SEC 1) Briefly explain the differences between state securities laws and federal securities litigation?

What was it necessary to pass federal securities laws? The Federal Securities Laws are comprised of a series of statutes, which in turn authorize a series of regulations promulgated by the government agency with general oversight responsibility for the securities industry, the Securities and Exchange Commission. The two main statutes involved in the Federal Securities laws are the The Securities Act of 1933 and the The Securities Exchange Act of 1934. Generally speaking, the '33 Act governs the issuance of securities by companies, and the '34 Act governs the trading, purchase and sale of those securities. Each has a wealth of regulations promulgated by the Securities and Exchange Commission, as well as regulations adopted by the National Association of Securities Dealers, Inc. and the various stock exchanges State Securities Laws While the SEC directly, and through its oversight of the NASD and the various Exchanges, is the main enforcer of the nation's securities laws, each individual state has its own securities regulatory body, typically known as the state Securities Commissioner. Each state has its own securities act, which governs, at least, the registration and reporting requirements for brokerdealers and stock brokers doing business, sometimes even indirectly, in the state. The various state securities regulators have most of their impact in the area of registration of securities brokers and dealers, and in the registration of securities transactions. State laws governing issuance and trading of securities are commonly referred to as blue sky laws. Compliance with federal securities laws (or exemption from compliance) does not imply compliance with or exemption of compliance from state securities laws; State law allows an official to judge the merits of an offering and could prohibit an offering if it is not fair, just, and equitable. 2) What are four elements of fraud? Generally speaking, a claim for [common law] fraud must include the following elements: (1) a false statement of material fact; (2) defendants knowledge that the statement was false; (3) defendants intent that the statement induce the plaintiff to act; (4) plaintiffs reliance upon the truth of the statement; and (5) plaintiffs damages resulting from reliance on the statement. 3) What is fraud by omission? When does a duty to speak (disclose) arise? A fraud claim based on intentional non-disclosure (i.e., omission), has the same elements as fraud, except that an omission is actionable as fraud only where there is an independent duty to disclose the omitted information. The duty to speak arises when one party has information that the other [party] is entitled to know because of a fiduciary or other similar relation of trust and confidence between them.

4) What is the basic difference between 1933 Securities Act and 1934 Securities and Exchange Act? When does each apply? Under which Act is litigation risk higher?

The Securities Act of 1933 (the 1933 Act): Applies any times new securities are sold to general public (like IPOs or seasoned equity offerings). Requires full and fair disclosure of the character of securities sold Securities must be registered with the SEC before they are offered to the public (prospectus). Securities Exchange Act of 1934 (the 1934 Act): Applies to the subsequent trading in outstanding securities that are listed on an exchange Provides for periodic filing of annual reports.

The Securities Act of 1933 legislation had two main goals: (1) to ensure more transparency in financial statements so investors can make informed decisions about investments, and (2) to establish laws against misrepresentation and fraudulent activities in the securities markets.

The Securities Exchange Act of 1934 was created to provide governance of securities transactions on the secondary market (after issue) and regulate the exchanges and broker-dealers in order to protect the investing public. 1933 Act applies to original issue of securities (initial public offering) where the 1934 Act applies to secondary trading. Most securities litigation concerns actions under the 1934 Act.

5) What is the purpose of Section 10b(5) of the 1934 Act? The rule prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security. It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading 6) What is fraud on the market? How does it to tie to the theory of market efficiency? Idea that stock prices are a function of all available information about the company, therefore misstatements defraud the entire market and impact the price of the stock. The Fraud-on-the-Market theory establishes a rebuttable presumption of reliance and satisfies transaction causation. Absence of loss causation is relevant to showing that either (1) the alleged misrepresentation was not material or (2) the market was not efficient, either of which can rebut the presumption.

*7) Which Divisions of the SEC deal with the accounting matters? What are the basic differences between those Divisions?

The Chief Accountant is the commissions chief accounting officer for all accounting and auditing matters. Chief Accountant advises the commission on accounting matters. But the ultimate power to establish the accounting rules lies with the SEC Commissioners. ? *8) How does filing review process of the Division of Corporation Finance influence the likelihood of restatements? -look in to red flags, and send a comment letter out and wait for a response. 9) How does the work of the Division of the Corporation Finance affect the work of the Division of Enforcement? Only the most egregious and obvious of these accounting errors lead to action by the Division of Enforcement. In the overwhelming majority of cases, the registrant restates its financial statements quietly after a challenge by the Division of Corporation Finance. Although further action by the Division of Enforcement may be considered, most often the staff decides that the investment of additional time and resources into the investigation and litigation of the accounting error is unlikely to accomplish significantly more than the comment process achieved already with the registrants restatement of its financial statements. 10) Who has the ultimate power to establish the accounting standards for public companies in the United States? How does it affect FASB? The ultimate authority for standard setting for public companies lies with the SEC. SEC prescribed business segment reporting before FASB Overruled FASB on issue of oil and gas accounting. SEC was the driving force behind adoption of fair value accounting 11) What is the nature of the relationship between SEC and PCAOB? Today, auditing standards for public companies are entirely within purview of Public Companies Accounting Oversight Board (PCAOB). The members of PCAOB are appointed by the SEC. Under the 2010 Supreme Court case, PCAOB members could be removed by the SEC at will. 12) What is the purpose of Regulation S-K? Standardizes non-financial disclosure requirements for documents to be filed with the SEC. 13) What is the purpose of Regulation S-X? It stipulates financial disclosure requirements under the Security Acts. It is the principal accounting regulation of the SEC, containing substantially all the requirements for financial statement, related footnotes, and supplemental financial schedules required under the SEC Acts. It presents a minimum standard of disclosure. Audited balance sheets for 2 most recent fiscal years, income statements and cash flow statements for 3 most recent years All notes to the financial statements and related financial statement supporting schedules. 14) What is the purpose of Regulation FD? Prohibits selective disclosure:

On August 15, 2000, the SEC adopted Regulation FD to address the selective disclosure of information by publicly traded companies and other issuers. Regulation FD provides that when an issuer discloses material nonpublic information to certain individuals or entitiesgenerally, securities market professionals, such as stock analysts, or holders of the issuer's securities who may well trade on the basis of the informationthe issuer must make public disclosure of that information. In this way, the new rule aims to promote the full and fair disclosure. 15) What is the purpose of Regulation G? Requires reconciliation of pro-forma disclosures to GAAP: For purposes of Regulation G, a non-GAAP financial measure is a numerical measure of a registrants historical or future financial performance, financial position or cash flow that: 1. Excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flow (or equivalent statements) of the issuer 2. Regulation G will not apply to a non-GAAP financial measure included in disclosure relating to a proposed business combination, the entity resulting therefrom or an entity that is a party thereof the disclosure is contained in a communication that is subject to the communications rules applicable to business combination transactions. *16) What is Staff Accounting Bulletin? What level of authority does it have? Staff Accounting Bulletins reflect the Commission staff's views regarding accounting-related disclosure practices. They represent interpretations and policies followed by the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the federal securities laws. Examples: SAB 101 (revenue recognition), SAB 99 (materiality). SEC has recently stopped issuing SABs and now all of its views are summarized in Corp Fin Financial Reporting Manual: Level E *17) What is the primary source of accounting guidance used by the Division of Corporation Finance? What is its relationship with Staff Accounting Bulletins? l Division of Corporation Finance: o Reviews both 33 and 34 Act Filings o Approximately 80% of Division employees involved in file reviews o As required by SOX, each SEC filer must be reviewed at least every 3 years o Initially performed by a first level examiner and then by a second level reviewer for consistency SAB represents interpretations and policies followed by the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the federal securities laws. 18) What is form S-1? What is its purpose? A document filed with the SEC explaining an initial public offering of securities. Form S-1 must contain a complete description of the security and the terms of the sale. It must also include

applicable information about the issuer's financial situation and applicable risk factors. This is done to protect investors from fraud. The Securities Exchange Act of 1933, often referred to as the "truth in securities" law, requires that these registration forms are filed to disclose important information upon registration of a company's securities. This helps the SEC achieve the objectives of this act, which is requiring investors to receive significant information regarding securities offered, and to prohibit fraud in the sale of the offered securities. 19) What types of companies are exempt from the registration requirements? Intrastate offerings: shares only sold to residents of the state in which an issuer is incorporated. No fixed limit exists on the size of offerings and number of purchasers. Private offering exemption to sophisticated investors (e.g. bank loans, private placements of securities with VC funds and institutional investors (e.g. Facebook) Small offering exemption (aka Regulation A short form offerings over one year amount is <$5 mln) Even if a security is exempt from registration, anti-fraud provisions of 1933 Act still apply, i.e. issuers are responsible for false or misleading statements, written or oral, in these offerings. Both civil or criminal redress is available. 20) What is form 10-K? 10-Q? 8-K? Proxy Statement? The federal securities laws require publicly traded companies to disclose information on an ongoing basis. For example, domestic issuers (other than small business issuers) must submit annual reports on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K for a number of specified events and must comply with a variety of other disclosure requirements. The annual report on Form 10-K provides a comprehensive overview of the company's business and financial condition and includes audited financial statements. Although similarly named, the annual report on Form 10-K is distinct from the annual report to shareholders, which a company must send to its shareholders when it holds an annual meeting to elect directors. Form 8-K: Each quarter, public companies file reports to the SEC containing unaudited financial statements and information about the company's operations in the previous three months. Proxy Statement: A document sent to shareholders letting them know when and where a shareholders meeting is taking place and detailing the matters to be voted upon at the meeting. You can attend the meeting and vote in person or cast a proxy vote.

*21) Give examples of some red flags that the SEC staff may use to generate its comment letters They looking for stuff inconsient earnings growth. (red flags ananlsysts use) SEC staff understands, based on comment letters and communications with industry representatives, that a number of investment advisers may not currently have identity theft red flags Programs. See Market Counsel Comment Letter; IAA Comment Letter. SEC staff also expects, based on Investment Adviser Registration Depository (IARD) data, that certain private fund advisers could potentially meet the definition of financial institution or creditor.

22) Give examples of some financial statement disclosure requirements in form S-1 (for example, three years of income statement data, etc.) l Audited income statement three years l Audited balance sheet two years l Statement of cash flows three years l Statement of stockholders equity three years 23) What could be the maximum age of financial statements for them to be eligible to be filed in form S-1? Most recent statements must be no older than 135 days before the S-1 effective date, e.g., September 30, 2011 interim information would be acceptable if effective on or before February 15, 2012. If effective after February 15, FY2012 would have to be audited. 24) What is incorporation by reference? Incorporation by reference is the act of including a second document within another document by only mentioning the second document.[1] this act, if properly done, makes the entire second document a part of the main document. Incorporation by reference is often done in creating laws as well as in contract law and trust and estate law. If financial statements are incorporated by reference into a registration statement, then stricter liability rules under 1933 Act apply. 25) What are top considerations in taking a company public? . Pros: . Diversification by the owner, Tax planning (liquidity of an estate), Liquidity, Broader access to sources of capital, Expansions through business combinations, Employee benefit plans/incentives, Higher market visibility . Cons: . Lack of operating confidentiality, Lack of business flexibility (loss of single authority) . Initial costs of offering. IPOs are expensive, Cost of public reporting, Insider trading restrictions on management, Possible loss of management control (threat of hostile takeovers), Pressure to meet short-term results (myopia) Fair Value Accounting (FVA) 1--10. . 1) What is the purpose of ASC 820-10 (SFAS 157)? Give examples of its scope (when it is applied). ASC 820-10 (formerly FAS 157) is a principles based standard which provides a framework for how to define/determine fair value when required or allowed by GAAP. ASC 820 defines how to determine fair value when its use is required or allowed. ASC 820 does not address when to apply or measure financial or non-financial assets or liabilities at fair value. When to use fair value is determined by specific standards (e.g. business combinations standard tells us to use fair value to estimate acquisitions goodwill) 2) Define price in the context of ASC 820-10. How is this definition different between assets and liabilities? What role does credit risk play in pricing liabilities? . ASC 820-10-35-3 states that the objective of a fair value measurement is to . determine the price that would be received to sell the asset or paid to transfer

. the liability at the measurement date (an exit price as opposed to entry or original transaction price paid to acquire an asset or a liability). . In many cases, the exit price and the transaction (or entry) price will be the same at initial recognition; . however, in some cases, the transaction price may not be representative of fair value. In those cases, a reporting entity may recognize an initial gain (or loss) upon applying ASC 820, even if the fair value measurement is based on a valuation model that uses significant unobservable inputs. . The initial (or Day One) gain or loss is the unrealized gain or loss resulting from the difference between the transaction price and the fair value (exit or transfer price) at initial recognition. . . 3) What is highest and best use? . After determining the unit of account, the reporting entity must assess the highest and best use for the asset, based on the perspective of a market participant. . The fair value of an asset is based on the use of the asset by market participants that would maximize its value. . The highest and best use for an asset must be determined based on the perspective of market participants, even if the reporting entity intends a different use. . Liabilities are valued based on the transfer of the liability to a market participant on the measurement date. However, reporting entities must still consider market participant assumptions relative to the transfer of the liability. 4) What is principal market? Most advantageous market? When do we use principal market valuation or most advantageous market valuation? . A principal market is the market in which the reporting entity regularly transacts with the highest volumes and level of activity. The principal market must be available to and accessible by the reporting entity. . If there is a principal market, fair value must be determined using prices in that market. . If there is no principal market, fair value is based on the price in the most advantageous market (the market which maximizes the amount that would be received for an asset or minimizes the amount that would be paid to transfer a liability). 5) What is valuation premise? In-use? In-exchange? . The valuation premise is established based on the highest and best use of the asset from the perspective of a market participant, which may be different from the reporting entitys intended use (e.g. market is willing to use property as a parking lot, while management wants to build a hotel). . In-exchange: The highest and best use of an asset is in-exchange if the asset would provide maximum value to market participants principally on a stand-alone basis. That may be the case for a financial asset that provides maximum value separate and apart from the other assets of the reporting entity. 6) Which areas does FVO exist for? . All entities may elect the fair value option for any of the following eligible items: . a. A recognized financial asset and financial liability, except as further noted.

. b. A firm commitment that would otherwise not be recognized at inception and that involves only financial instruments (for example, a forward purchase contract for a loan that is not readily convertible to cash that commitment involves only financial instruments a loan and cash and would not otherwise be recognized because it is not a derivative instrument). . c. A written loan commitment. . d. The rights and obligations under an insurance contract that has both of the following characteristics: . 1. The insurance contract is not a financial instrument (because it requires or permits the insurer to provide goods or services rather than a cash settlement). . 2. The insurance contracts terms permit the insurer to settle by paying a third party to provide those goods or services. . e. The rights and obligations under a warranty that has both of the following characteristics: . 1. The warranty is not a financial instrument (because it requires or permits the warrantor to provide goods or services rather than a cash settlement). . 2. The warrantys terms permit the warrantor to settle by paying a third party to provide those goods or services. . f. A host financial instrument resulting from the separation of an embedded nonfinancial derivative instrument from a nonfinancial hybrid instrument under paragraph 815-15-251, subject to the scope exceptions listed below (for example, an instrument in which the value of the bifurcated embedded derivative is payable in cash, services, or merchandise but the debt host is payable only in cash). 7) How can FVO be applied? . The financial instruments guidance in ASC 825-10 permits reporting entities to apply the FVO on an instrument-by-instrument basis. . Therefore, a reporting entity can elect the FVO for certain instruments but not others within a group of similar items (e.g., for some available-for-sale securities but not for others). . However, if the FVO is not elected for all eligible instruments within a group of similar instruments, the reporting entity is required to disclose the reasons for its partial election. . In addition, the reporting entity must disclose the amounts to which it applied the FVO and the amounts to which it did not apply the FVO within that group. . A financial instrument that represents a single contract may not be further separated into parts for purposes of electing the FVO. However, a loan syndication arrangement may result in multiple loans issued to the same borrower. Under ASC 825-10, each of those loans is a separate instrument, and the FVO may be elected for some loans but not others. 8) What are the market approach, the income approach, and the cost approach to FV? The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets, liabilities or a group of assets and liabilities. The income approach converts future amounts for example cash flows or income and expenses to a single current (i.e. discounted) amount. When the income approach is used, the fair value measurement reflects current market expectations about those future amounts; The cost approach reflects the amount that would be required currently to replace the service capacity of an asset (often referred to as current replacement cost).

9) Describe FV Hierarchy . Fair Value Hierarchydefines which fair value to pick. We always want to try to use the best (lowest) possible level (i.e. Level 1 is better to use than Level 2, etc.) . Level 1: Active Markets Valuations . Level 2: Observable Inputs other than prices . Level 3: Includes unobservable inputs (such as entitys own assumptions about cash flows, risk, etc.) 10) What are observable and non-observable inputs? . Observable inputs are based on data observable from the outside. Examples are: Prices or quotes from exchanges or listed markets Proxy observable market data that is proven to be highly correlated and has a logical, economic relationship with the instrument that is being valued (e.g., electricity prices in two different locations, or zones that are highly correlated); and Other direct and indirect market inputs that are observable in the marketplace. . Unobservable inputs come from inside the entity, i.e. represent entitys own data or assumptions on valuation inputs. *11) If you needed to name one main characteristic distinguishing between Level 1 and Level III characteristics, what would it be? Observable & unobservable Observable inputs are based on data observable from the outside. Unobservable inputs come from inside the entity, i.e. represent entitys own data or assumptions on valuation inputs. *12) What disclosures are needed for level 1, 2, and 3 securities? What specific additional disclosures are needed for level 3 securities? Disclosures under ASC 820 The extent (scope) to which a reporting entity measures assets and liabilities at fair value; The valuation techniques and inputs used to measure fair value; and the effect of fair value measurements on earnings. The required quantitative disclosures for recurring measurements in tabular format. In addition, qualitative disclosures about the valuation techniques and inputs used to measure fair value are required in all interim and annual periods. ASC 820s disclosure requirements vary depending on whether the asset or liability is measured on a recurring or nonrecurring basis and the classification of the fair value measurement within the fair value hierarchy. Disclosures recurring measurement The fair value measurement at the reporting date. The level that a measurement falls within the fair value hierarchy, segregated between Level 1, Level 2 and Level 3 measurements by class of assets or liabilities. The amounts of significant transfers between Level 1 and Level 2 and the reasons for the transfers. Significant transfers into each level shall be disclosed separately from transfers out of each level. For Level 3 fair value measurements

A reconciliation of the beginning and ending balances, separately presenting changes during the period attributable to any of the following: Total gains or losses for the period (realized and unrealized), separately presenting gains or losses included in earnings (or changes in net assets) and gains or losses recognized in other comprehensive income. A description of where those gains or losses included in earnings (or changes in net assets) are reported in the statement of income or in other comprehensive income. Purchases, sales, issuances, and settlements (each type disclosed separately) For the disclosure of gains or losses for Level 3 measurements, the amount of the total gains or losses for the period in included in earnings relating to those assets and liabilities still held at the reporting date and a description of where those unrealized gains or losses are reported in the statement of income. For Level 2 and Level 3 fair value measurements, a description of the valuation technique and the inputs used in determining the fair values of each class of assets or liabilities. If there has been a change in the valuation technique that change shall be disclosed as well as the reason for making it. Disclosures non-recurring measurement Fair value measurements recorded during the period and the reasons for the measurements. The level within the fair value hierarchy in which the fair value measurements in their entirety fall. Transfers in and/or out of Level 3 and the reasons for those transfers Significant transfers into Level 3 shall be disclosed separately from significant transfers out of Level 3 For fair value measurements using significant other observable inputs (Level 2) and significant unobservable inputs (Level 3), a description of the valuation techniques and the inputs. In addition, a reporting entity should discuss changes, if any, in the valuation techniques used to measure similar assets and/or liabilities in prior periods, including the reasons for changes, in both interim and annual financial statements. 13) Give examples of level 1, 2, and 3 securities which we covered in our cases. Level 1 assets and liabilities have observable fair market values that are published on a major exchange. Examples include active, exchanged-traded equity securities, exchange listed derivatives, certain government securities, some sovereign government obligations, etc. Level 2 assets and liabilities are those whose fair market value cannot be retrieved from a major exchange, but can be calculated from other observable data points. Level 2 asset values can be based on quotes from inactive markets or on values generated from a specific pricing model. Examples include:1) restricted stocks that have quoted prices on inactive markets, 2) corporate and municipal bonds (which are rarely traded) that have quoted prices, 3) assets whose pricing models have observable inputs like interest rate and currency swaps, and 4) certain residential and commercial mortgage related assets, loans, securities, and derivatives that have observable market values Level 3 assets are those whose fair value cannot be determined via observable measures. They are commonly illiquid, and have values that can only be assessed using estimates or riskadjusted value ranges. Level 3 assets have valuation models whose primary inputs are unobservable; for example, certain private equity investments, some residential and commercial

mortgage related assets, long-dated or complex derivatives, etc. Valuation of these (generally illiquid) assets is typically based on market expectations and assumptions. The underlying premise of these categories is the extent to which the inputs into the valuation models are observable -- the more observable the data, the more reliable the valuation. Thus, the value of a Level 1 asset is considered to be more reliable than the valuation of a level 3 asset, for example. In theory, stock valuation should now be easier and more reliable because publically traded companies are required to classify each of their assets as Level 1, 2, or 3. 14) How does non-performance risk affect valuation of liabilities? In accordance with ASC 820, the fair value of a liability is based on the price to transfer the obligation to a market participant at the measurement date. ASC 820-10-35-16 states: A fair value measurement assumes both of the following: o The liability is transferred to a market participant at the measurement date (the liability to the counterparty continues; it is not settled). o The nonperformance risk relating to that liability is the same before and after its transfer. The effect of nonperformance risk may differ depending on the liability, e.g. whether the liability is an obligation to deliver cash (a financial liability) or an obligation to deliver goods or services (a non-financial liability), and the terms of credit enhancements related to the liability, if any, e.g. a pledge of assets against default. The fair value of a liability would reflect the effect of non-performance risk on the basis of its unit of account. Therefore, the issuer of a liability does not include the effect of an inseparable third-party credit enhancement in the liabilitys fair value measurement if it accounts separately for the liability and the credit enhancement. Consequently, the fair value of the liability reflects the effect of non-performance risk based on the issuers own credit standing. 15) If markets become inactive (or not orderly), how does it affect FV reporting? What consequences does it have for fair value hierarchy classification? If a reporting entity concludes there has been a significant decrease in the volume and level of activity for an asset or liability, the reporting entity should perform further analysis of the transactions or quoted prices observed in that market. Further analysis is required because the transactions or quoted prices may not be determinative of fair value and significant adjustments may be necessary when using the information in estimating fair value. When the market for a financial instrument is inactive, observed market prices might not always be appropriate as the basis for determining fair value. Transaction prices in inactive markets may be inputs when measuring fair value, but would likely not be determinative. In such circumstances, fair value is estimated based on the results of a valuation technique that makes maximum use of inputs observed from markets, and relies as little as possible on inputs generated by the entity. The overriding objective of any valuation technique is to estimate what the market price of the instrument would have been at the balance sheet date in an arms length transaction motivated by normal business considerations. Regardless of the valuation technique used, that technique should not ignore relevant information and should reflect appropriate risk adjustments that market participants would make for credit and liquidity risks. The inactive markets and distressed transactions guidance applies to all assets and liabilities within the scope of pronouncements that require or permit fair value measurements under ASC

820. The guidance does not apply to Level 1 inputs, regardless of changes in the volume and level of activity for an asset or liability. Level 1inputs are defined in ASC 820 as quoted prices for an identical asset or liability in an active market. 16) What is a CDS? What is a CDO? What role did they play in the recent financial crisis? Two major credit derivatives that played a role in the financial crisis were Credit Default Swaps (CDS) and Collateralized Debt Obligations (CDO). CDS is akin to mortgage insurance you may have to buy when you get a house. When a lender buys a CDS he pays an insurance premium to the seller of CDS to buy protection in case a borrower defaults. If a borrower defaults, a seller of the CDS has to cover the lenders losses. The price of the CDS depends on the notional amount of the debt. Hence, CDS is a credit derivative (on a liability side of the balance sheet) and has to be carried at fair value by the CDSs seller. Just like with any insurance, as long as the number of defaults is low, the sellers of CDS make profit between the premiums they collect and the costs of defaults they have to cover. As long as the defaults are not massive, selling CDSs is a potentially very profitable proposition. What was the CDSs role in major defaults during the recent crisis? AIG was one of the largest CDSs sellers. When massive defaults on the subprime debt started, AIG was obliged to cover those losses. Because losses were so massive, AIG did not have the ability to cover them, and hence had to be bailed out by the government. AIG did not properly price their CDSs because they did not have good information on the likelihood of massive defaults. Hence, any cash they collected from CDSs premiums was not sufficient to cover massive losses. This is in part due to failure to correctly apply fair value to potentially highly risky subprime debt. AIG also did not correctly fair valued expected liabilities associated with future CDS payouts on their balance sheets. Otherwise, the market would have price protected AIG stock, and stockholders would not have lost as much. There could be two types of CDOs: Cash CDO and Synthetic CDO. Cash CDO Lender sells her loans to a special purpose vehicle (SPV). SPV then issues debt notes in various tranches: senior (highest rated, mezzanine and equity (lowest rating)). SPV invests the proceeds from this sale into the low risk investments. Original borrowers repay their loans to the SPV. Simultaneously SPV repays her obligations to the holders of various tranches. SPV makes money on the spread between subprime loans and interest it pays on her own notes. The ability of SPV to repay the notes is driven by her ability to collect on the subprime debt. If a bank maintains material recourse or repurchase obligations on the assets it transfers to SPV, it is not a sale, but rather a borrowing transaction requiring a liability with fair value on the banks balance sheet. If original subprime debt is not correctly valued by the holders of CDOs notes (i.e. risk premium was too low), then CDOs notes are majorly overvalued. Plenty of evidence suggests that bad information played a role in massive original over-valuation of CDOs. Contributors to this original over-valuation: o No docs loans o Manipulation of FICO scores to gain more favorable credit rating on CDOs debt. o Assumption of indefinite price increases in housing market o Low required collateral on houses. o Credit rating agencies gave highly optimistic ratings to CDOs debt.

Synthetic CDO The biggest difference between cash CDO and a synthetic CDO is that the original bank lender does not sell assets to the SPV, but rather SPV sells a CDS to the originating bank. Simultaneously SPV issues notes and makes money on the difference between CDS premia it collects and interest it has to pay on the notes. Same issues that pertain to cash CDO still pertain to synthetic CDO. Bad information on the underlying loans increases a chance that an originating bank that bought a CDS will require compensation. Massive CDS defaults will lead to eventual default of the CDO and losses to holders of the CDOs notes. 17) What concerns does PCAOB have when it comes to fair value reporting? The PCAOB is gathering its Standing Advisory Group to discuss the work undertaken so far by its Pricing Sources Task Force, formed to study how auditors audit the fair value of financial instruments when those instruments are not actively traded and how third-party pricing sources are used in the valuation and audit. The task force has so far studied a variety of issues related to financial instrument valuation, including the nature and extent of information pricing sources provide to issuers and auditors, the processes and controls over information gathered from pricing sources, and the auditor's procedures related to that information. Third-party pricing sources could include any number of sources from outside the company where companies might gather and rely on data to build a case for the fair value of an instrument that is not actively traded, and therefore not readily priced by the market. The task force has determined that a service organization audit at the pricing source could help assure controls over the pricing information, but auditors would still need their own audit evidence to support the fair value of financial instruments. 18) Describe goodwill impairment testing rules under IFRS and US GAAP. How are they different? The differences in U.S. GAAP and IFRSs goodwill impairment treatment flow largely from a fundamental difference in accounting approaches. As a principles-based accounting approach, IFRSs provide a conceptual basis for accountants to follow in a one-step test that has both a fair value and an asset-recoverability aspect. U.S. GAAP, on the other hand, dictates that goodwill is tested for impairment through a two-step, fair value test with the level of impairment, if present, determined in Step 2 after an extensive analysis of related asset values. However, the FASBs recent issuance of a step zero qualitative assessment for goodwill impairment testing did introduce an element of a principles-based approach under U.S. GAAP. Principles-based standards allow accountants to apply significant professional judgment in assessing a transaction. This is substantially different from the underlying box-ticking approach historically common in rules-based accounting standards. The lack of precise guidelines in a principles-based approach may create inconsistencies in the application of standards across organizations and countries, particularly in a very subjective area such as fair value. On the other hand, rules-based standards can be viewed as insufficiently flexible to accommodate a topic such as fair value, which often requires significant professional judgments gained through experience, with extremely limited market data.

19) Describe goodwill quantitative assessment option under recently passed US GAAP changes. What consequences does it have? Prior to 2012, companies were required to perform a quantitative assessment. In 2011 the FASB revised the requirements for annual Goodwill impairment testing to allow companies the annual option to assess qualitative factors to determine whether it is necessary to perform the quantitative two-step Goodwill impairment test. According to FASB ASC 350-20-35-3C, in performing the qualitative assessment, companies should consider the totality of relevant events and circumstances that suggest it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after evaluating the totality of the events and circumstances, a company determines that is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then no further evaluation is needed. The goodwill is not considered impaired. If, however, a company determines that it is it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the company is required to proceed through the two-step impairment test. The first part of the two-step Goodwill impairment test is to examine whether a given reporting unit is impaired. If it is not, then the company can cease testing after the first step. If it is, then the second part of the test is designed to identify whether the impairment pertains to the Goodwill asset that has been allocated to that reporting unit or to its other components (i.e., the identifiable net tangible and intangible assets). (dont need)20) What is acquisition method? How do we measure goodwill under acquisition method? Be able to do a numerical example, like we did on the quiz. The acquisition method of accounting takes into account two forms of accounting -acquisition accounting and merger accounting. In this form, any acquisition by a company, whether it be in terms of brick-and-mortar or monetary assets, must be accounted for at fair value. A fair value is defined as a rational estimate of an asset's current worth. In this method, the difference between the purchase price and the fair value price needs to be accounted for in the "goodwill" section of the balance sheet. Identify the acquirer Determine acquisition date Identify/measure assets acquired/liabilities assumed Recognize any goodwill. Any negative goodwill (bargain purchase) needs to be recognized as an acquisition gain. International Convergence 1) What is the goal of international convergence? Why is it done? The FASB believes that, over time, the ultimate goal of convergence is the development of a unified set of high-quality, international accounting standards that companies worldwide would use for both domestic and cross-border financial reporting. 2) How would you describe the current status of international convergence process? What are some key projects currently under consideration? During the past ten years, the FASB and IASB collaborated through joint projects to develop common standards. The FASB has issued those standards as U.S. GAAP and the IASB has issued them as IFRS. Over time, the two sets of standards are expected to both improve in

quality and become increasingly similar, if not identical. The four remaining joint projects are: revenue recognition; financial instruments; leases; and insurance. 3) What is -F reconciliation, and what kind of firms have been exempt from filing it? How did this exemption affect US firms cross-listed in the EU? A form issued by the Securities and Exchange Commission (SEC) that must be submitted by all "foreign private issuers" that have listed equity shares on exchanges in the United States. Form 20-F calls for the submission of an annual report within six months of the end of the company's fiscal year, or if the fiscal year-end date changes There are four types of form 20-F filings. A foreign company need to file Form 20-F to get registered with the SEC. A foreign company can issue its annual report using Form 20-F. If a company changes its fiscal year, it will also need to file a Form 20-F. Finally, if a company operated as a shell company, it needs to file a Form 20-F with the SEC. 2007 SEC removed 20-F reconciliation requirement for the Foreign Private Issuers that report under IFRS. EU passed a similar waiver of reconciliation to EU reporting rules in 2008. 4. What are some key convergence sticking points? Error Correction (US GAAP requires retroactive restatements; IFRS does not when not practical) ; LIFO: no LIFO under IFRS is allowed. Reversal of impairments. Not allowed under US GAAP. Allowed under IFRS. PP&E re-valuation. Not allowed under US GAAP. Component depreciation. Required under IFRS; allowed under US GAAP. Development Costs. Must be expensed under US GAAP. Can be capitalized under IFRS under certain conditions. -US doesnt have to reconcile if the follow with gap *5. What is the SEC doing with respect to adopting IFRS? SECs plan: Work Plan addresses the following areas: Sufficient development and application of IFRS for the US domestic reporting system; The independence of standard setting for the benefit of investors; Investor understanding and education regarding IFRS Examination of the US regulatory environment that would be affected by a change in the accounting standards; The impact on issuers, both large and small; Human capital readiness Work plan considers: The comprehensiveness of IFRS The auditability and enforceability of IFRS The comparability of IFRS financial statements within and across jurisdictions What is SEC doing?: Constituent outreach Research into experience of regulators in other jurisdictions Review of financial statements prepared under IFRS 6. What is condorsement Condorsement: Convergence and Endorsement of IFRS standards

The frameworks objective is to converge IFRS into U.S. GAAP through a FASB led transition process so that U.S. issuers eventually could assert that they are also in compliance with IFRS as issued by the IASB. The framework is essentially an endorsement approach, differing versions of which have been used by most countries with established capital markets. The FASB would change U.S. GAAP over a defined period by endorsing, and thereby incorporating, individual IFRSs into U.S. GAAP. 7. What are some key factors that the SEC is concerned with in its Progress Report on the Adoption of IFRS (e.g. auditability, comprehensiveness and comparability of IFRS) The comprehensiveness of IFRS SEC is inventorying areas in which IFRS does not provide guidance or where it provides less guidance than US GAAP Analyzing how issuers, auditors and investors currently manage these situations in practice; Identifying areas in which issuers, auditors, and investors would most benefit from additional IFRS guidance. The auditability and enforceability of IFRS SEC is in process of analyzing: Audit and regulatory challenges in the audit of financial statements prepared under IFRS and enforcement of IFRS Trends in error corrections and accounting-related enforcement actions How auditors, private security litigators and regulators manage these challenges in practice. The comparability of IFRS financial statements within and across jurisdictions SEC is in process of analyzing: Factors that influence the degree of comparability of financial statements prepared under IFRS Assessing the extent to which financial statements prepared under IFRS may not be comparable in practice and how investors manage these situations Identifying ways to improve the comparability of financial statements prepared under IFRS on a cross-border basis to provide the most benefit to investors 8. What kind of IFRS did EU adopt? Does it mean that all EU firms financial statements are automatically accepted in the US without 20-F reconciliation? EU endorses the IFRS: Variation in this approach: (1) full adoption of IFRS; (2) translation to local language; (3) make modifications to address country-specific issues. A newly issued IFRS must go through multiple steps before it becomes authoritative in EU. Only those IFRSs that are adopted by the EU need to be applied. For example, EU decided to carve out IAS 39 for certain entities This means that certain standards may be adopted in the US but not in the EU, and may require 20-F reconciliation to be accepted. 9. Based on reading Hail et al. (2010) paper and our discussion in class, are there clear benefits of adopting IFRS in the US? What kind of jurisdictions are more likely to benefit from the IFRS adoption? The benefit of a better Financial reporting standard is unclear. There are positive effects: Improved liquidity and cost of capital

Higher comparability of financial statement numbers Positive externalities to the other firms (information transfers) positive effects of improved financial reporting standards depend on whether in fact financial reporting standards positively affect overall information environment and transparency of information. *10. What is the current US GAAP revenue recognition principle? Give both short and longer formulation? SFAC 5: revenue is recognized when two conditions are met: the revenue is both realized or realizable and earned. 11. Under the proposed new revenue recognition standard, briefly explain how this principle will change? New Standard: Revenue is recognized when an entity satisfies its obligation to its customers, which occurs when a control of asset (or good or service) transfers to a customer The new statement seems to have more of a balance sheet flavor, whereas the old statement centers on revenue and expense flow. But do these statements differ in their guidance? Both statements deal somewhat vaguely with the nature of recognition, but one can argue that in no substantive sense do they differ. And in the absence of any reference to measurement, it is clear that much more is needed if one wants to prescribe an accounting that goes beyond broad generalities. 12. What is the possible effect of the new standard on the contracts with multiple deliverables? Long-term construction contracts? Long-term service contracts? Multiple deliverables arrangements? The proposed standard will be a significant shift in how revenue is recognized in many circumstances. The effect could be considerable, requiring management to perform a comprehensive review of existing contracts, business models, company practices, and accounting policies. The proposed standard could also have broad implications for an entity's processes and controls. Changes in the timing or amount of revenue recognized may affect long-term compensation arrangements, debt covenants, and key financial ratios. Revenue recognition process of multi-deliverable contracts will become following: Identify contracts, Identify separate performance obligations (e.g. when one obligation is conditional on the other, or prices are contingent, then it is one obligation), Determine transaction price, Allocate transaction price to individual performance obligations, Recognize revenue when seller satisfies performance obligation. Long-term construction contracts: No more percentage of completion method. It is all based on transfer of control now, not on managerial completion estimates Long-term service contracts: For long-term contracts, need to consider time value of money. Non-cash consideration has to be considered at fair value. If no fair value is available, then use standalone price of goods and services transferred for consideration. Multiple deliverable arrangements: The residual method of allocation of arrangement considerations will no longer be permitted. *13. How does the new proposed standard affect revenue recognition with the right of return? Warranties? Customers with higher than normal credit risk?

Right of Return: Revenue will no longer be recognized for units expected to be returned. Liability for expected refunds needs to be recognized Warranties: If a customer has an option to buy a warranty separately, it is a separate performance obligation; revenue should be allocated separately related to such a warranty contract If no separate purchase warranty option exists, a cost accrual for warranty is appropriate (warranty reserve) unless the warranty provides a service to the customer beyond assurance that the entitys performance was as specified in the original contract. Customers with higher than normal credit risks: Transaction price needs to be adjusted for consideration of credit risk. Collectability is no longer a criteria for revenue recognition, and hence revenue can be recognized earlier. *14. What is multiple deliverable arrangement? Why is it important? Definition: Product and service sales are negotiated at the same time with a single customer, resulting in a single contractually binding arrangement with multiple deliverables. Why is this important: This arrangement presents a challenging revenue recognition question: under accrual accounting, how should revenue be measured and assigned to components of the sale? Old standards lead to inconsistency and incomparability for such arrangements. 15) What is vendor specific objective evidence (VSOE)? Where is it used? Vendor specific objective evidence is used in revenue recognition concerning software sales, which requires the seller to establish vendor-specific objective evidence (VSOE) of fair value for each separate product or service promised under a single contract. Software vendors typically bundle products and services such as the software license, installation, training services, and postcontract customer support (PCS) under a single contract. A vendor is required to determine VSOE of fair value for each product or service in order to recognize partial revenue before the entire contract is fulfilled. If a vendor cannot establish VSOE of fair value, it may have to defer recognizing all revenue until the last element in the contract is delivered. IFRS vs. US GAAP 1) What are the requirements of first time adoption of IFRS? (e.g. retroactive balance sheet,etc) if an entity adopts IFRSs for the year ended 31 December 2009, it must apply all IFRSs effective at that date retrospectively to the 2009 and 2008 reporting periods, and to the opening statement of financial position on 1 January 2008 (assuming only one year of comparative information is provided). Effectively, this general principle would result in full retrospective application of IFRSs as if they had been the framework for an entitys accounting since its inception. However, IFRS 1 adapts this general principle of retrospective application by adding a limited number of very important exceptions and exemptions. An entitys first IFRS financial statements should include at least three statements of financial position (including one at the date of transition, i.e. at the beginning of the comparative period), two statements of comprehensive income, two income statements (if presented), two statements of cash flows and two statements of changes in equity. All of these statements must be in compliance with IFRSs. 1.recognition of all assets and liabilities whose recognition is required by IFRSs; 2. derecognition of items as assets or liabilities if IFRSs do not permit such recognition;

3. reclassify items that a company recognised in accordance with previous GAAP as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity in accordance with IFRSs; and 4, apply IFRSs in measuring all recognised assets and liabilities. ***All adjustments resulting from the application of IFRSs to the opening IFRS statement of financial position are recognised in retained earnings (or, if appropriate, another category of equity) at the date of transition, except for reclassifications between goodwill and intangible assets. 2) What are mandatory exemptions to the retroactive restatements under initial adoption of IFRS? Accounting estimates Accounting estimates required under IFRSs that were made under previous GAAP may not be adjusted on transition except to reflect differences in accounting policies or unless there is objective evidence that the estimates were in error. The primary objective of this exception is to prevent entities using the benefit of hindsight to adjust estimates based on circumstances and information which were not available when the amounts were originally estimated under previous GAAP. When restating previous GAAP amounts for the purpose of its opening IFRS statement of financial position, an entity may have information available that was not available at the time the estimate was made. This information is treated as non-adjusting (i.e. the amounts recognised are not adjusted). Derecognition of financial assets and financial liabilities A first-time adopter is required to apply the derecognition rules in IAS 39 Financial Instruments Recognition and Measurement prospectively from 1 January 2004 unless it chooses to apply the derecognition rules of IAS 39 retrospectively from a date of its choosing (see below). Therefore, if a first-time adopter derecognised non-derivative financial assets or non-derivative financial liabilities under its previous GAAP in a securitisation, transfer or similar derecognition transaction that occurred before 1 January 2004, it does not recognise those financial assets and liabilities at the date of transition (even if they would not have qualified for derecognition under IAS 39) unless they qualify for recognition as a result of a later transaction or event. Notwithstanding the requirement to apply IAS 39s rules on derecognition prospectively from 1 January 2004, an entity may opt to apply them retrospectively from a date of its own choosing, provided that the information needed to apply IAS 39 to financial assets and financial liabilities derecognised as a result of past transactions was obtained at the time of the initial accounting for those transactions. Hedge accounting Under IAS 39, a hedging relationship only qualifies for hedge accounting if a number of restrictive criteria are satisfied, including appropriate designation and documentation of effectiveness at inception of the hedge and subsequently. A hedging relationship will only qualify for hedge accounting at the date of transition if the hedging relationship has been fully designated and documented as effective in accordance with IAS 39 on or before the date of transition and is of a type that qualifies for hedge accounting under IAS 39. Designation of a hedging relationship cannot be made retrospectively. For a first-time adopter, this may be a significant change from previous GAAP which may not have required such rigorous hedge designation and documentation. Hedge accounting under IAS 39, and therefore on first-time adoption, can be applied prospectively only from the date that the hedge

relationship is fully designated and documented subject to all other hedge accounting requirements of IAS 39 being met. However, if an entity designated a net position as a hedged item under previous GAAP, it may designate an individual item within that net position as a hedged item, provided that the designation is made by the date of transition. Hedging relationships that were designated as hedges under previous GAAP, but which do not qualify for hedge accounting under IAS 39, are treated in accordance with the requirements of IAS 39 relating to the discontinuation of hedge accounting. Under previous GAAP, gains and losses on a cash flow hedge of a forecast transaction may have been deferred in equity. If, at the date of transition, the transaction is still highly probable and the hedging relationship was designated appropriately and documented as effective, hedge accounting may be continued in accordance with IAS 39. If the forecast transaction is not highly probable, but is still expected to occur, the entire deferred gain or loss remains in equity until the forecast transaction occurs. Non-controlling interests This exception applies for entities that have adopted the 2008 amendments to IFRS 3 Business Combinations and IAS 27 Consolidated and Separate Financial Statements. These amendments introduced new measurement requirements for non-controlling interests (previously described as minority interests) and a new mandatory exception to IFRS 1. The exception stipulates that a first-time adopter should apply the following requirements of IAS 27(2008) prospectively from the date of transition to IFRSs: the requirement that total comprehensive income be attributed to the owners of the parent and to the non-controlling interests even if this results in the non-controlling interests having a deficit balance; the requirements regarding the accounting for changes in the parents ownership interest in a subsidiary that do not result in a loss of control;and the requirements regarding the accounting for a loss of control over a subsidiary, and the related requirements in paragraph 8A of IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. 3) What is the difference between US GAAP revenue recognition principle and IFRS revenue recognition principle? GAAP: Generally, the guidance focuses on revenue being (1) either realized or realizable and (2) earned. Revenue recognition is considered to involve an exchange transaction; that is, revenue should not be recognized until an exchange transaction has occurred. beyond this standard, there are often detailed rules depending on the industry (ie. software revenue recognition). IFRS: Two primary revenue standards (IAS 18 Revenue and IAS 11 Construction Contract) capture all revenue transactions within one of four broad categories: Sale of goods Rendering of services Others use of an entitys assets (yielding interest, royalties, etc.) Construction contracts Revenue recognition criteria for each of these categories include the probability that the economic benefits associated with the transaction will flow to the entity and that the revenue and costs can be measured reliably. Additional recognition criteria apply within each broad category. The principles laid out within each of the categories are generally to be applied without significant further rules and/or exceptions. The concept of VSOE of fair value does not exist

under IFRS, thereby resulting in more elements likely meeting the separation criteria under IFRS. Although the price that is regularly charged by an entity when an item is sold separately is the best evidence of the items fair value, IFRS acknowledges that reasonable estimates of fair value (such as cost plus a reasonable margin) may, in certain circumstances, be acceptable alternatives. 4) What are the differences between US GAAP and IFRS with respect to long-term service contracts? Long-term construction contracts? Long-term service contracts GAAP: (cost-to-cost method is prohibited) Generally, companies would apply the proportional-performance model or the completed-performance model. Revenue is recognized based on a discernible pattern and, if none exists, then the straight-line approach may be appropriate. Revenue is deferred if a service transaction cannot be measured reliably. IFRS: (cost-to-cost method is allowed) IFRS requires that service transactions be accounted for by reference to the stage of completion of the transaction (the percentage-of-completion method). The stage of completion may be determined by a variety of methods, including the cost-to-cost method. Revenue may be recognized on a straight-line basis if the services are performed by an indeterminate number of acts over a specified period and no other method better represents the stage of completion. When the outcome of a service transaction cannot be measured reliably, revenue may be recognized to the extent of recoverable expenses incurred. That is, a zero-profit model would be utilized, as opposed to a completed-performance model. If the outcome of the transaction is so uncertain that recovery of costs is not probable, revenue would need to be deferred until a more accurate estimate could be made. Long-term construction contracts Completed Contract Method: prohibited under IFRS but allowed under GAAP is a readily estimate of percentage completion cannot be made Percentage-of-completion method: Within the percentage-of-completion model there are two acceptable approaches: the revenue approach and the gross-profit approach. IFRS utilizes a revenue approach to percentage of completion. When the final outcome cannot be estimated reliably, a zero-profit method is used (wherein revenue is recognized to the extent of costs incurred if those costs are expected to be recovered). The gross-profit approach is not allowed under IFRS. Combining and segmenting contracts: GAAP: Combining and segmenting contracts is permitted, provided certain criteria are met, but it is not required so long as the underlying economics of the transaction are reflected fairly. IFRS: required when certain criteria are met. 5) Give examples of differences in accounting for assets (e.g. assets revaluations,LIFO, etc.) Issues: Assets revaluations allowed under IFRS, and not allowed under US GAAP Differences in criteria for impairment testing for long-lived assets Capitalization of development costs Differences in criteria for impairment of intangibles with indefinite lives Differences in inventory accounting (LIFO is prohibited in IFRS) Differences in lease capitalization rules (IFRS is more principles-based).

6) How does one account for impairment of long-lived assets under US GAAP? IFRS? GAAP: INTANGIBLES, An impairment loss is recognized for the amount by which the carrying amount of the asset exceeds its FV. Option to first assess qualitative factors to determine whether it is necessary to estimate the FV of an asset. By electing this option you only have to estimate if MLTN the asset is impaired. ASSETS HELD AND USED, Impairment recognized when CV is greater than both undiscounted cash flows (Recoverability test) and FV. IFRS: An impairment loss is recognized for the amount by which the carrying value of the asset exceeds its recoverable amount. The recoverable amount is the greater of: (a) the fair value less costs to sell and (b) the value in use (i.e. the PV of future cash flows expected to be derived from the asset). Impairment recognized for this difference. 7) How does one account for impairment of acquisition goodwill under US GAAP? IFRS? GAAP: MLTN test can be performed to see if reporting unit (including goodwill) carrying value exceeds FV, then (1) if CV of reporting unit is >FV and if (2) CV of goodwill is > implied FV. Then, impairment loss recognized for difference to the extent that goodwill exists. IFRS: when the CV of a cash generating unit (including goodwill) is > recoverable amount, impairment loss recognized for the difference to the extent that goodwill exists. definition of recoverable amount is same as above. 8) What are basic differences in accounting for leases between IFRS and US GAAP? GAAP: Applies only to PPE. The guidance contains four specific criteria for determining whether a lease should be classified as an operating lease or a capital lease by a lessee. The criteria for capital lease classification broadly address the following matters: Ownership transfer of the property to the lessee Bargain purchase option Lease term in relation to economic life of the asset Present value of minimum lease payments in relation to fair value of the leased asset The criteria contain certain specific quantified thresholds such as whether the present value of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased property. IFRS: Goes beyond PPE. The guidance focuses on the overall substance of the transaction. Lease classification as an operating lease or a finance lease (i.e., the equivalent of a capital lease under US GAAP) depends on whether the lease transfers substantially all of the risks and rewards of ownership to the lessee. Although similar lease classification criteria identified in US GAAP are considered in the classification of a lease under IFRS, there are no quantitative breakpoints or bright lines to apply (e.g., 90 percent). A lease of special-purpose assets that only the lessee can use without major modification generally would be classified as a finance lease. This also would be the case for any lease that does not subject the lessor to significant risk with respect to the residual value of the leased property. Importantly, there are no incremental criteria for a lessor to consider in classifying a lease under IFRS. Accordingly, lease classification by the lessor and the lessee typically should be symmetrical. 9) What is other than temporary impairment of Available for Sale Securities under US GAAP? How does such an impairment work under IFRS?

GAAP: a significant or prolonged decline in the fair value of an investment below its cost management must assess whether (a) it has the intent to see the security or (b) it is MLTN that it will be required to see the security prior to its anticipated recovery. Then see if the ability to recover cost basis in investment exists. Under ASC 320-10-35, an OTTI has occurred: the entity intends to sell the security it is MLTN the entity will be required to sell before recovery of securities amortized cost basis the entity does not expect to recover the entire amortized cost basis of the security. compare PV of cash flows expected to be collected to amortized cost basis. impair excess. Under IFRS, the concept of OTTI does not exist and either a significant or prolonged decline in fair value is considered objective evidence of impairment. 10) How does US GAAP generally treat reversal of impairment charges? How is it different under IFRS? GAAP: Long-lived assets: The reversal of impairments is prohibited. Debt and Securities: Impairments of loans held for investment measured under ASC 310-10-35 and ASC 450 are permitted to be reversed; however, the carrying amount of the loan can at no time exceed the recorded investment in the loan. One-time reversals of impairment losses for debt securities classified as available-for-sale or held-to-maturity securities, however, are prohibited. Rather, any expected recoveries in future cash flows are reflected as a prospective yield adjustment. IFRS: Long-Lived Assets: If certain criteria are met, the reversal of impairments, other than those of goodwill, is permitted. Debt and Securities: For financial assets carried at amortized cost, if in a subsequent period the amount of impairment loss decreases and the decrease can be objectively associated with an event occurring after the impairment was recognized, the previously recognized impairment loss is reversed. The reversal, however, does not exceed what the amortized cost would have been had the impairment not been recognized. For available-for-sale debt instruments, if in a subsequent period the fair value of the debt instrument increases and the increase can be objectively related to an event occurring after the loss was recognized, the loss may be reversed through the income statement. Reversals of impairments on equity investments through profit or loss are prohibited. 11) What are the differences in accounting for contingent liabilities/provisions between IFRS and US GAAP? GAAP: A loss must be probable (in which probable is interpreted as likely) to be recognized. While ASC 450 does not ascribe a percentage to probable, it is intended to denote a high likelihood (e.g.,70% or more). Provisions may be discounted only when the amount of the liability and the timing of the payments are fixed or reliably determinable, or when the obligation is a fair value obligation (e.g., an asset retirement obligation under ASC410-20). The discount rate to be used is dependent upon the nature of the provision, and may vary from that used under IFRS. However, when a provision is measured at fair value, the time value of money and the risks specific to the liability should be considered.

In the event a range of measurements exist, Most likely outcome within range should be accrued. When no one outcome is more likely than the others, the minimum amount in the range of outcomes should be accrued. In regards to restructuring costs, Under ASC420, once management has committed to a detailed exit plan, each type of cost is examined to determine when recognized. Involuntary employee termination costs under a one-time benefit arrangement are recognized over future service period, or immediately if there is no future service required. Other exit costs are expensed when incurred. IFRS: A loss must be probable (in which probable is interpreted as MLTN) to be recognized. More likely than not refers to a probability of greater than 50%. Provisions should be recorded at the estimated amount to settle or transfer the obligation taking into consideration the time value of money. The discount rate to be used should be a pre-tax rate (or rates) that reflect(s) current market assessments of the time value of money and the risks specific to the liability. In the event a range of measurements exist, Best estimate of obligation should be accrued. For a large population of items being measured, such as warranty costs, best estimate is typically expected value, although midpoint in the range may also be used when any point in a continuous range is as likely as another. Best estimate for a single obligation may be the most likely outcome, although other possible outcomes should still be considered. In regards to restructuring costs, Once management has demonstrably committed (i.e., a legal or constructive obligation has been incurred) to a detailed exit plan, the general provisions of IAS 37 apply. Costs typically are recognized earlier than under US GAAP because IAS 37 focuses on the exit plan as a whole, rather than individual cost components of the plan. 12) What are the differences in accounting for restructuring provisions between IFRS and US GAAP? IFRS IFRS: A provision for restructuring costs is recognized if an entity has a present obligation. Present obligation exists when a company is demonstrably committed to restructuring, i.e. an entity has a legal or a constructive obligation. A constructive obligation exists if an entity has a formal plan to restructure, this plan has been announced to those affected, or an entity cannot withdraw from the plan if it already started implementing it. An entity must be demonstrably committed to the plan. Unusual delays to the implementation fail this condition. Liabilities related to voluntary termination benefits are recorded when the offer is made and is measured on the basis of the number of employees expected to accept the offer. US GAAP Guidance prohibits recognition of restructuring provisions based solely on a commitment to a restructuring plan. Recognition of a provision for one-time termination benefits requires communication of details of the plan to the employees that could be affected. This communication should have sufficient details with respect to employee termination benefits (i.e. type, amount, etc.). In case of a pre-existing understanding between employers and employees as to payments as a result of involuntary termination, liability is accrued is both payment is probable and amount can be reasonably determined.

 Inducements to voluntary terminations are to be recognized when (1) employees accept offers and (2) amounts can be estimated.

Hence, IFRS is likely to record restructuring liabilities more often, since the threshold of recognition is lower. 13) What are the differences in accounting for debt refinancing arrangements between IFRS and US GAAP? IFRS Such re-classification is only allowed if refinancing occurs before balance sheet date (more strict). US GAAP Entities can reclassify current debt as non-current if a binding agreement to refinance or refinancing occurs before the financial statements are issued. 14) What are the differences in Income Statement /Statement of Comprehensive Income Presentation between IFRS and US GAAP? IFRS All items can be shown either in (1) single statement of comprehensive income or in (2) two different statements (income statement and comprehensive income statement) Expenses can be presented by either function or nature. No prescribed format of comprehensive income statement exists. US GAAP Either single step income statement (all expenses are grouped by function) or multiple steps income statement (separate operating and non-operating components). SEC requires that all expenses be separated by their function. Depreciation expense could be shown separately, but in this case COGS should have a caption exclusive of depreciation. Three levels of format can be utilized: (1) combined income and comprehensive income statement (2) separate income and comprehensive income statements (3) separate category in the statement of changes in shareholders equity. 15) What are the differences in Balance Sheet Presentation between IFRS and US GAAP? US GAAP: Offsetting (netting of assets and liabilities) is not allowed unless right of setoff exists. Right of setoff: a debtors legal right to discharge the debt to the other party by applying the debt the other party owes debtor (e.g. offsetting of APs with ARs) FRS: similar right of setoff requirement is present. It is also required that the entity must intend to settle either on the net basis or to realize an asset and settle the liability simultaneously. Thus, this is stricter than US GAAP. 16) What are the differences in Statement of Cash Flow Presentation between IFRS and US GAAP? Statement of Cash Flows: Classification differences

Transaction

US GAAP

IFRS Classification

Classification Interest Received Dividends Received Interest Paid Dividends Paid Income Taxes Operating Operating Operating Financing Operating Operating or Investing Operating or Investing Financing or Operating Financing or Operating Operating unless specifically associated with financing or investing activity

(*CAN WE GET RID of above chart?) Statement of Cash Flows: Other differences IFRS includes cash over-drafts into cash balances, while US GAAP does not. US GAAP classified changes in bank overdrafts into financing cash flows. IFRS: short-term borrowings changes are classified into financing cash flows. IFRS requires disclosure of dividends/interest received/paid and taxes paid. IFRS allows both direct and indirect methods. 17) What are the differences in Shareholders Equity Statement Presentation between IFRS and US GAAP? IFRS Presented as a Primary statement US GAAP Can be presented either as a primary statement or in the footnotes to the financial statements. FIN 48 1) What is the purpose of FIN 48? What kind of guidance relevant to Uncertain Tax Positions existed prior to adoption of FIN 48? The goal of FIN 48 is to reduce inconsistencies in approaches to recognizing, measuring and presenting income taxes in financial statements. To accomplish this, FIN 48 establishes consistent criteria that an individual tax position must satisfy in order for any of the benefit of that position to be recognized in the entitys financial statements. Before FIN 48, accounting for uncertain tax positions was governed by SFAS No. 5, Accounting for Contingencies. FIN 48 replaces SFAS No. 5 with respect to the accounting for all tax positions, not just uncertain tax positions. FIN 48 applies to all entities that prepare GAAP financial statements. 2) What is more likely than not (MLTN) threshold under ASC 740? FIN 48 addresses the recognition and measurement of income tax positions using a more-likelythan-not (MLTN) threshold. The MLTN threshold means that:

. A benefit related to an uncertain tax position may not be recognized in the financial statements unless it is MLTN that the position will be is sustained based on its technical merits; and . There must be more than a 50 percent likelihood that the position would be sustained if challenged and considered by the highest court in the relevant jurisdiction. 3) What is the difference between highly certain and uncertain tax position? Highly certain tax position A tax position is considered sufficiently certain so that no reserve was required, and does not need to be reported on Schedule UTP, if the position is highly certain within the meaning of FIN 48. Uncertain tax position In accounting, a situation in which a taxpayer believes its interpretation of earnings recognition is less strong than what the interpretation of the IRS is likely to be. It needs to be reported under FIN 48. 4) What is unit of account and how does it relate to MLTN threshold? A unit of account can be thought of as the base unit for an entitys UTP methodology or as the item that the entity determines to be the tax position to be evaluated. In practice, a unit of account could be an entire tax computation, individual uncertain positions, or a group of related uncertain positions (i.e., all positions in a particular tax jurisdiction, or all positions of a similar nature or relating to the same interpretation of tax legislation). It is important that an accounting policy for a unit of account is established in order to determine which positions the entitys UTP methodology will be applied to. This will also aid in the consistency and comparability of an entitys UTP and any changes from one accounting period to another. For uncertain tax positions, an entity must make a key decision in developing any methodology as to whether to adopt a one step approach or a two step approach to the recognition and measurement of uncertain tax positions. The MLTN threshold is the first step in the recognition of uncertain tax positions. 5) Explain cumulative probability approach to recognition of UTPs. How does it relate the amount of UTP that can be recognized? . The following example, based upon Appendix A of FIN 48, illustrates the concept of measuring the cumulative probability of occurring. . Assume a tax position has the following distribution pattern of possible benefit outcomes:

Possible Benefit Outcome $100 (complete success in litigation, or settlement with IRS) 80 (very favorable compromise)

Percentage Probability of Successful Outcome 10% 20%

Cumulative Percentage Probability of Success 10% 30%

60 (Fair compromise) 40 (Unfavorable compromise) 0 (total loss)

25% 30% 15%

55% 85% 100%

In this example, $60 is the amount of tax benefit that would be recognized in the financial statements, because it represents the largest cumulative amount of benefit that is more than 50 percent likely to reflect the ultimate outcome. QUALIFIED VS. UNQUALIFIED STOCK OPTIONS 1) Describe tax implications of accounting for qualified vs. unqualified stock options. Non-qualified Qualified Non Qualified Stock Option: Tax consequences for recipient include No tax at the time of grant. The recipient receives ordinary income (or loss) upon exercise, equal to the difference between the grant price and the FMV of the stock at date of exercise.. Tax Consequences for the As long as the company fulfills withholding obligations, it can deduct the costs incurred as operating expense. This cost is equal to the ordinary income declared by the recipient. Company include Qualified Stock options: Tax consequences for recipient include No tax at the time of grant or at exercise. Capital gain (or loss) tax upon sale of stock if employee holds stock for at least 1 year after exercising the option.. Tax consequences for the company include non deductions avaible to the company. Tax consequences (recipient): No tax at the time of grant. The recipient receives ordinary income (or loss) upon exercise, equal to the difference between the grant price and the FMV of the stock at date of exercise. As long as the company fulfills withholding obligations, it can deduct the costs incurred as operating expense. This cost is equal to the ordinary income declared by the recipient. No tax at the time of grant or at exercise. Capital gain (or loss) tax upon sale of stock if employee holds stock for at least 1 year after exercising the option. No deductions available to the company.

Tax consequences (company):

-add something about level 2 swaps