Sometimes a task can seem so overwhelming that we simply don’t know where to start. Many CPA candidates feel that way about preparing for the financial accounting and reporting (FAR) test because this test covers so many topics. One way to plan your study time is to focus on these five FAR concepts– four topics and a study tip. If you understand these five steps, you’ll be able to correctly answer a large number of test questions.
A pension is defined as an employee benefit that provides an income stream to an employee when the worker retires. The benefit is based on years of service and the worker’s salary level shortly before retirement. CPA candidates struggle with these concepts because the pension accounting terms are vague.
The thing to visualize here is a bucket. The employer has to put pension contributions into the bucket, which earn a rate of return. When a worker retires and is paid a benefit, money comes out of the bucket in the form of a monthly pension payment. When you see a pension question, think about whether each term refers to money going into the bucket, or leaving the bucket. If the funds in the bucket are not sufficient to pay future benefits, the employer has a pension liability.
Bond accounting: buying a bond at a premium
I started my career in the investment business selling corporate and municipal bonds to investors, and I’ve noticed that accounting for bonds is not clearly explained to CPA candidates. The most common question: why would anyone buy a bond at a premium?
A premium means paying more than the face amount (par amount) of the bond, and bonds are sold in face amounts of $1,000. When the bond matures, you receive only the $1,000 face amount, so why would you pay more than $1,000? The answer is that the interest rate on the bond is higher than the current market rate for bonds with a similar credit rating and maturity.<
Say, for example, that you buy a $1,000 Microsoft corporate bond due in 20 years with an 8% interest rate. Bonds with a similar credit rating and maturity are currently being issued at 6%. It would make sense to pay more than $1,000 for the 8% bond, since you’ll earn more interest each year.
Inventory valuation methods
It doesn’t matter what method you use to value your inventory. In the end, the total number of units you purchase — and the total inventory cost — is the same using any method. The difference is in the timing.
The first in, first out (FIFO) method means that you sell the oldest units first. Since those are usually the cheapest, FIFO creates a lower cost of sales. LIFO means last in, first out. Selling the newest units first results in a higher cost of sales in the early years. In either case, the total inventory cost is the same.
Diluted earnings per share (EPS)
The basic EPS formula is (earnings available to common shareholders) / (common stock shares outstanding). Diluted earnings per share means that every security that can be converted into common stock is converted. Assuming that the total dollar amount of earnings is the same, more common stock shares outstanding decreases EPS. In other words, diluted EPS almost always less than regular EPS.
Index cards for formulas
I know it’s old school, but quiz yourself on FAR formulas by using index cards. They are still an effective way to digest a lot of information. Use this and the tips above to help you succeed on the FAR test.