Assets, Liabilities & Measurement

FAR tests this as a computation under a named method: the classic trap is double-declining balance, where you apply 2 × the straight-line rate to beginning-of-year net book value and ignore salvage until book value would fall below it (then stop at salvage). Watch for partial-year acquisitions (prorate) and for a change in estimate — revised life or salvage — applied prospectively: spread the remaining net book value over the remaining life; never restate prior years. A change in method is likewise handled prospectively as a change in estimate under ASC 250.

The tell separating this from its relatives: depreciation is the systematic, rational allocation that embodies the matching principle — it applies the principle, it is not the principle. Do not confuse it with impairment (ASC 360): an event-driven write-down of a held-and-used asset to fair value (only after it fails the recoverability test) that establishes a new cost basis; depreciation then continues on that lower base over the remaining life, with no reversal allowed. Land is never depreciated.

FAR loves a computational item that hands you the same purchase data and asks for ending inventory or COGS under FIFO, LIFO, and weighted average, so the “tell” is which layer you cost: FIFO ending inventory holds the newest costs, LIFO holds the oldest, and weighted average divides total cost of goods available by total units. The subtler trap is subsequent measurement under ASC 330: FIFO and weighted average write down to lower of cost or net realizable value (LCNRV) since ASU 2015-11, while LIFO and the retail method still use lower of cost or market (LCM) — where “market” is replacement cost, capped by a ceiling (NRV) and floored at NRV minus normal profit. Pick the wrong rule and the whole question fails.

Don’t confuse cost flow with physical flow, and remember the LIFO conformity rule (IRC §472): use LIFO for tax and you must report it on the books too. Memory hook: FIFO “First-In” keeps the Freshest costs in inventory, so in rising prices it inflates reported assets.

FAR loves to make you build an effective-interest amortization table: interest expense equals the carrying value times the market (yield) rate, while cash paid equals face times the stated rate, and the difference amortizes the discount or premium. The classic MCQ tell is being handed both rates plus a beginning carrying amount and asked for year-2 interest expense or the ending carrying value — the trap answer multiplies by the stated rate or uses face value instead of carrying value. Remember the direction: under a discount, carrying value and interest expense rise each period; under a premium, they fall, always converging toward face at maturity.

The classic confusion is method choice. GAAP requires the effective-interest method unless straight-line is not materially different; straight-line spreads the discount/premium evenly for constant expense (some older banks still drill it). Don’t confuse stated rate (the cash coupon) with market rate (expense), and report bonds payable net of unamortized discount/premium, not at face. Bond issuance costs reduce that carrying amount — not a separate asset.

FAR loves to make you classify the lease and then build the expense pattern, because that is where finance and operating diverge. The tell is any of the five ASC 842 finance-lease criteria—transfer of ownership, a reasonably-certain purchase option, term covering the major part of economic life, present value of payments at or above substantially all of fair value, or a specialized asset with no alternative use to the lessor. Meet none and it’s operating. Watch the split: a finance lease reports separate amortization plus interest (front-loaded total), an operating lease a single straight-line lease expense.

The classic trap is thinking operating leases are off-balance-sheet, the pre-842 world some older banks still echo; under current GAAP they aren’t. Don’t confuse the criteria with the old ASC 840 75%/90% bright lines—842 keeps those only as a non-mandatory benchmark for those two judgments. On the lessor side the same five tests apply: meet one and it’s sales-type; meet none but pass a collectibility-probable and a substantially-all PV check, and it’s direct-financing—otherwise operating.

FAR loves a calculation where book income is given and you must back into the provision: start with pretax book income, strip out permanent differences (municipal bond interest, fines, the dividends-received deduction) toward taxable income, then split the total into current versus deferred. The “tell” is a difference labeled as reversing in a future year. The high-yield rule: measure deferred balances using the enacted tax rate expected in the reversal period (not the current rate, and never a merely “proposed” rate), and run any rate-change effect entirely through continuing operations in the period that includes the enactment date.

The classic trap is direction. A future taxable amount (excess tax depreciation, installment receivables) builds a DTL, while a future deductible amount (warranty accruals, unearned revenue, NOL carryforwards) builds a DTA. Don’t confuse these with permanent items, which shift the effective tax rate but create zero deferred balance. Under current GAAP, deferred tax assets and liabilities are netted within each tax-paying jurisdiction and reported entirely as noncurrent (some older question banks still split current/noncurrent — that was eliminated by ASU 2015-17).

FAR tests this two ways. First, input classification: a fact pattern hands you a measurement technique and asks for the hierarchy level. The tell is whether the input is observable — a quoted price in an active market for the identical asset is Level 1; a quoted price for a similar asset, or an identical asset in an inactive market, drops to Level 2; an entity’s own internal cash-flow assumptions are Level 3. Second, which market: measure at the price in the principal market (greatest volume and activity for the item), and only when no principal market exists use the most advantageous market — and you do not deduct transaction costs from fair value (you weigh them only to identify which market is most advantageous).

The classic trap is confusing fair value with impairment mechanics: a long-lived asset held and used (ASC 360) first screens recoverability with undiscounted cash flows, but the write-down itself is measured to fair value. Another miss — for a nonfinancial asset, fair value assumes its highest and best use by market participants, not how the reporting entity actually uses or intends to use it.

FAR loves to feed you three numbers in one problem — carrying amount, undiscounted future cash flows, and fair value — and test whether you apply each in the right step. The tell is the two-step held-and-used model: Step 1 (recoverability) compares carrying amount only to the undiscounted cash flows; if carrying amount does not exceed them, you stop and recognize nothing. Only if it fails do you book Step 2, the loss equal to carrying amount minus fair value. The classic trap is discounting in Step 1 or skipping straight to fair value — discounting belongs in the fair-value (exit-price) measurement, never the trigger test.

Watch the related-term snares. Depreciation is systematic cost allocation, not a triggering event, though it resumes on the new, lower basis. Goodwill uses a one-step quantitative test at the reporting-unit level with no recoverability screen (post-ASU 2017-04, fair value vs carrying amount; the old Step 2 is gone). For held-for-sale assets, switch to lower of carrying amount or fair value less cost to sell, stop depreciating, and remember later recoveries can be recognized — but only up to the carrying amount at the date of reclassification, not original cost.

FAR loves the range-of-loss twist: when a loss is probable and only a range is estimable with no amount more likely than another, accrue the minimum (ASC 450-20), not the midpoint or maximum — the gap up to the high end is disclosed. The classic MCQ gives a $200,000–$500,000 lawsuit range and tests whether you book $200,000 (if a point in the range is the better estimate, accrue that instead). Watch the “tell” in the wording: probable plus can be reasonably estimated triggers accrual (debit loss, credit liability). The carve-out to remember is guarantees of others’ debt, which disclose even when loss is remote (under ASC 460).

The trap is treating a gain contingency symmetrically — you never accrue an expected lawsuit win, only disclose it once realization is assured. Don’t confuse the resulting accrued liability, a real obligation, with the broader balance sheet estimates it sits among. Separate this from subsequent events (ASC 855): a loss confirming a condition that existed at year-end adjusts the statements; one arising after is disclose-only.