restricted cash is classified as a current asset, though shown separately from regular cash. If the restriction extends beyond one year, it becomes a non-current asset (often under “Other Assets” or “Investments”).
• Compensating Balances: These are minimum balances required by a bank in connection with a borrowing arrangement. Disclosure requirements are key: the nature of the restriction and the amount must be disclosed, and the classification (current/non-current) depends on the related loan’s classification.

Bank Reconciliations: A Practical Application

Bank reconciliations are a common testing ground, assessing understanding of timing differences and error correction. Candidates must proficiently handle:

• Deposits in Transit: Added to the bank balance. These are cash receipts recorded by the company but not yet processed by the bank.
• Outstanding Checks: Deducted from the bank balance. These are checks issued and recorded by the company but not yet cleared by the bank.
• Bank Service Charges: Deducted from the book balance. Often discovered only upon receiving the bank statement.
• NSF (Non-Sufficient Funds) Checks: Deducted from the book balance. Checks deposited by the company that bounced.
• Notes Collected by Bank: Added to the book balance. Amounts collected by the bank on the company’s behalf.
• Errors: Corrections made to the respective side (book or bank) where the error occurred. Differentiating between company errors and bank errors is crucial.
• Interest Earned: Added to the book balance.

Simulations often require preparing a full bank reconciliation or adjusting journal entries based on reconciliation items. Understanding that only items affecting the book balance require journal entries is fundamental. The reconciliation process also highlights internal control weaknesses if discrepancies are significant or recurring.

• Check Kiting: This fraudulent scheme involves exploiting the float period (time between check deposit and clearing) by writing checks between accounts at different banks. Identifying unusual patterns in deposits and disbursements is part of the control aspect tested.

Accounts Receivable: Valuation and Management

Accounts Receivable (AR) represents amounts owed to the entity, usually from customers for goods sold or services rendered. The primary accounting challenge lies in valuing these receivables at their Net Realizable Value (NRV) – the amount expected to be collected.

Estimating Uncollectible Accounts: The Allowance Method

Accrual accounting necessitates estimating uncollectible accounts to match bad debt expense with the related revenue (matching principle) and report receivables at NRV (conservatism). GAAP requires the allowance method; the direct write-off method (recognizing expense only when an account is deemed uncollectible) is generally not permissible unless uncollectible amounts are immaterial.

The two primary approaches under the allowance method differ in their focus:

1. Percentage-of-Sales Method (Income Statement Approach):

• Focus: Matching bad debt expense to credit sales in the same period.
• Calculation: (Net Credit Sales for the Period) × (Historical Bad Debt Percentage).
• Entry: Dr. Bad Debt Expense / Cr. Allowance for Doubtful Accounts. The calculated expense amount is recorded directly.
• Limitation: Ignores the existing balance in the Allowance account. It primarily ensures the income statement reflects an appropriate expense level but may not result in the most accurate balance sheet valuation (NRV).

2. Aging-of-Receivables Method (Balance Sheet Approach):

• Focus: Reporting AR at its estimated net realizable value on the balance sheet.
• Technique: Classifies outstanding receivables into age categories (e.g., 0-30 days, 31-60 days, 61-90 days, >90 days). Assigns increasingly higher estimated uncollectible percentages to older categories based on historical experience.
• Calculation: Sum of (Receivable Amount in Category × Estimated Uncollectible % for Category) = Required Ending Balance in Allowance Account.
• Entry: Dr. Bad Debt Expense / Cr. Allowance for Doubtful Accounts. The amount recorded as expense is the plug figure needed to bring the existing Allowance balance to the calculated required ending balance.
• Advantage: Provides a more accurate estimate of NRV because it considers the specific age and likely collectibility of outstanding receivables.

Exam simulations frequently require candidates to prepare an aging schedule and calculate the necessary adjustment to the allowance account. Understanding the interplay between the beginning allowance balance, write-offs during the period, recoveries, and the calculated required ending balance is critical.

Example Aging Scenario: Assume:

• Beginning Allowance: $5,000 Cr
• Write-offs during year: $3,000
• Recoveries during year: $500
• Required ending balance per aging schedule: $7,000 Cr

Calculation:

• Allowance balance before adjustment = $5,000 Cr - $3,000 Dr + $500 Cr = $2,500 Cr
• Required adjustment (Bad Debt Expense) = $7,000 Required Cr - $2,500 Current Cr = $4,500
• Entry: Dr. Bad Debt Expense $4,500 / Cr. Allowance for Doubtful Accounts $4,500

Write-Offs and Recoveries: Mechanics

The allowance method separates the estimation process from the actual write-off of specific uncollectible accounts.

Write-off Entry: Removes a specific uncollectible account from AR.

• Dr. Allowance for Doubtful Accounts
• Cr. Accounts Receivable (Specific Customer)
• Impact: Reduces both Gross AR and the Allowance balance by the same amount, leaving NRV unchanged. Importantly, a write-off does not affect Bad Debt Expense.

Recovery Entry: Reinstates an account previously written off when collection unexpectedly occurs. Requires two entries:

1. Reverse the write-off:
   • Dr. Accounts Receivable (Specific Customer)
   • Cr. Allowance for Doubtful Accounts
2. Record the cash collection:
   • Dr. Cash
   • Cr. Accounts Receivable (Specific Customer)

• Impact: The reversal increases Gross AR and the Allowance. The cash collection reduces Gross AR. The net effect on NRV depends on timing relative to year-end adjustments. Recoveries do not directly impact Bad Debt Expense.

Transfer of Receivables: Factoring and Pledging

Companies may transfer receivables to generate cash quickly. Accounting treatment depends on whether the transfer qualifies as a sale or a secured borrowing.

• Pledging/Assignment: Using receivables as collateral for a loan. Receivables remain on the company’s books. Requires footnote disclosure of the arrangement. Cash received is recorded with a corresponding liability (Note Payable).
• Factoring: Selling receivables to a third party (factor).
  • Sale without Recourse: The factor assumes the risk of uncollectibility. Transferor removes receivables, recognizes cash received, records any factor’s holdback (due from factor), and recognizes a loss on sale (including factoring fee and any difference between book value and cash received). This qualifies as a sale if control is surrendered.
  • Sale with Recourse: The transferor retains the risk of uncollectibility. This often resembles a borrowing. Accounting depends on meeting specific sale criteria (transfer of control):
    1. Transferred assets are isolated from the transferor.
    2. Transferee has the right to pledge or exchange the assets.
    3. Transferor does not maintain effective control (e.g., through repurchase agreements). If criteria met -> Sale accounting (similar to without recourse, but includes recognition of a recourse liability). If criteria not met -> Secured borrowing (record cash and a liability).

Exam questions often test the journal entries for factoring arrangements, including calculating the loss on sale and recognizing the recourse liability.

Notes Receivable

Notes receivable represent formal written promises to pay, typically involving interest. Key issues include:

• Interest Recognition: Interest revenue is recognized over time using the effective interest method, especially for notes issued at a discount or premium (where stated rate differs from market rate).
• Non-Interest-Bearing Notes: These notes implicitly contain interest. The present value of the future cash flows (face amount) is recorded as the initial receivable balance, discounted at the prevailing market rate. The difference between the face amount and the present value represents the discount, which is amortized to interest revenue over the note’s life.
• Impairment: Notes receivable must be assessed for impairment. If it’s probable that not all contractual cash flows will be collected, an impairment loss is recognized (difference between carrying amount and present value of expected future cash flows discounted at the note’s original effective rate, or based on observable market price or collateral fair value).

Inventory: Costing, Valuation, and Estimation

Inventory accounting involves determining the cost assigned to inventory units and valuing inventory at the lower of its cost or market value. The choice of cost flow assumption significantly impacts reported COGS and ending inventory values, especially during periods of fluctuating prices.

Cost Flow Assumptions: FIFO, LIFO, Weighted Average

The cost flow assumption adopted dictates which costs are assigned to COGS and which remain in ending inventory.

1. FIFO (First-In, First-Out):

• Assumption: The first units purchased are the first units sold.
• Method: Ending inventory consists of the most recently purchased units. COGS consists of the oldest costs.
• Impact during Inflation: Results in lower COGS, higher net income, and higher ending inventory (closer to current replacement cost) compared to LIFO. Leads to higher income taxes.
• Balance Sheet Focus: Ending inventory approximates current cost.
• Advantages: Logical flow, matches physical flow for many businesses, consistent results between periodic and perpetual systems. Permitted under both GAAP and IFRS.

2. LIFO (Last-In, First-Out):

• Assumption: The most recently purchased units are the first units sold.
• Method: Ending inventory consists of the oldest costs (LIFO layers). COGS consists of the most recent costs.
• Impact during Inflation: Results in higher COGS, lower net income, and lower ending inventory (potentially significantly understated compared to current cost). Leads to tax deferral (LIFO conformity rule requires using LIFO for financial reporting if used for tax).
• Income Statement Focus: Better matching of current costs with current revenues.
• Disadvantages: Doesn’t match physical flow for most businesses, can lead to unrealistic inventory values on the balance sheet, potential for LIFO liquidation (selling older, lower-cost layers, causing a temporary profit surge), complex record-keeping (layers, pools), prohibited under IFRS.
• LIFO Reserve: The difference between inventory valued under LIFO and another method (like FIFO or average cost). Required disclosure under GAAP. Changes in the LIFO reserve affect COGS.
• Dollar-Value LIFO: A common LIFO application that pools inventory items and measures changes in inventory levels in terms of total dollar value, adjusted for price level changes using an internally or externally generated price index. This simplifies LIFO for companies with diverse inventory.

3. Weighted Average Cost:

• Method (Periodic System): Calculates a single average cost per unit based on total cost of goods available for sale divided by total units available for sale. This average cost is applied to both ending inventory and COGS.
• Method (Perpetual System - Moving Average): Recalculates the average cost per unit after each purchase. This moving average cost is used to value subsequent sales until the next purchase occurs.
• Impact: Produces results between FIFO and LIFO. Smooths out price fluctuations.
• Advantages: Relatively simple, less susceptible to profit manipulation compared to LIFO. Permitted under both GAAP and IFRS.

The exam requires calculating ending inventory and COGS under each method using provided purchase and sale data, often within both periodic and perpetual systems. Understanding the differences in outcomes between periodic and perpetual, particularly under LIFO, is crucial.

Inventory Systems: Periodic vs. Perpetual

• Periodic System: Inventory quantities determined by physical count at period-end. COGS calculated as Beginning Inventory + Purchases - Ending Inventory. Cost flow assumption applied only at period-end based on total activity.
• Perpetual System: Inventory balances (quantity and cost) updated continuously with each purchase and sale. COGS recorded at the time of each sale based on the chosen cost flow assumption. Physical counts still necessary to verify records and identify shrinkage.

Results under FIFO are identical for both systems. Results under Weighted Average and LIFO can differ significantly because the perpetual system applies the cost flow assumption transaction by transaction, while the periodic system applies it to the aggregate period activity.

Inventory Valuation: Lower of Cost or Net Realizable Value (LCNRV) / Lower of Cost or Market (LCM)

Conservatism dictates that inventory should be written down if its utility declines below its cost. The specific valuation rule depends on the costing method used:

1. LCNRV (Lower of Cost or Net Realizable Value):

• Applies to: Companies using FIFO or Weighted Average cost (GAAP & IFRS).
• Rule: Compare the historical cost of inventory to its Net Realizable Value (NRV).
• NRV = Estimated Selling Price - Reasonably Predictable Costs of Completion, Disposal, and Transportation.
• Write-down: If NRV < Cost, inventory is written down to NRV. The loss is typically recognized in COGS or as a separate loss line item.
• Application: Can be applied to individual items, logical inventory categories, or total inventory (though item-by-item is most common).
• Reversal: IFRS permits reversal of write-downs (up to original cost) if NRV subsequently increases. GAAP prohibits reversals; the reduced value becomes the new cost basis.

2. LCM (Lower of Cost or Market):

• Applies to: Companies using LIFO or the Retail Inventory Method (GAAP only).
• Rule: Compare the historical cost of inventory to a designated “Market” value.
• “Market” Value: Defined as the median value of three figures:
  • Replacement Cost (RC)
  • Ceiling: Net Realizable Value (NRV)
  • Floor: Net Realizable Value (NRV) - Normal Profit Margin (NPM)
  • Market = Median (RC, Ceiling, Floor)
• Write-down: If Market < Cost, inventory is written down to the Market value. Loss recognized similarly to LCNRV.
• Reversal: GAAP prohibits reversals.

Exam questions often provide cost and market data (selling price, completion costs, replacement cost, profit margin) and require calculating the correct inventory valuation under LCNRV or LCM.

Inventory Estimation Techniques

When physical counts are impractical or impossible (e.g., interim reporting, inventory destruction), estimation techniques are used:

• Gross Profit Method: Estimates ending inventory based on historical gross profit percentages. Requires knowing Beginning Inventory, Purchases, and Sales. COGS is estimated (Sales × (1 - Gross Profit %)), and Ending Inventory is derived (BI + Purch - Estimated COGS). Less precise, often used for interim reporting or insurance claims.
• Retail Inventory Method: Used by retailers maintaining records at both cost and retail prices. Estimates ending inventory at retail prices and converts it to cost using a cost-to-retail ratio. Several variations exist (Conventional, LIFO Retail) depending on how markups/markdowns are handled in the ratio calculation. More complex but acceptable for financial reporting if certain conditions met.

Property, Plant, and Equipment (PPE): Acquisition, Depreciation, Impairment

PPE represents long-lived tangible assets used in operations. Accounting focuses on proper capitalization of costs, systematic depreciation, and recognition of impairment losses.

Initial Recognition: Capitalization of Costs

The cost of PPE includes all expenditures necessary to acquire the asset and bring it to the condition and location necessary for its intended use.

1. Land:

• Capitalize: Purchase price, closing costs (title fees, legal fees, commissions), site preparation costs (grading, filling, draining), demolition of existing unwanted structures (less salvage value), back property taxes assumed, costs of surveying. Land has an indefinite life and is not depreciated.
• Land Improvements: Separately capitalized assets with finite lives, subject to depreciation (e.g., driveways, parking lots, fences, landscaping, lighting systems).

2. Buildings:

• Capitalize: Purchase price, closing costs, renovation/remodeling costs to ready for use, excavation costs, architectural fees, building permits. For self-constructed buildings: direct materials, direct labor, variable overhead, applicable fixed overhead, and capitalized interest.

3. Equipment:

• Capitalize: Purchase price (less discounts), sales tax, freight-in, installation costs, testing costs, special platforms/foundations.

4. Interest Capitalization (Self-Constructed Assets):

• Interest incurred during the construction period can be capitalized as part of the asset’s cost.
• Capitalization Period: Begins when (1) expenditures for the asset have been made, (2) activities to ready the asset are in progress, and (3) interest cost is being incurred. Ends when the asset is substantially complete and ready for intended use.
• Amount to Capitalize: Lower of (1) Actual interest incurred during the period or (2) Avoidable interest (interest that could have been avoided if construction expenditures hadn’t been made).
• Calculation:
  • Determine Weighted-Average Accumulated Expenditures (WAAE) for the construction period.
  • Apply appropriate interest rate(s):
    • Use the rate from specific new borrowings for construction, up to the amount borrowed.
    • Use a weighted-average rate of all other outstanding debt for expenditures exceeding specific borrowings.
  • Capitalized interest cannot exceed actual interest incurred.

5. Subsequent Expenditures:

• Capitalize: If the expenditure increases the asset’s future economic benefits (extends useful life, increases operating efficiency, improves quality of output). Examples: additions, improvements, replacements (if carrying amount of old component is known and removed), major overhauls.
• Expense: If the expenditure maintains the existing level of benefits (ordinary repairs and maintenance).

Depreciation Methods: Allocating Cost

Depreciation systematically allocates the depreciable base (Cost - Salvage Value) over the asset’s estimated useful life. Common methods include:

1. Straight-Line:

• Formula: (Cost - Salvage Value) / Estimated Useful Life
• Pattern: Equal depreciation expense each period.
• Rationale: Assumes benefits are received evenly over the asset’s life. Most common method.

2. Accelerated Methods (Declining Balance, Sum-of-the-Years’-Digits):

• Declining Balance (DB): Applies a constant rate (multiple of straight-line rate, e.g., 200% for Double-Declining Balance - DDB) to the asset’s book value (Cost - Accumulated Depreciation). Salvage value is ignored in the calculation initially but depreciation stops once book value equals salvage value.
  • DDB Rate = (1 / Useful Life) × 2
  • Depreciation = Book Value at Beginning of Year × DDB Rate
• Sum-of-the-Years’-Digits (SYD): Applies a decreasing fraction to the depreciable base.
  • Denominator = n(n+1)/2, where n = useful life.
  • Numerator = Remaining useful life at the beginning of the year.
  • Depreciation = (Cost - Salvage Value) × (Remaining Life / SYD Denominator)
• Pattern: Higher depreciation expense in early years, decreasing over time.
• Rationale: Better matching if asset is more productive or efficient in early years.

3. Usage-Based Methods (Units-of-Production):

• Formula: [(Cost - Salvage Value) / Total Estimated Lifetime Units] × Units Produced in Period
• Pattern: Depreciation expense varies directly with asset usage.
• Rationale: Best matching when asset wear is directly related to production volume.

Changes in Estimates: Changes in estimated useful life or salvage value are accounted for prospectively (affecting current and future periods), not retrospectively. The remaining undepreciated book value is depreciated over the revised remaining useful life.

Component Depreciation:

• IFRS: Requires entities to depreciate significant components of an asset with different useful lives separately.
• GAAP: Permitted but not required. If used, follows the same principle as IFRS.
• Example: Depreciating a building’s structure, roof, and HVAC system over their respective estimated lives.

Asset Impairment: Recognizing Value Declines

Long-lived assets (PPE and finite-life intangibles) must be tested for impairment whenever events or changes in circumstances indicate that their carrying amount may not be recoverable.

Impairment Testing Process (Assets Held for Use - GAAP):

Step 1: Recoverability Test

• Trigger: Indicators like significant decrease in market value, adverse change in asset’s use or physical condition, adverse legal factors or business climate change, cost overruns, history of operating losses associated with the asset.
• Comparison: Compare the asset’s Carrying Amount (Book Value) to the Sum of Undiscounted Expected Future Cash Flows generated by the asset.
• Result:
  • If Undiscounted Cash Flows ≥ Carrying Amount: No impairment loss recognized. Stop here.
  • If Undiscounted Cash Flows < Carrying Amount: Asset is not recoverable. Proceed to Step 2.

Step 2: Measurement of Impairment Loss

• Calculation: Impairment Loss = Carrying Amount - Fair Value of the Asset.
• Fair Value: Amount asset could be sold for in an orderly transaction between market participants (market price if available, present value of expected future cash flows using a discount rate, or other valuation techniques).
• Journal Entry: Dr. Impairment Loss / Cr. Accumulated Depreciation (or directly Cr. Asset).
• Subsequent Accounting: The reduced carrying amount becomes the new cost basis. Depreciation is calculated on the new basis over the remaining useful life. Reversal of impairment losses is prohibited under GAAP for assets held for use.

Impairment Testing (Assets Held for Sale):

• If management decides to sell an asset, it’s reclassified.
• Impairment Loss = Carrying Amount - (Fair Value - Costs to Sell).
• No depreciation is taken once classified as held for sale.
• Subsequent increases in (Fair Value - Costs to Sell) can be recognized as a gain, but only up to the cumulative impairment loss previously recognized.

IFRS Impairment:

• Uses a one-step test: Compare Carrying Amount to the Recoverable Amount.
• Recoverable Amount = Higher of (1) Fair Value less Costs to Sell or (2) Value in Use (present value of expected future cash flows).
• Impairment Loss = Carrying Amount - Recoverable Amount (if carrying amount > recoverable amount).
• Reversal of impairment losses is permitted under IFRS (except for goodwill) if the recoverable amount subsequently increases, up to the original carrying amount adjusted for depreciation.

Derecognition: Disposals and Exchanges

When PPE is sold, retired, or exchanged:

1. Update depreciation expense to the date of disposal.
2. Calculate the asset’s book value (Cost - Accumulated Depreciation).
3. Remove the asset’s cost and accumulated depreciation from the books.
4. Record cash or other assets received.
5. Recognize a gain or loss: Proceeds - Book Value.

Asset Exchanges (Nonmonetary Exchanges): Accounting depends on whether the exchange has commercial substance. An exchange has commercial substance if the entity’s future cash flows are expected to change significantly as a result of the transaction (considering risk, timing, and amount).

• Exchange Has Commercial Substance:
  • Recognize the acquired asset at its fair value.
  • Recognize gains and losses immediately (Fair Value of asset given up - Book Value of asset given up).
  • If fair value of asset received is more clearly determinable, use that; otherwise, use fair value of asset given up (plus/minus cash paid/received).
• Exchange Lacks Commercial Substance:
  • Losses: Recognized immediately.
  • Gains: Generally deferred. The acquired asset is recorded at the book value of the asset given up (plus/minus cash paid/received).
  • Partial Gain Recognition (Boot Received): If cash (boot) is received and represents ≤ 25% of the total consideration received, a proportional amount of the gain is recognized. Gain Recognized = Total Gain × [Cash Received / (Cash Received + Fair Value of Asset Received)]. If cash received > 25% of consideration, the entire gain is recognized (treat as having commercial substance).

Intangible Assets: Recognition, Amortization, Impairment

Intangible assets lack physical substance but represent legal or contractual rights providing future economic benefits.

Initial Recognition

• Purchased Intangibles: Capitalized at acquisition cost (purchase price plus legal fees, registration fees, etc.). If acquired in a basket purchase, allocate cost based on relative fair values. If acquired in a business combination, recognized at fair value.
• Internally Developed Intangibles: Costs generally expensed as incurred due to uncertainty about future benefits. Major exceptions:
  • Legal fees and costs associated with successfully defending a patent or trademark.
  • Registration or consulting fees.
  • Software development costs (see below).
  • Research and Development (R&D) Costs: Expensed as incurred under GAAP. IFRS requires capitalization of development costs once technical feasibility and intent to complete/use/sell are established (research costs still expensed).

Finite-Life Intangibles

Intangibles with a determinable useful life (e.g., patents, copyrights, customer lists with defined terms, franchise agreements) are:

• Amortized: Systematically allocated over their estimated useful life (shorter of legal life or economic life), typically using the straight-line method unless another pattern better reflects benefit consumption. Salvage value is usually assumed to be zero unless there’s a commitment from a third party to purchase or an active market exists.
• Impairment Tested: Subject to the same two-step impairment testing process as PPE when indicators of impairment exist.

Indefinite-Life Intangibles

Intangibles with no foreseeable limit on their useful life (e.g., trademarks, broadcast licenses, goodwill) are:

• Not Amortized: Their value is not consumed over a fixed period.
• Impairment Tested: Tested for impairment at least annually (or more frequently if indicators arise).
  • Optional Qualitative Assessment (“Step 0”): Assess if it’s more likely than not (>50% chance) that the fair value is less than the carrying amount. If yes, proceed to quantitative test. If no, no further testing needed for the period.
  • Quantitative Test (One-Step): Compare the intangible’s Fair Value to its Carrying Amount.
  • Impairment Loss: If Carrying Amount > Fair Value, recognize loss equal to the difference.
  • Reversal: Prohibited under GAAP. Permitted under IFRS (except for goodwill).

Goodwill

Goodwill arises only from a business combination and represents the excess of the consideration transferred (plus NCI fair value, plus previously held equity fair value) over the fair value of the identifiable net assets acquired.

• Not Amortized.
• Impairment Tested: Annually (or more frequently) at the Reporting Unit level (an operating segment or one level below).
  • Optional Qualitative Assessment: Same “Step 0” as indefinite-life intangibles, applied at the reporting unit level.
  • Quantitative Test: Compare the Fair Value of the Reporting Unit to its Carrying Amount (including goodwill).
  • Impairment Loss: If Carrying Amount > Fair Value, recognize impairment loss = Carrying Amount - Fair Value. The loss recognized cannot exceed the total carrying amount of goodwill allocated to that reporting unit.
  • Reversal: Prohibited under both GAAP and IFRS.

Specific Intangibles

• Patents: Legal life 20 years. Amortize over shorter of legal or useful life. Capitalize costs of successful defense; expense R&D leading to the patent.
• Copyrights: Legal life = life of creator + 70 years. Amortize over useful life.
• Trademarks/Tradenames: Legal life 10 years, renewable indefinitely. Typically treated as indefinite-life if renewal expected. Test for impairment annually.
• Franchise Agreements: Capitalize initial franchise fee. Amortize over franchise term if finite. Continuing fees expensed as incurred.
• Software Development Costs:
  • Costs before technological feasibility established -> Expense as R&D.
  • Costs after technological feasibility established but before product release -> Capitalize.
  • Costs after product release -> Expense (maintenance, training).
  • Amortization of capitalized costs: Greater of (1) Straight-line method or (2) Ratio of current revenue to total expected revenue.
  • Software for internal use: Capitalize costs during the application development stage; expense preliminary project and post-implementation costs. Amortize over useful life (straight-line).

Integrated GAAP vs. IFRS Asset Differences Summary

Conclusion: Strategic Importance of F2

Mastering the F2 section requires navigating a complex landscape of recognition, measurement, and valuation rules across diverse asset classes. The emphasis extends beyond mere calculation to understanding the underlying principles of matching, conservatism, and faithful representation. Candidates must demonstrate the ability to apply these rules in scenarios involving changing prices (inventory), long-term use and decline (PPE, intangibles), and uncertainty about collection (receivables). The frequent testing of impairment calculations and GAAP/IFRS differences highlights the practical importance of these topics. A strong foundation in F2 provides not only points on the exam but also essential knowledge for assessing an entity’s resources and operational capacity. The ability to synthesize information about cost capitalization, depreciation/amortization methods, and impairment triggers is fundamental to interpreting financial statements accurately.